From Invention to Start-Up: Money - Angels and Strategic Partners November 28, 2006 Susan Preston Entrepreneur-in-Residence Ewing Marion Kauffman Foundation AND Director of Attorney Training and Professional Development Davis Wright Tremaine

Financing Life Cycle Discovery Proof-of Concept Product Design Product Development Manufacturing/ Delivery Financing IdeaPre-seed Funding Seed Funding Expansion/Mezzanine Operating Cap. Friends and Family Angels Seed Funds Venture Funds Founder Institutional Equity Loans / Bonds Product Dev Angel Groups Start-up Funding Government Grants/Loans

Venture Capital Statistics: Investments in US 2005 – invested $21.7 billion (2,939 deals) 2004 – invested $20.9 billion (2,876 deals) 2003 – invested $18.9 billion Increase due largely to late stage investments:  $9.7 billion in 2005  $7.2 billion in 2004  $4.9 billion in 2003  Less than 2% in early/seed stage Source: NVCA

Venture Capital Investments by Stage of Development ($s in Millions) Source: MoneyTree

Venture Capital Investment: Historical and 2006 Projected Source: MoneyTree

Average VC Deal Size Per Financing Round ($ Million) Source: NVCA

US Angel Investments 2005 – invested $23.1 billion (49,500 deals) Increase of 2.7% in $’s over 2004 Increase of 3.1% in deals over – invested $22.5 billion (48,000 deals) 2003 – invested $18.1 billion 227,000 active angels 20% Healthcare/medical devices and equipment 18% Software 55% in seed/start-up 43% in post-seed/start-up (10% increase over 2004) Source: Center for Venture Research

Who Are Angels? Angels are accredited investors who: Expect a financial return Believe in giving back to their communities Invest locally and regionally Participate in the investment process Show interest in personal relationships with companies and employees Offer wisdom and guidance to entrepreneurs

Financial Attributes of Angels Provide early-stage investment dollars Invest smaller dollar amounts per investment Partially fill funding gap left by venture capitalists (VCs) Invest individual wealth Can tolerate loss of entire investment Have diversified portfolios Invest with “patient money”

Angels and VCs – Similarities Selective in investments  Requirements for an investable company  Expectation of return on investment - scalable  Similar investment terms (though angels can and often are – or must be – simpler)  Bring the attributes of a professional investor

Angels and VCs –Differences Venture capitalists:  Invest on “home-run” theory  ROI is ultimate goal  Investing 3 rd party money  Often more demanding and actively involved than angels:  Control often issue  Can requirement board and advisor approval and corporate actions  Angels:  Invest for returns – may be more modest expectations  Social /community aspect to investments  Individuals investing their own wealth  Patient money

Investment Preference 39 groups reporting

$0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $ * *2006 Estimated Value Startup/Seed Valuations Of Venture Capital Seed/Startup Rounds ($Millions)

Valuation: Expected ROIs ROIFive Year ROI Seed60%+/year10X+ Start-up50%8X Early stage40%5X 2 nd stage30%4X Near exit25%/year3X

Finding Angel Investors Angel Organizations: Several in Puget Sound area including: AoA, PSVC, Seraph Capital Forum, Zino Society, Keiretsu Forum, Tacoma Angel Network, Bellingham Angel Network Professional Service Providers Investment Forums Business Plan Competitions Professionally-funded Start-ups Venture Capitalists Corporate Boards

Forms of Investment Debt (note)Equity (stock) OptionsWarrants Debt: collateralized, non-collateralized, interest in cash or stock (deferred?), convertible (at election or automatic?), length of time, etc. Equity: common vs. preferred, dividends, many other terms discussed below

Professional Investors Angels, venture capital, corporations typically receive:  Preferred stock Convertible debt with warrants or additional stock Provide more than money: Can be proactive in developing business through (“win together”):  Company building experience  Company functionality experience  Industry experience  Contacts for partners, customers and follow-on financing

What Professional Investors Are Looking for: Investable Companies Clear path to profitability Solid management Realistic business concept and plan Scalable business Competitive edge/Technical superiority Market acceptance Realistic financial projections Realistic valuation Clear, well-articulated exit strategy Bottom line: Opportunity for financial return

What Professional Investors Are Looking for: Investable Companies How does an investor make this determination?  Passion of entrepreneur (presentation)  Team track record – individually and together Entrepreneur’s ability to succinctly articulate vision and mission  Entrepreneur seeks advice of trusted, experienced, honest advisors  Coachable entrepreneur

What Professional Investors Are Looking for: Investable Companies How does an investor make this determination?  Competitors researched and understood  Clear market differentiator  Value proposition for customer clearly evident  Market access strategy clear and realistic  Comprehensive summary of risks (and plans to cope/address)  Profit potential – good margins  Marketability of company – M&A exit Type, timing and realistic purchasers

Term Sheets: Debentures Convertible Debentures (Notes): Automatic upon event or investor controls conversion Note term Interest: cash or stock; payment schedule; part of conversion Security interest/collateralized?

Term Sheets: Preferred Stock Rights, preferences and privileges of preferred stock Price Use of Proceeds Dividends Liquidation preference Anti-dilution provisions Redemption Protective provisions Information requirements Registration rights Right of first refusal Co-sale rights Option pool Founder vesting Inventions agreements

Summation Angels invest primarily in seed/start-up rounds Angels represent patient money Angels are becoming sophisticated investors Angels make excellent advisors and mentors Many companies will need only angel investors Be open, coachable and realistic Show your commitment, passion and drive The essence of due diligence: So what? Who cares? Why you?