Prof. Vittorio de Pedys

FOR DISCUSSION

How Business Angel and Venture Capital evaluate investments

LESSON 6

WOULD YOU HAVE INVESTED?

MICROSOFT CORPORATION, 1978

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START SMALL AND THINK BIG

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START SMALL AND THINK BIG

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GRANDFATHER OF SILICON VALLEY

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GRANDFATHER OF SILICON VALLEY

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PRIVATE EQUITY AND VENTURE CAPITAL

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VENTURE CAPITAL INVESTMENT PROCESS

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U.S. VENTURE CAPITAL IN 2010

• 26 B$ into 2800 deals; up 11%

• 800 firms have 6.000 partners

• Average partner manages 223 M$ of investments, sits on 6 company boards

• 72 IPO’s vs 12 in 2009 & 160 average 1990-1994

• 1° California ; 2° Massachusettsss ; 3° NY

Source: UCLA

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ITALIAN VENTURE CAPITAL IN 2010

• 90 M€ investments in 30 companies (early stage)

• 13 players

• 2-3 disinvestments

• Exit generally through selling to other companies

• Italian venture capital & private equity association www.aifi.it

Source: AIFI

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Introduction to raising capital

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Capital raising sequence

1. Personal savings & credit card debt

2. Friends, families and “fools”

3. Business Angels

4. Venture capital

5. IPO or acquisition

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Stages

• Seed = product developed & launched, CEO in place, some early sales, not profitable

• Early stage = paying customers, proven business model, management team in place, break even revenue

• Expansion = needs investment for sales & marketing investments to sell more

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Business Angels

• Typically retired or semi-retired, successful professionals who have investment cash

• Many want to mentor CEO’s• To be considered “accredited investors” need

> 500.000 € net worth• Typical angel investment 40-60k per year• Like Venture Capitals, do not sign NDA

agreements• Normally invest locally & for themselves

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Angels groups

• Angel groups in almost every city• Most are non-profit organizations• Each member invests individually• Use standard deal term sheets• All investors sign same term sheet• Investors may invest different amounts

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The Italian Business Angels organization is called IBAN (Italian Business Angels Network)

http://www.iban.it/

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Typical angel deal in U.S. (2010)

• 1.7 B$ total investment*

• 400 K$ investment

• 1.5 M$ pre-money valuation

• 20-25% equity

• One seat on the board of directors

Source: ACA 2010

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Typical angel deal in Italy (2010)

• 33 M€ total investment

• 145 K€ average investment in each company

• 40-60 K€ average investment per Business Angel

• Consider 1-5 investment opportunities during the year

• One seat on the board of directors

Source: IBAN

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Venture Capital vs Business Angels

Venture Capital’s have:

• Expensive offices & high overhead costs (vs. angel’s home office)

• High labour costs (vs. angels work solo)

• Investors who expect high profits (vs. angels have lower profit expectations)

• VC board of directors (vs. no board)

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Club degli investitori

• Group of entrepreneurs of the Piemonte region that invests in new or recent constitution companies that are innovative, with highly growth potential

• Investments realized: Arenaways – Authix – Caspertech - Lachesi – Microcinema – Microwine – Skuola.net – Nicanti

• The club is formed by 40 members

Source: clubdeglinvestitori.it

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Evaluation process 1/2

• Entrepreneur sends Business Plan to the club

• Every member can examine the Business Plan

Source: clubdeglinvestitori.it

Selection is based on : • Innovation level of the product or the service proposed

• Credibility of the entrepreneur and the management

team

• Target market and selling strategy

• Headquarters in the Piemonte region

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• Club reviews plan & decides if appropriate to present to all members

• Entrepreneur makes 15 minute presentation & 20 minute Q&A

• If 4-6 Angels investors express interest, due-diligence team formed & meets with entrepreneur for 2-3 hours to learn more

• Typical pre-money valuation = 500K€ - 1M€

Evaluation process 2/2

Y1

Competitor 1

Competitor 2Competitor 3

Competitor 4Competitor 5

Competitor 6

Competitor 7

Competitor 8

Competitor 9

Competitor 10

Competitor 11

Y2

X1 X2

New Co

VCs AND ANGELS LOOKS FOR CREDIBLE DIFFERENTIATION…

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3.PRODUCT&TECHNOLOGY

TECHNOLOGY

PARTNERSHIPS

SIMPLICITY

BUSINESS PROCESS

DOMAIN KNOWLEDGE

NETWORK

…AND DEFENSIBLE BARRIERS

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METHODS TO EVALUATE A VC DEAL

It is important to know the meaning of post-money and pre-money valuation in Venture Capital or

Private Equity

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PRE MONEY VALUATION

A pre-money valuation refers to the valuation of a company 

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POST MONEY VALUATION

Post-money valuation is the value of a company after an investment has been made. This value is equal to the sum of

the pre-money valuation and the amount of new equity

If a company is worth $100 million (pre-money) and an investor makes an

investment of $25 million, the new, post-money valuation of the company will be $125 million. The investor will now own

20% of the company. 27

METHODS TO EVALUATE A VC DEAL IF THE COMPANY IS A START UP

¶ ANGEL VALUATION

¶ VENTURE CAPITAL METHOD

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METHODS TO EVALUATE A VC DEAL IF THE COMPANY IS A START UP

¶ ANGEL VALUATION

¶ VENTURE CAPITAL METHOD

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TIPICAL ANGEL VALUATION (1/2)

NO REVENUES?

