Professional Equity Investment Venture Capital and Angel Lecture

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Professional Equity Investment (Venture Capital
and Angel) Lecture

• EBD 481, Fall 2007
• Galbraith

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History of Venture Capital

• 1960s to early 1980s
• Individuals
• Money for equity
• Based upon technology
• Early 1980s to late 1980s
• Real estate money
• Formed partnerships to spread risk
• Required business plan

• Late 1980s to present time
• Institutional money
• OPM (other people money)
• Risk adverse
• Invest primarily in track record
• Money finders v. VC firms

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Professional VC v. Angel Investment

• Angel Networks
• Formal groups of individual investors
• Different from individual investors
• Angel Fund v. Individual Allocation within
  Network
• Typically Investment between 250K to 1m
• Often pool with other angel networks for a deal
• VC
• Professionally managed funds
• Typical investment great than 1m (more often 5m)

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Example of Angel Network

• Wilmington Investor Network (WIN)

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Equity Investment Process
Seed Money
1st Round Financing
2nd Round Financing
Clean-up Financing
50k 1 million 3 million
1 million
Year 1 Year 3
Year 5
Private Investment Venture Capital Firms
Milestones and Benchmarks
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Historical Development of Professional Venture
Capital

• 1946 Beginning of Professional VCs
• Formation of American Research Development
  (ARD)
• ARDs Performance
• 3.5 million was raised (2 million from
  institutional investors)
• By end of 1947, ARD had invested in eight
  ventures, six of which were startups
• By 1951 the performance was still lack-luster
  (stock price was at 19 down from the initial
  offering price of 25 in 1946)
• 1957 Invested in Digital Electronic Corporation
• ARD Sold 1972 made money, about 15.0 annual
  return for investors (v. 7.2 in stock market)

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Historical Development of Professional Venture
Capital (contd)

• 1953
• Small Business Administration (SBA) was formed
• Legislation permitted the federal government to
  actively engage in fostering new business
  formation
• 1958
• SBA Created Small Business Investment Companies
  (SBICs)
• Due to tax and leverage advantages, the SBIC
  became the primary vehicle for professionally
  managed venture capital

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SOLICITING INVESTMENTS Suppliers of Venture
Capital 25-Year Average
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Professional Venture Capital Investing Cycle
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ORGANIZING THE FUNDVC Fund Placement Memorandum

• Front-matter Declarations
• State Securities Disclosures
• Offering Summary
• Fund Overview
• Executive Summary
• Summary of Terms

Fund is Formed, Investments Made, New Fund Created
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Useful Terms

• Carried Interest
• portion of profits paid to the professional
  venture capitalist as incentive compensation
• Two and Twenty Shops
• investment management firms having a contract
  that gives them a 2 of assets annual management
  fee and 20 percent carried interest

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OBTAINING COMMITMENTSArrangements with Fund
Investors

• Capital Call
• when the venture fund calls upon the investors
  to deliver their investment funds
• Common to require subsequent investments
  consistent with the levels of investors initial
  contributions

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DUE DILIGENCE AND ACTIVE INVESTING VC Fund
Management

• Deal flow
• flow of business plans and term sheets involved
  in the venture capital investing process
• Due diligence (in venture investing context)
• process of ascertaining the viability of a
  business plan

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VC and Angel Screening - Venture Characteristics

• Management
• Fire Within
• Business Model
• Business Plan
• Deal Structure
• Exit Plan

• Proprietary
• Growth
• Founder Commitment
• Experience
• Track Record

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Screening Outcomes

• Seek lead investor position
• Seek a non-lead investor position
• Refer venture to more appropriate financial
  market participants
• SLOR (standard letter of rejection) the venture

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Structuring an Equity Investment

• Term Sheet
• summary of the investment terms and conditions
  accompanying an investment
• Typical Issues Addressed in a Term Sheet
• Valuation
• Ongoing funding needs
• Size and staging of financing
• Preemptive rights on new issues
• Commitments for future financing rounds and
• performance conditions
• Form of security or investment
• Redemption rights and responsibilities

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Structuring (contd)

• Typical Issues Addressed in a Term Sheet
• Dividend structure (Number of VCs and outsiders)
• Additional management
• Board appointments
• Conversion value protection
• Registration rights
• Exit conditions and strategy
• IPO-dictated events (e.g. conversion)
• Co-sale rights (with founders)
• Lock-up provisions

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Structuring (contd)

• Typical Issues Addressed in a Term Sheet
• Employment contracts
• Incentive options
• Founder employment conditions compensation,
  benefits, duties, firing conditions, repurchase
  of stock o termination, term of agreement,
  post-employment activities and competition
• Founder stock vesting
• Confidentiality agreements and protection for
  intellectual property

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Exit Strategies

• Acquisition -- least costly of exit strategies
• Public Offering -- most costly, but exciting and
  maintain some control (Future Lecture?)
• Joint Venture -- intermediate strategy
• Equity Buyback -- expensive, but way to get
  venture capitalists out of business

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Summary - Advantages and Disadvantages of VC
Funding

• Contractual Commitments
• Legal and paperwork
• Marketing and Management Assistance
• Leverage for debt financing
• Networking for additional funds and contacts

• Equity
• Oversight
• Control
• Over payment for funds
• Need to have exit strategy

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Grant and Guerrilla Financing
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Grant Financing

• Government and Private Grants for RD and
  Commercialization
• No equity
• Amount may be about 10billion per year in U.S.
  (angel financing about 20billion per year)
  largest in segments which are funded

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Grant Financing

• Small Business Innovation Research (SBIR)
• DoD, NASA, DHS, DoC, EPA, DoT, DoEd, DoE, HHS
  (NIH), NSF USDA
• The SBIR Program provides up to 850,000 in
  early-stage RD funding directly to small
  technology companies (or individual entrepreneurs
  who form a company)
• Phase 1 (75,000)
• Phase II (750,000)
• Phase III (sell product)
• Small Business Technology Transfer Research
  (STTR)
• The STTR Program provides up to 850,000 in
  early-stage RD funding directly to small
  companies working cooperatively with researchers
  at universities and other research institutions

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Grant Financing

• Department of Defense SBIR/STTR/Fast Track -
  Main Page
• TechLink Links to Department of Defense, DoD
  Component, and Related Websites for SBIR/STTR
  Information

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Grant Financing

• Other Grants (CCAT, TechLink, BAAs, etc)
• Local and Regional Economic Development Grants
• Industrial Development Bonds
• Tax Breaks
• Other Incentives
• Private Foundations

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Guerrilla Financing

• Credit Cards
• Relatives and Friends
• Trade Credit
• Revenue Financing
• Small Shares, with buyback provision
• Factoring

BOOTSTRAPPING