Early Stage Venture Capital Investments
Transcript of Early Stage Venture Capital Investments
1
Early Stage Venture CapitalInvestments
Stephen FlemingChief Commercialization Officer
29/18/07 Early Stage Venture Capital Investments
Stephen Fleming
• 10+ years investment experience.– General Partner, Alliance
Technology Ventures.
– 18 investments as leadinvestor, 15 exits to date.
• BS, Physics, Ga. Tech (Highest Honors).
• 15 years operational experience at AT&T Bell Labs,Nortel, LICOM (venture-backed startup).– Supervised startups developing first ADSL modem and one of
the first cablemodems in early 1990s.
• Multiple advisory boards at Georgia Tech; endowedchair in telecomm; occasional instructor in MBAentrepreneurship program.
• Strong regional technology leader.
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Overview
• Financing a startup
• Finding early-stage deals
• Series A term sheets
• Venture capital in the Southeast
• Lessons from experience
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Financing a Startup
• Options:
• The hard way.
• The other hard way.
• The very narrow way.
• The really hard way.
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Financing a Startup
• Options:
• The hard way. Debt
• The other hard way. Equity
• The very narrow… Grants
• The really hard way. Bootstrapping
Venture capital consists ofpurchasing equity in startupbusinesses.
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The Venture Equity Cycle
InstitutionalInvestor
VentureCapital Firm Entrepreneur
Liquidity Event(Sale or IPO)
Carried Interest
Equity
Capital
Gains
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$1x $ Amount Mechanism Type
104 10,000 Visa card Debt
30,000 Second mortgage Debt
105 100,000 Angel investor Debt/Equity
300,000 Angels and seed funds Equity
106 1,000,000 Seed-stage venture capital Equity
3,000,000 Early-stage venture capital Equity
107 10,000,000 Later-stage venture capital Equity
30,000,000 Public markets (IPO) Equity
108 100,000,000 Corporate bonds Debt+
Logarithmic Financing
Different stages of development means usingdifferent kinds of funds.
SARBANES
SARBANES
OXLEY
OXLEY
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$1x $ Amount Mechanism Type
104 10,000 Visa card Debt
30,000 Second mortgage Debt
105 100,000 Angel investor Debt/Equity
300,000 Angels and seed funds Equity
106 1,000,000 Seed-stage venture capital Equity
3,000,000 Early-stage venture capital Equity
107 10,000,000 Later-stage venture capital Equity
30,000,000 Public markets (IPO) Equity
108 100,000,000 Corporate bonds Debt
Logarithmic Financing
Focus on seed- and early-stage venture capital.
+
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After the “Bubble”
1995 1996 1997 1998 1999 2000 2001 2002 2003
Source:Source: PWC MoneyTreePWC MoneyTree
Quart
erly V
C I
nvestm
ent
($Billions)
Venture capital investments in the U.S., by quarter
2004 2005 2006 2007
5
10
15
20
25
30
Total Venture Capital Investment
Seed and Early-Stage Investment
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Lessons from Silicon Valley
What are the key value drivers of asuccessful startup?
• Large, fast-growing market segment
• Unique technology advantage
• Experienced management team
• Reasonable financial terms
• Measurable milestones for success
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Overview
✓Financing a startup
• Finding early-stage deals
• Series A term sheets
• Venture capital in the Southeast
• Lessons from experience
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Finding Early-Stage Deals
• Universities
• Local mature technology companies
– Especially those in transition (Cisco acquiringScientific-Atlanta, etc.)
• Local technology groups
• Standard network: lawyers, accountants,recruiters, etc.
• Dealflow can be overwhelming—so filteraggressively!
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Universities
• Now the wellspring of innovation for U.S.– Industrial research partnerships
– Technology transfer
– Entrepreneurial development
• Led by Federal R&D dollars– NSF, NIH, DoD, DoE, NASA, etc.
– $29.2B in FY2005
– Approx. half of all Federal R&D dollars aredevoted to healthcare and life sciences
– 70% of Federal R&D is directed to approx.80 universities
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Federal Dollars Dominate
Source: http://www.nsf.Source: http://www.nsf.gov/gov/
statistics/seind06statistics/seind06
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Distribution by Agency
Healthcaredominates
Source: http://www.nsf.Source: http://www.nsf.gov/gov/
statistics/seind06statistics/seind06
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Distribution by Specialty
Source: http://www.nsf.Source: http://www.nsf.gov/gov/
statistics/seind06statistics/seind06
Healthcaredominates
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Dealing with Universities
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Dealing with Universities
• Teaching a professor how to be anentrepreneur is like teaching a cat to swim:
– It can be done.
– You will lose blood.
– You’ll never be satisfied with the results.
– You will annoy the cat.
• Different motivations, different priorities,different views of “proper procedure”
• Best bet: Recruit an entrepreneur to workwith the professor. 1+1=3.
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Dealing with Universities
• Complex processes.
• Sometimes-absurd rules.
• Inexplicable delays.
• Petty rivalries.
• Just pretend it’s a Soviet pre-school and itwill all make sense!
