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Venture Capital Venture Capital and theand theEmerging Technology CompanyEmerging Technology Company

Hastings College of the LawHastings College of the Law

Mark BaudlerMark Baudler

Rob KornegayRob Kornegay

Spring 2008Spring 2008

2

Week 1: Introduction and Week 1: Introduction and OverviewOverview

Agency Theory to Agency Theory to

Financial ContractingFinancial Contracting

3

Introduction and Introduction and HousekeepingHousekeeping

Our backgroundOur background

Your backgroundYour background

4


Class rosterClass roster

Class participationClass participation

5


Course materialsCourse materials• Course syllabusCourse syllabus• Distributed readings and materials Distributed readings and materials

(required)(required)• ““Caselettes” and problem sets (required)Caselettes” and problem sets (required)• Course statutes and regulations (required)Course statutes and regulations (required)• Posted powerpoint presentations (pdf Posted powerpoint presentations (pdf

format)format) Class preparationClass preparation

6


Meet Monday afternoons 4:30-6:30pmMeet Monday afternoons 4:30-6:30pm• See semester class schedule See semester class schedule • Evening routine (breaks, questions, etc.)Evening routine (breaks, questions, etc.)

Our accessibility: Our accessibility: • after each class, and at the office after each class, and at the office

650-320-4597 Mark650-320-4597 Mark 650-320-4533 Rob650-320-4533 Rob

Email: Email: • [email protected]@wsgr.com• [email protected]@wsgr.com

7


Required course pre-requisite: Required course pre-requisite: • Business Organizations Business Organizations

Class communications: emailClass communications: email• Weekly postings and announcementsWeekly postings and announcements• Powerpoints will be posted before or Powerpoints will be posted before or

after each classafter each class

8


Grade componentsGrade components• 100% final exam100% final exam• Discretion to recognize class Discretion to recognize class

participationparticipation Final exam Final exam

• Short answer/multiple choiceShort answer/multiple choice• Hypothetical fact situations with essay Hypothetical fact situations with essay

questionsquestions• 2 hours—open book (bring a calculator)2 hours—open book (bring a calculator)

9

Course ObjectivesCourse Objectives

A basic understanding of the legal A basic understanding of the legal and business issues that are and business issues that are involved in the growth cycle of the involved in the growth cycle of the venture-backed technology venture-backed technology companycompany

A mainstream view from the A mainstream view from the perspective of Silicon Valleyperspective of Silicon Valley

The corporate lawyer as business The corporate lawyer as business counselorcounselor

10

Course ObjectivesCourse Objectives

Multi-disciplinary approach: Multi-disciplinary approach: • Business judgment and evaluationBusiness judgment and evaluation• AccountingAccounting• TaxTax• PsychologyPsychology• ProcessProcess• LawLaw

11

Course OutlineCourse Outline

Theories of financial contracting Theories of financial contracting High level view of the venture capital High level view of the venture capital

industry industry Venture capital: basic fund structureVenture capital: basic fund structure Start-ups: basic organizational mattersStart-ups: basic organizational matters Stock in the start-up environmentStock in the start-up environment Valuation of start-upsValuation of start-ups

12

Course OutlineCourse Outline

Primer on federal and state Primer on federal and state securities lawssecurities laws

Equity incentive plans and Equity incentive plans and arrangementsarrangements

Venture financing: term sheets and Venture financing: term sheets and related issuesrelated issues

13

Guest SpeakersGuest Speakers

Venture CapitalistVenture Capitalist• To be determinedTo be determined

Entrepreneur/CEO Entrepreneur/CEO • Jason Knight and Mark Hedlund of Jason Knight and Mark Hedlund of

Wesabe, Inc.Wesabe, Inc.

14

Principal Legal ResourcesPrincipal Legal Resources

California Corporations CodeCalifornia Corporations Code• California General Corporation LawCalifornia General Corporation Law• Delaware General Corporations LawDelaware General Corporations Law• California Corporate Securities LawCalifornia Corporate Securities Law

– California Department of CorporationsCalifornia Department of Corporations

15

Legal Resources Legal Resources

Federal Securities LawFederal Securities Law• Securities Act of 1933Securities Act of 1933• Securities Exchange Act of 1934Securities Exchange Act of 1934

Other Legal Resources (but we Other Legal Resources (but we won’t cover)won’t cover)• Nasdaq Corporate Governance RulesNasdaq Corporate Governance Rules• Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002• SEC rules and releasesSEC rules and releases

