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Business Start-up and Access to Finance for SMEs
and New Technology based firms The investment
activity of Venture Capital funds from deal flow
to investment   Sonia Dehò INSME-UNIDO 30th
November 2006
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Private Equity and Venture Capital
Early-stage
Venture Capital
Private Equity
Development
Change
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Private Equity in the financial system
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The offering of risk capital
Time
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Venture Capital

• Specialised form of finance, organised in
  close-end funds supporting new entrepreneurial
  initiatives
• Focused on investments in rapidly growing
  sectors, as like information technology and
  biotech
• Take higher risks with the expectation of higher
  returns (capital gains through divestments)
• Purchase equity securities (common stocks,
  preferred stocks, convertible loans)
• Assist in the development of new products and
  services
• Have a long-term orientation (3 to 7 years)
• Create value through active participation

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The role of Venture Capital in value creation

• Venture capital does not only mean financing!
• Support in development strategy definition
• Financial know-how
• Network of relationships in the industrial and
  financial sectors
• Contribution to a professional and objective
  management of the business
• Improvement of the entrepreneurs standing versus
  banks and markets
• Improvement in attracting outstanding managers

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Venture Capital transactions definition
Seed Financing (testing)
Investment during the phase of testing of a new
product/service
Start-up Financing
Investment during the phase of start-up of the
production activity
Expansion Financing
The company is in the development phase with the
need of consolidation of the activity
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Lessons from USA

•      
• The billions of dollars of venture capital pumped
  into U.S. companies from 1970 to the end of 2003
  has created 10.1 million jobs and USD 1.8
  trillion in revenue    
• As of the end of 2003, 9.4 of the jobs in the
  U.S. and 9.6 of the U.S. GDP were created by
  companies in which venture capital invested USD
  338.3 billion   
• From 2000 to 2003 venture-backed companies
  created 600,000 new jobs (i.e. Ebay, Google,
  Jetblue) with a growth of 6.5 in employment rate
  (against a 2.3 for U.S.)

High tech sectors contributed for 1/3 to the GDP
growth in USA At least 2 investments of success
for every 10 start-ups with IRR higher than 25
GLOBAL INSIGHT, (July 2004), Venture Impact
2004
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Venture Capital and management of innovation

• It is proven in many countries (the US, the UK
  and Israel for example) that venture capital has
  been the most effective means to manage
  innovation and creation of new companies
• The competitiveness of a country in high tech
  sectors is largely dependent on the quantitative
  and qualitative level of the existing venture
  capital
• Despite forecasts of the eighties, the lack of
  venture capital in Japan determined the
  impossibility to reach US in Information
  Technology (while Japan was leader in consumer
  electronics)
• The impact of venture capital on innovation is
  four to five time greater that corporate research
  development (J. Lerner)
• Companies like Digital Equipment Corporation,
  Apple, Federal Express, Compaq, Sun Microsystems,
  Intel, Microsoft are examples of venture-backed
  companies

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What a Venture Capital Fund is
Management Company Advisor
Investors pension funds, financial institutions,
insurance companies, corporations
Decision to invest(vision, idea, management,
technology, market, ecc.)
Venture Capital Fund
Decision to divest(IPO, trade sale,
write-off) capital gain/loss
Portfolio Companies
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What a Venture Capitalist does

• Deal flow analysis (Reactive or pro-active)
• Valuation
• Due diligence
• Investment execution
• Follow-up

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The process
FIRST DIRECT MEETING
SECOND DIRECT MEETING
FIRST CONTACT
PRELIMIN. DECISION
FINAL DECISION
INFORMATION GATHERING (B.P. B.I.)
VALUATION DEAL STRUCTURE
T/S INVESTMENT AGREEMENT
Follow-up
PROJECT ASSESSMENT
INVESTMENT
1-2 wks
1-2 wks
1 wk
3-4 wks
1 wk
Due diligence, investment execution
Deal flow analysis
Valuation
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Deal flow analysis decision drivers
EXIT
BUSINESS MODEL
BUSINESS IDEA
DECISION DRIVERS
IMPORTANCE
MANAGEMENT TEAM
COMPETITION ARENA
BUSINESS PLAN
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Decision drivers of investments business plan

• Executive summary
• the opportunity, mission, business model, target
  market, the competitive advantage, etc
• Team
• management, Board, key contributors
• Company
• general info, value proposition, partnerships,
  etc.
• Market analysis competition analysis
• Products/services offered
• products/services portfolio, technology, RD,
  pre
• post sale services, delivery, etc.
• Marketing and sales
• marketing plan and strategy, sales tactics,
  pricing,
• partners, advertising and promotion,
  distribution, etc.
• Economics and financial projections (PL, BS, CF)

