overview of venture capital …and why it matters ! jerome s. engel september 2005

Overview of Venture Capital …and why it matters !

Jerome S. Engel

September 2005

Jerry Engel UC Berkeley

- Founder and Executive Director of the Lester Center for Entrepreneurship and Innovation

- Chair of the Entrepreneurship Faculty- Teach Entrepreneurship, Venture Capital & Private

Equity, Technology Commercialization in the MBA and Executive Education programs

Outside of Academe:- Monitor Venture Partners, General Partner- Co-founded: Kline Hawkes Capital, AllBusiness.com,

ElectraScan Inc., Maxis, CardioProfile, and more…- Angel Investor, Board member, Advisor

1980s- Ernst&Young, Managing Partner

Entrepreneurial Services Apple, Intel, Genentech, Sun, Autodesk, more..

1970s – KPMG Academic - Wharton

Probing upper thermospheric Probing upper thermospheric neutral densities at Mars using neutral densities at Mars using

electron reflectometryelectron reflectometry

Overview of Venture Capital…and why it Matters!

Entrepreneurship is a key driver of value creation in the 21st century American economy

An approach to that starts with the recognition and pursuit of opportunity

The opportunity must be compelling to enable the entrepreneur to attract the necessary resources

Special mechanisms exist to enable resource alignment with the best opportunities

Venture Capital is such a mechanism Venture Capital is more than money It is a market mechanism It is this subtlety that makes rare

Technology /Opportunity Value

Entrepreneurship Bridges the Gap

Entrepreneurship

Entrepreneurship

The pursuit of Opportunity beyond the Resources you currently control

Harvard Business SchoolWorking Definition

Entrepreneurial Process

Identify - Need- Solution- ‘Unfair Advantage’ }

}

Opportunity

Resources

Acquire:

- Technology rights- People- Money

Entrepreneurial Process

Key Mechanism:

- Mobile Technology

- Mobile People

- Mobile Money

People

MoneyTechnology

The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

Time

CashFlow

I II III IV

Time

“Pure entrepreneurship”

CashFlow


The Entrepreneurial Venture PERIOD I: “Pure Entrepreneurship”

Defining the concept of the business Gathering financial resources Assembling the startup team Identifying customers Analyzing the competition Building the prototype Getting your first ‘customer’

Time

CashFlow

I II III IV

Time

“Strategic focus”

CashFlow


The Entrepreneurial Venture PERIOD II: “Strategic Focus”

Time

CashFlow

I II III IV

What business aren’t we in? IMPLEMENTING the business are we in! Knowing better than ANYONE else:

- What will people pay- How many will they buy- How to distribute- How to service the customer

Identifying strategic partners Developing relations with suppliers Going beyond the prototype to a truly scaleable product Recruiting a complete team Raising ‘institutional’ money

Time

“Systems building”

CashFlow


Time

CashFlow

I II III IV

The Entrepreneurial Venture PERIOD III: “Systems Building”

Financial controls Stable division of labor Reporting relationships and authorities Developing systems of internal control Formalizing the terms of a sale Operational systems

- Production, outsoucing- Distribution, sales- Service, warraties

CashFlow

Time

“Corporate management”


Time

CashFlow

I II III IV

The Entrepreneurial Venture PERIOD IV: “Corporate Management”

Hiring “outsiders” Going public Adding the follow-on product[s] Shedding those who can’t keep up Formalizing the culture Rationalizing the strategy

The Professional Entrepreneur

Time

CashFlow

I II III IV

Visioning the Future into the Present

New Venture Funding StreamSales$

Time

Cash Flow

$1 $8

Venture Capital RoundsFinancing to Milestones

$20

$40

$80IPO


Time

Cash Flow

$1 $8

Venture Capital Rounds

$20

$40

$80IPO

Investment Corporate “Window” and Spin-outs


Time

Cash Flow

$1 $8

Venture Capital Rounds

$20

$40

$80IPO

Acquisition

Investment

Corp Growth

Corporate “Window” and Spin-outs

U.S. Example:

Private R&D Spending Increasing

0

50

100

150

200

250

300

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Bill

ions

of 1

996

Dol

lars TOTAL

PRIVATE

FEDERAL

Note: Expenditures are deflated using the GDP implicit price deflator. Source: National Science Board (2000) and Economic Report of the President (2002)

