How Venture Capital is Like a Relationship

Copyrighted—All Rights Reserved

2011Copyright by Lisa Suennen

Innovation in Healthcare - Haas School of Business

Meet, Fall in Love, Then What?

How Doing a Venture Deal is Like a Relationship

CONFIDENTIAL 2Copyrighted—All Rights Reserved

The Venture Deal—Start to Finish


How a Venture Deal is Like a Relationship

Dating Scene

The Courting Phase

Engagement & the

Prenuptual Agreement

Building the Family

Golden Anniversary

Things go

badly

Break up

Things go

badly

Break up

Things go

badly

Divorce

Deal Due Term Due Deal Portfolio Positive or Identification Diligence Sheet Diligence Closing Management Negative Exit

Things go well

Marriage

Things go well

Things go well

Things go well

Defining Your Perfect Match

The

Pick-Up


Defining Your Perfect Match

When starting a venture fund, you have to think like eHarmony:– What do I want in a mate, er, I mean deal?– What age/stage– What size/shape/structure– What are my “gotta haves”?– What are my “no ways”?– How do I know the deal of my dreams when I see it?– How am I going to communicate with my mate ‘til exit?

Ultimate output of this process is an investment model that is more specific than: “big target market and it will make lots of money”

– What am I looking for, conceptually and culturally?– What attributes does it need to have?– What corporate governance structures do I want to utilize


The Perfect Match: Refining Deal Selection

Key considerations as you form your investment model and select deals:

– Healthcare vs. Life Sciences• Two very different types of investing

– What are your specific financial goals?

– What is your time horizon?

– Risk tolerance (belt & suspenders vs. “cowabunga, dude!”)

• Innovation (transformational vs. evolutionary)• Stage (lower valuation vs. lower risk)• Deal Size (runway vs. dilution)• Syndicate (risk sharing vs. control)


Psilos Investment Model: Investing to Improve the Healthcare Economy

Sole focus on healthcare: services, IT and medical technology Identification of businesses that improve the healthcare economy:

• Lower cost and improve quality• Align the incentives of payers, providers and patients • Contribute to transforming the healthcare system into a value-based economy

Later stage venture and growth equity • Series B or later• Invest to finance market adoption of

proven business models and technologies– Avoid: clinical/technology risk– Accept: market/execution risk

• Approximately 5-6 year holding period Structure

• Purchase majority of senior security• Maintain voting power over key decisions• Limited syndication

“Ownership” approach to portfolio company monitoring and selection

– Always the lead investor– Highly active and value-added board members – Strong partnership with management


Entering the Dating Scene

Where deals come from:– Referrals from known sources (VCs, industry colleagues, etc.)– Investment banks and placement agents– Other portfolio companies– Original research– Over the transom

Managing the “funnel”—welcome to speed dating

– An average year at Psilos:• 800 or so plans in the door• 300 or so company meetings• 20-25 serious looks• 2-3 deals closed

Portfolio “balancing”


The Pick-up: Now What?

You think you’ve got a live one…now what do you do to advance the relationship?

Here’s where the real work begins


The Courting Phase: Doing Your Due Diligence

The due diligence process– Create a due diligence plan and checklist– Data vs. conventional wisdom– There’s no way you know everything so

hire experts who know what you don’t

Rules of the road– Everything they tell you is only sort of true– Nothing is sacred – don’t be shy– Don’t check only the references they give you– Talk to lost customers not just current ones– Don’t be afraid to speak with the competitors– Don’t be seduced by the “brand name” investors– Talk to the rank and file, not just management– No one gets to $100MM in 4 years, but every business plan says they will– With respect to market adoption, assume everyone’s interests are financial first– It always takes longer and more money than they say it does– Remind the CEO you will probably fire him/her someday and note the response– Be extremely respectful of their confidential information


