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Everything You Need to Know about Preemptive Rights

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Have you been following the growing trend in continuity funds?

Listen to our 30-minute session with OurCrowd Investment Partner David Stark to learn how professional investors use preemptive rights to get further involved in winning companies.

• Get an insider’s view of how to leverage preemptive rights in startup investing
• Understand the basics of continuity funds and review case studies
• Learn how to get involved at a time when companies are staying private longer

Published in: Investor Relations
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Everything You Need to Know about Preemptive Rights

  1. 1. 1 Grab your seat at the table What you need to know about preemptive rights David Stark Investment Partner Presented by:
  2. 2. Legal Disclaimer The information contained in this presentation is provided solely for informational purposes and does not constitute an offer or solicitation of investment in any OurCrowd limited partnership. Anything contained in this presentation should not be construed as creating a presumption by you or OurCrowd that you are an accredited investor. The offer to invest in any OurCrowd limited partnership related to any company can only be made on the OurCrowd website and only to investors who have been fully qualified as accredited investors in accordance with the laws and regulations of their respective jurisdictions. OurCrowd makes no representation or warranty, express or implied, with respect to any data provided to you regarding any information provided by the companies on its web site or in this presentation, and will not be liable in any way to you or to any other person for any inaccuracy, error or omission of any company data. Please be aware that investments in early stage companies contains a high level of risk and you should consider this prior to making any investment decisions
  3. 3. Educational Webinar Series Previous Educational Webinars: 1. The Changing Relationship Between Investors and Investments 2. How High-Net-Worth Investors Stay Ahead 3. Conquering the Term Sheet: Everything you need to know about deal terms (3-part webinar series) 4. Cashing in: How to make money investing in startups 5. From Ideas to Assets: Common Investor Pitfalls with Intellectual Property and How to Avoid Them
  4. 4. Agenda Two important topics: 1. The most important principle in venture investing: Power Laws 1. The most important right in venture investing: Preemptive (aka Pro Rata) Rights
  5. 5. The exponential arc of success “Successful businesses tend to have an exponential arc to them. Maybe they grow at 50% a year and it compounds for a number of years. It could be more or less dramatic than that. But that model — some substantial period of exponential growth — is the core of any successful tech company. And during that exponential period, valuations tend to go up exponentially.” – Peter Thiel (PayPal and Palantir founder, angel investor in Facebook) “Exceptional performance … attracts new resources as well as rewards that facilitate continued high performance [repeat].” – Robert Merton (sociologist)
  6. 6. VC Returns Follow a Power Law Curve • Bulk of returns are generated by a small percentage of investments: “80/20 Rule” • According to Horsley Bridge, a longtime limited partner in vc funds, about ~6% of their hundreds of vc investments since 1985 generated ~60% of the total returns. “The task of a venture capitalist is to experiment on a trial and error basis in order to discover success from within a portfolio.” – Tren Griffin (Microsoft)
  7. 7. Quick Aside: Swing for the Fences Via Chris Dixon
  8. 8. Fred Wilson: “Early stage investing is a lot like poker.” • If your hand is getting stronger, you increase the betting, putting more money at risk in each subsequent round. That’s how smart poker players win and its also how smart VCs win. Fred’s Poker Analogy blog can be found in full here.
  9. 9. This is why the preemptive (aka pro rata) right is the most important right in venture capital. Definition: A preemptive right is the right of a shareholder to maintain a current share of the ownership of a company by purchasing a proportionate share of any new stock issues. Implication: Preemptive rights protect an investor’s ability to continue betting on the winning hands within the portfolio. Who gets them: All shareholders or “Major Investors”? Suggested reading: Mark Suster’s Authoritative Guide to Prorata Rights