The Players in the The Players in the Technology CommunityTechnology Community

The Public Equity MarketsThe Public Equity Markets

Venture CapitalistsVenture Capitalists

Angel InvestorsAngel Investors

AccountantsAccountants LawyersLawyers

Investment BankersInvestment Bankers

The UniversitiesThe Universities

Silicon Valley InfrastructureSilicon Valley Infrastructure

Technology, IncTechnology, Inc

16

Some Names of the Some Names of the Supporting CastSupporting Cast

Venture CapitalVenture Capital MayfieldMayfield

Sequoia CapitalSequoia Capital

Kleiner PerkinsKleiner Perkins

Accel PartnersAccel Partners

New Enterprise AssociatesNew Enterprise Associates

US Venture PartnersUS Venture Partners

Lightspeed VenturesLightspeed Ventures

Panorama CapitalPanorama Capital

Bessemer VenturesBessemer Ventures

Hummer WinbladHummer Winblad

Opus CapitalOpus Capital

Sutter Hill VenturesSutter Hill Ventures

Battery VenturesBattery Ventures

Draper Fisher JurvetsonDraper Fisher Jurvetson

Accounting FirmsAccounting Firms Pricewaterhouse CoopersPricewaterhouse Coopers

Deloitte & ToucheDeloitte & Touche

Ernst &YoungErnst &Young

KPMGKPMG

____________________________

Grant ThorntonGrant Thornton

BDO SiedmanBDO Siedman

Frank Rimerman + CoFrank Rimerman + Co

Investment BanksInvestment Banks Credit Suisse First BostonCredit Suisse First Boston

Goldman SachsGoldman Sachs

Morgan StanleyMorgan Stanley

UBS Investment BankUBS Investment Bank

Deutsche Bank SecuritiesDeutsche Bank Securities

Thomas Weisel PartnersThomas Weisel Partners

Bank America SecuritiesBank America Securities

Lehman BrothersLehman Brothers

Law FirmsLaw Firms Cooley GodwardCooley Godward

DLA Piper RudnickDLA Piper Rudnick

Fenwick & WestFenwick & West

Latham & WatkinsLatham & Watkins

Gibson Dunn & CrutcherGibson Dunn & Crutcher

Morrison & FoerrsterMorrison & Foerrster

OrrickOrrick

Pillsbury & WinthropPillsbury & Winthrop

Shearman & SterlingShearman & Sterling

Wilson Sonsini Wilson Sonsini Goodrich & RosatiGoodrich & Rosati

17

18

Agency Theory & Financial Agency Theory & Financial ContractsContracts

The corporation as a nexus of contractsThe corporation as a nexus of contracts

Agency theory focuses on the relationship Agency theory focuses on the relationship between the shareholder (principal) and the between the shareholder (principal) and the manager (agent).manager (agent).

Legal Entity

SuppliersSuppliers Management

Management Shareholder

s

Shareholders

Customers

Customers

Creditors/Lenders

Creditors/Lenders

Employees

Employees

19


““The directors of such [joint-stock] companies, however, The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than being the managers rather of other people’s money than of their own, it cannot be well expected, that they should of their own, it cannot be well expected, that they should watch over it with the same anxious vigilance with which watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their consider attention to small matters as not for their master’s honour and very easily give themselves a master’s honour and very easily give themselves a dispensation from having it. Negligence and profusion, dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the therefore, must always prevail, more or less, in the management of the affairs of such a company.”management of the affairs of such a company.”

Adam SmithAdam SmithThe Wealth of Nations The Wealth of Nations

(1776)(1776)

20


Agency relationship exists where a Agency relationship exists where a principalprincipal delegates decision-making authority to an delegates decision-making authority to an agentagent..

Shareholder/Manager is example of principal Shareholder/Manager is example of principal agent relationshipagent relationship

Challenge is to create financial contract Challenge is to create financial contract structures that align interests of structures that align interests of shareholders/managers in order to minimize shareholders/managers in order to minimize agency costsagency costs..

Agency costs refer to the lost benefit to the Agency costs refer to the lost benefit to the principal because the interests of the agent may principal because the interests of the agent may diverge from those of the principal. diverge from those of the principal.

““Shirking” – actions by managers that diverge Shirking” – actions by managers that diverge from the interests of shareholders.from the interests of shareholders.

