changing relationship between venture capital and angels - impact on funding of startups

Changing Relationship Between Venture Capital And Angels

Impact On Funding Of Startups

Prepared byCharles V. Fishel

Hoffman Row Groupfor

IP SocietyFebruary 4, 2004

Venture Capital Trends

Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

Venture Capital Historical Trend Data

$0 $5,000,000,000

$10,000,000,000

$15,000,000,000

$20,000,000,000

$25,000,000,000

$30,000,000,000

$35,000,000,000

1995-1

1996-2

1997-3

1998-4

2000-1

2001-2

2002-3

Investment Amount # of Deals

(National)

Venture Capital Trend Data Silicon Valley

$0

$2,000,000,000

$4,000,000,000

$6,000,000,000

$8,000,000,000

$10,000,000,000

$12,000,000,000

1995

-1

1995

-2

1995-

3

1995

-4

1996

-1

1996-

2

1996

-3

1996

-4

1997-

1

1997

-2

1997-

3

1997

-4

1998

-1

1998-

2

1998

-3

1998

-4

1999-

1

1999

-2

1999

-3

1999-

4

2000

-1

2000

-2

2000-

3

2000

-4

2001

-1

2001-

2

2001

-3

2001-

4

2002

-1

2002

-2

2002-

3

2002

-4

2003

-1

2003-

2

2003

-3

Investment Amount # of Deals

Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

Bygrave, Portable MBA in Entrepreneurship (Wiley, 2d) p. 1

Levels of Funding - Firm Maturity

Self-fu

nding

Credit C

ards

Family

Friend

s

Supplie

rs

Commerc

ial Ban

ks

Asset-b

ased

Lenders

Instituti

ons

Insuran

ce Com

panies

Ventur

e Capit

alists

Private

Equity

Public

Equity

Public

Debt

Commerc

ial Pap

er

Levels of Funding - Firm Maturity

Self-fu

nding

Credit C

ards

Family

Friend

s

Supplie

rs

Commerc

ial Ban

ks

Asset-b

ased

Lenders

Instituti

ons

Insuran

ce Com

panies

Ventur

e Capit

alists

Private

Equity

Public

Equity

Public

Debt

Commerc

ial Pap

er

IPO

ANGELS

FFF VENTURE CAPITAL

Pre-Bust

Levels of Funding - Firm Maturity

Self-fu

nding

Credit C

ards

Family

Friend

s

Supplie

rs

Commerc

ial Ban

ks

Asset-b

ased

Lenders

Instituti

ons

Insuran

ce Com

panies

Ventur

e Capit

alists

Private

Equity

Public

Equity

Public

Debt

Commerc

ial Pap

er

IPO

ANGELS

FFF VENTURE

CAPITAL

Now

VC Investments by Stage (2003Q3)

0

10

20

30

40

50

60

Startup/Seed Early Stage Later Stage Expansion

Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

“Pre-Bust”(1998)

lEntrepreneur self-funds through concept/patent application

lVCs step in to fund to IPO/acquisitionlAverage Deal Size: $4 – 6 Million

“Internet Boom”(1999-2000)

lEntrepreneur gets an idea!

lVCs step in to fund to IPO/acquisitionlAverage Deal Size: $10 Million

(+++)

“Post Bust”(2003)

lEntrepreneur gets an idealSelf-funds through revenue

generation

lVCs step in to fund to IPO/acquisitionlAverage Deal Size: $2 – 4 million lFewer deals done.

Valuation Changes1999:lSequoia Capital paid $5 million for

8% of eToys.

2003:lVCs agree to valuation of $4 million

and invest $4 millionl50%

SJ Mercury News, 5/18/2003, p.F1

l Venture market may be close to end of "post bubble" adjustment:

lhealthier technology stock market,

lhigher percentage of "new" Series A deals, and

l lower number of restructuring transactions.

The Buzz of the Week, PE and VC Issues and Commentary, December 16th, 2003

lNationwide, venture capital investments rose 6 percent to $4.49 billion from $4.24 billion in the third quarter, the highest level in a year

lSilicon Valley now provides more than 37 percent share of the nation's total venture capital -- up from the 34 percent average seen over the past six years.

Posted on Mon, Jan. 26, 2004 , Venture funding soars by 22% By Matt Marshall, Mercury News

lNationally, only 19% all the venture capital handed out in 2003 went to first-time fundings .

A Tough Chase for Venture Capital By Ellen McCarthy, Washington Post Staff Writer, Monday, February 2, 2004; Page E01

lUS venture capital investments jumped 15 percent in late 2003

lRisk-averse investors mostly shunned young startup companies, pushing late stage financing to a 20-year high.

http://www.msnbc.msn.com/id/4077505/ as of 040202

Changing Relationship Between Venture Capital And Angels

Shift Away from VC Funding

0%

20%

40%

60%

80%

100%

1998 1999 2000 2001 2002 2003 ytd

Non VC-backed IPOVC-Backed IPO

S.J. Mercury News, 5/18/2003, p. 1F

Shift Away from VC Funding

512003 ytd

81262002

86182001

1662182000

2782311999

305621998

Non-VC-backed IPO

VC-backed IPO

S.J. Mercury News, 5/18/2003, p. 1F

Angels vs. VCs

l Considerable overlap and interplay among langel investors, lprivate equity, and lventure capital.

