E145 Winter 2008
Copyright ©2008 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for
educational purposes only.
E145 2008 Workshop B
Venture Finance
Presented by Ann Miura-Ko and Austin Rachlin(with Thanks to Professor Tom Byers)
Stanford University
Special Thanks to Eric Carr, Scott Bowie and Mike Rosenbluth, Past E145 TAs
E145 Winter 2008
Some fundamentals...• What is a V.C.?• Why would I want to take their
money? and what will I have to give up?
• Would they want me to take their money?!?
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What is Venture Capital?
VENTURE CAPITALISTS(Finding and Funding
Entrepreneurial Companies)
ENTREPRENEURS(Starting and Building
Companies)
INSTITUTIONAL INVESTORS(Limited Partners – e.g.
Endowments, Pension Funds)
High Risk Equity Return (30%+)Diversification
Management FeesShare of Profits
Management HelpFinancing Credibility
Capital Capital, TimeHelp
“Liquid” Stock Preferred Stock
Limited partnerships, governed by partnership agreement covenants, of finite life, with substantial profit sharing ...
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Typical Asset Allocation for LP
• Asset allocation for Stanford– Endowment Size: $17.2B
40%
16%10%
7%
15%
12%
Public Equity
Real Estate
Private Equity
Natural Resources
Absolute Return
Fixed Income
E145 Winter 2008
Typical Asset Allocation for LP
• Asset allocation for Calpers– Fund size: $239.2B
53%
29%
9%
8%
1%
Global Equity Fund
Fixed Income
Private Equity
Real Estate
Inflation Linked Fund
Slice 6
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How does a VC work• Size of VC fund: $500M
– Institutional 20-40 @ $10-50M– Individuals 50-200 @ $0.5-5M
• Invests over 3-5 years, return within 10• On average delivers 30% per year
return• 10 partners, 30-40 companies per fund
What size deal would be interesting?
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Which do you like?• Suppose you were to invest $10M
– Fund 1:• 2x return on all 10 $1M investments
– Fund 2:• Loses all $1M investments in 8 deals• Wins 20x on the remaining 2 $1M
investments
Source: Andy Rachleff
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So, what do I have to give up?
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That’s not the right question
• It ain’t the angle of the slice - it’s the size of the PIE– Goal: Trade shares to grow the pie– Is worth more than the whole pie that never grows– Is not easy to achieve, even with lots of financing– Requires a good relationship between entrepreneur and
investors
E145 Winter 2008
A Real Life Example: Chemdex*
• How much money do the founders need?• How long until significant revenue?• How long until profitability?• What’s the going rate for 1st round deals?
Valuation is an art, not a science.
*Chemdex is now called NexPrise (NXPS)
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Chemdex in 1997: Series A
1. How much does the company need to raise?
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Series A
2. Negotiate a pre-money valuationpost $ = pre $ + amount raised = $2.7 M + $1.9 M
% of company sold = amount raised / post $ valuation = $1.9 M / $4.6 M
How much do the founders own at this point?
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Series A3. Determine share price and total
number of sharesIn Round A, share price is set so total shares = 5-10 million
Total Shares = post $ / share price = $4.6 M / $0.54 = 8.5 M shares
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Series B1. How much does the company
need to raise?
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Series B2. Negotiate a pre-money valuation
post $ = pre $ + amount raised = $11 M + $13 M
% of company sold = amount raised / post $ valuation = $13 M / $24 M
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Series B3. Determine new share price
Share price = (pre-money valuation) / (total pre-money shares)
= $11M / 8.5 M
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4. Determine total number of shares
Total Shares = pre $ shares + amount raised / share price
= 8.5 M + $13 M / $1.29
Series B
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Chemdex - Series C
3. Determine new share price
4. Calculate total number of shares
1. Decide how much you need to raise
2. Negotiate a valuation
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Chemdex Financing
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Calculating DilutionPercentage owned = owned shares / total shares
Founders’ shares = 59% of 8.5M = 5.02M shares
Series B Dilution: 5.02M / 18.6M = 27%
Series C Dilution: 5.02M / 24.2M = 21%
IPO Dilution: 5.02M / 31.8M = 16%
Post-$ Valuation
$471$24 $130$4.6
Could Chemdex
founders get to this size on
their own?
