Twoeyes Insight-34VCI


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Report & Reflections on 34th Venture Capital Institute, 2008

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Twoeyes Insight-34VCI

  1. 1. 2008 Twoeyes Insight: Report & Reflections from the 34th Venture Capital Institute Atlanta Georgia, USA 15-18 September Conor McKenna Managing Director Twoeyes Venture & Advisory PO BOX 1133 NORTH ADELAIDE SA 5006 AUSTRALIA 25/10/2008
  2. 2. Page 2 Twoeyes Insight – VCI 2008 TWOEYES INSIGHT 34th VCI Report October 2008 By Conor McKenna, Managing Director, Twoeyes Venture & Advisory PO Box 1133, North Adelaide SA 5006, Australia. Mobile: +61402 264670 THIS VCI REPORT LOOKS AT: Vive La Venturepreneur! Vive La Venturepreneur! 1 By Conor McKenna, Graduate, 34th VCI Venture Capital SA Scholarship 2 “I am still learning” was a famous remark by an elderly 34th Venture Capital Institute (VCI) 2 Michelangelo. While I am no Michelangelo – nor his „David‟ for VCI Curriculum & Remarks 3 that matter – I am a life-long student of the Art & Science of Golden Nuggets 6 Venture Investing. Linking SA VC Globally 11 Like Mike, I‟m still learning. I was therefore most fortunate to Bridging SA‟s Valley of Death 12 be one of three applicants to receive the Venture Capital SA From Little Things 15 Scholarship to attend the 34th Venture Capital Institute in About Conor McKenna 16 Atlanta, Georgia USA in September this year. About Twoeyes 17 Attending VCI 2008 has greatly extended my knowledge and appreciation of the venture capital industry outside of The most memorable VCI 2008 take-away for me was during the Australia. Just one month on, the experience has also proven session entitled “Being an Effective VC Director – Coach, beneficial in my everyday venture development & advisory Confident & Killer”. VCs were instructed to ask themselves two activities here in Adelaide. questions at each board meeting: “Are we going to fire the CEO today? If not, how can we help?” After 20 years working „in or on‟ early-stage, growth ventures, on the one hand I am comfortable calling myself a seasoned With 50% of management fired within months of an early-stage entrepreneur. On the other hand, I consider myself an VC investment, naive C-Level entrepreneurs need to understand apprentice Venture Capitalist. In my mind‟s eye I can see the that the smiling and nodding investor is likely their executioner; a day when I can hear the two hands clapping together in happy badly understood term-sheet their death warrant. unison. Post-VCI, I am now even more attracted to the VC term-sheet and Unquestionably, entrepreneurs without a tangible passion for less excited by the technology. As one venture-backed their technology, product or service are soon statistics. entrepreneur I know said to me recently, „the more you venture, the more you move to the Dark Side‟. However, the more experience I accrue from interacting with VC and developing entrepreneurial ventures, the more I VC learning is not a franchise owned by the investor set. It‟s time appreciate the importance of the deal and how it is conceived for our serious, growth-oriented entrepreneurs to learn for - let alone how it is constructed and the terms that define it. the investor really themselves how thinks and how VCs professionally craft the deal. If the end-game lies in a profitable The more I learn about the nooks and crannies hidden in the exit, the VC term-sheet describes what profitability will look like. VC term-sheet, the more I am convinced that too many entrepreneurs are guilty of “falling in love with love”. Too As one of my past investors said to me, as he tied me over the many are blinded by the wonders of their technology or the proverbial barrel, “It‟s the Golden Rule, mate: he who has the gold mind-blowing size of the market. Too many abdicate their makes the rules. That‟s life”. Post-VCI, I prefer to think that “He duty to learn the rules of the venture investment game. who knows HOW to make gold makes the rules. That‟s Alchemy”. In the fast-paced and heartless world of „Return on “Entrepreneurial Alchemy” lies in the rule book and the rule book Investment‟, ignorance is no longer a defense – particularly is the VC term-sheet. If both study this equally well, entrepreneur post September 2008. It only takes one run-in with Liquidity and venture investor alike, each will hear the coins hitting the Preference Shares; Redemption Provisions and Full Ratchet table and two hands clapping in time, to wild hoots and wolf Anti-dilution Clauses to crush even the most seasoned whistles: “Vive Le Venturepreneur”! “Vive Le Venturepreneur”! „technopreneur‟. © Twoeyes 2008. All rights reserved
  3. 3. Page 3 Twoeyes Insight – Trip Report VCI 2008 Venture Capital SA Scholarship Program By Conor McKenna On August 25th 2008, Venture Capital SA awarded three scholarships to locally based private equity practitioners to attend the 34th Venture Capital Institute education program in Atlanta, Georgia USA, from 15 – 18 September. 34th Venture Capital In announcing the winners, David Simmons, the Chair of the SA Centre for Innovation (which oversees Venture Capital SA), said Institute (VCI) the program provided a great opportunity to advance careers in venture capital and private equity and keep the industry vibrant. The Venture Capital Institute is the Educational Foundation for Venture Capital & Private Equity Professionals Worldwide. The awarding of these scholarships is consistent with Venture Capital SA‟s objective of „developing an active, growing and The VCI combines lectures, case studies, written outlines, and sustainable South Australian private equity sector‟. reference materials covering all the primary elements of the direct venture investing process. The scholarship program is also aligned with the Economic Development Board‟s objective of „fostering the development For the past 34 years, the Venture Capital Institute has offered and maintenance of high quality venture capital management 5,000 venture capital professionals what is viewed as both a and investment skills in South Australia, including through the “required course” for newcomers to the industry and an development of education courses.