sdfl

David RoweInvestment ManagerUniseed Management Pty Ltdd.rowe@uniseed.com

ELEC5701

Venture Financing

Uniseed – Funding Early Stage R&D

• Established 2000, a $61m ‘open ended’ fund– Focus on commercialisation of University R&D– Operate with financial and commercial discipline

• An early-stage, pre-seed fund– Initial investment of $250k-$500k– Invest Up to $2 million / investment

• Aim to bring in co-investment, leverage initial capital– 19 co-investments, 16 second rounds, 11 third rounds, 7 fourth

rounds, 3 fifth round, 1 sixth round + grants– Relationships with Australian and International VCs

• 40 investments to date; 2 exits; current portfolio of 18 companies e.g. QRX, BT Imaging

Other Commercialisation Funds

• Sydnovate – USyd– More focus on IP protection, consulting & licensing– Sydnovate fund: $50-100k, more proof of concept

• TransTasman Fund– MonashU, UAdelaide, UAukland, FlindersU– $30m open-ended fund, up to $2m

• ANU Connect Ventures– ANU and ACT opportunities– $30m open-ended fund, up to $2m

Why Raise Capital?!

The Financing Options

When Bootstrapping is Not Preferred

• Bootstrapping worked for HP, Microsoft, Apple, Dell and eBay – and Atlassian!

• Many business models benefit from raising additional capital while building revenue.

• Technology companies typically raise capital in exchange for equity in the business.

• One note: you should always be a bootstrapper – even if you raise capital– Raise as little as possible <x-ref Matt’s hockey stick>– Leverage non-dilutive funds e.g. EMDG, CommAus

Good Reasons to Raise Equity Finance

The bottom line: raising equity finance provides the working capital to enable acompany to sustain a higher burn-rate than if utilising organic/internal resources…

Speaking of Burn Rate…

• Webvan an online "credit and delivery" grocery business that went bankrupt in 2001

• Successful founders… e.g. Louis Borders

• Hot investors… e.g. Benchmark, Sequoia

• Raised a whack of cash...i.e. Over $500m

• Built a Titanic, when demand was much less

• Danny Rimer (now Index Ventures i.e. Skype): “Webvan was my billion dollar bonfire…”

• CNET hailed Webvan as one of the greatest dotcom disasters in history [Jun’08]

IPO IPO

Stages of Venture Investment

Seed Early StageSeries A, (B)

Later StageSeries B, C, D…

Expansion Stage/pre-IPO

Revenue Pre-revenue $500k - $1m $1m - $5m, negative EBIT

$2m+ EBITDApositive EBIT

Pre-Money Valn $200k-$1m $1m - $5m $5m - $20m 3-4x EBITDA

Investment Size $10k - $1m $1m - $3m $3m - $15m $5m+

Source of Funds FFFsGov’t GrantsIncubatorsAngelsUni Seed Funds(Venture Capital)

Super Angels(Angel Sidecar)Uni Seed FundsVenture Capital

Venture CapitalStrategic Investors

Late Stage VCEarly Stage Private EquityHedge Funds?

Expect Returns 3-5x ++ / 3-10yr 5-10x / 5yr+ 5-10x / 5yr- 3-5x / 2-5yrs

Talk to… ATP, Uniseed Uniseed, SXVP SXVP, IntelCap Champ/Quad

From the Founder’s Perspective...

• Our company was founded four years ago with seed capital of $50,000,

• We got a government grant of $75,000 nominally valuing the company at $125,000.

• Angels put in another $125,000 three years ago for one-third of the company valuing it at $375k.

• Our first VC put in half a million for 40% of the company valuing it at $1.25million two years ago.

• Last year another 2 VCs put in $1.5m for 40% of the company valuing it at almost $4 million.

• Next year the plan is to raise another $3.5m for 30% valuing the company at almost $12 million!

• We hope to trade-sale for $25-30m within 3 years!

But Nothing is Free: Equity Dilution...

OK Then: What’s my Slice of Pie?

• Help! I’m being diluted...

ESOP

OK Then: What’s my Slice of Pie?

• But my company valuation is going up...

OK Then: What’s my Slice of Pie?

• And so it my net worth!!

