sdfl

David RoweInvestment ManagerUniseed Management Pty Ltdd.rowe@uniseed.com

ELEC5701

Venture Financing

Uniseed – Funding Early Stage R&D

• Established 2000, a $61m ‘open ended’ fund– Focus on commercialisation of University R&D– Operate with financial and commercial discipline

• An early-stage, pre-seed fund– Initial investment of $250k-$500k– Invest Up to $2 million / investment

• Aim to bring in co-investment, leverage initial capital• 40 investments to date; across all sectors

– Current portfolio of 15 companies• BT Imaging: QA for photo-voltaics manufacturing• Smart Sparrow: intelligent tutoring platform for online learning

– 2 exits + 1 IPO (QRX:ASX)

Other Commercialisation Funds

• Sydnovate – USyd– More focus on IP protection, consulting & licensing– Sydnovate fund: $50-100k, more proof of concept

• TransTasman Fund– MonashU, UAdelaide, UAukland, FlindersU– $30m open-ended fund, up to $2m

• ANU Connect Ventures– ANU and ACT opportunities– $30m open-ended fund, up to $2m as VC– $100k PoC

Why Raise Capital?!

The Financing Options

Non-Equity Financing Equity Financing

Angel Financing

Venture Capital

Private Equity

Public Stock Markets

Self Finance/ Bootstrapping

Government Grants/ Rebates

Debt/Bank Finance

Bootstrapping and Couch-surfing

• The best form of funding is REVENUE!• Bootstrapping worked for HP, Microsoft, Apple, Dell,

eBay and Atlassian!• Keep costs low, work out of your bedroom, couch-

surf to Silicon Valley, grow organically.• Be a bootstrapper – even if you raise capital

– Raise as little as possible– Leverage non-dilutive funds e.g. EMDG, CommAus

• But… many business models benefit from raising additional capital while building revenue.

Good Reasons to Raise Equity FinancePR

E-RE

QU

ISIT

ES:Unique product

or conceptPassionate founding teamLarge potential market IM

PLIC

ATIO

NS:Product

development requiredPre-revenueIntense competition likelyNeed to move rapidly

VC F

UN

DIN

G SU

PPO

RTS:Hiring

Rapid product developmentCommercialisationPartnershipsInfrastructureInternational go to marketFurther fundingEtc…

The bottom line: raising equity finance provides the working capital to enable acompany to sustain a higher burn-rate than if utilising organic/internal resources…

Speaking of Burn Rate…

• Webvan an online "credit and delivery" grocery business that went bankrupt in 2001

• Successful founders… e.g. Louis Borders

• Hot investors… e.g. Benchmark, Sequoia

• Raised a whack of cash...i.e. Over $500m

• Built a Titanic, when demand was much less

• Hailed as one of the greatest dotcom disasters in history• Danny Rimer (now Index Ventures i.e. Skype):

“Webvan was my billion dollar bonfire…”

Dilution 101: Equity Financing

• NewCo• Valued at $100k• Founder has 100%

Founder100%

Dilution 101: Founder + Angel

Founder50%

Angel50%

• Angel invests $100k– “Equity investment”– Funds exchanged for %

ownership and rights within NewCo

• Founder ‘diluted’• Aim to ‘grow the pie’

Basic maths:Founder value = $100k (‘pre-

money’)Angel investment = $100kPost-money value = $200k (nominally)

Resulting equity:Founder = 100/200 = 50%Angel = 100/200 = 50%

Dilution 101: VC Comes In

Founder25%

Angel25%

VC50%• VC invests $200k

– Pre-money of $200k (flat)– Gains 50% equity

• Founder & Angel diluted

Dilution 201: Capitalisation Tables...

OK Then: What’s my Slice of Pie?

• Help! I’m being diluted...

Founded Angel Seed Series A Series B Trade Sale0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Founder's Equity (%)

ESOP

OK Then: What’s my Slice of Pie?

• But my company valuation is going up...

Founded Angel Seed Series A Series B Trade Sale$0

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

Company Valuation

OK Then: What’s my Slice of Pie?

• And so it my net worth!!

