seeking venture funding… what an investor looks for and what to look for in an investor a...
TRANSCRIPT
Seeking venture funding…what an investor looks for and
what to look for in an investor A discussion of considerations from a pre-seed and seed investor perspective…
August 25 and October 13, 2005
Teri F. Willey, Managing Partner
ARCH Development Partners
Planning to cover…
How a VC fund works Some background on ARCH Development Partners What investors like to see (and what you might look
for in investors) Risk and Return Term Sheet Tango Resources
Structure – how a fund works The Fund
Fund raises money from institutional investors (LP’s) University endowments, pension funds, insurance companies, corporate
venture funds, wealthy individuals Fund may range from $30M - 400M, $1-$10M per LP Fund lasts 10 years. First 3-4 years initial investments, then follow-on
investments and exits. Multiple Funds may be managed concurrently
The Partnership 20% carry. (For a $100M fund, all gains over $100M get split 80/20 with
investors/fund managers) The Management Company
2-3% fees per year. (2% fee on $100M is $2M year)
Return - % returns based on age of fund for period ending 2003 (www.nvca.org)
-30-20-10
0102030405060
3 yr5 yr10 yr,
Returns - by Stage of Business
Seed stage – developing product
250K-$1M IRR 70+% Need 10X in 5 years
Venture Series A – Revenue - paying Customers
$1- $3M IRR 50% Need 5 X in 3-4 years
Venture Series B – Sales Expansion
$3- 10M IRR 40% Need 3X in 2-3 years
Late stage – mature business
$15-50M IRR 25% Need 1.25X in 12 mos
Return – multiples and IRR Homeruns (10x) Singles/Doubles/Triples (1x<10x) Strikeouts (<1x)
Multiple: $exited/on $invested IRR: timing to exit from the first investment Note: 2.5X for a 20% IRR, 5X for a 40% IRR
Background…ARCH Development Partners
Currently $32 million under management LP’s: Universities, Foundations, Banks, Corporations, and Hospitals
Strategy: Strategically partner with communities to create start-ups Current partners: Kalamazoo, Peoria, Lafayette, Cincinnati, St. Louis Make “pre-seed” investments ($50,000 to $1,000,000) Syndicate deals with other early-stage investors, e.g. angels Structure deals for optimal early exits
Primary Deal Sources: University and Corporate spin-outs Investments: Biotechnology, Information Technology Geographic Focus: Upper Midwest: IN, IL, MI, OH General Partners: Experienced investors and entrepreneurs
Stage of investments
Pre-Seed
IP/Technology
Technologist /founder/business development
<$500K
Identifying technology via relationships
Determining commercial viability
Accessing rights/Recruiting CEO
Seed Early Stage Mid-Stage Exit
Description
Team
$ Needed
Keys to Success
Product-in-development
Plus first senior mgmt team member
$250K to $1M
Finding development partners
Developing business strategy
Recruiting BOD & SAB
Product at beta clients
Senior mgmt team formation
$1M to $5M
Growing the sales pipeline
BOD and SAB in place
Full customer pipeline
Senior mgmt team in place
$2M to $20M
Managing growth
Becoming profitable
Identifying exits
Focus
Business Expansion
Public Markets
The ARCH Model
Apply Time-tested Traditional VC Disciplines to: Identify Platform Technologies Create Patent Strategy Recruit the CEO Identify and Quantify the Market Create the Business Model Recruit BOD and SAB Raise $$$ Manage to Milestones
Inception
Product commercialization
CustomersRevenueSpace to growNext round
fundingUpdated Advisory
board and BOD
Recruiting and hiring
Organizational structure
Compensation planning
Staffing modelsCulture
building
IncorporationOffice spacePayroll and
benefitsAccountingIT and
telephoneAdvisory board
and BOD
Managing Licensor relationship
Technology due diligence
Business plan creation
Patent and IP protection
Finding and closing initial financing
Consultation/ liaison on university policy
Marketing/PRFinancial
modeland pricing
Business development
Operations processes
Product development
Groundwork Interim management Talent Toward independence
Accelerating New Business Growth
The “squeeze” perspective At the early stages … it is about squeezing out enough risk so
traditional corporate partners and investors can participate. We think about how you can facilitate: hitting the most critical milestone's) in the least amount of time with the least amount of money
light initial capitalization management compensated w/stock use non-dilutive funds outsource exit strategy flexibility
What we want to see – MANAGEABLE RISK
As we evaluate each of the foregoing we are considering the main types of risk, if they are manageable and if so how they will be managed: IP Market Technical Financing Management
Risk con’t
PROBABILITY
Sufficient capital 80% Management is capable and focused 80% Product development goes as planned 80% Production and component sourcing goes as planned 80% Competitors behave as expected 80% Customers want the product 80% Pricing is forecast correctly 80% Patents are issued and are enforceable 80%
Combined probability of success 17%
Harvard Business Review November-December 1998
What we like to see - TYPE
Science/innovation based company. Prefer university or corporate owned intellectual
property as the basis for the spin out (vs independent inventor).
