VC Bootcamp By DFJ Gotham Ventures and Wilson Sonsini Goodrich & Rosati

VENTURE CAPITAL BOOT CAMP June 3, 2009 Internet Week New York

Thank You!

Who is DFJ Gotham Ventures? Founding Date
Est. 1999
Focus Sectors
Digital Media
Financial Technologies
E-Commerce
Mobile Technologies
Network Infrastructure
Early Stage
First institutional round
Nominal or no revenue
Demonstrable technology
Global Presence
Leverage DFJ Network
Danny Schultz Mark Davis Ross Goldstein Thatcher Bell

Powerful and Growing DFJ Network 23 funds, >$6 billion in capital 150 professionals, 600 portfolio companies Unique access, insight and deal flow

MarkPeterDavis.com
VC Overview
Developing A Fundraising Strategy
Picking The VCs
Preparing Your Materials
The Pre-Fundraising Process
Getting The Meeting
The First Meeting
After The First Meeting
The Due Diligence Phase
Doing The Deal
CHAPTERS

Who is Wilson Sonsini Goodrich & Rosati?
Premier provider of value-added legal services to growth business enterprises worldwide, as well as the public and private capital markets that finance them
Represent multi-billion dollar global enterprises as well as venture-backed start-up companies
Our track record:
Represent more companies that receive venture financing than any other law firm
Advise more U.S. companies on their initial public offerings than any other law firm
Represent more technology companies in mergers and acquisitions than any other U.S. law firm
Advise more than 300 public and 3,000 private enterprises on issues of corporate law, securities, and corporate governance
Most frequently hired securities litigation firm in the country*
Over 100 patent infringement lawsuits successfully litigated throughout the U.S. over the last five years

WSGR Business Model

Founded in 1961
Approximately 650 attorneys
San Francisco Palo Alto San Diego Seattle Austin New York D.C. Shanghai WSGR Footprint = Wilson Sonsini Goodrich & Rosati offices

Select WSGR Clients

Agenda
What is VC?
Is VC Right for You?
Forming the VC Backed Company
Engaging with the VC
The Term Sheet
More Q&A

What is VC?

VCs Make Investments in Startups

VCs Backed by Institutional Limited Partners
Endowments
Insurance companies
Pension funds
Banks
Fund of funds
Family offices
High net worth

Limited Partners Require Risk-Adjusted Returns

Returns are Generated Through Exits: M&A or IPO

Is VC Right for You?

Is Your Company “Fundable” by a VC?
Strong management team
Large and growing market
Viable model
Competitive advantage/ barriers
Realistic exit opportunities

“ Great for entrepreneurs to own 80%, not great for investors to own 20%”

Build standalone companies, exit along the way

Other Sources of Risk Capital

Why is VC helpful?

Capital

Action Plan & Attack

Connections

Credibility

Governance

It’s a Marriage…

Reach for the Big Win

Shared Control – Shared Destiny

Forming the VC Backed Company

Form of Legal Entity
Sole proprietorship
Partnership
Limited partnership
Limited liability company
Corporation

The Corporation: Advantages
“ Separate legal entity”
Perpetual life
Separation of ownership from management
Fringe benefits (incentive stock options)
Familiarity
Limited liability
Limited liability can be lost (“piercing the corporate veil”)
Failure to observe corporate formalities
Commingling of assets and affairs
Undercapitalization
Deception
Personal guarantees

The Corporation: Disadvantages
Separate tax payer – the “double tax”
LLCs, S-corps and partnerships avoid the double tax, but have other limitations
No stock options
Limits type/number of stockholders
Legal complexities; higher legal costs
No IPOs

Things to Consider When Incorporating
Timing
Jurisdiction of incorporation
Board of Directors and Board of Advisors
Stock issuance to founders
Vesting; acceleration
Rights of first refusal/co-sale
Consideration to be paid/tax implications
Assignment of IP
Nominal cash payment

Engaging the VC

Getting the Meeting Mutual Contact LinkedIn Cold Email Spam Most Effective Least Effective Direct Introduction

What is the objective of the first meeting?

Cross Chasm from Pitch to Conversation

What’s After the First Meeting? The Due Diligence Phase Meet The Team Company Materials Experts References Facilitate proactively!