  10. 10. Preemptive example: AirCnC Example: • Investor A owns 10% of a startup called AirCnC • AirCnC is doing really well and is approached by Investor B to lead a subsequent $10M financing round • Thanks to preemptive rights, Investor A has the right to invest an additional $1M (and maintain a 10% stake) in AirCnC Preemptive rights are not just a right, they are an asset.
  11. 11. …which is more valuable now than ever since companies are raising more money prior to exit… Source: Dow Jones VentureSource and SEC filings via WilmerHale
  12. 12. …and all of the value capture is occurring while companies are still private. Source: Andreesen Horowitz
  13. 13. …and all of the value capture is occurring while companies are still private.
  14. 14. The Opportunity Fund Trend ”Every venture firm wants to invest in the handful of companies that generates the highest return. They compete vigorously for the chance to invest in these companies. Some compete on the basis of their brand. Some offer to pay the highest price. Others suggest they can bring strategic value, or that they have unique insight using a data- driven approach. Yet those who pioneered opportunity funds recognize that, while everyone competes to invest in the best companies, there is a better way to get access to these very best companies – and that is to already be an existing investor.” – John Backus (National Venture Capital Association)
  15. 15. Case Study #1: USV’s Opportunity Fund ($135M) Fund Name Vintage IRR Union Square Ventures 2004 Fund 2004 67.20% Union Square Ventures 2008 Fund 2008 28.30% Opportunity Fund 2010 2010 62.52% Union Square Ventures 2011 Fund 2011 41.80% Opportunity Fund 2014* 2014 3.75% Union Square Ventures 2014 Fund* 2014 -19.83% “At USV, we recognized the importance of pro rata early on but did not know what to do about it. So we let our pro-rata rights go unused in Zynga and Twitter because we did not have the funds to take those allocations... (The Opportunity Fund) will allow us to continue to invest in our most established and successful companies,” - Fred Wilson, USV Source: Pitchbook April 2016 *IRR of 2014 Funds likely reflects J-curve of all young funds.
  16. 16. Case Study #2: Foundry Group Select Fund ($225M) “The Foundry Group Select Fund will invest solely in our Foundry Group and previous funds’ portfolio companies that have achieved significant success… Up until this point, we’ve been limited in the amount we can invest in these rounds due to our early-stage strategy.” - Brad Feld, Foundry Group Fund Name Vintage IRR Foundry Venture Capital 2010 Annex 2015 -0.29% Foundry Group Select 2013 99.65% Foundry Venture Capital 2013 2013 25.12% Foundry Venture Capital 2010 2010 15.26% Foundry Venture Capital 2007 2007 52.47% Source: Pitchbook April 2016
  17. 17. “We're going to do our pro rata investment for every YC company in every round with a valuation below $300 million...” - Sam Altman, YC Case Study #3: Y Combinator Continuity Fund ($700M)
  18. 18. “We have a lot of really attractive later stage companies with pro-rata rights to invest.” - Danna Settle, Greycroft Partners Case Study #4: Greycroft Growth Fund ($200M) “Our most successful companies have all gone on to raise growth financings… The ability to have dry powder to support our best companies is a valuable asset for those entrepreneurs.” - Ian Sigalow, Greycroft Partners
  19. 19. 19 Introducing Giving investors access to OurCrowd portfolio companies with exponential momentum
  20. 20. Overview
  21. 21. OC2 is designed to provide OC investors a vehicle for capitalizing on these opportunities. • Dedicated fund that leverages our preemptive rights to provide our investors access to our most promising companies. • Automated investing process, only investing in follow-on, up-rounds with institutional lead investors. • First access to capture unexercised preemptives or to take additional allocations after existing investors. • Democratizing the Opportunity Fund strategy • Visit www.ourcrowd.com for more Peter Thiel: “If you back-test Founders Fund’s portfolios, one heuristic that’s worked shockingly well is that you should always exercise your pro rata participation rights whenever a smart VC was leading a portfolio company’s up round.”
  22. 22. Supplemental Reading • http://www.feld.com/archives/2014/06/the-opportunity-growth-fund- trend.html • http://nvca.org/columns/2551/ • https://www.usv.com/blog/the-opportunity-fund • http://blog.ourcrowd.com/index.php/2015/06/25/a-moonshot-bet-on- moonshots/ • http://avc.com/2014/07/the-pro-rata-opportunity/

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