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VC 201: The Investment Memo

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Building off the basics presented in VC 101, we will be using the components of a traditional VC investment memo as a vehicle to examine the aspects of an investment opportunity, and the associated analysis, that matter to VCs and why.

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VC 201: The Investment Memo

  1. 1. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved VC 201: The Investment Memo (and what you should understand as a Founder) Drew Russ, Startup & Venture Capital, Business Development
  2. 2. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved About Me
  3. 3. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Today’s Agenda • Quick review of what we covered in VC 101 • The Investment Memo: A Mechanism for us to examine what VCs assess – Part 1: The Problem & The Solution (The Purpose) – Part 2: The Details – Part 3: The Recommendation • Concluding remarks
  4. 4. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Quick Review of VC 101 • Venture Capital: The Definition, The Theory • Venture Capital Mechanics: Fund Structure, Time as a Factor, How VCs Make Money, Roles and Responsibilities and Deal Sourcing • Venture Capital: The Deal and the Bargain • The Other Flavors of Venture Capital and Corporate VC • A Glimpse of VC 201 (no need, because you are here!)
  5. 5. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved What is an investment memo, really? • A mechanism to provide an OBJECTIVE, FACT based assessment of an investment opportunity • The good, the bad and the ugly – it all goes in • Enlightens skeptics and the dupes in equal measure – it both the defense and the prosecution
  6. 6. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Why are we talking about Investment Memos? • I know. Memos = boring. Super lame topic and I am really surprised you are all here  • Reference architecture of a potential investment • For example: – Product – what is it and why does it matter? – Business model -- how do they (or plan to) make money? – Financial health – and what do they do with this (and their investors) money? – Management pedigree – have they done it before? What makes them suitable? – Risk & Concerns – what goes wrong? – Valuation and Exit – when do we lose money? When do we make money? • We are going to use that reference architecture to help us understand why VCs decide to invest or not invest* * Not all investment decisions are made equally
  7. 7. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Real World Example: Roelof Botha YouTube Memo, 2005 • Pro: Publically available example of how one of the best VC firms reviews investments (and one of the best individual investors) • Pro: detailed and well structured – perfect for our needs • Con: No detail on internal debate; had to move quickly on deal • I will supplement this example where needed
  8. 8. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 1: The Purpose • The Problem – Is it real? – Is it painful? – Is it widespread (or will be)? • The Solution – How does it work? – Why does it work? – Why is it better? &
  9. 9. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 1: The Purpose (problem & solution)
  10. 10. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 1: Is it Widespread? Market specifically targeted by your product Total Market Demand Market Share of SAM
  11. 11. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 1: Who else is doing this? • Competitors and existing players • Size, strategy, product differentiation • SWOT Analysis of competition – Strengths, Weakness, Opportunities, Threats • Relative positioning
  12. 12. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: The Details • Product Roadmap and Development • Revenue / Sales & Distribution • Team • The Deal: Valuation and Capitalization • Other: hiring plans, need for re-organization, company location etc
  13. 13. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Product Development & Roadmap • Going beyond core functionality • Dive deeper on how the product interacts with users • Getting from Point A to Point B (to Point C)
  14. 14. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Sales & Distribution • Monetization = how you generate revenue • Youtube: – Advertising – Pay-for distribution – Premium content – Premium features Advertiser Viewer Content Creator Youtube
  15. 15. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: The Team • The earlier the investment the more important the team • What have they done? Who vouches for them? Where do they come from? • Are they familiar to the VC firm or a trusted colleague of the VC firm? • PayPal Mafia…
  16. 16. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Team (contd.)
  17. 17. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Valuation and Capitalization • Three topics – Premoney vs. Postmoney – Cap Table – Investor preferences • Definitions – Valuation: Valuation is the process of determining the current worth of an asset or a company; there are many techniques used to determine value – Capitalization: In finance, capitalization is the sum of a corporation's stock, long-term debt and retained earnings. Capitalization also refers to the number of outstanding shares multiplied by share price.
