VENTURE CAPITAL FUNDING

Content
1. Introduction to Venture Capitalism 2. Venture Funding The Process 3. Evaluation Criteria for Venture Funding. 4. Role of a Venture Capitalist

1. In the Economy 2. In the Enterprise

5. Choosing an Investment Partner

Factors of Production
LAND CAPIT AL

LABO R

Stages of Funding
Venture Capital Loans Private Equity IPO

Maturity

Angel Funding Incubators Faith Money

Time

Venture Fund: Vertical & Horizontal Focus

IT, Telecom Convergence
Life Sciences, Manufacturing, Logistics Biotechnology

PRE-IPO EXPANSION STAGE

EARLY STAGE
SEED CAPITAL

Financing Stage

Period (funds locked in years)

7-10

Risk perception

Activity to be financed

Early stage finance Seed

Extreme

For supporting a concept or idea or R & D for product development

Start up

5-9

Very high

Initializing operations or developing prototypes

First stage

3-7

High

Start

commercial

production

and

marketing Second stage 3-5 Sufficiently high Expand market & growing working capital need Later stage finance 1-3 Medium Market company expansion, acquisition &

product development for profit making

Buy out-in

1-3

Medium

Acquisition financing

Turnaround

3-5

Medium to high

Turning around a sick company

Mezzanine

1-3

Low

Facilitating public issue

The Venture Capital Financing Process

The financing process varies depending on the stage of the enterprise. Venture capitalists usually describe businesses as being in one of the following six stages: Seed Stage:

Start-up Stage Second Stage

Third Stage
Bridge Stage Liquidity Stage

The Seed Stage The seed stage is where an idea for a product or services is first formed. As the name implies, it is the earliest stage in the life of an enterprise. The entrepreneur seeking financing in this stage faces a difficult challenge, to convince the investor that the venture will one day be profitable. The risk is high for the investors early, so very few ideas attract outside financing at this time. For those that do, the process usually involves submitting a report to an investor on the technical and economical feasibility of the idea-a Feasibility Study. In some cases, the founder may include a rough prototype with the study. The investor then considers the study and the prototype in deciding whether to take action. He is unlikely to invest more than minimum needed to determine whether the idea deserves further consideration and investment, however.

The legal risk for the entrepreneur at this stage is protecting the idea. Most investors are scrupulous and ethical people. But, it is especially important for the entrepreneur to obtain a fully executed non-disclosure agreement from the investor in advance of revealing any details and to make sure that all of her intellectual property is legally protected through the use of patents, trademarks, or copyrights, wherever possible. That way, should the investor decide against the project, the entrepreneur can proceed without fear that the investor might try to steal it.

If an investor does decide to provide an early investment, he will want to know that the entrepreneur is fully committed to the project financially. The investor will want to know that the founder wont walk away if the going gets rough. So, he will usually require that the entrepreneur places most or all of her assets at risk in the venture. Of course, thats not really in the founders best interests. She should consider sheltering personal assets with a sound asset protection plan. A good plan will allow her to truthfully say that she has fully committed her personal assets while keeping a cache of funds in an uncollectable class of asset so that she can start over if the venture capitalist divests or she needs more money in later stages to save the business.

Another issue for the entrepreneur is how the financing deal is structured. There are various investment vehicles in play, everything from a straight purchase of stock to a convertible debenture (a loan that can convert to stock). The risks associated with each type of instrument vary. It is important for the founder to consult with one of our venture capital attorneys before executing any agreements.

The Start-up Stage In the start-up stage, the entrepreneur decides, with or without investor participation, to bring the idea to market. He should form a business entity, such as a corporation, limited liability company (LLC), limited liability partnership (LLP), limited partnership (LP), or limited liability limited partnership (LLLP) to operate the business. In fact, we recommend that valuable assets are placed into a separate holding company for protection against creditors and that the choice of entity is made in a manner that provides for favorable tax treatment and will foster future investment.

At this stage, the founders decide on a management team and board of directors, although they may assume many of these duties in a small venture to preserve capital. If the business involves an original product, management will start extensive testing of the prototype and concurrently they will refine the business plan. The team will also try to attract its first clients to help offset expenses with early revenue.

Investors will provide additional capital in this stage only if the prospects look strong. They will also usually closely monitor the feasibility of the product and the capabilities of the management team. As the company beings to enter the market, these outside investors will start carefully assessing scalabilitythe potential size of the market; the larger the market, the more interested the investor.

Its especially important for the fledgling business to have a solid baseline set of contracts in place with key vendors, employees, and customers. This creates long-term enterprise value and puts the venture capitalists organization is well protected. If funding has not occurred, the lack of solid contractual relationships may cause some professional investors to take a pass on the business.

The Second Stage

A company enters the second stage after the company starts to take market share. Not all companies at this stage are profitable, but their potential for profitability should now be more certain. But, the enterprise probably needs more capital for equipment purchases, inventory, and receivable financing. At this stage, the venture capitalists start looking at the long-term viability of the company. They may suggest changes or restructuring in management. If the company doesnt look profitable or a territorial dispute arises between them and management, they may cut funding. If things continue smoothly, theyll usually do what needs to be done to take the company to the next stage, including providing more capital or finding more funding sources.

