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C L E A R S T O N E. V E N T U R E P A R T N E R S. Venture Capital Investing A Primer William Quigley Managing Director Clearstone Venture Partners [email protected] C L E A R S T O N E. V E N T U R E P A R T N E R S. Venture Capital.

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slide1

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital Investing

A Primer

William Quigley

Managing Director

Clearstone Venture Partners

[email protected]

venture capital

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

“I was seldom able to see an opportunity until it had ceased to be one”

Mark Twain

venture capital1

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

slide4

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

industry snapshot

C L E A R S T O N E

V E N T U R E P A R T N E R S

Industry Snapshot
  • 400+ institutional VC firms in the U.S.
  • Geographically concentrated
  • Stage/Industry focused
  • General partners/Limited partners
  • 10 year investment horizon
  • Co-investment with other VC’s common
typical firm profile

C L E A R S T O N E

V E N T U R E P A R T N E R S

Typical Firm Profile
  • 3 to 4 investment professionals
  • Review 1000+ business plans a year
  • Manage $50 to $200 million in capital
  • Buy equity (preferred stock) - rarely make loans
  • Investment horizon - 3 to 6 years
  • Sources of capital:

- Pension funds - Corporations

- College endowments - Wealthy individuals

investment stages

C L E A R S T O N E

V E N T U R E P A R T N E R S

Investment Stages

Most VC’s have a preference for a particular investment stage.

Five Stages:

  • Seed
  • Start-up
  • Early
  • Expansion
  • Mezzanine/Bridge
stage characteristic

C L E A R S T O N E

V E N T U R E P A R T N E R S

Stage/Characteristic

Stage Investment Characteristics

Seed $50-500K - Founder(s) only

- No product

- No customers

- Primary risk: R&D

Start-Up $500K to $1MM- Mgmt. team incomplete

- Prototype or beta product

- No revenues

- Limited customer interest

- Some capital invested

- Primary risk: market accept.

slide9

C L E A R S T O N E

V E N T U R E P A R T N E R S

Stage/Characteristic

Stage Investment Characteristics

Early $1MM - $3MM- Most of team in place

- Limited revenues

- Not profitable

- Primary risk:execution

Expansion $3MM - $10MM- Meaningful revenues

- Achieving profitability

- Growing customer base

- Primary risk: competition

slide10

C L E A R S T O N E

V E N T U R E P A R T N E R S

Stage/Characteristic

Stage Investment Characteristics

Mezzanine/ $10MM - $20MM- Significant revenues

Bridge - Profitable

- Industry player

- IPO in 6-12 months

- Risk much lower

the role of the vc

C L E A R S T O N E

V E N T U R E P A R T N E R S

The Role of the VC
  • Board involvement
  • Management recruitment
  • Future capital raising
  • Access to business network
  • Strategy development
  • Patience!
targeted industries
Information Technology

Medical Services/Devices

Communications

Biotechnology

Some Retail

C L E A R S T O N E

V E N T U R E P A R T N E R S

Targeted Industries

Most of the $10 billion invested by VC’s in 1997 was

concentrated in five industries.Why these?

how do vc s make money

C L E A R S T O N E

V E N T U R E P A R T N E R S

How Do VC’s Make Money?
  • Collect management fees from L.P.’s - 2 1/2% annually
  • Share profits with L.P.’s - 20/80 split on investment gains

Source of VC Income:

How do VC’s earn their income?

slide14

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

what do vc s want to see

C L E A R S T O N E

V E N T U R E P A R T N E R S

What Do VC’s Want to See?

Venture capitalists tend to focus on five specific areas

when evaluating a company:

Areas of Focus:

  • Management
  • Marketplace
  • Competition
  • Business Economics
  • Risks
management

C L E A R S T O N E

V E N T U R E P A R T N E R S

Management

The most important question: Has the team had experience

and success in the same industry?