The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

Angels vs. VCs

l Boundaries between angel investors and venture-capital investors are particularly fluid, lhaving mainly to do with degree of

organization and size of their investments.

The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

Funding “Sweet Spots”

12$15mFinancial Services16$22mRetailing/Distribution16$51mHealthcare Services12$99mElectronics/Instrumentation16$120mConsumer Products and Services32$146mIndustrial/Energy30$164mMedia and Entertainment31$167mComputers and Peripherals 24$168mSemiconductors37$173mIT Services28$209mBusiness Products and Services 48$324mNetworking and Equipment55$324mMedical Devices and Equipment73$492mTelecommunications

165$856mSoftware90$929mLife Sciences / Biotechnology

DealsAmountIndustry Sector

AMOUNTS RAISED BY SECTOR(National - 2003Q3)

Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

Amounts Raised by Sector(National - 2003Q3)

$0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000

B io t echno lo g y

T eleco mmunicat io ns

N et wo rking and Eq uip ment

IT Services

C o mp ut ers and Peripherals

Ind ust rial / Energ y

Elect ro nics/ Inst rument at ion

R et ail ing/ D ist rib ut io n

Ot her

Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

Software

Favored Sectors

l Life sciences dominated investments for second consecutive quarter, ldisplacing software as top sector

l Lagging far behind:ltelecommunications and lnetwork sectors.

http://www.msnbc.msn.com/id/4077505/ as of 040202

Less-Favored Sectors

lComputer and communications sectors continue to fight for funding following massive over-investments during dotcom boom yearsl Telecommunications, which suffers

from lingering overcapacity, had hardest time raising new money.

http://www.msnbc.msn.com/id/4077505/ as of 040202

Software

lMost viable new software companies will be those that sell software as a service.

“VCs make Silicon Valley predictions” Robert Mullins http://www.bizjournals.com/sanjose/stories/2004/01/12/daily50.html?f=et79Silicon Valley /San Jose Business Journal, January 16, 2004

Nanotechnology

lMay be “next wave”.

[Offshore] Outsourcing

l Venture capital firms are encouraging outsourcinglOne major American venture capital

firm, for example, is understood to insist, as a condition of investment, that “any company it invests in outsource its computer programming tasks to the greatest extent possible.”

VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green, `http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

Outsourcing

l Outsourcing will increasingly be viewed by venture capitalists l not just a way to save money, l but to make money

l Outsourcing is a way for small companies to speed development and focus on their core competencies by leveraging cash.

VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green, `http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

Outsourcing

l Company's ability to attract venture capital won't be limited to its location, but increasingly to its ability to make the best use of its assets –l both physical and intellectual

l Thus, outsourcing may help smaller companies attract venture capital.

VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green, `http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

Strategic Alliances

lEasier fundinglParticularly working with investment

bankers and consultants.

Desperation = Tough Terms

l The more urgent an entrepreneur's need for money, l the more onerous are the terms

l Desperate companies may sell equity to someone and promise that investor will never be diluted

l Severe terms can stop company's growth cold."

The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

Restrictive Terms

l During downturn, many venture capitalists, secured their investments with so-called ``liquidation preferences''

l Clauses guaranteed that, if start-up was sold, lVCs would get their money first –lbefore other executives or

employees.

Posted on Thu, Nov. 06, 2003, VCs hope higher spending will boost start-up salesBy Matt Marshall, Mercury News

Restrictive Terms

l This sets management and employees at odds with their VCslMay be counter-productive

l Start-up's employees won't profit, and will resist merger / acquisition

l Many deals fall apart on their own complexity.

Posted on Thu, Nov. 06, 2003, VCs hope higher spending will boost start-up salesBy Matt Marshall, Mercury News

Tough Termsl Down rounds continue to dominate (79%)

l However, use of some tougher terms such as lmultiple liquidation preference, l ratchet anti-dilution and l pay-to-play are trending toward more

customary levels

l Suggesting increased VC optimism.

The Buzz of the Week, PE and VC Issues and Commentary, December 16th, 2003

Angels

Traditional Angels

l In the past, most angels flew solo,

lmeeting with prospective entrepreneurs individually,

ldoing their own due diligence, and

l investing at their own pace.

A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

Major Hassle for Entrepreneurs

lCash-strapped business owners were forced to haul dog-and-pony shows from one angel to next,

lmaking the same pitch over and over.

A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

Good News?

l New wave of angel groups is changing

l Angel groups, generally composed of 50 to 60 wealthy individuals focus on reducing risk and increasing odds of finding a top-quality deal

l They are far more likely to spot a flawed business plan.

A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

Good News?

lAngels and seed funds that once provided needed capital for first two years of growth have adopted same criteria as traditional venture funds, lleaving entrepreneurs to fend for

themselves until they can demonstrate traction.

