Drivers of Innovation in the US High Tech Model

Transcription

1 Entrepreneurship and Venture Capital Jerome S. Engel Adjunct Professor, Haas School of Business Executive Director, Lester Center For Entrepreneurship and Innovation University of California at Berkeley Jerry Engel UC Berkeley Founder and Executive Director of the Lester Center for Entrepreneurship and Innovation Chair: Entrepreneurship Faculty Teach Entrepreneurship, Venture Capital & Private Equity, Technology Commercialization in the MBA and Executive Ed Outside of Academe: Venture Capital Monitor Venture Partners, General Partner Co-founded: Kline Hawkes Capital early 90s Entrepreneur Co-Founder: AllBusiness.com, ElectraScan Inc., CardioProfile Angel Investor, Board member, Advisor: Maxis, Leapfrog, MedAmerica Big Company Experience 1980s: Ernst & Young, Managing Partner, Entrepreneurial Services» Clients: Apple, Intel, Genentech, Sun, Autodesk,Fair Isaac, The Learning Company and more s: KPMG Entrepreneurship and Venture Capital What are the Drivers of Innovation? Why are Entrepreneurship and Venture Capital Important? What is Entrepreneurship? How Does Venture Capital Work What are the current trends? What does all this mean to me? Drivers of Innovation in the US High Tech Model U.S. Example: Private R&D Spending Increasing The Proportion of Research Expenditure at Our Largest Corporations is Decreasing 300 B illions of 1996 Dollar Note: Expenditures are deflated using the GDP implicit price deflator. Source: National Science Board (2000) and Economic Report of the President (2002) TOTAL PRIVATE FEDERAL Company Size <1000 employees 4.4% 9.2% 22.5% 22.4% 1,000-4, % 7.6% 13.6% 15.4% 5,000-9, % 5.5% 9.0% 8.4% 10,000-24, % 10.0% 13.6% 14.4% 25, % 67.7% 41.3% 39.5% Original - H. Chesbrough, 2003 Updated J. Engel 2003 Source: National Science Foundation, Science Resource Studies, Survey of Industrial Research Development, 1991,1999 and

2 to Market Adoption Continues to Decrease What is Entrepreneurship? Lag in Appearance of Competition (years) An approach to management that starts with opportunity Not just small companies Not just start ups Not simply promoters Interval between the introduction of an innovation and competitive entry, Agarwal and Gort 2001 Entrepreneurship Bridges the Gap Entrepreneurship is: A process Not a person Technology/ Opportunity Entrepreneurship Value About BIG companies that happen to be small Not about small business Important to BIG business Entrepreneurship Entrepreneurial Process The pursuit of Opportunity beyond the Resources you currently control Prof. Howard Stevenson Working Definition Identify Need Solution Unfair Advantage Acquire Technology rights People Money Opportunity Resources 2

3 The Entrepreneur s Task. Major Trends Key Resources Technology Money People Technology People Money Technology Discoveries of large companies and universities commercialized by small companies Money From Venture Capitalists: new structures for pooling risk-tolerant investors People The rise of the professional entrepreneur and entrepreneurial teams as a management process Entrepreneurial Process Entrepreneurial Process Key Mechanisms: Mobile Technology Mobile People Mobile Money Technology People Money Mobile Technology Transfer of technology from research institutions to commercial application Formal - through licensing Informal - through people Technology People Money Entrepreneurial Process Entrepreneurial Process Mobile People The emergence of the professional entrepreneurial management team Lifestyle: personal mobility, multiple employers Equity compensation Acceptance of the risk of failure Technology People Money Mobile Money New forms of Private Equity International investments by US Venture Capital Multinational corporations become more active Buy-out funds becoming more active Increased sophistication of the Angel communities Technology People Money 3

