Transcript Document 7124238

Seeking venture funding…
what an investor looks for and
what to look for in an investor
A discussion of considerations from a pre-seed and seed
investor perspective…
August 25 and October 13, 2005
Teri F. Willey, Managing Partner
ARCH Development Partners
[email protected]
Planning to cover…
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How a VC fund works
Some background on ARCH Development Partners
What investors like to see (and what you might look
for in investors)
Risk and Return
Term Sheet Tango
Resources
Structure – how a fund works
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The Fund
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The Partnership
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Fund raises money from institutional investors (LP’s)
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University endowments, pension funds, insurance companies, corporate
venture funds, wealthy individuals
Fund may range from $30M - 400M, $1-$10M per LP
Fund lasts 10 years. First 3-4 years initial investments, then follow-on
investments and exits.
Multiple Funds may be managed concurrently
20% carry. (For a $100M fund, all gains over $100M get split 80/20 with
investors/fund managers)
The Management Company
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2-3% fees per year. (2% fee on $100M is $2M year)
Return - % returns based on age of fund for
period ending 2003 (www.nvca.org)
3 yr
5 yr
10 yr
S& P
500
q
Nasd
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t eEq
uit y
A ll P
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/See
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Returns - by Stage of Business
Seed stage –
250K-$1M
developing product
IRR 70+%
Need 10X in 5
years
Venture Series A –
Revenue - paying
Customers
$1- $3M
IRR 50%
Need 5 X in 34 years
Venture Series B – $3- 10M
Sales Expansion
IRR 40%
Need 3X in 2-3
years
Late stage – mature $15-50M
business
IRR 25%
Need 1.25X in
12 mos
Return – multiples and IRR
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Homeruns (10x)
Singles/Doubles/Triples (1x<10x)
Strikeouts (<1x)
Multiple: $exited/on $invested
IRR: timing to exit from the first investment
Note: 2.5X for a 20% IRR, 5X for a 40% IRR
Background…ARCH Development Partners
 Currently $32 million under management
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LP’s: Universities, Foundations, Banks, Corporations, and Hospitals
 Strategy:
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Strategically partner with communities to create start-ups
 Current partners: Kalamazoo, Peoria, Lafayette, Cincinnati, St. Louis
 Make “pre-seed” investments ($50,000 to $1,000,000)
 Syndicate deals with other early-stage investors, e.g. angels
 Structure deals for optimal early exits
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Primary Deal Sources: University and Corporate spin-outs
Investments: Biotechnology, Information Technology
Geographic Focus: Upper Midwest: IN, IL, MI, OH
General Partners: Experienced investors and entrepreneurs
Stage of investments
Focus
Pre-Seed
Description  IP/Technology
Team
$ Needed
Keys to
Success
Seed
 Product-indevelopment
 Technologist /
founder/business Plus first senior
development
mgmt team
member
 <$500K
 $250K to $1M
 Identifying
technology via  Finding
relationships
development
 Determining
partners
commercial
 Developing
viability
business
 Accessing
strategy
rights/Recruiting  Recruiting BOD
CEO
& SAB
Early Stage
Mid-Stage
 Product at beta  Full customer
clients
pipeline
Exit
 Business
Expansion
 Senior mgmt
 Senior mgmt
team formation team in place
 $1M to $5M
 $2M to $20M
 Growing the
 Managing
sales pipeline
growth
 BOD and SAB  Becoming
in place
profitable
 Identifying exits
 Public Markets
The ARCH Model
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Apply Time-tested Traditional VC Disciplines to:
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Identify Platform Technologies
Create Patent Strategy
Recruit the CEO
Identify and Quantify the Market
Create the Business Model
Recruit BOD and SAB
Raise $$$
Manage to Milestones
Accelerating New Business Growth
Inception
Groundwork
Interim management
Managing
Licensor
relationship
Technology due
diligence
Business plan
creation
Patent and IP
protection
Finding and
closing initial
financing
Consultation/
liaison on
university policy
Incorporation
Office space
Payroll and
benefits
Accounting
IT and
telephone
Advisory board
and BOD
Marketing/PR
Financial
model
and pricing
Business
development
Operations
processes
Product
development
Talent
Recruiting and
hiring
Organizational
structure
Compensation
planning
Staffing models
Culture
building
Toward independence
Product
commercialization
Customers
Revenue
Space to grow
Next round
funding
Updated Advisory
board
and BOD
The “squeeze” perspective
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At the early stages … it is about squeezing out enough risk so
traditional corporate partners and investors can participate.
We think about how you can facilitate:
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hitting the most critical milestone's)
in the least amount of time
with the least amount of money
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light initial capitalization
management compensated w/stock
use non-dilutive funds
outsource
exit strategy flexibility
What we want to see – MANAGEABLE RISK
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As we evaluate each of the foregoing we are
considering the main types of risk, if they are
manageable and if so how they will be managed:
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IP
Market
Technical
Financing
Management
Risk con’t
PROBABILITY
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Sufficient capital
Management is capable and focused
Product development goes as planned
Production and component sourcing goes as planned
Competitors behave as expected
Customers want the product
Pricing is forecast correctly
Patents are issued and are enforceable
80%
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Combined probability of success
17%
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Harvard Business Review November-December 1998
What we like to see - TYPE
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Science/innovation based company.