Three Trends in Startup Financing 03.04.2003 - By Robert Dellenbach http://www.avce.com/main.php?load=displayMatch&newsid=128 on 040131

Active Investors

l 200,000 individuals

l Typical startupl5 – 6 angels.

Center for Venture Research at University of New Hampshire, Press Release 6/11/03

Sector Analysis

l 40% - Softwarel 14% - Life Sciences l(other than biotech)

l 5% each for other sectors.

Center for Venture Research at University of New Hampshire, Press Release 6/11/03

Stage

l 2002:lAngels typically fund seed/start-up

stagel47% of angel investments in seed/start-up ventures

l 33% of investments were early stage.

Center for Venture Research at University of New Hampshire, Press Release 6/11/03

“In the Zone”

l If you are raising an angel round from individual investors and you can get away with selling 10-15% of your company

l If you are raising a Series A round from professional institutional VC investors and you can get away with selling 20-40% of your company.

12 Secrets of Negotiating the Best Valuation for Your CompanyBy Jeff Parness

Regional Angel

Groups

Silicon Valley Band of Angels

l Founded in 1995. Invests across all high-technology categories. Majority of investments have been made in the seed or early round (Series A or B): $82.6 million into more than 132 startups

l Sweet Spot: Silicon Valley-based high-tech start-ups.l Average investment: $1 millionl Number of angels/investors in the network: 150

l Contact:Band of Angels 3130 Alpine Rd. Suite 200-7003 Portola Valley, CA 94028 415-441-2887 info@bandangels.com

CVBI Angel Investor Network(Central Valley Business Incubator)

l Accepts applications only from businesses in California's Central Valley region.

l Average investment range:$10,000 to $500,000

l Contact:CVBI Angel Investor Network 2555 Clovis Ave. Clovis, CA 93612 559-292-9033 kfurtado@csufresno.edu

Sierra Angelsl Preference businesses located in Nevada, California, or

other nearby locations ---companies with unique products / proprietary technology.

l Sweet Spot: Northern Sierra-based companies.l Average investment range: $500,000 to $2,000,000l Contact:l Sierra Angels

PO Box 3215 Incline Village, NV 89450-3215 775-831-7804 Send E-mail to the most appropriate address: l Software@sierraangels.com

Computing_Communications@sierraangels.comHealthSciences@sierraangels.comInternet@sierraangels.comOtherTech@sierraangels.com

The Angels' Foruml Invests in companies based in Silicon Valley / SF Bay Area. l Portfolio companies include consumer products, enterprise

software, industrial products, Internet and E-commerce, medical devices and services, networking technologies, pharmaceutical, semiconductors, telecommunications, and wireless. Most start-up companies come to group prescreened through professional contacts in the banking, investment, and legal fields.

l Sweet Spot: Companies specializing in disruptive technologies.

l Average investment range: $100,000 to $750,000l Number of angels/investors in the network: 25

l Contact: The Angels' Forum PO Box 1605 Los Altos, CA 94023-1605 650-857-0700 inquiries@AngelsForum.com

Fast Angels

l Invests primarily in companies in Silicon Valley. Seeks out technology entrepreneurs focused on helping business "act faster, act smarter."

l Sweet Spot: Seed-round financing in companies with less than a $2.5-million valuation. Average investment range:$50,000 to $1 million

l Number of angels/investors in the network: 12

l Contact: Web site onlyl Submit business ideas via the Web site.

Monterey Investor Roundtable

l affiliated with Gathering of Angelsl Monthly presentations have included

environmental, biotech, biomedical, eCommerce, nanotechnology, explosive detection, software, hardware, semiconductors

l Investments are made by individual members (Roundtable does not seek to invest as a group)

l Contact:l cfishel@hoffmanrowgroup.com

Golden Capital Network

lConferences where entrepreneurs can present to VCs and Angels.

International Angels Organization

l Led by Hal Nissley

Non-Disclosure Agreements

Use of NDAsl Most U.S. venture capital and investment

banking firms will not execute NDAs because they: l see many different projects and l do not wish to inadvertently be perceived to be

in violation of NDAl May want to steal your idea…

l Instead, entrepreneurs must rely upon firm’s integrity as a firm and its close working relationship with the client to achieve successful outcomes.

NDAs - an Investment Banker’s Perspective

l “Possibly we could get NDA's from people we talk to but then how could they help us without discussing what we have with others. Usually these types of agreements are not signed with investment banking firms because of the very nature of the work we are dealing with.

l We have already spent substantial time defining who would be the critical partner in this matter, but it would be hard to deal with anyone without telling them what we are doing.

l It undercuts everything we will be talking about when we meet.”

Robert Spira, Chapman Spira and Carson

Secrecy Backfiredl Entrepreneur

refused to provide investment banker with information for due diligence

l By default, another firm “won” funding of $5.5 million.

lOnly do business with someone you can trust

l It’s safer than an NDA

lNDAs are nearly worthless…

Hoffman Row Group, Inc.

98 Del Monte Ave., Suite 205Monterey, CA 93940

Tel: 831-224-8800 • Fax: 831-401-2340cfishel@hoffmanrowgroup.com

www.hoffmanrowgroup.com