1. 70-397 Venture Finance Fall 2002 Slide 1 The Investment Cycle Fund Economics Raising Money, Investing It, and Getting it Back! Investment Frameworks and Filters (Part 1) © Andrew W. Hannah and William C. Hulley

2. 70-397 Venture Finance Fall 2002 Slide 2 Agenda Assignments due tonight Info Card B Question Card A Fund economics The investment lifecycle Raising Harvesting Investing Investment frameworks and filters © Andrew W. Hannah and William C. Hulley

3. 70-397 Venture Finance Fall 2002 Slide 3 Fund Economics – venture capital firms Where does the money come from? What are VC’s allowed to do with the money? Who governs the VC? Who are the people in the firm? Partners Associates Industry Experts Venture Partners/Entrepreneur In Residence How do they get paid? Management Fee/Salary Carry © Andrew W. Hannah

4. 70-397 Venture Finance Fall 2002 Slide 4 Where VIs Spend Time Raising Money Angels – little to none VCs – junior partners, associates or analysts, little to none VCs – senior partners, ten to twenty percent Harvesting Angels – very little to twenty percent VCs – junior partners, associates or analysts, little to none VCs – senior partners, ten to twenty percent Investing Angels – eighty to one hundred percent VCs – junior partners, associates or analysts, almost all the time VCs – senior partners, sixty to eighty percent © William C. Hulley

5. 70-397 Venture Finance Fall 2002 Slide 5 Raising Money – Sources Pension Funds – the biggest dollars Unleashed by changes in the ERISA Prudent Man rules Old economy players (CALPERS, Crown and Cork, Mellon) Most dollars, most professional, biggest check writers Families and individuals – the oldest dollars The first venture capitalists Largest group, hardest to access, smaller check writers All shapes and sizes (Rockefellers, CEOs, 401(k) owners) Corporations – the fashionable dollars Investing for synergy Across many industries (Intel, GM, Nortel, Glaxo) Most opportunistic © William C. Hulley

6. 70-397 Venture Finance Fall 2002 Slide 6 Raising Money – What Happens? Venture firms gravitate to the largest pool of capital Brand name and short term returns mean more Defined investment strategies mean more What happens to venture investing as a result? Venture funds get bigger Deals get bigger Syndication gets less important Stage gets later Funds become “category” investors © Andrew W. Hannah and William C. Hulley

7. 70-397 Venture Finance Fall 2002 Slide 7 Harvesting Investments Harvesting Turning illiquid investments into liquid cash or securities Exiting Trading an investment for something else Exiting methods IPO – initial public offering of stock Sale – getting cash, securities or a note Bankruptcy – liquidating the business Write-off – valuing the company’s stock at zero Exiting is not always the same thing as harvesting © William C. Hulley

8. 70-397 Venture Finance Fall 2002 Slide 8 When Exits Go Bad… What categories of bad are there? The living dead The lifestyle business The virtual bankruptcy What can the investor do to avoid them? Contractual rights – put, demand, board rights Sell the position Why are they bad? The lost time The temptation to try and save them… © William C. Hulley

9. 70-397 Venture Finance Fall 2002 Slide 9 Investing – What Matters The ingredients… Money Time Experience Risk Control The questions… How do I turn this into a strategy? How do I use it to decide upon a particular deal? © William C. Hulley

10. 70-397 Venture Finance Fall 2002 Slide 10 The Strategy What Matters – The Model What you invest – what mix of time and money? How much you invest – what do you put into any deal? How often you invest – one deal or ten? How much risk you take – do you swing for the fence? After answering these questions you can determine What your deal filter will look like How your portfolio might look What your risk profile is likely to be The match between strategy, skills and the deal market © Andrew W. Hannah and William C. Hulley

11. 70-397 Venture Finance Fall 2002 Slide 11 Model and Deal Filter Exercise Separate into four groups Answer these two questions: What does your investment model look like? Five qualifiers that help you sift the 2000 plans that hit your desk What does your deal filter look like? 10 things you look for to narrow the 200 to 50 Take 20 minutes Its all about prioritization – getting from 2000 plans to the 5 to 10 deals that you will do © Andrew W. Hannah

12. 70-397 Venture Finance Fall 2002 Slide 12 The Investment Model Industry Markets Products Stage Size of Investment Geography Leads to the DEAL FILTER that answers the question – can I make money on my investment? © Andrew W. Hannah

13. 70-397 Venture Finance Fall 2002 Slide 13 The Deal Filter Management team – domain expertise (demonstrated execution) Large, growing market ($100M+ revenue opportunity) “Have-to-have” product/service (value proposition) (customer ROI is clear) Unfair advantage (can beat the competition; barriers to entry) Leverageable business model (strength of margins) Path to profitability (sound projections with deliverables) Strong partners/investors/board/advisors Developed sales and marketing plan – knows how to get to customer (buyer is well-defined and has budget) Exit Opportunity (IPO and Trade Sale) © Andrew W. Hannah

14. 70-397 Venture Finance Fall 2002 Slide 14 The Deal Filter A good deal filter disqualifies deals that don’t fit your strategy quickly and highlights deals that do. © William C. Hulley

15. 70-397 Venture Finance Fall 2002 Slide 15 The Portfolio What matters… Expected return profile How do deals usually do? Are strike outs common? Are home runs? Distribution of outcomes Can you limit losses? Do home runs matter? Time spans – how long to exit Showa the importance of lass management © William C. Hulley

16. 70-397 Venture Finance Fall 2002 Slide 16 Tonight’s Key Concepts Fundraising Most capital comes from pension funds Fundraising is a highly institutionalized process Harvesting Harvests generate liquid cash Bad exits (living dead, etc) must be avoided Most harvests are sales or write offs Success is measured by successful investing Investing VIs need a plan as much as any entrepreneur Expressed by an investment model and deal filter © Andrew W. Hannah and William C. Hulley

17. 70-397 Venture Finance Fall 2002 Slide 17 Next Week Guest Panel Jay Katarincic, Draper Triangle Paul Cohn, Mellon Ventures Jane Kirkpatrick, Angel Investor The Venture Capitalist Case Come prepared to discuss Info card C WA pp 83 - 114