1Copyright ©2007 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.E145 Autumn 2007Session 9Venture FinanceAlex Gould, Chi-Hua Chien2© 2003 Mark P. Rice, Babson Up Until Now:Idea Versus OpportunityThis Month:Realities of Business Operations3Today’s AgendaPart II. Given the nature of the business and the objectives of the founders, what capital resources are needed to build the venture?Part III. The Nitty Gritty of VC FinancingPart I. What is the purpose of a business plan?4Part I. What is the purposeand real value of a business plan?5Recall Sahlman’s ModelFocus of Next Two Weeks6Outline of a Business Plan• Executive Summary (why is this so key in reality?)• Market Analysis• Vision and Concept (including Technology)• Competitive Positioning and Marketing• Business Model• Organization• Financial Projections• OwnershipFocus of Next Two Weeks7Part II. How Tech E’s Finance Their Ventures … The ABCsA. Amount of Cash Needed and PurposeB. Sources of CapitalC. Deal Structure8TraditionalVentureCapitalAngel InvestorsCorporate VCBoot-strappingOtherSpecific Sources: Pros and Cons9Sources of Capital10Sources of CapitalDiagram 1: ŅEcologyÓ of VC Market Intermediate Investors(Repeat process)Other privatemarketallocations:- Hedge funds- LBO Funds- Real Estate- Pure PrivateEquityRepeatProcessAngels, Corps, BanksInstitutional Investors/ High Net worthIndividualsGatekeepers, Consultants, & ŅAllocationEngineersÓNew Enterprises, EntrepreneursDirectInvestments(Repeat process)VC FundsPublicly traded, Liquid debt &Equity Markets12The “Macro” Perspective:The Role of the Capital Markets13The “Macro” Perspective:The Role of the Capital Markets14The “Macro” Perspective:The Role of the Capital Markets15The “Macro” Perspective:The Role of the Capital Markets16The “Macro” Perspective:The Role of the Capital Markets17US Venture Capital• GDP: about $12.5 trillion annually• Hedge funds: $1 trillion over 3 years• Mutual funds: $136 billion in 2005• Buyout funds: $86 billion in 2005• Venture capital? $25 billion in 2005… just 0.2% of GDP.Source: BLS website, Investment Company Institute, Thomson Financial, NVCA18But VC-Backed Companies = 17% of GDPMarch 21, 2007, Washington, D.C. – U.S. companies that received venture capital from 1970-2005 accounted for 10 million jobs and $2.1 trillion in revenues in 2005… This represents 9 percent of the total private sector work force and 17 percent of total U.S. GDP.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.QuickTime™ and aTIFF (Uncompressed) decompressorare needed to see this picture.19At 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 PeakedSource: 2006 NVCA Yearbook, prepared by Thomson Financial, page 1820After a 2000 US Peak of over $100B, Now on a $20+B Annual Pace $0$20,000$40,000$60,000$80,000$100,000$120,000$ Million Invested198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420051H06Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report21Venture Exit Counts in US: IPOs and M&A by Year0100200300400500600700737475767778798081828384858687888990919293949596979899'00'01'02'03'04'051HYearNumber of IssuesM&AIPOSource: Thomson Financial/National Venture Capital AssociationInvestment FundsTheFundGeneralPartnerLimitedPartnersPortfolioCompany #1Individual Partners& Investment StaffInstitutions,Wealthy Individuals& FamiliesPortfolioCompany #2PortfolioCompany #3. . . .©jgqDiagram 2: VC Relationships Inv estorsDistributions less mgmt fees and carryCapit alCommit mentsVC Fund (LP)VC Firm Mgmt CoManages multiple fundsStaff employeesAnyone who derives income(includes investmentprofessionals )LLC, S. CorpGeneral Partners (LLC)“investment professionals ”MgmtServices~ 2% MgmtfeeCarry(override)~1% capitalcontributionPortfolio Fir ms (C Corps)~ 80% ofcommittedcap (the restis mgmt feeover 10 yrs)RestrictedStock(usuallypreferred)Side fundsC CorpContract forservic esKey Fund Terms• Terms can be both cyclical and a function of the track record and experience of the GPs• mgmt fee and carry (typically 2%, 80%/20%) • size of investment; minimum and maximum size of fund; life of fund (usually 10 years)• monetary contribution of GP (~1%)• “takedown” schedule of capital• pay down/distribution scheme: hurdle1) Strategy & deal flow2) Track record: quality, length, replicability3) Reputation4) The Team: Strength and depth? Has the team changed?5) Expertise with all facets of investment process6) Targeted areas of focus7) Competitive advantage with respect to deal flow 8) Fund Economics: fund size, # of partners, # of investments, size of investments, # of boards each GP is sitting on9) Terms: economics (carried interest, hurdles, management fees); key man provisions; clawbacks; etc. Are incentives aligned?Fund Selection Criteria1) Meet all members of investment team (note: if you are reviewing Fund-of-Funds manager, there are some other considerations like total fund size)2) Interview CEOs of portfolio companies3) Visit selected portfolio companies4) Reference checks5) Review investment record• ascertain values• check calculations• determine “parentage” of deals• examine results vis-à-vis macro factors (e.g., IPO market)Fund SelectionDue Diligence Process1) Valuation2) Disclosure3) Clawback4) Overhang and Related Issues5) Succession6) Private Equity/VC as an Asset ClassRecent Policy IssuesO&F Private Equity Fund L.P.“Statistics Don’t Lie, But Liars Use Statistics”Amount Holding AmountDeal Invested Period Returned IRRA $1.00 2 $2.00 41%B 2.00 4 6.00 32%C 50.00 3 50.00 0%D 2.00 1 3.30 65%Average 35%Blended 4%Investment Record AnalysisPortfolio #1Amount Holding AmountDeal Invested Period Returned IRRA $10.00 2 $22.00 48%B 20.00 4 55.00 29%C 50.00 3 130.00 38%D 20.00 1 25.00 25%Average 35%Blended