1Copyright ©2007 by the Board of Trustees of the Leland Stanford Junior Universityand Stanford Technology Ventures Program (STVP). This document may bereproduced for educational purposes only.E145 2007E145 2007Session 9Session 9Venture FinanceVenture FinanceTom Byers2© 2003 Mark P. Rice, BabsonLast Month:Idea VersusOpportunityThis Month:Realities ofBusinessOperations3TodayToday’’s Agendas AgendaPart II. Given the nature ofthe business and theobjectives of the founders,what capital resources areneeded to build the venture?Part III. “Meet the VCs”Part I. What is the purposeof a business plan?4Part I.Part I.What is the purposeWhat is the purposeand real valueand real valueof a business plan?of a business plan?5Recall SahlmanRecall Sahlman’’s Models ModelFocus ofNext TwoWeeks6Outline 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• OwnershipFocus ofNext TwoWeeks7Part II. How Tech EPart II. How Tech E’’s Finances FinanceTheir Ventures Their Ventures …… The ABCs The ABCsA. Amount of Cash Needed and PurposeB. Sourcesof CapitalC. DealStructure8A. Amount of Cash A. Amount of Cash ……Two Key QuestionsTwo Key Questions#1 How much money is needed forthis “round” of financing?Typical Financing Stages (or Rounds):Seed  Early  Mezzanine  Late (e.g., IPO)9#2 Which “white hot” risks areto be reduced with this money?Team RiskTechnologyRiskCapital RiskMarket Risk10B.B. High Risk/Return Capital High Risk/Return Capital11TraditionalVentureCapitalAngelInvestorsCorporateVCBoot-strappingOtherSpecific Sources:Specific Sources: Pros and ConsPros and Cons12US Venture CapitalUS Venture CapitalInvestment in PerspectiveInvestment in Perspective• US GDP is about $12.5 trillion annually• Hedge fund intake: $1 trillion over 3 years• Mutual fund intake: $136 billion in 2005• Buyout intake: $86 billion in 2005• Venture capital intake: $25 billion in 2005Venture capital fundraising &investment is just 0.2% of total GDP,but has fueled high-impact enterprisesSource: BLS website, Investment Company Institute, Thomson Financial, NVCA13At Year End # Venture Firms Capital Under Mgt 1970 28 $1B 1980 89 $4B 1990 398 $31B 2000 887 $223B 2001 949 $252B 2005 866 $259B Number of US VC Firms Has PeakedNumber of US VC Firms Has PeakedSource: 2006 NVCA Yearbook, prepared by Thomson Financial, page 1814After a 2000 US Peak of over $100B,After a 2000 US Peak of over $100B,Now on a $20+B Annual PaceNow on a $20+B Annual PaceSource: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report15Venture Exit Counts in US:Venture Exit Counts in US:IPOs and M&A by YearIPOs and M&A by YearSource: Thomson Financial/National Venture Capital AssociationUS and European Venture Capital:US and European Venture Capital: Historically Different Approaches? Historically Different Approaches?believe returns can beearned across theportfoliotarget a small number ofbig winners – home runinvestingReturnsminimise downsidemaximise upsidePhilosophycreate mediumsized companiescreate very largecompaniesObjectivehands offhands onStyle“just money”“value added”Provideearly (A Round),but not seedseedStageconsultants and bankerscompany founders andbuildersPeopleEuropean ModelUS ModelReference: Mowbray Capital, London17C. Key QuestionsC. Key QuestionsRegarding the Regarding the ““DealDeal””1. What percentage of the company dothe investors receive for their cash?2. What special terms and conditions arenecessary to compensate them for therisk?18Kaplan’s Startup Game“A race against time tocreate value andreduce risk”(1) Founding:An entrepreneur begins with a vision and shares of stock in the new venture.Entrepreneur trades stock forideas, money, and people(2) Seed Stage:•Venture capitalists providemoney in return for stock•Employees join via friends &associates in return for cashsalary and stock options•Ideas become intellectualproperty which represents theinitial value in the companyFurther growth is delayeduntil milestones arereached and risk offailure is reduced(3) Growth Stage:More money, ideas, and people areobtained, but for much less stock thanin the earlier stage due to lower riskCompany balances earningcash, taking investment, andspending cash to create value(4) Exit Stage (Success):•Company files for IPO orgets acquired (M&A)•A viable enterprise has beencreated (maybe public)•Entrepreneur, investors, andemployees can cash in stockfor money (eventually)•Each party continues to buildthe company, starts the gameagain, or something elseValue has beensuccessfully createdReference: Jerry Kaplan19A Simple Venture Finance ExampleA Simple Venture Finance Example• Roma’s hot startup requires $10 million in order to form its business. Sheexpects to earn $5 million in its fifth year.• Randy’s VC firm has reviewed the company's business plan and believesthat he is entitled to a 50% return on his investment. Hint: how many“times” must his firm’s money grow in 5 years?)• Publicly traded companies in this category and industry trade at anaverage of 30 times earnings (PE ratio). There is no material differencebetween these companies and Roma’s 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 = $76m2. StartUp’s Value in Year 5 = $5 m*(P/E of 30) = $150m3. VC Firm’s Share Today = Step 1/Step 2 = $76 m/$150m = ~ 50%4. “Post-Money” Value Today = $10 m / 50% = $ 20 m20 A Multi-Stage Venture Finance Example A Multi-Stage Venture Finance ExampleTimeI II III IV V33 1/3 %33 1/3 %33 1/3 %1mm sharesfor eachfounderΣ=3mmshares @$0.001 ea.Value=$3kNote: not to scale20 %20 %20 %20 %20 %+1mm shareseach for CEO& employeesΣ= 5mmshares @ $0.01eachValue=$50k10 %10 %10 %10 %10 %50 %+5mm sharesfor first VCfirmΣ=10mmshares @ $1.00eachValue=$10mmUse of $: R&DPost-money value = $10mmPre-money value = ?2133 1/3 %33 1/3 %33 1/3 %20 %20 %20 %20 %20 %10 %10 %10 %10 %10 %50 %TimeI II III IVV1mm sharesfor eachfounderΣ=3mmshares @$0.001 ea.Value=$3k1mm shareseach for CEO& employeesΣ= 5mmshares @ $0.01eachValue=$50k5mm sharesfor first VCfirmΣ=10mmshares @ $1.00eachValue=$10mmUse of $: R&D5 %5 %5 %5 %5 %25 %25 % 25