venture capital 101
TRANSCRIPT
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Financing: Stops Alongthe Investment Food Chain
Venture Capital 101
Mass. Software and Internet CouncilMarch 21, 2002
Financing: Stops Alongthe Investment Food Chain
Venture Capital 101
Mass. Software and Internet CouncilMarch 21, 2002
Mark B. SteinMark B. Stein
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Venture Capital 101Venture Capital 101
Agenda1. Venture Capital Overview
2. What VCs Are Looking For
3. Preparing for V.C. Investment
4. Investor Term Sheets
5. Alternatives to VC Financing
Agenda1. Venture Capital Overview
2. What VCs Are Looking For
3. Preparing for V.C. Investment
4. Investor Term Sheets
5. Alternatives to VC Financing
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Venture Capital 101Venture Capital 101
1. Overview of Venture Capital
I. Pooled Investment Vehicle -Partnership
II. Foundations, Universities, Corps,High Net Worth Indivs
III. Asset Allocation: 20-30% RoI
IV. 10-Year Term; 6-7 YearInvestment Period
1. Overview of Venture Capital
I. Pooled Investment Vehicle -Partnership
II. Foundations, Universities, Corps,High Net Worth Indivs
III. Asset Allocation: 20-30% RoI
IV. 10-Year Term; 6-7 YearInvestment Period
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Venture Capital 101Venture Capital 101
1. Overview of Venture Capital (continued)
V. 2/20 Economics
VI. 3-5 Year Investment
VII. Exit: IPO, Trade Sale, Recap
VIII. 6-10 Portfolio Companies per Investment Manager
1. Overview of Venture Capital (continued)
V. 2/20 Economics
VI. 3-5 Year Investment
VII. Exit: IPO, Trade Sale, Recap
VIII. 6-10 Portfolio Companies per Investment Manager
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$0
$2
$4
$6
$8
$10
Median AmountInvested (Total)
Median AmountInvested (Initial)
Venture Capital 101Venture Capital 101
$0
$20
$40
$60
$80
$100
Total Amount Invested
Source: Venture One
Amounts Invested --Highlights and Lowlights
Millions Millions
1998 19992000 2001
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Venture Capital 101Venture Capital 101
0
1,000
2,000
3,000
4,000
5,000
1999 2000 2001
Number of FinancingsInitial Rounds of Finance
Source: Venture One
Financings --Highlights and Lowlights
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17%
65%
17%17%
65%
17%
Venture Capital Investment Highlights - and LowlightsVenture Capital Investment Highlights - and Lowlights
29%
61%
9%29%
61%
9%
2000
33%
56%
10%
33%
56%
10%
1999
2001
Percentage of Financing Rounds by Industry
Source: Venture One
Information Technology
Healthcare
Products and Services
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Venture Capital 101Venture Capital 101
2. What VCs Look For
I. Unique/Breakthrough Idea
II. Barrier to Entry -- IP, Franchise
III. No Legacy
IV. Relevant Expertise in House
V. Solid Management Team
VI. 4-5x Investment in 3-5 Years
VII. $100 Million Business
2. What VCs Look For
I. Unique/Breakthrough Idea
II. Barrier to Entry -- IP, Franchise
III. No Legacy
IV. Relevant Expertise in House
V. Solid Management Team
VI. 4-5x Investment in 3-5 Years
VII. $100 Million Business
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Venture Capital 101Venture Capital 101
3. Preparing for V.C. Investment
I. Structure to contemplate futuredilution- Cash investors
- Employees/advisors
* Founders typically end up with 10-12% of company on fully-diluted basis by the time of I.P.O.
3. Preparing for V.C. Investment
I. Structure to contemplate futuredilution- Cash investors
- Employees/advisors
* Founders typically end up with 10-12% of company on fully-diluted basis by the time of I.P.O.