Presentation Materials
Executive Summary
PowerPoint presentation
Financial projections
Get the meeting Create interest Explain how

What Should be Included in an Executive Summary?
Geographic location
Mission statement
Product overview & pain point
Addressable market
Competitive landscape
Barriers to entry
Achievements to date
Projections
Capital needs & use of capital
Team bios
1-2 Page Executive Summary

Explain what your company does (in plain English)

Why is this needed? Why now?

Market Size Addressable Market

Why are you better than your competition?

Be thoughtful about barriers

Being the first mover is not a barrier, it’s an opportunity to create barriers

Common Barriers Scale Customer Captivity Information Technology IT Barriers

Don’t forget the jockey

What Should be Included in a Presentation?
Geographic location
Mission statement
Addressable market
Barriers to entry
Projections
Team bios
15-20 Slide Presentation How

Answer First: Start with an Investment Overview Slide
Geographic location
Mission statement
Addressable market
Barriers to entry
Projections
Team bios
How
Based in New York Seeking to revolutionize… Customers lose $X per year $X billion addressable market Unique tech = better service Strong network effect barrier Live & generating revenue Projections: $XXXM in X years Seek: $X-XM for new market Thought leaders, 3 rd startup Detailed strategy

Describe your place in the ecosystem

Describe the path to success

Don’t forget the jockey

Be Ready with Back-Up Materials
Market background
Technology background
Risk assessment
References
Potential industry/other experts
Other diligence materials

Identify the Right VC

Embrace Pinball Effect

Summary
Get in the door
Have a clear, simple pitch
Back it up with detailed strategy and tactics
Describe the path to success
Convince us that you are the one

The Term Sheet

Principles of Valuation
Valuation: how much the company is “worth”
Pre-money valuation
Post-money valuation
Valuation is the #1 issue in the negotiation between the founder and the investor
Valuation influenced by market conditions and competition for the deal, amongst other factors

The Employee Option Pool
What is an option and an option pool?
The reserve amount is typically based on anticipated headcount growth
This time horizon is usually about as far as the CEO and the investors can reasonably foresee the future
The reserve amount is usually assessed and replenished with each financing

Typical Option Grants
A very general rule of thumb for a “mid-stage” technology start-up (i.e., post-Series A)
The median range for option pools is around 15-25% for early stage companies, depending on their headcount requirements.
Position No. of Ees % of Capital Aggregate Equity CEO (1): 5 - 10% 7% CFO (1): 1 - 2% 1% VPs (2): 1 - 3% 8% Dir - level (6): < 1/2% 3% Others (?): < 1/4% 6% Total 25%

Startup Company Valuation Model Example – Incorporation
Founders A and B each purchase 2,000,000 shares of common stock at a purchase price of $0.001 per share
Person # Shares % of Shares Value A 2,000,000 50% $2,000 B 2,000,000 50% $2,000 Total 4,000,000 100% $4,000

Startup Company Valuation Model Example – Establishment of Option Plan
In order to attract employees, the company establishes an option plan and reserves 1,000,000 shares for issuance under the plan
Person # Shares % of Shares Value A 2,000,000 40% $2,000 B 2,000,000 40% $2,000 Option plan 1,000,000 20% $1,000 Total 5,000,000 100% $5,000

Startup Company Valuation Model Example – Initial Financing Round
The company completes a $4,000,000 venture capital financing round of Series A Preferred Stock at a purchase price of $1.00 per share, representing a $6,000,000 pre-money valuation. Option pool is increased to reflect 20% of the fully diluted capitalization.
Person # Shares % of Shares Value A 2,000,000 20% $2,000,000 B 2,000,000 20% $2,000,000 Option plan 2,000,000 20% $2,000,000 Series A 4,000,000 40% $4,000,000 Total 10,000,000 100% $10,000,000

Startup Company Valuation Model Example – Series B Financing Round
The company completes a $10,000,000 Series B financing at a $30,000,000 pre-money valuation, at a purchase price of $2.75 per share. The option pool is set at 20% post financing.
Person # Shares % of Shares Value A 2,000,000 13.75% $5,500,000 B 2,000,000 13.75% $5,500,000 Option plan 2,909,090 20% $8,000,000 Series A 4,000,000 27.5% $11,000,000 Series B 3,636,363 25% $10,000,000 Total 14,545,454 100% $40,000,000

