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Art of the deal workshopPower your potentialDecember 3, 2018
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 2
WelcomeTrent BrownPartner, Los Angeles EGC Practice LeaderDeloitte & Touche [email protected]+1 213 996 5838
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 3
Time Topic Presenter
8:30-8:55 Registration and networking
8:55-9:00 Welcome Deloitte
9:00-9:50 IPO basics and alternative liquidity strategies Latham & Watkins LLP
9:50-10:35 IPO pitfalls, things to consider, and war stories Deloitte
10:35-10:45 Break
10:45-11:30 How to optimize value during the lifecycle of a tech company Deloitte
11:30-12:15 Panel discussion amongst CFOs and VCs Safire Partners
12:15-1:00 Lunch and networking
1:00-1:45 State of the markets: Southern California SVB
Agenda
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 4
About this presentation
This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.
As used in this document, “Deloitte” means Deloitte & Touche LLP, which provides audit, assurance, non-attest accounting, and advisory services. This entity is a separate subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting.
The IPO ProcessSteve Stokdyk, Latham & Watkins LLP
OVERVIEW
Pros and Cons of Going Public
Pros
■ Access to capital
■ IPO proceeds
■ Additional capital after IPO
■ Acquisition currency
■ Liquidity
■ Attracting and retaining personnel
■ Increased public awareness
■ Prestige
■ Potential for increased market
value
■ Less dilution compared to other
forms of equity financing
Cons
■ Costs (money and time)
■ Loss of control and privacy
■ Public disclosure requirements
■ Investor expectations
■ Volatility
■ Insider illiquidity
■ No turning back
2
OVERVIEW
IPO Planning Considerations
■ Assemble a Strong Team
> Strong board of directors, executive officers and key employees
> Review executive compensation
> Select external advisors: bankers, lawyers and accountants
■ Clean up Financial and Accounting Issues
> Back year audits
> GAAP and SEC reporting requirements
> Develop internal control systems; budget and forecasting
■ Developing Public Company Infrastructure
■ Anticipate Corporate Issues
> Revise organizational documents for public company environment
> Revisit past contracts such as shareholders’ agreements, buy-sell
agreements and registration rights agreements
> Intellectual property issues
> Be organized - assemble a “data room” of key documents
■ Determine size/participation by selling stockholder
3
OVERVIEW
IPO Timetable
Quiet Period
S-1 Drafting
Week 35Week 36
(~9 Months)Weeks 33-35
Week 24(6 Months)
Week 17
Underwriter Selection
Beginning of IPO
Process
SEC Review
Road Show
Pricing
Closing
Week 19
Organizational Meeting
Day 0
First Filing of Registration Statement
Weeks 24-32
Building Infrastructure
Underwriter Due Diligence Investigation
4
UNDERWRITER SELECTION
Underwriter’s Role
■ Lead manager
■ Co-manager
■ Syndicate members
■ Selling group
Factors To Consider In An Underwriter
■ Industry knowledge
■ Firm experience
■ Banking team and experience
■ Institutional and retail distribution
■ Post pricing stock performance
■ Research and analyst coverage
■ Post IPO investment banking
capabilities
5
UNDERWRITER SELECTION
Steps in the Underwriter Selection
■ Identify potential underwriters
■ Contact potential underwriters
■ Select underwriters to interview
■ Hold “bake-off”
■ Select the underwriter
■ Select lead and co-managers
6
ORGANIZATIONAL MEETING
■ Kick-off meeting of the IPO Team
> Company
> Bankers
> Auditors
> Counsel
■ Includes IPO presentation by each of functional groups
■ Enables the company to begin to take shape
■ Begins IPO “Quiet Period” (Publicity Restrictions)
7
S-1 DRAFTING
■ Form S-1 is an SEC filing which contains the basic business and financial
information on an issuer with respect to a specific securities offering
■ Bankers will also offer market perspective
■ 4 - 6 Week Process
■ Concurrently, counsel will be conducting due diligence and negotiating
underwriting agreement and other legal matters
8
S-1 FILING AND SEC REVIEW
■ Initial SEC review is typically 30 days (comments often are returned on
Friday)
■ Involves 3 -5 rounds of comments from the SEC after initial review (lasts 10-
12 weeks)
■ Also involves filing of material agreements, and attempts to keep economic
competitively sensitive terms confidential
■ May require the company to update financial information which will cause
delay
9
BUILDING PUBLIC COMPANY INFRASTRUCTURE
■ Concurrent with S-1 drafting and SEC Review
■ The Board, management and counsel work together to create the post IPO
public company infrastructure
■ Company will need to adopt numerous policies (e.g. insider trading and
equity incentive policies)
10
BUILDING PUBLIC COMPANY INFRASTRUCTURE
■ Will involve creation of multiple committees
> Audit
> Compensation
> Nominating
■ Must consider composition of committees (e.g. need for financial expert on
Audit Committee)
■ Will require several Board and committee meetings which must be planned
and coordinated with S-1 drafting and IPO process
11
ROAD SHOW
■ 2 week trip to meet with prospective investors in the US and potentially
Europe
■ Senior management presents and markets the company
■ Begins with a presentation to banking sales forces
■ Company must distribute prospectus to offerees
■ Senior management may receive presentation training
12
PRICING AND CLOSING
Pricing
■ Occurs on the last day of the road
show after bankers have assessed
the market demand for the stock
■ Range established in preliminary
prospectus
■ Pricing Committee of the Board
must approve the transaction
■ Closely coordination between
bankers and counsel if pricing
range changes or if the deal is
upsized or downsized
Closing
■ Typically 3 days after pricing
■ Post closing obligations
> Exchange act registration
> Periodic reports
■ Over allotment option exercise
■ Other post closing matters
> Registration of employee plan
shares
> Annual meetings of shareholders
13
AVOIDING CRITICAL MISTAKES
■ Do not wait to be perfect
■ Prepare an IPO strategy with your team
■ Prepare your financials
■ Do not announce plans before the legal cleanup has been completed
■ Carefully manage the process
> Too much management time - business suffers
> Not enough management time - offering suffers
■ Keep costs under control
■ Do not be loud during the quiet period
14
Alternative Financing StructuresChris Shoff, Latham & Watkins LLP
PROS AND CONS OF DIFFERENT TYPES OF FINANCING
Convertible Notes SAFE Preferred Stock
Pros • Allows company to defer
valuation
• No initial loss of
ownership – debt v.
