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Evaluation and due diligence of business angel investments

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Extract from a workshop on evaluation of business angel investments prepared for a workshop at EPFL, May 22, 2012. Contributors included Swiss business angels : Claude Florin, Frank Gerritzen, Balz Roth, , Pascal Dutheil, Diego Braguglia.

Published in: Economy & Finance, Business

Evaluation and due diligence of business angel investments

  1. 1. EVALUATION AND DUEDILIGENCE OF BUSINESSANGELS INVESTMENTSClaude Florin, A3 Angels 2 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  2. 2. Evaluation of projects impacts results % exits 70 60 50 40 30 20 10 0 less 1X to 5X to 10X to more than 5X 10X 30X than 1X 30X Less than 20 hours More than 20 hoursSource: Kaufmann foundation 2007 N= 539 BAs - 3’000 BA investments 4 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  3. 3. Assessing and mitigating market risksScenario analysis Uncertain predictions Market size Market dynamics Market needs Willingness to pay Target market 5 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  4. 4. Valuation mattersPrinciples Investment example A bad business at a good CHF 1M investment price is a looser CHF 20M exit A good business at a bad ROI simulation price is not a winner Pre-money Exit after 5 Exit after 7 Price matters valuation years years Pre-money valuation impact 1 58% 39% The future determines the 5 27% 19% value, not the past 10 13% 9% Source : Peter Pfister, CTI Start-up, 2010 8 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  5. 5. Team - Why does it matter so much? The product/service is what attracts attention People transform the project into reality No individual has an infinite array of qualities and competencies The observer (i.e. you!) matters as much as the one observedSource : Frank Gerritzen,, CTI Start-UP, Angel Days 2012 12 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  6. 6. Inventory of competenciesTeam Assesment bias Inventor or entrepreneur ? How to assess the personality Who is part of the team? and competencies of the Are competencies entrepreneur and founding overlapping or team? complementary? Usus magister est optimus! Beware your own experience and projections. Do not trust your instincts: objectivity! Source : Frank Gerritzen,, CTI Start-UP, Angel Days 2012 13 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  7. 7. Competencies vs. attitudeFrequent attitudes Life goals1. Resistance to change Include entrepreneur and team2. Difficulty to question own Driving factors competencies Looking for lifetime employment ?3. Infatuation with product / service / colleagues. Industry experience4. Lack of sales skills / willingness to Ready to give up CEO title ‘hit the road’ Paranoid, strong personality Source : Frank Gerritzen,, CTI Start-UP, Angel Days 2012 14 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  8. 8. Team organization and recruitment What do you bring to the table? What is the start-up looking for? Transparency, honesty and clarity (no hurt feelings!) Know your limitations as much as the entrepreneur’s Young Experienced entrepreneurs Business Angels 16CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  9. 9. Strong personality may impact performance Risk factorsPersonality Underperformance• Over confidence • Poor delegation• Reliance on of personal taste • Poor planning and opinion • Excessive optimism• Intuitive decision-making led • Lack of awareness of the by emotive factors environment• Education or experience • Inability to adapt to change. gaps• Resistance to advice 24 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  10. 10. Role of BA in the team “Bring something to the party”  Expertise Share strategy  Skills Manage problems  Time Act in good faith  Networking No self-serving interest  Money Young Experienced entrepreneurs Business Angels 25CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  11. 11. Team motivation with participation Salaries lower than the market rate but performance bonus Stock are a useful tool for start-ups. Shares : employee tax discount 6% year of the lockup period, max 60% (law revision 2010). Options : taxed at exercise date.(GE, VD if vesting period) Attract key management and Act as an incentive for employees achieving growth targets Cost effective method for Limit size of pool to prevent rewarding employees for the dilution of overall share extraordinary efforts value 28CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  12. 