1. On Entrepreneurial Finance
MGT 709 New Venture Creation

2. Agenda Adams How VCs evaluate deals Funding New Ventures
Note on Valuation of VC deals
Allen Lane
Walnut Venture Associates

3. Adams On Finance Myth: Investors want their money back quickly
Reality: Good investors are in it for the long haul
You want smart money not ‘green’ money
Smart investors will do whatever is necessary to create value
If you want status quo or safety don’t seek investment capital

4. Pick your investors Domain expertise Chemistry & staying power
Core competencies – do they improve execution intelligence?
Sophistication
Prior successes

5. Types of investors Venture investors Strategic investors
Sophisticated, high hurdles
Launch your business as if you are seeking VC funds
Prove the opportunity – deep down knowledge of pain
Strategic investors
Provide market validation and industry insight
Target internal venture groups – outline the benefit to them
Angel investors
Should be as savvy as any other investor – make sure they can add real value
They can be important mentors

6. Value-added of smart investors
Fund-raising know-how and contacts
Recruiting,
Industry contacts and networking
potential strategic partners and customers
Unbeatable market intelligence
Technological know-how
Ability to redirect the team or refocus the business
A vested interest in the startup’s success

7. How VCs evaluate opportunities
Siegelman, KPCB
Big markets, competitive edge, great team
Technical due diligence is big, some customer and industry diligence, background checks on team
$500K smallest investment, $3-$5m to $10m,
FAST deals – a week or two
Don’t invest in low price products without a low price channel, $200K price tag for enterprise software
50% gross margin on hardware
Looking for IPO

8. Hoel, Menlo Ventures
Market first, $500m to $1bn, Fortune 100 customers, vertical markets are difficult
Favorite is a company doing well in spite of itself – boost the team
Aim for market share leaders
Market and developed product best predictors
Not team or proprietary technology
Founder must be willing to upgrade the team and in it for the lifestyle
Deal size $20-25m per co., 2-3 mths to work out, IPO or acquisition for “liquidity event”
Direct sale or telesales- understand required margins

9. Wang, Trinity Ventures
Team, market opportunity, value proposition/product
Focus on the CEO
It’s a sector bet – thesis process every quarter
Everything looks like its going to be a multi-billion dollar market
We avoid arm-wrestling with ‘wild eyed technologists’
Focus on smaller opportunities with less uncertainty
18 month window, Series A
Lot of time on financial model – bottom up

10. Simon, Alta Partners I think markets trump people and technology
I look for big opportunities, big painful problems that customers have
We don’t target market shares, we target revenue $60-$80m in 3 years
Ideal case – four PhDs solve a problem after a year or two and it’s 2 orders of magnitude better than whatever else is out there
Lot of focus on personal motivations of people
are they in it for the long haul (with passion)
Need to “monetize” customers (e.g. Skype)
One or two “brave new world” investments
Bet on marketing or technology side
1-6 month decision frame
Exit at $200m market and $60-$80m company size
Advise clients to not dilute a good business which won’t grow to that size (and thus is not a good venture opportunity)
Check out Sand Hill Road, Menlo Park, CA

11. Funding New Ventures How to get rich Start a business that is either:
Managing dilution effects in an important skill
Start a business that is either:
Self-funded growth or not capital intensive
Uses debt instead of equity
Has a huge ROE potential
A business generating 25% ROE must sell 100% of its shares to an investor seeking a 25% ROE
Bottom up valuation, alternatives, complications
See next slide
Capitalization Tables
See Exhibit 1

12. Note on Valuation SpiffyCalc Post money valuation = NPV of T = $4.9m
Expect to sell for terminal value (T) of $25m in 4 years
Need to raise $3m investment (I)
Vulture Ventures discount rate ( r ) =50%
Number of existing shares (x) = 1m
Post money valuation = NPV of T = $4.9m
Pre money valuation = POST – I
Ownership fraction (F) = I/POST
New shares (y): y/(x+y)=F => y=x/[F/(1-F)]
Share price = I/y

13. Special Cases Complications Estimating terminal value
Employee Stock Options
Add the option pool to the entrepreneur share
Preference shares can be tricky
Look for total share of future value being obtained
Estimating terminal value
P/E ratios and other multiples – see 2006 estimates
Accounting for risk
Expected values
Higher discount rates
Scenario analysis
Multiple financing rounds
Changing discount rates and time periods
Effect of future dilution must be factored in

14. Allen Lane Evaluate Allen Lane and his search for a business
What did he do right?
What did he learn as the process progressed?
Is he suited to running his own business?
How should Allen value Plas-Tek?
How much should be bid? Why?
What conditions should he place on his bid?
How should he finance and structure the purchase?

15. Walnut Venture Associates (D)
What do you think the investors are trying to accomplish with the vesting provisions?
What would you try to renegotiate if you were O’Connor?
What is a reasonable valuation for RBS in June 1998?
Assume RBS is liquidated in 5 years for $3m – who would get the money according to the term sheet? How about $10m or $30m?