equity
• Non-diluted
• Cheaper and less time
consuming than preferred
stock financings
• Same as Convertible
Notes
• Additional ‘pro’ = this is
not treated as ‘debt’
• Larger financing
• Value of VCs as advisors
• Successive participation
of VCs in later rounds
• Single or few professional
investors
Cons • Debt
• Difficulty of multiple
lenders (“herding cats”)
• Lenders less
sophisticated than VCs
• Investors are less
familiar/comfortable with
this newer structure
• Dilution will still occur
down the line when
lenders convert
• Difficulty of multiple
lenders (“herding cats”)
• Lenders less
sophisticated than VCs
• Founders lose some
control of the company
(and must respect rights
of preferred holders)
• Requires valuation of the
company
• More expensive and time
consuming
16
CONVERTIBLE NOTES – PROS AND CONS
Pros
■ Allows company to defer valuation
■ No initial loss of ownership – debt v. equity
■ Scaled raises of funds
■ Cheaper and less time consuming than preferred stock
financings
Cons
■ Drawbacks of debt instruments
■ Dilution may still occur if lenders convert
■ Difficulty of multiple lenders (“herding cats”)
■ Lenders less sophisticated than VCs
17
CRITICAL TERMS FOR CONVERTIBLE NOTES (CONT.)
• The date on which the debt is due or converted to equity
• Typically should not be more than a year
Maturity Date
• The rate at which the debt will accrue interest, typically on an
annual basis
• Usually 3-6%
Interest Rate
• The price at which the note (plus accrued interest) would
convert into shares of preferred stock
Conversion Price
18
CRITICAL TERMS FOR CONVERTIBLE NOTES (CONT.)
• Mechanism for noteholders to convert the note (plus accrued
interest) at a reduced price (in percentage terms) to the
purchase price paid by the investors in the next equity
financing
Conversion Discount
• Capped = ceiling on the valuation at which investors’ notes
convert to equity (which protects the noteholders’ stake when
they convert to equity in the future equity round)
• Uncapped = noteholders get no guarantee of how much
equity their note purchases (more favorable for company)
Uncapped vs Capped
19
CRITICAL TERMS FOR CONVERTIBLE NOTES (CONT.)
• Warrants to purchase additional shares in next equity
financing
• Not as common given more paperwork and higher legal fees
Warrant Coverage
• Timing
• Penalty
Pre-Payment
20
CRITICAL TERMS FOR CONVERTIBLE NOTES (CONT.)
• Enforceable claim or lien that gives the beneficiary of the
security interest certain preferential rights in the disposition of
secured assets
• Convertible notes are typically unsecured by any assets of
the company
Security Interest
• Reflects the priorities in claims for ownership or interest in
various assets
• Convertible notes are typically subordinate to all other
company debt
Subordination
21
SAFE
Safe – stands for “simple agreement for future equity.”
Alternative to convertible note created by Y Combinator.
What is it?
22
SAFE FINANCING – PROS AND CONS
Pros
■ Allows company to defer valuation
■ No initial loss of ownership – debt v. equity
■ Non-diluted
■ Cheaper and less time consuming than preferred stock financings
■ Not treated as ‘debt’
Cons
■ Investors are less familiar/comfortable with this newer structure
■ Dilution will still occur down the line when lenders convert
■ Difficulty of multiple lenders (“herding cats”)
■ Lenders less sophisticated than VCs
23
PREFERRED STOCK
A class of equity ownership in a corporation that has a higher
claim on the assets and earning than common stock
What is it?
24
PREFERRED STOCK – PROS AND CONS
Pros
■ Larger financing
■ Value of VCs as advisors
■ Successive participation of VCs in later rounds
■ Single or few professional investors
Cons
■ Founders lose some control of the company (and must
respect rights of preferred holders)
■ Requires valuation of the company
■ More expensive and time consuming
25
CONSIDERATIONS FOR VC FINANCINGS
What do we (the founders) want from a VC?
■ Sophisticated guidance
■ Valuable sources of contacts and expertise
■ Potentially successive rounds of financing
■ But don’t forget the drawbacks:
> Loss of some control
> Potentially divergent visions for the company (e.g., timing of IPO or sale of
the business)
How can we gauge our valuation?
