financing a start-up

Financing a Start-Up

Presentation by Brian Goncher, Deloitte Venture Capital GroupUniversity of California, BerkeleyFebruary 8, 2006

Agenda

PART I

Venture Capital Trends

PART II

Creating Financial Projections

Valuation Techniques

Capitalization

PART I

•Deloitte’s Venture Capital Group•Venture Capital in 2005•Valuation Trends•Term Sheet Trends•IPO's and Acquisitions

Deloitte’s Accelerator Program

Venture Capital Virtuous Cycle

Company Funded

Company Grows

Company Goes Public

Venture Capital Relationships

Deloitte Venture Capital Team

Success Story: Techwell

Techwell founded in 1997, raised 5 rounds of funding

Techwell has annual sales of $50M+ and grew 100% in the past year

Public Offering in Q4 2005

Techwell Investors Include Technology Crossover Ventures

Venture Capital Relationships

• Silicon Valley VCs– Accel Partners– August Capital– Bay Partners– Benchmark Capital– Charter Venture Capital– ComVentures– Doll Capital Management– Draper Fisher Jurvetson– Focus Ventures– Foundation Capital– Granite Ventures– Hummer Winblad– Kleiner Perkins Caufield & Byers– Lightspeed Venture Partners– Mayfield Fund– Menlo Ventures– Mobius Venture Capital– Mohr Davidow– Outlook Ventures– Redpoint Ventures

– Sequoia Capital– Spectrum Equity Investors– Technology Crossover Ventures– US Venture Partners– VantagePoint Venture Partners– Walden– Woodside– Worldview Technology Partners

• National VCs– Apax Partners– Battery Ventures– Canaan Partners– Greylock Partners– Morganthaler Ventures– New Enterprise Associates– Oak Investment Partners– Summit Partners– TA– Venrock

* All available through Deloitte Accelerator online

Deloitte Accelerator™ Services

A C C E L E R A T O R P A C K A G E

Audit*

Tax* Human Resources*

Business Advisory Events & Services

B E N E F I T SCEO Development – fundraising, financial management, corporate

governance, leadership, team building, sales process,

networking and resources

B E N E F I T SImproved controls and reporting procedures

B E N E F I T SCompliance and

cost-savings strategies

B E N E F I T SCompliance,

HR Best Practices and Recruiter Network

Tangible Deliverables

Business Advisory Events & Services

• Critical Success Factors for CEOs – 300 CEOs and 50+ VCs; review macro funding/industry trends; VC/colleague networking

• CEO Development Workshops – Small group hands-on workshops focused on coaching and mentoring CEOs, providing valuable best practices training on fundraising, personal and team development

• Investor Forum- CEOs of both early stage and late stage tech companies pitch to 50+ VCs

• Balanced Schedule - 22 events scheduled for 2005

• Internal Accounting Control Checklist

• Revenue Recognition Policies & Procedures

• Option Valuation Model• Account Reconciliation

Templates• Financial Statement Closing

Checklist• Audit Readiness Guide• Sample Audit Committee

Charters and Checklist

• Financial Literacy Quiz• Audit Committee Resource Guide• Financing & Risk Management

Service Cycles for Emerging Companies

• GSC Guidebooks• IQ Series• Audit Committee Brief• Controller’s Monthly Closing

Checklist• New Templates & Best Practices

Released on A Regular Basis

• Multistate Income/Franchise Tax, Sales & Use Tax, and Property Tax Checklist

• International Tax Review• R&D Tax Credit Overview• Tax Compliance Due Date Calendar• Tax News & Views Newsletter• DBriefs Webcasts• CSM Ideas for Emerging Companies• New Templates & Best Practices Released on A Regular Basis

• Critical Legal, Labor & Compliance Issues• Sample HR Internal Policies Guidebook• Sample HR Employee Manual• Employee Personnel File Checklist• Executive Recruiter Network• Executive Compensation Newsletter• GSC Guidebooks, Including “Stock Options for

Growing Companies”• Human Capital IQ Newsletter• New Templates & Best Practices Released on A

Regular Basis

Human Resources

Venture Capital in 2005

•Fundraising •Investment Trends•Valuation •Term Sheets•Exits

Fundraising Trends

•Accelerated fundraising-$6B in Q2 2005•Large funds raising record amounts

–Menlo Ventures ($1.2B)–August Capital ($550M)–Mohr Davidow ($400M)–Blue Run Ventures ($188M)