The Proportion of Research Expenditure at

Our Largest Corporations is Decreasing

Company Size 1981 1989 1999 2000

<1000 employees 4.4% 9.2% 22.5% 22.4%1,000 - 4,999 6.1% 7.6% 13.6% 15.4%5,000 - 9,999 5.8% 5.5% 9.0% 8.4%10,000 - 24,999 13.1% 10.0% 13.6% 14.4%25,000+ 70.7% 67.7% 41.3% 39.5%

Original - H. Chesbrough, 2003 Updated J. Engel 2003Source: National Science Foundation, Science Resource Studies, Survey of Industrial Research Development, 1991,1999 and 2000.

The State of the Venture Capital Industry

September 2005

Jerome S. Engel

Venture Capital & Private Equity

Reminder: Entrepreneurs Forum Thursday night

EntrepreneursPerspective

Limited PartnersPerspective

General PartnersPerspective

InvestmentOpportunit

y

Venture Capital and Private Equity…require a convergence of interests

Instutional Investors PerspectiveVC is a sub-category of Private

EquityWhat is Private Equity? Venture Capital [our principal focus] Leveraged Buyouts Mezzanine Investments Build-ups/Roll-ups Distressed Debt

Characteristics: Generally structured as a partnership Huge growth in funds [$5b in 1980 to over $250b today] Still a relatively small allocation [only $1 for every $40 in

public equities] Instability and volatility in valuations and funds flows Demand and Supply likely to expand, especially overseas

20 Years of Venture Capital ?

Nasdaq Composite Index

$0

$20

$40

$60

$80

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 2000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

VC Fundraising ($B) VC Median Returns by vintage year

VC Median Returns

279%

Sou

rces:

Asset

Alt

ern

at i

ves,

Cam

br i

dg

e A

ssocia

tes,

CS

I, I

nc.

VC InvestmentVC Investment1980 – The Long View1980 – The Long View

($ in billions)

$41.0

$15.3$8.2

$21.3

$4.2$3.7

$18.7$21.5

$54.7

$105.9

$14.9

$11.5

$3.6$2.2$2.8$3.3$3.4$3.3$3.1$2.8$3.0$3.0$1.6$1.2$0.6$0

$20

$40

$60

$80

$100

$120

'80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 Q3'04

Annual Venture Capital Investments 1980 to YTD Q3 2004

U.S. Fundraising

Fundraising Running at ’96-’97 levelsCommitments to Venture Capital Funds

$83.5

$3.0

$17.7

$9.4$13.1

$50.5

$58.8

$26.9

$17.1$12.7

$7.0$5.4

$0

$20

$40

$60

$80

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Funds

Rai

sed

($B)

Median Fund Size Continues to increase after the shake-out

Median VC Fund Size (for funds greater than $20M)$185

$160

$100

$75

$105$100$110

$97

$76$83

$67$53

$0

$50

$100

$150

$200

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Med

ian F

und

Size

($M

)

Half of Funds Closed > $100M in Size

Allocation of Fund Size by Number of Funds Raised per Vintage Year

10%16% 25%21%

25%

25%

75% 70%

50%

2%0%

20%

40%

60%

80%

100%

1995 1997 1999 2001 2003 1Q05

Under $100M

$100M-$249M

$250M-$499M

$500M-$999M

$1B+

U.S. Investment: Overall

Am

ou

nt

Investe

d

($B

)N

um

ber o

f Deals

Deal Flow and Investment On Track with 2004

Deal Flow and Equity into Venture-Backed Companies

Source: Dow Jones VentureOne/Ernst &Young

$94.6

$10.1

$21.3$19.1$22.0

$36.2

$49.5

$17.9$13.1

$9.2$6.4

1012

219921312365

3253

6303

4586

25472211

1912

1315

$0

$25

$50

$75

$100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

0

1,000

2,000

3,000

4,000

5,000

6,000

Amount Invested ($B) Number of Deals

IT dominates VC Investing [Health Care

#2] Deal Flow Allocation by Industry Sector

% o

f Tota

l V

C R

ou

nd

s


0%

20%

40%

60%

80%

100%

2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05

Other

Products &Services

IT

Healthcare

27%

53%

17%

26%

17%

23%

57%

15%

64%

5%5%3%

Comm’s Share of IT Dollars Highest Since 4Q’02

IT Investment Allocation by Sector

% o

f D

ollars

In

veste

d


0%

20%

40%

60%

80%

100%

2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05

Semiconductors

InformationServices

Electronics

Communications

Software35%

35%

6%

14%

10%

39%

33%

3%

10%

14%

12%

14%

33%

48%

18%

Healthcare Activity Strong and SteadyEquity into Venture-Backed Healthcare Companies