‟ excellent continuing professional education program for those already involved. The three 2008 scholarships follow on from the awarding of four in 2005, two in 2006 and three in 2007 – a total of 12 in Held annually at the Emory Conference Centre in Atlanta, the the last 4 years. Venture Capital Institute is an intense, four-day, in-residence program conducted by experienced venture capital managers, The cost of the program, including accommodation and return investors, and attorneys who are recognized experts in their economy air travel – valued at about $9,000 per attendee - was fields and committed to sharing their knowledge and funded by Venture Capital SA. experiences. Recipients of the 2008 Scholarships - and now Graduates of VCI attracts attendees from around the world who benefit not the 34th VCI - are Ben Bergo, Terra Rossa Capital; Dan Hill, only from the practical knowledge they take from the program Paragon Private Equity and Conor McKenna, Twoeyes Venture & but also from the relationships they form with their peers in Advisory. the venture capital industry. Previous Scholarship recipients and VCI Graduates Include: The Venture Capital Institute is sponsored by the National 33rd VCI: Melissa Brasted, Terra Rossa Capital; Remco Marcelis, Association of Small Business Investment Companies, (NASBIC). Paragon Private Equity and Doug Adamson, Playford Capital. NASBIC is the oldest organization of venture capitalists in the 32rd VCI: Amanda Heyworth, Playford Capital and Damian world. Formed just months after the passage of the Small Papps, Strategon Capital. Business Investment Act of 1958; NASBIC has played a pivotal role in promoting the growth and vitality of the industry for 31rd VCI: Geoff Thomas, Paragon Private Equity; Shane Cheek, nearly half a century. ITEK; Alistair McEwin, Rundle Capital; Jeremy Steele, ANZ Private Equity. © Twoeyes 2008. All rights reserved
  4. 4. Page 4 Twoeyes Insight – VCI 2008 34th VCI Curriculum & Remarks By Conor McKenna By Conor McKenna Now in its 34th year, the Venture Capital Institute is an interactive four-day educational program that incorporates detailed lectures, forums and networking events designed to strengthen participants‟ understanding of the entire process of risk capital investing. The Institute has been refined and improved each year to reflect changes in investment strategies and cyclical industry conditions. Clare Fairfield (Centre Right), Chair of VCI, with the three South Australian Scholarship recipients, Dan Hill (Paragon), Utilising a practitioner-led approach, the Curriculum offers Conor McKenna (Twoeyes) and Ben Bergo (Terra Rossa). innovative techniques for the traditional aspects of the venture investing process, including due diligence; ethical considerations; Business Plans, Due Diligence & Tips pricing, structuring and negotiating deals; preparing profitable on the CEO Interview Process exit strategies; and understanding current tax and legal issues affecting investments. Eugene D. Hill, SV Life Sciences Advisors, Boston MA Effective Communication as a Eugene stressed that time is the VC‟s most precious resource. He Venture Capitalist explored how to prioritize and evaluate viable business plans by developing critical screening and organizing techniques based on Steve Vivian, Prism Capital, Chicago IL analysis of the substantive due diligence issues: Market; Management; Method; Money & Metrics. Eugene also examined Held as an optional session on the eve of VCI proper, this the major risk factors facing an investment decision: Management workshop looked at what best practice is in preparing, writing (esp. CEO); Technological; Market; Regulatory & Operational. and presenting investment committee memos, LP reports and other critical correspondence. Steve stressed the importance of . listening (or not talking) and body language, as well as written Marketing - Developing Effective and verbal communication. Deal Flow The Art V Science of Venture Bart Schachter, Blueprint Ventures, San Francisco CA Investing Deal flow is the lifeblood of a successful venture fund. Bart looked Pitch Johnson, Asset Management, Palo Alto CA at innovative and more traditional techniques for improving the quality and quantity of the deals a VC would like to receive. In Delivered by one of the industry‟s most respected pioneers, this many respects, this session comprehensively covered the session questioned if VCs are too reliant on spreadsheet analysis. fundamentals of marketing and proved that marketing and brand Pitch explored the balance between „Art‟ (utilization of judgment development for a VC firm is no different to any other professional & gut intuition) and „Science‟ (collecting and analyzing facts & services business. numbers that describe the business). He also gave an insight into how successful VCs develop their investment philosophies through consistent evaluation of the purpose, structure, risk, returns and environment. He also looked at the personal style of their funds and their relations with people. © Twoeyes 2008. All rights reserved
  5. 5. Page 5 Twoeyes Insight – Trip Report VCI 2008 Being an Effective VC Director - Reviewing Techniques of Pricing & Coach, Confidante & Killer Valuations Stephen Fleming, GA Tech Enterprise Innovation Monro B. Lanier III, Hickory VC, Huntsville AL Institute, Atlanta GA This session was focused on how to capture the appropriate Stephen gave an excellent overview and some very practical compensation for the risks inherent in Venture Investing. It advice as to the responsibilities and accountabilities of VCs was a thorough and high quality examination of the basic serving as directors of their portfolio companies. Topics included formulas and new alternatives in pricing and valuation. the policy decisions to be encountered; working with CEOs (until you fire them!) and keeping your partners advised. He also Monro discussed how to build pricing models, develop examined structuring the investor‟s needs into the deal, in order sensitivity analysis and how best to use industry comparables to provide the foundation for a mutually rewarding directorship. to help determine enterprise value. He considered investments at multiple stages and how to address this in reaching a final valuation. He also stepped through examples of Term Sheets for Structuring & dilution/exit/liquidity, considering the impact of Liquidity Negotiating Deals Preferences; Redemption Provisions and Full Ratchet Anti- Jeffrey Leavitt, DLA Piper US LLP, Atlanta GA dilution clauses. This was a most beneficial look at key mechanisms used in constructing VC term-sheets. Jeffrey demonstrated how even the best deal structure won‟t convert a lousy investment into a successful one. However, a well Ethics in Venture Capital - A Candid structured VC term sheet can make a good investment better and Discussion minimise losses. Key definitions; checklists; sample term sheets Andrew C. Wicks, the Darden School, UVA and models for successful deal negotiations were examined. During this thought-provoking session, Andrew challenged the Changing the Management & Board audiences‟ thinking about ethics in venture capital investing. in Troubled Times We explored a couple of case studies and „what if „scenarios, Lew Jaffe, Jaffe & Associates, Marblehead MA which were followed by quite heated debate. It was surprising how many delegates did not fully grasp their Fiduciary Duty as What should a management team be doing during an actual turn- a Director. Most were solely focused on winning the deal. This around? A highly experience „Gun for Hire‟ and turnaround was a really worthwhile session and exposed how important a specialist, Lew offered a hard-nosed perspective from inside the thorough understanding of Directors‟ Duties is to be an bowels of a venture. effective investor. An Entrepreneur‟s View of the Specialized Networking for Venture Capital Industry International Students Patrick Hamner, Servant Capital Partners & Heelys Chris Davis, McCarter & English, LLP, New York NY An entrepreneur‟s perspective regarding deal structure, the Chris led an informal discussion about the “good, bad and the ugly” negotiating process and the value VCs bring - or don‟t bring - to of dealing with US VCs. The session provided a unique policy the company. Qualified to speak from both sides of the discussion about building and structuring a venture capital industry. investment equation, Patrick made candid and compelling Chris also discussed the role of US VC lawyers in detail. comments about the VC/Entrepreneur relationship. © Twoeyes 2008. All rights reserved