4 Liquidity Cycle in Venture Capital Venture Capital Some Fundementals LP investment in VC VC investments in companies Company growth Company liquidity events Funds Raised ($B) $80 $60 $40 VC: $26.7 $17.0 $12.7 A Cyclical Industry US Fundraising $57.6 $83.5 $49.8 $24.5 $18.3 $13.1 $9.4 $ H06 Amount Invested ($B) Investment Levels Reflect the Same Cycle Deal and Equity into Venture-Backed Companies $100 $75 $ $25 $17.9 $13.1 $ $ $94.8 4, ,000 $ $22.1 $19.5 $22.2 $23.4 2, $13.0 1, H06 Amount Invested ($B) Number of Deals 6,000 5,000 0 Number of Deals $120 $100 $80 $60 $40 ($ in billions) VC Investment The Long View Annual Venture Capital Investments 1980 to YTD 1H 2006 $21.3 $14.9 $11.5 $8.2.6 $3.0 $3.1 $3.3 $3.4 $3.3 $1.2 $1.6 $3.0 $2.8 $2.8 $2.2 $3.6$3.7 $4.2 $54.7 $105.9 $41.0 $21.5 $19.5$22.2 $23.4 $13.0 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 1H'06 Venture Capital Industry and Geographic Influences VC investment is cyclical but on a long term upward trend Investment Capital for Entrepreneurial Ventures tends to clump By Region By Industry It is important to understand where VC financing works and Where it does not Operating outside the mainstream can add significantly to financing challenges and risk 4

5 IT Leads Deal Allocation Deal Allocation by Industry Sector 100% 2% 12% 16% 13% 5% 5% 9% Other U.S. Investment: Overall % of Total VC Rounds 80% 60% 40% 20% 62% 24% 27% 65% 60% 26% Business, Consumer, Retail IT Healthcare 0% 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 % of Dollars Invested 100% 80% 60% 40% 20% 0% 16% 1% 10% 53% 36% IT Dollars Pick Up in 3Q 06 Investment Allocation by Industry Sector 4% 62% 16% Other Business, Consumer, Retail 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 36% 12% 6% 9% 54% 32% IT Healthcare Amount Invested ($B) Investment in IT Companies Stable in 3Q 06 Equity Investment in Information Technology Companies 392 $ $ $3.6 $3.2 $3.5 $3.2 $3.7 $3.6 $3.1 $3.1 $3.2 $3.4 $3 $ $2.6 $2 $1 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 Amount Invested ($B) Number of Deals Number of Deals % of Dollars Invested 100% 80% 60% 40% 20% Software Garners Most IT Investment IT Investment Allocation by Sector 15% 12% 10% 26% 37% 12% 19% 48% 31% 12% 14% 18% 9% 24% 41% Semiconductors Information Services Electronics Communications Software Bay Area Draws Most Investment Dollars Regional Investment in the United States 3Q 06 Washington State 3% All Other US 19% Research Triangle 2% Potomac 4% Texas 5% Bay Area 38% 0% 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 New York Metro 8% New England 10% Southern California 11% 5

6 45% of Deals in California Companies Regional Deal in the United States 3Q 06 Research Triangle 1% Washington State 3% Potomac 4% All Other US 24% Texas 5% New York Metro 7% Southern California 10% Bay Area 35% New England 11% European Investment: Overview Amount Invested ($B) $7 $6 $5 $4 $3 $2 Perspective on European Market Equity Investment in Venture-Backed Companies, US vs. Europe ($) U.S. Equity Investment Overall Investment Biopharm Leads Investing Equity Investment in European Venture-Backed Companies by Industry, 3Q 06 Semiconductors 15% Retail 1% Software 14% Services 1% Products 1% Media 2% Bus. Cons. Retail 9% Healthcare Info. Tech. 44% 51% Biopharmaceuticals 36% $1 European Equity Investment 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 Information Services 6% Electronics 4% Communications 12% Healthcare Services 0.3% Medical Devices Medical IS 7% 1% UK & France Garner Over Half of Deal Total Deals in Europe by Country, 3Q 06 Ireland 2% Switzerland 3% Denmark 6% Other 15% United Kingdom 30% Valuation of the Venture Capital Funded Venture Germany 9% Sweden 12% France 23% 6

7 Valuations Continue Upward Trend Median Premoney Valuation by Year U.S. Investment: Valuations This section will be updated in December. Median Premoney Valuation ($M) $25 $15 $10 $5 $9.3 $25.2 $ $15.5 $16.0 $15.0 $13.0 $13.0 $11.1 $10.7 $ H06 2Q 06 Valuations Soar Median Premoney Valuation Second Round Valuations Climb Median Premoney Valuations by Round Class (All Industries) Median Premoney Valuation ($M) $25 $15 $10 $5 $10.1 $8.8 $11.9 $13.9 $13.0 $13.0 $12.0 $15.0 $15.6 $13.0 $17.5 $15.8 $23.0 Median Premoney Valuation ($M) $40 $30 $10 $19.5 $13.1 $4.1 $1.8 $1.3 $36.8 $22.8 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 $5.6 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 Later Stage Second Round First Round Seed Round Rising IT Valuations Surpass HC Median Premoney Valuations by Industry Median Premoney Valuation ($M) $30 $10 $25.0 $22.5 $15.5 $8.1 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 Healthcare Information Technology U.S. Liquidity 7

