VCIC PREP SESSION

“VC 101”

Prepared by P a t r i c k Ve r n o n

Dir. of Venture Initiatives

©2014 UNC Kenan-Flag ler

What is Venture Capital?

Institutional equity investments

in high growth startups.

Institutional equity investments in high growth startups.

Institutional Professional money managers

Equity Investments

Private equity (not public, not debt), shared ownership

High Growth Hit-driven investment thesis

Startups Debatable term, not mature businesses

What is a VC’s Job?

Return 20-25%

to Their Investors (Limited Partners, or LPs)

Question?• How is a VC similar to a mutual fund manager? • Different?

What is a VC?• Professional money manager • Private equity • High risk/return • Portfolio of investments

What is Venture Capital?• Asset class• Subset of private equity• High risk, high return• Hit driven

Early Venture Firms

1962: Draper and Johnson Inv. Co.

1969: Venrock (renamed)

1972: Kleiner Perkins, Sequioa

1985: Draper Fisher Jurvetson

Example: Kleiner Perkins• 1980: KPCB II $55M• 1989: KPCB V $150M• 2000: KPCB X $750M• 2010: 3 funds closed: nearly $2B

VC Job Duties

1. Fundraising

2. Sourcing deals

3. Investing

4. Growing ventures

5. Exiting

VC Job Cycle

Fundraise

1. Close Fund Source Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

VC’s Job Cycle

Fundraise

1. Close Fund Source Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

Raising a Fund

• VC fund is a partnership• GPs (general partners) are the VCs who

actively invest the fund in startups• LPs (limited partners):

– Financial investors with no active role– “Institutional” - pension funds, university

endowments, insurance companies, etc.

VC Cash Flow

Startup

Startup

Startup

Startup

StartupStartup

Startup

Startup

Startup

Startup

Startup

$$

$$

$$

$$

$$

$$

VC Firm

VC Cash Flow

LP2

LP3

LP4

VC Firm(General Partners

GPs)

Fund 1$$$$

LimitedPartner

LPn

$$

$$

$$

$$

$$

Startup

Startup

Startup

Startup

StartupStartup

Startup

Startup

Startup

Startup

Startup

$$

$$

$$

$$

$$

$$

LP2

LP3

LP4

VC Firm(General Partners

GPs)

LimitedPartner

LPn

$$

$$

$$

$$

$$

Fund I Fund II

Fund III

Fund IV

Raising a Fund

LP2

LP3

LP4

VC Firm(GPs)

Fund 1$$$$

LP1

LPn

Pledge $$

Pledge $$

Pledge $$

Pledge $$

Pledge $

$

Raising a Fund

CalPERS

Morgan Creek Capital

VC Firm(GPs)

Fund 1$$$$

UNC Endowment

AIG

Pledge $$

Pledge $$

Pledge $$

Pledge $$

Pledge $

$

ExampleNC Pension

Fund

Commitments only. No actual cash changes hands.

“Capital Call”

CalPERS

Morgan Creek Capital

VC Firm(GPs)

Fund 1$$$$

UNC Endowment

AIG

Series A

Capital Call

Capital Call

Capital Call

Capital C

all

NC Pension Fund

Capital Call

Startup

VC’s Job Cycle

Fundraise

1. Close FundSource Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

Source Deals: High Growth• Tech

– Social media– SaaS– Hardware

• Media• Cleantech

• Life Sciences – Med Device– Therapeutics – Biotech

• Healthcare IT

Source Deals: Network• Lawyers, CPAs, CFOs, bankers• Other VCs (syndication)• Serial entrepreneurs• Conferences• Universities

– Technology transfer– Teach, coach, mentor, judge

Due Diligence• Research to decide whether or not to invest• Includes meeting with the founders • Rely on vast network of experts

VC’s Job Cycle

Fundraise

1. Close FundSource Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

Equity Investing• Buying % of startup• Exchange cash for new “preferred” shares of stock• Not debt

Typical Growth of Bootstrap Venture

Normal bootstrap businessgrows steadily (if you’re lucky).

Rounds of Equity Funding

(Gross Approximations)

Friends/Family

$1,000-$100,000

Seed or Pre-Seed

$50,000-$250,000

Angel

$100,000 - $1,000,000 IPO or

M&A or Later Stage

PE

$2-3M | $5-15M | $25M+

Early Late

VC Rounds A, B, C…

(Institutional)

How Does a Round Work?

Pre-Money Valuation

+

Investment

=

Post-money Valuation

$

$

$$

+

=

Simplified Example: “1 on 2”

Investment $1M

Pre-Money Valuation

$2M $2M Pre-Money+ $1M Investment

= $3M Post

Simplified Example: 1 on 2

Investors33%

Founders67%

Mechanics Include Shares

1,000,000 Preferred Shares

at $1/ea.

2,000,000Founders Shares

@ $1/ea.

New shares created and assigned to

investorsShares created in

articles of incorporation

How Does a Round Work?

Negotiated Pre-Money Valuation

+

Negotiated Investment

=

Post-money Valuation

$

$

$$

+

=

VC’s Job Cycle

Fundraise

1. Close Fund Source Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

Growing Ventures

• On the Team– “Active” participation = board seat(s)– Advisors (connections, strategy, etc.)

