how to get a venture capitalist excited about your business

How To Get A Venture Capitalist Excited About Your BusinessVenture Association of New Jersey

Tuesday, September 16, 2008

Warren Haber, Jr.

Managing Partner, Crossbar Capital

2Crossbar Capital 04/10/23

Agenda

Background 3

What type of business do you have? 4 - 5

Keys to a good business plan 6 - 11

What are various sources of capital available to an entrepreneur? 12 - 13

LLC vs. C Corp. 14

What is venture capital? 15 - 18

How do you identify firms which match your needs? 19 - 20

What appeals to venture capitalists? 21 - 23

How are investments structured? 24 - 25

What can you expect from venture capitalists and investors? 26

Topic Pages


Background

Warren Haber, Jr.

Venture capital experience (14 years venture capital experience) Managing Partner of Crossbar Capital – NY based venture capital fund Lead General Partner in Mellon Venture’s NY office – software/services

focus Founding Partner of Grand Central Holdings – Metro NY venture firm GE Capital, Equity Capital Group

Education MBA Wharton School BA Brown University in Computer Science

Crossbar Board of Director member of Reimage, Board Advisor to Payoneer and Bitwine


What type of Small Business or Idea do you have? Your business’ attributes determine investor interest:

Industry – what is attractive about the industry you’re competing in?

Defensibility – what prevents competitors from replicating your idea?

Growth potential – how big can the business really get?

Growth trajectory – how quickly can the business grow?

Margins - how do your margins compare to competitors?

Scalability – how much incremental costs are required to support additional revenue?

Capital requirements – how much capital is required to achieve your objectives?


What are your objectives in launching a business? Different business objectives require different types of capital:

Fame/Fortune – how committed are you to being an entrepreneur?

Ownership – how much ownership do you need?

Governance – are you willing to share governance with outsiders?

Leadership – what are your strengths/weaknesses as a business leader?

Transparency – how much transparency are you willing to provide to investors?

Cash Flow – when your business begins to throw off cash, what will you do with the cash?

Income – how much salary do you require?


KEYS TO GOOD BUSINESS PLANAll the elements must work together

Competition

Financials

Market

Value

Proposition

Business

Plan


KEYS TO GOOD BUSINESS PLANValue Proposition

Make sure that your plan clearly articulates what problem you are solving.

Your solution should be concise and focused on the problem.

The business plan should communicate why the industry requires your solution now.

If there are changes in your industry which are prompting a need for your product or service, make sure to mention them.

Make sure to specify any barriers to competition.


KEYS TO GOOD BUSINESS PLANMarket

If it’s a small market that you’re targeting, the focus should be on why this market is about to explode now.

If it’s a large market, then the focus should be on how your product or service is fundamentally altering the market.

Make sure you mention structural issues within the market which could favorably or unfavorably impact your entry into the market.

Data regarding market size, growth and composition add credibility to your business plan.


KEYS TO GOOD BUSINESS PLANCompetition

Develop a detailed table which illustrates that you clearly understand the market you’re competing in.

Make sure that you are current on your competitor’s product so that you can demonstrate your understanding of your market.

If there have been any acquisitions or IPO’s in your sector, make sure you understand all the information behind this events.

Channel Partners, Pricing, Websites and company acquisitions are also important to understand

Company Attribute 1 Attribute 2 Attribute 3 Attribute 4 Attribute 5 Attribute 6 Attribute 7

Newco X X X X X X X

Comp 1 X X X X X

Comp 2 X X X X X

Comp 3 X X X X


KEYS TO GOOD BUSINESS PLANFinancials – Capital Needs

Financial Projections for at least 2 – 3 years are essential.

Insure that you have a deep understanding of the assumptions behind your Revenue projections and make them explicit.

Project Gross and Operating Margins and compare them to public companies in your overall sector to do a “reality check”.

Make sure that your capital raise is consistent with your financial plan. Specify the “Uses of Capital” so that investors can understand where the money

is being used.

2008 2009 2010Revenues -$ 1,500,000$ 4,000,000$ Cost of sales -$ 1,200,000$ 2,500,000$ Gross profit -$ 300,000$ 1,500,000$

Operating expenseProduct 100,000$ 225,000$ 371,250$ R&D 300,000$ 675,000$ 1,113,750$ Sales and marketing -$ -$ 250,000$ Customer Services -$ -$ 75,000$ G&A 350,000$ 787,500$ 1,299,375$ Total OPEX 750,000$ 1,687,500$ 3,109,375$

Operating income -750,000 $ -1,387,500 $ -1,609,375 $

Cash at end of year 300,000$ -1,087,500 $ -2,696,875 $


Surround yourself with great stakeholders?

