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ELEC5701
Venture Financing
sdfl
David Rowe
Investment Manager
Uniseed Management Pty Ltd
[email protected]
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
– 19 co-investments, 16 second rounds, 11 third rounds, 7
fourth rounds, 3 fifth round, 1 sixth round + grants
– Relationships with Australian and International VCs
• 38 investments to date; current portfolio of 18
companies e.g. QRX, BT Imaging
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
A Review of Financing Options
Non-Equity
Financing
Equity Financing
When Bootstrapping is Not Preferred
• Bootstrapping worked for HP, Microsoft, Apple,
Dell and eBay – and Atlassian!
• Many business models benefit from raising
additional capital while building revenue.
• Technology companies typically raise capital in
exchange for equity in the business.
• One note: you should always be a bootstrapper –
even if you raise capital
– Raise as little as possible <x-ref Matt’s hockey stick>
– Leverage non-dilutive funds e.g. EMDG, CommAus
Passionate
founding team
Large potential
market
Product
development
required
Pre-revenue
Intense
competition likely
Need to move
rapidly
VC FUNDING SUPPORTS:
Unique product
or concept
IMPLICATIONS:
PRE-REQUISITES:
Good Reasons to Raise Equity Finance
Hiring
Rapid product
development
Commercialisation
Partnerships
Infrastructure
International go
to market
Further funding
Etc…
The bottom line: raising equity finance provides the working capital to enable a
company 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
• Danny Rimer (now Index Ventures i.e. Skype):
“Webvan was my billion dollar bonfire…”
• CNET hailed Webvan as one of the greatest dotcom disasters
in history [Jun’08]
Review: Stages of Investment
Seed
Early Stage
Series A, (B)
Later Stage
Expansion
Series B, C, D… Stage/pre-IPO
Revenue
Pre-revenue
$500k - $1m
$1m - $5m,
negative EBIT
$2m+ EBITDA
positive 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
FFFs
Gov’t Grants
Incubators
Angels
Uni Seed Funds
(Venture
Capital)
Super Angels
(Angel Sidecar)
Uni Seed Funds
Venture Capital
Venture
Capital
Strategic
Investors
Late Stage VC
Early Stage
Private Equity
Hedge Funds?
Expect Returns
3-5x ++ / 3-10yr 5-10x / 5yr+
5-10x / 5yr-
3-5x / 2-5yrs
Talk to…
ATP, Uniseed
SXVP, IntelCap
Champ/Quad
Uniseed, SXVP
IPO
Venture Capital: how VCs work
• Raise a fund: $40m+
– High net worths, 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%pa of funds deployed
– Carry (profit share) of 20-25% of returns above investment
IRR: Bang for Buck
• IRR = Internal Rate of
Return
• IRR is the discount rate
where NPV of cashflows
equals zero.
• A measure of ongoing
value creation
considering the ‘time
value of money’.
• Allows ready comparison
of investment options.
Angel Funding: how HNWs work
• Angels invest their own money
– Invest 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
• Finding Angel funding
– Australian Association of Angel Investors (www.aaai.net.au)
– Sydney Angels (www.sydneyangels.net.au) + Sidecar Fund
What to look for in an Investor
• Look for:
– Synergies
– Complimentary
skills/personalities
– Track-record, network
– Etc…
• Remember:
– 5+ years is a long time…
– They will have control…
• In the event of ‘No’…
– Learn and improve pitch
– Don’t expect a free TShirt… ;-)
VCs have Cool T’s too…
What Does an Investor Look For?
• Guy Kawasaki: “Investors are actually looking for
a reason not to do a deal…”
• The Venture Funnel:
–
–
–
–
–
2000 business plans in
200 moderately credible
100 potentially investible
40 for due diligence
10 get funded
• To be VC-ready,
you need to think like a VC
– Aim for 5-10x in 3-5 years
– Great Team, Technology, Traction
[over 300/yr]
[1 or 2 a month]
[1 a month]
[3-4 in parallel]
[2-3/yr]
$
Investment Ready: You Need a Plan
PEOPLE
IP
MARKET
GROWTH
MODEL
EXIT
Deep expertise, clean track-record
Experience growing companies, ability to execute plans
Synergy with venture capital management team
Compelling products & disruptive technology
IP ownership: who owns it, clean freedom to operate
Ability to protect and defend the intellectual property
Barriers to entry
Growing, large, definable market
Awareness of the competitive landscape
Rapid growth and ability to scale
Clear strategy to execute the route to market
Global opportunities & international marketing
Identifiable sales cycle & pipeline, revenue streams
Sustainable margins & ability to leverage scale
Clear path to break-even and maintain profitability
Clear path to exit
 Key exit options: IPO; trade sale; share buy-back
Creation of significant returns to investors & founders
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.
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
Enterprise 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
Dilution on Equity: the Cap Table
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
1) Seed Round
2) Series A-1
Spinout
$5m
$3m
$2.7m
3) Convertible Note
$1.8m
Industry Institute Grant
$13m
$1m
ClimateReady
4) Series A-2
$9m
$4m
$2.1m
5) Strategic Investor
$500k
PLUS Working Capital (EFIC)
$500k
Total Funds Raised: $10.3m Equity + $4.8m Grants
THANKS!
Any Questions?!
sdfl
David Rowe
Investment Manager
Uniseed Management Pty Ltd
[email protected]