E$OP

Venture Capital: how VCs work

• Raise a fund: $40m+– High net worths (HNW), partners, pension funds (part of their

‘alternative’ asset allocation) & financial institutions– 10 year horizon: then return funds + profits– Objective: superior returns; 10x -> 50% IRR

• Invest money: years 3-5– Employ ‘large licks’ into companies that ‘fit’ the fund– Early stage first, then later stage + ‘follow-ons’

• Drive exits: years 5-10– Finish investing year 5, then ‘work out’ portfolio– Out of 10: 2 fail; 2 lose $$; 3 break even; 2 make (lots) of $$

• Keeping the lights on: VCs need to eat too…– Management fee of 1 - 2.5%pa of funds deployed– Carry (profit share) of 20-25% of returns above investment

IRR: Bang for my Buck

• IRR = Internal Rate of Return

• Technically: IRR is the discount rate where NPV of cashflows equals zero.

• Practically: a measure of ongoing value creation considering the ‘time value of money’.

• Allows ready comparison of investment options.

Angel Funding: how HNWs work

• Angels invest their own money– Invest smaller amounts at earlier stage, lower valuations– Value add in experience, hands-on, business and finance intros– Potential liability in excessive control, non-commercial terms, etc…

• Two “exits” for an Angel– Firm might be sold quickly for $2-10m, make 2-5x– Firm goes on to raise VC and IPO, Angel becomes passive, rides early exposure

• Take Angels seriously– Be prepared, passionate and professional– Often need a product/prototype, market analysis, go to market strategy– And be nice…

• Typical terms: Term Sheets, Shareholders Agreements, Rigour required– Businesses seeking $100k-$1m equity capital– Angel investors expect >10% equity

• Finding Angel funding– Australian Association of Angel Investors (www.aaai.net.au)– Sydney Angels (www.sydneyangels.net.au) + Sidecar Fund

What to look for in an Investor

• Look for:– Synergies– Complimentary

skills/personalities– Track-record, network– Etc…

• Expect:– Further rounds of

funding– Existing investors have

capacity– More VCs coming in

• Remember: – 5+ years is a long time…– The VC will have

control…

One Year on... How is The Funded Going?

• Members: up 13%• Reviews: up 11%• Comments: up 12%

Not too well by the looks of it...

$

• Guy Kawasaki: “Investors are actually looking for a reason not to do a deal…”

• The Venture Funnel: – 2000 business plans in [over 300/yr]– 200 moderately credible [1 or 2 a month]– 100 potentially investible [1 a month]– 40 for due diligence [3-4 in parallel]– 10 get funded [2-3/yr]

• To be VC-ready,you need to think like a VC– Aim for 5-10x in 3-5 years– And have plan...

What Does an Investor Look For?

Investment Ready: Build the Plan

PEOPLEDeep expertise, clean track-recordExperience growing companies, ability to execute plansSynergy with venture capital management team

IPCompelling products & disruptive technologyIP ownership: who owns it, clean freedom to operateAbility to protect and defend the intellectual property

MARKETBarriers to entryGrowing, large, definable marketAwareness of the competitive landscape

GROWTHRapid growth and ability to scaleClear strategy to execute the route to marketCapitalisation plan (how much money required?)

MODELIdentifiable sales cycle & pipeline, revenue streamsSustainable margins & ability to leverage scaleClear path to break-even and maintain profitability

EXITClear path to exit Key exit options: IPO; trade sale; share buy-backCreation of significant returns to investors & founders

The Pitch: Tell me a Story...

• Telling a good story won’t sell rubbish, but it will prevent a gem going unnoticed

• Tagline (1 sentence) > Elevator pitch (1 min) > presentation (20 min)• The key points (apart from the other stuff):

– What is the problem– What is exciting about your... X?– How much do you need?– How far will you get with that cash?– How much will I, errr... we make?

• And to get the best deal, you want multiple investors interested– Stalking at conferences, coffee shops is OK...

• E.g Open Coffee Club, but VC sightings are rare in Aus– Ideally work via introductions

• E.g. Networks e.g. Innovation Bay ; other Entrepreneurs e.g. Matt– But don’t shop it around too much... and don’t just post it out.

• If a “No” – say thanks, learn and keep moving forward...

I Blew It... : VC Anti-Portfolios

TwitterWe offered a term sheet to Twitter in April 2007 (I believe it was their first). They turned it down... And a few months later, when they had term sheets for their Series A round, I declined -- mainly because the pre-money valuation was 4x larger than the terms we offered them a few months prior and 2x larger than any other investment we had made. Big mistake.

FaceBookMy brother-in-law called me up to tell me he had some friends at Harvard building this social network called The Facebook. It had already gotten some traction, so when I looked into it, I thought “this thing is amazing.” I sent a note to all of my colleagues with information about the business... But there wasn’t a lot of enthusiasm from our group, so I didn’t get in touch.

