Tacoma Angel Network Angel Investing Essentials October 10, 2006 Susan Preston Entrepreneur-in-Residence Ewing Marion Kauffman Foundation AND Director of Attorney Training and Professional Development Davis Wright Tremaine

Financing Life Cycle Financing Idea Pre-seed Funding Seed Funding Expansion/Mezzanine Operating Cap. Friends and Family Angels Seed Funds Venture Funds Founder Institutional Equity Loans / Bonds Product Dev Angel Groups Start-up Funding Government Grants/Loans Discovery Proof-of Concept Product Design Product Development Manufacturing/ Delivery

Venture Capital Statistics: Investments in US 2005 – invested $21.7 billion (2,939 deals) 2004 – invested $20.9 billion (2,876 deals) 2003 – invested $18.9 billion Increase due largely to late stage investments: $9.7 billion in 2005 $7.2 billion in 2004 $4.9 billion in 2003 Less than 2% in early/seed stage Source: NVCA

2005 – invested $21.7 billion (2,939 deals)

2004 – invested $20.9 billion (2,876 deals)

2003 – invested $18.9 billion

Increase due largely to late stage investments:

$9.7 billion in 2005

$7.2 billion in 2004

$4.9 billion in 2003

Less than 2% in early/seed stage

Source: NVCA

Venture Capital Investments by Stage of Development ($s in Millions) Source: MoneyTree

Venture Capital Investment: Historical and 2006 Projected Source: MoneyTree

Average VC Deal Size Per Financing Round ($ Million) Source: NVCA

US Angel Investments 2005 – invested $23.1 billion (49,500 deals) Increase of 2.7% in $’s over 2004 Increase of 3.1% in deals over 2004 2004 – invested $22.5 billion (48,000 deals) 2003 – invested $18.1 billion 227,000 active angels 20% Healthcare/medical devices and equipment 18% Software 55% in seed/start-up 43% in post-seed/start-up (10% increase over 2004) Source: Center for Venture Research

2005 – invested $23.1 billion (49,500 deals)

Increase of 2.7% in $’s over 2004

Increase of 3.1% in deals over 2004

2004 – invested $22.5 billion (48,000 deals)

2003 – invested $18.1 billion

227,000 active angels

20% Healthcare/medical devices and equipment

18% Software

55% in seed/start-up

43% in post-seed/start-up (10% increase over 2004)

Who Are Angels? Angels are accredited investors who: Expect a financial return Believe in giving back to their communities Invest locally and regionally Participate in the investment process Show interest in personal relationships with companies and employees Offer wisdom and guidance to entrepreneurs

Angels are accredited investors who:

Expect a financial return

Believe in giving back to their communities

Invest locally and regionally

Participate in the investment process

Show interest in personal relationships with companies and employees

Offer wisdom and guidance to entrepreneurs

Financial Attributes of Angels Provide early-stage investment dollars Invest smaller dollar amounts per investment Partially fill funding gap left by venture capitalists (VCs) Invest individual wealth Can tolerate loss of entire investment Have diversified portfolios Invest with “patient money”

Provide early-stage investment dollars

Invest smaller dollar amounts per investment

Partially fill funding gap left by venture capitalists (VCs)

Invest individual wealth

Can tolerate loss of entire investment

Have diversified portfolios

Invest with “patient money”

Support for Angel Organizations Angel Capital Education Foundation 501c3 public charity Education: Summits & meetings Workshops & webinars Research: Group investment data Research reports that benefit general public Public awareness Angel Capital Association 501c6 trade association Membership organization Professional standards Members’ only Web site Member networking Industry tools Awareness campaigns Advocacy

Angel Capital Education Foundation

501c3 public charity

Education:

Summits & meetings

Workshops & webinars

Research:

Group investment data

Research reports that benefit general public

Public awareness

Angel Capital Association

501c6 trade association

Membership organization

Professional standards

Members’ only Web site

Member networking

Industry tools

Awareness campaigns

Advocacy

Member Locations Full Member Provisional Member

August 2005 Does not include 18 Provisional Members Angel Networks Networks w/Sidecar Funds Angel Funds ACA Membership (81): Networks and Funds 60 9 12