8 M&As Remain Primary Exit Option Percentage Breakdown of Venture Backed Liquidity Events: IPO vs. M&A YTD06* YTD06*: 1Q06 3Q06 0% 20% 40% 60% 80% 100% IPOs M&As What are the Trends we have Observed? Venture Capital is a very special and unique category of PE It is highly concentrated in a few unique locations and industries Cyclicality and uncertainty are key factors There are surprising consistencies given these factors UC Berkeley, right here, right now is a unique and great place to study VC! Financing Design of the Venture Capital Funded Venture $ New Venture Funding Stream $1 $8 $40 $80 IPO Sales time Venture Capital Rounds 100% Early Stage Investing Picks Up in 3Q 06 Deal Allocation by Round Class 9% 10% 5% 100% Annual Round Allocation Steady Deal Allocation by Round Class (Annual) 11% 8% 6% % of Total VC Rounds 80% 60% 40% 20% 36% 25% *30% 23% 38% *40% 34% 23% *38% Restart Later Second First Seed % of Total VC Rounds 80% 60% 40% 20% 36% 39% 36% 33% 22% 22% *54% *36% *28% Restart Later Second First Seed 0% 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 *Seed and First Rounds Combined 0% YTD06* YTD06*: 1Q06 3Q06 *Seed and First Rounds Combined 8

9 Dollars Allocated to Later Stage Remains Strong Investment Allocation by Round Class % of Dollars Invested 100% 80% 60% 40% 20% 0% 10% 45% 28% *17% 9% 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 *Seed and First Rounds Combined 29% 53% *27% 5% 44% 27% *24% Restart Later Second First Seed % of Dollars Invested 100% 80% 60% 40% 20% More than ½ of Dollars Go To Later Rounds Investment Allocation by Round Class (Annual) 0% 2% 33% 23% *42% *38% 36% YTD06* YTD06*: 1Q06 3Q06 *Seed and First Rounds Combined 9% 48% 7% 49% 24% *20% Restart Later Second First Seed Median Deal Size Slips in 3Q 06 Median Amount Invested Per Financing Round Median VC Rounds Slightly Smaller Median Amount Invested Per Financing Round, VC Only Median Amount Invested ($M) $8 $6 $4 $2 $6.3 $6.0 $6.0 $6.9 $6.5 $6.0 $7.5 Median Amount Invested ($M) $8 $6 $4 $2 $6.7 $6.5 $7.3 $6.4 $6.8 $6.3 $7.5 $7.6 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 Round Sizes Remain Flat Median Amount Invested by Round Class, VC Only Round Sizes Hold Steady in 2006 Median Amount Invested by Round Class (Annual), VC Only Median Amount Invested ($M) $12 $10 $8 $6 $4 $2 $8.2 $8.0 $5.0 $1.0 $10.0 $8.8 $5.0 $1.0 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 Later Round Second Round First Round Seed Round Median Amount Invested ($M) $15 $10 $5 $5.0 $4.3 $3.5.8 $ YTD06* Later Round Second Round First Round Seed Round $8.8 $5.0 $1.0 YTD06*: 1Q06 3Q06 9

10 Structuring the Financing The Why of multiple rounds Adding Technology Value Value Value is a Step Function: Technology/Product Marketing Management Value Working Prototype Patent Application Feasibility or Prototype Concept Market Introduction Regulatory Approvals Manufacturing Prototype Adding Market Value Adding Management Value Value Backlog Satisfied Customers Market Launch Beta Test Technical Reports Published Surveys/Concept Testing Qualitative Research (Focus Groups) Market Analysis - Published Data Value Human Resources Mgr Chief Financial Officer Sales Manager Manufacturing Vice President Controller Marketing Vice President President Chief Technologist Company Formation Startup Company Valuation Model: The Expanding Value Pie* * [or not confusing ownership with value] Founders A, B and C each purchase 1M shares of Common Stock at a purchase price of $.001 per share. Person Shares % Total Value Founder A 1,000, % $1,000 Founder B 1,000, % $1,000 Founder C 1,000, % $1,000 totals 3,000, % Post-Money Valuation $3,000 10