Typical Dilution Metrics Financing stage Amount Raised Dilution Seed – develop beta product, develop plan $50k - $1m 15-30% A – complete initial product, build initial team $1m-$5m 40-60% B – bring product to market, complete team $5m-$15m 25-35% C – expand sales and marketing, working capital for liquidity event $10m-$25m <20%

Seed Financing Through Bridge Notes
In seed round financings, the first investment is frequently done as a convertible bridge loan
WSGR Entrepreneurs Report : 41% of seed financings were completed through the issuance of convertible bridge notes
One clear advantage of bridge note financing: no need to set valuation for the company
Bridge loan terms
Principal and interest automatically convert into the Series A Preferred
Will typically include warrant coverage in 10-30% range -or- a discount to the Series A Preferred price on conversion in the same range
Frequently provide for a cap or floor on conversion price

Preferred Stock Term Sheet
Preferred stock
Valuation/option pool
Liquidation preference
Dividends
Conversion features
Antidilution protection (stock splits, price-based)
Voting rights
Board composition
Redemption
Registration rights
ROFR/Co-sale
Preemptive rights
Pay to play
Founder/employee vesting
Non-competes
Exclusivity
Expenses
Confidentiality

Two class stock structure
Preferred and common stock
Common stock is generally used for compensatory purposes (i.e., as a form of payment to employees, board members, consultants, advisors and other service providers) and issued to founders at incorporation
Preferred stock is generally used for investment purposes and has many more rights, preferences and privileges than common stock
Common stock is typically “priced” at a lower price than preferred stock (i.e., for option granting purposes)

Liquidation Preference
Investors get a “Liquidation Preference” in the event of a liquidity event of the company
“ Liquidity events” include M&A transactions
A typical liquidation preference would provide the investors their money back before any other stockholders receive any proceeds
A “participating” liquidation preference entitles investors to their money back, plus the right to participate in the remaining amounts
Caps are often negotiated

Liquidation Preference Example of Fully Participating Preferred (assumes $100m sale price and $25m invested) Shares % o/s Liquidation preference Payment of remainder Total proceeds A 3,500,000 23.33% $3,000,000 $17,500,000 $20,500,000 B 4,000,000 26.66% $7,000,000 $20,000,000 $27,000,000 C 3,000,000 20.00% $15,000,000 $15,000,000 $30,000,000 Common (founders) 2,500,000 16.66% N/A $12,500,000 $12,500,000 Option pool 2,000,000 13.33% N/A $10,000,000 $10,000,000 Total 15,000,000 100.00% $25,000,000 $75,000,000 $100,000,000

Dividends
Accruing/non-accruing
Compounding/non-compounding
Payable on specified dates/payable “if, as and when” declared
Participating/non-participating

Conversion
Preferred stock convertible into common stock at option of holder, initially on one for one basis
Automatically convert upon an IPO
Typically size of deal and share price must exceed certain levels
Automatically convert upon the vote of the particular series

Antidilution protection
Conversion rate adjusts on certain events
Proportionate in the event of stock splits
Price based antidilution upon a “down round” financing
Weighted average protection: Conversion price is adjusted based on a formula that considers the number of new shares being issued compared to the shares outstanding and the price at which the new shares are issued
Full ratchet protection: Conversion price is adjusted so that the price per share is reset to the price per share in the new financing, regardless of the number of shares issued and the price at which they are issued.
Provide for appropriate carveouts to antidilution protection (i.e., for option issuances, strategic warrants, etc.)

Board composition/Voting rights
Companies are controlled by the board of directors
Control over the board means control over the company
Typical board composition post Series A investment is two founders, two Series A investor representatives and one industry expert/independent
Even if board approves, “protective provisions” require preferred holders to approve certain events, including:
Change of control transactions
Amendments to charter/bylaws
Hiring/firing senior management
Issuing senior securities
Increasing size of the option pool
Incurring debt

Other terms
Redemption
Registration rights
ROFR/Co-Sale
Preemptive rights
Last but not least, legal expenses!

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VC Bootcamp By DFJ Gotham Ventures and Wilson Sonsini Goodrich & Rosati

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