E145. Workshop B Staged Venture Financing

Transcription

1 E145 Workshop B Staged Venture Financing Presented by Eric Carr (with Thanks to Professor Tom Byers) Stanford University Special Thanks to Scott Bowie and Mike Rosenbluth, Past E145 TAs Copyright 2007 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only.

2 Agenda 1. Quick Accounting Review 2. Venture Funding (Cap Tables) Dilution + Growth (The Exploding Pie) Chemdex financing example 3. Valuing Public Companies (Ratios) 4. Valuing Start-Ups (The Challenges)

3 Accounting Review

4 Financial Statements Dept Budget Dept Budget Dept Budget Dept Budget Revenue Model Income Statement Revenue COGS Expenses Profit Balance Sheet Assets = Liabilities + Equity Cash Flow Operating Cash Flow Investing Cash Flow Financing Cash Flow Product Cost Model Corp Capital Budget Capitalization Plan

5 Common Sizing Common Sizing DNA MRK QCOM CSCO INTC DELL MSFT GOOG 19% 21% 33% 20% 22% 6% 28% 24% Net Income 29% 25% 36% 25% 31% 8% 37% 33% Operating Income 19% 17% 20% 14% 13% 1% 15% 10% R&D 34% 33% 15% 25% 15% 9% 31% 14% SG&A 85% 77% 71% 66% 59% 18% 83% 58% Gross Margin 15% 23% 29% 34% 41% 82% 17% 42% COGS 100% 100% 100% 100% 100% 100% 100% 100% Revenue

6 Margins & Growth High Revenue Growth Volume business Venture opportunities Creating most value! Low / Negative Margins High Margins Potentially destroying value Life style business Low / Negative Revenue Growth

7 Accounting Big Picture Financial snapshot of the business Tells you where your money is coming from and where it is going Cash Flow is key Tells you how much value is being created by the business Balance operating margins & growth Financial challenges with rapid growth

8 Venture Funding

9 (1) Founding: An entrepreneur begins with a vision and shares of stock in the new venture. Entrepreneur trades stock for ideas, money, and people Value has been successfully created. (2) Seed Stage: Venture capitalists provide money in return for stock Employees join via friends & associates in return for cash salary and stock options Ideas become intellectual property which represents the initial value in the company Kaplan s Startup Game: A race against time to create value and reduce risk (4) Exit Stage: Company files for IPO Entrepreneur, investors, and employees can cash in stock for money A viable public company has been created Each party continues to build the company, retires, or starts the game again Further growth is delayed until milestones are reached and risk of failure is reduced Reference: Start-Up by Jerry Kaplan (3) Growth Stage: More money, ideas, and people are obtained, but for much less stock than in the earlier stage due to lower risk Company balances earning cash, taking investment, and spending cash to create value

10 The Exploding Pie The smaller slice of the bigger pie Goal: Trade shares to grow the pie Is more fun and rewarding for most entrepreneurs Is worth more than the whole pie that never grows Requires high growth rates Is not easy to achieve, even with lots of financing Requires a good relationship between entrepreneur and investors

11 A Real Life Example: Chemdex* How much money do the founders need? How long until significant revenue? How long until profitability? What s the going rate for 1st round deals? Valuation is an art, not a science. *Chemdex is now called NexPrise (NXPS)

12 Chemdex in 1997: Series A 1. How much does the company need to raise? Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

13 Series A 2. Negotiate a pre-money valuation post $ = pre $ + amount raised = $2.7 M + $1.9 M % of company sold = amount raised / post $ valuation = $1.9 M / $4.6 M Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

14 Series A 3. Determine share price and total number of shares In Round A, share price is set so total shares = 5-10 million Total Shares = post $ / share price = $4.6 M / $0.54 = 8.5 M shares Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

15 Series B Series B 1. How much does the company need to raise? Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

16 Series B 2. Negotiate a pre-money valuation post $ = pre $ + amount raised = $11 M + $13 M % of company sold = amount raised / post $ valuation = $13 M / $24 M Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

17 Series B 3. Determine new share price Share price = (pre-money valuation) / (total pre-money shares) = $11M / 8.5 M Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

