Walnut Ventures (D) : What happens next

1. Entrepreneurial FinanceEntrepreneurial Finance

2. AgendaAgenda
 AdamsAdams
 How VCs evaluate dealsHow VCs evaluate deals
 Funding New VenturesFunding New Ventures
 Note on Valuation of VC dealsNote on Valuation of VC deals
 Walnut Venture Associates (D)Walnut Venture Associates (D)
 Base ScenarioBase Scenario

3. Adams On FinanceAdams On Finance
 Myth: Investors want their money backMyth: Investors want their money back
quicklyquickly
 Reality: Good investors are in it for the longReality: Good investors are in it for the long
haulhaul
 You want smart money not ‘green’ moneyYou want smart money not ‘green’ money
 Smart investors will do whatever is necessarySmart investors will do whatever is necessary
to create valueto create value
 If you want status quo or safety don’t seekIf you want status quo or safety don’t seek
investment capitalinvestment capital

4. Pick your investorsPick your investors
 Domain expertiseDomain expertise
 Chemistry & staying powerChemistry & staying power
 Core competencies – do they improveCore competencies – do they improve
execution intelligence?execution intelligence?
 SophisticationSophistication
 Prior successesPrior successes

5. Types of investorsTypes of investors
 Venture investorsVenture investors
 Sophisticated, high hurdlesSophisticated, high hurdles
 Launch your business as if you are seeking VC fundsLaunch your business as if you are seeking VC funds
 Prove the opportunity – deep down knowledge of painProve the opportunity – deep down knowledge of pain
 Strategic investorsStrategic investors
 Provide market validation and industry insightProvide market validation and industry insight
 Target internal venture groups – outline the benefit to themTarget internal venture groups – outline the benefit to them
 Angel investorsAngel investors
 Should be as savvy as any other investor – makeShould be as savvy as any other investor – make
sure they can add real valuesure they can add real value
 They can be important mentorsThey can be important mentors

6. Value-added of smart investorsValue-added of smart investors
 Fund-raising know-how and contactsFund-raising know-how and contacts
 Recruiting,Recruiting,
 Industry contacts and networkingIndustry contacts and networking
 potential strategic partners and customerspotential strategic partners and customers
 Unbeatable market intelligenceUnbeatable market intelligence
 Technological know-howTechnological know-how
 Ability to redirect the team or refocus theAbility to redirect the team or refocus the
businessbusiness
 A vested interest in the startup’s successA vested interest in the startup’s success

7. How VCs evaluate opportunitiesHow VCs evaluate opportunities
 Siegelman, KPCBSiegelman, KPCB
 Big markets, competitive edge, great teamBig markets, competitive edge, great team
 Technical due diligence is big, some customer andTechnical due diligence is big, some customer and
industry diligence, background checks on teamindustry diligence, background checks on team
 $500K smallest investment, $3-$5m to $10m,$500K smallest investment, $3-$5m to $10m,
 FAST deals – a week or twoFAST deals – a week or two
 Don’t invest in low price products without a low priceDon’t invest in low price products without a low price
channel, $200K price tag for enterprise softwarechannel, $200K price tag for enterprise software
 50% gross margin on hardware50% gross margin on hardware
 Looking for IPOLooking for IPO

8. Hoel, Menlo VenturesHoel, Menlo Ventures
 Market first, $500m to $1bn, Fortune 100Market first, $500m to $1bn, Fortune 100
customers, vertical markets are difficultcustomers, vertical markets are difficult
 Favorite is a company doing well in spite of itself –Favorite is a company doing well in spite of itself –
boost the teamboost the team
 Aim for market share leadersAim for market share leaders
 Market and developed product best predictorsMarket and developed product best predictors
 Not team or proprietary technologyNot team or proprietary technology
 Founder must be willing to upgrade the team and in it for theFounder must be willing to upgrade the team and in it for the
lifestylelifestyle
 Deal size $20-25m per co., 2-3 mths to work out, IPODeal size $20-25m per co., 2-3 mths to work out, IPO
or acquisition for “liquidity event”or acquisition for “liquidity event”
 Direct sale or telesales- understand required marginsDirect sale or telesales- understand required margins

9. Wang, Trinity VenturesWang, Trinity Ventures
 Team, market opportunity, valueTeam, market opportunity, value
proposition/productproposition/product
 Focus on the CEOFocus on the CEO
 It’s a sector bet – thesis process every quarterIt’s a sector bet – thesis process every quarter
 Everything looks like its going to be a multi-billion dollarEverything looks like its going to be a multi-billion dollar
marketmarket
 We avoid arm-wrestling with ‘wild eyed technologists’We avoid arm-wrestling with ‘wild eyed technologists’
 Focus on smaller opportunities with less uncertaintyFocus on smaller opportunities with less uncertainty
 18 month window, Series A18 month window, Series A
 Lot of time on financial model – bottom upLot of time on financial model – bottom up