• Future rounds– Valuation – Milestones– Syndication

Board Seats

• Board of directors controls the venture (unlike board of advisors)

• Small ventures have small boards that meet often (quarterly), 3-7 members

• Odd number to prevent ties• % ownership of stock should be

(approximately) reflected in % of board seats– E.g. own 60% of stock, control 3 of 5 seats

Advisors

• Even if not on board, VCs will have strategic input

• VC network benefits– Management team additions– Customers– Partners– Competitors

Future Rounds

• Future rounds are the norm, not the exception (most entrepreneurs do not realize this)

• VCs help find “syndicate” investors– Later rounds can be much larger– New network benefits

• Up round: valuation is higher and investment is (usually) higher

• Down round: valuation is lower

Year 0 510

Fund Life: 10 Years

Invest and Reserve

Follow-On Rounds

Harvest

“Raise” Fund

Example Successful Investment

Invest and Reserve

Follow-On Rounds

HarvestS

erie

s A

Due Diligence

HitMilestones

HitMilestones

Ser

ies

B

EX

IT

0 2 3 5 8 10

Fin

d D

eal

A Pattern That Repeats

A B Exi

t

0 2 3 5 8 10

One of Many

0 2 3 5 8 10

A B

Exi

t

0 2 3 5 8 10

A B

A B

Portfolio of 10-25 Investments

A B

A B C

A B

A B

Bu

st

A

Bu

st

BA

Bu

stA

Bu

st

A B C

A

D

B

Exi

t

Exi

t

Big

Exi

t

Exi

t

Startup

Startup

Startup

Startup

Startup

Invest

Startup

Startup

Startup

Startup

Startup

Startup

Portfolio

VC Firm(GPs)

$$

$$

$$

$$

$$

$$

Fund 1$$$$

Capital Call $$

Capital Call $$

Capital Call $$

Capital Call $

$

Capital C

all $

$

LP2

LP3

LP4

LP1

LPn

Future Rounds

• VCs in Series A almost always join Series B– “Pro rata” means they invest to keep same %

ownership– aka, “maintain position”

• In a hits-driven business, not maintaining a position is the third rail– “Last money in” dictates the terms

Future Rounds

It is absolutely imperative that you reserve funding for future rounds!

Your analysis of the deal at VCIC must include assumptions about future rounds and the exit.

VC’s Job Cycle

Fundraise

1. Close Fund Source Deals

2. Invest Grow Ventures

3. Exit Fundraise…

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise

VC Return• “Top Quartile” venture firms return >20% average ROI to

LPs• Fund has life of 10 years• Average investments are 5-7 years

Big

Exi

t

0 2 3 5 8 10

A B

A B

Portfolio of 10-25 Investments

A B

A B C

A B

A B

Bu

st

A

Bu

st

BA

Bu

stA

Bu

st

A B C

A

D

B

3

2

5

6

8

9

11

10

Exi

t

Exi

t

Exi

t4

1

7

0 2 3 5 8 10

A B

A B

Exit Scenario

A B

A B C

A B

A B

Bu

st

A

Bu

st

BA

Bu

stA

Bu

st

A B C

A

D

B

Exi

t

Exi

t Big

Exi

t

Exi

t

?

?

?

Bust Exit ?

Startup

Startup

Startup

Startup

Startup

Invest

Startup

Startup

Startup

Startup

Startup

Startup

Portfolio

VC Firm(GPs)

$$

$$

$$

$$

$$

$$

Fund 1$$$$

Capital Call $$

Capital Call $$

Capital Call $$

Capital Call $

$

Capital C

all $

$

LP2

LP3

LP4

LP1

LPn

Single

Exits

HomeRun

dud

dud

dud

Triple

VC Firm(GPs)

Fund 1$$$$

$$

$$

$$

dud

dud

dud

dud

Single

Single

Double

dud

$$$$$$$$$$

$$

$$

$$$$

$

$

$$

$$

Single

LP2

LP3

LP4

LP1

LPn

Fund Return Examples• 150M fund• Fees: 3M/year (salaries, rent, travel)• 12 portfolio ventures at $10M avg. investment• To get 20% ROI, we need ~$450M

(20% of 150M = $30M x 10 years)– That’s two ventures going 20X!!

Getting to 20% ROI• Rule of thumb: 3X on entire fund• However, each investment is not 10 years

– Money not “put to work” until a capital call– Exit could happen before end of fund

• You could reach 20% with only 1.5X

Deal Return Example• VCIC Round A: Negotiate 1 on 2

– $1M investment on $2M pre, post-money = $3M– Ownership for VCIC firm, 33%

• Assume B Round: 3 on 9– $3M investment on $9M pre, post-money = $12M– Ownership for VCIC firm: 25% + (33% of 75%) = $50%

• Assume Exit of $80M at acquisition• VCIC fund return: $40M/$4M = 10X

See “VCIC Math Help.ppt” for more about deal structure.

What is a VC’s Job?

Return 20-25%

to investors (LPs)

1. Close Fund

Source Deals

2. Invest

Grow Ventures

3. Exit

Fund-raise