BUSINESS PLAN
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Decision drivers of investments competition
arena
COMPETITION ARENA

• Target market analysis
• Competition analysis
• Competitive strategy (control over costs,
  prices,
• and distribution)
• Barriers to entry (i.e. proprietary protection,
• legal/contractual advantage, networks)
• Delivery and distribution channels
• Market penetration and sales forecasts

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Decision drivers of investments management team

• Who is the ideal entrepreneur? HE/SHE MUST BE
• fast, have vision, informed, able to copy
• experience track record, knowledge of target
  market
• able to change, recognise and understand its
  mistakes
• a sailor, a team leader and a builder
• willing to step back at the right time
• able to go bankrupt and willing to start again
• able to be at the right place at the right time
• lucky !!!

MANAGEMENT TEAM

• Recognising Entrepreneurial people
• Personal characteristics Learnable
• commitment, long-term involvement, low need for
• status and power, opportunity oriented,
  integrity
• Personal characteristics More difficult to
  acquire
• high energy, emotional stability, conceptual
  ability,
• creativity, capacity to inspire

CAUTION WITH TECHNICAL ENTREPRENEURS!!!
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Decision drivers of investments business idea
and business model

• Value of the innovation/product (an unanswered
  need)
• All ideas are not opportunities
• Scalability/Crystal clear

BUSINESS IDEA

• Business margins
• companies with good margins are better
  evaluated!
• Speed of execution
• speed and timing of revenue generation
• speed in reaching operating and financial break
  even
• Sustainable growth
• value addition growth sustainable for a long
  time
• (i.e. technological advantage, offering
  differentiation)
• Capital intensity
• What is cash burn
• more cash is needed to reach a competitive
• dimension, more the investment is risky !!!

BUSINESS MODEL
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Valuation

• Three stages early stage investment, new rounds
  of financing,
• divestment (IPO or trade sale)
• Valuation methods
• early stage investment negotiation with the
  entrepreneur (uncertainty on values used for
  calculations, the only certainty is cash needs!)
• new rounds of financing/divestment multiples,
  DCF, options (valuation given by external
  advisors)
• Definition of pre-money. FINAL VALUE
  pre-moneyinvestment
• pre-money is based on intangibles, such as
  level of innovation and
• potential of the idea, value of the
  management, etc., and tangibles like
• how much already invested by the entrepreneur,
  patents, strategic
• agreements, etc.
• investment is the cash required (funding
  need), even divided into
• several tranches
• The ratio between pre-money and cash injected
  determines the share
• of the investor
• We dont want the majority, however it can
  happen
• When the investment is divided into several
  tranches, assumptions on
• future valuation is made, subject to certain
  milestones agreed are reached

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Due diligence

• Business due diligence
• Management
• Does the IDEA work? - Intellectual Property
• Is there an unmet market need/pent-up demand?
• Competitive advantage
• Financial due diligence
• Financial analysis PL, BS and CF (actual, if
  any, and projections)
• Returns analysis (child vs. dwarf)
• Tax position
• Legal due diligence
• Company books, deed of incorporation, articles
  of association, CEO powers
• Agreement and commitments (with customers,
  suppliers, banks,)
• Insurance, guarantees, trademarks, patents,
  licences
• Litigation

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Negotiation and investment execution (1/2)

• TERM SHEET/INVESTMENT AGREEMENT
• Milestones of the agreement (the handshake
  between gentlemen)
• Valuation
• Anti dilution/ratchet clause
• Business plan
• Governance (board seats)
• Exit
• Non-binding and no-shopping condition
• Subject to positive due diligence and investment
  committee approval

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Negotiation and investment execution (2/2)

• NEGOTIATION
• Pre-money valuation and anti dilution rights
• Corporate governance
• Exit strategy/rights
• (SHAREHOLDERS/INVESTMENT) AGREEMENT
• Present and future capital increases
• warrants tranches earn-out
• Rights/majority/veto rights for the shareholders
  meeting
• Rights/majority/veto rights for the board
• Stock Option plan
• Lock up and permitted transfer
• Exit IPO, trade sale, first refusal/offer, tag
  and drag along

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Follow-up from start-up to company

• RELATIONSHIP WITH THE ENTREPRENEUR
• Board and day by day management
• Budget control and forecast (cash management!!!),
  reporting
• Sounding board for strategy, marketing and
  operations
• Mediation
• Next rounds
• Exit
• SUPPORT ACTIVITIES
• Communication and public relations
• Networking (revenues) and portfolio synergies
• Head hunting
• Support in future round of financing

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