11 Hiring a President/CEO Creation of an Option Plan The company hires a chief executive officer who purchases 1M shares of Common Stock at a purchase price of $.01 per share. Additionally, in order to attract additional key employees, the Company establishes an employee stock option plan and reserves 1M shares of Common Stock for issuance under this plan. The pre-financing valuation is $30,000. Initial Venture Capital Round $5,000,000 venture capital financing at a purchase price of $1 per share, representing a pre-financing valuation of $5,000,000 (5M shares with a value of $1 per share). The new shares are typical venture capital Series A Preferred Stock, with each share of Series A Preferred Stock being convertible into one share of Common Stock. Person Shares % Total Value Founder A 1,000, % $10,000 Founder B 1,000, % $10,000 Founder C 1,000, % $10,000 President 1,000, % $10,000 Option Plan 1,000, % $10,000 totals 5,000, % Post-Money Valuation $50,000 Person Shares % Total Value Founder A 1,000, % $1,000,000 Founder B 1,000, % $1,000,000 Founder C 1,000, % $1,000,000 President 1,000, % $1,000,000 Option Plan 1,000, % $1,000,000 Series A Inv 5,000, % $5,000,000 totals 10,000, % Post-Money Valuation $10,000,000 Series B Preferred Financing $10,000,000 Series B Preferred Stock financing at a purchase price of $2 per share, representing a pre-financing valuation of,000,000 (10M shares with a value of $2 per share). Like the Series A Preferred Stock, each share of Series B Preferred Stock is convertible into one share of Common Stock. Person Shares % Total Value Founder A 1,000, % $2,000,000 Founder B 1,000, % $2,000,000 Founder C 1,000, % $2,000,000 President 1,000, % $2,000,000 Option Plan 1,000, % $2,000,000 Series A Inv 5,000, % $10,000,000 Series B Inv 5,000, % $10,000,000 totals 15,000, % Post-Money Valuation $30,000,000 Initial Public Offering (IPO) A total of 5M shares to be sold in the offering, including 3M shares sold by the Company and 1M shares sold by each of the Series A and Series B investors. Shares will be sold at a price of $10 per share, representing a pre-financing valuation of $150,000,000 (15M shares with a value of $10 per share.) Series A and Series B Preferred Stock automatically converted into Common Stock. All shares sold in offering will be Common Stock. Note that the interest of each founder has decreased from 33.33% at the Company s formation to 5.55% following the IPO. However, the value of the interest of each founder has increased from $1,000 to $10,000,000. Person Shares % Total Value Founder A 1,000, % $10,000,000 Founder B 1,000, % $10,000,000 Founder C 1,000, % $10,000,000 President 1,000, % $10,000,000 Option Plan 1,000, % $10,000,000 Series A Inv 4,000, % $40,000,000 Series B Inv 4,000, % $40,000,000 Public IPO 5,000, % $50,000,000 totals 18,000, % Post-Money Valuation $180,000,000 How to Evaluate a Deal from the Company s Perspective Founder s Issues Employee s Issues Corporate Issues Sufficient Capital Freedom of Operation Previous Investor and Creditor Issues Etc. How to Evaluate a Deal from the Investor s Perspective Potential for Adequate Return Opportunity for a Home Run? Potential Fatal Flaws Requirements Follow-on Investment Requirements Portfolio and Fund Compatibility Etc. 11

12 Effect of Eleven Factors on Company Valuation Variables Lower Valuation Higher Valuation Technology Stage of Development Concept Product Patent Status None Filed Issued to Market Long Short Market Demonstrable Need No Yes Size & Growth Small Large Market Penetration Slow Rapid Management Team Novice Tested Financial Profit Margins Low High Total Capital Required High Low Return on Investment Potential Future Valuation Low High to Liquidity Long Short Corporate Form Typically NOT a passthrough Common Stock [sweat] Founders Stock Nominal Issuance Vesting Incentive Stock options Preferred Stock [money] Convertible Liquidation Preference Dividends Antidillution Protection Voting Rights Board Representation The Term Sheet Protective Provisions Sale of Company Additional Issuances of Stock Co-investment Rights Information Rights Demand and Piggy-Back Registration Rights Expenses The Venture Capital Model and The Professional Entrepreneur Venture Capital and the Professional Entrepreneur Staged financing to match the stages of growth How the Professional Entrepreneur manages rapid transitions through the stages How the Entrepreneurial Ecosystem supports rapid growth Meshing with VC model; How does the entrepreneur have to behave? How does company have to be structured? TO ACHIEVE HYPERGROWTH! This means starting new businesses that are designed to grow rapidly This rapid growth poses special problems and requires special skills 12

