venture capital investing a primer william quigley managing director clearstone venture partners...
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Venture Capital InvestingVenture Capital Investing
A PrimerA Primer
William QuigleyWilliam Quigley
Managing DirectorManaging Director
Clearstone Venture PartnersClearstone Venture Partners
[email protected]@clearstone.com
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Venture CapitalVenture Capital
“I was seldom able to see an opportunity until it had ceased to be
one”
Mark Twain
C L E A R S T O N EV E N T U R E P A R T N E R
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
S
Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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Industry SnapshotIndustry Snapshot
400+ institutional VC firms in the U.S. Geographically concentrated Stage/Industry focused General partners/Limited partners 10 year investment horizon Co-investment with other VC’s common
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Typical Firm ProfileTypical Firm Profile
3 to 4 investment professionals Review 1000+ business plans a year Manage $50 to $200 million in capital Buy equity (preferred stock) - rarely make loans Investment horizon - 3 to 6 years Sources of capital:
- Pension funds - Corporations
- College endowments - Wealthy individualsC L E A R S T O N EV E N T U R E P A R T N E R
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Investment StagesInvestment Stages
Five Stages:– Seed
– Start-up
– Early
– Expansion
– Mezzanine/Bridge
Most VC’s have a preference for a particular investment stage.
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Stage/CharacteristicStage/Characteristic
Stage Investment CharacteristicsSeed $50-500K - Founder(s) only
- No product- No customers- Primary risk: R&D
Start-Up$500K to $1MM - Mgmt. team incomplete- Prototype or beta product- No revenues- Limited customer interest- Some capital invested- Primary risk: market accept.
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Stage/CharacteristicStage/Characteristic
Stage Investment CharacteristicsEarly $1MM - $3MM - Most of team in place
- Limited revenues- Not profitable- Primary risk:execution
Expansion $3MM - $10MM - Meaningful revenues- Achieving profitability- Growing customer
base- Primary risk:
competition
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Stage/CharacteristicStage/Characteristic
Stage Investment CharacteristicsMezzanine/ $10MM - $20MM - Significant revenues
Bridge - Profitable- Industry player- IPO in 6-12 months- Risk much lower
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The Role of the VCThe Role of the VC
Board involvement Management
recruitment Future capital raising Access to business
network Strategy development Patience!
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Targeted IndustriesTargeted Industries
• Information Technology• Medical Services/Devices• Communications• Biotechnology• Some Retail
Most of the $10 billion invested by VC’s in 1997 was concentrated in five industries. Why these?
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How Do VC’s Make Money?How Do VC’s Make Money?
– Collect management fees from L.P.’s - 2 1/2% annually
– Share profits with L.P.’s - 20/80 split on investment gains 5%
95%
Mgmt. Fee Investment Gains
How do VC’s earn their income?
Source of VC Income:
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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What Do VC’s Want to See?What Do VC’s Want to See?
Areas of Focus:• Management• Marketplace• Competition• Business Economics• Risks
Venture capitalists tend to focus on five specific areas when evaluating a company:
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ManagementManagement
VC Focus:– DIRECT sales experience?
– Prior P/L responsibility?
– Personal financial stake?
– Willingness to share equity
– “Fire in the belly”?
– Functional areas covered?
The most important question: Has the team had experience and success in the same industry?
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MarketMarket
VC Focus:– Market size and growth
rate?
– Market drivers?
– Customer involvement in the R&D process?
– Number of competitors?
Can management demonstrate a thorough understanding of the marketplace dynamics?
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CompetitionCompetition
VC Focus:– Why are competitors
successful?– What is the prevailing
business model?
– Barriers to entry?
Does management have a clear understanding of the competitive landscape?
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Business EconomicsBusiness Economics
VC Focus:– Margins comparable to
industry norm?
– Break-even < 2 years ?
– Appropriate sales model?
– Moderate capital intensity?
Does management have a deep understanding of the financial dynamics of the business and industry?
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RiskRisk
VC Focus:– Reasonable financial projections?
– New technology adoption rate?
– Length of sales cycle?– Best and worst case scenarios
explored?– Regulatory hurdles?
Does management recognize, accept, and have strategies to deal with key risks?
