Raising Venture Capital

May 17, 2011

Vinit NijhawanExecutive-in-Residence

vinit@bu.edu

Startup Ecosystem

OECD

Capital People

Sources of Capital• Venture Capital

– Angel– Institutional VCs

• Government– SBIR (<500 people, $5B)

• Eleven departments participate: NIH, NSF, DoD, DoE, etc.• Two phases: $100K, $750K

– STTR (<500 people, $900M)• Five departments participate: NIH, NSF, DoD, DoE, NASA• Collaboration with universities, government labs• Two phases: $100K, $750K

– Massachusetts• Mass Life Sciences• MTDC• Mass Energy

What is Venture Capital?

Johannes Gutenberg, a goldsmith, had the idea of producing small, regular blocks of steel with letters on them to be used as mould to mass-produce letter blocks. However, it took many years before he convinced a businessman, Johann Fust, in 1450 to back his invention and loan him 1600 guilders. Source: The Economist, 31 December 1999.

Venture capital is one type of private equity investing and typically refers to equity investments made in young companies during their launch, early development or expansion.

Definition….

It is not new….

Launch velocity….

Began in US after WWII and took off in the 1980s driven by ICT. Then took off in Europe and Israel in 1990s and now is taking off in India and China.

US Venture Capital Invested

US - 2006– $25.7bn– 1446 transactions– $10.5m average investmentEurope - 2006– €4.1bn– 867 transactions– €14m average investment

NVCA

Am

ou

nt

Investe

d

($B

)N

um

ber o

f Deals

Investment on Track to Match Last YearDeal Flow and Equity into Venture-Backed Companies

Source: Dow Jones VentureSource

$6.4

$28.5$23.8

$32.5$34.0$31.0

$25.1$23.6$20.3$22.5

$36.8

$94.0

661

6348

3339

2479 2291 2461 26182834 3042 2939

26572874

$0

$25

$50

$75

$100

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q'2011

0

1,000

2,000

3,000

4,000

5,000

6,000

Amount Invested ($B) Number of Deals

Healthcare Deal Flow Allocation Down Slightly in 2011 Deal Flow Allocation by Selected Groups (Annual)

% D

eal Flo

w A

llocati

on

Source: Dow Jones VentureSource

26% 24%27%13%

51%

34%34%50%

9%

17%18%10%

12%

20%17%26%

2% 5%4%<1%

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q'2011

Energy andUtilities

Business &FinancialServices

ConsumerServices

InformationTechnology

Healthcare

Northern California Companies Continue to Garner Most InvestmentRegional Investment Dollars in the United States 1Q’ 11

Source: Dow Jones VentureSource

Southern California

9%

Northern California

36%

Mid-Atlantic19%

All Other US5%

Pacific Northwest

3%

New England14%

South Central3%

South East7%

Midwest East4%

US Venture Capital Returns

Working with Angels, VCs, Both?

• Individual “Angel” or “Private” Investor– Invests own money, gets full return– Typically industry veterans

• Venture Capitalists– Compensated on fees, profit share– Dedicated, institutional investor

• Angel Groups– Large networks of industry experts– Usually 2-3 with greatest skills lead + “bench”– Organized, institutional structure

Angel Groups Addressing Void Left by VC

Stage Pre-Seed Seed/Start-Up

 

 Funding Gap between

$500,000 and $5,000,000, targeting average M&A and up

Early Later

Source Founders, Friends

and Family

 Individual

Angels 

 

Venture Funds

Investment  

$25,000 to $100,000

$100,000 to $500,000

$5,000,000 and up(initial capital may be smaller,

but exit targets higher)

VC Firm Incentives

• >$250M in Fund– >$40M/Partner– >$10M/Investment– >$50M Liquidity/Deal, Exits >$500M

• Institutional LPs– Meticulously measure IRR– Next fund depends on top quartile performance

• From Company’s Perspective– Pro/con: 800lb Gorilla as your friend– Technical risk OK ($ can fix that);

Can’t Bring Market Risk (exit too small)– Return needs to justify $30-40M+ from syndication, multiple

rounds– “We Fund BIG Ideas….”

Angel Investor Incentives

• <$100M in Fund/Network– $10M/Partner or less– $500K-$3M Investment– $5M-20M Liquidity/Deal, Exits $50M-100M

• Institutional LPs, SBIC, Individuals– Maybe more flexibility in performance (non-ERISA $)– Maybe less, eg., SBIC program….

• From Company’s Perspective– Pro/con: good returns on average M&A transaction– Market risk OK; technical risk bad (can be bottomless pit)– Shallower pockets may be disincentive to pile on risk– “Who is going to buy you?...”

Submissions(~30 PlansPer Month)

Managing Director pre-

screens emailed

submissions.

Screening TeamReview

(5 – 10 PlansPer Month)

Screening team votes on

which companies to

invite to general

meeting.

General MeetingPresentations(1 – 3 PlansPer Month)

Managing Director polls members for

level of investment

interest in deals, recruits diligence

team, and facilitates

selection of deal lead to begin term

sheet negotiations.

Manage Investment

Board member represents

member interests and

seeks an attractive exit.

Deal lead closes

transaction and the sidecar

fund invests in companies that attract at least

$250K in investment

from at least 5 members.

Diligence & TermSheet Negotiations

(Coordinated byManaging Director

& Deal Lead)

Typical Deal Process (Angel)1-2 months

1 month 1-2 months 3-5 years

Submissions(~100 PlansPer Month)

Associate pre-screens

emailed submissions.

Associate Review

(20 – 30 PlansPer Month);

Lead & Secondary

Partner Review (3-5 per month)

Lead partner decides to invite to general

meeting.

General MeetingPresentations(1 – 2 PlansPer Month)

Partnership agrees to submit

term sheet to begin exclusive due diligence. Negotiate term

sheet

Manage Investment

Board member represents

member interests and

seeks an attractive exit.

Negotiate deal documents and

close

Diligence & Investment Term

Negotiations

Typical Deal Process (VC)2-3 months

1 month 2-3 months 3-5 years

Preferred Stock Deal Terms

•Liquidation Preferences

•Participating Preferred

•Cumulative Dividends

•Cash-Out Election on Sale

•Anti-Dilution Protection

•Class Voting/Veto Rights

•Board Composition

Preferred Stock Deal Terms

•Basket (the “Pool”) for Management Shares

•Noncompetition & Nonsolicitation Agreements for Management

•Employment/Severance Agreements for Founders and Management

•Vesting, Buy-Back of Founders’ Stock

•Co-Sale & Rights of First Refusal on Management, Founders’ Shares