What terms should we be concerned with?■ Contractual Dilution
■ Board Composition
■ Liquidation Preference
■ Protective Provisions
26
THE TERM SHEET
27
THE TERM SHEET
Terms of the initial round tend to stick in future rounds – think
carefully about the critical terms and work with your counsel to
negotiate them■ The “engagement ring” of the financing process
■ Summarizes the principal legal and business terms of the financing
Details are found in the Charter and financing agreements■ Typically non-binding
■ You should be aware of what terms are important to negotiate
28
CRITICAL TERMS FOR PREFERRED STOCK
■ Pre-money = estimated value of company prior to accepting funding
■ Post-money = pre-money valuation + new funding amount
■ Don’t forget the option pool, equity reserved for future distribution to hires, which is often included in the pre-money valuation and thus will directly affect the founders’ equity stake
Valuation
29
SAMPLE VALUATION MODEL – THE FOUNDERS
+ OPTION PLAN + FIRST ROUND OF PREFERRED FUNDING
The company successfully completes a $4,000,000 Series A Preferred Stock
Financing at a purchase price of $1.00 per share. The pre-money valuation is $1.00 x
10,000,000 = $10,000,000. The post-money valuation is pre-money valuation +
amount invested = $10,000,000 + $4,000,000 = $14,000,000. Pretty typical for option
pool to be 20% of the fully diluted capitalization.
Entity Pre-Series A #
of Shares
Pre-Series A %
of Shares
Post-Series A
% of Shares
Post-Series A
Value
Post-Series A
# of Shares
Katniss 4,000,000 40% 28.6% $4,000,000 4,000,000
Peeta 4,000,000 40% 28.6% $4,000,000 4,000,000
Option Plan 2,000,000 20% 20% $2,000,000 2,000,000
Series A
Investors
0 0% 28.6% $4,000,000 4,000,000
Total 10,000,000 100% 100% $14,000,000 14,000,000
30
SAMPLE VALUATION MODEL – THE FOUNDERS
+ OPTION PLAN + FIRST ROUND OF PREFERRED FUNDING
The company successfully completes a $4,000,000 Series A Preferred Stock Financing at a purchase price of $2.00 per share. The pre-money valuation is $2.00 x 10,000,000 = $20,000,000. The post-money valuation is pre-money valuation + amount invested = $20,000,000 + $4,000,000 = $24,000,000. Pretty typical for option pool to be 20% of the fully diluted capitalization.
Entity Pre-Series A #
of Shares
Pre-Series A %
of Shares
Post-Series A
% of Shares
Post-Series A
Value
Post-Series A
# of Shares
Katniss 4,000,000 40% 33.3% $8,000,000 4,000,000
Peeta 4,000,000 40% 33.3% $8,000,000 4,000,000
Option Plan 2,000,000 20% 20% $4,000,000 2,000,000
Series A
Investors
0 0% 14.4% $4,000,000 2,000,000
Total 10,000,000 100% 100% $24,000,000 12,000,000
31
CRITICAL TERMS FOR PREFERRED STOCK
■ The terms that determine the order in which creditors/shareholders are paid in the event of a liquidation event (IPO, sale or bankruptcy)
■ Creditors Preferred Stockholders Common Stockholders
■ Usually a multiplier (such as 1x)
■ Non-participating vs Fully participating (more on next slide)
Liquidation Preference
32
CRITICAL TERMS FOR PREFERRED STOCK (CONT.)
■ Fully participating means that the preferred stockholder with this right receives full liquidation preference amount first and are then entitled to share with the holders of common stock in the remaining amount
■ Non-participating means there is no additional amount after the full liquidation preference amount
■ Capped participation means the preferred stockholder with this right stops participating after it has received back a pre-determined dollar amount
■ See examples on next slide
Non-Participating vs Fully Participating vs Capped Participation
33
CRITICAL TERMS FOR PREFERRED STOCK:
LIQUIDATION PREFERENCE – PARTICIPATION
Katniss and Peeta sell the company for $500,000,000
Series A investors has a liquidation preference of $4,000,000
Series A preferred stock representing 40% of the outstanding shares
Participation Preferred before
Participation
Preferred after
Participation
Common
Non-Participating $4 million $4 million $496 million
Fully Participating $4 million $4 million + 40% of
($500 million - $4
million) = $202.4 million
$297.6 million
Capped Participation
(for example, 3x)
$4 million $4 million + $12 million
= $16 million
$484 million
34
CRITICAL TERMS FOR PREFERRED STOCK (CONT.)
■ Board seats
■ General matters v. Special matters
■ Drag along
Voting Rights
35
CRITICAL TERMS FOR PREFERRED STOCK (CONT.)
■ Consent of preferred class required for certain actions/events
> Altering rights of preferred
> Increasing/decreasing amount of common or preferred stock
> Creating senior or pari passu classes of stock
> Merger or sale of the company
> Increasing/decreasing the size of the board
Protective Provisions
36
CRITICAL TERMS FOR PREFERRED STOCK (CONT.)
■ Adjustment to conversion price of preferred
■ Types
> Broad-based weighted average
> Narrow-based weighted average
> Full ratchet
■ Carve outs of certain types of issuances
Anti-Dilution Provisions
37
CRITICAL TERMS FOR PREFERRED STOCK (CONT.)
• Right to participate in future issuances
Pre-Emptive Right
• Right to purchase shares before transferred to third party
Right of First Refusal
• Investors may sell portion of stock if founders sell their stock
Co-Sale
38
THANK YOU
+1.213.891.7421
STEVEN STOKDYK
Partner, Century City
# 1Band 1 for Capital Markets
California and Nationwide by
Chambers USA 2018
US$8.4
Billion
Advised on 36 US IPOs in 2017 worth US$8.4billion – more than any other law firm
2,600 Lawyers around the globe
Law360 selected Latham
as a 2017 “Capital Markets
Practice Group of the
Year,” highlighting the
practice’s execution of
landmark, high-stakes
deals and regulatory
prowess, and noting that
the firm “served as counsel
on more initial public
offerings than any of its
peers.”
