Dynamics and Structure of Venture Rounds David M. Lee 29 January 2003
Agenda <ul><li>Sources of Funding </li></ul><ul><li>Rounds of Financing </li></ul><ul><li>Liquidation of a Company </li></...
Sources of Funding Idea Business Plan Prototype Beta Sales Profitability Decreasing Risk $ 1M $ 50M $ 100M Decreasing Retu...
Building the Syndicate <ul><li>Getting a Lead investor is always the hardest part </li></ul><ul><ul><li>Once a VC is in, h...
When to Raise Money 0 1 2 3 4 5 6 Valuation 0  50  100  150  200  250  300 Years Balance Conservative Cash Needs vs. Valua...
Early Stage 13% 15% G&A 5% 0% Marketing 4% 0% Services 5% 0% Sales 3% 0% Cost of Maintenance 70% 85% R&D 2 int., 2 inv., a...
Early Stage <ul><li>Seed Stage </li></ul><ul><ul><li>Should be convertible debt </li></ul></ul><ul><ul><li>Salaries are fo...
Expansion/Strategic 11% 12% G&A 19% 12% Marketing 8% 6% Services 15% 10% Sales 7% 5% Cost of Maintenance 40% 55% R&D 2 int...
Expansion/Strategic <ul><li>Second Round </li></ul><ul><ul><li>Breakeven is key to round </li></ul></ul><ul><ul><li>Manage...
Later Stage 11% G&A 21% Marketing 15% Services 20% Sales 8% Cost of Maintenance 25% R&D 3 int., 5 inv., and 1 ind. Board o...
Exit Preparation <ul><li>Mezzanine Round </li></ul><ul><ul><li>Optional round (generally taken out by M&A) </li></ul></ul>...
Liquidation of a Company <ul><li>“Waterfall” for payout </li></ul><ul><li>Example, $50M deal with $23M invested </li></ul>...
Purpose of S.O.P. <ul><li>Alignment of Interests </li></ul><ul><ul><li>Distribute enterprise value to employees </li></ul>...
Size of the S.O.P. <ul><li>Generally 10% - 25% of the overall equity </li></ul><ul><ul><li>Depends upon stage of the compa...
Type of employee-ownership <ul><li>Founders’ shares (outright ownership) </li></ul><ul><li>Stock grants </li></ul><ul><li>...
Purpose of “Vesting” <ul><li>Hand-Cuffs - Force founders and employees to remain part of the company to receive the full v...
Elements of a Vesting Schedule <ul><li>Total vesting time </li></ul><ul><ul><li>Typically 3-5 years; 4 is typical </li></u...
Vesting vs. Reverse Vesting <ul><li>Reverse vesting generally only applies to “founders’ stock” </li></ul><ul><ul><li>It r...
Pricing Stock Options <ul><li>For public companies – current market value </li></ul><ul><ul><li>Different specific methods...
Region – Q3 ‘02 –  PWC Moneytree $4.5B and 662 deals 1   0.01%      $1M   AK/HI/PR   3   0.07%      $3M   South Central   ...
Industry – Q3 ’02 –  PWC Moneytree 1   0.04%      $2M   Other     14   0.88%      $40M   Electronics/Instrumentation     1...
Stage – Q3 ’02 –  PWC Moneytree 35   1.26%      $57M   Startup/Seed   94   20.48%      $929M   Later Stage   162   20.88% ...
Alternatives <ul><li>SBIR Grants </li></ul><ul><li>Consulting </li></ul><ul><li>Garage </li></ul><ul><li>Virtual Team/Cont...