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What besides cash do they offer?
• (Picture of Randy) Randy Komisar– Expertise– Contacts (their and the firm’s rolodex)
Your due diligence of the VC firms you interact with should be at least as in depth as their due
diligence of you
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Chemdex and Dilution
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Andy Rachleff
Juniper Networks - First
$2,000,000
$2,000,000
$4,000,000
Price/Share $1.00
2,000,000
Pre-Money
Seed Investor
Post-Money
Amount Shares Percentage
50.0%
Founders
Employee Pool
Total Employees
1,500,000
500,000
2,000,000
37.5%
12.5%
50.0%
Total Shares Outstanding
4,000,000
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Andy Rachleff
Juniper Networks - Second
$32,000,000
$4.80
2,312,500
1,354,167
34.7%
20.3%
1,500,000
1,500,000
3,000,000
22.5%
22.5%
45.0%
$24,000,000
$1,500,000
$6,500,000
$2,000,000
$2,000,000
$4,000,000
Price/Share $1.00
2,000,000
Pre-Money
Seed Investor
Venture Investor
Post-Money
Amount Shares Percentage
50.0%
Founders
Employee Pool
Total Employees
1,500,000
500,000
2,000,000
37.5%
12.5%
50.0%
Amount Shares Percentage
Total Shares Outstanding
4,000,000 6,666,667
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Juniper Final Cap Table
Milestone Start Early Team POC
Round 1 2 3Amount Shares % Amount Shares % Amount Shares %
Founders 1,500,000 37.50% 1,500,000 22.50% 1,500,000 14.82%Pool 500,000 12.50% 1,500,000 22.50% 2,500,000 24.71%Total Employees 2,000,000 50.00% 3,000,000 45.00% 4,000,000 39.53%
Seed Investors 2,000,000 2,000,000 50.00% 1,500,000 2,312,500 34.69% 0 2,312,500 22.85%Venture Investors 0 0 0.00% 6,500,000 1,354,167 20.31% 0 1,354,167 13.38%Corporate Investors 0 0 0.00% 0 0 0.00% 40,000,000 2,452,483 24.24%Total Investors 2,000,000 2,000,000 50.00% 8,000,000 3,666,667 55.00% 40,000,000 6,119,150 60.47%
Total Shares Outstanding 4,000,000 6,666,667 10,119,150
Price/Share $1.00 $4.80 $16.31
Post money $4,000,000 $32,000,000 $165,043,333
E145 Winter 2008
Valuing Public Companies
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Ratios & Valuing Public Companies Today
• Market Cap = # shares outstanding x Share price– Answers “What does the market think the
company is worth?”– Examples
• GOOG with 306M outstanding shares @ $467.29 / share = $143B market cap
• YHOO with 1.36B outstanding shares @ $28.56 / share = $48.9B market cap
E145 Winter 2008
Ratios & Valuing Public Companies Today
• Ratios– EPS = Earnings per share
• An indicator of value created for shareholders – P/E = Market Cap / Annual Earnings = Stock Price /
EPS• How much does $1 of earnings cost an investor?