The legal risk to management at this stage is in focus. It is not uncommon for some investors to get greedy or panicky and start taking steps to further their interests at the expense of the organization. Key staff may also decide to jump ship and make deals to start up competing enterprises. It is important for management to shore up these risks with solid legal advice and clearly written agreements if they havent already done so.

The Third Stage

The third stage is where the company moves into solid profitability but still lack expansion capital. For third-stage companies, sales growth is probably fast, and positive profit margins have taken away most of the downside investment risk. But, the rapid expansion requires more working capital than can be generated from internal cash flow. New venture capitalist funds may be used for further expansion. At this stage, banks may also be willing to supply some credit if it can be secured by fixed assets or receivables.

Threats to the enterprise at this stage are the same as in the previous ones. But, in addition to these risks, the business will also find itself in occasional disputes with its competitors, often in the form of claims for unfair competition, patent or trademark infringement, or tortious interference. Our litigation team can advise and protect management on how to deal with these treats. We recommend having a sound litigation policy in place before trouble starts brewing.

The Bridge Stage

This stage is the last in the venture capital financing process. The main goal here is to search for a way to allow the investors to cash out. The investors will not usually put in additional capital at this point, so the enterprise usually obtains bridge (mezzanine) financing to sustain growth while the company looks at those options. The Liquidity Stage
The liquidity stage is where the venture capital investors finally cash out of most or all of their position in the company. The liquidity may come in the form of an initial public offering, an acquisition, or a leveraged buyout.

The Ideal Angel Investor

1. Seed Investor is an entrepreneur at heart

2. Can provide 300T USD to 1M USD

3. Participates in seed round (Series A) 4. A Coach who has done it before. Has invaluable inputs on:
o o o o o Need-based definition of product & market segment Fund raising strategy Building the core team Contacts with VCs Exit strategy formulation

Characteristics of a Venture Capital Investment

1. Equity investment 2. Substantial minority/equity stake 3. No Takeover Management Mentality, but rather has a Company First Philosophy 4. Board Position desired but not mandatory (Passive vs. Active Investor) 5. Exit is very important (within 3 - 5 years) 6. Early Stage, Expansion Stage, Later Stage.

Venture Funding Process

Release of Funds
Agreement

Term Sheet
Negotiation of Terms

Due Diligence Queries & Response

Validation of Concept and Business Plan

Team Meeting Analysis

Proposal

Venture Capital Funding Round

1. 2. 3. 4. Knowledge of the industry sector Substantial market size Quality of the management team Business plan
1. 2. 3. 1. Product and marketing space Technology & product development roadmap Sales ramp-up Customers, Technology, Team

5. Due Diligence

Venture Capital Funding Round

Valuation Conditional funding is possible!
(> 5x)
Late Stage

(10 20) (20 100)

Early Stage VC

(Multiple) Time

Characteristics of Different Rounds

SERIES A SERIES B SERIES C
Milestones
1. 2. 3. Complete Team Complete Product Beta Customers

Milestones
1. 2. Complete marketing strategy Sales ramp-up
a) b) Sales force in place First commercial shipment

Milestones
1. 2. Sales ram More customers
a) b) Smoothen out revenue curve Create backlog

3.

Customer support in place

Criteria for Evaluation

1. 2. 3. 4. 5. 6. 7. 8. 9. Credentials and track record of the founding team Market potential for the concept or idea Technology dependence and intensity Sustainable competitive advantage Scalability of business Execution capabilities Risks and mitigation strategies Exit options Intuitive Feel-good Factor

What makes an Investment-grade company?

1.

2.

3.

Core Management Team. Venture funds back entrepreneurs and the team. Market Size, Opportunity and Scalability. Competitive advantage today; potential to change the rules of the game; the opportunity to compete globally . Family Wealth today or potentially. In the form of brand, intellectual property, methodologies, processes, etc., which influence valuations.

4. 5. 6. 7. 8.

Clean structure - Most preferred is a single and transparent company: NO cross-holding and NO subsidiary structure. Valuations and share of company. Return on Investment potential. Co-investment potential with added value. Exit opportunity.

Role of a Venture Capitalist in the Economy

1. Supporting ideas which have high risk and high reward 2. Nurturing innovation and creativity 3. Sustaining a competitive business environment 4. Supporting the growth of entrepreneurial excellence

Role of a Venture Capitalist in an Enterprise

1. Providing funds

2. Providing insights to the evolving business strategy

3. Developing alliances and partnerships

4. Providing networking access to vital prospective customers. 5. Assistance in head hunting for senior positions. 6. Sharing vital and relevant information.

Choosing an Investment Partner

1. 2. 3. 4. Industry and stage of funding focus Global or country specific Cleary defined value additions Referrals from investee Co.s of the VCs.

5. Referrals from financial institutions and other VCs 6. Professional conduct of the partners and their knowledge of the industry 7. Patience

The Ideal Venture Capitalist Investor

1. Knowledge of industry, deal structuring and exits 2. Industry and VC network 3. Ability to stay over 2 to 3 rounds. 4. Assistance with business strategy, recruitment, fund raising, partnering, customer contacts and exits (IPO, M&A) 5. Active board participation

Exit Strategies
1. Initial Public Offering o Requires revenue visibility o Requires backlog o Requires a complete team o Ready for post-IPO issues (e.g. lawsuits, etc.) 2. M & A Usually for an asset o Technology, product, people

END