Venture Capital

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Venture Capital
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What is Venture Capital?

• Ownership, or convertible to ownership, capital
• High Risk capital
• Investors are active rather than passive
• Typically add other value
• Contacts
• Expertise

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Types of Venture Capitalists

• Public and private venture capital firms
• Small Business Investment Companies (SBIC) and
  Minority Enterprise SBICs (MESBIC)
• Corporate Venture Capital
• Publicly traded VC funds (mutual funds)

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Public Private VC Firms

• Usually limited partnerships
• Seek other VC investments from institutions
• Tend to specialize based on
• Industry
• Stage of development
• Territory

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SBIC / MESBIC

• Created in 1958 by Small Business Investment Act
• Expanded in 1972 to include minority enterprise
  SBIC
• National program for licensing privately-owned
  small business investment cos
• Eligible for government loans (SBA)

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Corporate VC

• Divisions of a major corporation
• A joint-venture between corporation and the
  smaller company
• Smaller company has research or resources that
  the larger company needs
• Smaller company gets access to the resources of
  the larger company

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Corporate VC

• Fastest growing segment
• 49 companies in 1996 200 in 1999 accounting for
  15 of total VC
• Example Intel 8B
• Others
• ATT, Motorola, Lucent, Nokia, IBM, Microsoft, EDS

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Preparing for VCs

• Well written business plan and financing proposal
• Amount and use of proceeds
• Networking
• Unsolicited proposals are numerous and unlikely
  to get fair shake
• Simply trying to get considered

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Preparing for VCs

• What are Venture Capital preferences?
• Geographic location
• Types of products and services
• Risk and rates of return
• Amount of capital needed
• Stage of development

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VC Stages

• Seed financing
• Product development
• Market research
• Product feasibility
• Start-up or early stage
• Completion of product development
• Recruitment of management team
• Completion of business plan begin marketing

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VC Stages

• First-stage
• Full-scale manufacturing
• Completion of management team
• Second-stage
• Production and distribution begun
• Established inventory accts receivable
• Working capital for growth

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VC Stages

• Third-stage
• Research develop new products/markets
• Expansion of physical facilities
• Expansion of sales and marketing efforts
• Bridge-financing (mezzanine)
• Company expected to go public within 12 months
• Additional working capital required

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VC Jargon

• Products 90 complete ? weve got a name for it
• Leading-edge technology ? we cant make it work
• Limited downside ? things cant get much worse
• Proven technology ? it nearly worked once
• Were repositioning the company ? were lost
• Upside potential ? it stopped breathing

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Meeting with the VC

• Dress rehearsal (no second first impressions)
  game plan specific
• Find a mentor someone who has used a VC before
  or is a VC
• Have key personnel available
• Ultimately, VC will make decision based on
  management team

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Meeting with the VC

• Enlightened passion
• Demonstrate personal commitment
• Time and energy
• Financial
• Open and honest exchange of information
• Rather than hide previous failure, learn from it
  and demonstrate such

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Meeting with the VC

• Big market and big upside
• Turn off
• Narrow market
• Limited demand
• Thin margins
• Sustainable competitive advantage
• Demonstrated need for product
• Barriers to entry?

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Meeting with the VC

• Exit strategy
• How is VC going to get money back?
• Usually, IPO ? later

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Key Components of VC Decision

• Management team
• Products and services
• Markets
• Return on investment

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Management Team

• Education, background, knowledge and skills
• Experience relevant to the business proposal at
  hand
• How does this team manage and eliminate the risks
  and problems?
• Entrepreneurial attributes drive, tenacity,
  energy, leadership

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Management Team, cont.

• Be able to adapt
• Know the competition
• Be able to manage rapid growth
• Show financial commitment

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Products and Services

• At what stage are the products and services how
  long will the window of opportunity be open?
• What makes your product/service unique?
• Do you control means of production or provision?
• How are they dependent on technology?

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Products and Services

• Be real and work
• Be unique and proprietary
• Solve a problem or improve a process
• Be for mass production with potential for cost
  reduction

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Markets

• Stage in life-cycle of industry why?
• Size and projected growth of market?
• Current customers potential for many more
• Grow rapidly per year (25 - 45)
• What are the sales and distribution channels?
• Does your product/service create new markets?

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Return on Investment

• Current and projected valuation
• How much of your time money have you already
  invested, how have you managed it, and how much
  more are you willing to commit?
• How much more capital is required?
• What is the projected ROI?

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Success Rates

• 10 Begin
• 2 - 3 Succeed
• 3 - 4 Breakeven
• 3 - 5 fail

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Negatives to Avoid

• Unqualified family members/friends on management
  team
• Unwillingness to provide personal guaranty on
  debt financing
• Incomplete, or overly slick business plans
• Unrealistic assumptions, goals objectives

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Assessment of VC

• How well does firm know your industry?
• Experience with others within industry
• What does VC bring to the table besides
• Expertise, contacts, other services
• Reputation of firm within investment community?
• Ability to participate in later rounds?

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Your Concerns

• Loss of management control
• Dilution of personal stock
• Adequate financing
• Future capital requirements

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VC Concerns

• Current and projected valuation of company
• Level of risk and expected return
• Investment objectives
• Ability to participate in future rounds upside
  protection
• Rights in future financing or IPO

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Mutual Concerns

• Retention of key members of management team
• Tax issues
• Future valuations of company

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Structuring the Deal

• Preferred Stock
• Convertible Debenture
• Debt with warrants
• Common Stock

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Preferred Stock

• Most common
• Dividend and liquidation preference (downside
  protection)
• Anti-dilution protection
• Convertible into common (upside potential)
• Special voting rights

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Convertible Debenture

• Debt security with fixed rate of return
• Company can deduct interest for tax purposes
• Convertible into shares of common
• Gives investor the position of a creditor while
  risk is high
• If subordinated, some lenders may treat as equity

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Debt with Warrant

• A debt security like before
• Warrant is like a call option right to buy
  shares
• Warrant provides upside potential
• Doesnt have to convert existing debt keeps
  preferred creditor position

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Ratchet Clause

• Pertains to the price at which debt or other
  securities are converted to common
• Issue many other shares may have been issued
  subsequent to convertible security, at different
  prices
• Full ratchet adjusts conversion price to lowest
  price at which stock has been sold