21


Corporation’s capital composed of Corporation’s capital composed of generally alienable, divisible claims generally alienable, divisible claims on the assets and cash flows of the on the assets and cash flows of the corporationcorporation• Equity Claims of StockholdersEquity Claims of Stockholders• Debt Claims of CreditorsDebt Claims of Creditors

22


Problem of Information AsymmetriesProblem of Information Asymmetries• Economic impact on markets where one party Economic impact on markets where one party

has more or superior informationhas more or superior information Used Car Market As Classic ExampleUsed Car Market As Classic Example

• George A. Akerlof, “The Market for Lemons: George A. Akerlof, “The Market for Lemons: Quality Uncertainty and the Market Quality Uncertainty and the Market Mechanism,” Mechanism,” Quarterly Journal of EconomicsQuarterly Journal of Economics (August 1970)(August 1970)

Impact on Market Pricing → Bad Drives Impact on Market Pricing → Bad Drives Out the GoodOut the Good

23


Adverse Selection / “Rational Paranoia”Adverse Selection / “Rational Paranoia”• Common knowledge that someone (the Common knowledge that someone (the

informed party), knows more than someone else informed party), knows more than someone else (the uninformed party), and the uninformed (the uninformed party), and the uninformed party will draw inferences from the actions party will draw inferences from the actions taken and decisions made by the informed partytaken and decisions made by the informed party

• “’“’Rational paranoia” because when there is a Rational paranoia” because when there is a conflict of interest, it often involves drawing the conflict of interest, it often involves drawing the conclusion that the informed party might be conclusion that the informed party might be taking an action that is not helpful to the taking an action that is not helpful to the uninformed partyuninformed party

AKA – the Groucho Marx theoremAKA – the Groucho Marx theorem Examples: InsuranceExamples: Insurance

24


Moral HazardMoral Hazard• The risk that one party to a contract The risk that one party to a contract

may change their behavior to the may change their behavior to the detriment of the other party once the detriment of the other party once the contract has been concludedcontract has been concluded

Examples: Automobile InsuranceExamples: Automobile Insurance

25

GOLDMAN SACHS IPOGOLDMAN SACHS IPO

26

Review – Agency Theory and Review – Agency Theory and Financial ContractingFinancial Contracting

Agency Cost – diminution in value of Agency Cost – diminution in value of enterprise relative to the value realized enterprise relative to the value realized if agent acted solely in the interest of if agent acted solely in the interest of the principalthe principal

Impact of Information AsymmetriesImpact of Information Asymmetries Moral HazardMoral Hazard

27

Venture Capital Venture Capital Industry Industry OverviewOverview

Powered

By:

28

U.S. FundraisingU.S. Fundraising

29

U.S. Fundraising Slows in 1H’07Commitments to Venture Capital Funds

$6.4

$24.7$25.4

$17.9

$9.9$13.1

$50.2

$83.2

$57.3

$26.7

$17.2

$0

$20

$40

$60

$80

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07

Funds

Rai

sed

($B)

30

Fund Sizes on Track Through 1stHalf 2007 Median VC Fund Size (for funds greater than $20M)

$201$194 $190

$156

$100

$75

$112$100

$118

$100

$83

$0

$50

$100

$150

$200

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07

Med

ian F

und

Siz

e ($

M)

31

Funds Continue to Get LargerAllocation of Fund Size by Number of Funds Raised per Vintage Year