AtlassianBill Bartee was heard saying one night, “I tried for years to get Mike to accept our investment terms...” ;-)

Atlassian then goes on to close a $60 Million investment from Accel Partners (US)!

Getting to Yes: Investment Terms

The Investor will invest up to a total of AU$750,000 in exchange for Series A Preference Shares at a pre-money valuation of $550,000. Share price to equal Pre-money Valuation / # Shares on issue, following the extinguishing of any outstanding Equity Liabilities. Preference rights include 1x Liquidation Preference, Conversion Ratio of 3:1, Anti-Dilute with Full Ratchet and Drag Along of minority shareholders. Investor to have first right of refusal on future Equity raisings.Company must consent to Critical Business Matters being subject to Special Majority Approval including the Investor Director. The Company shall reserve an employee share option plan (ESOP) of up to 10% of the fully-diluted capital, allocated subject to SMA. Investment subject to full due diligence and all conditions precedent being met. Etc Etc Etc…

Basic Investment Terms

• Pre-money Valuation– Perceived value of your business/IP/beermat– Sets price per share equity issued at i.e. pps = Value/#shares

• Ordinary Share Investment– Simplest form, often used by Angels– All Shareholders have similar rights

• Convertible Note– Increasingly used by Angels and VCs– Avoids valuation issue at time of investment– Typically when another financing is anticipated– Note attracts interest (10-15%) and a discount (20-40%) on next

round (*if* the next round investor is sympathetic)– PLUS typical terms required by the investor e.g. liquidation pref

Valuation: Art vs Science

• Discounted Cash Flow (DCF)– Time value of money – future operating free cash flows discounted at

appropriate rate to net present value– Hmmm… you are pre-revenue, EBIT for the next 3 years is negative,

discount rate 40-50% (risk)• Relative Value/Industry Comparables

– Industry multiples e.g. P/E, revenue multiple or EBITx e.g. Internet Industry (239) Value/EBIT = 20.22x

– Recent acquisition data e.g. Microsoft acquired Greenfield Online in 2008 for US$486m on approx $30m EBIT (16x)

– Hmmm… M&A values dropping, can I believe your 5 year forecast, assumes flawless execution, what about competitors (including MSFT)

• “Venture Metrics”– You look like a seed round, so I think you are worth $XXX– Post money val for this round shouldn’t exceed likely val at next round– Hmmm… I need to see 15% of the company at exit to make 5x

More Investment Terms

• Preferred Share Investment– More typical structure used by VCs– Additional rights over Ordinary Shares including…

• Liquidation Preference– In the event of liquidity event (e.g. exit, wind-up) the Prefs receive any

payout ahead of Ords– After Liquidation Amount paid out (could be a multiple) then Prefs

convert to Ords• Board and Veto Rights

– Investors to have board representation (usually while holding >15%)– Investors to have veto right over critical business matters e.g. changing

business plan, taking on debt, issuing new shares• Employee Share Option Plan (ESOP)

– Pool of Shares/Option to be allocated to management/staff– Effectively dilutive, managed by Board/Investor

The Cap Table: Another Round…

More (Severe) Investment Terms

• Conversion Ratio– Prefs to convert to not one, but a number of Ords (e.g. 1:3)– Leverages up the Prefs and increases effective payout

• Anti-Dilute– Provides protection to Prefs in a ‘down-round’ i.e. lower pps– Effectively awards more shares to maintain equity

• Tag Along & Drag Along– If a shareholder sells their stake, then others to have the right

(tag along) or obligation (drag along) to join the transaction– Effectively allows the Investor to effect liquidity/exit events

• “Pay to Play”– Sometimes introduced by incoming investors on ‘tough’ rounds– Extinguishing old rights (e.g. convert to Ords) unless you

participate fully i.e. pay up. “Cash is king”…

A ‘Real Life’ Example

Valuation $600k $5m $9m $13m $22m1) Seed Round $1m

2) Series A $3m + ClimateReady $2.7m

3) Convertible Note $1.8m

4) Series B $4m + Industry Institute Grant $2.1m

5) Strategic Investor (B-2) $500k6) Series C $6m + Working Capital (debt) $3m

Total Funds Raised: $16.3m Equity + $4.8m Grants

Spinout

Spinout

$60-

$100m Yr5

EXIT?$60-

$100m Yr5

EXIT?

sdfl

David RoweInvestment ManagerUniseed Management Pty Ltdd.rowe@uniseed.com

THANKS!

Thoughts, questions?

Oh yeah: Sparrow (www.adaptiveelearning.com)