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Professional Equity Investment (Venture Capital and Angel) Lecture 2
EBD 481, Fall 2009Galbraith
Equity Investment Process
SeedMoney
1st RoundFinancing (Series A)
2nd RoundFinancing(Series B)
Clean-upFinancing(Series C)
Year 1 Year 3 Year 5
$50k $1 million $3 million $1 million
Milestones and Benchmarks
Private InvestmentVenture Capital Firms
Historical Development of Professional Venture Capital
1946: Beginning of Professional VCsFormation of American Research & Development (ARD)
ARD’s Performance$3.5 million was raised ($2 million from institutional investors)By end of 1947, ARD had invested in eight ventures, six of which were startupsBy 1951 the performance was still lack-luster (stock price was at $19 down from the initial offering price of $25 in 1946)1957 Invested in Digital Electronic CorporationARD Sold 1972; made money, about 15.0% annual return for investors (v. 7.2% in stock market)
Historical Development of Professional Venture Capital (cont’d)
1953: Small Business Administration (SBA) was formed
Legislation permitted the federal government to actively engage in fostering new business formation
1958:SBA Created Small Business Investment Companies (SBICs)
Due to tax and leverage advantages, the SBIC became the primary vehicle for professionally managed venture capital
Corporate Venture CapitalAbout 7 to 10% of VC dollarsInvest in technologies/deals that have transferability to the corporationDon’t necessarily share the “profit” motive as Angels and fund-based VCsDeal rate is much lower, but support is much higher for funded firmsPopular in pharmaceuticals, telecommunications, software and defense technologies
Microsoft, Intel, Merck, Qualcomm, and Millennium
Pharmaceuticals
Qualcomm Ventures (QVC)Qualcomm Ventures (QCV) was formed and began funding in 2000, with a $500-million fund commitment to make strategic investments in early-stage high-technology ventures. Since then, QCV has funded numerous companies in the wireless sector, and set up several exclusive regional funds to spur development in key strategic markets, including a $60-million fund in Korea, a $30-million fund in Japan, a $100-million fund in China and a €100-million fund in Europe.QCV makes strategic investments in wireless-industry ventures that provide both a strong potential return on investment (ROI) and complement existing Qualcomm products and services. When selecting portfolio companies, QCV seeks a balance between ROI and long-range strategic value to the company and the wireless industry.
Qualcomm Ventures – Investment Criteria
Strategic Value CriteriaA strong fit with Qualcomm's products and initiatives The potential to significantly affect the wireless value chain A significant and sustainable competitive advantage
Financial CriteriaPotential liquidity and financial returns - Comparable to VC investors Investment stage - Expansion, typically the second round of financing Investment size - Between $500,000 and $10M, based on the opportunity Ownership - Typically investing in privately held entities Syndication - A strong investor group and board; typically QCV co-invests with financial VCs
SOLICITING INVESTMENTS: Suppliers of Venture Capital – 25-Year Average
Professional Venture Capital Investing Cycle
ORGANIZING THE FUND:VC Fund Placement Memorandum
Front-matter DeclarationsState Securities DisclosuresOffering SummaryFund OverviewExecutive SummarySummary of Terms
Fund is Formed, Investments Made, New Fund Created
Useful TermsCarried Interest:portion of profits paid to the professional venture capitalist as incentive compensation
Two and Twenty Shops:investment management firms having a contract that gives them a 2% of assets annual management fee and 20 percent carried interest
OBTAINING COMMITMENTS:Arrangements with Fund Investors
Capital Call:when the venture fund calls upon the investors to deliver their investment funds
Common to require subsequent investments consistent with the levels of investors’ initial contributions
DUE DILIGENCE AND ACTIVE INVESTING: VC Fund Management
Deal flow:flow of business plans and term sheets involved in the venture capital investing process
Due diligence (in venture investing context):process of ascertaining the viability of a business plan
VC and Angel Screening - Venture Characteristics
ProprietaryGrowthFounder CommitmentExperienceTrack Record
ManagementFire WithinBusiness ModelBusiness PlanDeal StructureExit Plan
Screening Outcomes
Seek lead investor positionSeek a non-lead investor positionRefer venture to more appropriate
financial market participantsSLOR (standard letter of rejection) the venture
Structuring an Equity InvestmentTerm Sheet:summary of the investment terms and conditions accompanying an investment
Typical Issues Addressed in a Term SheetValuationOngoing funding needsSize and staging of financingPreemptive rights on new issuesCommitments for future financing rounds and performance conditionsForm of security or investmentRedemption rights and responsibilities
Structuring (cont’d)Typical Issues Addressed in a Term Sheet
Dividend structure (Number of VCs and outsiders)Additional managementBoard appointmentsConversion value protectionRegistration rightsExit conditions and strategyIPO-dictated events (e.g. conversion)Co-sale rights (with founders)Lock-up provisions
Structuring (cont’d)Typical Issues Addressed in a Term Sheet
Employment contracts
Incentive options
Founder employment conditions: compensation, benefits, duties, firing conditions, repurchase of stock o termination, term of agreement, post-employment activities and competition
Founder stock vesting
Confidentiality agreements and protection for intellectual property
Exit Strategies
Acquisition -- least costly of exit strategiesPublic Offering -- most costly, but exciting and maintain some control (Future Lecture?)Joint Venture -- intermediate strategyEquity Buyback -- expensive, but way to get venture capitalists out of business
Summary - Advantages and Disadvantages of VC Funding
EquityOversightControlOver payment for fundsNeed to have exit strategy
Contractual CommitmentsLegal and paperworkMarketing and Management AssistanceLeverage for debt financingNetworking for additional funds and contacts
Grant and Guerrilla Financing
Grant FinancingGovernment and Private Grants for R&D and Commercialization
No equityAmount may be about $10billion per year in U.S. (angel financing about $20billion per year) – largest in segments which are funded
Grant FinancingSmall Business Innovation Research (SBIR)
DoD, NASA, DHS, DoC, EPA, DoT, DoEd, DoE, HHS (NIH), NSF & USDA The SBIR Program provides up to $850,000 in early-stage R&D funding directly to small technology companies (or individual entrepreneurs who form a company);
• Phase 1 ($75,000)• Phase II ($750,000)• Phase III (sell product)
Small Business Technology Transfer & Research (STTR)
The STTR Program provides up to $850,000 in early-stage R&D funding directly to small companies working cooperatively with researchers at universities and other research institutions;
Grant Financing
Department of Defense: SBIR/STTR/Fast Track - Main PageTechLink : : Links to Department of Defense, DoD Component, and Related Websites for SBIR/STTR Information
Grant FinancingOther Grants (CCAT, TechLink, BAAs, etc) Local and Regional Economic Development Grants
Industrial Development BondsTax BreaksOther Incentives
Private Foundations
Guerrilla Financing
Credit CardsRelatives and FriendsTrade CreditRevenue FinancingSmall Shares, with buyback provisionFactoring
BOOTSTRAPPING