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Dynamics and Structure of Venture Rounds

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Dynamics and Structure of Venture Rounds

  1. 1. Dynamics and Structure of Venture Rounds David M. Lee 29 January 2003
  2. 2. Agenda <ul><li>Sources of Funding </li></ul><ul><li>Rounds of Financing </li></ul><ul><li>Liquidation of a Company </li></ul><ul><li>Stock Option Plan </li></ul><ul><li>State of Venture Capital </li></ul><ul><li>Alternative Funding Sources </li></ul>
  3. 3. Sources of Funding Idea Business Plan Prototype Beta Sales Profitability Decreasing Risk $ 1M $ 50M $ 100M Decreasing Return Venture Capital Banks Angels FFF Gov’t IPO Strategic Partners
  4. 4. Building the Syndicate <ul><li>Getting a Lead investor is always the hardest part </li></ul><ul><ul><li>Once a VC is in, he/she wants to get friends and others </li></ul></ul><ul><ul><li>No re-negotiation of most of the terms </li></ul></ul><ul><li>However, there is still work to do: </li></ul><ul><ul><li>Additional due diligence </li></ul></ul><ul><ul><li>Presentations and meetings </li></ul></ul><ul><li>The syndicate needs to be one that is going to help the company with more than just money. </li></ul>
  5. 5. When to Raise Money 0 1 2 3 4 5 6 Valuation 0 50 100 150 200 250 300 Years Balance Conservative Cash Needs vs. Valuation Based on Funding Milestones plus At Least 6 Months To Raise the Next Round
  6. 6. Early Stage 13% 15% G&A 5% 0% Marketing 4% 0% Services 5% 0% Sales 3% 0% Cost of Maintenance 70% 85% R&D 2 int., 2 inv., and 1 ind. 3 to 5 internal Board of Directors Expense/Employee Breakdown: 33% 25% Investor Acq. In Round 50% 25% Investor Ownership $5,500,000 $1,650,000 Founder Value 37% 55% Founder Ownership 13% 20% Employee Ownership Ownership: (Best Case) $15,000,000 - $3,000,000 $3,000,000 - $500,000 Valuation (Post-Money) 27 - 20 15 - 10 Cash/Burn Rate (Months) $5,000,000 - $1,500,000 $750,000 - $50,000 Funding - - - - - - Earnings Before Tax (A) - - - - - - Earnings Before Tax (%) 4 - 0 0 - 0 Customers $2,000,000 - $0 $0 - $0 Revenue (Annual) $187,500 - $75,000 $50,000 - $5,000 Burn Rate (Monthly) Cash Management: Beta - GA version 1 Idea - Beta Product 25 - 10 10 - 1 Employees Complete Partial Management Team Revenue Development Stage First Round Seed Financing Early Stage Stage:
  7. 7. Early Stage <ul><li>Seed Stage </li></ul><ul><ul><li>Should be convertible debt </li></ul></ul><ul><ul><li>Salaries are for the most part deferred (personally need 18 months cash) </li></ul></ul><ul><ul><li>Develop Beta product </li></ul></ul><ul><ul><li>FFF funding – friends, families, and fools </li></ul></ul><ul><ul><li>R&D line share of expense (85%) </li></ul></ul><ul><ul><li>Initial option pool (25%) – dilution created beyond investor ownership </li></ul></ul><ul><ul><li>Lose control of the board (2,2,1) </li></ul></ul><ul><li>First Round </li></ul><ul><ul><li>Series A Preferred </li></ul></ul><ul><ul><li>First opportunity for real payroll (be ready for this – CEO last paid) </li></ul></ul><ul><ul><li>Develop first GA product </li></ul></ul><ul><ul><li>Financing commitments milestone based </li></ul></ul><ul><ul><li>Initiates longest growth cycle (up to 2 years) </li></ul></ul><ul><ul><li>Founders still own 1/3 rd of company </li></ul></ul><ul><ul><li>R&D remains the line share of expense, but Sales & Marketing execs hired </li></ul></ul><ul><ul><li>Lose control of company (50% owned by investors, preferred rights) </li></ul></ul>
  8. 8. Expansion/Strategic 11% 12% G&A 19% 12% Marketing 8% 6% Services 15% 10% Sales 7% 5% Cost of Maintenance 40% 55% R&D 2 int., 4 inv., and 1 ind. 2 int. 2 inv. and 1 ind. Board of Directors Expense/Employee Breakdown: 30% 38% Investor Acq. In Round 74% 66% Investor Ownership $7,045,833 $4,283,333 Founder Value 14% 21% Founder Ownership 12% 12% Employee Ownership Ownership: (Best Case) $50,000,000 - $20,000,000 $20,000,000 - $15,000,000 Valuation (Post-Money) 10 - 10 10 - 20 Cash/Burn Rate (Months) $15,000,000 - $7,500,000 $7,500,000 - $5,000,000 Funding $2,250,000 - $300,000 $300,000 - $0 Earnings Before Tax (A) 15% - 5% 5% - 0% Earnings Before Tax (%) 30 - 12 12 - 4 Customers $15,000,000   $6,000,000 $6,000,000 - $2,000,000 Revenue (Annual) $1,500,000 - $750,000 $750,000 - $250,000 Burn Rate (Monthly) Cash Management: GA version 3 GA version 2 Product 150 - 75 75 - 25 Employees Complete Upgraded Management Team Profitability Breakeven Stage Third Round Second Round Financing Expansion/Strategic Stage:
