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Raising Early-Stage Venture Capital and Private Equity

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Raising Early-Stage Venture Capital and Private Equity Powered By Docstoc
					Raising Early-Stage Private Equity Capital

Bessemer Trust

George H. Wilcox Managing Director Wilcox@Bessemer.com Bessemer Trust Company 1050 Connecticut Avenue, N.W., Washington, D.C. 20036 Tel. 888-659-3330 Fax 202-659-4059 www.Bessemer.com

Contents
•Introduction •The Capital Formation Process •Required Documents •Common Mistakes in Business Plans •Common “Spin” by Entrepreneurs •Meeting with Investors •Investor Due Diligence •Venture Capital Investment Trends •Financing Lifecycle •Valuation & Pricing •Legal Considerations •Due Diligence Checklists •Biography 3 4-5 6 7 8 9 10 11-18 19 20-21 22 23-25 26

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Introduction
• Bessemer Trust is a private investment firm that was founded by Henry Phipps in 1907 to manage his proceeds from the sale of Carnegie Steel, the company he co-founded with Andrew Carnegie. For nearly 100 years Bessemer has focused exclusively on one business - that of managing substantial family fortunes. Today we manage more than $32 billion for approximately 1,400 families, including more than one hundred Fortune 500 CEOs, former U.S. Presidents, old-economy industrialists and new-economy technology entrepreneurs. Bessemer has been a longtime and active participant in alternative investments, including venture capital, hedge funds, buyout funds and real estate. With regard to venture capital, we participate in one of three ways: (1) through Bessemer Venture Partners, one of the oldest and most successful venture capital firms in the U.S.; (2) through our funds-of-funds, whereby we place money with the premiere venture capital firms across the globe, gaining diversification by stage, style, sector and geography, and; (3) through direct investments, whereby we evaluate direct investment opportunities on behalf of our clients.

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The Capital Formation Process
• Preparation
– – – – – – – Discuss Objectives Draft/Review/Revise Business Plan Draft/Review/Revise Executive Summary Draft/Review/Revise PowerPoint Presentation Estimate Enterprise Value and Price Offering Compile Due Diligence Book Conduct Mock Presentations

• Road Show
– – – –
– – –

Contact Investors and Distribute Executive Summary Distribute Business Plan to Interested Investors Arrange Management Meetings Evaluate and Negotiate Term Sheets
Respond to Information Requests Evaluate Investor Actively Manage the Process

• Expedite the Due Diligence Process

• Negotiate the Investment Agreement
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The Capital Formation Process
Typical Timeline

Wk. 1 Wk. 2 Wk. 3 Wk. 4 Wk. 5 Wk. 6 Wk. 7 Wk. 8 Wk. 9 Wk. 10 Wk. 11 Wk. 12 Wk. 13 Wk. 14 Wk. 15 Wk. 16

Review/Revise Plan, Summary & Presentation Est. Enterprise Value & Compile Due Dil. Book Conduct Mock Presentations Contact Investors & Distribute Summary Follow-up and Distribute Plan to Investors Arrange Management Meetings Secure & Evaluate Term Sheets Due Diligence Negotiate Definitive Agreement Close the Transaction

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Required Documents
• Business Plan
– Do not include proprietary information – Include capitalization table – Include audited or reviewed financial statements