•New Funds entering market–Elevation Partners ($1B)–Agenda Capital (TBD)–Spark Capital ($250M)–Shasta Ventures ($210M)

Fundraising in 2005Commitments to Venture Capital Funds

$9.4$13.1

$17.1$12.7

$7.0$5.4

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Median Fund Size Increases Median VC Fund Size (for funds greater than $20M)

$105$100$110

$76$83

$67$53

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Half of Funds Closed > $100M Allocation of Fund Size by Number of Funds Raised per Vintage Year

10%16% 25%21%

75% 70%

1995 1997 1999 2001 2003 1Q05

Under $100M

$100M-$249M

$250M-$499M

$500M-$999M

Investing Trends

•Steady investment from VCs in Silicon Valley-200 deals/qtr

•New activity among seed and angel investors•“Boomer” group finally matures•Valuations increasing•Bi-polar world of newbies and serial entrepreneurs

ber of Deals

Deal Flow and Investment in 1Q’05Deal Flow and Equity into Venture-Backed Companies

Source: Dow Jones VentureOne/Ernst &Young

$6.4 $9.2$13.1

$21.9 $19.0 $20.9

19122211

23562114

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Amount Invested ($B) Number of Deals

Investment Activity in 1Q’05 Deal Flow and Equity into Venture-Backed Companies

ber of Deals

$4.6$5.0$4.8

$5.7$5.5$5.3

$4.8$4.5$4.4$5.0$4.8

$6.4$5.9 474

543504

500521502538

650598

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

Amount Invested ($B) Number of Deals

Early and Later Stage Rounds Prevail in 1Q’05Deal Flow Allocation by Round Class

*Seed and First Rounds Combined Source: Dow Jones VentureOne/Ernst &Young

1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05

Restart

Second

Seed*30%

Financing Sizes Pick Up in 1Q’05Median Amount Invested by Round Class , VC Only

$10.0$10.0

$8.2$7.1

$0.7$1.5

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

Later Round Second Round First Round Seed Round

Amount Invested in Rounds at Late 90’s LevelsMedian Amount Invested by Round Class (Annual) , VC Only

$1.0 $0.7$0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Later Round Second Round First Round Seed Round

More Investors Go It Alone in 1Q’05Number of Investors Per Round

30% 34% 31%

22% 23% 20%

23%30%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

5+ Investors

4 Investors

3 Investors

2 Investors

1 Investor

Valuation Trends

•Higher Median Valuations–In Q4 2004, 60% up rounds–In Q1 2003, 80% flat or down rounds

•More competition for deals•Greater ability to fund without a syndicate•Exits continue to improve

Valuations On Upward TrendMedian Premoney Valuation by Year

$15.0$13.0

$10.0$10.7

$12.9$11.1

$9.3$10.0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

o ne y

1Q’05 Valuations Highest Since 2001Median Premoney Valuation

$13.3$13.8

$12.2$12.0

$10.1$9.1

$10.0$10.3$10.0

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

2nd and Later Stage Valuations Dip in 1Q’05Median Premoney Valuations by Round Class (All Industries)

$12$12

$3$3$0

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

Later Stage Second Round First Round Seed Round

Term Sheet Trends

•Use of senior liquidation preferences decreasing (especially multiples)

•Full ratchet anti-dilution is unusual•Pay to play is still in use•Number of corporate reorgs for post A financings has dropped

Exit Trends

•M&A has greatly improved•IPO's are sparse, but still happening

M&As Remain Primary Exit OptionPercentage Breakdown of Venture Backed Liquidity Events: IPO vs. M&A

0% 20% 40% 60% 80% 100%

IPOs M&As

M&A Activity Steady in 1Q ’05Transactions and Amount Paid in M&As

$13.0$10.8

$14.8$12.7

380402

253232

197162

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Amount Paid ($B) Number of Transactions

umber of Transactions

Gains from M&A Exits Pick Up Median Amount Paid in M&As vs. Median Amount Raised Prior to M&A

$19$21

$17$15$10$11$7$6$6$5

$23$18

$31$33$40

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Median Equity Raised Prior to M&A Median Amount Paid ($M)

Median A

mount Paid ($M

60% of 1Q’05 M&As Initially Financed in ’99-’01Median Time From Initial Equity Funding to M&A