Capital Markets Practice Group of the Year
Law360 2017
For the eighth year in a
row, Latham ranked first as
counsel to both issuers and
underwriters, helping US
and foreign companies
raise more than US$8.4
billion through 36 US IPOs
– more IPOs than any other
firm in 2017.
Top Ranked IPO Firm
IPO Vital Signs YE 2017
+1.424.653.5505
CHRISTOPHER SHOFF
Partner, Century City
Latham Contacts
39
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 44
Preparing for an IPOReady to unlock your potential?Barrett DanielsPartner, IPO Center of Excellence LeaderAccounting & Reporting AdvisoryDeloitte & Touche [email protected]+1 415 783 7897
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 45
Preparing for an IPO
IPO readiness
IPO execution
• IPO audits
• F-pages
• S-1
• Preparation for quarterly reporting
• SEC filings, timeline
Life as a public company
Topics
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 46
IPO readiness
IPO readiness is not just a finance thing. It involves tax, investor relations, human resources, corporate governance, etc.
IPO readiness is a luxury.
IPO reality is often a chaotic scramble.
IPO timelines can be impossibly bad. The goal is to be ready when the call comes.
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 47
IPO readiness
Inc.’s expected IPOs for 2015
Four years later, half are still private.
US News most anticipated IPOs of 2017
Two years later, seven of 10 are still private.
Anticipated 2017 IPOsAnticipated 2015 IPOs Actual IPO
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 48
IPO readinessSEC filings and comments: Timeline examples
Example 1
• Initially filed in 2015
• Completed in August 2018
Example 2
• Initially filed in June 2018
• Completed in September 2018
Timing can vary dramatically.
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 49
IPO readiness
“IPO windows are fickle. Be ready when the call comes.”
IPO windows
• Point – you never really know
• IPO windows are fickle
• Right now – the IPO window is very open
• Tomorrow – maybe not
• Be ready – whenever the call comes, it will feel like a surprise
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 50
IPO readiness
Finance
Put together a strong team
Streamline the close
Get your audits in order
Clean up your cap table
Start thinking about Qs
Collaborate with the right advisors
Assume the current timeline is wrong, because it isValuations and forecasts
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 51
IPO execution
S-1
SEC filings and commentsIPO audits
Preparation for quarterly reporting
F-pages
IPO execution
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 52
IPO executionAudits
• IPO audits are generally significantly more diligent
− Risk profile dramatically increases
− AICPA vs. PCAOB
− Be prepared for more:
◦ Auditors
◦ Questions
◦ Memos
◦ Tie-outs
◦ Checklists
• Better financials (see F-page discussion)
• Additional valuation (409a) and tax analyses
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 53
IPO executionF-pages
• SEC-ready F-pages
− No more cutting corners
− Stock compensation, business combinations, debt, derivatives, equity, etc.
• EPS and segment disclosures
− These can be challenging for private companies
• Interim stub periods
• Rule 3-05 financials for significant acquisitions
• Stock (reverse) splits and conversions – eventually
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 54
IPO executionF-pages
• Emerging growth company (EGC)
− Created by JOBS Act in 2012
− Less than:
◦ $1B in revenue
◦ $1B in non-convertible debt
◦ $700M public float
• EGC benefits
− Reduced financial statement requirements
◦ FAST Act
− Delayed compliance for new GAAP pronouncements
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 55
IPO executionS-1
• F-pages, discussed previously
• MD&A
− Components of income statement
− Results of operations
− Critical accounting policies
− Cash flow, contractual obligations, etc.
− Quarters
• S-1 front – summary and selected data, dilution, capitalization
• EGC – confidential filings and reduced CD&A
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 56
IPO executionPreparation for quarterly reporting
• Quarters are not required, but often requested
− A lot of work – always underestimated
− Less for biotechs, etc., but prior year quarters will be needed as public company and stub periods could be required depending on IPO timing
• Preparation
− SAS 100 reviews – different than management reports
− Information required
◦ SAS 100
◦ Financials
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 57
IPO executionSEC filings and comments
• Ensure F-pages and S-1 are SEC-ready (see F-page and S-1 discussions)
• Staying on schedule is hard, especially for finance
• Drafting and printer sessions
• Navigating SEC comment letter process
− Revenue recognition
− Stock compensation (cheap stock)
− EPS
− Contingencies
− Derivatives
− Fair value
− MD&A and more
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 58
IPO executionSEC filings and comments: Sample timeline under JOBS Act
IPO PREP SEC REVIEW PRICE, ROAD, IPO
Address final SEC comments, cheap stock update, stock split, public
company readiness, pricing, trading
15 days required between 1st public filing and road show
Assumes eight-day road showAssumes three days to price and close
SEP 15First
public filing
OCT 1Road show
OCT 11InitialPublic
Offering
Close audit, F-pages, MD&A, revenue recognition, segment analysis, EPS, non-GAAP / key metrics, prep for quarterly reporting, and cheap stock
Drafting sessions
Approx. 1-2 months between org. meeting and initial confidential submission
MAY 6Org.
meeting
JUN10Initial
submission
Approx. 30 days to receive initial comments from SEC (best case, 25 days)Approx. 2 weeks to respond to initial comments from SEC (best case, 1 week)Subsequent comments received approx. 2 weeks (best case, 10 days)Common to have 3 rounds with SEC (best case, 2 rounds) with each getting progressively quicker (i.e. 1st round 30 days, 2nd round 2 weeks, 3rd round 1 week, etc.)