  9. 9. Expansion/Strategic <ul><li>Second Round </li></ul><ul><ul><li>Breakeven is key to round </li></ul></ul><ul><ul><li>Management team upgraded (1 st major transition, gain traction) </li></ul></ul><ul><ul><li>Version 2.0 – real product ready (death march) </li></ul></ul><ul><ul><li>Must have at least half a dozen reference accounts to move forward </li></ul></ul><ul><ul><li>Already need to increase option pool </li></ul></ul><ul><ul><li>CFO and direct sales channel developing (indirect sales secondary) </li></ul></ul><ul><li>Third Round </li></ul><ul><ul><li>Strategic investor often comes in (be careful) </li></ul></ul><ul><ul><li>Enhancements requests clump to make new GA release </li></ul></ul><ul><ul><li>Earnings only on paper because still investing for growth </li></ul></ul><ul><ul><li>Another option pool increase </li></ul></ul><ul><ul><li>Services, Sales, and Marketing now 50% of the budget </li></ul></ul><ul><ul><li>Amount of money now invested will force an exit, regardless </li></ul></ul>
  10. 10. Later Stage 11% G&A 21% Marketing 15% Services 20% Sales 8% Cost of Maintenance 25% R&D 3 int., 5 inv., and 1 ind. Board of Directors Expense/Employee Breakdown: 27% Investor Acq. In Round 81% Investor Ownership $7,750,417 Founder Value 10% Founder Ownership 9% Employee Ownership Ownership: (Best Case) $75,000,000 - $50,000,000 Valuation (Post-Money) 7 - 10 Cash/Burn Rate (Months) $20,000,000 - $15,000,000 Funding $16,000,000 - $2,250,000 Earnings Before Tax (A) 20% - 15% Earnings Before Tax (%) 160 - 30 Customers $80,000,000 - $15,000,000 Revenue (Annual) $3,000,000 - $1,500,000 Burn Rate (Monthly) Cash Management: GA version 4+ Product 300 - 150 Employees Upgraded Management Team Growth Stage Mezzanine Financing Later Stage Stage:
  11. 11. Exit Preparation <ul><li>Mezzanine Round </li></ul><ul><ul><li>Optional round (generally taken out by M&A) </li></ul></ul><ul><ul><li>Another upgrade of management team (IPO, >$30M) </li></ul></ul><ul><ul><li>No longer able to develop one-off products </li></ul></ul><ul><ul><li>Not a time to be conservative and limit funds raised </li></ul></ul><ul><ul><li>R&D now 25% or less of the company </li></ul></ul><ul><ul><li>Founders own 10%, but remain paper millionaires – over $7.5M </li></ul></ul><ul><ul><li>Employees own 9% </li></ul></ul><ul><ul><li>VCs/Investors own 81% </li></ul></ul><ul><li>$200M Exit </li></ul><ul><ul><li>VCs make $160M for $50M invested </li></ul></ul><ul><ul><li>Founders make $20M for 6 years of sweat equity </li></ul></ul><ul><ul><li>Employees split $18M for various investments of up to 6 years </li></ul></ul>
  12. 12. Liquidation of a Company <ul><li>“Waterfall” for payout </li></ul><ul><li>Example, $50M deal with $23M invested </li></ul><ul><ul><li>$500K - Accounts Payable </li></ul></ul><ul><ul><li>$7.5M - Incentive Pool and Bankers Fees (15%) </li></ul></ul><ul><ul><li>$3M - Bridge Note Holders with Interest </li></ul></ul><ul><ul><li>$39M - ($20M x 3 = $60M) - Preferred Share Holders (In Reverse Order with Liquidation Preferences) </li></ul></ul><ul><ul><li>$0 - Common Share Holders, Warrants, and Options </li></ul></ul>
  13. 13. Purpose of S.O.P. <ul><li>Alignment of Interests </li></ul><ul><ul><li>Distribute enterprise value to employees </li></ul></ul><ul><li>Provide incentives to employees to work harder </li></ul><ul><ul><li>More effective in early-stage companies </li></ul></ul><ul><li>Conserve cash </li></ul><ul><ul><li>Allows start-ups to be competitive with established companies </li></ul></ul><ul><li>Retention </li></ul>
  14. 14. Size of the S.O.P. <ul><li>Generally 10% - 25% of the overall equity </li></ul><ul><ul><li>Depends upon stage of the company </li></ul></ul><ul><ul><li>Depends upon how many founders are part of management </li></ul></ul><ul><ul><li>Depends upon how much additional funding is required </li></ul></ul><ul><li>For public companies, this is generally 10% to 15% </li></ul>
