E145/STS173E145/STS173

Session 9Session 9ABC’s of Venture Finance and TeamsABC’s of Venture Finance and Teams

Professor Tom ByersStanford University

Copyright © 2004 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be

reproduced for educational purposes only.

© 2003 Mark P. Rice, Babson

Today’s AgendaToday’s Agenda

Part II and III. Given the nature of the business and the objectives of the founders, what human (II) and capital (III) resources are needed to build a venture?

Part I. As a “blueprint” for building the business, what is the purpose of a business plan?

Part I. Part I. What is the Purpose of a Business Plan?What is the Purpose of a Business Plan?

And Is It Really Worth All the Effort?And Is It Really Worth All the Effort?

Outline of a Business PlanOutline of a Business Plan• Executive Summary• Market Analysis*• Vision and Concept (including Technology)*• Competitive Positioning and Marketing*• Business Model*• Organization• Financial Projections• Ownership

* Our Opportunity Analysis Team Project covers the first four components!

Recall Sahlman’s ModelRecall Sahlman’s Model

Reference: Sahlman

Part II: ABCs of TalentPart II: ABCs of TalentA. Team … Recruiting

B. Compensation… Rewards

C. Culture

… Norms

A. Recruiting Key Players in Start-UpsA. Recruiting Key Players in Start-Ups

InternalKey issues: When to hire? Experience versus passion and energy? Qualifications versus motivation and character?

Founders or Initial Partners CEO and VPs Designers, Developers, “Architects” and Managers of Products & Services Sales and Marketing Operations and Administration Others?

External Key issue: how to manage?

Board Of Directors Investors Advisory Boards Professional Services and Suppliers Others?

Q&A with VC John Doerr of KPCBQ&A with VC John Doerr of KPCB

Q. What is the most important part of any business plan?

A. “I always turn to the bios of the team first. For me, it’s team, team, team. Others might say, people, people, people -- but I’m interested in the team as a whole.”

“The way I attract these people to SOFTBANK is to explain what my dream is. It is not money because they actually come to work and we never talk about payment. They come to work, then a week passes, or longer, then we finally get around to talking about money. I’ll ask them, by the way, how much do you want? And they say, whatever you want to give me. Then I ask them, how much were you making last year? Then I give them the same amount. So they don’t come to SOFTBANK for the money. It’s for the dream that everyone has together. The dream of making the company successful.”

Masayoshi SonCEO of

SOFTBANK CORP. (Japan)

B. Compensation and RewardsB. Compensation and Rewards

Understanding Rewards Understanding Rewards In High Potential VenturesIn High Potential Ventures

• Status Often Determined by Contributions to Improving Culture and Increasing the Value of the Company

• Hence, Rewards Tend to Be Value-Enhancing such as Stock Options (Employees Have Equity Ownership)

Major Compensation Major Compensation Components in Start-Ups Components in Start-Ups

• Cash Salary and Bonus Benefits

• Equity Common Stock Plans

(Incentive Stock Options Have Favorable Tax Rates)

Vesting Schedule and Stock Budget

Tax Implications (IRS in USA) and Security Laws (SEC in USA)

Will Cover in Great Detail in the

Bonnie Bryte Case

C: Culture …C: Culture … The Secret to Long-Term Success? The Secret to Long-Term Success?

Definition“A strong system of informal rules that spells out

how people are to behave most of the time”

Two Great Quotes

“The most durable asset of a venture is its culture” (Cook)

“First four letters of culture spell c-u-l-t” (Collins)

Culture: Major Challenge to Create a Fertile Culture: Major Challenge to Create a Fertile Environment for InnovationEnvironment for Innovation

• Develop Sense of Teamwork• Understand Personalities of Key People• Develop Open Internal Communication • Remain Open to Ideas & Suggestions from Anywhere• Be the Customer• Be Willing to Experiment• Include Creative and Unusual People• Address the Issue of AutonomyReference: Collins & Lazier, Beyond Entrepreneurship

Preview of “Characteristics of Effective and Preview of “Characteristics of Effective and Ineffective Teams” Exercise Ineffective Teams” Exercise

We are all angels with only one wing. We can only fly

while embracing each other.