12. Investment sectors ICT, Software and Multimedia Medtech, biotech Environment, Energy and Health Creative industries Manufacturing, Food, Retail ServicesSource : Popular sectors for investments in EBAN 2008 survey 29CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  13. 13. Involvement in Company Lead investor Board member Advisor / coach / mentor Crisis management support Exit or next round of fund raising Passive 30CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  14. 14. «More or Less Correct» vs. «Completely Wrong» vsSource : Diego Braguglia, CTI Start-UP, Angel Days 2012 32 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  15. 15. Technology Adoption Life Cycle Mainstreet market Pragmatists: Conservatives: Use it when it’s ready! Make sure it’s ready! Early market Late market Skeptics: Techies: Visionaries: Never happen! Try it! Be the first mover! Bowling Alley Innovators Early adopters Early majority Late majority Laggards© Chasm Group 2.5% 13.5% 34% 34% 16% 33 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  16. 16. Assessing the target market # patients Market size Total value of segment Growth rate Accessibility Potential for reimbursement Market dynamics # competitors per segment Maturity of product/services Market penetration and share Revenue, profitability, pricing SWOT Market needs Intensity of competition (Porter) Investor interest in segment Variability of needs in segment Are needs met by current treatments Willingness Unmet needs and gaps to pay Openness of stakeholders to innovations Likelihood of adopting innovations Willingness to absorb costsSource : Stanford Bio design Target market 34CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  17. 17. Market size evaluation Market Size for product and / or technology to be correctly identified Top  Down Reports, Conferences, Web, Stats, … Bottom  Up Harvest “real” numbers from different sources Interviews with industry experts & veterans, sales reps, local players, Re-calculate the market size Top  Down and Bottom  UP estimations should be in the same log rangeSource : Diego Braguglia, CTI Start-UP, Angel Days 2012 35 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  18. 18. Market Size Identification Market Size for Product and / or Technology to be Correctly Identified Strength of the “selling proposition” New Markets to be created (i.e. social media, …) Prime Market vs. OEM “off label” sale potential Generic vs Branded Strength of Brand IP and Trade Mark …Source : Diego Braguglia, CTI Start-UP, Angel Days 2012 37 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  19. 19. Medtech market analysis Prevalence Market size 100000 ESRD 47% Cost / patient / year $ 274% Severe CKD 10000 190% Moderate CKD 15% Mild CKD 1000 0 5 10 15 20 % 10 100 1000 Mild CKD Total medical expenses $B Moderate CKD Severe CKD ESRDSource : Stanford Bio design 39 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  20. 20. “Shifts” Founder(s) Entrepreneur Manager Friends Team Organisation Science Product Market Prototype Trial/Small Scale Manufacture / Sale Unit: 1x Unit: 10x Unit: 100x $ $$$ $$$...$Source : Diego Braguglia, CTI Start-UP, Angel Days 2012 41 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  21. 21. Porter’s Five Forces Newcomers Ability of new entrants to start operations Suppliers Competitive environment Customers Relative Competitive Relative strength and strength of rival strength and number of firms number of sellers buyers Substitution Ability of new products products to replace existing products 48CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  22. 22. Medtech sales channels Yes Complex / expensive No medical device ? No dedicated sales Dedicated sales force force Complex High Low Yes No Volume ? product pipeline Sales force No Funding supports Yes Access to KOL relationships sales force ? 2-4 years Manufacturer Direct sales Specialized Hybrid model Distributor licensing force distributorSource : Stanford Bio design 53CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  23. 23. Evaluation of the product and technologyQuestions you should consider in relation to products Is or could the product/technology solving a core problem? What could be the applications the technology can be used for? Is the technology disruptive (By factors, not just 10%) e.g.: Faster Lighter Cheaper Less power consumption Etc. What is the status of the development (Research, prototype, industrialization)Source : Balz Roth, CTI Start-UP, Angel Days 2012 67 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  24. 