  6. 6. Page 6 Twoeyes Insight – VCI 2008 Early Stage Venture Investments Buyouts, Mergers & Acquisitions Rob Palumbo, Accel-KKR, Atlanta GA Karen Kerr, Agile Equities, New York NY Rob explored how buyouts are unique to other private equity Karen provided an interesting discussion that explored the „5 investments. He discussed what types of opportunities were Myths of Venture Capital‟. She also gave tips on how to find good better suited for buyouts and investigated how to position an deals, conduct meaningful due diligence and monitor investments investee company for a profitable acquisition. in a way that is helpful to the management venture-backed teams. Valuations, second rounds and the effect on the VC fund‟s ability to raise another fund were also relevant discussion topics. Selecting A Venture Management Pricing, Structuring & Negotiating: A Team – A Limited Partner‟s View Case Study Analysis 4 Person Panel Discussion Sean Foote, Labrador Ventures, Palo Alto CA The panel explored the partnership offerings received by Limited Partners versus the investments completed. What are the evaluation criteria of the proposed fund and its management Divided into teams of venture capitalists and entrepreneurs, team? Is there standardization in the fund review process? What participants had to determine the present and future value of a are IRR expectations for alternative investing? The panel fictitious company. The teams then structured and prepared the provided US VC Fund Managers with a check list of the „do‟s and terms for the proposed investment and negotiated a deal. don‟ts‟ in finding and working with their Limited Partners. Conducted before, during and after the evening meal, this workshop-cum-lecture session offered an intensive hands-on Developing Global Venture case study opportunity. It proved to be an interesting exercise on Partnerships both sides of the negotiating table. 3 Person Panel Discussion The following morning, Sean reported on the various deal negotiation outcomes. This was another dynamic and interactive International funds see the U.S. as a key investment target with session where we reviewed and debated the structure and terms of solid IPO opportunities and a proven marketplace. U.S. fund the deals made the night before. We also debated and analyzed managers are seeing remarkable opportunities overseas. why the negotiations proved successful or not. The panel discussed how bridge cultural differences, implement common analysis and control systems and find the right partners ZEN & the Art of Venture Exits to build successful global ventures. Art Marks, Valhalla Partners, Vienna VA The author was invited to join the panel as the representative of the international venture capital community. Art Marks led a most informative session on the due diligence of exiting an investment. He explored how to build the exit tactics I shared a view from a regional economy seeking access to the US into the VC term sheet and how to prepare the company and it‟s market. Using Australia as the example, I stressed the importance „State of Mind‟ for the actual exit – especially an IPO. He also of developing relationships with our US VC colleagues to ensure explored other options including recaps, mergers and sale back that our products can access the greater US market, to mutual to management. benefit. © Twoeyes 2008. All rights reserved
  7. 7. Page 7 Twoeyes Insight – Trip Report VCI 2008 Golden Nuggets On the Art & Science of VC By Conor McKenna There is both „Art & Science‟ in every step in the Venture Some of the „golden nuggets‟ I took away from my experience Capital Process. in Atlanta, Georgia when I attended the 34 Venture Capital Institute in September 2008 include: The Science is in: a) The collection of facts. 1. It takes 20 years to build a reputation and five minutes to b) The analysis of those facts. ruin it. If you think about that, you‟ll do things differently. c) Developing & analyzing numbers that describe the business. 2. Remind yourself every morning: nothing I say this day will teach me anything. So if I‟m going to learn about the The Art is in: entrepreneur‟s business, I must do it by listening. a) What facts to collect. b) What numerical analysis to make. 3. You can observe a lot by just watching. Good listening is c) What the facts and analysis mean. the most needed skill of a venture capitalist. d) Dealing with people. e) The utilization of judgment & intuition. 4. Winning deals is a competitive effort. You need to clearly f) Carrying out all actions with honesty and personal and convincingly show sellers dealing and partnering with integrity. your firm that it is good for them. This requires hearing what they want and need. Understand that much Art involves making decisions about people and working with them. Do not fail to make 5. When it comes to venture investing, the only successful calculations and analysis based on numbers. Cultivate your substitute for brains is silence. judgment about the meaning of the numbers. Listen to your gut. And base all your actions on a high degree of personal 6. When dealing with entrepreneurs and other investors, integrity. remember you are not dealing with creatures of logic, but creatures of emotion. There are 10 key steps in the Venture Capital Process: 1. Determining the purpose of the VC Fund. 7. Never write when you can talk. Never talk when you can 2. Clarifying the internal decision making process. nod. And never put anything in email. 3. Getting quality deal flow. 4. Meeting with entrepreneurs. 8. It‟s difficult to be a jerk to people who treat you with 5. Analyzing Business Plans. respect; to people you like. 6. Determining pathways to liquidity. 7. Making valuations. 9. Have a Goal and make it clear. However, when negotiating 8. Making & closing deals. a deal, the goal isn‟t to win every point. Listen more than 9. Following & advising companies. you talk. Seek a fair outcome that still allows you to serve 10. Orchestrating significant future liquidity events. your fiduciary. Figure out what you think is really important before you begin. But don‟t start there. Start in Top Ten Lies of Venture Capitalists places you agree and places where you can concede. Use your partnership but try not to get ahead of it. Remember that negotiations have very long memories. 1. “We can make a quick decision.” 2. “I liked your company, but my partners didn't.” 10. Consider making your enemies your friends. Try not to 3. “If you get a lead, we will follow.” take business personally but don‟t be pushed around by 4. “Show us some traction, and we'll invest.” people impugning your integrity. 5. “We have lots of dry powder.” 6. “We're investing in your team.” 7. “I have lots of bandwidth to dedicate to your company.” 8. “This is a vanilla term sheet.” 9. “We can open up doors for you at our client companies.” 10. “We like early-stage investing.” © Twoeyes 2008. All rights reserved