24%

23%

31% 29%

67%

32%

13%

26%29%

7%

71%

34%

0%

20%

40%

60%

80%

100%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07

Under $100M

$100M-$249M

$250M-$499M

$500M-$999M

$1B+

32

U.S. Investment: U.S. Investment: OverallOverall

33

$13.1$17.9

$49.5

$94.8

$36.5

$22.1 $19.7 $22.4 $24.2 $27.2$22.7

1976

25772477235422262432

3321

6351

4590

2547

2211

$0

$25

$50

$75

$100

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

0

1,000

2,000

3,000

4,000

5,000

6,000

Amount Invested ($B) Number of Deals

Am

ount

Inve

sted

($B

) Num

ber of D

eals

2007 Investment On TrackDeal Flow and Equity into Venture-Backed Companies

Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07

34

$8.1$7.5$7.2

$6.3

$7.5$7.0

$6.5$6.1$6.1

$6.7

$5.2$5.4$5.3

635

727

614603

676676622

664621636

556614

546

$0

$3

$6

$9

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

0

150

300

450

600

Amount Invested ($B) Number of Deals

Equity Jumps in 3Q07Deal Flow and Equity into Venture-Backed Companies

Am

ount

Inve

sted

($B

) Num

ber of Deals

Source: Dow Jones VentureOne/Ernst &Young

35

Early Stage Investing Steady in 3Q’07Deal Flow Allocation by Round Class

0%

20%

40%

60%

80%

100%

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

Restart

Later

Second

First

Seed% o

f Tot

al V

C R

ounds

*Seed and First Rounds Combined

*36%

20%

37%

7%

*38%

37%

22%

*41%


4%

23%

38%

9% 4%

31%

17%

*34%

36

Seed and First Round Allocation Increases Deal Flow Allocation by Round Class (Annual)

0%

20%

40%

60%

80%

100%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Restart

Later

Second

First

Seed

% o

f Tot

al V

C R

ound

s

*49%


*39%

24%

33%

26%

35%

4%

*54%

22%

36%

2%8%


20%

20%

*31%

YTD07: 1Q07 –3Q07

37

Dollars Allocated to Later Stage Remains StrongInvestment Allocation by Round Class

0%

20%

40%

60%

80%

100%

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

Restart

Later

Second

First

Seed

% o

f Dol

lars

Inve

sted


5%

*23%

51%

21%

*26%

45%

23%

27%

52%

10%


6%

*27%*21%

42%

38

Median Deal Size Increases in 3Q’07Median Amount Invested Per Financing Round

$6.0

$6.7$7.0

$6.3 $6.2

$7.0 $7.1 $7.0 $7.0

$7.6 $7.5$7.9

$7.0

$0

$3

$6

$9

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

Med

ian A

mou

nt

Inve

sted

($M

)


39

Later Rounds Climb in 3Q’07Median Amount Invested by Round Class , VC Only

$12.4

$8.8$8.4

$9.0

$5.4

$4.3

$0.9$0.9

$0

$2

$4

$6

$8

$10

$12

$14

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

Later Round Second Round First Round Seed Round

Medi

an A

mou

nt

Inve

sted

($M

)


40

Median of Later Rounds Continue To IncreaseMedian Amount Invested by Round Class (Annual), VC Only

$8.4

$5.0

$1.0

$11.5

$5.8

$5.1$3.5

$1.0

$0

$5

$10

$15

$20

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Later Round Second Round First Round Seed Round

Medi

an A

mou

nt

Inve

sted

($M

)


41

Number of Deals with 2 or Fewer Investors Continues to RiseNumber of Investors Per Round

34% 32%

22%

16% 16%

10% 12%

18% 18%

28%

22%

22%

20%

15%

30%

0%

20%

40%

60%

80%

100%

1997 1999 2001 2003 2005 YTD07

5+ Investors

4 Investors

3 Investors

2 Investors

1 Investor


42

U.S. Investment: U.S. Investment: RegionsRegions

43

West Coast Dominates Venture InvestmentRegional Investment in the United States YTD07

New England12%

Southern California

14%

Texas4%

Bay Area 31%

All Other US23%

New York Metro7%

Potomac3%

Washington State4%

Research Triangle

2%


44

West Coast Leads Venture DealsTotal Number of Deals in the United States YTD07

Bay Area 31%

New England12%

Southern California

11%

Texas4%

Potomac4%

All Other US24%

New York Metro 8%

Research Triangle

2%

Washington State4%


45

U.S. Investment: U.S. Investment: ValuationsValuations

46

Valuations Dip in 1H’07Median Premoney Valuation by Year, VC Financings Only

$9.3

$12.9

$15.4

$21.0

$25.2

$15.8

$10.8 $10.0

$12.9

$15.0

$18.0$16.3

$0

$5

$10

$15

$20

$25

1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07

Med

ian P

rem

oney

Val

uation

($M

)

47

2Q’07 Valuations FlatMedian Premoney Valuation, VC Financings Only

$13.6$12.5 $12.0

$15.0$15.8

$11.9

$16.0 $16.6$17.8 $18.0

$21.0

$16.1 $16.3

$0

$5

$10

$15

$20

$25

2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07

Med

ian P

rem

oney

Val

uation

($M

)