C L E A R S T O N EV E N T U R E P A R T N E R
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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The Venture Capital ProcessThe Venture Capital Process
Business Plan First Meeting Second Meeting Term Sheet Due Diligence Negotiations
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Business PlanBusiness Plan
“Madam, enclosed please find the novel you commissioned. It is in two volumes.
If I had had more time I could have written it in one.”
Voltaire
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Business PlanBusiness Plan
Business Plan Basics:– Written by the entrepreneur– Keep it short– Financials (3-5 year proj.)
• Income statement• Balance sheet• Cash flow• “What-ifs” helpful
#1 objective of the the business plan: Get the VC interested in hearing more about the opportunity.
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Business PlanBusiness Plan
50 5 10
Magic Numbers?
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Business PlanBusiness Plan
We have no competition…. We conservatively project….. We only need a 10% market share…. We will offer the most features at the lowest price…. We valued our Internet start-up using multiples of
comparable companies…like Netscape, Cisco, Microsoft.…
Business plan phrases that ‘spook’ VC’s...
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First MeetingFirst Meeting
The Details:– Location: VC’s office
– Duration: 2-3 hours
– Attendees: 1 to 2 VC’s
– Format: Formal presentation with Q/A
‘Skepticism’ might best describe the venture firm’s attitude in the first meeting. Don’t be alarmed by this.
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Second MeetingSecond Meeting
Focus On :• Business opportunity - not
the technology
• Addressing concerns of the skeptics - THIS IS CRITICAL!
• Next steps
Getting to the second meeting is an important milestone. The team will now make its case to the entire partnership.
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What Went Wrong? - A Few TipsWhat Went Wrong? - A Few Tips
Dont’s• Make vague, ambiguous, or unsubstantiated
statements• Make reference to unnamed/ mysterious people on
the management team• Use statistical arguments for market penetration
assumptions• Use technical jargon• Assume you have a deal if there is no term sheet
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What Went Wrong? - A Few TipsWhat Went Wrong? - A Few Tips
Dos
• Involve the entire team
• Discuss/disclose potential problems
• Demonstrate financial commitment to the venture
• Prepare realistic market and sales projections
• Know your target investor (angel, bank, VC)
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What Went Wrong? - Getting FeedbackWhat Went Wrong? - Getting Feedback
Some Guidelines:– Needs to be solicited!
– From knowledgeable sources
– Develop a dialogue first
– Avoid answering, debating
– Have a market-researcher mindset
“The greatest gift that God hath given us is to see ourselves as others see us.”
Scottish Proverb
Getting honest feedback can be challenging…
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Term SheetTerm Sheet
Term Sheet - Common questions:– Is it a legally binding
document?– What’s covered?– What is it designed to do?– Why participating preferred
stock?
After the second meeting, the VC typically provides a term sheet to the entrepreneur.
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Term Sheet ConditionsTerm Sheet Conditions
Post-money valuation $ amount of the financing Investors identified Size of employee option
pool Vesting periods Key-person insurance
Board representation Additions to management
team, if any Monitoring covenants,
Restrictive covenants Other deal specific issues
The term sheet is intended to embody the overall conditions of a business agreement. What’s covered?
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Due DiligenceDue Diligence
Due Diligence Overview:– Length: 6-12 weeks
– Will perform up to 100 reference calls
– Interview customers, former employees, competitors, industry experts
– Intense legal, financial work
The “heavy lifting” for the venture capitalist starts with the due diligence process.
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NegotiationsNegotiations
Some flexibility in:
– Valuation
– Total investment
– Vesting periods
– Size of option pool
Less flexibility in:
– Equity instrument type
– Board make-up
– Anti-dilution rights
– Restrictive covenants
Negotiations take place throughout the due diligenceprocess. What is negotiable?
C L E A R S T O N EV E N T U R E P A R T N E R
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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The Business PlanThe Business Plan
Executive SummaryMain BodyAppendix
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Executive SummaryExecutive Summary
Mission statement Brief company history Description of
investment opportunity
Market overview
Management team Product & technology Customers Strategy Competition Capital requirements
What should the executive summary address?
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Main BodyMain Body
Key Questions to Address:
Who are the key people in the company?
Where did they come from, and why are they the right people to run the company?
Have they had previous experience and success in growth companies?
Management
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Main BodyMain Body
Key Questions to Address:
What does the customer have access to today?