Lawyers Accountants

Industry AdvisorsBoard Members

Management


What are the other sources of capital?Most companies do not secure venture capital

Debt financing – commercial banks, venture banks, government grants

Angel financing – early capital which can be strategic and often comes in the form of Common Stock

Strategic financing – vendors, suppliers or customers who have a vested interest in the success of the business

Friends & family – high net worth individuals who oftentimes have a direct connection with the entrepreneur


How are investments structured?Different groups structure securities different ways

Debt– senior in the capital structure, often require cash flow and generally have interest payment required or accrued

Preferred Equity – sandwiched between Debt and Common Stock, oftentimes has a number of features and protections associated with institutional capital – general features include preference, participation, Board rights, anti-dilution provisions and information rights.

Common Equity – most junior capital which oftentimes is the first capital but lacks features of Preferred Equity – generally used for management and employees

Convertible Debt – sits in between Debt and Preferred Equity and is oftentimes convertible upon a specific event (e.g. a future financing)


LLC vs. C Corporation

S Corps & LLC’s are both “pass-through” entities meaning income is passed to the owner’s personal income tax returns.

LLC’s require less paperwork and more flexible to divide up profits. S Corps allow owners to save on employment taxes.

LLC’s can have an unlimited number of members and non-US residents can be member of LLCs while S Corps can only have 75 shareholders & none can be nonresident aliens.

S Corp is typically perpetual while LLC has a dissolution date.


What is Venture Capital?

Industry Overview – Capital Flows & Stages

Professionally managed money invested in young, rapidly growing companies with large economic potential.

According to PriceWaterHouse Coopers Money Tree Report Venture Capitalists invested $7.1 billion into 922 deals in QI ‘08. Quarterly investment activity was down 8.5 percent from

QIV ’07. QIV ’07 $7.8 billion invested in 1,045 deals. Despite the decline, QI ’08 was the fifth highest quarter

since 2001. Expansion stage was flat while Early & Later stage was

down.


Industry Overview – Industry Sectors

Biotechnology was number one with $1.27 billion in 126 deals.

Software was close number two with $1.26 billion in 234 deals.

Life Sciences Sector (Biotechnology & Medical Devices combined) dominated first quarter with $2.3 billion invested in 220 deals.

Clean Tech (Alt Energy, Pollution, Recycling, Power Supplied & Conservation) dropped to $625 million with 44 deals in first quarter representing a 6% decline

Semiconductors positive quarter with $566 million going into 50 deals.



Seed & Early stage fell 17 percent to $1.7 billion into 330 deals with average seed deal of $3.6 million down slightly from $3.8 million last quarter.

Expansion stage deals were flat with $2.9 billion going into 318 deals with the average expansion deal up to $9.0 million from $8.1 million in Q’ IV 2007.

Later stage investments fell 11 percent with $2.6 billion going into 274 deals & accounting for 30 percent of total deal volume. Later stage deals in QI ’08 were $9.6 million was slightly higher than $9.4 million in last quarter.

Industry Overview – Stage Breakdowns



Silicon Valley continues to be #1 with 36 percent of dollars invested in US-based companies comprising $7.1 billion.

New England is #2 with 108 companies garnering $721.5 million – a 24 percent decline in funding compared to QIV ’07.

New York Metro is #3 with an 8 percent decrease in deals but a 17 percent increase in investment activity from QIV ’07.

Industry Overview – Geographic Breakdowns



How does a Venture Capital Firm Work?

Firm consists of 1 to 10 Senior Partners who are responsible for running the firm consisting of:

Raising capital from Pensions, Endowments, Fund of Funds and High Net Worth Individuals every two to five years with a ten to twelve year management period.

Employing their relationships and network to find promising entrepreneurs building rapidly growing companies.

Conducting due diligence on prospective investments and negotiating terms to invest in companies.

Ensuring a fiduciary responsibility to their investors by assuming Board positions on the companies they invest in.

Using their contacts and prior experience to support the entrepreneur in their growth.

Finding and evaluating suitable exit opportunities for their investments over a two to seven year time horizon.


