E145/STS173 Workshop C Staged Venture Financing E145/STS173 Workshop C Staged Venture Financing Professor Tom Byers Stanford University Special Thanks to Scott Bowie and Mike Rosenbluth Copyright © 2004 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only.

Agenda 1. Valuing public companies (Ratios) 2. Dilution + Growth: The exploding pie 3. Chemdex financing

Ratios & Valuing Public Companies Today Market Cap = # shares outstanding x Share price –Answers “what does the market think the company is worth?” Ratios –EPS = Earnings per share An indicator of value created for shareholders –P/E = Market Cap / Annual Earnings or Stock Price / EPS How much does $1 of earnings cost an investor? –P/S = Market Cap / Annual Sales Similar companies facing similar risks should have similar ratios

Metrics in Action Market Cap Net Income: $10 M P/E: 30 $300 M Share Price: $15 # Shares: 20 M $300 M Sales: $100 M P/S: 3 $300 M

A Sampling of Public Companies

Metrics Calculation Public Company Info: (must be filed with SEC) We can calculate:

Metrics Calculation Public Company Info: (must be filed with SEC) We can calculate:

The Venture Financing Game

Kaplan’s Startup Game: A race against time to create value and reduce risk (1) Founding: An entrepreneur begins with a vision and shares of stock in the new venture. Entrepreneur trades stock for ideas, money, and people (2) Seed Stage: Venture capitalists provide money in return for stock Employees join via friends & associates in return for cash salary and stock options Ideas become intellectual property which represents the initial value in the company Further growth is delayed until milestones are reached and risk of failure is reduced (3) Growth Stage: More money, ideas, and people are obtained, but for much less stock than in the earlier stage due to lower risk Company balances earning cash, taking investment, and spending cash to create value (4) Exit Stage: Company files for IPO Entrepreneur, investors, and employees can cash in stock for money A viable public company has been created Each party continues to build the company, retires, or starts the game again Value has been successfully created. Reference: Start-Up by Jerry Kaplan

The Exploding Pie The smaller slice of the bigger pie –Goal: Trade shares to grow the pie –Is more fun and rewarding for most entrepreneurs –Is worth more than the whole pie that never grows –Requires high growth rates –Is not easy to achieve, even with lots of financing –Requires a good relationship between entrepreneur and investors

A Real Life Example: Chemdex* How much money do the founders need? How long until significant revenue? How long until profitability? What’s the going rate for 1st round deals? Valuation is an art, not a science. *Chemdex is now called NexPrise (NXPS)

Chemdex in 1997: Series A 1. How much does the company need to raise?

Series A 2.Negotiate a pre-money valuation post $ = pre $ + amount raised = $2.7 M + $1.9 M % of company sold = amount raised / post $ valuation = $1.9 M / $4.6 M

Series A 3. Determine share price and total number of shares In Round A, share price is set so total shares = 5-10 million Total Shares = post $ / share price = $4.6 M / $0.54 = 8.5 M shares

Series B 1. How much does the company need to raise?

Series B 2. Negotiate a pre-money valuation post $ = pre $ + amount raised = $11 M + $13 M % of company sold = amount raised / post $ valuation = $13 M / $24 M

Series B 3. Determine new share price Share price = (pre-money valuation) / (total pre-money shares) = $11M / 8.5 M

4. Determine total number of shares Total Shares = pre $ shares + amount raised / share price = 8.5 M + $13 M / $1.29 Series B

Chemdex - Series C 3. Determine new share price 4. Calculate total number of shares 1. Decide how much you need to raise 2. Negotiate a valuation

Chemdex Financing

Calculating Dilution Percentage owned = owned shares / total shares Founders’ shares = 59% of 8.5M = 5.02M shares Series B Dilution: 5.02M / 18.6M = 27% Series C Dilution: 5.02M / 24.2M = 21% IPO Dilution: 5.02M / 31.8M = 16%

Chemdex and Dilution

Lessons Learned Know what public company metrics mean Most financings done in multiple rounds A smaller piece of a big pie is better than a big piece of a small pie Know how to work out multiple stage financings