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  1. 1. RAISING VENTURE CAPITAL: MANAGING THE PROCESS FOR A MEDICAL START-UP Presented by: Fred Dotzler, Managing Director De Novo Ventures When raising venture capital, operating experience; vital network firms considering an investment in your connections to potential management, company. Its focus is primarily on three thorough planning will help you board members and professionals variables: your management team, obtain sufficient funds to achieve (patent attorneys, law firms, consult- market opportunity and technology. ants); and help in achieving liquidity your milestones at an acceptable through a merger, acquisition or initial Prepare a list of references on key man- valuation, from value-added public offering. agement team members, with names, investors and with minimal addresses and phone numbers. Also Plan to complete the financing as develop a list of references on your disruption to your company. quickly as possible so that the disruption technology – perhaps your scientific Today I will offer you some and diversion of management doesn’t advisory board or experts in the field. A guidelines for success. cause your company to falter. list of your customers or beta sites will be valuable. If your product is not Fund Raising Essentials developed, compile a list of people who The amount of money you plan to raise will attest to its need. should be enough to enable you to Before you begin raising venture capital, accomplish key milestones that will prepare a written business plan. This If you have been in business for a year or either make your company self sufficient document should include an executive more, investors are likely to request or will enable you to raise additional summary, followed by an overview of audited financial statements. Most inves- funds at a higher valuation. Ideally, your markets and marketing, technology and tors will also review issued and pending current round of financing should have a products, clinical/regulatory plans, patents. Have your patent firm prepare a valuation above the last round price (if manufacturing and operations, the status report on your patents, so you can there was previous financing). Higher management team, and financials. The verify that your products are proprietary valuations enable management to own a financial section should have a discus- and that you are not encumbered by the greater percent of the company. sion of your capital requirements and patents of others. how the money will be used. Typical Seek the backing of value-added venture business plans are 20 to 50 pages in Timing Is Important capital investors who can help to length. (See Table I.) increase the worth of your company. Begin raising money well before your These investors can offer strategic Your next step is to prepare for the due coffers are empty. Venture financings advice based on their knowledge of your diligence process. “Due diligence” is the can be completed in one month but may industry; guidance stemming from prior analysis and evaluation conducted by take as long as four months.
  2. 2. The time to begin raising venture capital TABLE I network as well as references to evaluate is after you complete a significant value- each venture capital firm’s reputation. BUSINESS PLAN OUTLINE added step. Major increments in value Determine if the firm has added value to usually accrue in management team I. Executive summary/company strategy its portfolio companies. Also try to recruiting, technology development and II. Markets/marketing gauge the personal chemistry between market verification. (See Table II.) The A. Markets you and the firm’s partners. B. Competition capital you raise should be enough to C. Forecasts enable you to achieve your company’s D. Selling and distribution If you plan to raise additional money in next set of milestones, which will either III. Technology/product the future, target venture capital inves- take you to liquidity or increase your A. Technology description tors who will have money to support valuation and allow further financing. B. Development plan another round of financing. C. Proprietary protection Be sure your milestone objectives are IV. Clinical/regulatory plans Because some venture capital prospects achievable. Raising new venture capital V. Manufacturing and operations will not be prepared to invest at your is difficult when you fail to achieve the A. Facilities proposed price, send business plans to objectives that were established for a B. Equipment more investors than you need. If you are C. Process previous financing. raising $3 million, for example, send D. Cost of goods sold plans to enough firms to complete a VI. Management team Try to avoid raising money during the VII. Financial review $6 million financing. Don’t send your summer or between Thanksgiving and A. General discussion plan to too many firms, since this deper- New Year’s Day. Many venture capital B. Profit and loss sonalizes your approach and makes your partnerships require investment approval C. Balance sheet company appear “shopped around.” by all partners, some of whom may not D. Cash flow (sources and uses) be available during these periods. VIII. Risks Managing the Evaluation IX. Appendices Targeting Venture Firms After you identify and screen potential If you have previously raised venture investors, send a business plan to those Presently 625 venture capital partner- capital, determine whether existing who have expressed an interest in your ships manage over $30 billion dollars. investors plan to invest again. The company. Someone from the venture These firms specialize by industry, failure of current investors to support the capital firm – preferably a partner who geography and stage. Some invest small company will dramatically reduce your can make decisions and speak for the amounts, $50,000 to $100,000, while chances for a successful financing. partnership – will then begin the due others will not join a financing syndicate diligence process, evaluating the data if they cannot invest $1.5 million dollars Target lead investors. They tend to have and information you divulge in your or more. Determine the preferred invest- a solid reputation, and they are able to business plan. The following are tips on ment range of the firms you target, to attract other venture capital firms into managing this due diligence review. ensure that your financial objectives are the financing syndicate. Lead investors compatible with theirs. usually negotiate the terms of the deal. I. Tell Everything – Disclose both If you currently have lead investors who good news and bad news. Venture Also try to identify venture capital part- are willing to lead the new financing, capital investors are realistic and don’t nerships which have invested in your your job is simplified. expect everything to be perfect. If you industry and your geographic region. fail to identify potential problems or The experience they have acquired with Ask potential investors if they require a risks, you will have unhappy investors other companies in related (but not board seat or are content to be passive. who will question your integrity if these competitive) markets will be helpful to You may need to expand your Board of problems surface after they invest. you. It’s important to ask whether they Directors in order to obtain funding. have competing investments that would II. Ask for Feedback – Solicit feedback preclude their consideration of your You will spend a lot of time with your periodically so you can gauge whether company. investors over several years. So use your or not prospective investors are seriously