  8. 8. Page 8 Twoeyes Insight – VCI 2008 On Valuations Top Ten Lies of Entrepreneurs 1. What is the market – for investing now and for exiting the 1. “Our projections are conservative.” investment in the future? 2. “Gartner says our market will be $50B by 2009.” 3. “Boeing will sign our contract next week.” 2. What might the company be worth to new investors (Return 4. “Key hires will join us when we get funded.” on Investment & Cash Return, both adjusted for risk)? 5. “No one else is doing what we do.” 6. “Several firms are doing due diligence.” 3. What is the company worth to management and existing 7. “Google is too slow to be a threat.” investors (pre and post investment)? 8. “Beta sites will pay to test our software.” 9. “Patents make our business defensible.” 4. Is the valuation fair? Does it work? Are there adequate 10. “All we have to do is get 1% of the market.” management options? Is everyone still motivated? 5. What is the Supply & Demand for deals & money like at Tidbits present? 6. How good is management‟s experience, pedigree & Pricing and valuation techniques used in VC Term-sheets providence? are designed to capture appropriate compensation for risks inherent in venture investing. 7. How loud is the „Buzz‟ factor currently around the deal? Spreadsheets are less useful at start up and early stages, 8. If existing investors are participating in the round, other than as a sanity check. valuation doesn‟t change their % ownership if pro rata. Do not confuse precision with accuracy (beware 9. If no pro rata, the VC‟s incentive is for higher valuation. spreadsheets with many decimal places). 10. If fundraising, VC may want a very high valuation often There is no precisely correct method of valuation, so make regardless of other economics. sure to estimate from several perspectives. 11. Never forget the Fiduciary Duty that all Directors must Analyze range of returns based on reasonable outcomes. focus on all shareholders and act in the best interests of the company. Remember that the more dollars invested requires more dollars returned at exit. 12. Fair market value is established by a willing buyer & a willing seller – without compulsion to buy or sell and The market sets the price – but the market can be fickle. armed with reasonable knowledge of relevant facts. Valuation should never be the only consideration. Anecdotal Evidence Suggests Key VC Calculations Valuation matters more than it seems to.  Pre money = Post money – New $$ Post money = New $$ / % Acquired When it comes to valuations:  The Math: $3.0M buys 30% ownership Inexperienced VC‟s (and entrepreneurs) over-price as they Post money = $3.0 / 30% underestimate risks and the need for capital going forward. Post money = $10.0 Pre money = $10.0 – $3.0 Early stage VC‟s under-price later stage deals, using an Pre money = $7.0 overly high discount rate. Later stage VCs over-price early-stage deals. © Twoeyes 2008. All rights reserved
  9. 9. Page 9 Twoeyes Insight – Trip Report VCI 2008 “We cater to two constituencies: the On VC Directorships founders and management of private companies who have selected us as There is a very definite hierarchy of who a VC Director has a their venture capital partners and the responsibility to: limited partners who have trusted us with their money. We want to do well by 1. All Shareholders - „Fiduciary Responsibility‟. both but founders and management 2. Then, the VC‟s class(es) of shareholder. come first. We have learned that the 3. Then the VC‟s Limited Partners. only way to develop a fabulous company 4. Then the VC Partnership. is one step at a time. This only happens 5. Then the VC themselves. if the company makes wonderful products or delivers a service that thrills If there is ever an occasion for conflict between two sets of large numbers of customers. If that responsibilities, the higher one always wins. occurs, the founders, management and employees of these companies prosper. Remember that, as a VC Director, you are not the CEO! If you It is only then that the investor deserves want to run a company, go get one funded. Until then, you are to be rewarded. It has to happen in that there to advise and encourage - NOT to run the show. order. There are no shortcuts”. The key asset a VC Director can bring is their perspective from Sequoia Capital experience. It makes sense that a VC Director should therefore have appropriate experience. “VC‟s invest in people they like and don‟t invest in people they don‟t like. It‟s easy to become friends with the CEO. That‟s fine On Management but, sometimes the CEO has to go. This is very common in early-stage investments. When a company grows quickly, the required skill-set changes dramatically. When the need arises Manage the 7 C‟s: – and it does – you must be able to shoot your own dog” Cash.  “In an ideal world, all investors would have identical objectives: Customers.  obscene capital gains for their stock”. Culture/co-workers.  Change.  In the real world, where people are involved, other factors Clock.  intrude: Co-operation.  Series of Preferred stock owned by each firm. Communication.  Size of VC fund. Age of VC fund entity owning stock (are they still The 5 attributes of a successful Enterprise or Turnaround: investing from the fund or are they ready for harvest?). 1. An executable plan. Other investments taking priority. 2. Sufficient liquidity to fund the plan. Over-lapping board memberships. 3. Management (and a supportive BOD) that are: Time commitments. a. Focused on execution. b. Dedicated to doing whatever it takes to Selling a new series of Preferred at a price lower than the last succeed. round will dramatically dilute the stake of earlier investors, c. Good communicators (listeners, not just managers and founders. A „Down Round‟ is especially painful talkers). for earlier investors who cannot participate („pay to play‟) in 4. A product that the market place needs &/or wants. the new round (ie end of life of their fund, other deals have 5. Supportive outside community: drained their capital, mortgaged to the hilt). a. Customers willing to buy. Keep focused on what is right for the company – not for your b. Vendors willing to sell. class of stock. © Twoeyes 2008. All rights reserved