2.02.4

2.83.03.5

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

IPO Activity Slows in 1Q’05Deals and Amount Raised Through IPOs

$1.6 $1.4

$0.4$1.8

$19.2$19.5

$3.7$4.6

222022

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Amount Raised ($B) Venture-Backed IPOs

Venture-Backed IPO

Fewest Venture-Backed IPOs in Six QuartersDeals and Total Amount Raised Through IPOs

$0.4$0.4

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

Amount Raised ($B) Venture-Backed IPOs

Venture-Backed IPOs

Half of 1Q’05 IPOs from Vintage Years ’99-’00 Median Time From Initial Equity Funding to IPO

5.75.7

3.12.92.8

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

IPOS in 2004 and 2005

IPOs in Calendar '05(by Effective Date)

Six Months Ended June 30, 2005 and the 12 Months Ended December 31, 2004

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

20052004

PART II

•The Fundraising Process•Tools for Financing your Company•Financial Modeling•Valuation Techniques•Capitalization•Exits

Preparing to Fundraise

•Sales Mindset•Sales Process•Sales Tool Kit

Sales Process

Prepare Approach Term Sheet

1 to 2 Months 1 to 3 Months 1 to 2 Months

Sales Process (Prepare)

Prepare

1 to 2 Months

Key Elements include:•Create Runway (or Perceived Runway)

•Get Current Investor Commitment

•Scrub The #s

•Align The Organization

•Define Your Objective

•Define Roles & Responsibilities

•Prepare Sales Tool Kit

•Identify Targets

•Create Scarcity Value

Sales Process (Approach)

Approach

1 to 3 Months

Key Elements include:•Get Referrals

•First Meeting

•Subsequent Meetings

•All-Partners Meeting

•Consultant Meetings

•Customer Meetings

•Due Diligence

•Site Visit

•Term Sheet (or Pass)

Sales Process (Term Sheet)

Term Sheet

1 to 2 Months

Key Elements include:•Negotiate

•Draw Legal Documents

•Signature

•Pre-Close Review

•Close

•Confirm $ Deposited

•Due Diligence IS Still Happening!

Financing your Company

•Be realistic on timing and pricing•Become a great writer and spreadsheet jock•Plan your approach using all resources•Practice, practice, practice•The first term sheet is often the best

Financing Tool Kit

•Elevator Pitch•Story/Demo•Presentation•Executive Summary•Business Plan•Due Diligence Package

Elevator Pitch

• Definition– 2-3 sentences that defines the market, customer,

problem/solution and uniqueness of the business– Place on slide one (display as brief bullets with a

graphic)• Framework

– What market are you in? – What urgent problem are you solving?– What is the size of the opportunity? – Why will you win (differentiation, barriers to

entry, unfair advantage)? – Where is the validation (customers, investors,

etc.)?

Elevator Pitch• Example

Diamond develops proprietary thin film diamond products and equipment that dramatically improve heat dissipation on microprocessors, solving one of the highest priority pain points in the industry.

We address growing markets that will exceed $1.5B by 2006 and will become the dominant supplier with the best team having the most comprehensive patent position in the industry. Intel is our largest current investor, and we are actively engaged with other top target customers and partners who provide very strong references.

Building the Executive Summary

•Primary Uses– Initial introduction to investors (may accompany

introductory email)– Prepares investors for meeting

•Best Practices– Text derived from your presentation– Drill down in key areas, but be concise– Highlight external validation– Less than 5 pages– Use as tool to sell the team

•Supporting Materials– Business plan, sales pipeline, IP roadmap,

competitive landscape, etc.– Make available only as appropriate (avoid material

overload)

Executive Summary Outline

• Definition– 3-5 pp text document which includes all the

elements of a business plan• Outline

– Business Definition/Company Purpose– Business/Technology Problem– Company/Product Solution– Market Trends/Size /Growth– Competitive Assessment/Point-of-Difference– Product/Technology/IP– Sales/Distribution– Team/BOD– Financials

Business Plan Outline

• Definition– 10-20 pp text document with before appendices

• Outline– Executive Summary (3-5 pages)– Business Overview and Strategy (1-2 pages)– Technology and Product (3-5 pages)– Market and Competition (3-5 pages)– Sales and Marketing (3-5 pages)– Management and Board (3-5 pages)– Financial Summary (2-3 pages)

Appendices

•Full management resumes•Annual Financial Projections•Product Information•Market Studies