  3. 3. considering your company. If a high percentage do not appear positive, you TABLE II may want to increase the number of firms you contact. ADDING MANAGEMENT VALUE Typical statements that suggest a lack of Human Resources Vice President investment interest include the follow- Chief Financial Officer ing. “We have a lot on our plate.” “We’re Manufacturing Vice President presently raising money for a new part- Value Regulatory/Clinical nership.” “It’ll take us awhile to get up to Controller speed.” “Call us when you have a lead Marketing Vice President investor.” “We’ll be in your area in three President weeks.” “We haven't invested in com- Chief Technologist panies like yours before.” No contact Milestones from the firm for seven days often means you are not a top prospect for them. ADDING TECHNOLOGY VALUE III. Reserve Time – Allocate sufficient time for your management team to Market Introduction complete the financing. You can expect FDA Approval members of senior management to spend Human Clinical Trials up to 50% of their time interfacing with Value Animal Testing In-Vitro Proof investors and answering questions prior Patent Application to closing the financing. Feasibility or Prototype Concept IV. Manage Cross Talk – If your com- Milestones pany is being evaluated by several inves- tors, try to manage the communications among them. Venture capitalists will ask ADDING MARKETING VALUE for the names of other firms considering an investment. Don’t divulge the names Backlog until one of the firms signals an intent to Satisfied Customers negotiate, because both positive and Market Launch Value Clinical Results Published negative biases will be amplified. Surveys/Concept Testing V. Negotiate Price and Terms – Qualitative Research (Focus Groups) When a venture partnership concludes Market Analysis - Published Data that it wants to invest, suggest a price at Milestones which you would like to complete the financing; but be flexible. When a firm makes an offer, determine how it was adverse terms that might offset a favor- rates of return expected by venture calculated. If the offer is not acceptable, able company valuation. capitalists at various stages of invest- ask if the price is negotiable. Many ment. Create a financial model for your investment offers have fallen apart VI. Analyze the Investment from the company, making assumptions about because of management intransigence on Perspective of the Venture Capitalist – when you will raise additional money the valuation. Also pay careful attention Calculate the rate of return you are and how much cash you will need; then to the investment terms (the liquidation offering investors to insure it is accept- project a liquidation value. Calculate the preference, redemption rights, etc.). able to the venture partnerships you are amount owned by each investor and Good legal counsel will help you avoid targeting. Table III shows representative determine each investor’s rate of return.
  4. 4. VII. Request Return of Plans – After Venture Proposed was raised, of which $3.1 million was the financing is complete, send a letter Capital Price Investment from current investors. The post- to the firms which do not invest. Thank Partnership Per Share (000) financing valuation was $17.0 million. them for evaluating your opportunity, and request they return the business plan A $ 3.50 $ 1,500 Closing Comments B $ 5.50 $ 1,500 and other confidential information. C $ 4.75 $ 2,000 As illustrated by this example, the best D $ 6.00 $ 500 time to raise venture capital is after you An Example To Guide You E $ 5.10 $ 1,300 have completed a value-added step and An analysis of patents in process raised have written a business plan. Direct your To clarify certain points I have made, concerns with Investor B. Although the efforts toward reputable venture capital suppose that Medcap, a venture capital partnership, received a business plan patent counsel for Investor B confirmed firms which have previously invested in the strength of the patents, the company your industry. Prepare carefully for the from NewCo, a start-up company, in and Investor B agreed to a new price of due diligence process, and leave nothing February 1987. The company’s founders had developed a prototype of a medical $5.25 per share with Investor B taking to chance. Successful venture capital the lead. A total of $4.6 million dollars financing requires thorough planning. device. The product was a single-use device with a high gross margin; the TABLE III estimated market size was $200 million; and the capital required for development EXPECTATIONS AT VARIOUS STAGES and testing was projected at $1.5 mil- Financing Business Objectives Expected Time To Liquidity lion. A patent application had been filed. Round (capital use) Annual Return (IPO or merger) Seed Product Research 75 - 100% 5 - 8 Years After four weeks of due diligence, Market Research Medcap invested $1.5 million in NewCo Preliminary Plan at a price of $1.50 per share. Based on Start-up Product Development 50 - 75% 4 - 7 Years this price, the company’s valuation was In-Vitro/In-Vivo Proof $1.8 million before the venture financ- Complete Management Team Confirm Market Size ing and $3.3 million afterwards. (The pre-financing valuation equals the total 1st, 2nd, 3rd Clinical Trials 30 - 50% 3 - 5 Years rounds Selling number of shares outstanding prior to Manufacturing the new financing, multiplied by the Expand Work Force price per share of the financing. The Mezzanine Prepare For IPO 25 - 30% 1 - 2 Years post-financing valuation adds the total Public offering Market Development 10 - 20% Immediate amount of money being raised.) New Products In April of 1988, a business plan for NewCo's next round of financing was prepared and mailed to five venture DE NOVO capital firms. At this time, the company V E N T U R E S was preparing to launch its first product, and a second product had been devel- De Novo Ventures is a lead venture capital investor focusing on the oped. A Director of Marketing and a early stage financings (the seed, start-up and first round) of medical Chief Financial Officer had been hired, companies in the western U.S., particularly in California. and production for the second product had been scaled up. De Novo Ventures 1550 El Camino Real, Suite 150, Menlo Park, CA 94025 By the end of May, all five partnerships 650-329-1999 FAX: 650-329-1315 offered to invest in the company, at the www.denovovc.com following prices per share and amounts. ©2001 De Novo Management