  10. 10. Page 10 Twoeyes Insight – VCI 2008 On Management Turnarounds On what Entrepreneurs should care about Have a clearly defined goal from the beginning. 1. VC‟s ability to help company grow: Because the company has always done it a certain way, - Experience with start ups, early stage, contacts, doesn‟t make it right. “Sacred cows make the best customer assistance. hamburgers”. 2. VC‟s industry operating experience can be a negative. Determine viability of current strategies: do they support 3. VC‟s reputation for trust, honesty and good the end game (over the short, medium or long term). treatment of entrepreneurs. Maximize your market opportunities. 4. VC‟s ability to give company sufficient attention: Beware of becoming a „one trick pony‟. Identify profitable - Location, fund size, fund life cycle core competencies & diversify within them. - Internal dynamics: desperate for exit? Succession It‟s the customers‟ job to be enamored with the issues? Distracted by fundraising? technology - not the company‟s. 5. VC‟s ability to facilitate an exit – Generate Returns Talk to customers and find out what they need and will - Most VC returns come from a handful of funds. pay for. Senior management should manage – delegate and The 5 Myths of Venture Capital leverage all your team. Key personnel retention – incentives for success. Communication plans/shared vision – repair corporate Myth 1: VC is an easy way to get rich quickly. culture & morale; rebuild customer trust & stakeholder support. Reality: It‟s a slow road to wealth accumulation: Break down walls between departments to allow smooth - 2+ years to raise the fund. and efficient transfer of customer (and other) information. - 3-4 years to invest the fund. Analyze the industry & the company‟s competitive - 5-10 years to harvest the fund. position. - Significant risk of claw backs. Use competitive benchmarking (internal & external). Always look for efficient methods to dispose of non- Myth 2: Efficiency is achievable. essential assets. If an asset is not making money, turn it into cash. Reality: Venture is inherently inefficient. All resources must be leveraged - cash, team, external - VC couldn‟t make high returns if it weren‟t. relationships (with customers, vendors and stakeholders - - Back to fist myth > VC isn‟t easy! both debt & equity). Take calculated risks: determine payback, what resources need to be employed (what are the trade-offs?). Myth 3: VCs are all geniuses. Make the hard employee decisions swiftly. Reality: NOT!! Always have a back door: things change so be prepared to - Technical knowledge is not as important as execute alternate plans. interpersonal skills. Stay focused on the goal. - Once successful, VC‟s personality flaws tend to be interpreted as genius. Myth 4: Hyper-specialization is required. On Networking Reality: Hyper-specialization produces blind spots to new innovations that are the big investment winners. VC‟s must focus on developing proprietary deal-flow  - Connecting is more important - and profitable - by building, nurturing and leveraging their networks. than dissecting. read the book, „Innovators Dilemma‟. - Leverage your networks to understand the  opportunity and to understand the risks. Myth 5: Too few good ideas. Reality: Innovation hasn‟t slowed down: - Translating innovation into $$$ is the job of VC. © Twoeyes 2008. All rights reserved
  11. 11. Page 11 Twoeyes Insight – Trip Report VCI 2008 On Due Diligence On Adding Value  Focus on the People: Management, directors, advisors, 1. Recruit professional management ASAP: existing shareholders. Do you want to marry these guys? - “B Technology and A Management team always make money” (Old VC adage).  Focus on the Market: Does the product/service solve a 2. Team building includes the Board of Directors: „bleeding neck‟ problem? Who is the customer and how can - Fewer VCs and more industry pros. they be helped to increase revenues, reduce costs. Who are - Other value added investors both VC & the Competitors? Corporate. 3. Become Unofficial VP of Business  Focus on the Assets: What is the innovation? Can it be Development/Sales: protected? What are the competing solutions? - Leverage networks for sales/strategic relationships.  “Buy assets and sell revenues”. - Keep eye out for technology or business combinations.  Focus on the Exit: Who is the ultimate buyer? On Managing the Fund On Structuring 1. Remember to maximize the value of the portfolio:  Structure depends on diligence. - Identify the risks and develop mitigation strategies.  Use structure to win deals and manage risk. - Don‟t throw good money after bad.  Wash out risk by tranching the deal and by having a - Put more money into your best deals. financing syndicate. 2. Cash-on-Cash is more important than Internal Rate of Return. This is even more the case for early stage  “Your price, my structure”. investors. - Keep it simple if possible. - Be fair, but don‟t over pay. 3. Communication with Limited Partner is critical in advance - “Buy low & sell high”. of fund raising - even if they are not an LP yet. 4. Build a good team and share the rewards. Risk Mitigating Tool 5. Build lasting companies with good teams at all levels – Technology Tranche management, board and partnerships. Market Tranche, anti-dilution, liquidation 6. The venture business is scored on returns. Returns come preference from exits. No exits and nothing else matters. Management Board seat(s), protective provisions Finance Syndication, participation/co-sale rights, 7. Have a defined exit strategy. anti-dilution, protective provisions, 8. Don‟t rely on IPO market. liquidation preference, voting rights 9. It‟s the portfolio, stupid! 10. Network. Network. Network. On Managing the Investment 1. Starts before the close: There are 3 Moments of Truth in the - Identify risks during due diligence and develop Venture Business……… risk mitigation strategies. 2. Build the right syndicate. 1. The price at which you buy. 3. Leverage your network to add value. 2. The price at which you sell. 4. Communicate, communicate, communicate: 3. The price at which you distribute. - During board meetings, but especially between board meetings. - Avoid surprises. Surprises erode trust. 5. Most importantly, build a great board! © Twoeyes 2008. All rights reserved