Founded Angel Seed Series A Series B Trade Sale$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

Founder's Net Worth

E$OP

IPO

Stages of Venture Investment

Seed Early StageSeries A, (B)

Later StageSeries B, C, D…

Expansion Stage/pre-IPO

Revenue Pre-revenue $500k - $1m $1m - $5m, negative EBIT

$2m+ EBITDApositive EBIT

Pre-Money Valn $200k-$1m $1m - $5m $5m - $20m 3-4x EBITDA

Investment Size $10k - $1m $1m - $3m $3m - $15m $5m+

Source of Funds FFFsGov’t GrantsIncubatorsAngelsUni Seed Funds(Venture Capital)

Super Angels(Angel Sidecar)Uni Seed FundsVenture Capital

Venture CapitalStrategic Investors

Late Stage VCEarly Stage Private EquityHedge Funds?

Expect Returns 3-5x ++ / 3-10yr 5-10x / 5yr+ 5-10x / 5yr- 3-5x / 2-5yrs

Talk to… ATP, Uniseed Uniseed, SXVP SXVP, IntelCap Champ/Quad

Facebook: How to IPO at $100bn

Valuation: $5mValue/User: $5

Valuation: $100bValue/User: $125

Viacom: $750m offerValue/User: $62

Facebook: Capitalisation History

~$150k Founders Feb’04: Zuckerberg develops and launches thefacebook.com (~64%)Saverin funds with his Brazilian insider oil trades (~35%)

Angels$5m Sep’04: Peter Theil leads super-Angel Series A round of $500k for 10%.First outside investment, included Paypal Mafia

VC Round 1$98m Apr’05: Accel Partners make Series B investment of $12.7m for 13%How’s this thing going to make money?! Bold move!

VC Round 2$500m Apr’06: Accel leads Series C of $27.5m for 5.5%.Brings in many of the key SV VCs, focus on growth.

Strategic$15b Oct’07: Microsoft invests $240m for 1.6%.Overpaying? Priced users at around $300!

IPO$104b May’12: 421m (15%) shares offered for $38/share.Key shareholders locked in for 221 days.

Valu

atio

n

Venture Capital: how VCs work

• Raise a fund: $40m+– High net worths (HNW), partners, pension funds (part of their ‘alternative’

asset allocation) & financial institutions– 10 year horizon: then return funds + profits– Objective: superior returns; 10x -> 50% IRR

• Invest money: years 3-5– Employ ‘large licks’ into companies that ‘fit’ the fund– Early stage first, then later stage + ‘follow-ons’

• Drive exits: years 5-10– Finish investing year 5, then ‘work out’ portfolio– Out of 10: 2 fail; 2 lose $$; 3 break even; 2 make (lots) of $$

• Keeping the lights on: VCs need to eat too…– Management fee of 1 - 2.5% p.a. of funds deployed– Carry (profit share) of ~20% of returns above investment

Angel Funding: how HNWs work

• Angels invest their own money– Smaller amounts at earlier stage, lower valuations– Value add in experience, hands-on, business and finance intros– Potential liability in excessive control, non-commercial terms, etc…

• Two “exits” for an Angel– Firm might be sold quickly for $2-10m, make 2-5x– Firm goes on to raise VC and IPO, Angel becomes passive, rides early exposure

• Take Angels seriously– Be prepared, passionate and professional– Often need a product/prototype, market analysis, go to market strategy– And be nice…

• Typical terms: Term Sheets, Shareholders Agreements, Rigour required– Businesses seeking $100k-$1m equity capital– Angel investors expect >10% equity (valuations between $1-2.5m)

• Finding Angel funding– Australian Association of Angel Investors (www.aaai.net.au)– Sydney Angels (www.sydneyangels.net.au) + Sidecar Fund

Incubators: much buzz lately

• Combination of seed funds, facilities, mentors, interim execs, network…

• Investment terms– Standard e.g. $25k for 7.5%

[pre-money ~$300k]– Angel-like e.g. $100k for 10%

[pre-money $900k !!]• Many funded by a “rental

model” i.e. start-up hotels• Can be a good start…

– Beware of “what next”?!– Some have follow-on funds

What to look for in an Investor

• Look for:– Synergies– Complimentary skills/

personalities– Track-record, network– Etc…

• Expect:– Further rounds of funding– Existing investors have capacity– More VCs coming in