Finalize quarters, update numbers, cheap stock update, address SEC comments
Q1 number update (FAST Act)
Test the waters
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 59
Life as a public companyS-1
• Life as a public company can be hard
• 10-Qs and 10-Ks, related reviews and audits
• Rigid calendar can feel like the process never stops
• Legal and market pressures
• SOX
− EGC deferral
− Eliminate attestation report on internal controls
Questions?
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 61
Break
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 62
For inquiries related to how to optimize value during the lifecycle of a tech company please contact: [email protected].
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 63
Todd GitlinManaging Partner & FounderSafire Partners
Dan MurrayCEOCreatorIQ
David WaxmanPartner & FounderTenOneTen Ventures
PanelCFO and VC perspectives
Los Angeles Art of the Deal WorkshopCopyright © 2018 Deloitte Development LLC. All rights reserved. 64
Lunch
State of the MarketsInside Views on the Health and Productivity of the Global Innovation Economy
Fourth Quarter 2018
SPECIALREPORT:Venture in SouthernCalifornia
2
State of the Markets: Fourth Quarter 2018
Predictions: Grading Our 2018Outlook
Public Markets: Tech Stumbles at the Top
Fundraising: AbundantCapital, RisingValuations
SouthernCalifornia:CapitalandValuationTrends
ExitConditions:Dual-TracksOpen
State of the Markets: Fourth Quarter2018
3
Grading Our 2018 Outlook
2018 Predictions1
SVB anticipates the deal count to remain flat interms of deal count, but investment will remainstrongwith
an uptick in capital committed perdeal.
GradeEarly Stage
2018 Reality2018 could well break records for early stage capital flow with deal counts in line with prior years. However, there are signs of a slowdown in angel and seedfinancings.
With an abundance of capital searching forgrowth andnew workarounds to satisfy liquidity, valuations at thelate-stageclimbhigherwithsteadycapital investment.
Late Stage Three quarters into the year, we’ve already witnessed143$100M+ rounds —flying past the 2015 record by 35. Secondary transactions are now the talk of thetown.
Market conditions and early filings signal astrongyear for IPOs. Liquidity demands spur a stream oflistings and
acquisitions, but many will still opt for privatecapital.
Exits While there has been an upswing in listings this year, it’s clear capital from the private markets is preferred. In fact, the largest U.S. listing of 2018 arrived from Europe (p.22).
LPs remain interested, particularly fromforeign sources of capital. As opportunity fundsbecomemore
prevalent, we predict another year above$30B.
Fundraising Venture fundraising has already surpassed $30B for theyear—it took just ninemonths.However,foreign capitalhasbeensubduedbycurrentgeopoliticaltension.
With earnings growth across industries andgeographies, firms can bet on the next big thing, throughacquisitions
and investments. Expect strong CVCinvolvement.
Corporates Corporates around the world continued pressing into thefuture through partnerships, venture and acquisitions —withhigh-profileM&Aatpremiumstoprivatevaluations.
Innovation has thrived through the first three quarters of 2018. Investment across stages remains elevated, marquee venture firms and newcomers alike have been actively fundraising and startups have enjoyed a healthy exit environment —both through IPO andacquisition.
Note: 1) Predictions made by SVB in the State of the Markets Q1 2018 distributed January 2018. Sources: PitchBook, S&P Capital IQ and SVBanalysis. State of the Markets: Fourth Quarter2018
4
Public Markets:Tech Stumbles at the Top
State of the Markets: Fourth Quarter2018
40%
50%
60%
70%
80%
90%
100%
Jan2018 Apr2018 Jul2018 Oct2018
Salesforce Netflix Facebook Tesla Tencent
5
Double-Digit Drops After MassiveRun-UpsSeveral high-profiletech companieshit arough patch leading into the fourth quarter. However, these declines comeonthe heels of record highs reachedearlier this yearafter years of sustainedgrowth.
Market Cap Relative to All-TimeHigh: 1/1/18–10/15/18 Stock Performance as of10/15/18
Company Decline fromPeak
Three-Year Returns1
-12% +134%
-20% +230%
-30% +75%
-32% +37%
-40% +120%
State of the Markets: Fourth Quarter2018Note: 1) Three-year returns based on market cap performance from Oct. 15, 2015 to Oct. 15, 2018. Sources: S&P Capital IQ and SVB analysis.
State of the Markets:Q3’18 6
Could Market Turmoil Spoil the Party forVenture?
50%40%30%20%10%0%
-10%-20%-30%-40%-50%
50%40%30%20%10%0%
-10%-20%-30%-40%-50%
1 57
50%40%30%20%10%0%
-10%-20%-30%-40%-50%
$35B
$30B
$25B
$20B
$15B
$10B
$5B
$0B
$14B
$12B
$10B
$8B
$6B
$4B
$2B
$0B
S&P500IndexReturns S&P500IndexReturns S&P500IndexReturns
U.S.VentureInvestment U.S.VentureInvestment U.S.VentureInvestment$35B
$30B
$25B
$20B
$15B
$10B
$5B
$0B
Venture capital by its very nature is a riskier asset. The last two bouts of U.S. market turmoil had a marked effect on investment flows into emerging tech and life sciencescompanies.
