Some Basics of Venture Capital Michael Kearns Chief Technology Officer Syntek Capital Outline The basics how VC works Case study DDoS defense companies What is Venture Capital Private or institutional investment capital in relatively early stage companies ventures Recently focused on technology heavy companies Computer and network technology Telecommunications technology Biotechnology Types of VCs Angel investors Financial VCs Strategic VCs Angel Investors Typically a wealthy individual Often with a tech industry background in position to judge high risk investments Usually a small investment 1M in a very earlystage company demo 2 3 employees Motivation Dramatic return on investment via exit or liquidity event Initial Public Offering IPO of company Subsequent financing rounds Interest in technology and industry Financial VCs Most common type of VC An investment firm capital raised from institutions and individuals Often organized as formal VC funds with limits on size lifetime and exits Sometimes organized as a holding company Fund compensation carried interest Holding company compensation IPO Fund sizes 25M to 10 s of billions Motivation Purely financial maximize return on investment IPOs Mergers and Acquisitions M A Strategic VCs Typically a small division of a large technology company Examples Intel Cisco Siemens AT T Corporate funding for strategic investment Help companies whose success may spur revenue growth of VC corporation Not exclusively or primarily concerned with return on investment May provide investees with valuable connections and partnerships Typically take a back seat role in funding The Funding Process Single Round Company and interested VCs find each other Company makes it pitch to multiple VCs Business plan executive summary financial projections with assumptions competitive analysis Interested VCs engage in due diligence Technological market competitive business development Legal and accounting A lead investor is identified rest are follow on The following are negotiated Company valuation Size of round Lead investor share of round Terms of investment Process repeats several times builds on previous rounds Due Diligence Tools and Hurdles Tools Tech or industry background in house rare among financials Industry and analyst reports e g Gartner Reference calls e g beta s and clients Visits to company DD from previous rounds Gut instinct Hurdles Lack of company history Lack of market history Lack of market Company hyperbole Inflated projections Changing economy Terms of Investment Initially laid out in a term sheet not binding Typically comes after a fair amount of DD Valuation investment VC equity share Other important elements Board seats and reserved matters Drag along and tag along rights Liquidation and dividend preferences Non competition Full and weighted ratchet Moral These days VCs extract a huge amount of control over their portfolio companies Basics of Valuation Pre money valuation 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 Partners in a venture vs outright purchase 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 Board Seats and Reserved Matters Corporate boards Not involved in day to day operations Hold extreme control in major corporate events sale mergers acquisitions IPOs bankruptcy Lead VC in each round takes seat s Reserved matters veto or approval Any sale acquisition merger liquidation Budget approval Executive removal appointment Strategic or business plan changes During difficult times companies are often controlled by their VCs Other Typical VC Rights Right of first refusal on sale of shares Tag along rights follow founder sale on pro rata basis Drag along rights force sale of company Liquidation preference multiple of investment No compete conditions on founders Anti dilution protection Recompute VC shares based on subsequent down round Weighted ratchet use average weighted share price so far Full ratchet use down round share price Example Founders 10 shares VC 10 shares at 1 per share Founder issues 1 additional share at 0 10 per share Weighted ratchet avg price 10 10 11 VC now owns 10 89 shares 21 89 total Full ratchet VC now owns 10 0 10 100 shares out of 111 Matters in bridge rounds and other dire circumstances Right to participate in subsequent rounds usually follow on Later VC rights often supercede earlier Why Multiple Rounds and VCs Multiple rounds Many points of valuation Company money gets cheaper if successful VCs allows specialization in stage risk Single round wasteful of capital Multiple VCs Company Amortization of control VCs Share risk Share DD Both different VC strengths financial vs strategic So What Do VCs Look For Committed experienced management Defensible technology Growth market not consultancy Significant revenues Realistic sales and marketing plan VARs and OEMs vs direct sales force Case Study DDoS Defense Technology DDoS Distributed Denial of Service Web server router DNS server etc flooded with automated spurious requests for service at a high rate Outcomes Resource crashes Legitimate requests denied service Bandwidth usage and expense increase Attack types SYN flood ICMP echo reply attack Zombie attacks IP spoofing Continually evolving Attack characteristics Distributed Statistical Highly adaptive Not defendable via cryptography firewalls intrusion detection An arms race Market Landscape Victims include CNN eBay Microsoft Amazon 4000 attacks per week UCSD study Recent Code Red attack on White House foiled but 300K client zombies infected Costs Downtime lost productivity Recovery costs personnel Lost revenue Brand damage Attack costs 1 2B in Feb 00 2005 market estimate 800M Yankee Group Who Can and Will Pay Internet composed of many independently owned and operated autonomous networks Many subnets embedded in larger networks Detecting defending DDoS requires a minimum network footprint Must solve problem upstream at routers with sufficient bandwidth to withstand attack traffic May simply trace attack source to network edge Target customers Large and medium ISPs MSPs NSPs Large and medium data centers Backbone network providers Future wireless operators