Am

ou

nt

Investe

d

($B

)N

um

ber o

f Deals


$1.4$1.2

$1.6$1.7$1.7$1.9$1.9

$1.8

$1.4

$1.1

$1.5

$1.1

$2.0122

97

136126

141

118

154

125115

106

132

111

174

$0

$1

$2

$3

2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05

0

25

50

75

100

125

150

175

Amount Invested ($B) Number of Deals

Biopharm & Devices Dominate HC Investment

Healthcare Investment Allocation by Sector

% o

f D

ollars

In

veste

d


0%

20%

40%

60%

80%

100%

2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05

Medical IS

MedicalDevices

HealthcareServices

Biopharm

5%

11%

28%

56%

7%

30%

55%

8%

35%

10%

77%

9%

More than half of VC deals are seed or first round

Deal Flow Allocation by Round Class

% o

f Tota

l V

C

Rou

nd

s

*Seed and First Rounds Combined


0%

20%

40%

60%

80%

100%

2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05

Restart

Later

Second

First

Seed*30%

29%

37%

4%

*31%

42%

21%

*36%

6%

28%

39%

10%

Round Allocation Mirrors Mid-’90s Levels

Deal Flow Allocation by Round Class (Annual)

% o

f Tota

l V

C

Rou

nd

s



0%

20%

40%

60%

80%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

Restart

Later

Second

First

Seed*32%

*32%

20%

33%

39% 40%

7%

*54%

20%

39%

9% 11%

More than ½ of Dollars Go To Later Rounds

Investment Allocation by Round Class (Annual)

% o

f D

ollars

In

veste

d



0%

20%

40%

60%

80%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

Restart

Later

Second

First

Seed*43%

25%

31%

7%

*17%

55%

20%

9%

45%

36%

*42%

Median Deal Sizes Relatively ConsistentMedian Amount Invested Per Financing Round

Med

ian

Am

ou

nt

Investe

d

($M

)


$6.9$7.0

$6.0

$7.0$7.0$7.0

$6.0$6.4

$6.0$5.6

$6.3$6.0$6.0

$0

$2

$4

$6

$8

2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05

Early Stage Deals are ½ Size of Later Rounds

Median Amount Invested by Round Class , VC Only

Med

ian

Am

ou

nt

Investe

d

($M

)


$10.0

$7.5$8.0

$6.8

$5.6

$4.0

$0.9$1.3

$0

$2

$4

$6

$8

$10

$12

$14

2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05

Later Round Second Round First Round Seed Round

Amount Invested in Rounds at Late 90’s Levels

Median Amount Invested by Round Class (Annual), VC Only

Med

ian

Am

ou

nt

Investe

d

($M

)


$5.0

$10.0

$4.0

$8.4

$2.9

$5.0

$1.0 $0.9$0

$5

$10

$15

$20

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

Later Round Second Round First Round Seed Round

U.S. Investment: Regions

Bay Area Draws Most Dollars, NY Metro 2nd

Regional Investment in the United States 2Q’05


All Other US18%

Potomac3%

Research Triangle

1%

Texas4%

Washington State4%

New England10%

Southern California

11%

New York Metro15%

Bay Area 34%

2 Out of 5 Deals in CaliforniaRegional Deal Flow in the United States 2Q’05


All Other US25%

Washington State5%

Texas5%

Research Triangle

1%

Potomac5%New York Metro

6%

Southern California

10%

New England13%

Bay Area 30%

Most Deals are SyndicatedNumber of Investors Per Round


30% 34%26%

22% 23%21%

16%

19%20%

9%15%

13%

23%30%

21%

0%

20%

40%

60%

80%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

5+ Investors

4 Investors

3 Investors

2 Investors

1 Investor

U.S. Investment: Valuations

Valuations Continue Upward TrendMedian Premoney Valuation by Year

$15.0$13.0

$10.0$10.7

$16.0

$25.5

$21.1

$15.5

$12.9$11.1

$9.3$10.0

$0

$5

$10

$15

$20

$25

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1Q05

Med

ian P

rem

oney

Val

uat

ion (

$M

)