Dot-com Era: Q2’98–Q1’02 Financial Crisis: Q4’05–Q3’09 Current Bull Run:Q3’16–Q2’18
Source:PwC/CBInsightsMoneyTree,PitchBook/NVCA,S&PCapital IQandSVBanalysis.
7
Fundraising: Abundant Capital, Rising Valuations
State of the Markets: Fourth Quarter2018
8
2018 Venture Fundraising on Pace for Decade High
U.S. Venture Firm Fundraising:2010–Q3’181
In just nine months, U.S. venture firms have already raised more than $30B for afifth consecutiveyear—bolstered in large part bymega-funds.Even better news for startups: For each$1 raised byfunds, another$1.50 is invested in startups from the likes of corporateVCsandsovereign wealth.
Ratio of U.S. Venture Investment to Capital Raised byU.S.VentureFirms2
State of the Markets: Fourth Quarter2018
Notes: 1) Fourth quarter extrapolated from Q1–Q3 2018. 2) Amount of venture capital invested into startups divided by capital raised by venture capital funds.Sources: PitchBook and SVBanalysis.
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
2010 2012 2014 2016 2018$0B
$10B
$20B
$30B
$40B
$50B
2010 2012 2014 2016 2018YTD’18 YTD’18
Extra
polat
ed
$14B
$12B
$10B
$8B
$6B
$4B
$2B
$0B
$16B
$18B
9
Early Capital Steady Underneath Mega-Round FrothSteady venture fundraising bodes well for sustained investment in early and growth stages. Although later-stage investment flows have ebbed and flowed over the last five years, this year has been the most active for $100M+ rounds.
VentureCapital Investedin U.S.Tech Startups: 2014–Q3’18SplitbyRoundSize:
$100M+$25M–$99.9M$0–$24.9M
State of the Markets: Fourth Quarter2018Sources: PitchBook and SVBanalysis.
Q1 Q2 Q3
2014
Q4 Q1 Q2 Q3
2015
Q4 Q1 Q2 Q3
2016
Q4 Q1 Q2 Q3
2017
Q4 Q1 Q2
2018
Q3
2.0x
4.0x
10.0x
10
Public Multiples Point PositiveThe abundance of private capital, especially for later-stage companies, has pushed valuations to parity with public company multiples. For example, the strong showing by cloud software companies bodes well for the most promising growth stories in venture.
Enterprise SoftwareValuations: Revenue RunRate Multiple1
Notes: 1) Revenue run rate = Most Recent Quarter’s Revenue x 41. Valuations based on pre-money for private transactions and enterprise value for public companies. 2) More info on BVP Cloud Index athttps://www.bvp.com/strategy/cloud-computing/index.3) Data from SVB’s observations of ~175 transaction multiples of venture-backed companies with $25M+ runrate.Sources: PitchBook, S&P Capital IQ, Bessemer Venture Partners and SVB proprietary dataand analysis. State of the Markets: Fourth Quarter2018
2014 2015 2016 2017
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2018
Median of BVP Cloud Index2
Public CompanyConstituents
Median of Next20 Private Enterprise SoftwareTransactions3
8.0x
Prediction
6.0x
State of the Markets: Fourth Quarter2018 11
Southern California: Equity Trends
12
Late-Stage Capital Looks Beyond the BayWhile still the epicenter for venture, the Bay Area is no longer alone in accessing growth capital. Sizable funding rounds are not uncommon for startups across thecountry.
Bay AreaVentureInvestment1 East Coast VentureInvestment2
$50B
$40B
$30B
$20B
$10B
2018
$25B
$20B
$15B
$10B
$5B
2018
$0B
$5B
$10B
$15B
2009 2018
$5B
$10B
$15B
2015 2018
39%
29%
32%
28%
Split by RoundSize:$50M+<$50M
Split by RoundSize:$50M+<$50M
Split by RoundSize:$50M+<$50M
Split by RoundSize:$50M+<$50M
State of the Markets: Fourth Quarter2018
$0B2012 2015 YTD’18 2009 2012
Notes: 1) Includes startups headquartered in the San Francisco Bay Area. 2) Includes startups headquartered in ME, VT, NH, MA, CT, NY, DE, PA, MD and VA. 3) Includes startups headquartered in WA, OR, and CA (ex. Bay Area).4) Includes startups headquartered in states not covered in the above definitions. Sources: PitchBook and SVBanalysis.
YTD’18
$0B2009 2012 2015 YTD’18
WestCoast (Ex. Bay Area) VentureInvestment3
$0B2009 2012 2015 YTD’18
Mid-Regions (Ex.Coasts) Venture Investment4
20%
40%
60%
80%
100%
140%
120%
2014 2016 2018
13
Valuations Climb Nationwide, EspeciallyLate-Stage
Series A: Pre-MoneyValuations Relative to BayArea (100%)
As access to capital spreads nationwide, valuations are climbing — particularly in later stages. Increasingly, Silicon Valley–based investors are sourcing deals outside the Bay Area. Median valuations in hubs like Los Angeles and Seattle surpassed the Bay Area throughQ3.
Series C: Pre-MoneyValuations Relative to BayArea (100%)
State of the Markets: Fourth Quarter2018
20%
40%
60%
80%
100%
2012 2018
BayArea1
140%
YTD’182014 2016 YTD’18 2012
Notes: 1) Includes startups headquartered in the San Francisco Bay region. 2) Includes startups headquartered in ME, VT, NH, MA, CT, NY, DE, PA, MD and VA. 3) Includes startups headquartered in WA, OR, and CA (ex-Bay Area).4) Includes startups headquartered in states not covered in the above definitions. Sources: PitchBook and SVBanalysis.