• Executive Summary (critical) • PowerPoint Presentation • Due Diligence Package
– – – – – –
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Articles of Incorporation Bylaws Board Minutes Shareholder Agreements Contracts Client/Customer References
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Common Mistakes in Business Plans
1. Grammatical and spelling errors 2. Written in narrative, rather than outline/bullet, format 3. Poor research and identification of the total addressable target market 4. Lack of internal logic in the financial model 5. Leaps of faith (unsupported assertions) 6. Focusing on the technology and not the business 7. Being an inch deep and a mile wide 8. Ignoring/dismissing the competition 9. Projections that are too aggressive or too conservative 10.Lack of a crisp two-page executive summary that clearly articulates the investment case and compels the investor to read the full plan
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Common “Spin” by Entrepreneurs
1. “Our projections are conservative” 2. “Our market will hit $40 billion by 2004” 3. “We’re about to sign a contract with [insert any Fortune 100 company]” 4. “Key members of the team will join as soon as we get funding” 5. “We don’t have any competitors” 6. “We’ve got first-mover advantage” 7. “[Oracle/IBM/EMC/JDSU] is too slow to be a threat” 8. “Our patents create barriers to entry” 9. “We only need 1% of the market” 10.“A number of VCs are interested”
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Meeting With Investors
Do:
• • • • • Prepare a concise 15-minute PowerPoint presentation A dress rehearsal/mock presentation Have a team leader (CEO/President) who speaks for the company Establish an open and honest channel of communication Demonstrate passion for the business and strategy (but not to the extent that you can’t see its risks and weaknesses, or are rigid and incapable of compromise) Demonstrate the personal commitment of the team to the company (all of your resources – personal, emotional and financial – must be committed before most investors will risk their capital) Be prepared to defend your key strategic assumptions and financial forecasts Have an exit strategy (IPO, merger/acquisition), but don’t appear anxious to jettison the company

Don’t:
• • • • • • • Talk so much that you forget to listen Give evasive answers to specific questions Oversell Appear unfocused Go alone. Key team members should attend Dismiss the competition. You must clearly articulate your competitive advantage Attach your ego to your idea (i.e., don’t be defensive when your strategy is challenged; investors want to know that you are open-minded and receptive to their suggestions) Forget that you are being evaluated from the moment you say hello to the moment you say goodbye, and that camaraderie and rapport play an important role in getting the investor to “yes”. Go to the meeting without having a firm command of the company’s key operating metrics and how they are/will be tracked and utilized.

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What You Need to Know About Your Lead Investor
• • • • How well does it know your industry Are any of its portfolio companies competitors? Potential partners/customers/suppliers? What is its reputation in the financial community? How effective will it be in helping attract co-investors for this round? For the next round? Is it seeking any special terms/compensation for acting as the lead and how will this effect potential co-investors? Will it participate in the next round if the company meets its milestones? Beyond capital, what assistance will it offer? Executive recruiting, key strategic partnerships, high-profile board members? How frequently and in what manner does it prefer to communicate with management? If a strategic investor, what is motivating its investment and will it seek to block partnerships with or an acquisition by its competitors.

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Equity for Venture-Backed Companies Comes from Multiple Sources
100%
80% 60% 40% 20% 0% 1995 1996 1997 1998 1999 2000
Source: VentureOne/PwC

Venture Leasing, Individuals & Other Corporations Private Placements Venture Capital

Venture Capital Investment in Venture-Backed Companies
$30

1132 842 859 552 548 553 594

1275 1217 1024
1,200

$20

$19.8 $19.7 $17.4 800 $16.2 609 $14.5
600 400 200 0

927

1,000

433
$10

$8.5 $9.2

$8.8

$3.8$4.1 $4.2$5.2 $3.2
$0 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01

Amount Invested ($B)

Number of Deals
Source: VentureOne/PwC

Corporate Investment in Venture-Backed Companies
115 $2,500 $2,000 $1,500 $1,000 $500 $0 26 94 $2,089 73 75 50 25 $143 0 100

60

58

$1,519 58 $1,316
$745 34

23 17

26 $135 $147

25 $255

40 $902 $825 $382

$265 $248

Total Invested ($M)

Total # of Deals
Source: VentureOne/PwC

Private Placements of Equity into Venture-Backed Companies
81 75 $5,000 $4,000 $3,000 $2,000 $1,000 $0 12 4 $39 32 $1,722 52 48

$3,130
30 16 9 $756 $800

44 34 29

50

$2,207 $1,514

12

$1,158

25 $863

$278 $282 $105 $267 0

1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01

Total Invested ($M)

Total # of Deals

Source: VentureOne/PwC

Individual Investments in Venture-Backed Companies
80 72

80

$200
49

57 $169 34 33 27 $82 $43 $107 45

60

$150

40

$143 $143
26 $94 $74 10 $29 $9 3 4

40

$100 $142 $50

20
$29

$46

$0

0

1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01

Total Invested ($M)

