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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]