Prefer university or corporate owned intellectual
property as the basis for the spin out (vs independent
inventor).
Biomedical, biotechnology, pharmaceutical,
bioinformatics, information technology, wireless,
internet infrastructure.
What we like to see - STAGE
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Pre-business plan and management team is fine.
We prefer to act as founders at this stage, assist with
company formation and management and board
recruitment and the acquiring the necessary
intellectual property rights.
What we like to see - $ REQ
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50k to 1 million needed for the purpose of squeezing
risk out of the venture and positioning it for further
investment or revenue generation.
20-50 million total to get to exit.
Realistic expectations regarding valuation, that is
what the investment buys in ownership and control
What we like to see - MARKET
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The product(s) the company is proposing to develop should
have a market of 200 million or more (that is the company’s
sales are expected to be 200 million or more annually in a
reasonable time after product launch)
Understanding of the commercialization strategy and
competitive advantage.
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Clear and realistic idea of who and what the competition is and how
the idea will reach the market in the form of a product.
Know where the pain is that this product addresses and where a the
incentives are to adopt the new product (the value proposition).
What we like to see - IP
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The proposed product should be based on an
appropriate proprietary position, preferably a strong
patent position or the real potential for one.
This includes understanding freedom to operate
issues and determining that they are clearly
addressed or reasonably manageable.
What we like to see - MGMT
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If there are there already or if we need to recruit
them:
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Product development experience and operating experience
(fund raising a plus).
Reasonable compensation expectations.
Chemistry with the founding scientists/innovators.
Early stage company experience
Network
What we like to see - EXIT
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The company or proposed company should be one
poised for an acquisition exit or in some cases an
IPO exit.
Pre-seed and seed stage investors like ARCH may
lean toward an acquisition exit as it is consistent
with our model (and the only choice when the
window is closed) and hence towards deals in
industries in which M&A is the favored transaction.
What we like to see - RETURNS
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At exit it’s about how…
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many shares are we going to own.
much do we invest to get there.
much to others invest to get there.
long will it take us to get there.
much will they be worth at exit.
Sources of these shares…of equity
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In addition to acquiring equity as consideration
for investing dollars in the company (usually
preferred) equity may also be obtained…
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As consideration for the technology license (common
or preferred)
As consideration for forming
the company or providing services (sweat equity –
usually common)
As compensation (options for common or restricted
stock)
How much equity
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Pre-money valuation + dollars invested = post
money valuation
Equity ownership equals dollars invested divided by
the post money valuation…or does it?!
Equity ownership on a fully-diluted basis
Term Sheet
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Financial Terms
Non-financial Terms
Equity Provisions
Terms to address the traditional ‘valuation gap’
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Pre-money valuation
Financial tools
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Incentive based tools
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Liquidation preferences
Warrants
Dividends
Price controls aka ratchet mechanisms
Preemptive rights
Performance based incentives
Management options
Vesting founders shares
Terms to address managing risk via control
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Board representation
Class voting
Voting the option pool
Protective provisions
Liquidation preferences
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These preferences allow certain investors, in
the case or acquisition or liquidation, to get
their initial investment back (or multiples of it
in the case of 2x or 3x liquidation
preferences) before returns are shared ratably
with the other share holders.
Warrants
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Another word for an option to purchase a security. The term
is generally used for options provided by the company to
outside investors (as distinct from officers, employees, etc.)
Contract which covers time frame during which the investor
can convert the warrants and the price they can convert/buy
stock
Sometimes used with or without interest on convertible
bridge loans and can be based on a percent of the bridge
This can be a cashless transaction if the warrants are
converted at exit
Taken into consideration when determining a fully diluted
share price
Anti-dilution
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Price protections…if stock is sold, at a price less
what the investor with anti-dilution protection paid
for it, the lower price is applied to the conversion
formula
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Full-ratchet
Weighted average
Preemptive rights…the right of the investor to
acquire new securities issued by the company to the
extent necessary to maintain its percentage interest
on an as converted basis)
Vesting founders shares
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Incentive to keep founders with the company
“Earning back” the initial ownership in the
company over time or against milestones
Control via business decisions
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Protective provisions
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May provide significant control of the investors even if
they do not own a majority of the company.
Outlines which decisions require approval of the investors
(which class of investors, percent, etc.)
Board representation
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Investors my require one or more board seats
Resources
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Indiana Venture Center
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Indiana Seed Fund I. LLC (ISF)
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www.biocrossroads.com/entrepreneur/isf.htm
Model documents and industry overview
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www.indianaventurecenter.org
www.nvca.org
More course work
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www.vcinstitute.org
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