About Venture Capital

December 2012 Herv Lebret

Stanford ecorner

Venture Capital Is a Time Bomb David Heinemeier Hansson | 37signals

How do venture capitalists decide what to invest in, and why? Steve Jurvetson

Some introductory numbers

VC Kleiner Perkins Sequoia NEA Benchmark IVP Accel Greylock Oak Venrock Index Ventures Mayfield Sofinnova Mohr Davidow Atlas USVP Innovacom 3i Bechtolsheim TVI Crosslink MPAE DFJ Redpoint Harbor Vest Union Square Total USA 16 12 7 7 7 6 5 3 5 2 5 4 1 4 2 3 3 2 3 3 1 3 147 10 3 10 3 24 2 2 UK CH Sweden India France China Total 16 12 8 8 8 6 5 5 5 5 5 4 4 4 4 4 3 3 3 3 3 3 3 3 3 199

1 1 1

1 1 1 1 2

3 2 4

1 1 1 1

Extracted from data in http://www.startup-book.com/2011/08/15/more-data-on-ipo-and-founders

Agenda

Historical background Economic perspective The VC process

History of venture capital

Full story in:

You can also read chapter 4

Start-Up, what we may still learn from Silicon Valley

It began as a hobby of the rich

Laurence Rockfeller was interested in science and technology and less in his family business. He assembled a team of advisers, backed many entrepreneurs. In 1969, he structured a $7.5M fund into Venrock Associates.

Founded as the one of the first private equity firms in 1946 by "Jock" Whitney, J.H. Whitney & Co. provided capital and professional assistance to entrepreneurs.

He invested in MinuteMaid, Memorex, Genera Signals but also in movies (Gone with the Wind) He coined the term venture capital.

The Ancestors investments

Arthur Rock, a banker on the East Coast, is contacted to help them raising $1.5M; an amount he will find in the person of Sherman Fairchild, the largest individual shareholder of IBM and owner of Fairchild Camera. In 1957, Fairchild Semiconductor is founded.

Fairchild Semiconductor was very successful and reached 12,000 employees but the founders were bought back their shares by Fairchild they still became wealthy. Faichild bought back for $2.4M the stake of the 8 founders.
ARD financed High Voltage (a $1.8M return for a $200k investment) and Digital Equipment in 1957 (a $70k inv. worth $355M after 14 years). ARD stopped in 1972. ARD biggest flaw was no incentive for associates (no carried interest).

A genealogy

Kleiner Perkins first fund

$7M fund with $4M from Hilman (Wilmington), $1M from Rockefeller University. Both Kleiner and Perkins put $150k each.

Tandem ($152M) Genentech ($47M)

KP First Fund (1972-1984)

$16'000'000 $14'000'000 $12'000'000 $10'000'000 $8'000'000 $6'000'000 $4'000'000 $2'000'000 $0
qu ip m e An nt A t Co Ap nt e ekn rp pl x I a I . ie nd nc d M ust . N at rie O ov e ffi ac Dy ria s ce o n l C r M ast Inc om e or . m d ic In un a l c . Sp ica Co Am e e tio rp er ch i c T Qu ns . an ec m In At hn e C c . hl ol o o et ic gy rp. Ta Sh Co nd o r em C e C p. e Co tus o rp m C . o p Am ute rp. rs G dah I n en l C c. En e v i C nte orp ro o . c An D l lag h In d r ev e en c . os lo C An pm o rp a l en . yz t er Co s In . c.

Cost ($)

Value on June 30,1984

More on http://www.startup-book.com/2009/02/09/about-kleiner-perkins-first-fund-episode-3

Ad va nc ed

ec re at io n

Agenda

Historical background Economic perspective The VC process

Nasdaq and the VCs

1971-2006
4'500 4'000 3'500 3'000 2'500 2'000 1'500 1'000 500 0 1971 1976 1981 1986 1991 1996 2001 90 80 70 60 50 40 30 20 10 0

1974: the oil crisis and ERISA act 1984: the HDD crisis 1990: US recession and declining IRRs

2001: the Internet crash

100

Natural scale

Nasdaq ( end y ear)

VC f unds ( $B)

10'000

1'000

10

100

10

0. 1

1 1971 1976 1981 1986 1991 1996 2001

0. 01

Source: Compilation HL

Log scale

Nasdaq ( end y ear)

VC f unds ( $B)

Some returns
Although the data are not so easy to obtain (the numbers below are not fully consistent), the VC world has generated exceptional returns. The individual success stories are known. Some previous slides give some more numbers. The reader can compare to the typical Wall Street numbers

Geography of venture capital

How do VC make money?