13 Motivations: To make money To build an ego monument To to put some new technology to use To runs one s own show To avoid authority To build something new Opportunity: Lethargy of the big boys (girls) Speed of the process lies in access to resources Entrepreneurs are not necessarily strong managers Entrepreneurs are gatherers of resources Managers are efficient allocators People who start new companies need to know how to attract resources: Concept of the company Business model Customer and need Why it is an opportunity for the investor People who start new companies need to know how to attract resources: Oral presentation skills Reference accounts Why they would buy from this company Are they spending money now? VC s look for: Big opportunities and the talents for rapid acceleration Obvious strategic alliances Well-rounded management team (how much time will it take to advise) What makes someone professional? Separation of what is good for the person from what is good for the company (required if outside investors) Recognition of what one is not good at Ability to change one s role to fit needs Serial entrepreneur 13

14 The Entrepreneurial Venture FOUR STAGES of DEVELOPMENT The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT I II III IV Pure entrepreneurship I II III IV The Entrepreneurial Venture PERIOD I: Pure Entrepreneurship The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT Defining the concept of the business Gathering financial resources Assembling the startup team I II Identifying customers III IV Analyzing the competition Building the prototype Getting your first customer I Strategic focus II III IV The Entrepreneurial Venture PERIOD II: Strategic Focus The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT What business aren t we in? IMPLEMENTING the business we are in! Knowing better than ANYONE else: What Iwill people payii III IV 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 I Systems building II III IV 14

15 The Entrepreneurial Venture PERIOD III: Systems Building The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT Financial controls Stable division of labor Reporting relationships and authorities I II III IV Developing systems of internal control Formalizing the terms of a sale Operational systems Production, outsourcing Distribution, sales Service, warranties I Corporate management II III IV The Entrepreneurial Venture PERIOD IV: Corporate Management Hiring outsiders Going public Adding the follow-on product[s] I II III IV Shedding those who can t keep up Formalizing the culture Rationalizing the strategy I II III IV Visioning the Future into the Present Venture Capital and the Professional Entrepreneur I II III IV Zone of Collaboration Staged financing to match the stages of growth How the Professional Entrepreneur manages rapid transitions through the stages How the Entrepreneurial Ecosystem supports rapid growth Zone of Competition 15

16 $ New Venture Funding Stream $80 Sales $ New Venture Funding Stream $80 Sales $40 IPO $40 IPO $1 $8 time $1 $8 time Venture Capital Rounds keyed to milestones Venture Capital Rounds Investment Corporate Window and Spin-outs $ $1 New Venture Funding Stream $8 $40 Venture Capital Rounds $80 IPO Sales time Venture Capital and the Professional Entrepreneur Staged financing to match the stages of growth How the Professional Entrepreneur manages rapid transitions through the stages How the Entrepreneurial Ecosystem supports rapid growth Investment Corporate Window and Spin-outs Acquisition Corp Growth The game changes over time. What makes one good at it at one point may actually hurt at another. Dilemma - entrepreneurial success leads to managerial failure. Why? Axiom: Difficulty of managerial work driven by problem complexity Axiom: Problem complexity driven by complexity of the company Axiom: Company complexity increases with growth The faster the company grows, the more difficult it is to manage. 16

17 The better a person is at being an entrepreneur, the faster the company grows. People start with some level of managerial skill and learn as they go along. The smarter they are, the faster they learn, and their learning curve is more steeply sloped. Slow growing firm Fast growing firm Learning Curve Problem Complexity Problem Complexity Learning Curve TIME TIME So: Rapid growth often requires an infusion of managerial expertise Founders have to lower their influence or exit The motivations discussed earlier are impacted differently - so prioritize Venture Capital and the Professional Entrepreneur Staged financing to match the stages of growth How the Professional Entrepreneur manages rapid transitions through the stages How the Entrepreneurial Ecosystem supports rapid growth 17

18 Building Relationships Law Firm TIME Advisory Board Venture Capital 1 Angel/ Seed Key Hires Key Suppliers Reference Customer Venture Capital 2 Series A Accounting Firm Venture Capital 3 Series B Exec Search Strategic partner/ Distribution Venture Capita 4 Series C Venture Debt Mezzanine Entrepreneurship is a Team Sport Thank You 18