24. Evaluation of the product and technologyBe aware:• You might not find the disruptive element in the product/technology but in the meta-system of potential client (E.g. Lemoptix: Pico-projector: unreached miniaturization makes it useful for mobile phones. Arktis: Reduction of false alarms in container ports)• Calculate the cost-, product-advantage of a potential client application to get a feel for the market demand, pull.Source : Balz Roth, CTI Start-UP, Angel Days 2012 68 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  25. 25. Evaluation of the product and technologyQuestions you should consider in relations to clients Are some clients already willing to pay for services, prototypes? Has the company identified the most promising application to “test the water”? Are they focused or just all over the place? Are they talking to engineers only or is there some pull from business development of the client company? Are they able/willing to develop the final product/services in an iterative way with clients?Source : Balz Roth, CTI Start-UP, Angel Days 2012 69 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  26. 26. Evaluation of the product and technologyBe aware: Don’t get dragged away by the technology. It’s all about the application, even if the startup does not yet know, which application might be the most promising one. What is the design in effort for the client? Even if the technology might have a huge advantage for the client, if his own engineering effort is substantial he might be reluctant. The “pain relieve” for the client is the key, not the nice technology!Source : Balz Roth, CTI Start-UP, Angel Days 2012 70 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  27. 27. Intellectual Property Rights - Intangible assets Patent Copyright Design Author right Trademark Trade secrets Domain names Know How Topography Plant varieties 71CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  28. 28. IP Due DiligenceGranted Patents Patent Applications Granted claims covering the Assess patentability of existing product on the market patent applications Maintenance fees (annuities) Scope of protection (Interpretation paid ? of the claims may differ from one Appropriate territorial coverage country to another) Assess FTO and enforceability of Further searches may be needed IPR to ascertain patentability Review licensing policies Ownership of rights Review the register for security Take into account the 18 months interests ‘blind period’ 73 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  29. 29. Decision to apply IP ProtectionPros Cons protection from infringement risk of disclosure of sensitive competitive advantage knowledge returns on R&D investments long, complex and costly increasing company value procedures licensing revenues potential difficulties in raising image of company enforcement of IPRs security for investors short life-cycle of products lack of knowledge 74 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  30. 30. Evaluation of the product and technologyQuestions you should consider considering IP, patents Who owns the IP, it is protected & has freedom to act Do the have a second opinion report, e.g. CTI label package? What’s the patent all about? Can it easily be circumvented (Most of them can)?Source : Balz Roth, CTI Start-UP, Angel Days 2012 76 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  31. 31. Evaluation of the product and technologyBe aware:• Can you defend a patent as a startup? Most likely you cant. Think about ways to protect your IP differently (E.g. produce the building blocks with different outsourcing partners)Source : Balz Roth, CTI Start-UP, Angel Days 2012 77 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  32. 32. Evaluation of the product and technologyTake away: Connect the dots, try to think about the meta-system: the client application the clients effort to use the particular technology Iterate 3h First meeting, read docs, are there enough green lights? 3 days Are the red lights manageable, what do clients say? 3 month Interview with field experts, IP analyses, etc. Don’t analyze endlessly, rather stop, you never know it allSource : Balz Roth, CTI Start-UP, Angel Days 2012 78 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  33. 33. IP Due DiligenceRegistered Trademarks Trademark applications Check effective use of the Assess registrability (availibilty trademark searches) Renewal fee paid ? Ownership of rights Appropriate territorial coverage Review licensing policies Review the register for security interests Review commercial agreements (exclusivity …) 79 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  34. 