  12. 12. Page 12 Twoeyes Insight – VCI 2008 Linking SA VC Globally The world-class learning and international connections they have brought home could well turn out to be a key bridge to the By Conor McKenna future of venture in South Australia. Having experienced networking at an international level at the At a personal level, VCI 2008 provided me with a unique 34th VCI, my hardened view is that international exposure is a key opportunity to share experiences and network with private ingredient to the ongoing success of South Australia‟s private equity professionals from around the world – about 150 of equity and venture capital community. them from 12 countries from 4 continents. While up-skilling is a requirement of most professions, for our Ranging in age groups from very recent college graduates to nascent local industry the opportunity to gain experience and university types in their late fifties, the average Private Equity & exposure on a global scale is invaluable. Venture Capital industry experience was a modest 2.6 years. Private equity and venture capital investment is not contained to Representing US$41B in capital under management, the state or even national boundaries. It‟s therefore important that majority came from VC Corporates (30%) and VC Partnerships our resident practitioners remain at the forefront of industry (21%). There were a goodly amount of Government officials – developments and mix with their international peers. especially from developing VC communities, such as Canada, South Africa, Brazil, Nicaragua, China, India & Japan. Despite turbulent times, there is a growing supply of money as well as a growing cohort of experienced investment professionals Most were armed with a blackberry, an Ivy League MBA, a set of and other essential service providers now resident in Adelaide. sharp cuff-links and a pair of even sharper elbows. At the onset, most egos seemed to be on stilts and steroids. Importantly, there is a healthy multi-sector deal-flow delivering better prepared investment opportunities. These ventures are As the days progressed, we underwent structured networking: increasingly led by savvy entrepreneurs and are supported by each dining experience was designed to match you with those more astute „Business Angel‟ investors and board members. on your table, be it by industry type, investment stage or geography. People soon relaxed out of their „VC persona‟. Since the establishment of Playford Capital in 2001, the private equity and venture capital sector in South Australia has started to A key element of the formalized networking was on the first build size and momentum. Key milestones have included the night when we partook in „Speed Networking‟. Debuting at VCI launch of Paragon Equity in 2002, AVCAL‟s foundation in 2008, this event required pre-registration using special on-line Adelaide in 2003, the establishment of the Venture Capital Board, networking software. This was designed to match the individual ANZ Private Equity and Rundle Partners in 2004, and the launch with 10 others who fitted the preferred industry profile. You of Terra Rossa Capital in 2006. then met at numbered/coloured tables for 6 minutes and then moved on to your next „date‟. However, to maintain momentum, it is paramount we continue to up-skill our venture community and seek international By day 2, we had all started to relax, most realizing they didn‟t experience wherever possible. know as much as they thought they knew. Personally, I was were pleasantly surprised that, even though I came from a To ensure equitable deal-making and worthwhile outcomes for all little-known place „somewhere near Sydney‟, I felt I could stack stakeholders, greater professionalism through world-class up with the cohort in terms of knowledge and experiences. education & training is required on both sides of the equation – entrepreneurs and venture investors alike. By day, 3 we were provided with the invaluable „VCI Facebook‟, a printed and bound Participant Directory, complete with photos Educational programs like the Venture Capital Institute (VCI) (taken day 1) and contact details. provide participants from all corners of the globe with the opportunity to create international networks they can draw on On the last day we established an on-line community on throughout their careers and learn from some of the world‟s Groups: VCI 2008. This is a powerful & instant leading practitioners. international network that can be shared and accessed for many years going forward. VCI is globally recognised as the Private Equity & Venture Capital industry‟s premier educational program and has nearly 5000 Suddenly, Adelaide is part of an international Venture Capital graduates from around the world. Thanks to the vision and network. It‟s nice to think that there‟s no one on the list from commitment of the Venture Capital Board, 12 industry the venture community in Sydney or Melbourne. practitioners from SA have already attended VCI over the last 4 years. © Twoeyes 2008. All rights reserved
  13. 13. Page 13 Twoeyes Insight – Trip Report VCI 2008 Bridging SA‟s Valley of Death By Conor McKenna Contrary to what many might think, few Angel investors come The term “venture capital” has been defined in many ways but from the more traditional and conservative „family money‟. generally refers to relatively high-risk, early-stage equity financing of young and emerging high growth companies. Whereas professional VCs tend to come from a strong finance or consulting background, the characteristics of the Angel There are two primary sources of external equity capital for investor appear to be that of a well-educated, middle-aged, entrepreneurs: one is visible and highly formalized and the other „cashed-up‟ or „cashed-out‟ entrepreneur or senior corporate is largely invisible and very informal. executive. The „visible‟ venture capital market is composed of formal The best private investors tend to have considerable operating venture capital funds. These funds are managed by highly trained experience, having successfully founded and/or grown one or finance professionals who invest capital in growth companies on more businesses. behalf of a group of passive investors (usually Superannuation Funds). Invariably, they possess a deep, influential and highly valuable local & international network of business, government and In Australia, the formal Private Equity community is professionally financial contacts. represented by AVCAL, the Australian Venture Capital & Private Equity Association Limited. ( Most of all, they seem to really enjoy the challenge of backing the next generation of entrepreneurs, rolling up their sleeves Most small to medium-size businesses looking for venture and actively working alongside the foundation team when the funding probably aren't going to find big East Coast VC firms going gets tough. interested in what they're doing. While most entrepreneurs just want money, there is a great As a result, there is a big gap between start-up and early-stage difference between „smart capital‟ and „dumb money‟. Unlike funds (grants, personal resources, sweat equity, boot-strapping, the dollars you can convince Aunty Mavis to part with, Angels family and friends) and venture capital. can position a young company for growth and help it survive in tough times. This capital gap is also known as the “Valley of Death”, because it is littered with the broken bones and business plans of thousands They do this through the „value add‟ they bring to the venture, of entrepreneurs who have been