How does it differ from competing offerings
What is the superior value proposition to the customer?
Product/Technology/Service
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Main BodyMain Body
Key Questions to Address:
What is happening in the marketplace? Is it growing, if so, why and at what rate?
What is lacking from the market leaders that this product/tech/service will provide?
Which customers have been involved in the development of the product and are likely to purchase it?
Marketplace
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Main BodyMain Body
Why will the customer be compelled to purchase the product?
How will the company maintain its competitive differentiation?
What barriers exist/will be created to curtail new entrants?
Strategy
Key Questions to Address:
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AppendixAppendix
Relevant industry articles to bolster management claims
Major customer testimonials
Other information likely to impress those not familiar with the market
Not all business plans require an Appendix section, but it can be useful. What to include?
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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ValuationValuation
Stage Criteria Methodology Range
Seed - Mgmt. track record Comparables, $400K to $1.5MM - Market size/growth Whats the “going - Competition rate” in the region - Investment to date
Start-up - Market size/growth Comparables $750K to $2.0MM - Working prototype? - Team complete?
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ValuationValuation
Stage Criteria Methodology Range
Early - Market size/growth Comparables $1.5 to $5.0MM - Revenue run rate - Gross margin % - Performance to date
Expansion - Revenue run rate - 1X sales Varies - Profitability ratios - EBIT multiple - Performance vs. plan
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ValuationValuation
Stage Criteria Methodology Range
Mezzanine/ - Market share/size Multiples of VariesBridge - IPO environment proxy companies
- Performance Relative to plan
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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Exit StrategiesExit Strategies
• Sale or Merger– Most likely exit
• Initial Public Offering– Small fraction go this way
• Redemption– Least attractive
• Management buy-out– Generally not possible
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Secrets of Success?Secrets of Success? CEO carried a bag Called on same customer base Gross margin > 50% Some degree of technology Cash flow break-even < $5M Sourced the deal 25% ownership or greater First institutional investor
The Eight Commandments
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Odds of Getting a Deal Done?Odds of Getting a Deal Done?
Hurdle Likelihood of Occurring
1. Review the plan and - 1 in 15 conclude it makes sense
2. Meet the team and like them - 6 in 10
3. Be attracted to the market - 7 in 10 opportunity and the company strategy
4. Introduce team to the other partners and get their buy-in - 7 in 10
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Odds of Getting a Deal Done?Odds of Getting a Deal Done?
Hurdle Likelihood of Occurring5. Complete the due diligence - 7 in 10
process satisfactorily
6. Get a term sheet agreed to - 8 in 10 in principle
7. Find co-investors - if necessary - 9.9 in 10
8. Get legal documentation done - 9 in 10
9. Fund the company EQUATES TO 1%
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Commonly Asked QuestionsCommonly Asked Questions
“Will I have to give up control of my company?”
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Commonly Asked QuestionsCommonly Asked Questions
“Why don’t VC’s sign NDA’s?”
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Commonly Asked QuestionsCommonly Asked Questions
“Raising money - all at once or spread out over time?”
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Commonly Asked QuestionsCommonly Asked Questions
“Its a great invention, so why aren’t they interested?”
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Commonly Asked QuestionsCommonly Asked Questions
“Why do VC’s want to know the other firms that I am talking to?”
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Commonly Asked QuestionsCommonly Asked Questions
“When should I initiate contact with a VC?”
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Venture CapitalVenture Capital
Industry OverviewIndustry Overview
Screening Venture OpportunitiesScreening Venture Opportunities
The Venture Capital ProcessThe Venture Capital Process
The Business PlanThe Business Plan
Valuation Valuation
ExitExit
Getting in TouchGetting in TouchC L E A R S T O N EV E N T U R E P A R T N E R
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How do you Contact a VC?How do you Contact a VC?
Introductions are best:– Attorney
– Accountant
– Banker
– Angel Investor
– Industry Executive
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The Michael Dingman Center at U of MD. The Morino Institute - Netpreneur Program Baltimore/Washington Venture Group NVTC - Emerging Business Network functions Silicon Valley Bank, other community banks Private Investors Network, Grubstakes (networks
of angel investors) Pratts Guide to Venture Capital
Local Resources
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Venture Capital Venture Capital
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