  18. 18. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Premoney vs. postmoney Premoney The valuation of a business prior to any additional investment of capital Postmoney The valuation of the business PLUS additional capital invested
  19. 19. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Valuation & Capitalization (a few equations) (1) Pre-money Valuation = Post-money valuation – Venture Capital Investment (2) Post-money Valuation = Venture Capital Investment/Venture Capital Fund Ownership Percentage (or premoney + investment) (1) Example: Fund invests $1mm into a company with premoney valuation of $4mm. The Venture fund owns 20% of the company. 1,000,000 / 0.20 = 5,000,000 (3) Share Price = Pre-money Valuation/Number of Pre-money shares. (4) New Shares Issued = Venture Capital Investment/Share Price
  20. 20. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: An Example • StartupZee is a newly formed business and is seeking to raise $1mm seed round in the form of Venture Capital • StartupZee has authorized 10,000,000 shares and have allocated those shares between two co-founders 50/50 • A term sheet is accepted from VeeCee Capital and VeeCee Capital has put the pre-money value of StartupZee at $3mm • So…. – What is the post money? – What % of the company does VeeCee Capital own? – What was the share price? – How many shares were issued to VeeCee Capital?
  21. 21. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: An Example (contd.) Share Price = Pre-money Valuation/Number of Pre-money shares. 3,000,000 / 10,000,000 = 0.30/share New Shares Issued = Venture Capital Investment/Share Price 1,000,000 / 0.30 = 3,333,333.33 shares Ownership % = shares owned / shares outstanding 3,333,333.33 /(10,000,000) + (3,333,333.33) = 25% Post-money Valuation = Venture Capital Investment/Venture Capital Fund Ownership Percentage 1,000,000 / .25 = 4,000,000
  22. 22. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Youtube Valuation • Going to invest $5mm over a two-tranche investment • Milestone specific • Can we back into the valuation? • 5,000,000/0.30 = $16.6mm postmoney • $11.6mm premoney
  23. 23. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Cap Table as a Mathematical Proof EXAMPLE: Cap Table Name Money Shares Current % Post % Founder 1 $ - 3,333,333.33 33% Founder 2 $ - 3,333,333.33 33% Founder 3 $ - 3,333,333.33 33% Total $ - 10,000,000 100% Pre-money $11,600,000.00 Pre-money Price per Share $ 1.160 Investment $ 5,000,000.00 Post Money $ 16,600,000.00 New Investors VeeCee $ - - 0% Total $ - 10,000,000 100% - The knowns or the assumed: - 10mm authorized shares (assumed) - $5mm investment (known) - Investor will own 30% of company after $5mm investment (known) - Option Pool will be 17% of common shares outstanding after investment (known) - Only investor participating in the round (assumed) Post Financing VeeCee $ 5,000,000.00 4,310,345 30% Founder 1 2,523,810 18% Founder 2 2,523,810 18% Founder 3 2,523,810 18% Option Pool 2,428,571 17% Total $ 5,000,000.00 14,310,344.83 100%
  24. 24. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Definitions within the Deal • Liquidation Preference: – is frequently used in venture capital contracts to specify which investors get paid first and how much they get paid in the event of a liquidation event, such as the sale of the company. • Participating Preferred & Cap: – A cap on participation limits the amount received by the preferred stock to a fixed amount. The cap is typically fixed as a multiple of the original investment, such as 2x or 3x. Once holders of preferred stock have received the cap amount, they will stop participating in distributions with the common stock, or convert. • Wait…don’t you just own part of a company and just get that percentage? – Well, sometimes…
  25. 25. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: The Waterfall (last part I promise) • Not all exits are as straightforward as they appear • Example: • VC invested $5mm • 1x Liquidation preference • Participation rights with 2x cap • VC owns 40% of company • Company sells for $20mm • What is the return to VC? $10mm!
  26. 26. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 2: Waterfall (contd). • Here is why: Scenario 1: Convert to Common • Always an option • You convert at the rate of ownership • VC would receive 40% of sale $8mm! Scenario 2: Participate Fully • Take your liquidation preference off the top: $5mm • THEN YOU CONVERT and own 40% of remaining common stock or 40% of 15mm. • But capped at 2x of total investment, so… $10mm! Scenario 2: Imagine no cap! • Take your liquidation preference off the top: $5mm • THEN YOU CONVERT and own 40% of remaining common stock or 40% of 15mm. • But not capped, so VC gets $5mm + $6mm… $11mm!
  27. 27. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved Part 3: The Risks, The Exit & The Recommendation • Should we invest? • What needs to happen to make this work? • What goes wrong? • What type of return can we approximate if all goes well? • What are the factors to closing the deal? – Timing? • Competitive deal • Capital requirements – Lead the deal? – Take a board seat? • Observer seat?
  28. 28. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved aws.amazon.com/activate Thanks!
  29. 29. © 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved© 2016, Amazon Web Services, Inc. or its Affiliates. All rights reserved

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