VC Focus:

  • DIRECT sales experience?
  • Prior P/L responsibility?
  • Personal financial stake?
  • Willingness to share equity
  • “Fire in the belly”?
  • Functional areas covered?
market

C L E A R S T O N E

V E N T U R E P A R T N E R S

Market

Can management demonstrate a thorough understanding

of the marketplace dynamics?

VC Focus:

  • Market size and growth rate?
  • Market drivers?
  • Customer involvement in the R&D process?
  • Number of competitors?
competition

C L E A R S T O N E

V E N T U R E P A R T N E R S

Competition

Does management have a clear understanding of the

competitive landscape?

VC Focus:

  • Why are competitors successful?
  • What is the prevailing business model?
  • Barriers to entry?
business economics

C L E A R S T O N E

V E N T U R E P A R T N E R S

Business Economics

Does management have a deep understanding of the

financial dynamics of the business and industry?

VC Focus:

  • Margins comparable to industry norm?
  • Break-even < 2 years ?
  • Appropriate sales model?
  • Moderate capital intensity?
slide20

C L E A R S T O N E

V E N T U R E P A R T N E R S

Risk

Does management recognize, accept, and have strategies to deal with key risks?

VC Focus:

  • Reasonable financial projections?
  • New technology adoption rate?
  • Length of sales cycle?
  • Best and worst case scenarios explored?
  • Regulatory hurdles?
slide21

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

the venture capital process

C L E A R S T O N E

V E N T U R E P A R T N E R S

The Venture Capital Process
  • Business Plan
  • First Meeting
  • Second Meeting
  • Term Sheet
  • Due Diligence
  • Negotiations
business plan

C L E A R S T O N E

V E N T U R E P A R T N E R S

Business Plan

“Madam, enclosed please find the novel you commissioned. It is in two volumes.

If I had had more time I could have written it in one.”

Voltaire

business plan1

C L E A R S T O N E

V E N T U R E P A R T N E R S

Business Plan

#1 objective of the the business plan: Get the VC

interested in hearing more about the opportunity.

Business Plan Basics:

  • Written by the entrepreneur
  • Keep it short
  • Financials (3-5 year proj.)
      • Income statement
      • Balance sheet
      • Cash flow
      • “What-ifs” helpful
business plan2

C L E A R S T O N E

V E N T U R E P A R T N E R S

Business Plan
  • 50
  • 5
  • 10

Magic Numbers?

business plan3

C L E A R S T O N E

V E N T U R E P A R T N E R S

Business Plan

Business plan phrases that ‘spook’ VC’s...

  • We have no competition….
  • We conservatively project…..
  • We only need a 10% market share….
  • We will offer the most features at the lowest price….
  • We valued our Internet start-up using multiples of comparable companies…like Netscape, Cisco, Microsoft.…
first meeting

C L E A R S T O N E

V E N T U R E P A R T N E R S

First Meeting

‘Skepticism’ might best describe the venture firm’s

attitude in the first meeting. Don’t be alarmed by this.

The Details:

  • Location: VC’s office
  • Duration: 2-3 hours
  • Attendees: 1 to 2 VC’s
  • Format: Formal presentation with Q/A
second meeting

C L E A R S T O N E

V E N T U R E P A R T N E R S

Second Meeting

Getting to the second meeting is an important milestone.

The team will now make its case to the entire partnership.

Focus On :

  • Business opportunity - not the technology
  • Addressing concerns of the skeptics - THIS IS CRITICAL!
  • Next steps
what went wrong a few tips

C L E A R S T O N E

V E N T U R E P A R T N E R S

What Went Wrong? - A Few Tips

Dont’s

  • Make vague, ambiguous, or unsubstantiated statements
  • Make reference to unnamed/ mysterious people on the management team
  • Use statistical arguments for market penetration assumptions
  • Use technical jargon
  • Assume you have a deal if there is no term sheet
what went wrong a few tips1

C L E A R S T O N E

V E N T U R E P A R T N E R S

What Went Wrong? - A Few Tips

Dos

  • Involve the entire team
  • Discuss/disclose potential problems
  • Demonstrate financial commitment to the venture
  • Prepare realistic market and sales projections
  • Know your target investor (angel, bank, VC)
what went wrong getting feedback
Some Guidelines:

Needs to be solicited!