unsuccessful in finding venture over and above the dollars they invest: professional guidance backing to fund their growth. and mentoring; introductions to strategic partners & industry experts; helping attract and recruit experienced managers to fill That's where the „invisible‟ venture capital market becomes key roles; and importantly, attracting „follow-on‟ investors to critical. The invisible market is a highly elusive source of provide the next round of funding. financing for entrepreneurial ventures. In Australia, it is still very unstructured and largely informal, comprising a diverse and „Informal‟ Angel investors and „formal‟ venture capital funds geographically dispersed set of high net worth individuals. play complementary rather than competing roles in the financing of new ventures. This complementary relationship has These private investors, typically known as „Business Angels‟, are two dimensions – stage and size. interested in investing a portion of their personal wealth in high- risk, high-return early stage entrepreneurial ventures, usually in Compared to venture capital funds, Angel investors exhibit a exchange for equity in the company or a share of future profits. significantly higher propensity to invest at the seed, start-up and early-stage. This class of investor typically gets involved in a venture long before larger, more formal rounds of venture capital. Angel investors also tend to have longer exit horizons and less risk aversion than venture capital funds. Because they afford fledgling businesses the time and money they need to survive the start up phase and grow, Angel investors are In terms of size of investment, venture capital funds tend to often the backbone to building successful high growth invest substantially more dollars per round of funding than do entrepreneurial ventures. private individuals. © Twoeyes 2008. All rights reserved
  14. 14. Page 14 Twoeyes Insight – VCI 2008 South Australia‟s entrepreneurial ventures currently attract less In recent years, VC funds have grown so large that they simply than about 5% of all funds invested by the formal venture cannot invest amounts less than a few million dollars. capital community. In the main, an Australian VC‟s “sweet spot” is an investment of The challenge facing our emerging venture community is to between $3M and $10M. Consequently, they tend to shy away ensure that the largely latent - yet very deep - pool of from seed and early stage investments, which are the ones Angels indigenous capital gets motivated to actively consider private prefer. equity investing as an alternative asset class to traditional investments, such as property and shares. Funding boundaries vary, but Angel investments typically ranges from $50,000 to $3.0 million, largely dependent on whether the SA cannot depend on traditional industries for its future investment is made by a single Angel or a syndicate of private economic development. We need to birth a base of new investors. companies that have access to the wealth and experience of a well-organised and accessible local Angel investing community. Other than those differences, the successful Angel Investors are thinking more and more like venture capital investors. Like VCs, Entrepreneurs and Angels can then work collaboratively with Angel investors today want more than ever to see that the government and private sector service providers to develop risk entrepreneur has a significant personal stake in the company reduced, „capital ready‟ ventures, some of which will potentially before they'll invest. prove attractive to the East Coast Venture Capital community. The telltale sign is the amount of sweat equity - the money, To beat the „Valley of Death‟ in South Australia, the local hours and effort – the entrepreneurs have personally committed business community, government, universities and research to developing the start up business. If there's no blood, sweat centres need to work together to create an environment where and tears on the ground and „skin in the game‟, more than likely, technology innovation, entrepreneurship and venture investing they won‟t be interested in taking negotiations to the next stage. can flourish. In many cases, Angel investors are the only way a start up venture can bridge the „Valley of Death‟ and grow large enough to attract the interest of the venture capitalists. Angel investment is oftentimes essential to „harden‟ the business case for the early stage venture, allowing it to secure its Intellectual Property, bed down the operating management team, build the board of directors, attract strategic partners, complete product development, win first customers and ramp up revenue growth. Once this has been achieved, the „capital ready‟ venture has a better – but certainly not guaranteed - chance of attracting formal venture investors who can provide the next round of follow-on expansion funding to unlock its growth potential. Another and exceptionally important similarity between VCs and Business Angels is that, given a choice, both groups prefer that their investments be located close to home. The vast majority of Australian Venture Capital funds are located in the VC Hot Spots of Sydney and Melbourne. As a result, the „indigenous capital‟ provided by local high net worth individuals is essential to fund the growth of entrepreneurial ventures in „regional economies‟ like South Australia, that have limited direct access to formal Venture Capital funds. © Twoeyes 2008. All rights reserved
  15. 15. Page 15 Twoeyes Insight – Trip Report VCI 2008 From Little Things However, it‟s not the word “small” that matters, but the attitude behind it, the mindset that utters it. In a global market, if you By Conor McKenna think small, you are. If you don't, you're not. All the rest is just Member, Business Development Council commentary. Chair, Innovation & Entrepreneurship Sub-Committee South Australia doesn‟t need big, mature businesses to be globally competitive. What we need are more export-focused, Having spent 5 days with about 150 VCs from 12 countries and 4 high-growth ventures where technology and innovation are the continents, it is interesting to reflect upon the business landscape coin and currency of the future. of South Australia in 2008: If we can set this as our clear objective, our business community The small business sector of South Australia comprises – public and private – could focus on being brilliant at the basics. 