Docstoc

Venture Capital Investing

Document Sample
Venture Capital Investing Powered By Docstoc
					Venture Capital Investing A Primer
William Quigley Managing Director Clearstone Venture Partners william@clearstone.com
CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
“I was seldom able to see an opportunity until it had ceased to be one”
Mark Twain
CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

Industry Snapshot

 


 

400+ institutional VC firms in the U.S. Geographically concentrated Stage/Industry focused General partners/Limited partners 10 year investment horizon Co-investment with other VC’s common
CLEAR STO N E
V E N T U R E P A R T N E R S

Typical Firm Profile
     

3 to 4 investment professionals Review 1000+ business plans a year Manage $50 to $200 million in capital Buy equity (preferred stock) - rarely make loans Investment horizon - 3 to 6 years Sources of capital: - Pension funds - Corporations - College endowments - Wealthy individuals
CLEAR STO N E
V E N T U R E P A R T N E R S

Investment Stages
Most VC‟s have a preference for a particular investment stage. Five Stages:
– – – – – Seed Start-up Early Expansion Mezzanine/Bridge
CLEAR STO N E
V E N T U R E P A R T N E R S

Stage/Characteristic
Stage
Seed

Investment
$50-500K

Characteristics
- Founder(s) only - No product - No customers - Primary risk: R&D - Mgmt. team incomplete - Prototype or beta product - No revenues - Limited customer interest - Some capital invested - Primary risk: market accept.
CLEAR STO N E
V E N T U R E P A R T N E R S

Start-Up

$500K to $1MM

Stage/Characteristic
Stage
Early

Investment
$1MM - $3MM

Characteristics
- Most of team in place - Limited revenues - Not profitable - Primary risk:execution - Meaningful revenues - Achieving profitability - Growing customer base - Primary risk: competition
CLEAR STO N E
V E N T U R E P A R T N E R S

Expansion $3MM - $10MM

Stage/Characteristic
Stage Investment Characteristics
Mezzanine/ $10MM - $20MM - Significant revenues Bridge - Profitable
- Industry player - IPO in 6-12 months - Risk much lower

CLEAR STO N E
V E N T U R E P A R T N E R S

The Role of the VC



 

 

Board involvement Management recruitment Future capital raising Access to business network Strategy development Patience!
CLEAR STO N E
V E N T U R E P A R T N E R S

Targeted Industries
Most of the $10 billion invested by VC‟s in 1997 was concentrated in five industries. Why these? • • • • • Information Technology Medical Services/Devices Communications Biotechnology Some Retail
CLEAR STO N E
V E N T U R E P A R T N E R S

How Do VC’s Make Money?
Source of VC Income:
– Collect management fees from L.P.’s - 2 1/2% annually – Share profits with L.P.’s 20/80 split on investment gains How do VC’s earn their income?

5% 95%

Mgmt. Fee

Investment Gains
CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

What Do VC’s Want to See?
Venture capitalists tend to focus on five specific areas when evaluating a company: Areas of Focus:
• Management

• Marketplace
• Competition • Business Economics

• Risks
CLEAR STO N E
V E N T U R E P A R T N E R S

Management
The most important question: Has the team had experience and success in the same industry? VC Focus:
– – – – – – DIRECT sales experience? Prior P/L responsibility? Personal financial stake? Willingness to share equity “Fire in the belly”? Functional areas covered?
CLEAR STO N E
V E N T U R E P A R T N E R S

Market
Can management demonstrate a thorough understanding of the marketplace dynamics? VC Focus:
– Market size and growth rate? – Market drivers? – Customer involvement in the R&D process? – Number of competitors?
CLEAR STO N E
V E N T U R E P A R T N E R S

Competition
Does management have a clear understanding of the competitive landscape? VC Focus:
– Why are competitors successful? – What is the prevailing business model? – Barriers to entry?
CLEAR STO N E
V E N T U R E P A R T N E R S

Business Economics
Does management have a deep understanding of the financial dynamics of the business and industry? VC Focus:
– Margins comparable to industry norm? – Break-even < 2 years ? – Appropriate sales model? – Moderate capital intensity?

CLEAR STO N E
V E N T U R E P A R T N E R S

Risk
Does management recognize, accept, and have strategies to deal with key risks? VC Focus:
– – – – Reasonable financial projections? New technology adoption rate? Length of sales cycle? Best and worst case scenarios explored? – Regulatory hurdles?

CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

The Venture Capital Process

    

Business Plan First Meeting Second Meeting Term Sheet Due Diligence Negotiations
CLEAR STO N E
V E N T U R E P A R T N E R S

Business Plan
“Madam, enclosed please find the novel you commissioned. It is in two volumes. If I had had more time I could have written it in one.”
Voltaire

CLEAR STO N E
V E N T U R E P A R T N E R S

Business Plan
#1 objective of the the business plan: Get the VC interested in hearing more about the opportunity. Business Plan Basics:
– Written by the entrepreneur – Keep it short – Financials (3-5 year proj.) • Income statement • Balance sheet • Cash flow • “What-ifs” helpful
CLEAR STO N E
V E N T U R E P A R T N E R S

Business Plan
Magic Numbers?





50 5 10
CLEAR STO N E
V E N T U R E P A R T N E R S

Business Plan
Business plan phrases that „spook‟ VC‟s...
    

We have no competition…. We conservatively project….. We only need a 10% market share…. We will offer the most features at the lowest price…. We valued our Internet start-up using multiples of comparable companies…like Netscape, Cisco, Microsoft.…
CLEAR STO N E
V E N T U R E P A R T N E R S

First Meeting
„Skepticism‟ might best describe the venture firm‟s attitude in the first meeting. Don‟t be alarmed by this. The Details:
– – – – Location: VC’s office Duration: 2-3 hours Attendees: 1 to 2 VC’s Format: Formal presentation with Q/A
CLEAR STO N E
V E N T U R E P A R T N E R S

Second Meeting
Getting to the second meeting is an important milestone. The team will now make its case to the entire partnership. Focus On :
• Business opportunity - not the technology • Addressing concerns of the skeptics - THIS IS CRITICAL! • Next steps
CLEAR STO N E
V E N T U R E P A R T N E R S

What Went Wrong? - A Few Tips
Dont’s
• Make vague, ambiguous, or unsubstantiated statements • Make reference to unnamed/ mysterious people on the management team • Use statistical arguments for market penetration assumptions • Use technical jargon • Assume you have a deal if there is no term sheet
CLEAR STO N E
V E N T U R E P A R T N E R S

What Went Wrong? - A Few Tips
Dos
• Involve the entire team • Discuss/disclose potential problems • Demonstrate financial commitment to the venture • Prepare realistic market and sales projections • Know your target investor (angel, bank, VC)
CLEAR STO N E
V E N T U R E P A R T N E R S

What Went Wrong? - Getting Feedback
Getting honest feedback can be challenging… Some Guidelines:

“The greatest gift that – Needs to be solicited! God hath given us is – From knowledgeable sources to see ourselves as – Develop a dialogue first others see us.”
– Avoid answering, debating – Have a market-researcher mindset
Scottish Proverb

CLEAR STO N E
V E N T U R E P A R T N E R S

Term Sheet
After the second meeting, the VC typically provides a term sheet to the entrepreneur. Term Sheet - Common questions:
– Is it a legally binding document? – What’s covered? – What is it designed to do? – Why participating preferred stock?
CLEAR STO N E
V E N T U R E P A R T N E R S

Term Sheet Conditions
The term sheet is intended to embody the overall conditions of a business agreement. What‟s covered?
 Post-money valuation  $ amount of the financing  Investors identified  Size of employee option

pool  Vesting periods  Key-person insurance

 Board representation  Additions to management team, if any  Monitoring covenants, Restrictive covenants  Other deal specific issues
CLEAR STO N E
V E N T U R E P A R T N E R S

Due Diligence
The “heavy lifting” for the venture capitalist starts with the due diligence process. Due Diligence Overview:
– Length: 6-12 weeks – Will perform up to 100 reference calls – Interview customers, former employees, competitors, industry experts – Intense legal, financial work
CLEAR STO N E
V E N T U R E P A R T N E R S

Negotiations
Negotiations take place throughout the due diligence process. What is negotiable? Some flexibility in:
– Valuation – Total investment – Vesting periods – Size of option pool

Less flexibility in:
– Equity instrument type – Board make-up – Anti-dilution rights – Restrictive covenants

CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

The Business Plan
Executive Summary Main Body Appendix

CLEAR STO N E
V E N T U R E P A R T N E R S

Executive Summary
What should the executive summary address?  Mission statement  Brief company history  Description of investment opportunity  Market overview  Management team  Product & technology  Customers  Strategy  Competition  Capital requirements
CLEAR STO N E
V E N T U R E P A R T N E R S

Main Body
Management
Key Questions to Address:
 

Who are the key people in the company? Where did they come from, and why are they the right people to run the company? Have they had previous experience and success in growth companies?
CLEAR STO N E
V E N T U R E P A R T N E R S



Main Body
Product/Technology/Service
Key Questions to Address:
  

What does the customer have access to today? How does it differ from competing offerings What is the superior value proposition to the customer?
CLEAR STO N E
V E N T U R E P A R T N E R S

Main Body
Marketplace
Key Questions to Address:


What is happening in the marketplace? Is it growing, if so, why and at what rate? What is lacking from the market leaders that this product/tech/service will provide?