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IP Mgmt./Evaluation
InventionDisclosures
Dept. Chairs /Deans / GTRI
TechnologyEvaluation
Path?
Rights toFaculty?
Initiate IP Prot.
Need more information / development
MarketEvaluation
TechnologyAnalysis
ProtectIP?
MarketAnalysis
PatentApplication
ExternalCounsel
$
...continued
Export Control
Industrial Contracts
Screens
Responsibility
GTRC
EI2 / CS
$ $
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IP Business Development
Rights toFaculty?
VentureLab Tech. Marketing
Path?
Startup / Spinout Industrial License
Consulting
GeorgiaResearchAlliance
$
Licensee?Rights toFaculty?
Funding& CEO?
Term Sheet Negotiation
Rights toFaculty?
LicenseNegotiation
ComplianceReview
StandardTemplates
...continued
Responsibility
GTRC
EI2 / CS
MarketingWhite Paper
External Counsel
BusinessPlan
Conflict ofInterest Plan
StandardTemplates
COI Review
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Royalty Collection Monitoring
Compliance / LitigationPatent Maint. & Defense
IP Licensing/Compliance
License
LicenseNegotiation
Startup / Spinout Industrial License
Startup Formed
Incubator?
SuccessfulStartup
ATDC orEmTech Bio
IndustrialPartner
Responsibility
GTRC
EI2 / CS
Distributionof Payments
Inventor(s)
Academic Department(s)
GTRC
PortfolioLIquidation
$
Royalties & etc.Equity
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Intellectual Property
• Permitted:
• Educational– Instruction or training of individuals and community
• Scientific– Research to be carried in the public interest.
– Results of research available to the public in a non-discriminatorybasis.
• Forbidden:
• Activities ordinary to commercial or industrialoperations.
• Inspection or testing of materials or products
• Designing or construction of equipment, building, etc.
• No “work for hire” — would affect tax exempt status
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Publication Policy
• Contract must outline the expectations ofsponsor and institution with respect todissemination of research results
– Right to publish results is important to facultyand students.
– Also important to help maintain non-profitstatus and overcome most export issues
– Should provide industrial sponsor the right toreview 30 days prior to publication, not toapprove.
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Export/ITAR Restrictions
• Every university campus depends onforeign national graduate students andpost-docs to function.
• Interaction with foreign companies isgrowing (“the world is flat”).
• National security implications mean thatuniversities are under closer scrutiny.
• “Deemed export” rule (Dept. of Commerce)
• ITAR (Department of State)
• Since 9/11: Arrest first, explain later!
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Export Control List
• Nuclear Materials, Facilities & Equipment
• Materials, Chemicals, Microorganisms, and Toxins
• Materials Processing
• Electronics
• Computers
• Telecommunications
• Information Security
• Sensors and Lasers
• Navigation and Avionics
• Marine
• Propulsion Systems, Space Vehicles and RelatedEquipment
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Implications for Startups
• You need to verify the nationality ofeveryone working on your technology:– Employees
– Contractors
– Consultants
– Graduate students
• This may violate EEOC regulations. Tough.
• If you have non-US nationals who do nothave permanent residency (green card),you need to talk to an export lawyer soon!
• Criminal penalties apply — jail time!
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Finding Early-Stage Deals
✓Universities
• Local mature technology companies
– Especially those in transition (Cisco acquiringScientific-Atlanta, etc.)
• Local technology groups
• Standard network: lawyers, accountants,recruiters, etc.
• Dealflow can be overwhelming—so filteraggressively!
– Does each deal pass the “LP Test”?
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The “LP Test”
• If you feel uncertain about a deal, imaginethat:
– It has completely imploded, and
– You are explaining it to your toughest, mostcynical LP.
• Do you feel embarrassed? Defensive?Stupid?
• Do you really want to do this?
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Overview
✓Financing a startup
✓Finding early-stage deals
• Series A term sheets
• Venture capital in the Southeast
• Lessons from experience
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Series A Term Sheets
• If the entrepreneur hasn’t done this before,he or she will not understand the process
– Don’t take advantage of your greaterexperience to slip something past... it willcome back to bite you!
• Key issues:
– Valuation
– Board seats
– Liquidation preferences
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Valuation
• Early-stage valuation is an art, not ascience.
• Needs to be high enough to rewardentrepreneurs for risk (quitting job, etc.)
• Needs to be low enough to allow step-up atSeries B round.
• Irrational but true: Valuation depends onthe amount of money being raised!
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Valuation
• Ask Monro Lanier about “MMM” and“COMBAT” valuations.
• Any rule will have error bars so large as tobe meaningless... but:
• If you wind up with
– Investors 40%
– Founders 40%
– Employee Option Pool 20%
• ...you probably won’t be wrong.
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Board Seats
• After Series A, an early stage board shouldhave at least three members:
– One founder
– One investor
– One outsider with relevant experience
• More is okay, if they are truly committedto participate:
– Confiscate BlackBerries; ban speakerphones– Scheduling difficulty rises as N2-N
• Don’t worry about an odd or even number!
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Liquidation Preferences
• Entrepreneurs assume they are goingpublic, so they ignore these terms.