Years in Operation 68 groups reporting Groups Average = 4.23 Median = 3

Average Group Investment Per Deal 45 groups reporting (Caution: source data is incomplete & unverified) Groups Average = $351,050 Median = $300,000 In $1,000s

39 groups reporting (Caution: source data is incomplete & unverified)

Investment Preference 39 groups reporting

Forms of Investment Debt (note) Equity (stock) Options Warrants Debt: collateralized, non-collateralized, interest in cash or stock (deferred?), convertible (at election or automatic?), length of time, etc. Equity: common vs. preferred, dividends, many other terms discussed below

Debt (note) Equity (stock)

Options Warrants

Debt: collateralized, non-collateralized, interest in cash or stock (deferred?), convertible (at election or automatic?), length of time, etc.

Equity: common vs. preferred, dividends, many other terms discussed below

Professional Investors Angels, venture capital, corporations typically receive: Preferred stock Convertible debt with warrants or additional stock Provide more than money: Can be proactive in developing business through (“win together”): Company building experience Company functionality experience Industry experience Contacts for partners, customers and follow-on financing

Angels, venture capital, corporations typically receive:

Preferred stock

Convertible debt with warrants or additional stock

Provide more than money: Can be proactive in developing business through (“win together”):

Company building experience

Company functionality experience

Industry experience

Contacts for partners, customers and follow-on financing

Investment Terms Agree on essential terms prior to due diligence: Valuation Post investment role: Active vs. passive Board, advisor, consultant Debt vs. equity If convertible debt – general discount; triggers Warrants – general % Milestone investing? Post-investment communication

Agree on essential terms prior to due diligence:

Valuation

Post investment role:

Active vs. passive

Board, advisor, consultant

Debt vs. equity

If convertible debt – general discount; triggers

Warrants – general %

Milestone investing?

Post-investment communication

Angel Organizations: Investment Evaluation and Process Investment Terms and Negotiations (not absolute rules) : Keep the terms simple if follow-on funding necessary Reserve an investment amount Use professional service providers Double-check due diligence Be realistic Diversify

Investment Terms and Negotiations (not absolute rules) :

Keep the terms simple if follow-on funding necessary

Reserve an investment amount

Use professional service providers

Double-check due diligence

Be realistic

Diversify

Expected Rates of Return 3X 25%/year Near exit 4X 30% 2 nd stage 5X 40% Early stage 8X 50% Start-up 10X+ 60%+/year Seed Five Year ROI ROI

Valuations Of Venture Capital Seed/Startup Rounds ($Millions) $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006* *2006 Estimated Value Startup/Seed

Term Sheets: Debentures Convertible Debentures (Notes): Automatic upon event or investor controls conversion Note term Interest: cash or stock; payment schedule; part of conversion Security interest/collateralized?

Convertible Debentures (Notes):

Automatic upon event or investor controls conversion

Note term

Interest: cash or stock; payment schedule; part of conversion

Security interest/collateralized?

Term Sheets: Preferred Stock Rights, preferences and privileges of preferred stock Price Use of Proceeds Dividends Liquidation preference Anti-dilution provisions Redemption Protective provisions Information requirements Registration rights Right of first refusal Co-sale rights Option pool Founder vesting Inventions agreements

Price

Use of Proceeds

Dividends

Liquidation preference

Anti-dilution provisions

Redemption

Protective provisions

Information requirements

Registration rights

Right of first refusal

Co-sale rights

Option pool

Founder vesting

Inventions agreements

Summation Angels invest primarily in seed/start-up rounds Angels represent patient money Angels are becoming sophisticated investors Angels make excellent advisors and mentors Many companies will need only angel investors Be open, coachable and realistic Show your commitment, passion and drive Answer the questions: So what? Who cares? Why you?

Angels invest primarily in seed/start-up rounds

Angels represent patient money

Angels are becoming sophisticated investors

Angels make excellent advisors and mentors

Many companies will need only angel investors

Be open, coachable and realistic

Show your commitment, passion and drive

Answer the questions:

So what?

Who cares?

Why you?