34. Patents Exclusive right or monopoly to prevent competitors from manufacturing, using, selling, offering for sale, importing the invention in a specific territory for a limited time. Protect inventions that are new, involve an inventive step and are susceptible of industrial application. They protect : Technical characteristics / features (product claim) Process of manufacturing or functions (method or use claim) 20 years from filing date (+5 years for medical 85CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  35. 35. Trademarks ® ™ Sign for distinguishing goods and services from competitors on the market place May take different forms (word, image, logo, sound, smell, three dimensional representation …) Not limited in time Protection for specific goods or services in a determined territory Prevent others from using, selling, offering to sale, advertising identical or similar products or services under the registered trademark 87CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  36. 36. Designs ® Protect the aesthetical aspect (two or three dimensional, shape, contour, line, appearance, colour, texture …) of a product for a limited time in a specific territory. Criteria for registration Novelty (Prior disclosure prevents obtaining a valid design) Original creation (Not original if the overall impression only distinguishes from existing designs by minor characteristic) Registered for five years, may be renewed for 4 additional 5 years periods 89CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  37. 37. Copyright / Author Right © Protects the original work of an author. books, manual, maps, charts, prints, musical compositions, dramatic works, photographs, paintings, drawings, sculptures, motion pictures, computer programs, sound recordings, choreography and architectural works Protects the expression or the materialization of an idea, not the idea or concept itself Automatic protection, does not need registration (use of the © copyright, [date], [name], all rights reserved) mention recommended Duration 70 years after the death of the author International recognition (Bern convention) 90CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  38. 38. How to Protect IP and Manage it ? Keep invention related information confidential Use Non-Disclosure Agreement in preliminary discussions, studies or collaboration with sub contractors or academics Determine ownership of IPR Assess patentability of the invention (prior art searches) Determine a strategy for protecting the invention File and prosecute patent applications Monitor the market and enforce IP rights 95CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  39. 39. Choose your VC VCs will become your partners and you will spend a lot of time & energy with them > Choose them carefully; Target equity at exit is not a function of initial equity stake but the reflects of the company strategy; Equity at exit depends on: Technology success; Negotiation power; Market; Competition.Source : Diego Braguglia, CTI Start-UP, Angel Days 2012 107 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  40. 40. The VC’s new Investment Model Same as before for the beginning of the story (Company creation with 100k, founders and F&F are shareholders), but… Once the business model is in place, the first round of investors come into the company. Ideally some smart money together with deep pockets to follow over time. Small investment “to see”… This shareholders’ group is ready to support the company even in rough times as long as the end goal is still in sight and reachable with reasonable means. Else down-rounds occur frequently. New investors may be attracted at a later stage, depending on the actual cash needs of the company. Will not happen at a “huge” premium towards initial investors. Exceptions are always possible! Only investors with long term view and deep pockets might end-up having healthy portfolios.Source : Diego Braguglia, CTI Start-UP, Angel Days 2012 111 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  41. 41. Some Lessons Learnt What comes out of our experience … A game is not won (or lost) until is really over; Always think a couple of strokes in advance; Common sense is key; Grab your luck when you recognize it; Endurance, Endurance, Endurance; Timing is keySource : Diego Braguglia, CTI Start-UP, Angel Days 2012 112 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  42. 42. Some Lessons Learnt II Consider fully funded scenarios only; Ensure full support of investors and co-investors in rough times; Start with very small amounts; Be patient; Ensure support of larger funds; Back mainly big ideas; Small ideas have to be “cheap” or avoided…Source : Diego Braguglia, CTI Start-UP, Angel Days 2012 113 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  43. 