Financial Modeling

•It is forecasting, not a budgeting, tool•Work on the financial model together with the presentation and executive summary

•Do not provide more detail than the plan•Use sensitivity analysis, but present the “expected case”

•Refer to assumptions throughout the plan•Check for mistakes and “reasonableness”•Get help

Creating Financial Projections

•Create a revenue model•Plan New Hires•Estimate any Significant One-Time Costs•Use only annual income statement and balance sheet

•Prepare monthly or quarterly cash flow forecast until breakeven

•Don’t sweat the details

Revenue Model

•Build a specific revenue model that mirrors your industry

•Compare with industry standards, highlight any differences

•Prepare the model from the “bottoms up”•Do not over estimate first year revenue•Do make a 5 year forecast•Know the way revenue is recorded for your industry

Headcount

•80% of all early year expenses are headcount related

•Make sure you are reasonable with salaries•Match additions of people with company milestones

•Don’t forget taxes, benefits and recruiting expenses

•Build a sales commission model, if necessary•Index salaries to inflation and add bonuses

Other Expenses

•Don’t sweat the other expenses•Make sure rent increases as needed•Watch consulting and professional services•Begin taxes at the appropriate time

Balance Sheet

•Do create a balance sheet •Use industry standards for AR and AP assumptions (typically 60 days and 30 days)

•Include financing assumptions on your balance sheet

•Make sure it balances (the balancing item is cash)

Cash Flow Statements

•A Flow of Funds statement is typical and easiest

•Use the Receipts and Disbursements statement if you are brave

•Cash flow statements are derived from the income statement and balance sheet

•Do not make changes on the cash flow statement

•Show monthly or quarterly cash flows until breakeven in the appendix or as backup slide

Charts and Tables

•In the presentation or business plan, use charts and tables to highlight–Revenue (esp. as compared to competitors)–Sales and distribution model (to explain those

90% gross margins)–Five year annual summary

•Other charts and graphs can show key events to next funding round, cash flow breakeven or the cash flow cycle

Valuation Techniques

•Comparables (as in real estate)•Discounted Cash Flows (DCF)•Return on Investment•Other rules of thumb

Post and Pre Money

•You know the pre-money valuation when you have an offer to purchase stock

•Post money is simply the amount of money you have raised divided by the portion of the company you sold to raise it–For example, in a seed round you raise $2M and

give up 40% of the company–The post money is $5M ($2M/40%) and the pre

money is $3M ($5M - $2M)

Capitalization-Founders Round

•Before first financing is founders round–Founders vs. early employees–Typically split common stock among the founders–Low per share price

•Cap Table shows 4M shares at $.01 per share•Post money valuation is $40,000

Capitalization-Seed or A Round

•First outside financing•Typically is funded by angels•Often completed as a note to convert into equity when a VC participates

•Investors purchased 1.5M shares at $.50 per share which is 27% of the company (1.5/5.5)

•The company then established a stock option plan of 1M shares, diluting the investors by 4% to 23%

Capitalization-Series B

•Second round of outside financing •Usually completed after a significant milestone is reached

•The company raised $2.5M at $.62 per share, a 24% increase from the prior round

•The post money valuation is now $6.5M ($2.5M raised divided by 38%)

•The company again added to the stock option plan, diluting the Series B investors by 6% to 32%

Capitalization-Series C and Later

•The typical life span of a company is 5-7years before an IPO or acquisition

•Usually there are 3 rounds of funding•The last round before an exit is called the mezzanine round

•The company raised $4M for 29% of the company for a post money valuation of $14M

•The company did not add any shares to the stock option plan

IPO or Acquisition

•In the Acquisition scenario, the company sold all of its shares for $75M in cash

•In the IPO scenario, the company sold $35M of common stock for 15% of the company for a post money valuation of $238M (3x the acquisition price)

•All of the preferred stock was converted to common stock

•Which would you choose?

Choosing an Exit

•Prepare for an IPO–Build a great management team–Put business systems in place to support rapid

growth–Act like a public company

•Do business development as if an acquisition was likely–More than 80% of exits are by acquisition–Cash in the bank can be better than an IPO–Work with business partners that can acquire you–“Dual track” is a popular tool for maximizing value

Summary

•Create a great demo and presentation•Use the executive summary to market your company

•Make the financial projections work with the assumptions in your pitch

•Practice your pitch with an experienced audience

•Keep revising your plan and projections as you grow

•Good luck

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