State of VC 2004 Seminar on Corporate & International VC
When we say “VC Embracing Failure”…. You might get the idea that VCs will support and encourage you …. Even if your company fails. WRONG!! We’re looking at how VCs can take a lot of Failure…. And have the tools to respond and come out ahead ANYWAY!!!
Voting rights Actually veto rights…All key decisions require consent of Series A preferred.. Pay dividends, re-purchase company stock, Capital expenditures, merger, debt over $100K, any deal questionable as arms length, issue new securities at equal or better rights, TRY TO LIMIT VETO RIGHTS TO MAJOR CORPORATE EVENTS Liquidation preference / participating preferred VC gets his money, PLUS MULTIPLE out before common stock holders (that’s you) get a dime. 2-3 is common Anti-dilution (weighted average vs full-ratchet) Designed to protect the investor against later sale of stock at a lower price. Weighted average tries to address actual dilution. Options & vesting Important to realize need for 15-25% option pool, or you’ll be forced, get surprise dilution. Vesting means if you leave tomorrow, you don’t walk away with all your stock… Theory is the company is nothing without the people. 25% cliff. PanOp STORY. Redemption After x years, majority of Preferred can request their money back )typically in 3 traunches… PLUS accrued dividends… THIS FOR SIDEWAYS PLAY… liquidity. No shop & confidentiality
Venture capital & failure presentation by professor eli zelkha
Industry CharacteristicsHigh riskMany, many losersDifficult to discern in advance: No “rules”Massive gains concentrated in few top dealsMany ways to lose your money
Venture Capital Lifecycle Fund life cycle:Raisea Fund(Pension, Families,Corporations)Invest(Evaluate, duediligence, close…)Harvest(IPO, mergers,managementbuyout)CoreVentureCapitalProcess• Raise capital from institutionaland individual investors- Finance new and growing companies;- Purchase preferred equity- Add value through active participation
VC’s segment in a number of waysStageSector Healthcare versus IT versus clean energyGeography US, EU, China, India, IsraelIndependent vs Corporate VCSize Small fund (<$100M) to large fund (>$1B+)Specialization leads to deep expertise Source: W. Price, 3/6/07 Hummer WinbVenture Capital ModelFlavors of VCs
5 Initial contact Review business plan… basic diligencebasic diligence Emergence of deal advocate Partners meeting with entrepreneur Due diligenceDue diligence Unanimous partner approvalUnanimous partner approval Term sheet Final due diligenceFinal due diligence Legal documentation FundingMulti-stage, extended process, very few selectedVenture Capital ModelInvestment Process
The Entire Business Model Presumes &Leverages Multiple Failures• Deal with entrepreneurs: - Gives VCs control for course change- Puts VCs first in line on pay day• Deal with limited partners: - Participate on fund upside,but not on downside• Deal with other VCs: - Home run phenomena- Broad deal sharing among VCs- Enables many bites on few home runs• Investment process: - Optimized to avoid losers- Funds participate in many big “at bats”
8Reverse Vesting of Founder Stock Mandatory Minimum Employment PeriodMandatory Minimum Employment PeriodVoting rights a/k/a veto rightsa/k/a veto rightsLiquidation preference a/k/a VC gets 2-5 multiple before you see a dimea/k/a VC gets 2-5 multiple before you see a dimeOptions & vesting A/k/a you’re locked in baby.A/k/a you’re locked in baby.Redemption A/k/a in a sideways play, we’re out of here … with our money & profit of course.A/k/a in a sideways play, we’re out of here … with our money & profit of course.Anti-dilution (weighted average vs full-ratchet) …… if things go bad (under full ratchet) you can get wiped outif things go bad (under full ratchet) you can get wiped outEnables effective controlVenture Capital ModelDeal w/ Entrepreneurs
9 Positive Covenants – things you will do Information rights, auditing requirements Negative Covenants – things you will not do Selling debt, raising money, hiring management Representations We’ve told you everything that is material to making your investmentdecisionVenture Capital ModelDeal w/ Entrepreneurs
Venture Capital ModelDeal with Limited PartnersManagement Fees (typically 2-2.5% of AUM) Charge a management fee to cover the costs of managing the committed capital. $100 M fund generates $2m per year in management fees Carried Interest (typically 20-25%) "Carried interest" is the term used to denote the profit split of proceeds to the generalpartner.Participate on fund upside, but not downsideSource: W. Price, 3/6/07 Hummer Winblad
Venture Capital ModelDeal with Other VCs Industry with blockbuster winners! Broad deal sharing among VCs enables many bites onfew big home runs …. multiplying effect. Portfolio effect allows for big success while absorbingmany failures. Impact of few very large numbers VC gets portfolio effect, (while entrepreneur is all ornothing)
Venture Capital ModelInvestment Process Multi-phase, intense, in-depth due diligence process Deep evaluation process Decision to invest requires consensus of all general partners Only invest if other VCs go in (syndication) Multi-round investment process Short leash Seed, series A, B, C, D, Mezzanine…
Venture Capital ModelFundamentals of VC structure, deal terms,timing, and core processes presume andwork with “failure”But…..