Business 16Stanford Department of Continuing EducationClass # 4, 10/19/09

Venture Capital, Angels, Banks

www.alloyventures.com/class.html

Financingo Comes in several flavors

Equity vs. debt vs. bootstrapping

o Best depends on several factors How much you need When you need it Your experience/How much help you need Your confidence in your idea/When you can pay

it back Attractiveness of investment Control

Equity: Venture Capital

o Structureo A group of partners raise OPM

o Typically foundations, endowments, companieso These groups like the high returns

from good firmso Typically, $100,000,000+o Promise to invest in 20-30 companieso Invest over 2-3 years, then raise

new fundo Goal is to at least triple the fundo To do that, each investment must

have the potential to make 10X

Equity: Venture Capital

o Incentiveo Partnerships take 20% to 30% of

profitso For a $100M fund that goes 3X,

$200M in profit, of which $40M goes to the VC partners

o 2.5% management fee for salaries, expenses

Equity: Venture Capital

o So why doesn’t everybody do it?o A lot of people tried, and they got

destroyedo However, I got a great house out of ito It’s really hardo It takes a long time to make moneyo It is extremely stressfulo It takes a network of relationships

o Investorso Entrepreneurso Bankerso Lawyerso Academicso Industrial leaders

Equity: Venture Capital

o So why doesn’t everybody do it? o It takes time to build a reputationo Like an ER; triage managemento Success begets successo For the same amount of work, I-

bankers make, ah, hmm, made a lot more

What does a VC do?o Gets 200-400 business plans/yro Actually does 2 to 4 investments/yro Ave. investment $2-10MM

o If co. needs more, VCs group together into a “syndicate”

o The finder typically “leads” the deal/does the work

o Sets up meeting with entrepreneurso If it goes well, does “due diligence”

o Calls references, industry people, academics, customers

o Most VCs look for good people and big marketso If that goes well, presents to partnerso If that goes well, puts together a draft “term

sheet” and circulates it to partnerso Says how much to be invested and terms of the

deal

What does a VC do?o Usually, negotiations ensue between the

entrepreneur and the VCo There may be competitive term sheetso Anything goes; collusion is common

o When deal is struck, term sheet goes to lawyerso More negotiations between VCs and

entrepreneurso The deal closes, co. gets the moneyo Usually at least one VC on the Board of

Directorso VC works w/management to:

o Set strategy & tacticso Make introso Recruit key managemento Resolve ongoing problemso Hold management to milestoneso Raise additional capitalo Take company to liquidity

A good venture capitalist:

o Has a track record of successo Has a ton of contactso Predictable, won’t freak out when times get

tougho A solver, not a blamero Resolves issues before BOD mtgs.o Has unquestionable integrityo Likes & respects you, and vice versao Has a clear vision of where the company is

going

A good venture capitalist:

o Has partners who trust him/hero Is always availableo Is not too busy with other companieso Is technically fluento Can see synergieso Doesn’t let you get away with anything

How do you know if you have a bad

venture capitalist?o Too busyo Likes to hear himself talk/doesn’t listeno Yells when the stuff hits the fano Takes credit for your worko No experience in a company but micromanageso Not interested in what your needs areo Focuses on “going public” instead of building a

big companyo Doesn’t know anybodyo Has no/poor referenceso Name dropper at the wrong altitude

How does a venture capitalist figure out how much of my company

to buy?o Investment ino 10X that investment in 5 yearso Terminal value of company in 5 yearso What percentage of the company is that?o That’s the percentage he has to buy

Equity: Angels

o Incentiveso Ex-entrepreneurso Rich, want to keep a hand ino Rich, want to get richero Rich, want to show how smart they are to

their rich friendso Want to stay relevant

Equity: Angels

o Good pointso Typically pay more than VCso Typically ask fewer questionso Have a reputation in your field

o Many are well-connectedo May make personal introductions

o Willing to get involved earlyo Have lower expectations than VCso May be willing to devote a huge amount of

time

Equity: Angels

o Bad points o Busy playing golfo Busy flying their jeto Busy sailing their yachto Busy in Provence with no answering machine

and a maid that doesn’t speak Englisho Often first round players onlyo May not be stable in a pinch

Equity: Angels

o Bad points o Predictability?o Motives?o Overpaying makes later rounds hardero May be seen as flakey, which may taint youo Angels work best with:

o seasoned entrepreneurs who need little help

o entrepreneurs who know they will get mindshare

Angels

o Angels Forum (www.angelsforum.com)o Life Sciences Angels

(www.lifesciencesangels.com)o Band of Angels (www.bandangels.com),

monthly meetingso Loose affiliationso Many have invested in VC firms, and use

these contacts

Loans: Banks/Companies

o When you are sure you can pay it backo Will want a business plano Likely to give you money only for fixed assetso May be a lot of strings attachedo You remain undiluted, just pay it off with

interesto Can make a lot of sense o Will provide no helpo Cannot differentiate good contacts from bado Beware of quick-start loans

Loans: Relatives

o You may never live it downo No help other than greeno Can put you in a weird position if your

company starts to crater

Bootstrapping

o Don’t take money from anybodyo Difficult in high-growth businesseso Bad idea when there is a lot of

competitiono A competitor with equity money could

kick your butto You don’t get any help unless you set

up the other boardso A reasonable solution for smaller

companieso Forget about a spouse and children