Which customers have been involved in the development of the product and are likely to purchase it? CLEAR STO N E
V E N T U R E P A R T N E R S

Main Body
Strategy
Key Questions to Address:


Why will the customer be compelled to purchase the product? How will the company maintain its competitive differentiation?





What barriers exist/will be created to curtail new entrants?
CLEAR STO N E
V E N T U R E P A R T N E R S

Appendix
Not all business plans require an Appendix section, but it can be useful. What to include?


Relevant industry articles to bolster management claims Major customer testimonials Other information likely to impress those not familiar with the market
CLEAR STO N E
V E N T U R E P A R T N E R S

 

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

Valuation
Stage Seed Criteria
- Mgmt. track record - Market size/growth - Competition - Investment to date - Market size/growth - Working prototype? - Team complete?

Methodology

Range

Comparables, $400K to $1.5MM Whats the “going rate” in the region

Start-up

Comparables

$750K to $2.0MM

CLEAR STO N E
V E N T U R E P A R T N E R S

Valuation
Stage
Early

Criteria
- Market size/growth - Revenue run rate - Gross margin % - Performance to date

Methodology
Comparables

Range
$1.5 to $5.0MM

Expansion - Revenue run rate
- Profitability ratios - Performance vs. plan

- 1X sales - EBIT multiple

Varies

CLEAR STO N E
V E N T U R E P A R T N E R S

Valuation
Stage Criteria Methodology
Multiples of proxy companies

Range
Varies

Mezzanine/ - Market share/size Bridge - IPO environment - Performance Relative to plan

CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

Exit Strategies
• Sale or Merger
– Most likely exit

• Initial Public Offering
– Small fraction go this way

• Redemption
– Least attractive

• Management buy-out
– Generally not possible
CLEAR STO N E
V E N T U R E P A R T N E R S

Secrets of Success?
The Eight Commandments
       

CEO carried a bag Called on same customer base Gross margin > 50% Some degree of technology Cash flow break-even < $5M Sourced the deal 25% ownership or greater First institutional investor
CLEAR STO N E
V E N T U R E P A R T N E R S

Odds of Getting a Deal Done?
Hurdle
1. Review the plan and

Likelihood of Occurring
- 1 in 15 - 6 in 10 - 7 in 10

conclude it makes sense 2. Meet the team and like them 3. Be attracted to the market opportunity and the company strategy 4. Introduce team to the other partners and get their buy-in

- 7 in 10
CLEAR STO N E
V E N T U R E P A R T N E R S

Odds of Getting a Deal Done?
Hurdle
5. Complete the due diligence process satisfactorily 6. Get a term sheet agreed to in principle 7. Find co-investors - if necessary - 8 in 10 - 9.9 in 10

Likelihood of Occurring
- 7 in 10

8. Get legal documentation done
9. Fund the company

- 9 in 10
EQUATES TO 1%
CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“Will I have to give up control of my company?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“Why don’t VC’s sign NDA’s?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“Raising money - all at once or spread out over time?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“Its a great invention, so why aren’t they interested?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“Why do VC’s want to know the other firms that I am talking to?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Commonly Asked Questions
“When should I initiate contact with a VC?”

CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital
Industry Overview Screening Venture Opportunities The Venture Capital Process The Business Plan Valuation Exit Getting in Touch
CLEAR STO N E
V E N T U R E P A R T N E R S

How do you Contact a VC?
Introductions are best:
– Attorney – Accountant

– Banker
– Angel Investor – Industry Executive

CLEAR STO N E
V E N T U R E P A R T N E R S

Local Resources


    



The Michael Dingman Center at U of MD. The Morino Institute - Netpreneur Program Baltimore/Washington Venture Group NVTC - Emerging Business Network functions Silicon Valley Bank, other community banks Private Investors Network, Grubstakes (networks of angel investors) Pratts Guide to Venture Capital
CLEAR STO N E
V E N T U R E P A R T N E R S

Venture Capital

CLEAR STO N E
V E N T U R E P A R T N E R S


				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:114
posted:9/5/2008
language:English
pages:62