Biomedical, biotechnology, pharmaceutical, bioinformatics, information technology, wireless, internet infrastructure.
What we like to see - STAGE
Pre-business plan and management team is fine. We prefer to act as founders at this stage, assist with
company formation and management and board recruitment and the acquiring the necessary intellectual property rights.
What we like to see - $ REQ
50k to 1 million needed for the purpose of squeezing risk out of the venture and positioning it for further investment or revenue generation.
20-50 million total to get to exit. Realistic expectations regarding valuation, that is
what the investment buys in ownership and control
What we like to see - MARKET The product(s) the company is proposing to develop should
have a market of 200 million or more (that is the company’s sales are expected to be 200 million or more annually in a reasonable time after product launch)
Understanding of the commercialization strategy and competitive advantage. Clear and realistic idea of who and what the competition is and how
the idea will reach the market in the form of a product. Know where the pain is that this product addresses and where a the
incentives are to adopt the new product (the value proposition).
What we like to see - IP
The proposed product should be based on an appropriate proprietary position, preferably a strong patent position or the real potential for one.
This includes understanding freedom to operate issues and determining that they are clearly addressed or reasonably manageable.
What we like to see - MGMT
If there are there already or if we need to recruit them: Product development experience and operating
experience (fund raising a plus). Reasonable compensation expectations. Chemistry with the founding scientists/innovators. Early stage company experience Network
What we like to see - EXIT
The company or proposed company should be one poised for an acquisition exit or in some cases an IPO exit.
Pre-seed and seed stage investors like ARCH may lean toward an acquisition exit as it is consistent with our model (and the only choice when the window is closed) and hence towards deals in industries in which M&A is the favored transaction.
What we like to see - RETURNS
At exit it’s about how… many shares are we going to own. much do we invest to get there. much to others invest to get there. long will it take us to get there. much will they be worth at exit.
Sources of these shares…of equity In addition to acquiring equity as consideration
for investing dollars in the company (usually preferred) equity may also be obtained… As consideration for the technology license (common
or preferred) As consideration for forming
the company or providing services (sweat equity – usually common)
As compensation (options for common or restricted stock)
How much equity Pre-money valuation + dollars invested = post
money valuation Equity ownership equals dollars invested divided by
the post money valuation…or does it?! Equity ownership on a fully-diluted basis
Term Sheet
Financial Terms Non-financial Terms Equity Provisions
Terms to address the traditional ‘valuation gap’ Pre-money valuation Financial tools
Liquidation preferences Warrants Dividends
Incentive based tools Price controls aka ratchet mechanisms Preemptive rights Performance based incentives Management options Vesting founders shares
Terms to address managing risk via control Board representation Class voting Voting the option pool Protective provisions
Liquidation preferences
These preferences allow certain investors, in the case or acquisition or liquidation, to get their initial investment back (or multiples of it in the case of 2x or 3x liquidation preferences) before returns are shared ratably with the other share holders.
Warrants Another word for an option to purchase a security. The term
is generally used for options provided by the company to outside investors (as distinct from officers, employees, etc.)
Contract which covers time frame during which the investor can convert the warrants and the price they can convert/buy stock
Sometimes used with or without interest on convertible bridge loans and can be based on a percent of the bridge
This can be a cashless transaction if the warrants are converted at exit
Taken into consideration when determining a fully diluted share price
Anti-dilution Price protections…if stock is sold, at a price less
what the investor with anti-dilution protection paid for it, the lower price is applied to the conversion formula Full-ratchet Weighted average
Preemptive rights…the right of the investor to acquire new securities issued by the company to the extent necessary to maintain its percentage interest on an as converted basis)
Vesting founders shares
Incentive to keep founders with the company “Earning back” the initial ownership in the
company over time or against milestones
Control via business decisions Protective provisions
May provide significant control of the investors even if they do not own a majority of the company.
Outlines which decisions require approval of the investors (which class of investors, percent, etc.)
Board representation Investors my require one or more board seats
Resources
Indiana Venture Center www.indianaventurecenter.org
Indiana Seed Fund I. LLC (ISF) www.biocrossroads.com/entrepreneur/isf.htm
Model documents and industry overview www.nvca.org
More course work www.vcinstitute.org
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