angel & venture capital finance: where is the money moving?

Angel & Venture Capital Finance: Where is the Money Moving?

James Geshwiler

Managing Director, CommonAngels

Web Innovators Group

9 December 2008

James Geshwiler, 781-274-9124, [email protected]

Where’s the Money?!

• Public Market Crash Hits Everybody “Venture Capital Hits a Cash-Call

Crunch,” WSJ, 12/8 “High-tech Wrestles with credit crisis,”

Boston Globe 10/8 “A lot of [VCs] could be on the sidelines

for four or five years." –Boston-based general partner

Most angels net worth down 30-50%


Risk Isn’t Up that Much; Just Changed

• Financial risk—very high Can’t count on follow-on investment

Syndication gone from tough to nearly impossible

• Competitive Risk—way down! Little threat from existing companies

Fewer VC-backed chasers

• Market Risk—mixed, depends on sector, company

• People Risk—down; great teams, attrition down

• Product Risk—unchanged


Working with Investors Today

• Target Investors who Succeed on Lower M&A

High M&A, IPO closed for big exits

Very hard to move the needle on a big fund

• Shouldn’t be Focused on Today’s Market

Companies backed today targeting 5-7 years for exit

• Cash is King of Kings

Cash-flow break even on 1 round if at all possible


Working with Angels, VCs, Both?

• Individual “Angel” or “Private” Investor Invests own money, gets full return Typically industry veterans

• Venture Capitalists Compensated on fees, profit share Dedicated, institutional investor

• Angel Groups Large networks of industry experts Usually 2-3 with greatest skills lead + “bench” Organized, institutional structure


Who are the Top Investors?

Entrepreneurial Experience

Low High

Industry Experience

HighOperational expertise

angelGuardian Angels

Low Financial Return AngelProfessional Entrepreneur

Angel

Source: MIT Entrepreneurship Center & HBS Study on Angel Investing, Feb 2000

Founder, ChairmanFormer CEO

Successful company in your or complementary

sector


Angel Groups Addressing Void Left by VC

Stage Pre-Seed Seed/Start-Up

Funding Gap between

$500,000 and $5,000,000, targeting average M&A and up

Early Later

Source Founders, Friends

and Family

Individual

Angels

Venture Funds

Investment

$25,000 to $100,000

$100,000 to $500,000

$5,000,000 and up(initial capital may be smaller,

but exit targets higher)


Median Fund Remains ~$200M!

Source: DowJones/VentureOne

$206

$153

$96

$75

$105$100

$107$98

$80$80

$201

$0

$50

$100

$150

$200

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

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


Funds < $100M Disappearing

Allocation of Fund Size by Number of Funds Raised per Vintage Year

Source: DowJones/VentureOne

2% 4%

29%21%

25%

25%

29%

65% 71%

34%

12%8%0%

20%

40%

60%

80%

100%

1996 1998 2000 2002 2004 2006

Under $100M

$100M-$249M

$250M-$499M

$500M-$999M

$1B+


Angels Institutionalizing

• ACA Formed 2004 46 Groups

Charter Members

• As of 2008: 142 Groups 18 Affiliate Organizations >6,500 Investors 43 States & Provinces

Member Locations

Full Member

Provisional Member


CommonAngels Target Investments

Series A Financing of $500K - $5M

Total Capital Less than $20M

• New Areas of Information Technology

• Current Expertise within the Membership

• Passionate with CEO Capabilities

• Within the Geographic Area – 1 Hour Travel

• Possibility of Liquidity Event in 5 years


Submissions(~30 PlansPer Month)

Managing Director pre-

screens emailed

submissions.

Screening TeamReview

(5 – 10 PlansPer Month)

Screening team votes on

which companies to

invite to general

meeting.

General MeetingPresentations(1 – 3 PlansPer Month)

Managing Director polls members for

level of investment

interest in deals, recruits diligence

team, and facilitates

selection of deal lead to begin term

sheet negotiations.

Manage Investment

Board member represents

member interests and

seeks an attractive exit.

Deal lead closes

transaction and the sidecar

fund invests in companies that attract at least

$250K in investment

from at least 5 members.

Diligence & TermSheet Negotiations

(Coordinated byManaging Director

& Deal Lead)

Typical Deal Process


Who Matters More than What

“The most important item on a term sheet is the name of the investor at the top”—Mark Gorenberg, Hummer Winblad Venture Partners

• View Investors like any other Strategic Relationship Cash is a commodity, firms and people aren’t Long-term partners Influence of style, expertise

• Big Investor vs. Small Investor Incentives

• “Instant Company” vs. Organic Approach

• 1st round dilution matters much less than later rounds


Big Investor Incentives

• >$250M in Fund >$40M/Partner >$10M/Investment >$50M Liquidity/Deal, Exits >$500M

• Institutional LPs Meticulously measure IRR Next fund depends on top quartile performance

• From Company’s Perspective Pro/con: 800lb Gorilla as your friend Technical risk OK ($ can fix that);

Can’t Bring Market Risk (exit too small) Return needs to justify $30-40M+ from syndication, multiple rounds “We Fund BIG Ideas….”


Small Investor Incentives

• <$100M in Fund/Network $10M/Partner or less $500K-$3M Investment $5M-20M Liquidity/Deal, Exits $50M-100M

• Institutional LPs, SBIC, Individuals Maybe more flexibility in performance (non-ERISA $) Maybe less, eg., SBIC program….

• From Company’s Perspective Pro/con: good returns on average M&A transaction Market risk OK; technical risk bad (can be bottomless pit) Shallower pockets may be disincentive to pile on risk “Who is going to buy you?...”


Big vs Small Investor Incentives

$ Exit

Probability

Big Investor (>$500M):Has capital, incentive to push for big outcome, but can drive failure seeking bigger exit

Small Investor (<$200M):Has capital to avoid failure, incentive to sell earlier for similar IRR

Courtesy Dharmesh Shah, founder Hubspot


Textbook Case Studies of Incentives

Fund Size

Large Small

Company Capital

Requirements

High

BIOTECH

(drug discovery)

CLASSIC TELECOM

(routers, CLECs)

Likely Clash:Run out of money,

cramdown, premature sale

Low

Likely Clash:Small return for opportunity

cost, incentives to dream big, assume more risk

SOFTWARE(Web 2.0)

Medical Devices(Orthopedics, Non-invasive)


“Instant Company” vs. Organic Approach

• Timelines, Competition Also Key Variables

• Some Opportunities Require Big Money Up Front Taking on public company Making a market Need critical mass for audience Large capital requirement to finish R&D, prove concept, build infrastructure Analogy: launching a rocket…you get there fast! But aim correctly!

• Others Are Better Done in Stages Greenfield opportunity with barriers to entry Multiple market opportunities that need exploration Multiple exit opportunities, friendly acquirers Analogy: flying an airplane….slower than a rocket, easier to change course


Example Investment: Carbonite

• Long-time friends of CEO

• All-star team, 5th

company

• Operational breakthrough

on consumer backup

• Rapid initial adoption

• $2.6M 1st Round, Oct ‘05

• $3.5M 2nd Round, Aug ’06

• $15M 3rd Round, Apr ‘07


Case Study:

• Sloan MBA & Co-Founder

• First-time CEO

• Closely ties to market

• Rapid initial adoption

• $1.1M 1st Round,

All Angels, June ‘06

• $6.0M 2nd Round,

2 VCs + Angels, June ’07

angel & venture capital finance: where is the money moving?

Technology

expertise big investor

big investor incentives

big fund shouldnt

median fund

exit cash

angel venture capital

bigger exit small investor

angel investing