1. E145/STS173 Session 9 ABC’s of Venture Finance and Teams E145/STS173 Session 9 ABC’s of Venture Finance and Teams Professor Tom Byers Stanford University 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.

2. © 2003 Mark P. Rice, Babson

3. Today’s Agenda Part II and III. Given the nature of the business and the objectives of the founders, what human (II) and capital (III) resources are needed to build a venture? Part I. As a “blueprint” for building the business, what is the purpose of a business plan?

4. Part I. What is the Purpose of a Business Plan? And Is It Really Worth All the Effort?

5. Outline of a Business Plan Executive Summary Market Analysis* Vision and Concept (including Technology)* Competitive Positioning and Marketing* Business Model* Organization Financial Projections Ownership * Our Opportunity Analysis Team Project covers the first four components!

6. Recall Sahlman’s Model Reference: Sahlman

7. Part II: ABCs of Talent A. Team … Recruiting B. Compensation … Rewards C. Culture … Norms

8. A. Recruiting Key Players in Start-Ups Internal Key issues: When to hire? Experience versus passion and energy? Qualifications versus motivation and character? Founders or Initial Partners CEO and VPs Designers, Developers, “Architects” and Managers of Products & Services Sales and Marketing Operations and Administration Others? External Key issue: how to manage? Board Of Directors Investors Advisory Boards Professional Services and Suppliers Others?

9. Q&A with VC John Doerr of KPCB Q. What is the most important part of any business plan? A. “I always turn to the bios of the team first. For me, it’s team, team, team. Others might say, people, people, people -- but I’m interested in the team as a whole.”

10. “The way I attract these people to SOFTBANK is to explain what my dream is. It is not money because they actually come to work and we never talk about payment. They come to work, then a week passes, or longer, then we finally get around to talking about money. I’ll ask them, by the way, how much do you want? And they say, whatever you want to give me. Then I ask them, how much were you making last year? Then I give them the same amount. So they don’t come to SOFTBANK for the money. It’s for the dream that everyone has together. The dream of making the company successful.” Masayoshi Son CEO of SOFTBANK CORP. (Japan) B. Compensation and Rewards

11. Understanding Rewards In High Potential Ventures Status Often Determined by Contributions to Improving Culture and Increasing the Value of the Company Hence, Rewards Tend to Be Value-Enhancing such as Stock Options (Employees Have Equity Ownership)

12. Major Compensation Components in Start-Ups Cash Salary and Bonus Benefits Equity Common Stock Plans (Incentive Stock Options Have Favorable Tax Rates) Vesting Schedule and Stock Budget Tax Implications (IRS in USA) and Security Laws (SEC in USA) Will Cover in Great Detail in the Bonnie Bryte Case

13. C: Culture … The Secret to Long-Term Success? Definition “A strong system of informal rules that spells out how people are to behave most of the time” Two Great Quotes “The most durable asset of a venture is its culture” (Cook) “First four letters of culture spell c-u-l-t” (Collins)

14. Culture: Major Challenge to Create a Fertile Environment for Innovation Develop Sense of Teamwork Understand Personalities of Key People Develop Open Internal Communication Remain Open to Ideas & Suggestions from Anywhere Be the Customer Be Willing to Experiment Include Creative and Unusual People Address the Issue of Autonomy Reference: Collins & Lazier, Beyond Entrepreneurship

15. Preview of “Characteristics of Effective and Ineffective Teams” Exercise We are all angels with only one wing. We can only fly while embracing each other. ~ Luciano de Crescenzo

16. Recall Success Formula for E145 Show up on time (with cell phones and pagers off please). Be nice to people (e.g., constructive comments only, listen carefully and only one speaker). Do what you say you will do and deliver more than you promise (both in class and out). Do it with energy and passion. Reference: JM Perry

17. Part II: ABCs of Financing A. Amount of cash needed and purpose B. Sources of Capital C. Deal Structure and Terms

18. A. Amount of Cash … Two Key Questions #1 How much money is needed for this “round” of financing? Typical Financing Stages (or Rounds): Seed  Early  Mezzanine  Late (e.g., IPO)

19. #2 Which risks are to be reduced with this money in this round? Team Risk Technology Risk Capital Risk Market Risk

20. B. Raise Money From Where? Sources of Capital for High-Technology Entrepreneurs Traditional VC Angel Investors Corporate VC Boot- strapping Other

21. U.S. Venture Capital Investment In 2003, VC’s invested $18 billion in U.S. and angels invested about $16 billion. (Sources: Venture Economics, NVCA and Center for Venture Research) Number of US VC Investments

22. A Simple Venture Finance Example Roma’s hot startup requires $10 million in order to form its business. She expects to earn $10 million in its fifth year. Randy’s VC firm has reviewed the company's business plan and believes that he is entitled to a 50% return on his investment. (Hint: how many “times” must his money grow in 5 years?) Publicly traded companies in this category and industry trade at approximately 15 times earnings (PE ratio). There is no material difference between these companies and the startup. What portion of the company should Randy’s VC firm receive today? (Hint: what is future value of that investment?) 1. Value of VC Investment in Year 5 = $10 m*(1+50%)^5 = $76m 2. StartUp’s Value in Year 5 = $10 m*(P/E of 15) = $150m 3. VC Firm’s Share Today = Step 1/Step 2 = $76 m/$150m = ~ 50% 4. “Post-Money” Value Today = $10 m /.50 = $ 20 mm

23. A Multi-Stage Venture Finance Example A Multi-Stage Venture Finance Example Time IIIIIIIVV 1mm shares for each founder  =3mm shares @ $0.001 ea. Value=$3k Note: not to scale +1mm shares each for CEO & employees  = 5mm shares @ $0.01 each Value=$50k +5mm shares for first VC firm  =10mm shares @ $1.00 each Value=$10mm Use of $: R&D

24. Time IIIIIIIVV 1mm shares for each founder  =3mm shares @ $0.001 ea. Value=$3k 1mm shares each for CEO & employees  = 5mm shares @ $0.01 each Value=$50k 5mm shares for first VC firm  =10mm shares @ $1.00 each Value=$10mm Use of $: R&D +5mm shares for sale to public in IPO  = 20mm shares @ $15.00 each Value=$300mm Use of $: Operations +5mm shares for second round VCs  =15mm shares @ $5 each Value=$75mm Use of $: Mktg. A Multi-Stage Venture Finance Example A Multi-Stage Venture Finance Example V Note: not to scale