Total # of Deals

Source: VentureOne/PwC

Median Pre-Money Valuations Decline in All Rounds
$100

$80
$60 $40 $20 $0 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01

Seed

First Round

Second Round

Later
Source: VentureOne

Median Amount Invested Regressing Toward the Mean
$25 $20 $15 $10 $5 $0 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01
Seed First Second Later
Source: VentureOne/PwC

Percentage of Deals with Multiple Investors Increases
100%
5+

80%

4
3 2 1

60%
40% 20% 0% 1995 1996 1997 1998 1999 2000

Source: VentureOne/PwC

Financing Lifecycle
The Chasm Angels Founders Seed Capital Venture Capital Strategic Investors The Wall Public Markets IPO Later Stage Mezzanine

Early Stage

Secondary Offerings

Revenue
B A

C

Time
Valley of Death

Seed or Start-up: Market research and product development. Early Stage: Funding full-scale operations and selling products/services. Not yet profitable. Later Stage: Funding expansion and new products. Near break-even.

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Valuation & Pricing
Typical Pricing Model
Expected $3,000,000 50% 40% 20 5 50% 40% $100,000.00 50.00% $5,000,000 $22,781,250 $5,567,500 $111,349,992 $14,663,373 34.10% Possible Scenarios Pricing Factors Base Year Revenue (At or near financing event) Expected C AGR Revenue Exit Year Pre-Tax Profit as % of Rev. Expected IPO or M&A Multiple Years to Exit Probability of Outcome Tax Rate Int. Expense In Exit Yr. (M&A Exit Only) Required Annual ROR Equity Investment Required Projected Revenue (Exit Year) Exit Year Net Income (If IPO) or EBIT (if M&A) Future Value of Venture at Exit Event Valuation (Discounted Present Value) Pricing: Equity Percentage Required Worst $2,000,000 45% 40% 15 6 25% 40% $100,000.00 50.00% $5,000,000 $18,588,229 $4,561,175 $6,006,485 83.24% Best $4,000,000 55% 40% 30 4 25.0% 40% $100,000.00 50.00% $5,000,000 $23,088,025 $5,641,126 $33,428,892 14.96%

$68,417,618 $169,233,768

Pricing (Equity % Required based on Weighted Average of Scenarios) 36.8%

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Valuation & Pricing
Key Negotiating Points

• Company’s Stage of Development
– Seed, Early, Late

• VC’s ROI (discount rate)
– Seed: 55% - 60% – Early: 30% - 50% – Late: 20% - 33%

• Comparable Companies (and exit multiples) • Staged Discussions to Minimize Dilution
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Legal Considerations
• Don’t issue common stock to investors – Establishes value and impairs issuance of cheap options/restr. stock to employees Option Pool (10% - 25%) – Establish early but be reasonable – deemed issued for valuation purposes Securities to be issued – Convertible Debt – Warrants – Preferred Stock – Convertible Preferred Stock – Participating Preferred Stock • Resist or cap participation (2x – 3x) – Redeemable Preferred Stock – Super-preferred Stock • Converts to red. and conv. pfd. – adverse tax impact to investors upon conversion Registration Rights – Demand, Piggy-back, Lock-up • Anti-dilution Rights – Straight Percentage (harsh, rare) – Full Ratchet (harsh) • Purchase price reduced to lowest subsequent purchase price regardless of shares issued – Weighted Average (fair) • Adjusts using a formula based upon the number of shares issued – Carve-outs • Issuances under stock option plan, conversions, partners, lenders and in acquisitions Preferred Stock Voting Rights – Vote with common vs. special voting as a separate class on issuances, mergers, etc. Board Seats vs. Observer Rights Stockholder Rights – Transfer restrictions, pre-emptive and cosale rts. Founders – Stock vesting, 83(b) elections, Noncompetes No Shop (resist, limit duration and scope)

