Entrepreneurial FinanceEntrepreneurial Finance

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

Adams On FinanceAdams On Finance Myth: Investors want their money back Myth: Investors want their money back

quicklyquickly Reality: Good investors are in it for the long Reality: 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 necessary Smart investors will do whatever is necessary

to create valueto create value If you want status quo or safety don’t seek If you want status quo or safety don’t seek

investment capitalinvestment capital

Pick your investorsPick your investors

Domain expertiseDomain expertise Chemistry & staying powerChemistry & staying power Core competencies – do they improve Core competencies – do they improve

execution intelligence?execution intelligence? SophisticationSophistication Prior successesPrior successes

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 – make Should 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

Value-added of smart investorsValue-added of smart investors

Fund-raising know-how and contacts Fund-raising know-how and contacts Recruiting, Recruiting, Industry contacts and networkingIndustry contacts and networking

potential strategic partners and customers potential strategic partners and customers

Unbeatable market intelligenceUnbeatable market intelligence Technological know-howTechnological know-how

Ability to redirect the team or refocus the Ability to redirect the team or refocus the businessbusiness

A vested interest in the startup’s successA vested interest in the startup’s success

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 and Technical 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 price Don’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

Hoel, Menlo VenturesHoel, Menlo Ventures

Market first, $500m to $1bn, Fortune 100 Market 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 the Founder 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, IPO Deal 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

Wang, Trinity VenturesWang, Trinity Ventures

Team, market opportunity, value Team, 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 dollar Everything 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

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 customers I look for big opportunities, big painful problems that customers

havehave We don’t target market shares, we target revenue $60-$80m in 3 We 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 and Ideal 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 people Lot 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 that Advise 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

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 shares A 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

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)=F New shares (y): y/(x+y)=F

=> y=x/[F/(1-F)]=> y=x/[F/(1-F)] Share price = I/yShare price = I/y

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 tricky Preference 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

Walnut Venture Associates (D)Walnut Venture Associates (D)

What do you think the investors are trying to What 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 were What would you try to renegotiate if you were

O’Connor?O’Connor?

What is a reasonable valuation for RBS in June What is a reasonable valuation for RBS in June 1998?1998? Assume RBS is liquidated in 5 years for $3m – who Assume 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?

Base ScenarioBase Scenario