Today VCs manage funds of other financing institutions and usually not their own (this is BAs or syndicates of Bas). A typical VC fund lasts 10 years with an investment period of 5-7 years VCs have two sources of funding: A management fee: usually 2% to 2.5% of the size of the fund per year A carried interest: usually 20% of the fund net profits Possibly a hurdle rate (6-8%)

Agenda

Historical background Economic perspective The VC process

You can read chapter 5

Start-Up, what we may still learn from Silicon Valley

What do VCs look for?

Some winning venture capitalists claim to look almost exclusively at the backgrounds and personalities of the founders; others focus mostly on the technology involved and the market opportunity the venture addresses
from The New Venturers, Wilson (1984)

There are people risks, markets risks, product development risks and finance risks. We will not invest in a company unless we understand and are comfortable with three of these risks. The components of success are product differentiation, a fast-growing market, a team of dedicated people and money. Don Valentine quoted in Wilson (1984)

The main terms of an investment

The size of the investment and related valuation. The pre- and post-money valuations differ by the size of the investment.

The ESOP size also has an impact and the fully diluted valuation includes the newly avalables stock options.

The price per share and the number of shares created. The class of shares, usually preferred. The structure of the board of directors. The vesting and reverse vesting mechanism of the stock options and founders shares. The kind of liquidation preference. The anti-dilution mechanism. The redemption rights. The priority rights, the restrictions on the sales and the transfer of shares. The exit conditions, and in particular the clauses that may force a sale (tag along, drag along). The expenses linked to the investment. The kind of decisions that investors control after their investment, usually through veto rights (the protective provisions).

$200'000'000

$300'000'000

$400'000'000

Liquidation preference

$100'000'000

$500'000'000

$600'000'000

$0
Series C

Series B

Series A

Common

$0 $11'000'000 $22'000'000 $33'000'000 $44'000'000 $55'000'000 $66'000'000 $77'000'000 $88'000'000 $99'000'000 $110'000'000 $121'000'000 $132'000'000 $143'000'000 $154'000'000 $165'000'000 $176'000'000 $187'000'000 $198'000'000 $209'000'000 $220'000'000 $231'000'000 $242'000'000 $253'000'000 $264'000'000 $275'000'000 $286'000'000 $297'000'000 $308'000'000 $319'000'000 $330'000'000 $341'000'000 $352'000'000 $363'000'000 $374'000'000 $385'000'000 $396'000'000 $407'000'000 $418'000'000 $429'000'000 $440'000'000 $451'000'000 $462'000'000 $473'000'000 $484'000'000 $495'000'000 $506'000'000 $517'000'000 $528'000'000 $539'000'000 $550'000'000 $561'000'000 $572'000'000 $583'000'000 $594'000'000

Anti-dilution
Investors protect their shares in case of a down-round, i.e. a new financing round with a lower price per share. There are three mechanisms (see excel-file): Full ratchet Weighted narrow-based average Weighted broad-average
The full ratchet gives the new (lower) price to the previous preferred shareholders who receive new shares. A weighted average is a combination of old and new price. The narrow-based weighted average takes into account only the total number of outstanding preferred shares for determining the new weighted average price for the old shares. The broad-based weighted average accounts for all equity previously issued and currently undergoing issue.

Price Amount Antidilution Common Series A Series B Total

2nd round $0.75 $750000 Broad-based Narrow-based Full ratchet Shares % Shares % Shares % Shares % 10'000000 76.9% 10'000000 70.7% 10'000000 68.8% 10'000000 52.6% 3000000 23.1% 3'140187 22.2% 3'555556 24.4% 8'000000 42.1% 1'000000 7.1% 1'000000 6.9% 1'000000 5.3% 13'000000 14'140187 14'555556 19'000000

1st round $2.00 $6'000000

Comments on terms
A term sheet follows the technical due diligence (3-6 months) and is conditional to legal and accounting due diligence. If all is positive, an investment should follow in 1-3 months. Terms are seldom balanced and reflect investors power. There is a noprisoner approach! There are however standard with not much deviation Confidentiality/exclusivity/costs are the only binding terms Avoid milestones! Be prepared

If you want to be part of the game

Career Traits for the Aspiring Venture Capitalist Steve Jurvetson