500K-1M€ STANTARD PRE-MONEY VALUATION

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TIPICAL ANGEL VALUATION (2/2)

….or bridge loan to A round Venture capital investment:

Angels can buy A round shares at 75% share price

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METHODS TO EVALUATE A VC DEAL IF THE COMPANY IS A START UP

¶ ANGEL VALUATION

¶ VENTURE CAPITAL METHOD

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VC METHOD

POST = V/ (1+r)t

V= EBITDA x multiple exit

R= required annual return of the fund

t= time to exit

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EXAMPLE

POST = 25/ (1+50%) 4

= 4.9 M€

EBITDA Year 4 = 5M€

Value in 4 years= 5 M€ x 5 = 25M€

Required annual return: 50%

Time to exit = 4 years

Investment = 3 M€

PRE = 4.9 - 3 = 1.9 M€

VC QUOTA = 3/ 4.9 = 60% 34

Single period NPV method Base Model Variatio 1 Variation 2Exit value V 25.000.000,00$ 22.500.000,00$ 25.000.000,00$ Time to exit t 4 4 4Discount rate r 50,00% 50,00% 60,00%Investment amount I 3.000.000,00$ 3.000.000,00$ 3.000.000,00$ Numeber of existing shares x 1.000.000 1.000.000 1.000.000 Post-Money POST 4.938.272$ 4.444.444$ 3.814.697$ Pre-Money PRE 1.938.272$ 1.444.444$ 814.697$ Ownnership fraction of investors F 60,75% 67,50% 78,64%Ownnership fraction of entrepreneurs 1-F 39,25% 32,50% 21,36%Number of new shares y 1.547.771 2.076.923 3.682.349Price per share p 1,94$ 1,44$ 0,81$ Final wealth of investors 15.187.500,00$ 15.187.500,00$ 19.660.800,00$ Final wealth of entrepreneurs 9.812.500,00$ 7.312.500,00$ 5.339.200,00$ NPV of investors` wealth 3.000.000,00$ 3.000.000,00$ 3.000.000,00$ NPV of entrepreneurs` wealth 1.938.272$ 1.444.444$ 814.697$

Single period NPV method Variation 3 Variation 4 Variation 5Exit value V 25.000.000,00$ 25.000.000,00$ 25.000.000,00$ Time to exit t 4 4,4 4Discount rate r 50,00% 50,00% 50,00%Investment amount I 3.300.000,00$ 3.000.000,00$ 3.000.000,00$ Numeber of existing shares x 1.000.000 1.000.000 2.000.000 Post-Money POST 4.938.272$ 4.198.928$ 4.938.272$ Pre-Money PRE 1.638.272$ 1.198.928$ 1.938.272$ Ownnership fraction of investors F 66,83% 71,45% 60,75%Ownnership fraction of entrepreneurs 1-F 33,18% 28,55% 39,25%Number of new shares y 2.014.318 2.502.235 3.095.541Price per share p 1,64$ 1,20$ 0,97$ Final wealth of investors 16.706.250,00$ 17.861.700,15$ 15.187.500,00$ Final wealth of entrepreneurs 8.293.750,00$ 7.138.299,85$ 9.812.500,00$ NPV of investors` wealth 3.300.000,00$ 3.000.000,00$ 3.000.000,00$ NPV of entrepreneurs` wealth 1.638.272$ 1.198.928$ 1.938.272$

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METHODS TO EVALUATE A VC DEAL IF THE COMPANY EXISTS

¶ DCF

¶ MULTIPLES

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DCF MODEL

Sum of all future cash flows that are estimated and discounted to give their present values

WACC: Kd (no debt) + ke (35%-50%)

Used by VC to check

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METHODS TO EVALUATE A VC DEAL IF THE COMPANY EXISTS

¶ DCF

¶ MULTIPLES

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MULTIPLESEV/EBIDTA

EV/REVENUES

EV/CASH FLOW

EV/EBIT

P/E

Private comparable companies + AIM companies

Very simple but easy to make mistakes

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AVERAGE EBITDA MULTIPLE = 5 X EBITDA

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