From knowledgeable sources

Develop a dialogue first

Avoid answering, debating

Have a market-researcher mindset

“The greatest gift that God hath given us is to see ourselves as others see us.”

Scottish Proverb

C L E A R S T O N E

V E N T U R E P A R T N E R S

What Went Wrong? - Getting Feedback

Getting honest feedback can be challenging…

term sheet

C L E A R S T O N E

V E N T U R E P A R T N E R S

Term Sheet

After the second meeting, the VC typically provides a

term sheet to the entrepreneur.

Term Sheet - Common questions:

  • Is it a legally binding document?
  • What’s covered?
  • What is it designed to do?
  • Why participating preferred stock?
term sheet conditions
Post-money valuation

$ amount of the financing

Investors identified

Size of employee option pool

Vesting periods

Key-person insurance

Board representation

Additions to management team, if any

Monitoring covenants, Restrictive covenants

Other deal specific issues

C L E A R S T O N E

V E N T U R E P A R T N E R S

Term Sheet Conditions

The term sheet is intended to embody the overall

conditions of a business agreement. What’s covered?

due diligence

C L E A R S T O N E

V E N T U R E P A R T N E R S

Due Diligence

The “heavy lifting” for the venture capitalist starts

with the due diligence process.

Due Diligence Overview:

  • Length: 6-12 weeks
  • Will perform up to 100 reference calls
  • Interview customers, former employees, competitors, industry experts
  • Intense legal, financial work
negotiations
Some flexibility in:

Valuation

Total investment

Vesting periods

Size of option pool

Less flexibility in:

Equity instrument type

Board make-up

Anti-dilution rights

Restrictive covenants

C L E A R S T O N E

V E N T U R E P A R T N E R S

Negotiations

Negotiations take place throughout the due diligence

process. What is negotiable?

slide36

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

the business plan

C L E A R S T O N E

V E N T U R E P A R T N E R S

The Business Plan
  • Executive Summary
  • Main Body
  • Appendix
executive summary
Mission statement

Brief company history

Description of investment opportunity

Market overview

Management team

Product & technology

Customers

Strategy

Competition

Capital requirements

C L E A R S T O N E

V E N T U R E P A R T N E R S

Executive Summary

What should the executive summary address?

main body

C L E A R S T O N E

V E N T U R E P A R T N E R S

Main Body

Management

Key Questions to Address:

  • Who are the key people in the company?
  • Where did they come from, and why are they the right people to run the company?
  • Have they had previous experience and success in growth companies?
slide40

C L E A R S T O N E

V E N T U R E P A R T N E R S

Main Body

Product/Technology/Service

Key Questions to Address:

  • What does the customer have access to today?
  • How does it differ from competing offerings
  • What is the superior value proposition to the customer?
slide41

C L E A R S T O N E

V E N T U R E P A R T N E R S

Main Body

Marketplace

Key Questions to Address:

  • What is happening in the marketplace? Is it growing, if so, why and at what rate?
  • What is lacking from the market leaders that this product/tech/service will provide?
  • Which customers have been involved in the development of the product and are likely to purchase it?
slide42

C L E A R S T O N E

V E N T U R E P A R T N E R S

Main Body

Strategy

Key Questions to Address:

  • Why will the customer be compelled to purchase the product?
  • How will the company maintain its competitive differentiation?
  • What barriers exist/will be created to curtail new entrants?
appendix

C L E A R S T O N E

V E N T U R E P A R T N E R S

Appendix

Not all business plans require an Appendix section,

but it can be useful.What to include?

