1. 70-397 Venture Finance Fall 2002 Slide 1 Class 10 Notes Deal Structure: Ownership and Control © Andrew W. Hannah

2. 70-397 Venture Finance Fall 2002 Slide 2 Agenda Homework due tonight Winning Angels – 179 - 222 Diligence B moved to next week Global village discussion Comparables Ownership and control © Andrew W. Hannah

3. 70-397 Venture Finance Fall 2002 Slide 3 Analyzing Comparables © Andrew W. Hannah

4. 70-397 Venture Finance Fall 2002 Slide 4 The Difference… Comparable Analysis Are the assumptions and plan REASONABLE? Competitive Analysis What are the STRENGTHS AND WEAKNESSES vs. the competition? © Andrew W. Hannah

5. 70-397 Venture Finance Fall 2002 Slide 5 Comparables Allow us to assess a particular aspect of a company We use comparable in the sense of analogy “Resembles”, “parallels”, “corresponds to” Good comparables Are ANALOGIES along multiple dimensions Are timely Provide a clear answer to a question © William Hulley and Andrew W. Hannah

6. 70-397 Venture Finance Fall 2002 Slide 6 Questions Comparables Ask Is this a reasonable product development schedule? Does this marketing budget make sense? Can this product be sold through wholesalers? Does the exit strategy make sense? What other companies are in similar businesses and is the plan reasonable? Do 95% margins make sense in manufacturing? Is $500,000 of sales per sales person high or low? Is $200,000 of revenue per employee high or low? © Andrew W. Hannah

7. 70-397 Venture Finance Fall 2002 Slide 7 Some Types of Comparables Industry Financial Competitive Managerial/Human Resources Channel Operational © William Hulley and Andrew W. Hannah

8. 70-397 Venture Finance Fall 2002 Slide 8 Marks of “Good” Comparables It asks a single question Does this channel make sense? Are this sales projections realistic? How are the competitors marketing? The question Addresses a risk or opportunity Verifies a fact Answers an unknown Frames an uncertainty Can be addressed in a timely and economic manner © William Hulley

9. 70-397 Venture Finance Fall 2002 Slide 9 Finding Comparables – The Assignment Are the PolyTronics Financial Statements reasonable? Choose a basis of comparison – see updated diligence B Revenue size (especially 2006) Revenue growth rate (be careful to consider age of companies) Gross margins Gross margin growth rate Operating margins Revenue per headcount Capital required to produce revenue Others you believe to be relevant Find a couple of companies (3 or 4) that look like PolyTronics Set them up side-by-side © Andrew W. Hannah

10. 70-397 Venture Finance Fall 2002 Slide 10 Deal Structure © Andrew W. Hannah

11. 70-397 Venture Finance Fall 2002 Slide 11 Deal Structure – what matters? The basics: Control – mechanisms of governance Who makes decisions? Ownership Who owns what and when? Price Who pays what and when? Term sheets – captures the basics © William Hulley and Andrew W. Hannah

12. 70-397 Venture Finance Fall 2002 Slide 12 Control: Who makes decisions? What decisions matter? Hiring and firing Raising money Spending money Choosing strategic direction Making operating decisions Who makes them? Employees Management Directors Shareholders Which decisions map to which group? © William Hulley and Andrew W. Hannah

13. 70-397 Venture Finance Fall 2002 Slide 13 Control: How are decisions made? What determines who decides what? Default – someone just does it Custom – what is normally done in a business Law – legal and regulatory restrictions or process Contract – binding agreements between parties Basic rule: whatever isn’t required by law or contract falls to the realm of custom or default The term sheet divides the power between the investors, board and management (by contract) © William Hulley and Andrew W. Hannah

14. 70-397 Venture Finance Fall 2002 Slide 14 Ownership: Who owns what? Ownership can be divided among: Debt – asset financing, A/P, etc Equity – preferred or common Contingent equity – options and warrants Who owns what isn’t fixed until: Someone wants to buy something The price they are willing to pay is determined Stakeholder rights to the cash are sorted out The term sheet describes the stakeholder rights © William Hulley and Andrew W. Hannah

15. 70-397 Venture Finance Fall 2002 Slide 15 Preferred vs. Common Stock Preferred Redeemable Get your bait back, participate in upside Advantage? Downside protection Convertible Choose between debt or equity Advantage? Don’t have to decide today Participating Get your bait back, participate in upside Advantage? Downside, don’t have to decide Common – what’s left over… © William Hulley and Andrew W. Hannah

16. 70-397 Venture Finance Fall 2002 Slide 16 Price: How much is it worth? Valuation is an art not a science and sometimes complicated… What do I do with debt? What about options and warrants? What are the value of preferences? Typical valuation tools don’t work No cash flow No revenue No assets Term sheets defines the valuation © William Hulley and Andrew W. Hannah

17. 70-397 Venture Finance Fall 2002 Slide 17 Term Sheets Term sheets divide power between investors, board and mgmt describe the stakeholder rights to ownership define the rules for setting valuation create a sense of “the spirit” or “intent” Always evaluate the term sheet by looking at Control – who gets to do what Ownership – who owns what Price – how much is it worth Always evaluate in context of today & future © William Hulley and Andrew W. Hannah

18. 70-397 Venture Finance Fall 2002 Slide 18 Covenants and Representations Positive Covenants – things you will do Information rights, auditing requirements Negative Covenants – things you will not do Selling debt, raising money, hiring management Representations We’ve told you everything that is material to you in making your investment decision Looking for the “Gotcha’s” © William Hulley and Andrew W. Hannah

19. 70-397 Venture Finance Fall 2002 Slide 19 Term Sheet Review Two to three pages long: Amount of the investment Pre- and post-money valuations Option pool information Rights and preferences Anti-dilution Liquidation (e.g., participation) Warrants Dividends Redemption Board seats Voting © Andrew W. Hannah

20. 70-397 Venture Finance Fall 2002 Slide 20 Next Week Homework Diligence Card “B” – comparables Syllabus review Investment Recommendation Working Session Your Investment Recommendation Draft is due on 11/12! © Andrew W. Hannah