Venture CapitalConsiderations for University

Tech Transfer OfficesPresented by:

Gene Schleppenbach and Mark Catan

Miles & Stockbridge P.C.

and

Mark Frantz

RedShift Ventures, Inc.

Understand the Sources of Funding

Many different sources of financing

Venture capital

Angels – professional and friends & family

Federal government (various grant programs – SBIR and STTR)

State and local government – economic development programs

Strategic investors (established companies in the industry)

Important to understand the investment objectives of each

Who has the $$ and at What Stage?• Stages of Venture Capital

Know when and under what circumstances venture capital is a realistic possibility.

Seed ($100K-$1 million) -- typically used for product (alpha and earlier) and BPlan development

Early Stage -- Series A ($1 - $5 million) -- product needs to be developed (beta or beyond), solid BPlan, core management team, and some significant interest from a player in the target industry

Expansion Capital ($5 - $15 million) -- need to have the product fully developed, proof of market (meaningful sale to a player in the market), solid management team and B Plan

Venture Economics

Most venture funds have a 10-12 year target life cycle, which shapes its receptivity to new investment opportunities

Early stage venture funds strive to find 1-2 investment “homeruns” on each deal, given the high betas on outcomes – which is different from investment objectives of Angels and corporate investors/licensees

Most funds look to earn at least gross annual returns in excess of thirty percent (30%) over their term (approximately 22.5% annual net return)

Most funds are almost fully committed within three - five years

The evaluation analysis is keyed off of expected investment return (multiples on amount invested in the range of at least 5x to 20x)

Valuation Considerations

The valuation that a company receives includes many considerations:

What’s been accomplished to date The long-term potential of the business The amount of money in this round, which is typically determined

based on the funding needed to achieve targeted milestones The anticipated “pre-money” valuation of the company at the next

round – assuming increased valuation based upon application of proceeds invested in current round of financing

The number of subsequent rounds required until liquidity event (IPO or sale, including the likely amount of each round)

Because each deal is hopefully unique, comparables are of limited utility

What do VCs Look For?

A compelling product or service (preferably paradigm shifting) in a new, high-growth market

A clear path to commercialization – go to market strategy

Product at beta stage or beyond, with initial customer testing or, better, customer purchase

Compelling unmet need that product or service meets

Significant advantage to market or barriers to entry – a strong IP position (both freedom to operate and power to exclude) is very helpful and a big differentiator

Financing Pre-VC

Self finance as much as possible -- not even friends and family, much less professional angels, will invest if you do

not have a well conceive idea and plan

Fiends/Family/Casual Angels – make sure they

understand the risk, properly document and don’t overValue

Professional Angels – harder to find professional angels;

they understand they are a bridge to early stage VC, so

need to conclude VC fundable. Rarely take common.

Financing Pre-VC (cont’d)

Federal Sources Government sponsored VCs (In-Q-Tel;

OnPoint) – similar to strategic partners

SBIR/STTR • Phase I ($100K; 6 months; basic R&D/feasibility)

• Phase II (up to $750K (sometimes higher at NIH for drug dev.); 12-18 months (3 years for drug dev);

proof of concept/prototype) • Phase III (commercialization; previously no

money and not much help; changing landscape)

Financing Pre-VC (cont’d)

State/Local – many states have seed-level financingthrough economic development programs

Strategic/Corporate Investors -- looking for technology that fits into their strategic plan

Do Your Own Diligence on VCs

Differing stages of investment focus Different industry focuses Geographic considerations Management style -- active or passive management Competing companies in their portfolio? Personalities compatible? Strong syndicate to help with follow-on rounds? Help with distribution channels/sales and executive

recruitment?

Avoid Start-Up Pitfalls

Do Not Create Hurdles to Investment

Appropriately document equity commitments to co-founders or promoters involved in company formation and/or financing

Avoid unconventional corporate or capital structures or insure convertible to standard structures

Build management team with appropriate critical skill sets – understand/acknowledge areas where there are holes and evolving needs as the company grows

Avoid over/under valuing at seed round; convertible debt can help Bottom line…get good people in and around the business and keep

bad/not good enough people away from the business – don’t accept half solutions

IP Essential Basics

Investor due diligence will reward diligence and best practices WRT Title to IP (all required assignments in-hand); Patenting and defensive publishing directed to product ecosystem; Freedom to operate including access to essential technology and materiel,

particularly in view of rights of prior sponsors; Practical knowledge of prior art and where the most important patent

opportunities exist (the white space); An IP strategy: Processes for using IP effectively; IP clauses and other contractual restrictions on principal personnel; Access to and ability to transfer non-IP intangible assets such as know-how,

consulting agreements, relationships, special knowledge and business processes.

