Emerging Companies & Venture Capital:

1. Emerging Companies & Venture Capital: Start-Ups 101 Presented By: Jason D. Crain, Orrick’s Silicon Valley Office October 26, 2010

2. Roadmap • Venture Capital and Liquidity Markets Statistics • Fundamentals of Formation • Top Ten Pitfalls

3. Venture Capital & Liquidity Markets Statistics

4. U.S. Venture Capital Investment: 2003 – 1H 2010 Billions ($) Source: VentureSource

5. U.S. Venture Capital Investment by Industry: 2008 – 1H 2010 Billions ($) Source: VentureSource

6. U.S. Exits by M&A: 2003 – 1H 2010 # of Deals Source: VentureSource

7. U.S. Exits by M&A: Large Deals in 2009 and 2010 • Mar 2009 - Cisco acquires Pure Digital (makers of Flip Video) for >$500 million. • Nov 2009 - Google inks deal to acquire AdMob for $750 million. • Jan 2010 - Apple acquires Quattro Wireless for $275 million. • July 2010 - Disney acquires Playdom for $763 million. • Oct 2010 – Google proposes to acquire ITA Software for $700 million. Source: VentureSource

8. U.S. Exits by IPO: 2003 – Q1 2010 # of Deals Source: VentureSource

9. Timeline to Exit • Acquisition • 2010 – 5.4 years after raising $19 million • 2009 – 4.7 years after raising $16 million • IPO • 2010 – 10.4 years after raising $156 million • 2009 – 7.9 years after raising $32 million Source: VentureSource

10. Fundamentals of Formation

11. Forming the Company • Choice of Entity • C Corp • LLC • IP Ownership • Dual Stock Model • Common Stock: Founders • Common Stock Options: Employees and Consultants • Preferred Stock: Investors

12. Founders’ Stock & Stock Options • Shares of Common Stock for Founders • Stock Options for employees and consultants/contractors • Each subject to Vesting • Basic: Four-year schedule with a one-year cliff • Change in Control: Acceleration • Single Trigger • Double Trigger • Pricing and Consideration

13. Funding Options • What? • Convertible Note Financing • Preferred Stock Financing • Other - Venture Debt, Bank Loans, Grants • Who? • Friends & Family / Angels • VCs • Banks & Government

14. Convertible Note – Key Terms • Sweetener • Conversion Discount • Valuation Cap • Warrant • Change of Control • Maturity • Interest Rate • Covenants

15. Preferred Stock – Key Terms • Senior Liquidation Preference – important in acquisition • Board Representation • Special Voting Rights • Rights of First Offer • Anti-Dilution Protection • Information Rights • Registration Right • Redemption

16. Preferred Stock – Key Drivers • Pre-Money Valuation • Amount Raised • Option Pool Will determine resulting ownership

17. Capitalization Table – Pre-Money

18. Capitalization Table – Post-Money • Details: • $5.0 million investment • $5.0 million pre-money valuation • 15.0% option pool

19. Capitalization Table – Post-Money • Details: • $5.0 million investment • $10.0 million pre-money valuation • 10.0% option pool

20. Ten Pitfalls

21. 1. RUNNING OUT OF RUNWAY Preserve Cash • Plan for at least 24 months of runway • Plan cash to reach a major milestone • Will the market allow you to reach the milestone? • Raise money early Take the money – it always takes longer than you planned and, if you have an option, take more.

22. 2. POOR CHOICE OF INVESTOR & INVESTOR REPRESENTATIVE It’s a Marriage • Consider lower valuation for broader choice – Valuation is not paramount – in the first round – Be prepared for lower valuations • Reference Checks • Understand investor representative’s role in partnership • Understand the condition of the particular investment fund

23. 3. FOUNDER’S CLASH – with each other; with investors The Company comes first • Founders must acknowledge that at some point there will be: – Dilution of shareholding – Likely a change in role and title • Remain Valuable: – Maintain focus on core strength

24. 4. RECRUITING MISSTEPS - Hesitation to Hire; Hiring Choice Can’t succeed without a team that can execute • “Slow to hire, quick to fire” • If you can’t find the right person – wait • Fire the wrong person – don’t wait • A mistake can cause tremendous turmoil, but so can not filling the gaps • Judge the person first, the resume second • Hire “athletes”; individuals who know their “sport” • It is critical to maintain the team and company culture

25. 5. BOARD REWARD & BOARD IGNORE Research & Recruit Board Members - then use them • Your directors are part of your team – recruit thoughtfully and well • Board members: • Open doors to strategic partners, customers and employees • Keep the Board informed • Learn how to prepare for and conduct a board meeting • Use other constituents (advisors, lawyers and accountants)

26. 6. FOCUS, FOCUS, FOCUS Do few things and do them exceptionally well • Many start-ups are unfocused and seek to do too much • Keep it simple, measurable and achievable – Many CEOs believe they have to set lofty goals to get funded – Investors value CEOs who set clear goals and routinely achieve them EVERYONE in the company should be able to articulate the corporate goal which allows for a dogged, unyielding focus at all levels of the company

27. 7. FAILURE TO ITERATE TO THE CUSTOMER Must understand all aspects of the customer – What the product should do at a DETAILED level – How it fits in the customer’s world – What influences the customer’s opinion of the product’s value – How does the customer want it sold to him/her – What the product is displacing and why the customer should take a risk on your new product – Need to be as intimate in understanding the customer’s needs as you are conversant with your own technology No matter how cool the technology, nothing happens until a customer gives you money

28. 8. GOT OUTCOMPETED outcompeted Simple past tense and past participle of outcompete. Plan that your competition will steal your technology & your customers • Understanding your competition is understanding your market • Competitors can take your customers, employees, market share and investors • Track competitors’ sales and market share; monitor their growth relative to your company’s

29. 9. UNDERESTIMATE THE DIFFICULTY OF ACQUIRING CUSTOMERS It will take longer and cost more than you expect • Very common mistake -- seriously underestimating the time and effort necessary to get acquire customers • It doesn’t matter how you intend to distribute (direct sales, OEM, distributors, dealers or Internet) all channels take a lot of effort and are always slower to develop than planned • Know what is the cost of customer acquisition and focus on the valuable ones

30. 10. GIVE UP FLEXIBILITY The fundamental strength of a start-up is its flexibility - DON’T BE AFRAID TO USE IT • Your initial assumptions will be wrong – continually revise and hone • If the market, technology, customers, economy change – innovate to capitalize • If necessary – make a substantial change in your business model

31. IN SUMMARY Establish & Maintain this Focus: Build a Company that sells what customers will buy

32. Contact • Jason D. Crain • Orrick’s Silicon Valley Office • jcrain@orrick.com • (650) 289-7114 • http://www.orrick.com/practices/corporate/emergingCompanies/startup/forms_index.asp