~ Luciano de Crescenzo

Recall Success Formula for E145Recall Success Formula for E145

• Show up on time (with cell phones and pagers off please).

• Be nice to people (e.g., constructive comments only, listen carefully and only one speaker).

• Do what you say you will do and deliver more than you promise (both in class and out).

• Do it with energy and passion.

Reference: JM Perry

Part II: ABCs of FinancingPart II: ABCs of Financing

A. Amount of cash needed and purpose

B. Sources of Capital C. Deal Structure and Terms

A. Amount of Cash …A. Amount of Cash …Two Key QuestionsTwo Key Questions

#1 How much money is needed for this “round” of financing?

Typical Financing Stages (or Rounds):

Seed Early Mezzanine Late (e.g., IPO)

#2 Which risks are to be reduced with this money in this round?

Team Risk

Technology RiskCapital Risk

Market Risk

B. Raise Money From Where?B. Raise Money From Where?Sources of Capital for Sources of Capital for

High-Technology EntrepreneursHigh-Technology Entrepreneurs

TraditionalVC

Angel Investors

Corporate VC

Boot-strapping

Other

U.S. Venture Capital InvestmentU.S. Venture Capital Investment

In 2003, VC’s invested $18 billion in U.S. and angels invested about $16 billion. (Sources: Venture Economics, NVCA and Center for Venture Research)

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Nu

mb

er

of

US

VC

In

vestm

en

ts

A Simple Venture Finance ExampleA Simple Venture Finance Example• Roma’s hot startup requires $10 million in order to form its business. She

expects to earn $10 million in its fifth year.

• Randy’s VC firm has reviewed the company's business plan and believes that he is entitled to a 50% return on his investment. (Hint: how many “times” must his money grow in 5 years?)

• Publicly traded companies in this category and industry trade at approximately 15 times earnings (PE ratio). There is no material difference between these companies and the startup.

• What portion of the company should Randy’s VC firm receive today? (Hint: what is future value of that investment?)

1. Value of VC Investment in Year 5 = $10 m*(1+50%)^5 = $76m

2. StartUp’s Value in Year 5 = $10 m*(P/E of 15) = $150m

3. VC Firm’s Share Today =   Step 1/Step 2                    =  $76 m/$150m = ~ 50%

4. “Post-Money” Value Today = $10 m / .50 = $ 20 mm

A Multi-Stage Venture Finance ExampleA Multi-Stage Venture Finance ExampleTime

I II III IV V

33 1/3 %

33 1/3 %

33 1/3 %

1mm shares

for each

founder

=3mm

shares @

$0.001 ea.

Value=$3k

Note: not to scale

20 %

20 %

20 %

20 %

20 %

+1mm shares

each for CEO

& employees

= 5mm

shares @ $0.01

each

Value=$50k

10 %10 %

10 %

10 %10 %

50 %

+5mm shares

for first VC

firm

=10mm

shares @ $1.00

each

Value=$10mm

Use of $: R&D

33 1/3 %

33 1/3 %

33 1/3 %

20 %

20 %

20 %

20 %

20 %

10 %10 %

10 %

10 %10 %

50 %

TimeI II III IV V

1mm shares

for each

founder

=3mm

shares @

$0.001 ea.

Value=$3k

1mm shares

each for CEO

& employees

= 5mm

shares @ $0.01

each

Value=$50k

5mm shares

for first VC

firm

=10mm

shares @ $1.00

each

Value=$10mm

Use of $: R&D

5 %5 %

5 %

5 %

5 %

25 %

25 % 25 %

+5mm shares for

sale to public in

IPO

= 20mm

shares @ $15.00

each

Value=$300mm

Use of $: Operations

6 2/3 %6 2/3 %

6 2/3 %

6 2/3 %

6 2/3 %

33 1/3 %

33 1/3 %

+5mm shares

for second

round VCs

=15mm

shares @ $5

each

Value=$75mm

Use of $: Mktg.

A Multi-Stage Venture Finance ExampleA Multi-Stage Venture Finance Example

V

Note: not to scale