18 Series B 4. Determine total number of shares Total Shares = pre $ shares + amount raised / share price = 8.5 M + $13 M / $1.29 Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Round Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $

19 3. Determine new share price Chemdex - Series C 1. Decide how much you need to raise 2. Negotiate a valuation 4. Calculate total number of shares Round Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price* Total Shares* Series A $2.7 $1.9 $4.6 41% $ Series B $11 $13 $24 54% $ Series C $100 $30 $130 23% $

20 Chemdex Financing Date Round Premoney Valuation Amount Raised Postmoney Valuation % of Company Sold Share Price Total Shares 9/97 Series A $2.7 $1.9 $4.6 41% $ /98 Series B $11 $13 $24 54% $ /99 Series C $100 $30 $130 23% $ /99 IPO * $358 $113 $471 24% $ /00 $7.7B $ Today $103M $ * based on data from Hoover's Online valuations and share numbers in millions

21 Calculating Dilution Percentage owned = owned shares / total shares Founders shares = 59% of 8.5M = 5.02M shares Series B Dilution: 5.02M / 18.6M = 27% Series C Dilution: 5.02M / 24.2M = 21% IPO Dilution: 5.02M / 31.8M = 16% Series A Series B Series C IPO Founders & employee pool 59% 27% 21% 16% Total Shares

22 Chemdex and Dilution Series A Series B Series C IPO IPO ($M) IPO (times) return in Feb-00 return now Founders & employee pool 59% 27% 21% 16% $74.08 Series A VCs 41% 19% 15% 11% $ Series B VCs - 54% 42% 32% $ Series C VCs % 18% $ Public % $ Total 100% 100% 100% 100% $ * Assumes equal sharing of dilution every round

23 Another Cap Table Example Source: Technology Ventures 2e (Dorf / Byers) p. 530

24 Valuing Public Companies

25 Ratios & Valuing Public Companies Today Market Cap = # shares outstanding x Share price Answers What does the market think the company is worth? Examples GOOG with 306M outstanding $ / share = $143B market cap YHOO with 1.36B outstanding $28.56 / share = $48.9B market cap

26 Ratios & Valuing Public Companies Today Ratios EPS = Earnings per share An indicator of value created for shareholders P/E = Market Cap / Annual Earnings = Stock Price / EPS How much does $1 of earnings cost an investor? P/S = Market Cap / Annual Sales Similar companies facing similar risks should have similar ratios (Comparables / Comps) Enterprise Value - Market Cap + Debt

27 Metrics in Action Market Cap Net Income: $10 M Share Price: $15 Sales: $100 M P/E: 30 $300 M # Shares: 20 M $300 M P/S: 3 $300 M

28 Note: Updated Feb 6, 2006 Close A Sampling of Public Companies Stock Price ($/share) Market Cap ($B) EPS ($/share) P/E P/S GE $ $ Microsoft $ $ Walmart $ $ Google $ $ Cisco $ $ Coca Cola $ $ Ebay $ $ Apple $ $ Sony $ $ Disney $ $ Yahoo! $ $ Gap $ $ Sun $ 4.36 $ (0.10) 1.35 Alkermes $ $ 2.11 (0.28) Palm $ $ BioTransplant $ 0.02 $380.78k (1.97) 0.23

29 Industry Comparables Example Note: Remember to factor in the growth story Source: Technology Ventures 2e (Dorf / Byers) p. 536

30 Metrics Calculation Public Company Info: (must be filed with SEC) Sales: $100 M Net Income: $10 M Shares Outstanding: 20 M Stock Price: $15 We can calculate: EPS: P/E: P/S: Market Cap:

31 Metrics Calculation Public Company Info: (must be filed with SEC) Sales: $100 M Net Income: $10 M Shares Outstanding: 20 M Stock Price: $15 We can calculate: EPS: $ 0.50 P/E: 30 P/S: 3 Market Cap: $ 300

32 Other Possible Valuation Metrics Comparable Companies (Public Market Market Caps or Acquisition Prices) Multiple of Operating Cash Flow (or Free Cash Flow) Discounted Cash Flow Models Cash Flow Return on Investment (or EVA) Since most Start-Ups are cash negative for the first few years of existence (i.e. EPS will be negative), other valuation methodologies must be used...