• Remember: – 5+ years is a long time…– The VC will have control…

2010 -> 2011 • Members: up 13%• Reviews: up 11%• Comments: up 12%

2011 -> 2012 • Members: up 8%• Reviews: up 8%• Comments: up 5%Not looking good…

$

• Guy Kawasaki: “Investors are actually looking for a reason not to do a deal…”

• The Venture Funnel: – 2000 business plans in [~300 disclosures/yr]– 200 moderately credible [3-4 a month]– 100 potentially investible [2-3 a month]– 40 for due diligence [12 overall]– 10 get funded [2-3/yr]

• To be VC-ready,you need to think like a VC– Aim for 5-10x in 3-5 years– And have a plan...

What Does an Investor Look For?

Investment Ready: Build the Plan

PEOPLE Deep expertise, clean track-record Experience growing companies, ability to execute plans Synergy with venture capital management team

IP Compelling products & disruptive technology IP ownership: who owns it, clean freedom to operate Ability to protect and defend the intellectual property

MARKET Barriers to entry Growing, large, definable market Awareness of the competitive landscape

GROWTH Rapid growth and ability to scale Clear strategy to execute the route to market Capitalisation plan (how much money required?)

MODEL Identifiable sales cycle & pipeline, revenue streams Sustainable margins & ability to leverage scale Clear path to break-even and maintain profitability

EXIT Clear path to exit Key exit options: IPO; trade sale; share buy-back Creation of significant returns to investors & founders

The Pitch: Tell me a Story...

• A good story won’t sell rubbish, but it will highlight a gem• Tagline (1 sentence) > Elevator pitch (1 min) > presentation (20 min)• The key points (apart from the other stuff):

– What is the problem– What is exciting about your... X?– How much do you need?– How far will you get with that cash?– How much will I, errr... we make?

• And to get the best deal, you want multiple investors interested– Stalking at conferences, coffee shops is OK...

• E.g Open Coffee Club, but VC sightings are rare in Aus– Ideally work via introductions

• E.g. Networks e.g. Innovation Bay ; other Entrepreneurs e.g. Matt– But don’t shop it around too much... and don’t just post it out.

• If a “No” – say thanks, learn and keep moving forward...

I Blew It... : VC Anti-Portfolios

TwitterWe offered a term sheet to Twitter in April 2007 (I believe it was their first). They turned it down... And a few months later, when they had term sheets for their Series A round, I declined -- mainly because the pre-money valuation was 4x larger than the terms we offered them a few months prior and 2x larger than any other investment we had made. Big mistake.

FaceBookMy brother-in-law called me up to tell me he had some friends at Harvard building this social network called The Facebook. It had already gotten some traction, so when I looked into it, I thought “this thing is amazing.” I sent a note to all of my colleagues with information about the business... But there wasn’t a lot of enthusiasm from our group, so I didn’t get in touch.

AtlassianBill Bartee was heard saying one night, “I tried for years to get Mike to accept our investment terms...” ;-)

Atlassian then goes on to close a $60 Million investment from Accel Partners (US)!

Getting to Yes: Investment Terms

The Investor will invest up to a total of AU$750,000 in exchange for Series A Preference Shares at a pre-money valuation of $550,000. Share price to equal Pre-money Valuation / # Shares on issue, following the extinguishing of any outstanding Equity Liabilities. Preference rights include 1x Liquidation Preference, Conversion Ratio of 3:1, Anti-Dilute with Full Ratchet and Drag Along of minority shareholders. Investor to have first right of refusal on future Equity raisings.Company must consent to Critical Business Matters being subject to Special Majority Approval including the Investor Director. The Company shall reserve an employee share option plan (ESOP) of up to 10% of the fully-diluted capital, allocated subject to SMA. Investment subject to full due diligence and all conditions precedent being met. Etc Etc Etc…

Basic Investment Terms

• Pre-money Valuation– Perceived value of your business/IP/beermat– Sets price per share equity issued at i.e. pps = Value/#shares