43. Levels and methods of valuation Investor‘s Capital Cash Operating expenses Customers Company expenses payment Outflow costsInvestor Investor‘s Dividends Cash Operating earnings return + capital Inflow revenues „VC“ •Discounted cash-flow , method •Multiples (comparables) 114 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  44. 44. Valuation on the timeline Par Value Price a Price b Final Price Time Foundation Intermediate Valuations Most (with up- and downrounds) important Valuation Pie Financing Rounds Exit Calculator (Trade Sale, watch out for IPO issues)Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 116 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  45. 45. Valuation: two views Company’s View (DCF Method classical) Company Value = CV Sum of discounted FCF + Continuing Value discounted CV 1 2 3 4 5 ∞ tInvestor’s View(Venture Capital Method)IRR (Internal rate of return) EXIT ValueSum discounted CF = 0 1 2 3 4 5 tSource : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 119 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  46. 46. Success rateNumber of Category ProbabilityProjects (in %) Highflyer (IPO) 1-2 Star (Trade Sale) 10-20 % Successful EXIT LifeStyle company 3-4 Survival mode 30-40 % Bankruptcy 5-6 Failure 50-60 % Winding downSource: Rule of thumb of the VC industry. 120 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  47. 47. Expected return by stage of company Project stage Expected Return Multiplicator (p.a.) (holding period: 5 Years) Seed 60-80 % 10.5 - 18.9 x Start-up 50-70 % 7.6 - 14.2 x First stage 40-60 % 5.4 - 10.5 x Put those numbers in relation the expected success rates and the VC Business model!Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 121 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  48. 48. Business model Venture Capital Initial situation : VC Company with CHF 10 Mio. in funds 10 Investments of CHF 1 Mio. in Start-up All Exits in 5 years Data Factor Return Target IRR for all projects 40% 5.3 x Highflyers / Star (successful exit) 2 5.3 x CHF 10.6 Mio. Lifestyle companies (buyback founders) 4 1x CHF 4.0 Mio. Bankruptcy 4 0x 0 Return of VC in 5 years CHF 14.6 Mio. Return of VC in % p.a. (IRR) 8% (calculated on profit of CHF 4.6 for 5 years)Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 122 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  49. 49. Business Angel methodsBerkus Method Meier Method Sound idea CHF 1 Mio. 1 Manager CHF 1.5 Mio. Prototype + CHF 1 Mio. 2 Managers + CHF 1.5 Mio. Quality mgt team + CHF 1-2 M. Value Range: CHF 1.5 - 6 Mio. Quality board + CHF 1 Mio. Any roll-out, sales + CHF 1 Mio. Value Range: HF 1 - 6 Mio. Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 126 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  50. 50. Business Angel methods Rule of thirds Morbitzer method 1/3 Founders Businessidea CHF 0.75 Mio. 1/3 Management Tea Mgt Team CHF 1.5 Mio. 1/3 Investor (BA) Prototype (PoC) CHF 0.75 Mio. Board/Investors CHF 0.75 Mio. Total CHF 3.75 Mio.Price range method -Value add investor CHF 0.75 to 1.0 Mio.Only consider to invest if: Valuation CHF 2.75 - 3 Mio.Valuation range proposed byfounders is CHF 2 - 5 Mio.Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 127 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  51. 51. Valuation of an high potential venture (1)Lemoptix case study What do we need ? 24-month old technology company, 1. Risk adjusted cost of capital (IRR) Successfully beta-tested its product 2. Capital Need (investment) Seeking $2 million of venture capital to 3. Exit timing of investor go into volume production and 4. Exit Value: distribution. -Future earnings and profits (NP = net Forecasting sales revenue of $30 profit) million with net income of $5 million in 5 -Comparable P/E years. What percent of the equity will the venture capitalists require? Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 128 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  52. 52. Pre- and post-money valuation Post-money valuation CHF 9.5 Mio 100 % -Investment CHF 2.0 Mio. 42 % Pre-money valuation CHF 7.5 Mio. 58 %Source : Jean-Pierre Vuilleumier, Angel Days 2012 © CTI -Invest 131 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  53. 53. Internal rate of return (IRR) to compensate risk Years Years IRR % Multiple 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 - - - - - - - 0% 1.00 1.00 1.00 1.00 1.00 1.00 1.00 2 100 41 26 19 15 12 10 5% 1.05 1.10 1.16 1.22 1.28 1.34 1.41Multiple 3 200 73 44 32 25 20 17 10% 1.10 1.21 1.33 1.46 1.61 1.77 1.95 4 300 100 59 41 32 26 22 5 15% 1.15 1.32 1.52 1.75 2.01 2.31 2.66 IRR % 400 124 71 50 38 31 26 6 500 145 82 57 43 35 29 20% 1.20 1.44 1.73 2.07 2.49 2.99 3.58 7 600 165 91 63 48 38 32 25% 1.25 1.56 1.95 2.44 3.05 3.81 4.77 30% 1.30 1.69 2.20 2.86 3.71 4.83 6.27.xls function 35% 1.35 1.82 2.46 3.32 4.48 6.05 8.17 = IRR(values, guess) 40% 1.40 1.96 2.74 3.84 5.38 7.53 10.5 e.g.: IRR(D1:D:60,0.3/12) monthly or annual compounding 136 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  54. 