This document discusses key considerations for early-stage companies seeking funding from venture investors. It outlines various sources of early funding for technology development and provides an overview of the drivers and expectations of angel and venture capital investors. The document also discusses important due diligence factors for investors and terms that can be used to both manage risk and leverage upside potential in investments. Finally, it touches on building value post-investment and exit scenarios in later transactions.

1. 1
Show Me the Money
Venture-Stage Evaluation, Investment and Exit
Dennis M. DeLeo, President
www.venturejobs.org
4-Nov-12

2. Early Sources of Funding
2
 Grants: SBIR, University, Other for technology development
 Corporate Partnerships: Technology/Product Development
 Regional Economic Development: Seed Funds, Match funds
 License or License Option Fees
 Founders or management capital
 Friends & family (dilutive to ownership of founders)
 Angel Capital (dilutive to ownership of founders)
 VC Capital (dilutive to ownership of founders)
4-Nov-12

3. Key Drivers for Venture Investors
3
 Angels/VC’s are Financial Investors
● Driven by risk adjusted return expectations
● Models drive aggressive investment terms
 Clear milestone path prior to revenue
● Raising capital pre-revenue is usually a challenge
 Manageable Risk: technology, market, competition, IP solid,
execution, etc.
 Significant commercial partnerships in place or likely
 Confidence in CUSTOMER validated Revenue Projections
 Management team has/will have needed business capabilities
4-Nov-12

4. Prior Terms of Interest
4
 University Conditions
● Royalty Payments: Fixed vs. Variable; Equity Alternative
● Access to improvements (potentially competitive research)
● Excessive Field of Use Constraints
● Constraints on Founder/Investigator
● Board or Observer Status
 Friends & Family Terms
● Valuation levels
● Anti-Dilution Provisions:
4-Nov-12

5. Valuation: Compromising on Risk
5
 Entrepreneurs See Opportunity; Investors See Risk
 Valuation For Early Stage Companies Can Be Emotional
 Performance Triggers that Adjust Ownership
● Revenue growth
● Earnings Growth
● Development Milestones, etc.
 Pricing Shares at a Discount to the next Negotiated Round
● Discount Vary, e.g. Time to Round
4-Nov-12

6. Due Diligence Basics
6
 Technology, Product and Transition to Revenue
● Remaining development efforts
● Time to revenue and revenue growth outlook
● Product enhancements required to sustain growth
 Market, Marketing and Competition
● Is the market understood and represented appropriately?
● Is competition understood and represented appropriately?
● Who are the early customers and when will revenue begin
 Corporate Structure and Finances
● Can cash sources (equity, debt, sales) support the fixed cost base?
 Can they fund the business to the next planned investment round?
● Are cash sufficiency risks understood, and can they be managed?
 Are there contingency plans if financial targets are missed?
4-Nov-12

7. Terms to Leverage Upside Potential
7
 Warrants included in base “Investment Unit”
● Pricing, term, mode of exercise
 Pre-Emptive rights in later financing rounds
● Pro-rata share or all?
 Co-sale Provisions
● Tag along and come along
 “Put” of primary security at “fair market value”
● Usually after 4-5 years if fund needs to exit
4-Nov-12

8. Terms to Manage Downside Risk
8
 Preferred Security with liquidation and participation preferences
 Milestone-linked funding to manage initial cash exposure
 Board representation: Executive and compensation committees
 Negative covenants in stock purchase agreement:
● Debt limits, credit extension, change in number of Directors
● Stock issuance or redemption
● Hiring limits, transactions with insiders or affiliates
● Change in areas in which the company does business
● Full ratchet or weighted average protection against lower priced rounds
● Variable conversion ratio based on perfomance
 Share “put” after a set term if performance is lagging projections.
4-Nov-12

9. Building Value Post Investment
9
 Have an Agreed Cash Management Plan
 Have a Clear Set of First Year Business Milestones
 Have a Clear Go-to-Market Plan Supported by Investors
 Have a Contingency Option if Business is Behind Plan
 Identify and Implement Industry Partnerships
 Start Early to Build Contacts with Next Round Investors
 Make Liquidity a Priority and Drive to Achieve it
4-Nov-12

10. The Investor Decision
10
 Does the Opportunity Feel Right (Price, Potential Return, Exit Plan)
 Is There a Credible Product or Service and Clear Value Proposition
 Is the Marketing and Sales Case Plausible (Can it scale?)
● Revenue growth, profit growth and competitive offering
● Qualified management to drive growth
 Is the Financing Sought Well Matched to Needs:
● Business funded to next planned round of financing
● Interim milestones will create shareholder value
 Can Investors Work Constructively With Management
4-Nov-12

11. Valuation in Later Transactions
11
 Always actively negotiated
 Often based on financial performance of the business
● Multiple of Revenue or EBITDA
● Likely future cash flow impact of product/service introductions
 May be opportunistic:
● Competitor with a strong takeover strategy
● Unforeseen market development changing competitive dynamics
● Major technology achievement drives acquisition activity
 IPO threshold ~$100 million in revenue and positive EBITDA
4-Nov-12

12. How Terms Impact Founders
12
 Warrants issued to venture investors
 Liquidation and participation preferences
 Structure of pro-rata “as if converted” equity distributions
 Exit timing set by a Put
 Tools to enhance founder distributions
● Earn back based on performance achievements
 Reduced warrants
 Cap on pro-rata distribution to Preferred Shareholders
4-Nov-12

13. 13
Thank You
Dennis M. DeLeo, President
dmdeleo@venturejobs.org
(585) 943-9000
4-Nov-12