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Due Diligence Checklists
Corporate
1. Management, Officers, Directors & Employees •Key Management: resumes & references •Directors & Officers of the company: contact information •List all Employees: job title, base salary, options/equity •Current Organizational Chart 2. Capitalization/Securities •Capitalization Structure: include a description of any rights attached to preferred shares •List any Non-Employee holders of any options or rights to purchase securities including warrants 3. Business Description •Business Plan •Executive Summary •Investor Presentation 4. Marketing & Sales •Sales Plan •Marketing Plan •Company Marketing Materials and Brochures •Historical Sales Data •Customer Sales Pipeline for next 6 months •Sales Literature describing Product Features & Applications •Describe Sales Process 5. Customers •Pricing Model and Current Price List •Provide Complete Customer List - Detail on 10 biggest - Detail on 10 medium - Detail on 10 smallest •Provide contact information for top 5 customers for product/service review 6. Target Market Sizing •Provide any Third Party data supporting # of customers in US eligible to purchase Product/Service

Continued…
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Due Diligence Checklists
Corporate
7. Competition •Competitive Market Analysis 8. Operations •List of Top 10 Suppliers: include contact information •Organizational Chart for R&D •Development Calendar for next 12-24 months 9. Information Technology •List Proprietary Technology & Patent references •Technical Literature describing Product Design and Functionality •Key Information Technology (IT) Suppliers •List any Third Party Embedded Code •Provide Graphic Layout of Technology Platform 10. Financial Information •Latest Financial Statements •Latest A/R Aging Schedule •Revenue/Sales Projections & Budget •Capital Expenditures Budget for next 12 months •Create a Win/Loss Report 11. Intellectual Property (Patent, Trademarks, Copyrights) •Schedule of Patent Registrations/Applications identifying each patent by title, registration number, date of registration & status •Schedule of Trademark Registrations/Applications identifying each mark by title, registration #, date of registration & status •List any Licensing/Merchandising Agreements relating to Patents, Technology, Trade Secrets, Trademarks and Copyrights 12. Contract & Strategic Partnerships •List any Joint Venture or Strategic Partnership Agreements •List Legal & Accounting Firms: include contact information

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Due Diligence Checklists
Technology
1. Company, Product and Service Documents •Product Documents User Manuals [including Installation Guides, etc.] Reference Manuals Architecture/implementation Product Design Documents Brochures, Product Fact Sheets White papers Industry Analyst Articles Corporate and technical management biographies Case studies / User Stories 2. Product Maintenance Information •Problem Reports: details by Customer, severity, resolution - past 6 months trend report – monthly problems by product version, severity - preceding 1 year •Product Release Documentation Release documents for previously shipped 2 product versions/releases Release planning documents [upcoming versions/releases] Post-mortem documents on latest production release 3. Plans and schedules •Project plans & schedules for current development projects •Project plans & schedules for maintenance releases in progress 4. Customer reference information •Customer technology testimonials, articles, papers, etc. 5. Process (Method) Documentation •Development process •Quality Assurance / Testing process •Configuration Management process •Change Management process •Information Development (Documentation) process •Packaging and/or Distribution process •Client Support process •Maintenance process •Project plans & schedules for maintenance releases in progress

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Biography
George H. Wilcox, Managing Director Mr. Wilcox is the Managing Director in Bessemer’s Washington, D.C. office where he is responsible for oversight of more than $1.2 billion in client investments. Mr. Wilcox joined Bessemer in 1997, and took a brief sabbatical to co-found and serve as Chairman and CEO of US Venture Exchange, Inc., a leading mergers and acquisitions exchange. Earlier in his career, he was a member of the capital markets group at Legg Mason in Baltimore. Prior to that, he practiced corporate law with Kirkpatrick & Lockhart in Boston and with Jones Day Reavis & Pogue in Atlanta. Mr. Wilcox holds a Bachelors degree in economics from Boston University, where he was a scholar-athlete. He holds a Juris Doctor degree, cum laude, from New England School of Law, where he was Managing Editor of the New England Law Review. Mr. Wilcox is a member of the Board of Directors of US Venture Exchange, Inc., as well as a member of the Massachusetts and Georgia Bar Associations, the MidAtlantic Venture Association's Private Investor's Network, and the BaltimoreWashington Venture Group.

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Description: Raising Early-Stage Private Equity Capital