Business 16 Stanford Department of Continuing Education Class # 4, 10/19/09

1. Business 16Stanford Department of Continuing EducationClass # 4, 10/19/09 Venture Capital, Angels, Banks www.alloyventures.com/class.html

2. Financing • Comes in several flavors • Equity vs. debt vs. bootstrapping • Best depends on several factors • How much you need • When you need it • Your experience/How much help you need • Your confidence in your idea/When you can pay it back • Attractiveness of investment • Control

3. Structure A group of partners raise OPM Typically foundations, endowments, companies These groups like the high returns from good firms Typically, $100,000,000+ Promise to invest in 20-30 companies Invest over 2-3 years, then raise new fund Goal is to at least triple the fund To do that, each investment must have the potential to make 10X Equity: Venture Capital

4. Equity: Venture Capital • Incentive • Partnerships take 20% to 30% of profits • For a $100M fund that goes 3X, $200M in profit, of which $40M goes to the VC partners • 2.5% management fee for salaries, expenses

5. Equity: Venture Capital • So why doesn’t everybody do it? • A lot of people tried, and they got destroyed • However, I got a great house out of it • It’s really hard • It takes a long time to make money • It is extremely stressful • It takes a network of relationships • Investors • Entrepreneurs • Bankers • Lawyers • Academics • Industrial leaders

6. Equity: Venture Capital • So why doesn’t everybody do it? • It takes time to build a reputation • Like an ER; triage management • Success begets success • For the same amount of work, I-bankers make, ah, hmm, made a lot more

7. What does a VC do? • Gets 200-400 business plans/yr • Actually does 2 to 4 investments/yr • Ave. investment $2-10MM • If co. needs more, VCs group together into a “syndicate” • The finder typically “leads” the deal/does the work • Sets up meeting with entrepreneurs • If it goes well, does “due diligence” • Calls references, industry people, academics, customers • Most VCs look for good people and big markets • If that goes well, presents to partners • If that goes well, puts together a draft “term sheet” and circulates it to partners • Says how much to be invested and terms of the deal

8. What does a VC do? • Usually, negotiations ensue between the entrepreneur and the VC • There may be competitive term sheets • Anything goes; collusion is common • When deal is struck, term sheet goes to lawyers • More negotiations between VCs and entrepreneurs • The deal closes, co. gets the money • Usually at least one VC on the Board of Directors • VC works w/management to: • Set strategy & tactics • Make intros • Recruit key management • Resolve ongoing problems • Hold management to milestones • Raise additional capital • Take company to liquidity

9. A good venture capitalist: • Has a track record of success • Has a ton of contacts • Predictable, won’t freak out when times get tough • A solver, not a blamer • Resolves issues before BOD mtgs. • Has unquestionable integrity • Likes & respects you, and vice versa • Has a clear vision of where the company is going

10. A good venture capitalist: • Has partners who trust him/her • Is always available • Is not too busy with other companies • Is technically fluent • Can see synergies • Doesn’t let you get away with anything

11. How do you know if you have a bad venture capitalist? • Too busy • Likes to hear himself talk/doesn’t listen • Yells when the stuff hits the fan • Takes credit for your work • No experience in a company but micromanages • Not interested in what your needs are • Focuses on “going public” instead of building a big company • Doesn’t know anybody • Has no/poor references • Name dropper at the wrong altitude

12. How does a venture capitalist figure out how much of my company to buy? • Investment in • 10X that investment in 5 years • Terminal value of company in 5 years • What percentage of the company is that? • That’s the percentage he has to buy

13. Equity: Angels • Incentives • Ex-entrepreneurs • Rich, want to keep a hand in • Rich, want to get richer • Rich, want to show how smart they are to their rich friends • Want to stay relevant

14. Equity: Angels • Good points • Typically pay more than VCs • Typically ask fewer questions • Have a reputation in your field • Many are well-connected • May make personal introductions • Willing to get involved early • Have lower expectations than VCs • May be willing to devote a huge amount of time

15. Equity: Angels • Bad points • Busy playing golf • Busy flying their jet • Busy sailing their yacht • Busy in Provence with no answering machine and a maid that doesn’t speak English • Often first round players only • May not be stable in a pinch

16. Equity: Angels • Bad points • Predictability? • Motives? • Overpaying makes later rounds harder • May be seen as flakey, which may taint you • Angels work best with: • seasoned entrepreneurs who need little help • entrepreneurs who know they will get mindshare

17. Angels • Angels Forum (www.angelsforum.com) • Life Sciences Angels (www.lifesciencesangels.com) • Band of Angels (www.bandangels.com), monthly meetings • Loose affiliations • Many have invested in VC firms, and use these contacts

18. Loans: Banks/Companies • When you are sure you can pay it back • Will want a business plan • Likely to give you money only for fixed assets • May be a lot of strings attached • You remain undiluted, just pay it off with interest • Can make a lot of sense • Will provide no help • Cannot differentiate good contacts from bad • Beware of quick-start loans

19. Loans: Relatives • You may never live it down • No help other than green • Can put you in a weird position if your company starts to crater

20. Bootstrapping • Don’t take money from anybody • Difficult in high-growth businesses • Bad idea when there is a lot of competition • A competitor with equity money could kick your butt • You don’t get any help unless you set up the other boards • A reasonable solution for smaller companies • Forget about a spouse and children