• You know that you’re going to sell thecompany, so you insist on a preference.
• Very entrepreneur-hostile.
– Can dilute founder’s equity down to point ofmeaninglessness
• Can’t “un-ring the bell”... if you havepreferences in Series A, you will see themin all future rounds.
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Liquidation Preferences
• At Series A time:– 1x is probably okay.
– 2x is painful.
– 3x and above are “vulture capitalism.”
• Exception: If the entrepreneur is stuck ona high valuation...– You accept his/her valuation...
...but insist on a high liquidation preference.
– If it’s a skyrocket, entrepreneur maintainsmore ownership.
– Protects you in case of a mediocre buyout.
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Overview
✓Financing a startup
✓Finding early-stage deals
✓Series A term sheets
• Venture capital in the Southeast
• Lessons from experience
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VC in the Southeast
1995 1996 1997 1998 1999 2000 2001 2002 2003
Source:Source: PWC MoneyTreePWC MoneyTree
Quart
erly V
C I
nvestm
ent
($Billions)
Venture capital investments in the U.S., by quarter
2004 2005 2006 2007
5
10
15
20
25
30
Total Venture Capital Investment
Investment in the Southeast U.S.
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VC in the Southeast
1995 1996 1997 1998 1999 2000 2001 2002 2003
Source:Source: PWC MoneyTreePWC MoneyTree
Quart
erly V
C I
nvestm
ent
($Billions)
Southeast: steady state of less than $500M/quarter
2004 2005 2006 2007
5
10
— off scale —Total Venture Capital Investment
Investment in the Southeast U.S.
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Technology in Southeast
Multiple technologyMultiple technology
centers.centers.
Anchored by:Anchored by:
Atlanta, Atlanta,
Research Research
Triangle, Triangle,
Florida.Florida.
Pockets ofPockets of
innovation:innovation:
Universities,Universities,
FederalFederal
R&D centers.R&D centers.
Biggest challenge:Biggest challenge:
Lack of local venture capital.Lack of local venture capital.
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Attractive Targets in SE
Silicon ValleySilicon Valley
NewNew
EnglandEngland
NY MetroNY Metro
SoutheastSoutheast8%8%
TexasTexas
SoCalSoCal
MidwestMidwest
OtherOther
Source:Source: MoneyTree MoneyTree
Survey, 1998-2003Survey, 1998-2003
• Local startups have demonstrated consistentpotential to attract investment dollars.
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Regional Capitalization
• Local venture firms do not offer adequateleverage for local R&D.
0
5
10
15
20
25
30
35
40
45
Bay Area Northeast Southeast
University R&D ($B)
Venture Investment ($B)
1.61.6 xx
99 xx
2121 xx
SubstantialSubstantial
room forroom for
improvement!improvement!
Source:Source: Venture Economics and Venture Economics and
the Center for R&Dthe Center for R&D
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Overview
✓Financing a startup
✓Finding early-stage deals
✓Series A term sheets
✓Venture capital in the Southeast
• Lessons from experience
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Maalox Systems, Inc.
• Raised multiple rounds of professionalventure capital (over $20M invested).
• Ran into a market buzzsaw.
– Staffed up to meet customer demand.
– Customer turmoil meant zero sales.
– Burn rate killed them.
• Sold to a competitor for pennies on thedollar.
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Maalox Systems, Inc.
• Raised multiple rounds of professionalventure capital (over $20M invested).
• Ran into a market buzzsaw.
– Staffed up to meet customer demand.
– Customer turmoil meant zero sales.
– Burn rate killed them.
• Sold to a competitor for pennies on thedollar. x3
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TulipsOnline.com
• Initial business model based on Internetsubscription revenue.
• Switched to advertising-based model,brought in new management.
• Went public at height of Internet hysteria.
– Sustained a market cap in excess of $1 billionfor several months.
– Now trading 90% off its high.
– Layoffs, underwater options, etc., etc.
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LP Exit
IPO
TulipsOnline.com
• Timing is everything!
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Whistling Dixie Corp.
• Concentrated on proprietary technology.
• Got an initial customer commitment.– Demonstration led to field trial.
• Management realistically assessed capitalrequirements to take product throughdevelopment.– When an acquiror called, they listened.
• Sold for 30x return on investment.– Founder is now living on a sailboat in the
British Virgin Islands!
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Tortoise Technologies, Inc.
• Technology transfer from university.
• Very tight focus on one particular piece ofintellectual property.
– Almost all employees were Masters/PhD levelwith industry experience.
– Relied on corporate partnerships to handlemanufacturing, sales, and marketing.
• Went public with top-notch bankers basedon expected royalty streams.
• “Slow and steady wins the race.”
509/18/07 Early Stage Venture Capital Investments
Overview
✓Financing a startup
✓Finding early-stage deals
✓Series A term sheets
✓Venture capital in the Southeast
✓Lessons from experience
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For Further Information
Stephen Fleming
Chief Commercialization Officer
Georgia Institute of Technology
<http://innovate.gatech.edu/commercial/>
<http://academicvc.blogspot.com>
(404) 385-2360