The aim of the project is to analyze the feasibility of a proposed venture loan to Windvane Tech. - Constructed cap table, burn rate & return analysis for proposed $5M venture debt to Windvane Tech

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FBE423
Introduction to Venture Capital and Private Equity
Steve G. Moyer
Pinnacle Ventures Case
Prepared by:
Ryan Hurst
Min Ho Hwang
Jonathan Tsao
November 4, 2015

2. To: ​Pinnacle Ventures (PV) Investment Committee
From: ​Patrick Lee
Date: ​August 2005
RE: ​Windvane Technologies Venture Loan
Executive Summary:
Upon analyzing Windvane Technologies (WV) and its business model, I recommend our investment
committee to follow through with the proposed $5M in venture loans to WV. WV is not only a high tech company
that complements our strategic criteria, WV is capable of tremendous upside that can be capitalized by our 8%
warrant coverage and our option to partake in Series B financing. There are relevant risks, primarily due to WV’s
infancy and its lack of revenue, which leads to higher burn rates and increased chance of default. Moreover, $5M
in venture debt is large relative to WV’s recent $7.5M equity round. In spite of these risks, I believe our ability at
PV to play both equity and debt spectrums will allow both downside protection and upside capture and thus
provides for an attractive investment.
Windvane Technologies Background and Loan Terms:
WV is a company that fits our strategic needs; it’s a really early stage tech company. WV has a patent for
a wireless technology, and it recently raised $7.5M in its Series A round led by highly respected Seacrest and
Woodhull Partners (each invested ~$3.65M). Since WV is an early stage company, it does not have a proven
management team, its technology is in development, and it has no formal customer agreements. The uncertainties
regarding WV’s cash flow and its ability to scale are amplified when potential entrants by well­established
competitors are considered. However, the market has potential and is currently only dominated by a handful of
startups. As we’ve already made another investment in the same operating space as WV, we already have the
resources to help WV meet its growth projections.
In order to help WV dominate a relatively untapped market space, I propose a $5M venture debt loan that
has a 3­year loan term, an annual interest rate of 12%, and a draw down date on September 30, 2005.
Furthermore, interest payments are paid monthly at 1%, with interest only payments for the first 6 months
followed by 30 equal monthly payments of principal and interest. The loan term also includes an 8% warrant
coverage that is exercisable for 10 years, and a Series B round investment option of $750,000. As explained
further in the next section, our debt financing will increase WV’s runway by five months, which allows the
company to stay afloat until its Series B round (Appendix A).
Burn Rate (Appendix A):
According to its actual expenses in June and July of 2005 and its expense projections for the next 16
months, WV has an average monthly burn rate of $768,140. At this rate, WV will run out of its $7.5M by May
2006, 5 months short of its September 2006 Series B round. Since we are entering the investment in tandem with
WV’s Series A round, our $5M venture debt is invaluable to WV even after accounting for its loan payment
obligations. Readjusting WV’s financials, I found that our $5M venture debt infusion starting September 2005
allows WV extend its runway by 5 months, in time for its Series B financing. WV’s burn rate, after our debt
infusion, will increase to $925.35K per month, and WV will have ­$464.52K left in September 2006 without any
Series B funding. Therefore, it is imperative for WV to not exceed budget forecast prior to its Series B round.
With that said, I am optimistic of WV’s ability to make all monthly interest and annuity payments, as my
current projections only considered cash flows from WV’s series A round ($7.5M) and our debt infusion ($5M).
In fact, WV is hoping to start customer trials in January 2006 and will begin a formal product launch in April
2006. With the product launch, WV will have an inflow of cash from its sales prior to September 2006 to cover
expenditures up to its milestone.
Return Analysis
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3. Given our term structure, our payouts will differ depending on the loan terms we exercise our rights upon.
The biggest risk of this investment is when WV defaults before Series B, as we won’t recover much of our
principal. Looking at the possible default scenarios (Appendix B), September 2006 is an important date where
liquidation is possible if WV fails to receive series B financing. If liquidated on this date, we would recover only
about $2.2mm, or 44% of our principal, including the proceeds from asset sales upon liquidation, and realize an
IRR of ­48%. Even though we have seniority on the claims, there aren’t enough liquidated assets to pay us back
given the nature of the IT business, which is not capital intensive. However, in a different default scenario
assumed to take place on September 2007, we would be able to recover almost all of our principal (97%) from
earlier payments and from proceeds made from sale of assets, giving us an IRR of 10% and overall return of 19%.
Therefore, if WV is able to survive 2 years into our debt infusion (September 2007), our downside risk of losing
the principal is greatly eliminated since there will be enough assets sold to satisfy our claims.
On the bright side, if WV’s business goes according to plan, we, as providers of venture debt, will be
compensated handsomely. Since the term structure provides that we receive an 8% warrant of our principal, and
an option to participate in Series B financing, we have a lot of flexibility to capitalize on WV’s upsides. Just from
the loan, should we choose not to call the warrant nor partake in Series B financing, we would receive 13% IRR
(Appendix C), which is above the average venture debt return of 10­12% . In the assumption that WV exits at
$300mm on 2011, we would receive a much higher return by calling our warrant. The warrant would grant us the
right to buy 533,333 shares, which will have close to $5.5mm in value upon exit, giving us an IRR of 30%, MOIC
of 2.1x, and overall return of 115%. (Appendix C, D). Should we decide to move forward with Series B financing
as well, our investment will bring us an IRR of 32%, a 2.5x MOIC, and an overall return of 149%. This includes
375,000 shares from our participation in Series B in addition to the 533,333 shares from our warrant, each valued
at $3.8mm and $5.4mm respectively (Appendix E). Both warrant scenarios generate returns well within our firm’s
expected return of 20­25% IRR and satisfy 2­2.5x MOIC.
Investment Risks & Recommendation:
WV’s major risks are mostly a result of the company’s early stage. To reiterate, WV does not have a built
management team, the technology is not fully developed, and it does not have any formal customer agreements
yet. As a result, WV’s cash flow uncertainties are high. Moreover, as the wireless technology space is dominated
by only a handful of startups, the barriers to entry for well­established competitors is low, elevating the
unpredictability of returns. With a burn rate of ~$925.35K after our proposed $5M venture loan, WV is not only
leveraged high in comparison to its latest equity financing, its expense projections allow them no margins of
error. Moreover, WV’s Series B fundraising round is likely not guaranteed until actual product launch, increasing
more restrictions on budget fluctuations.
However, these are all manageable risks. Our venture loan will provide a timely injection for WV to reach
its Series B milestone, which allows it to increase its pre­money valuation to $40M, a ~167% increase in
valuation, and it is strategically advantageous since we have the option to invest $750K in the Series B round and
have 8% warrant coverage. It should also be noted that WV’s projected cumulative cash flow have exceeded their
actual cash flow in June & July of 2005, and it is likely that WV will continue to spend less than projected as
CAPEX stabilizes once product is launched. Due to the fixed income component of our investment, we have
minimized the amount of principal we might lose. Once WV reaches its second milestone, we will be able to
recover ~99% of our principal a year after its series B round. Furthermore, if WV’s business operates as planned,
our participation in series B and warrant coverage can help us capitalize on a potential 1900% increase in
valuation since Series A until exit. Ultimately, on a risk adjusted basis, this is an attractive investment since we’ve
mitigated downside risks and am able to capture the required returns that our firm is satisfied with in various
scenarios.
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4. Appendix A ­ Burn Rate
Burn Rate without Loan
Burn Rate with Loan
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5. Appendix B
Loan Amortization Table
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6. Appendix C
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