• Ordinary Share Investment– Simplest form, often used by Angels– All Shareholders have similar rights

• Convertible Note– Increasingly used by Angels and VCs– Avoids valuation issue at time of investment– Typically when another financing is anticipated– Note attracts interest (10-15%) and a discount (20-40%) on next round

(*if* the next round investor is sympathetic)– PLUS typical terms required by the investor e.g. liquidation pref

Valuation: Art vs Science

• Discounted Cash Flow (DCF)– Time value of money – future operating free cash flows discounted at appropriate

rate to net present value– Hmmm… you are pre-revenue, EBIT for the next 3 years is negative, discount rate 40-

50% (risk)• Relative Value/Industry Comparables

– Industry multiples e.g. P/E, revenue multiple or EBITx e.g. Internet Industry (239) Value/EBIT = 20.22x

– Recent acquisition data e.g. Microsoft acquired Greenfield Online in 2008 for US$486m on approx $30m EBIT (16x)

– Hmmm… M&A values dropping, can I believe your 5 year forecast, assumes flawless execution, what about competitors (including MSFT)

• “Venture Metrics”– You look like a seed round, so I think you are worth $XXX– Post money val for this round shouldn’t exceed likely val at next round– Hmmm… I need to see 15% of the company at exit to make 5x

Valuation: Entrepreneur Tips

• Do your Homework– Understand other recent financing deals– Talk to multiple investors; have a friendly VC on your side– “Maximise” you, the company, capabilities and market opportunity

• Hold your line– Work up the cap table, have a minimum set– Ensure alignment with co-founders– Resist agreeing on certain items, without agreeing on overall

• Be Prepared to Negotiate– Be firm, but not unreasonable (and not desperate)– Understand (and model) the investment terms– Trade-off between terms often the way e.g. val vs perf options

More Investment Terms

• Preferred Share Investment– More typical structure used by VCs– Additional rights over Ordinary Shares including…

• Liquidation Preference– In the event of liquidity event (e.g. exit, wind-up) the Prefs receive any payout

ahead of Ords– After Liquidation Amount paid out (could be a multiple) then Prefs convert to Ords

• Board and Veto Rights– Investors to have board representation (usually while holding >15%)– Investors to have veto right over critical business matters e.g. changing business

plan, taking on debt, issuing new shares• Employee Share Option Plan (ESOP)

– Pool of Shares/Option to be allocated to management/staff– Effectively dilutive, managed by Board/Investor

The Cap Table: Another Round…

More (Severe) Investment Terms

• Conversion Ratio– Prefs to convert to not one, but a number of Ords (e.g. 1:3)– Leverages up the Prefs and increases effective payout

• Anti-Dilute– Provides protection to Prefs in a ‘down-round’ i.e. lower pps– Effectively awards more shares to maintain equity

• Tag Along & Drag Along– If a shareholder sells their stake, then others to have the right (tag along) or

obligation (drag along) to join the transaction– Effectively allows the Investor to effect liquidity/exit events

• “Pay to Play”– Sometimes introduced by incoming investors on ‘tough’ rounds– Extinguishing old rights (e.g. convert to Ords) unless you participate fully i.e.

pay up. “Cash is king”…

A ‘Real Life’ Example

Valuation $600k $5m $9m $13m $22m1) Seed Round $1m

2) Series A $3m + ClimateReady $2.7m

3) Convertible Note $1.8m

4) Series B $4m + Industry Institute Grant $2.1m

5) Strategic Investor (B-2) $500k6) Series C $6m + Working Capital (debt) $3m

Total Funds Raised: $16.3m Equity + $4.8m Grants

Spinout$60-$100m

Yr5 EXIT?

sdfl

David RoweInvestment ManagerUniseed Management Pty Ltdd.rowe@uniseed.com

THANKS!

Questions?BTW: www.smartsparrow.com is HIRING!

IRR: Bang for my Buck

• IRR = Internal Rate of Return

• Technically: IRR is the discount rate where NPV of cashflows equals zero.

• Practically: a measure of ongoing value creation considering the ‘time value of money’.

• Allows ready comparison of investment options.