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Venture Capital 101Venture Capital 101
3. Preparing for V.C. Investment
Typical Structure Post-Series A
Founders (+ Angels) = 40%
VCs = 40%
Reserve for Employees = 20%
3. Preparing for V.C. Investment
Typical Structure Post-Series A
Founders (+ Angels) = 40%
VCs = 40%
Reserve for Employees = 20%
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Venture Capital 101Venture Capital 101
3. Preparing for V.C. Investment
II. Organize as “C” Corporation
III. Take Steps to Protect IntellectualProperty- Copyright, Trademark
- Domain Names
- Provisional Patent or Patent
- NDA
3. Preparing for V.C. Investment
II. Organize as “C” Corporation
III. Take Steps to Protect IntellectualProperty- Copyright, Trademark
- Domain Names
- Provisional Patent or Patent
- NDA
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Venture Capital 101Venture Capital 101
3. Preparing for V.C. Investment
IV. Core Management Team- Stock Vesting
- Stockholders Agreement
V. Business Plan Executive Summary
3. Preparing for V.C. Investment
IV. Core Management Team- Stock Vesting
- Stockholders Agreement
V. Business Plan Executive Summary
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Venture Capital 101Venture Capital 101
4. Investor Term Sheets
Typical Objectives in Investment
I. Upside Return on Investment
- Convertibility
- Participation
- Convertible Redeemable Preferred
- Warrants
4. Investor Term Sheets
Typical Objectives in Investment
I. Upside Return on Investment
- Convertibility
- Participation
- Convertible Redeemable Preferred
- Warrants
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Venture Capital 101Venture Capital 101
4. Investor Term Sheets (continued)
II. Downside Investment Protection- Liquidation preference
- Fixed dividend
- Anti-dilution ratchet
III. Operational Governance
- Board of Directors composition
- Selection of key management team
- Consent to major actions
4. Investor Term Sheets (continued)
II. Downside Investment Protection- Liquidation preference
- Fixed dividend
- Anti-dilution ratchet
III. Operational Governance
- Board of Directors composition
- Selection of key management team
- Consent to major actions
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Venture Capital 101Venture Capital 101
4. Investor Term Sheets (continued)
IV. Other Control Features
- Right of First Refusal
- Reports
- Affirmative/negative covenants
* Affiliate transactions
* Presentation to LPs
* Confidentiality
- Key-man insurance
4. Investor Term Sheets (continued)
IV. Other Control Features
- Right of First Refusal
- Reports
- Affirmative/negative covenants
* Affiliate transactions
* Presentation to LPs
* Confidentiality
- Key-man insurance
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Venture Capital 101Venture Capital 101
4. Investor Term Sheets (continued)
V. Exit From Investment
- Registration rights
- Co-Sale rights
- Drag-along rights
- Redemption right
4. Investor Term Sheets (continued)
V. Exit From Investment
- Registration rights
- Co-Sale rights
- Drag-along rights
- Redemption right
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Venture Capital 101Venture Capital 101
Sample Venture Capital Term Sheet
• Security: Convertible Preferred Stock
• Pre-Money Valuation: $______ (including the Option Pool).
• Capitalization: immediately after the proposed financing :– Common Stock 45%– Series A Preferred 34%– Stock Option Pool 21%– Total 100%
Sample Venture Capital Term Sheet
• Security: Convertible Preferred Stock
• Pre-Money Valuation: $______ (including the Option Pool).
• Capitalization: immediately after the proposed financing :– Common Stock 45%– Series A Preferred 34%– Stock Option Pool 21%– Total 100%
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Venture Capital 101Venture Capital 101
Rights and Preferences:
• Dividends: Cumulative dividends of __%, payable upon liquidation or dissolution, redemption, (conversion)
• Liquidation preference: 1 1/4x original price, plus all unpaid dividends; participation with Common Stock on “as-converted” basis thereafter. Merger, sale of substantially all assets of Company treated as liquidation.
Rights and Preferences:
• Dividends: Cumulative dividends of __%, payable upon liquidation or dissolution, redemption, (conversion)
• Liquidation preference: 1 1/4x original price, plus all unpaid dividends; participation with Common Stock on “as-converted” basis thereafter. Merger, sale of substantially all assets of Company treated as liquidation.
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Venture Capital 101Venture Capital 101
• Conversion: Elective; Automatic upon vote or QPO
• Anti-dilution: Full/[Weighted Average] ratchet adjustments for subsequent issuances of stock at a lower price, customary exclusions.