54. Valuation mattersPrinciples Investment example A bad business at a good CHF 1M investment price is a looser CHF 20M exit A good business at a bad ROI simulation price is not a winner Pre-money Exit after Exit after Price matters valuation 5 years 7 years Pre-money valuation impact 1 58% 39% The future determines the 5 27% 19% value, not the past 10 13% 9% Source : Peter Pfister, CTI Start-UP, 2010 137 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  55. 55. Discounted Cash Flow Net residual value Discounted by capital costs Net value of the free cash-flow during the planning period Point of time of valuation 0 1 2 3 4 5 >5 Planning period Residual value 142CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  56. 56. Discount rates Stage Discount CAPM Seed stage 70-100% 4-14% Start-up stage 50-70% 4-14% First stage 50-70% Second stage 35-50% Later stage 25-40%Source: Patrick Frei & Benoît Leleux 143CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  57. 57. Every method gives a different valuationDiscounted Cash-Flow Multiples Often over estimates real value Simple– no negative numbers Uncertain assumptions Time value not considered Not applicable for growth Just a high-level forecast companies year 2011 2012 2013 2014 2015 2016 turnover multip 0.5 0 250 1,000 2,500 5,000 10,000 1.0 0 500 2,000 5,000 10,000 20,000 1.5 0 750 3,000 7,500 15,000 30,000 annual growth of the residual value 2.0 0 1,000 4,000 10,000 20,000 40,000 8% 10% 15% 2.5 0 1,250 5,000 12,500 25,000 50,000 35% 4,850 5,144 6,135 40% 3,351 3,517 4,048 year risk ratio 2011 2012 2013 2014 2015 2016 45% 2,359 2,458 2,766 5.0 neg. neg. neg. 2,500 10,000 25,000 EBIT-Multiple 50% 1,675 1,737 1,926 6.0 neg. neg. neg. 3,000 12,000 30,000 55% 1,190 1,230 1,351 7.0 neg. neg. neg. 3,500 14,000 35,000 8.0 neg. neg. neg. 4,000 16,000 40,000 9.0 neg. neg. neg. 4,500 18,000 45,000 145 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  58. 58. Growing annuity A growing stream of cash flows with a fixed maturity. C C×(1+g) C ×(1+g)2 C×(1+g)T-1 … 0 1 2 3 T Present value of a growing annuity: 149CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  59. 59. Comparables (public companies Europe)Industry EV/EBITDA EV/EBITBiotechnology NA NACommunications Equipment 5.33 7.75Computer Hardware 4.91 7.40Consumer Electronics 3.44 6.35Consumer Finance 42.67 49.19Electronic Components 3.70 6.39Electronic Equipment and Instruments 5.62 8.01Health Care Technology 5.51 10.45Home Entertainment Software 4.17 31.04Integrated Telecommunication Services 5.17 10.28Internet Retail 13.73 18.41Internet Software and Services 8.03 22.55Semiconductor Equipment 4.65 6.37Semiconductors 6.31 NASystems Software 6.27 8.90Wireless Telecommunication Services 6.61 12.17Source: Damodoran on-line 153 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  60. 60. Comparables (public companies Europe)Industry Group Price/Sales Net Margin EV/Sales Pre-tax Operating MarginBiotechnology 4.72 -11.84% 4.63 -4.23%Computer Software 2.89 11.09% 2.94 18.16%Computers/Peripherals 0.85 8.62% 0.84 10.23%Electronics 1.29 5.48% 1.41 10.25%Electronics (Consumer & Office) 0.81 3.21% 1.00 7.77%Heathcare Information andTechnology 1.61 5.47% 1.79 10.84%Heathcare Products & Services 2.85 14.19% 2.97 19.21%Internet software and services 1.62 4.63% 1.68 6.87%Pharma & Drugs 2.22 15.48% 2.57 24.46%Power 0.89 7.69% 1.62 14.59%Semiconductor 1.40 1.42% 1.53 6.42%Semiconductor Equip 2.33 11.85% 2.27 19.44%Telecom (Wireless) 1.83 23.63% 2.46 16.07%Telecom. Equipment 0.80 2.54% 0.84 6.53% 154 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  61. 61. Creating a startup is a tough journey!Many interesting projects do not take off, or die… Growth Industrialisation Product development Financing Commercial validation CommercialisationProject Technical validation 158CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  62. 62. To build a successful startup, one must: “Solve an important, valuable problem… For clients who have money… Who want to pay well… With a short sales cycle… And will buy more, soon” 159 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept SàrlSource: Index - Adapted from Ken Morse, MIT