Effective IP position reduces risk. Particularly important in view of fact that Universities will not permit strong representations and warranties or indemnification.

Patent early. Patent often.

Basic idea

1 Year Grace Period (Paris Convention)

Basic idea

First data

Basic idea

First data

Seconddata

Basic idea

First data

Seconddata

Refinementof basic

Basic idea

First data

Seconddata

Refinementof basic

Relatedtechnology

File File File File File

IP: Tendency to focus on research

Product

Newtechnology

Researchers love HARD problems

… and ignore the easy ones

But in the patent world, the only thing thatmatters is whether there is infringement

Product Ecosystem

Purchasechain

Explain valueproposition

Purchase

Install

Use

ProductManufactureRaw materials Distribute Disposal

Supply chain

Adjunctservices

Training

Safety

Regulatoryhurdles

Environmental

Communicate

Recurringrevenue

Repair

Protect or block others using defensive publication

Commercialspawn

Real worldconstraints

Subsidies,taxes

Alliedproducts

It isn’t just an issue of how strong your patent position is.It’s also a question of freedom to operate

It’s the value proposition (stupid)

Other ways to get there

Technology we developed

Valueproposition

Other ways to get there

We preferredin vivo tissue generation

over in vitro ...

Non-tracking solarwas on our design

critical path

Our (lame)

patent

Protecting the technology

It’s the value proposition (stupid)

Other ways to get there

Technology we developed

Valueproposition

Other ways to get there

Team player

Broad patent

Protecting the value proposition

Values patents haveŸ Residual capital value for investor if business failsŸ Collateral for loans (Asset Based Lending)Ÿ Out-licensable propertyŸ Currency for exchange in a dispute such as in-infringementŸ Currency for exchange for in-licenseŸ Portfolio value (aggregate to achieve market exclusivity)Ÿ Don’t need to be enforced directly Deterrent effect (Détente, even) Sell enforcement right to big entity

Calculation on IP should not just be what topatent but also what to invent!

Companies routinely invent for strategicpatents. Patents are a business tool.

Venture Terms

The Term Sheet – Obviously a key hurdle What does it take to get there? Diligence – on the technology, the potential market,

the team, the business plan, projections, etc. Partnership meetings/presentations Building a syndicate

Investment Terms Valuation/Price per Share/Percentage of the

Company Type of Security

• Preferred Stock• Why Delaware?

Anti-dilution Liquidation Preference Dividends Conversion

Investment Terms Preemptive Rights - Pay to Play Voting Rights

• amends to charter or bylaws

• liquidation, dissolution

• increase in authorized existing preferred

• creating any new class of preferred on parity with or senior to existing preferred

• merger, consolidation, reorganization, sale of all or substantially all of assets

• redemptions

• declaring or paying dividends

Investment Terms

Redemption

Registration Rights

- demand, piggy-back, short-form

Stockholders’ Voting Agreement

Investment Terms Investor Rights Agreement

• Stockholder Restrictions/Obligations• restriction on transfer of common• right of first refusal/co-sale • drag rights

• Affirmative Covenants/Protective Provisions• Information Rights – financials (budget, quarterly, annual);

material filings (e.g., with regulatory agencies); law suits; notices of defaults, etc.

• Board – seats; observer rights; compensation/reimbursement/D&O; committees (comp/audit/exec.)

• Employees – IP Assignment, non-compete and non-disclosure agreements; standard terms of options (unless Preferred Director approval)

Investment Terms

• Negative Covenants/Protective Provisions• Expenditures/commitments re same• Indebtedness• Loans• Hiring/firing key executives or key employees• Compensation levels• Changing business• Changing locations

Gene  Schleppenbach  Mark Catan Mark A. Frantz

Principal Principal General Partner

Miles Stockbridge, PC Miles Stockbridge, PC RedShift Ventures

1751 Pinnacle Drive 1751 Pinnacle Drive 2425 Wilson Boulevard

Suite 500 Suite 500 Suite 402

McLean, Virginia 22102-3833 McLean, Virginia 22102-3833 Arlington, VA 22201-3326

Direct Number: 703.610.8623 Direct Number: 703.610.8675 Phone: (703) 904-9800

Main Number: 703.903.9000 Main Number: 703.903.9000

Fax Number: 703.610.8686 Fax Number: 703.610.8686 Fax: (703) 904-0571

gschleppenba@milesstockbridge.com mcatan@milesstockbridge.com mfrantz@redshiftventures.com