48

First & Second Round Valuations Climb in 2Q’07Median Premoney Valuations by Round Class (All Industries)

$31.5

$29.8

$16.1$15.0

$8.7$5.4

$0

$10

$20

$30

$40

2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07

Later Stage Second Round First Round

Medi

an P

rem

oney

Val

uat

ion ($M

)

49

U.S. LiquidityU.S. Liquidity

50

Exit Via IPO Increasing Vs. M&APercentage Breakdown of Venture Backed Liquidity Events: IPO vs. M&A

0% 20% 40% 60% 80% 100%

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

YTD07

IPOs M&AsYTD07: 1Q07 –3Q07

51

M&A Transaction Count Down in 2007Transactions and Amount Paid in M&As

$28.4$31.9$30.5

$24.0

$13.3$11.0

$22.4

$98.6

$43.3

$14.8$12.7

279

420414422

346383

407

307

253232

462

$0

$25

$50

$75

$100

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

0

150

300

450

Amount Paid ($B) Number of Transactions

Am

ount

Paid

($B

)Num

ber of T

ransactions

YTD07: 1Q07 –3Q07

52

Median Amount Paid Soars in 2007 Median Amount Paid in M&As vs. Median Amount Raised Prior to M&A

$6 $7

$21$22$20$20$19$17

$15$10$11

$33 $31

$55

$100

$28

$19$24

$39

$47$51

$89

$0

$25

$50

$75

$100

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

$0

$25

$50

$75

$100

Median Equity Raised Prior to M&A Median Amount Paid ($M)

Med

ian A

mou

nt

Rai

sed P

rior

to

M&

A ($M

)M

edian A

mou

nt Paid ($M

)

YTD07: 1Q07 –3Q07

53

Age of Acquired Companies Continues to RiseMedian Time From Initial Equity Funding to M&A

3.5

3.0 2.82.4

2.0

2.7

3.7

4.6

5.4

6.0

6.6

0

2

4

6

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Num

ber

of Y

ear

s

YTD07: 1Q07 –3Q07

54

Amount Raised in IPOs Highest Since 2004Deals and Amount Raised Through IPOs

Am

ount

Rai

sed ($B)

Ven

ture-B

acked IPO

s

$4.7$4.6 $3.7

$19.5 $19.0

$1.8 $1.6 $1.5

$5.0

$2.4$3.7

201

250

120

68

22 20 23

67

4356 48

$0

$5

$10

$15

$20

$25

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

0

50

100

150

200

250

Amount Raised ($B) Venture-Backed IPOsYTD07: 1Q07 –3Q07

55

IPO Activity Declines in 3Q’07Deals and Amount Raised Through IPOs

$1.7

$1.2

$0.5$0.2

$1.0

$0.7 $0.6 $0.7

$2.8

$1.2$1.2

$0.6

$1.3

14

19

9

5

17

1213

16

9

18

13

24

11

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

0

5

10

15

20

Amount Raised ($B) Venture-Backed IPOs

Am

ount

Rai

sed ($B

)Ventu

re-Backed IPO

s

56

Time to Liquidity Continues to IncreaseMedian Time From Initial Equity Funding to IPO

6.86.3

5.65.75.7

3.6

4.5

3.12.82.8

3.1

0

1

2

3

4

5

6

7

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Num

ber

of Y

ears

YTD07: 1Q07 –3Q07

57

Equity Raised Prior to IPO Continues AscentMedian Amount Raised Prior to IPO

$13

$22

$31

$47 $48 $49$55

$73

$52

$68

$58

$0

$25

$50

$75

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Med

ian A

mou

nt

Rai

sed P

rior

to

IPO

($M

)

YTD07: 1Q07 –3Q07

58

Valuations for 2007 IPOs SkyrocketMedian Pre-Valuation at IPO

$314

$202

$167

$224$226$229

$281

$362

$314

$172

$105

$0

$75

$150

$225

$300

$375

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07

Medi

an P

re-V

alua

tion

at

IPO

($M

)

YTD07: 1Q07 –3Q07

59

European European Investment: Investment: OverviewOverview

60

Perspective on European Perspective on European MarketMarketEquity Investment in Venture-Backed Companies, US Equity Investment in Venture-Backed Companies, US vs. Europe (vs. Europe ($$))

Overall Investment

3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07$0

$1

$2

$3

$4

$5

$6

$7

$8

European Equity Investment

U.S. Equity Investment

Am

ou

nt

Investe

d

($B

)