33 Valuing Startups

34 Standard Venture Model High Risk Equity Return (30%+) Diversification Management Fees Share of Profits Management Help Financing Credibility Capital Capital, Time, Help Limited Partner Venture Partner Portfolio Company Liquid Stock Preferred Stock Limited partnerships, governed by partnership agreement covenants, of finite life, with substantial profit sharing...

35 Lifetime of a Venture Fund Year 0 Year 5 Year 10 Investors Institutional $10-50M Individuals $0.5-5M Cash in 5-10% chunks Around companies per fund Company Zombies...

36 In which of the following firms would you rather invest? Each invests $1 million per company in 10 companies: One gets 2x their money on all 10 The other loses all their money in 8 and gets 20x their money on the remaining 2 Source: Andy Rachleff

37 VC Discount Rates and Risk Reduction Milestone Funding Idea is Feasible Technology Works A Customer Buys P(success) = 80% Req d IRR = 30% Valuation P(success) = 50% Req d IRR = 50% P(success) = 30% Req d IRR = 100% P(success) = 40% Req d IRR = 70% Risk (ß) Capital Seed Funding R&D Capital Go-to-Market Capital Expansion Capital Source: Jim White (SHV)

38 VC Milestone Staged Timeline Seed A B C/D IPO/ M&A Size ~$1m $3-8m $10-20m ~$20m ~$50m Source Angel VC VC Mezz IB Runway 6-12 months months months 2+yrs # Empl. <10 ~30 ~50 ~100 >100 Milestone Clear plan & Team Beta product & customers Sales, mkt size, competition Strategic, financial execution Growth, profit

39 Quick Review: Returns, Discount Rates and IRR 1. Rate of Return $100 VC s do not usually think in terms of 10% RoR 30% RoR 70% RoR Present Value return. They think in Year terms 0 of in Future multiples. Year 5 10X Return = 115.4% return over 3 years 58.5% return over 5 years 2. Discount Rate 10% Discount Rate 20% Discount Rate 38.9% return over 7 Year years 0 Future Value in Present $100 Year 5 (LPs think in terms of return though ) 3. Internal Rate of Return (IRR) -$100 IRR of 30% Year 0 $371 Year 5

40 Venture Capital Method Valuing Cash, Time and Risk This method defines one simple valuation approach: 1. Forecast Future Results (Financial Statements) 2. Determine likely value at that point (P/E Ratio) 3. Determine Dilution (Capital, Stock Options) 4. Determine share of pie demanded given required rates of return 5. Convert future values to present to derive share prices, ownership percentages Source: Prof. Doug Mackenzie (KPCB)

41 Venture Capital Quick Example 1. Forecast Future Results (Financial Statements) Net Income of $10M in Year 5 2. Determine likely value at that point (P/E Ratio) Industry currently demanding P/E ratios of 30, future value of $300M (year 5) 3. Determine Dilution (Capital, Stock Options) See Chemdex example (identify capital needs and shares required for management and employees)

42 Venture Capital Quick Example 4. Determine share of pie demanded given required rates of return Each investor class (VC Round) will require a rate of return, lower over time as risk is mitigated through successful milestones 5. Convert future values to present to derive share prices, ownership percentages Chemdex shows share valuation and issuance of new shares If a VC invests $5M today with expected IRR of 70%, would require ownership stake of $71M (23%) in year 5 at exit / IPO.

43 Ranges of Grants Position Pre-Rev Post-Rev CEO 5-10% 3-8% VP Engineering 3-5% 1-3% VP Marketing 3-5% 1-3% VP Sales 1-2% 1% CFO 2-3% 1-2% Other VPs 1-2% 1% Key Individuals 0.5-2% 0.3-1%

44 Lessons Learned Summary Know what public company metrics mean Most financings done in multiple rounds A smaller piece of a big pie is better than a big piece of a small pie Know how to work out multiple stage financings