Seed Funding and Venture Capital Course Certificate Program

Greg Horowitt, Managing Director, T2 Venture Capital Kauffman Fellow, Class XV

Overview •  Introduction to Venture Capital

•  Instruction provided by: –  Bradley Bertoch, President, Wayne Brown Institute –  Greg Horowitt, Managing Partner, T2 Venture Capital; Co-Founder,

Global CONNECT, Kauffman Fellow, Class XV •  Instruction focus:

–  Introduction of key terms –  The role venture capital plays in the funding of early stage companies –  The venture capitalist as a human capitalist –  The right funding for you –  Preparation and execution

VENTURE 101 Seed Funding and Venture Capital Course Certificate Program

Venture 101   Introduction to Private Equity and Venture Capital

–  The ‘Capital Food Chain’ –  Overview of Venture Capital

•  History •  Definitions •  Evolution of the industry •  Fund stages

–  VCs as individuals •  Background (…where do these people come from?) •  Qualities (…are they human?) •  Style (…are they all so arrogant?) •  Leadership (…how can I learn from them?)

–  What motivates them? –  Where do they find their deals? –  How do they assess an opportunity?

Venture 101  The Entrepreneur

–  How do you assess the right type of capital for your company? •  Horses for courses

–  How much do you really need? –  All venture firms are NOT the same

•  How do you know if it’s the right fit? •  What diligence should you do on the investor / firm? •  Besides capital, what else do they bring?

–  The ‘rich or king’ dilemma •  What do YOU want??!!! •  Why you….and why now? •  What is your business really worth (valuation)? •  Having a company ≠ having a business

–  What will the VCs expect from you? (…besides your first born child) –  Communication (how to read the abstract signals some VCs send) –  How do you get them to notice you? –  When will they make you rich beyond your wildest dreams?

Risk and Rewards

The Capital Food Chain •  Friends,family,fools • Grants, SBIRs, etc. • Angels •  VCs •  Strategic Partners •  Venture Debt •  Liquidity (M&A,

IPO)

•  ‘Inside’ money • Not equity •  Seed Equity •  Early Mid, Late •  Early, Mid, Late • Mid, Late Stage • Usually later stage

The Birth of Venture Capital

1910 1960 1970 1980 2000 1990

Innovation Networks

Microwaves/ Defense

Personal Computers

Integrated Circuits

Internet

1930 1940 1950 1920

Test Equipment

Vacuum Tubes

Venture Capital

Steve Blank, Stanford University 2009

The Growth of Venture Capital  East Coast Family Offices

  Whitney, Rockefeller, Bessemer (1946-1969)

 West Coast IPOs   Varian, Hewlett Packard, Ampex (mid to late ‘50’s)

 SBIC Act of 1958 (SBA)   3:1 government match   700 SBIC funds by 1965

  Limited Partnerships   External investors as LPs (pension funds, endowments, HNW)   The General Partners (GP) manage the money in exchange for:

 2% management fee  20% of the carried interest (profits)

 Capital Gains Reduction (‘78)   49.5% 28%

 ERISA (Employee Retirement Income Security Act (‘79)   Pension Funds can invest

Venture Capital is Born

 Draper, Gaither & Anderson (‘58)  Rock and Davis (‘61)  Sutter Hill (‘64)  Patricof & Co. (‘69)  Kleiner Perkins (‘72)  Sequoia (‘72)

Types of Investment Capital  Angels

–  Usually a wealthy individual who wants to stay ‘active and involved’ –  Often has some knowledge or connection to the technology or life

sciences world –  Usually makes smaller investments ($25-50K per investment as part

of an angel group, or perhaps more as a single investor) –  Wants to stay involved and feels their contribution to the start up

goes beyond the ‘cash’ invested.

  Institutional VC –  Professionally managed (GP) –  Usually have a ‘theme’ or focus (sector, stage, industry, etc) –  Money raised from pension funds, endowments, high net worth

individuals, fund of funds, sovereign wealth funds, etc. –  Most often set up as a Limited Partnership –  2/20 (management fee + carried interest)

 Grants –  Non-dilutive investment –  Government programs –  Foundations

Types of Investment Capital  Strategic Ventures

–  Usually corporate (think Intel, Qualcomm, Novartis, Google) –  Often a focus on companies that are complimentary and synergistic

to their internal efforts –  Balanced ROI with strategic goals –  Most often not the ‘lead’, and will invest with institutional VCs

 Private Equity –  Invest in the tangible assets of a company –  Buy low, sell high –  Usually an investment bank that is compensated as a percentage of

the deal –  Usually syndicated capital –  Motivated by ROI

 Banks –  Issue debt (loans) secured by assets (receivables, property,

equipment, etc.) or other assets (including intellectual property)

Entrepreneurs:

Go Where the Investors Are

Investment (one round)

Num

ber

of In

vest

ors

$5 million $10 million

Angels

VCs

Valley of Death

New Company Formation

Source of Funds

0 200,000 400,000 600,000 800,000

40-50,000 Angel Investments

500-700,000 New Companies

<100 IPOs (VC funded)