– P/S = Market Cap / Annual Sales
• Similar companies facing similar risks should have similar ratios (Comparables / Comps)
• “Enterprise Value” - Market Cap + Debt
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Metrics in Action
Market Cap
Net Income: $10 M
P/E: 30
$300 M
Share Price: $15
# Shares: 20 M
$300 M
Sales: $100 M
P/S: 3
$300 M
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A Sampling of Public Companies
Note: Updated Feb 6, 2006 Close
Stock Price($/share)
Market Cap ($B)
EPS ($/share)
P/E P/S
GE 32.75$ 346.04$ 1.54 21.25 2.09 Microsoft 27.17$ 280.76$ 1.21 22.45 7.27 Walmart 45.08$ 187.69$ 2.57 17.55 0.62 Google 385.10$ 113.82$ 5.02 76.70 21.48 Cisco 17.83$ 109.52$ 0.86 20.68 4.39 Coca Cola 40.94$ 97.40$ 2.17 18.88 4.23 Ebay 40.77$ 56.82$ 0.78 52.54 12.42 Apple 67.30$ 56.72$ 1.85 36.30 4.35 Sony 48.83$ 48.72$ 1.09 44.80 0.79 Disney 24.96$ 48.01$ 1.22 20.41 1.51 Yahoo! 32.92$ 46.70$ 1.28 25.80 9.84 Gap 18.74$ 16.30$ 1.27 14.79 1.01 Sun 4.36$ 14.89$ (0.10) 1.35 Alkermes 23.04$ 2.11$ (0.28) 17.91 Palm 39.84$ 2.01$ 5.83 6.84 1.37 BioTransplant 0.02$ $380.78k (1.97) 0.23
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Metrics Calculation
Sales: $100 MNet Income: $10 MShares Outstanding: 20 MStock Price: $15
Public Company Info:(must be filed with SEC)
EPS:P/E:P/S:Market Cap:
We can calculate:
E145 Winter 2008
Metrics Calculation
Sales: $100 MNet Income: $10 MShares Outstanding: 20 MStock Price: $15
Public Company Info:(must be filed with SEC)
EPS: 0.50$ P/E: 30P/S: 3Market Cap: 300$
We can calculate:
E145 Winter 2008
Valuing Startups
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Capital
Risk (ß)
Valuation
Idea isFeasible
TechnologyWorks
A CustomerBuys
SeedFunding
R&DCapital
Go-to-MarketCapital
ExpansionCapital
P(success) = 30%Req’d IRR = 100%
P(success) = 40%Req’d IRR = 70%
P(success) = 50%Req’d IRR = 50%
P(success) = 80%Req’d IRR = 30%
Source: Jim White (SHV)
VC Discount Rates and Risk Reduction
MilestoneFunding
E145 Winter 2008
VC Milestone Staged Timeline
SeedSeed ““A”A” ““B”B” ““C/D”C/D” IPO/IPO/M&AM&A
SizeSize ~$1m~$1m $3-8m$3-8m $10-20m$10-20m ~$20m~$20m ~$50m~$50m
SourceSource AngelAngel VCVC VCVC MezzMezz IBIB
RunwayRunway 6-12 months6-12 months 12-18 months12-18 months 18-24 months18-24 months 2+yrs2+yrs
# Empl.# Empl. <10<10 ~30~30 ~50~50 ~100~100 >100>100
MilestoneMilestone Clear plan & Clear plan & TeamTeam
Beta product & Beta product & customerscustomers
Sales, mkt Sales, mkt size, size,
competitioncompetition
Strategic, Strategic, financial financial
executionexecution
Growth, Growth, profitprofit
36E145 Winter 2008
“Venture Capital” Method
Valuing Cash, Time and RiskThis method defines one simple valuation approach:
1. Forecast Future Results (Financial Statements)
2. Determine likely value at that point (P/E Ratio)
3. Determine Dilution (Capital, Stock Options)
4. Determine share of pie demanded given required rates of return
5. Convert future values to present to derive share prices, ownership percentages
Source: Prof. Doug Mackenzie (KPCB)
37E145 Winter 2008
“Venture Capital” Quick Example
1. Forecast Future Results (Financial Statements)
• Net Income of $10M in Year 5
2. Determine likely value at that point (P/E Ratio)
• Industry currently demanding P/E ratios of 30, future value of $300M (year 5)
3. Determine Dilution (Capital, Stock Options)
• See Chemdex example (identify capital needs and shares required for management and employees)
38E145 Winter 2008
“Venture Capital” Quick Example
4. Determine share of pie demanded given required rates of return
• Each investor class (VC Round) will require a rate of return, lower over time as risk is mitigated through successful milestones
5. Convert future values to present to derive share prices, ownership percentages
• Chemdex shows share valuation and issuance of new shares
• If a VC invests $5M today with expected IRR of 70%, would require ownership stake of $71M (23%) in year 5 at exit / IPO.
E145 Winter 2008
Position Pre-RevPost-Rev
CEO 5-10% 3-8%VP Engineering 3-5% 1-3%VP Marketing 3-5% 1-3%
VP Sales 1-2% 1%CFO 2-3% 1-2%
Other VPs 1-2% 1%Key Individuals 0.5-2% 0.3-1%
Ranges of Grants