The Pre-Nup: Term Sheets and Setting the Deal Ground Rules

The Term Sheet:– Defines the financial terms on which you will

invest.– Sets for the “rules” for the due diligence

process, deal timeline, closing, and life after closing

– Outlines the fundamental understanding between the company and the investor about how the relationship will be conducted

– Lays out what happens if due diligence leads to deal break-up

– Is the first test of how the parties get along


The Pre-Nup: Term Sheets and Why Structure Matters

Key Term Sheet Features:– Who is investing (syndicate)– Price and valuation and capitalization

• Equity• Debt

– Use of funds– Terms of the security you are buying

• liquidation preferences• seniority• dividends• conversion and redemption rights

– What happens in future financings• pre-emptive rights• anti-dilution protection

– Voting and protective provisions– Board structure and other corporate governance terms– Employment agreements and stock options– Definition of exit (liquidation)– Exclusivity and no-shop provisions (binding terms)– Conditions to close the financing (due diligence)


The Break-Up:Knowing When to Leave Them at the Altar

You must always reserve the right to change your mind– Never sign a binding term sheet (unless you have to)

– It ain’t over ‘til the fat lady signs the deal documents

Reasons to run, not walk, from a deal:– You find out your original hypothesis

was just plain wrong—don’t drink your your own Kool-Aid

– Dishonesty on the part of management

– Questionable intellectual property claim

– Squirrelly clinical data

– Squirrelly financial audit

– Worrisome lawsuit


Marriage: Getting the Deal Inked

Starts with a very detailed term sheet Use an experienced lawyer with good business savvy Get to know your deal documents

– Certificate of Incorporation

– Purchase Agreement

– Schedule of Exceptions

– Shareholder Agreement

– Investor Rights Agreement

– Management Rights Agreement

– Indemnification Agreements

– Insurance Certificates

Stay in close touch– What changes between term

and closing?


Building the Family: Activism is Key to Successful Portfolio Management

“You get what you inspect, not what you expect” Don’t be a drive-by board member – venture capital vs. “advisory capital” Be smart money – use your experience and contacts to help the

company Stay in touch with the numbers and team

– Befriend the CFO Don’t forget long-term planning

– Product road map– Capital formation– Management succession– Exit planning


Building the Family: The [Inevitable] Next Round of Financing

Long term capital planning is a key responsibility of management and the Board

Critical issues:– Milestones– How much?– When?– Reserves in the investor base– What expertise is needed in

syndicate?– What is the “personality” of the

new investor? How will they fit with the family?

What special rights can the early investor retain?

What does the early investor have to give up, if anything?


Golden Anniversary vs. Divorce: The Exit

The “Good Way” (M&A, IPO, Other sale)

• In the timeframe you want to go

• At the price you want to get (meets your fund’s IRR/multiple goals

• With terms you can live with

• So you can get your money out fast

The “Bad Way” (fire sale, bankruptcy)

• Because you have to go

• Business idea failed

• Lost the race to a competitor

• Ran out of money; inadequately capitalized

• At a lousy price without a return

• Money held hostage in lengthy escrow/earn-out


Your Role in Helping the Company Exit Well

Internal– Set clear expectations about your exit

goals– Set clear expectations about milestones

you expect to see and when– Be brutally honest about management’s

capabilities; act fast when it’s time for a change

– Advise management on resources (bankers, accountants, lawyers) that facilitate a more effective exit

– Assist in negotiation of the exit

External– Know the buyers and ask them what they are looking to buy– Introduce management to the players that affect their potential exit– Know the investment bankers and understand the public and M&A market

requirements and conditions


And Now for Something Ideological….

• If you have two companies that make similar products, which is worth more: the one that has a better clinical outcome or the one that has higher sales?

• If you know you can get a great deal on the cheap by blowing up your fellow investors (diluting their equity value), should you do it?

• The U.S. healthcare system is a mess: should venture capitalists have a responsibility to add value to the system or just make money?

Economy & Finance

How Venture Capital is Like a Relationship