  15. 15. Type of employee-ownership <ul><li>Founders’ shares (outright ownership) </li></ul><ul><li>Stock grants </li></ul><ul><li>Stock Options </li></ul><ul><ul><li>Incentive Stock Options (ISO) </li></ul></ul><ul><ul><li>Non-qualifying (NQ) </li></ul></ul>
  16. 16. Purpose of “Vesting” <ul><li>Hand-Cuffs - Force founders and employees to remain part of the company to receive the full value of their stock </li></ul><ul><ul><li>Especially “Golden” Hand-Cuffs </li></ul></ul><ul><li>Reinforce the idea that enterprise value is built going forward </li></ul>
  17. 17. Elements of a Vesting Schedule <ul><li>Total vesting time </li></ul><ul><ul><li>Typically 3-5 years; 4 is typical </li></ul></ul><ul><li>The “cliff” </li></ul><ul><ul><li>Period of time during which none of the stock (or options) vests. Typically the first year of employment. </li></ul></ul><ul><li>Monthly vesting </li></ul><ul><ul><li>Percentage of the stock (or options) which vests at the end of each month of employment. Depends upon total vesting time. </li></ul></ul><ul><li>Hint: Ownership percentage!!! </li></ul>
  18. 18. Vesting vs. Reverse Vesting <ul><li>Reverse vesting generally only applies to “founders’ stock” </li></ul><ul><ul><li>It really is a stock repurchase agreement with a similar schedule to vesting </li></ul></ul><ul><ul><li>Founders typically get 1/4 to 1/3 vested up-front </li></ul></ul><ul><ul><li>Founders own and can vote all shares as long as employed by the company </li></ul></ul>
  19. 19. Pricing Stock Options <ul><li>For public companies – current market value </li></ul><ul><ul><li>Different specific methods, but basically a ten day trailing average </li></ul></ul><ul><li>For private companies - ???? </li></ul><ul><ul><li>With venture backed firms, can use =>10% of last round price </li></ul></ul>
  20. 20. Region – Q3 ‘02 – PWC Moneytree $4.5B and 662 deals 1   0.01%      $1M   AK/HI/PR   3   0.07%      $3M   South Central   4   0.67%      $31M   Sacramento/ N.Cal    13   1.02%      $46M   Colorado   7   1.10%      $50M   Upstate NY   19   2.06%      $93M   Philadelphia Metro   12   2.18%      $99M   SouthWest    12   3.25%      $147M   North Central   25   3.88%      $176M   San Diego   40   4.39%      $199M   Midwest   39   4.48%      $203M   Northwest   32   5.79%      $263M   LA/Orange County   51   6.05%      $274M   DC/ Metroplex    41   6.09%      $276M   Texas   52   6.27%      $284M   NY Metro   68   10.33%      $469M   Southeast   83   12.34%      $560M   New England   160   30.01%      $1362M   Silicon Valley     Deals  Percent   Invested    Regions  
  21. 21. Industry – Q3 ’02 – PWC Moneytree 1   0.04%      $2M   Other     14   0.88%      $40M   Electronics/Instrumentation     15   1.72%      $78M   Retailing/Distribution     16   1.73%      $78M   Consumer Products and Services     14   2.19%      $99M   Healthcare Services     25   2.70%      $122M   Business Products and Services     31   2.92%      $132M   Media and Entertainment     20   3.27%      $148M   Financial Services     30   3.96%      $179M   Industrial/Energy     23   4.70%      $213M   Computers and Peripherals     42   5.21%      $236M   IT Services     30   6.03%      $273M   Semiconductors     39   7.49%      $340M   Networking and Equipment     49   9.54%      $433M   Medical Devices and Equipment     49   10.49%      $476M   Biotechnology     71   14.03%      $637M   Telecommunications     193   23.10%      $1048M   Software     Deals Percent Invested Industries  
  22. 22. Stage – Q3 ’02 – PWC Moneytree 35   1.26%      $57M   Startup/Seed   94   20.48%      $929M   Later Stage   162   20.88%      $948M   Early Stage   371   57.38%      $2604M   Expansion   Deals Percent Invested Stages
  23. 23. Alternatives <ul><li>SBIR Grants </li></ul><ul><li>Consulting </li></ul><ul><li>Garage </li></ul><ul><li>Virtual Team/Contingency Contracts </li></ul><ul><li>University Research </li></ul><ul><li>Joint Development </li></ul>

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