THE “ADVOCACY” MODELUnderstand how a firm works

Find an individual venture capitalist who has prior positive experience with your sector/business model.

Present information in a clear, concise and compelling presentation which engages & empowers the Partner to become your advocate.

Expect that if the firm is interested, they will come back to you with a list of “follow up” questions which are the “exceptions” from the Partnership.

Many Partnerships ask that the entrepreneur eventually to come present their business to the entire firm in person.


Venture Capitalists screen many business plans

Typical venture capitalist may meet with 50-100 companies/year & selects a handful to invest in.

Your objective is to network into the CEO’s, Advisors, Investors who are “trusted” within the venture capitalists network.

Leverage your network employing six degrees of separation. It’s amazing who you can meet if you employ your network properly.

412 Prospects Screened

4Deals

5 Term Sheets

11 Due Diligence

116 Meetings

Referral source Market disruptorLeadership potential

Management qualityCapital efficiencyReview Go to market milestones

Verification of market needCompetitive reviewCapital requirements

Terms promote alignmentReasonable risk/rewardOwnership objective met

Board involvement


Select a large and rapidly growing market with a disruptive idea which enables your company to secure a market leadership position.

Write an Executive Summary & Business Plan which: Articulates clearly the value proposition Illustrates the growth and size of the market employing objective data Validates why your product/service is clearly distinctive Details the uses of the capital Projects financials for at least three years with thorough assumptions

Network with other entrepreneurs who have successfully raised venture capital and ask for their “war stories” and introductions.

Target individual venture capitalists (General Partners) within specific firms who have prior positive experience with a similar business model/sector as your business.

To raise venture capital, focus on market leadership. Critical steps


Demonstrate Market Momentum Nothing attracts vc’s more than validation

Demonstrate market momentum through rapid customer adoption. Determine an analogous business(es) to your own Analyze it’s early market penetration and ascension to market leadership Identify relevant and appropriate metrics to measure your growth Benchmark your company’s metrics against analogs (e.g. 1% growth/day)

Do everything economically feasible to delight your customers. Results in terrific ”reference clients” Lowers customer acquisition costs and churn rates Creates positive “buzz” around the company Facilitates raising capital

Establish a clear line of communication with your customers and encourage an open and honest feedback loop.


Communication with Venture CapitalistsDistinguish your company through your achievements

Once you’ve established a rapport with venture capitalists, keep them updated as to your company’s successes & failures.

Present information in a factual manner and do everything to exceed expectations through your achievement of market leadership.

Allow the market to determine the appropriate valuation and terms for your company as opposed to dictating what you require.

Do more diligence on prospective investors than they do on you.


List of General Term Sheet Items

Amount of Financing: Capital raise & number of closings. Type of Security: Series & equity features. Purchase Price: Price/share & pre-money valuation. Anticipated Closing: Closing dates. Capitalization: Cap table & uses of proceeds. Rights & Preferences: Distribution, preference & liquidation rights. Conversion Right: Conversion to Common Stock. Automatic Conversion: Conversion upon “qualified” IPO. Anti-dilution Provisions: Later financings at lower price/share. Voting Rights: # of votes/share. Board of Directors: Composition & nominees. Redemption: Time & amount. Protective provisions: M&A, liquidation or change of control. Information rights: Dissemination of financials. Registration rights: Share registration parameters. Preemptive rights: Defines participation in later rounds. Bring Along Rights: Shareholders rights prior to an IPO. Fees: Assumption of legal fees. Closing: Proposed date to finalize.


What should you expect from investors?Different financing sources bring different resources

Banks – No Board seat and minimal strategic insight

Venture Capital – Generally require 1-2 Board seats and can be very active in the strategic direction, executive and financing decisions.

Angels – May look for Board representation and strategic insight varies significantly depending on the background and proclivity of the Angel(s)

Strategic – can become extremely involved in business development and potentially can repel other strategics from partnering with company


General Advice when dealing with investors?Communicate frequently with objective information

Information – provide investors with periodic updates presented in a balanced and objective manner

Financings – discuss future financings with investors far in advance of when the company requires capital

Board – use your Board to help evaluate important decisions and be prepared to support your proposals

Strategic – discuss strategic partnerships with investors in that they can oftentimes consume a great deal of resources


Warren Haber, Jr.Managing PartnerCrossbar Capital747 Third Avenue

New York, NY 10119Tel: 212-710-5313

[email protected]

how to get a venture capitalist excited about your business

Economy & Finance