< 500 VC Seed/Start-up Investments Typical Year

Outside Equity Capital for Entrepreneurs

•  <1 in 10 Start-ups obtain angel financing •  <1 in 1000 Start-ups are VC financed •  <1 in 10,000 new companies go public •  <1 in 10 angel deals see VC money

Stage •  Seed •  Start-up •  Early •  Mid •  Later

ROI 5 year increase

•  60% 10x+ •  50% 8x •  40% 5x •  30% 4x •  25% 3x

Investment Exit Year

Revenues (5th year) Net Profit (5th year)

P/E (industry) Company Value

Required ROI Required Capital Growth

% Equity Required at Exit Pre-money Valuation

$2 million 5th Year $40 million 10% = $4 million 12X $48 million 50% = 8X $16 million 33% $4 million

* In reality, we would need more than 33%, since dilution will probably occur

Venture Mechanics: Valuation •  Pre-money V: agreed value of company prior to

this round’s investment (I) •  Post-money valuation V = V + I •  VC equity in company: I/V = I/(V+I), not I/V •  Example: $5M invested on $10M pre-money

gives VC 1/3 of the shares, not ½ •  This should be viewed as a partnership, not an

acquisition •  I and V are items of negotiation •  Generally company wants large V, VC small V,

but there are many subtleties… •  This round’s V will have an impact on future

rounds •  Possible elements of valuation:

–  Multiple of revenue or earnings –  Projected percentage of market share

The Venture Lifecycle

• Deal Sourcing • Deal Structuring • Value Creation • Preparation for exit • Liquidity event

Venture Mechanics  Deal Sourcing:

  Where do VCs find deals?

•  Other VCs •  Service providers (lawyers, accountants, etc) •  Angel investor groups •  Individual angels •  ….from a trusted colleague / friend in their network

  Analysis (research) –  Scouting universities and other Research Labs –  Looking at opportunities in a related space to existing portfolio

companies

  Rarely, but on occasion: –  Funding programs such as SBIR, STTR –  Trade Organizations –  Business Plan Competitions –  Corporate events –  Networking events

Venture Mechanics  Deal development:

 What do they look for? •  Great management that is emotionally competent •  Market opportunity that is trending in the right

direction •  Sustainable competitive advantage •  Managed and mitigated risk •  Convinced that people will buy the product…and

hopefully buy it again and again and…. •  Solid team with high integrity •  Strong IP position and / or significant trade secret •  Entrepreneurial passion, relentlessness

imagination, flexibility, coachability, and ‘pushing hard at the edges’

•  VCs want to be assured that they will get their money out before they die

Venture Mechanics  Deal Evaluation

•  What must we confirm? •  How do we calibrate the opportunity against the market? •  What don’t we know, and what is the risk of not finding out? •  How do we find this information and what is the cost? •  Are there any deal killers?

Technology  Product Business Model & Strategy 

Market 

Management  Talent  Intellectual Property  Culture 

Capital risk Policy and 

Regulatory 

Partnering and Supply 

Chain Exit 

You, the Entrepreneur  Deal Structuring

–  Alignment of goals and expectations •  What motivates you, the entrepreneur?

–  Fame? –  Wealth? –  Peer positioning? –  Social good?

–  Do you play nicely with others? –  What do you want for yourself, and where do you see

yourself 5 years from now? •  How do you assess if you should take outside, dilutive

capital?

•  How do you do due diligence on a potential investor? –  Look at their portfolio companies, and identify synergies –  Talk to their entrepreneurs –  Ask around. Find out about the individual as well as the firm.

•  What diligence will they do on you? (Answer: Everything)

Value Creation  What the VC will bring to the table

 The pre-investment relationship •  Helping entrepreneurs validate, calibrate, and refine

value proposition •  Assistance in building global advisory boards •  Introductions to other investors •  Mentorship and education

•  Helping them understand what’s ahead

 The post-investment relationship –  Being an effective board member –  Mentorship, coaching and insights –  Using networks to accelerate value creation

•  Access to high quality talent •  Access to domain and market experts •  Access to customers and partners •  Access to licensees / licensors •  Engineering a liquidity event

Value Creation  What will you bring to the table?

 Execution and adaptation off business model to market demands and customer needs

 Being able to attract, motivate, and empower team members

 Being capable of synthesizing new ideas, and demonstrating relevance

 Being able to mobilize and allocate resources efficiency and effectively

 Giving customers what they need, AND what they want

 Leadership and talent development  Staying ‘authentic’  How to use 360° feedback (from customers,

team, market trends, valued advisors)

The Exit!  Exits

–  Preparing for the exit –  Timing

•  Factors which influence the timing – Market conditions – Investor desires – Entrepreneur desires – Capital constraints – Offers for mergers or acquisition – Availability of necessary future resources – Competition

–  Mechanics –  Communication –  Execution

THANK YOU

Greg Horowitt Managing Director