61

Industry TrendsIndustry Trends

The good news...The good news...• There clearly has been a recovery in activity and There clearly has been a recovery in activity and

investment levels in the US venture capital investment levels in the US venture capital industry from the first half of the decadeindustry from the first half of the decade– Dollars and # of deals have modestly but steadily Dollars and # of deals have modestly but steadily

increased since 2002; activity levels map back to 1995-increased since 2002; activity levels map back to 1995-1996 timeframe1996 timeframe

– Importantly, the number of seed/first round deals has Importantly, the number of seed/first round deals has increased: innovation rates are returning, as VCs are increased: innovation rates are returning, as VCs are able to focus less energy on triaging existing companiesable to focus less energy on triaging existing companies

– Top tier venture funds are willing to invest modest Top tier venture funds are willing to invest modest amounts (i.e., <$1 million) to get in early on “good deals“amounts (i.e., <$1 million) to get in early on “good deals“

– Term sheets are back to historical conventions, i.e., fair Term sheets are back to historical conventions, i.e., fair and even handed (relatively speaking)and even handed (relatively speaking)

62


The good news...The good news...• 2006 was the fourth largest year ever 2006 was the fourth largest year ever

in VC investments in the U.S.: $27 in VC investments in the U.S.: $27 billionbillion

• 2007 is on track2007 is on track– Somewhat higher from pre-bubble yearsSomewhat higher from pre-bubble years

63


The good news...The good news...• VC money for investment is abundantVC money for investment is abundant

– Silicon Valley has “market share” over #2 Silicon Valley has “market share” over #2 region, New England by a ratio of 3-to-1region, New England by a ratio of 3-to-1

– California (Silicon Valley + Southern California (Silicon Valley + Southern California) has over 40% of all VC California) has over 40% of all VC investments in the U.S.investments in the U.S.

64


The bad news...The bad news...• Spending by the Fortune 500 on IT Spending by the Fortune 500 on IT

requirements is flat, with bias against requirements is flat, with bias against purchases from startupspurchases from startups

• Startup valuations are climbingStartup valuations are climbing– Basic supply and demand: more money Basic supply and demand: more money

chasing fewer dealschasing fewer deals

65

Industry TrendsIndustry Trends The bad news...The bad news...

• Liquidity event is taking longer from Liquidity event is taking longer from the date of first fundingthe date of first funding– 2.8 years (1999) vs. 6.6 years (2007) for 2.8 years (1999) vs. 6.6 years (2007) for

an IPOan IPO– 2.0 years (2001) vs. 6.6 years (2007) for 2.0 years (2001) vs. 6.6 years (2007) for

M&AM&A– Result: more capital is required to carry Result: more capital is required to carry

the company to an exit event (e.g., $17 the company to an exit event (e.g., $17 million in 1997 to $68 million in 2007)million in 1997 to $68 million in 2007)

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Industry TrendsIndustry Trends The bad news...The bad news...

• U.S. IPO market in general not a U.S. IPO market in general not a viable exit to most VC-backed viable exit to most VC-backed companiescompanies– Ratio of M&A:IPO exits in 2007 is Ratio of M&A:IPO exits in 2007 is

approximately 10:1. In 2001-2005, it was approximately 10:1. In 2001-2005, it was as high as 20:1. In 1999-2000, it was as high as 20:1. In 1999-2000, it was almost 1:1. almost 1:1.

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The bad news...The bad news...– IPO market open only to companies with IPO market open only to companies with

substantial and predictable revenues and substantial and predictable revenues and economic fundamentals economic fundamentals

– General wisdom: minimum annual revenues General wisdom: minimum annual revenues of $100 million to absorb compliance costs of $100 million to absorb compliance costs ($2-3 million/year) under Sarbanes Oxley($2-3 million/year) under Sarbanes Oxley

– Sarbanes Oxley not likely to be modified by Sarbanes Oxley not likely to be modified by Congress anytime soonCongress anytime soon

– Scarcity of directors willing to sit on boards in Scarcity of directors willing to sit on boards in the wake of Enron, Worldcom, et al.the wake of Enron, Worldcom, et al.

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Week 2: The Venture Capital Week 2: The Venture Capital Industry and Related TopicIndustry and Related Topic

Anatomy of a Venture FundAnatomy of a Venture Fund

Economy & Finance

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