80,000 businesses that employ less than 20 staff. We could focus on ensuring locally-born intellectual capital is These businesses make up 95.8% of all businesses. converted into sustainable, world-class ventures, to the ultimate Small businesses employ more than half of the workforce - benefit of our State. about 235,000 workers. Over 83% of employ less than 4 people. The vast majority of these businesses employ no staff at all. If we do this repeatedly and professionally, size will come with Only 13,000 businesses employ between 5 and 20 staff. age. “From little things, big things grow”. Only 4,000 businesses could be classed as 'Big' - meaning they employ over 20 full-time staff. In short, we need to change the way we think and approach the problem. If we want to achieve better than our current results, we Some might think these figures paint a pretty bleak picture for need to change our strategy. South Australia‟s future. The good news, however, is 1 in 4 small businesses exports overseas and the majority employ between 5 With this in mind, the South Australia‟s Business Development and 20 people. Council has recently created 4 work groups to focus on 4 key issues facing the South Australian small business sector. That makes about 20,000 vibrant businesses that each possess a global outlook. One of these groups is the Sub-committee for Fostering Innovation & Entrepreneurship. These businesses are the beating heart of South Australia. They represent the current wave of enterprises bringing the best of The group brings together four members of the Business South Australia to global markets. Development Council. Members are business owners and they represent the private sector. Joining the members are key people Today, it‟s the commercialization of market-driven intellectual from across relevant Government departments -including the SA capital that drives competitive advantage. Wealth is created by Centre for Innovation; Venture Capital SA; Department of Trade & turning innovation into new technologies and capabilities that can Economic Development; the Office of Small Business and The lead to globally competitive products and services. Science and Innovation Directorate. From the perspective of many of the entrepreneurs driving these The focus of the Innovation & Entrepreneurship Group is to ventures - and the investors backing some of them - they are Sustainably create the operating explore ways to: definitely not „small businesses‟. They just haven‟t reached their environment in South Australia where technology, growth potential yet. innovation, entrepreneurship, business ownership and venture investing can build deep roots and flourish. Many are owners of businesses that are in the early or adolescent stages of their development. A great deal of them would share a The Innovation & Entrepreneurship Sub-committee will also boundless entrepreneurial mindset, a truly global vision and provide specific feedback to the Business Development Council unrestricted export aspirations. on ways in which the Government and the business sector can work together to capitalise on opportunities and create a dynamic For many of them, “small” is restrictive and not in their economy that is competitive, resilient, diverse and innovative. vocabulary. Instead, they like “big” words - Innovation; Technology; Intellectual Property; Commercialization; Venture To the birth of the initiative, I say “Vive Le Venturepreneur” – Funding; Exports; Global Markets. because they are the ones who see the future first. Our future. © Twoeyes 2008. All rights reserved
  16. 16. Page 16 Twoeyes Insight – VCI 2008 About Conor McKenna Areas of Specialization BA(Lit) GDBusAdmin MBA(Adv) MAICD Commercial viability assessment  Founder and Managing Director of Twoeyes, Conor McKenna is a Technology validation  venture developer, strategic advisor, agent of change, 'interim CEO', Strategic due diligence  business owner, company director and equity investor. Investment opportunity recommendation  Deal structuring & negotiation  During his 20 year career, he has lived and worked in Ireland, Strategic plan development & documentation  England, Canada, Italy and Australia. Marketing & operations plan development & execution  „Key hire' recruitment & strategic board building  His experience spans many industries, including manufacturing, Intellectual property protection  distribution, retail, professional services, IT, internet, multimedia, Technology commercialisation  glass and plastic packaging, wine marketing, water desalination, Systems & process development & documentation  venture capital, medical and allied health services, corporate Quality systems accreditation  training and event management. Integrated on-line/off-line marketing strategy development  Brand design & development  Within these industries, Conor has worked with start-ups, spin- Joint venture marketing  outs, family businesses, small-to-medium enterprises, large Strategic network building & business matching  corporates, not-for-profit organisations and State and Local Sales management  Government agencies. Operations management  Grant application & tender writing  He has broad operating experience - from the first employee in a Private equity capital raising  start-up to a management role with the Australian subsidiary of a Exit strategy formulation  Fortune 500 American multi-national, where he was responsible for Strategic trade sale strategy development  a $50M budget and reported on 1B units in „Just in Time‟ supply. Due diligence preparation  Credentials He has been a strategic business consultant, government ministerial advisor and non-executive director of a number of Graduate private companies and not-for-profit organisations. 34th Venture Capital Institute, Atlanta GA, USA Member An award-winning venture developer, strategic network-builder Australian Institute of Company Directors and repeat entrepreneur, Conor is also the inventor of a patented Master of Business Administration (Advanced) technology that forms the basis of a successful global product Adelaide University School of Business innovation. Graduate, Foundation Course in Venture Capital Australian Venture Capital & Private Equity Association Ltd The company he subsequently founded has since commercialised Executive Diploma in Business Planning the technology and raised significant equity investment and grant South Australian Enterprise Workshop funding. It has secured strategic partners in all its major global Graduate Diploma Business Administration markets and has developed manufacturing capacity on 3 University of South Australia continents. Bachelor of Arts (Italian & English Literature) University College Galway, Ireland Conor is currently retained as a strategic advisor to a number of growth-oriented ventures. He is also an active member on a Contact number of private sector boards where he specializes in strategic operations management consulting. Conor is a Member of the Business Development Council of South Australia. He is also Chairman of the Business Development Council‟s Sub-Committee for Innovation and Entrepreneurship. Going forward, Conor remains a market-driven strategic thinker with an entrepreneurial ability to identify and unlock commercial potential, execute to plan, leverage strategic connections, effect change and deliver results that reduce risk and create value, particularly in the eyes of the next round of investor. © Twoeyes 2008. All rights reserved