  63. 63. The process Timeline and milestones Investments criteria SWOT and strategic analysis Due diligence Contract, term sheetDeal flow Deal Due Investment Structure Investmentgeneration screening diligence decision transaction management 160CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  64. 64. Investment process 50% Screening Evaluation 4 Months Due diligence Investment 1% 161CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  65. 65. Due diligence process as an ongoing dialogue Entrepreneur Business Angel Negotiations Introduction Deal flow of business Pitching identification opportunity Valuation Business plan Due diligence discussions Investment Shareholder Financing readiness agreement 162 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept SàrlSource: fiban.org
  66. 66. Steps in the investment process Stage Evaluating B. Plan Due diligence Negotiation Monitoring EXIT Entrepreneur Prepare Business Plan Provide information Disclose all relevant Provide periodic business information management Contact investors accounts Communicate with investors Entrepreneur & Meet to discuss BP Negotiate final terms investor Build relationship Document constitution Outline terms and voting rights Liaise with external consultants and accountants Investor Review the Business Conduct enquiries Draw up completion Seat on board ? Plan Value the business documentation Monitor Consider financing investment structure Constructive input Initiate external DD Involvement in major decisions Reports Business Plan Offer letter Disclosure letter Management Consultants reports Warranties and accounts Accountant reports indemnities Minutes of boards Memorandum and and other articles of association meetings Shareholder agreementSource : Guide to private equity, BVCA / PWC, 2003 165CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  67. 67. Investors are evaluating a number of parameters 166CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  68. 68. Four main risks to evaluate Product risk Technology, patents Financial risk Expenses, refinancing People risks Entrepreneur, team Market risks Business model, customer demandSource : Peter Pfister, CTI Start-UP, 2010 168 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  69. 69. Top Investment criteriaSelected Criteria BAs VCsEnthusiasm of the entrepreneur(s) 1 3Trustworthiness of entrepreneurs(s) 2 1Sales potential of the product 3 5Expertise of the entrepreneur(s) 4 2Investor liked entrepreneur(s) upon meeting 5 9Growth potential of the market 6 6Quality of the product 7 10Perceived financial rewards (for investors) 8 4Niche market 9 13Track record of the entrepreneurs 10 8Source : Mark Van Osnabrugge and Robert J. Robinson, Angel Investing, 2000 172 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  70. 70. Business modelKey Partners Key Activities Value Customer Customer Propositions Relationships Segments Key Resources ChannelsCost structure Revenue streams 174CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  71. 71. Financial Forecasts© Dilbert – International Herald Tribune 17.09.2011 177CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  72. 72. Five Types of Start-ups – Be aligned ! Lifestyle Work to live their passion Small business Work to feed the family Scalable start-ups Born to be big Buyable start-ups Born to Flip Social start-ups Driven to make a differenceSource : Steve Blank’s blog, Sept 6th, 2011 178 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept Sàrl
  73. 73. Due Diligence ProcessSource: http://www.angelcapitalwiki.org/mediawiki/index.php5?title=Due_Diligence 181CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl
  74. 74. Due Diligence Process Extreme A Best Practice Extreme B Eyes-wide-shut Reasonable Exhaustive due investing investigations diligence Forget cardinal rule : To ensure as far as See themselves as killer ideas + possible that financial moguls profitable business entrepreneurs can do rather than mentors what they say with money 182 CTI Commission for Technology and Innovation | Start-up program Supported by Venture Concept SàrlSource: http://www.angelcapitalwiki.org/mediawiki/index.php5?title=Due_Diligence
  75. 75. Due Diligence checklistTrack record of the managementSize and growth potential of the marketDemand for product/service among target customersAbility to deliver product/service on time and at agreed priceCompetitive advantage of the productCompetitorsMarketing and distribution plansSoundness of financial projectionsAssessment of the intellectual property rights, if anyExisting or possible legal contingenciesValuation for the ventureSource : Mark Van Osnabrugge and Robert J. Robinson, Angel Investing: Matching Start-Up FundsWith Start-Up Companies 183CTI Commission for Technology and Innovation | Start-up program Supported byVenture Concept Sàrl

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