10. Simon, Alta PartnersSimon, Alta Partners
 I think markets trump people and technologyI think markets trump people and technology
 I look for big opportunities, big painful problems that customersI look for big opportunities, big painful problems that customers
havehave
 We don’t target market shares, we target revenue $60-$80m in 3We don’t target market shares, we target revenue $60-$80m in 3
yearsyears
 Ideal case – four PhDs solve a problem after a year or two andIdeal case – four PhDs solve a problem after a year or two and
it’s 2 orders of magnitude better than whatever else is out thereit’s 2 orders of magnitude better than whatever else is out there
 Lot of focus on personal motivations of peopleLot of focus on personal motivations of people
 are they in it for the long haul (with passion)are they in it for the long haul (with passion)
 Need to “monetize” customers (e.g. Skype)Need to “monetize” customers (e.g. Skype)
 One or two “brave new world” investmentsOne or two “brave new world” investments
 Bet on marketing or technology sideBet on marketing or technology side
 1-6 month decision frame1-6 month decision frame
 Exit at $200m market and $60-$80m company sizeExit at $200m market and $60-$80m company size
 Advise clients to not dilute a good business which won’t grow to thatAdvise clients to not dilute a good business which won’t grow to that
size (and thus is not a good venture opportunity)size (and thus is not a good venture opportunity)
 Check out Sand Hill Road, Menlo Park, CACheck out Sand Hill Road, Menlo Park, CA

11. Funding New VenturesFunding New Ventures
 How to get richHow to get rich
 Managing dilution effects in an important skillManaging dilution effects in an important skill
 Start a business that is either:Start a business that is either:
 Self-funded growth or not capital intensiveSelf-funded growth or not capital intensive
 Uses debt instead of equityUses debt instead of equity
 Has a huge ROE potentialHas a huge ROE potential
 A business generating 25% ROE must sell 100% of its sharesA business generating 25% ROE must sell 100% of its shares
to an investor seeking a 25% ROEto an investor seeking a 25% ROE
 Bottom up valuation, alternatives, complicationsBottom up valuation, alternatives, complications
 See next slideSee next slide
 Capitalization TablesCapitalization Tables
 See Exhibit 1See Exhibit 1

12. Note on ValuationNote on Valuation
 SpiffyCalcSpiffyCalc
 Expect to sell for terminal value (T) of $25m in 4 yearsExpect to sell for terminal value (T) of $25m in 4 years
 Need to raise $3m investment (I)Need to raise $3m investment (I)
 Vulture Ventures discount rate ( r ) =50%Vulture Ventures discount rate ( r ) =50%
 Number of existing shares (x) = 1mNumber of existing shares (x) = 1m
 Post money valuation = NPV of T = $4.9mPost money valuation = NPV of T = $4.9m
 Pre money valuation = POST – IPre money valuation = POST – I
 Ownership fraction (F) = I/POSTOwnership fraction (F) = I/POST
 New shares (y): y/(x+y)=FNew shares (y): y/(x+y)=F
=> y=x/[F/(1-F)]=> y=x/[F/(1-F)]
 Share price = I/yShare price = I/y

13. Special CasesSpecial Cases
 ComplicationsComplications
 Employee Stock OptionsEmployee Stock Options
 Add the option pool to the entrepreneur shareAdd the option pool to the entrepreneur share
 Preference shares can be trickyPreference shares can be tricky
 Look for total share of future value being obtainedLook for total share of future value being obtained
 Estimating terminal valueEstimating terminal value
 P/E ratios and other multiples – see 2006 estimatesP/E ratios and other multiples – see 2006 estimates
 Accounting for riskAccounting for risk
 Expected valuesExpected values
 Higher discount ratesHigher discount rates
 Scenario analysisScenario analysis
 Multiple financing roundsMultiple financing rounds
 Changing discount rates and time periodsChanging discount rates and time periods
 Effect of future dilution must be factored inEffect of future dilution must be factored in

14. Walnut Venture Associates (D)Walnut Venture Associates (D)
 What do you think the investors are trying toWhat do you think the investors are trying to
accomplish with the vesting provisions?accomplish with the vesting provisions?
 What would you try to renegotiate if you wereWhat would you try to renegotiate if you were
O’Connor?O’Connor?
 What is a reasonable valuation for RBS in JuneWhat is a reasonable valuation for RBS in June
1998?1998?
 Assume RBS is liquidated in 5 years for $3m – whoAssume RBS is liquidated in 5 years for $3m – who
would get the money according to the term sheet?would get the money according to the term sheet?
How about $10m or $30m?How about $10m or $30m?

15. Base ScenarioBase Scenario