WestCoast3
EastCoast2
Mid-Regions4
WestCoast3
BayArea1
EastCoast2
Mid-Regions4
SVB Equity Trends 2018 14
Series BDeal Count and Capital Invested
*DatathroughOct.31,2018 Source:PitchBook.
2018Projection
$888M$857M
$545M$678M
$755M
37
46
27
3336
27
0
10
20
30
40
50
60
$0M
$200M
$400M
$600M
$800M
$1,000M
SoCalTechnology– DealCountand Capital Invested: 2013–2018*Capital Invested ($) # ofDeals 2018Projection
$1,200M
YTD201820172016201520142013
$310M
SVB Equity Trends 2018
Series BPre-Money Valuations & InvestedCapital
SoCal Technology – CapitalInvested Middle 50%: 2013–2018*
SoCal Technology – Pre-MoneyValuations Middle 50%: 2013–2018*
15*DatathroughOct.31,2018 Source:PitchBook.
$7M$8M
$5M$5M
$3M
$20M
$15M
$12M$11M
$6M
$26M$26M$28M
$20M
$16M
$0M
$5M
$10M $9M
$15M
$20M
$25M
$30M
2013 2014 2015 2016 2017 YTD2018
$30M$28M$28M
$17M$16M$18M
$50M$53M
$24M$29M$25M
$100M$97M
$82M
$54M
$90M
$62M$57M
$M
$20M
$40M
$60M
$80M
$100M
$120M
2013 2014 2015 2016 2017 YTD2018
$15M
$12M
SVB Equity Trends 2018
Series BPre-Money Valuations & InvestedCapital
Tech Deals in SoCal vs. Bay AreaCapital Invested: Middle 50%: 2014–2018*
Tech Deals in SoCal vs. Bay AreaPre-Money Valuations: Middle 50%: 2014–2018*
16*DatathroughOct.31,2018 Source:PitchBook.
$0M
$6M
$12M
$18M
$24M
$30M
$36M
$0M
$20M
$40M
$60M
$80M
$100M
$120M
2014 2015 2016 2017 YTD’18 2014 2015 2016 2017 YTD’18
State of the Markets:Q3’18 17
Exit Conditions: Dual-Tracks Open
0
10
20
30
40
50
State of the Markets:Q3’18 18
IPOs Look More Attractive in 2018
Notes: 1) More information on BVP Cloud Index at: https://www.bvp.com/strategy/cloud-computing/index.2) Revenue run rate = Most Recent Quarter’s Revenue x 4. Valuations based on total enterprise value. Source: Bessemmer Venture Partners, S&P Capital IQand SVB analysis.
20
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
8.0x
9.0x
10.0x
The backlog of companies looking to access liquidity and capital with an IPO found low valuations to start 2016 and high volatility to start 2018. However, heading into the summer of 2018 both indications appear ripe for public debuts. IPOs are likely to follow.
U.S. Equity Volatility Index(^VIX): 2H’15–1H’18 BVPCloudIndex1: Rev.RunRate Multiple (Median)2
LowVolatility
July Jan.2015 2016
July Jan. 2017
July Jan. 2018
July Jan.2015 2016
July Jan. 2017
July Jan. 2018
$0.0B
$8.0B
$7.0B
$6.0B
$5.0B
$4.0B
$3.0B
$2.0B
$1.0B
State of the Markets:Q3’18 19
IPOs Provide Price Discovery forAcquisitions
Notes: 1) AppDynamics was reportedly pricing IPO below last privateround.2) Mobike was acquired at a 10% discount to their last privateround.Source: PitchBook, S&P Capital IQ, The Wall Street Journal, CNBC and SVBanalysis.
Privately HeldPublic In IPORegistration
Mar.2018 Jan. 20171 May 2018 June 2018 June2018 June2018 Apr. 20182 June2018 Apr.2018 Dec. 2017 June2018
Valuationat Acquisition
LastPublic Valuation
IPOValuation
LastPrivate Valuation
Target
Acquirer
DealDate
Legend
Strategics have been willing to pay up in 2018. Acquirers are so hungry for tech assets that several companies in IPO registration have been acquired for healthy premiums before hitting themarket.
Notable $1B+ TechAcquisitions: 2017–1H’18
State of the Markets:Q3’18 20
Continued M&A for Scaled Mid-MarketCompanies
Note: 1) For acquisitions with the same criteria as the chart. Source: PitchBook and SVBanalysis.
Cisco 8 $3.1B
Oracle 6 $3.5BThomaBravo
VistaEquity5
4
$2.4B
$2.4B
Salesforce 4 $2.3B
GTCR 3 $1.7B
Intel 3 $1.1B
U.S. Tech GiantsAlphabet 2 $0.9B
Microsoft 2 $0.8B
Amazon 1 $0.5B
Facebook 1 $0.5B
Apple 0 $0.0B0
10
20
30
$0.0B
$1.0B
$2.0B
$3.0B
$4.0B
$5.0B
$6.0B
$7.0B
$8.0B 40
1 Q 2 Q
1H'184 Q 2 Q 3 Q
20171 Q 4 Q 2 Q 3 Q
20161 Q 4 Q 2 Q 3 Q
20151 Q 4 Q 2 Q 3 Q
20141 Q 3 Q 4 Q
2H’13
Most Active Deals Capital
Beneath the megadeals, financial buyers continue to offer another exit path for companies at <$1B. Private equity deals accounted for more than one-third of 1H’18 transaction value in this range.