  • Relevant industry articles to bolster management claims
  • Major customer testimonials
  • Other information likely to impress those not familiar with the market
slide44

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

slide45

C L E A R S T O N E

V E N T U R E P A R T N E R S

Valuation

StageCriteriaMethodology Range

Seed - Mgmt. track record Comparables, $400K to $1.5MM

- Market size/growth Whats the “going

- Competition rate” in the region

- Investment to date

Start-up - Market size/growth Comparables $750K to $2.0MM

- Working prototype?

- Team complete?

slide46

C L E A R S T O N E

V E N T U R E P A R T N E R S

Valuation

StageCriteriaMethodology Range

Early - Market size/growth Comparables $1.5 to $5.0MM

- Revenue run rate

- Gross margin %

- Performance to date

Expansion - Revenue run rate - 1X sales Varies

- Profitability ratios - EBIT multiple

- Performance vs. plan

slide47

C L E A R S T O N E

V E N T U R E P A R T N E R S

Valuation

StageCriteriaMethodology Range

Mezzanine/ - Market share/size Multiples of Varies

Bridge - IPO environment proxy companies

- Performance

Relative to plan

slide48

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

exit strategies

C L E A R S T O N E

V E N T U R E P A R T N E R S

Exit Strategies
  • Sale or Merger
        • Most likely exit
  • Initial Public Offering
        • Small fraction go this way
  • Redemption
        • Least attractive
  • Management buy-out
        • Generally not possible
secrets of success

C L E A R S T O N E

V E N T U R E P A R T N E R S

Secrets of Success?
  • CEO carried a bag
  • Called on same customer base
  • Gross margin > 50%
  • Some degree of technology
  • Cash flow break-even < $5M
  • Sourced the deal
  • 25% ownership or greater
  • First institutional investor

The Eight

Commandments

odds of getting a deal done

C L E A R S T O N E

V E N T U R E P A R T N E R S

Odds of Getting a Deal Done?

Hurdle Likelihood of Occurring

1. Review the plan and - 1 in 15

conclude it makes sense

2. Meet the team and like them - 6 in 10

3. Be attracted to the market - 7 in 10

opportunity and the company strategy

4. Introduce team to the other

partners and get their buy-in - 7 in 10

slide52

C L E A R S T O N E

V E N T U R E P A R T N E R S

Odds of Getting a Deal Done?

Hurdle Likelihood of Occurring

5. Complete the due diligence - 7 in 10

process satisfactorily

6. Get a term sheet agreed to - 8 in 10

in principle

7. Find co-investors - if necessary - 9.9 in 10

8. Get legal documentation done - 9 in 10

9. Fund the company EQUATES TO 1%

commonly asked questions

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“Will I have to give up control of my company?”

commonly asked questions1

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“Why don’t VC’s sign NDA’s?”

commonly asked questions2

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“Raising money - all at once or spread out over time?”

commonly asked questions3

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“Its a great invention, so why aren’t they interested?”

commonly asked questions4

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“Why do VC’s want to know the other firms that I am talking to?”

commonly asked questions5

C L E A R S T O N E

V E N T U R E P A R T N E R S

Commonly Asked Questions

“When should I initiate contact with a VC?”

slide59

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

Industry Overview

Screening Venture Opportunities

The Venture Capital Process

The Business Plan

Valuation

Exit

Getting in Touch

how do you contact a vc

C L E A R S T O N E

V E N T U R E P A R T N E R S

How do you Contact a VC?

Introductions are best:

  • Attorney
  • Accountant
  • Banker
  • Angel Investor
  • Industry Executive
slide61

C L E A R S T O N E

V E N T U R E P A R T N E R S

Local Resources

  • The Michael Dingman Center at U of MD.
  • The Morino Institute - Netpreneur Program
  • Baltimore/Washington Venture Group
  • NVTC - Emerging Business Network functions
  • Silicon Valley Bank, other community banks
  • Private Investors Network, Grubstakes (networks of angel investors)
  • Pratts Guide to Venture Capital
slide62

C L E A R S T O N E

V E N T U R E P A R T N E R S

Venture Capital

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