• Consent Rights: 2/3 vote required for: liquidation, merger, sale of all assets, increase/decrease in authorized Preferred Stock, change in the terms of the Preferred Stock, amendments to Charter or By-Laws.
• Conversion: Elective; Automatic upon vote or QPO
• Anti-dilution: Full/[Weighted Average] ratchet adjustments for subsequent issuances of stock at a lower price, customary exclusions.
• Consent Rights: 2/3 vote required for: liquidation, merger, sale of all assets, increase/decrease in authorized Preferred Stock, change in the terms of the Preferred Stock, amendments to Charter or By-Laws.
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Venture Capital 101Venture Capital 101
• Optional Redemption: 1/3 of Preferred Stock redeemable on 6th, 7th, and 8th anniversaries of Closing. Price per share = original purchase price plus all unpaid dividends.
• Registration Rights: – 2 S-1 demand registrations on S-1; – Unlimited S-3 demand and piggybacks. – No grants of additional registration rights without
consent of Preferred Stock.
• Optional Redemption: 1/3 of Preferred Stock redeemable on 6th, 7th, and 8th anniversaries of Closing. Price per share = original purchase price plus all unpaid dividends.
• Registration Rights: – 2 S-1 demand registrations on S-1; – Unlimited S-3 demand and piggybacks. – No grants of additional registration rights without
consent of Preferred Stock.
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Venture Capital 101Venture Capital 101
• Rights of First Refusal, Co-Sale, Drag-Along:– Company option to acquire shares to be sold by
Founders before QPO.
– Preferred Stock may sell proportional share as part of sale by Founder.
– Preferred Investors can purchase their pro rata share in any subsequent offering before QPO.
– Preferred Stock right to cause Founders to vote for sale of Company if (i) no QPO by 6th anniversary; or (iii) 2/3 Preferred vote in favor.
• Rights of First Refusal, Co-Sale, Drag-Along:– Company option to acquire shares to be sold by
Founders before QPO.
– Preferred Stock may sell proportional share as part of sale by Founder.
– Preferred Investors can purchase their pro rata share in any subsequent offering before QPO.
– Preferred Stock right to cause Founders to vote for sale of Company if (i) no QPO by 6th anniversary; or (iii) 2/3 Preferred vote in favor.
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Venture Capital 101Venture Capital 101
• Information Rights:– Audited financials w/in 120 days of FY end;
performed by a “Big Five” accounting firm;
– Unaudited quarterly and monthly financials w/in 30 days of period end;
– Progress reports from the CEO (research, development, sales, marketing, etc.) monthly;
– Annual budget 30 days before each FY.
• Information Rights:– Audited financials w/in 120 days of FY end;
performed by a “Big Five” accounting firm;
– Unaudited quarterly and monthly financials w/in 30 days of period end;
– Progress reports from the CEO (research, development, sales, marketing, etc.) monthly;
– Annual budget 30 days before each FY.
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Venture Capital 101Venture Capital 101
• Information Rights: (continued) – Non-Competition Agreements: Founders and
Key Employees not to compete with Company for one year after termination of employment.
– Attorneys Fees: Fees not to exceed $[ ] and expenses of such counsel will be borne by Company.
• Information Rights: (continued) – Non-Competition Agreements: Founders and
Key Employees not to compete with Company for one year after termination of employment.
– Attorneys Fees: Fees not to exceed $[ ] and expenses of such counsel will be borne by Company.
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Venture Capital 101Venture Capital 101
5. Alternatives to VC Financing
I. Friends & Family
II. Angels
III. Corporate/Strategic
5. Alternatives to VC Financing
I. Friends & Family
II. Angels
III. Corporate/Strategic
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Financing: Stops Alongthe Investment Food Chain
Venture Capital 101
Mass. Software and Internet CouncilMarch 21, 2002
Financing: Stops Alongthe Investment Food Chain
Venture Capital 101
Mass. Software and Internet CouncilMarch 21, 2002
Mark B. SteinMark B. Stein