U.S. Venture-Backed Tech Acquisitions$250M–999M: Q3’13–Q2’18 Most Active Acquirers1
FinancialBuyers DealCountStrategicBuyers
State of the Markets: Fourth Quarter2018 21
Appendix
2 00 7
2 00 8
2 00 9
2 01 0
2 01 1$0B
$100B
$200B
$300B
$400B
$500B
2 01
$0B
$3B
$6B
$9B
$12B
2 00 7
2 00 8
2 00 9
2 01 0
2 01 1
State of the Markets: Fourth Quarter2018 22
Fundamentals Lift Tech ThroughDownturns
Sources: S&P Capital IQ and SVBanalysis.
Let history beour guide.During theGlobalFinancial Crisis, eachof these tech companieslost half of their market cap.But those ableto provegrowth (while remainingat break-evenor better) despiteeconomic woes emerged even morevaluable.
Microsoft Google Yahoo! Salesforce
$0B
$5B
$15B
$10B
$0M
$200M
$400M
$600M
$800M
2 00 7
2 00 8
2 00 9
2 01 0
2 01 1
Revenue andEBITDA
2 00 9 2 01 1
’07 ’08 ’09 ’10 ’11’07
2 00 8 2 01 0
’07 ’08 ’09 ’10 ’11
Revenue
’07 ’08 ’09
andEB
’10 ’11
ITDAReve
’09 ’10 ’11
ndEBITDA
$0.0B
$0.5B
$1.0B
$1.5B
$2.0B
2 00 7
2 00 8
2 00 9
2 01 0
2 01 1
$0B $0B
$150B $30B
$100B $20B
$50B $10B
2 00 8
’08
nuea
2 2 01 0 2
$0B
$6B
$12B
$18B
$24B
2 00 7
2 00 8 2 00 9
2 01 0
2 01 1
MarketCap $250B MarketCap $50B MarketCap $25B MarketCap
$200B $40B $20B
Revenue andEBITDA
$0.0T
$0.5T
$1.0T
$1.5T
$2.0T
State of the Markets:Q3’18 23
Ample Cash at the Ready for TechM&A
Notes: 1) Net cash for strategic acquirers includes cash and ST & LT investments, net ST & LT debt. No consideration was given to domicile of holdings. 2) Based on constituents of the S&P 500 as of June 30, 2018. 3) Based on dry powder for private equity as of September 30, 2017, multiplied by SVB estimate of amount invested in technology deals.Source: PitchBook and SVBanalysis.
$107B $109B
$51B$44B
$1B
$20B
$40B
$60B
$80B
$100B
$120B
$0BU.S. PETechDryPowder3
Capital remains plentiful for traditional acquirers: Private equity firms are nearing all-time highs for dry powder, and strategics are cash-and equity-rich. As tech moves to disrupt all industries, note that current S&P 500 constituents have doubled their cash over the last decade.
Net Cash: Financial andStrategic Buyers1 S&P 5002: Cash and Cash Equivalents:2008–1H’18$145B
$140B $2.5T
2008 2010 2012 2014 2016 2018
24
Authors
State of the Markets: Fourth Quarter2018
Steven Pipp,CFAVice President,[email protected]
Erin PlattsHeadof RelationshipBanking, [email protected]
Steven Pippis aVice President basedinSan Francisco responsible for capitalmarkets research and data-drivenanalysis of the innovationeconomies that SVBserves globally. In this role, he has led research efforts exploring investment, fundraising and exit dynamics between the venture ecosystems of the U.S., China, Southeast Asia and Europe.
Prior to his research role, Steven managed strategicadvisory and valuation engagements for venture-backedtechnology companies as part of SVBAnalytics. Before joining SVB, Steven workedin Minneapolisas a consultant and entrepreneurwitha focusoncleanenergy technology.
Steven earned a Master of Science in Finance fromBoston College and a Bachelor of Science in Business fromthe University of Minnesota. In addition, he holds the CharteredFinancial Analyst (CFA)designation.
Bob Blee heads Silicon Valley Bank’s Corporate Finance Group, which leads SVB’s relationshipswith publicand late-stageprivate companiesin the Innovationsector throughout NorthAmerica,providing a fullsuite of lending and banking products,as well asguidance asa trusted partner, helping our clients succeed and quicklyscale.
Previously, Bob held a variety of rolesinSVB’s California and Midwest regions, including heading seed, earlyand mid-stage Infrastructure, Hardware, Consumer Internet and Fintech banking in the Bay Area and Southern California and was responsible for SVB’s Mezzanine Lending and Loan Syndicationspractices.
Bob sits on the nonprofit boardof the Network for Teaching Entrepreneurship(NFTE)and the Silicon Valley Advisory Council of the CommonwealthClub.He is alsoactive withhis almamater,the University of Illinois.
Erin Platts is the Head of Relationship Banking for Europe atSilicon Valley Bank. She hasbeenwith Silicon Valley Bankfor 14 years, beginning hercareerat its Bostonoffice.
Erin providesstrategic input into the bank’s business, including potentialproducts and services as well as expansion into new markets.
Erin and her teams are dedicatedto providing debt financing toearly, growth,and late stage innovation businesses of all lifestages in the UK, Ireland and Germany.Erin is responsible for developing new relationships and overseeing the continuedgrowth of the Europeanteamand client base.
Erin wasfeaturedonManagementToday’stop 35 Women Under 35 list and was included in the Innotribe’s Power Women in FinTech report.
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State of the Markets: Fourth Quarter2018 25
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