SESSION 9A: SOURCES OF CAPITAL, VC FUND ECONOMICS

Copyright 2014 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only. AUTUMN 2014 E145 - TECHNOLOGY ENTREPRENEURSHIP SESSION 9A: SOURCES OF CAPITAL, VC FUND ECONOMICS TOM BYERS & CHI-HUA CHIEN STANFORD UNIVERSITY! HTTP://E145.STANFORD.EDU

FRAMEWORK A: TWO PERSPECTIVES Idea Vs. Opportunity (modules 1+2) PRODUCT OR SERVICE MARKET OPPORTUNITY RECOGNITION PEOPLE AND ORGANIZATION PURSUIT OF OPPORTUNITY RESOURCES AND CAPITAL Realities of Business Operations (modules 3+4) Mark P. Rice, Babson 2

SAMPLE OUTLINE OF TRADITIONAL BUSINESS PLAN Executive Summary Market Analysis Vision and Concept (Including Technology) Competitive Positioning and Marketing Business Model Organization Financial Projections Ownership } Amplify in E145 Modules 3 and 4 3

ABC S OF HOW VENTURES GET FINANCED A AMOUNT OF CASH NEEDED AND PURPOSE B C SOURCES OF CAPITAL DEAL STRUCTURE 4

A) AMOUNT: TWO KEY QUESTIONS Q1: How much money is needed for this round of financing? Q2: Which white hot risk will be reduced with this money? Typical Financing Stages (or Rounds):! Seed Early Mezzanine Late (e.g., IPO) 5

FRAMEWORK F: THE MOST IMPORTANT RISK RIGHT NOW (QUESTION 2) Capital Risk Team Risk Technological Risk Market Risk

RECALL THE SIRTRIS AND YAHOO CASES Sirtris: Assume that Christoph and Michelle Dipp have just been told that J.P. Morgan Securities, which is a reputable investment bank, is eager to help Sirtris go public soon by filing for an Initial Public Offering (IPO). Furthermore, assume that Glaxo Smith Kline (GSK) has also just contacted them to discuss an offer to buy Sirtris entirely. Therefore, assuming Sirtris has three options: (1) Staying private and funding the company with more venture capital and corporate partnerships, (2) taking the company public via an IPO, or (3) being acquired as an operating division of an established company, what are the advantages and disadvantages of each choice? "We suggest that Christoph and Michelle [stay private, file for an IPO, be acquired by GSK because! Yahoo: What are the advantages and disadvantages of each of the three major options they could pursue to finance the venture in 1995 (e.g., venture capital, corporate partnerships and sponsorships, and acquisition to become an operating division of an established company)? I suggest that Jerry and David [accept/do not accept] Sequoia's offer because..."

FINANCING TRADEOFFS SIRTRIS 2008 M&A SELLING 100% TO ANOTHER FIRM MORE COSTLY DILUTION OF EQUITY PARTNERSHIPS SPONSORSHIPS OR STRATEGIC INVESTORS INCREASING ENTANGLEMENT LOSS OF CONTROL VC TAKE VENTURE CAPITAL INVESTMENT YAHOO! 1995 8

B) SOURCES OF CAPITAL ANGELS SEED OR SERIES A INVESTMENT BANKS IPO & PUBLIC PLACEMENT New Business Firm VENTURE CAPITAL FIRMS SERIES A,B, C FRIENDS AND FAMILY SEED FUNDS PENSION FUNDS PRIVATE INVESTORS CORPORATIONS Table 18.4 9

B) SOURCES OF CAPITAL Increasing Investment Size $10M $1M $100K Angels (Groups & Syndicates) FFF Crowd Strategic Partners Gov t VC IPO Banks Business Plan Beta Idea Prototype Profitability Sales Decreasing Risk Reference: Trevor Loy (Flywheel) 10

VENTURE CAPITAL FIRMS: LIMITED PARTNERSHIPS WITH A FINITE LIFE AND SUBSTANTIAL PROFIT SHARING High-Risk Equity Return Diversification Management Fees Share of Profits Management Help Financing Credibility INSTITUTIONAL INVESTORS (Limited Partners e.g. Endowments, Pension Funds) VENTURE CAPITALISTS (Finding and Funding Entrepreneurial Companies) ENTREPRENEURS (Starting and Building Companies) Capital Capital + Time and Help Liquid Stock Preferred Stock

VC BACKED COMPANIES >20% OF US GDP 12

WHAT DO VC S OFFER BESIDES CASH? Your friendly neighborhood VC: - Expertise - Contacts (their own and the firm s rolodex) AS A STARTUP, THE DUE DILIGENCE YOU CONDUCT OF THE VC FIRMS YOU INTERACT WITH 13

HOW DOES VC WORK? Size of VC Fund: $130 Million - Institutional: 7 @ $5-30M Each - Individuals: 20 @ $50K - $2M Each Invests Over 3-5 Years, Return within 10 On Average, Delivers 30+% Per Year Return WHAT SIZE DEAL WOULD BE INTERESTING? 14

WHICH DO YOU PREFER? Suppose you were to invest $10 million Fund 1: 2x return on all 10 $1M investments Fund 2: Loses all $1M investments in 8 deals Wins 20x on the remaining 2 $1M investments Source: Andy Rachleff 15

HOW DOES VC MAKE MONEY? Size of VC Fund: $130 Million - 2.5% annual management fee - 20% profit share (aka carried interest) HOW MUCH DO THE PARTNERS EARN ON A 3X FUND? 16