Valuation has a strong corellation to round

Median Premoney Valuations by Round Class (All Industries)

$31

$24

$12$12

$7$5

$3$3$0

$10

$20

$30

$40

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05

Later Stage Second Round First Round Seed Round

Med

ian P

rem

oney

Val

uat

ion ($M

)

U.S. Liquidity

M&As Remain Primary Exit OptionPercentage Breakdown of Venture Backed Liquidity Events: IPO vs. M&A

0% 20% 40% 60% 80% 100%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

1H05

IPOs M&As

IPO Activity slows in 1H’05 after a strong ‘04

Deals and Amount Raised Through IPOs

Am

ou

nt

Rais

ed

($

B)

Ven

ture

-Backed

IP

Os

$0.6

$5.0

$1.4$1.6$1.8

$19.2$19.5

$3.7$4.6

$8.7

$5.0

13

67

222022

202

250

68

120

216

144

$0

$5

$10

$15

$20

$25

$30

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

0

50

100

150

200

250

Amount Raised ($B) Venture-Backed IPOs

Fewest Venture-Backed IPOs in 7 Quarters

Deals and Total Amount Raised Through IPOs

Am

ou

nt

Rais

ed

($

B)

Ven

ture

-Backed

IP

Os

$0.2$0.03

$0.4$0.4

$0.7

$0.8

$0.2

$0.4

$1.2$1.4

$1.7

$0.9

5

8

19

14

24

10

14

6

2

6

1

9

$0.0

$0.3

$0.6

$0.9

$1.2

$1.5

$1.8

2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05

0

5

10

15

20

25

Amount Raised ($B) Venture-Backed IPOs

Half of 2005 IPOs from Vintage Years ’99-’00

Median Time From Initial Equity Funding to IPO

Nu

mb

er

of

Years

5.35.75.7

3.6

4.5

3.12.82.8

3.1

3.5

4.1

0

1

2

3

4

5

6

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

IPOs have raised Greater amounts of VCbefore going public

Median Amount Raised Prior to IPO

Med

ian

Am

ou

nt

Rais

ed

Pri

or

to

IPO

($

M)

$61.7

$73.2

$60.2

$49.0$47.8$46.9

$31.3

$22.4

$13.0$15.0$10.3

$0

$25

$50

$75

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1H05

European Investment:

Overview

Perspective on European MarketEquity Investment in Venture-Backed Companies, US vs. Europe ($)

Overall Investment

Am

ou

nt

Investe

d

($B

)


1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05$0

$1

$2

$3

$4

$5

$6

$7

European Equity Investment

U.S. Equity Investment

Biopharm & Software Lead 1Q’05 Investing

Equity Investment in European Venture-Backed Companies by Industry, 1Q‘05


Retail0.5%

Products1%

Services3%

Software18%

Medical IS0.4%

Communications7%

Electronics3%

Information Services5%

Semiconductors14%

Medical Devices5%

Biopharmaceuticals44%

Info. Tech.49%

Prod. & Serv.6%

Healthcare45%

UK Leads 1Q’05 European Investment

Investment in Europe by Country, 1Q’05


Other13%

Ireland5%

Sweden7%

Switzerland8%

Denmark9%

France12%

Germany16%

United Kingdom 30%

Top European Investors, 1Q’05Number of Equity Investments in European Venture-Backed

Companies

3i Group 22SPEF Venture 6CDC Entreprises Innovation 6Atlas Venture 6Societe Generale Asset Management 5Siparex Group 5MTI Partners 5ACE Management 5Life Sciences Partners BV 5I-Source Gestion 5

So What Have We Learned?

overview of venture capital …and why it matters ! jerome s. engel september 2005

Documents

rare slide

gap entrepreneurship

periods of development

entrepreneurial venture

electron reflectometry

overview of venture

time strategic focus

time systems