Session 09 Venture Finance and Teams Tom Byers Copyright 2006 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. 1
2003 Mark P. Rice, Babson 2
Today s s Agenda Part I. What is the purpose of a business plan? Part II and III. Given the nature of the business and the objectives of the founders, what human (II) and capital (III) resources are needed to build a venture? 3
Part I. What is the Purpose of a Business Plan? (And Is It Really Worth All the Effort?) 4
Outline of a Business Plan Executive Summary Market Analysis Vision and Concept (including Technology) Competitive Positioning and Marketing Business Model Organization Financial Projections Ownership 5
Recall Sahlman s s Model Reference: Sahlman 6
Part II: ABCs of Talent A. Team Recruiting B. Compensation Rewards C. Culture Norms 7
A. Recruiting Key Players in Start-Ups Internal Key issues: When to hire? Experience versus passion and energy? Qualifications versus motivation and character? Outsourcing? External Key issues: How to select? How to manage?! Founders or Initial Partners! CEO and VPs! Designers, Developers, Architects and Managers of Products & Services! Sales and Marketing! Operations and Administration! Others?! Board Of Directors! Investors! Advisory Boards! Professional Services and Suppliers! Others? 8
Even _ Was a Team! 9
Q&A with VC John Doerr of KPCB Q. What is the most important part of any business plan? A. I always turn to the bios of the team first. For me, it s team, team, team. Others might say, people, people, people -- but I m interested in the team as a whole. 10
B. Compensation and Rewards Masayoshi Son CEO of SOFTBANK CORP. (Japan) The way I attract these people to SOFTBANK is to explain what my dream is. It is not money because they actually come to work and we never talk about payment. They come to work, then a week passes, or longer, then we finally get around to talking about money. I ll ask them, by the way, how much do you want? And they say, whatever you want to give me. Then I ask them, how much were you making last year? Then I give them the same amount. So they don t come to SOFTBANK for the money. It s for the dream that everyone has together. The dream of making the company successful. 11
Understanding Rewards In High-Potential Ventures Status Often Determined by Contributions to Improving Culture and Increasing the Value of the Company Hence, Rewards Tend to Be Value-Enhancing such as Stock Options (Employees Have Equity Ownership) 12
Compensation in Start-Ups Cash! Salary and Bonus! Benefits Equity! Common Stock Plans (Incentive Stock Options Have Favorable Tax Rates)! Vesting Schedule and Stock Budget! Tax Implications (IRS in USA) and Security Laws (SEC in USA) 13
C: Culture The Secret to Long-Term Success? Definition A strong system of informal rules that spells out how people are to behave most of the time Two Great Quotes The most durable asset of a venture is its culture (Cook) First four letters of culture spell c-u-l-t (Collins) 14
Culture: Major Challenge to Create a Fertile Environment for Innovation Develop Sense of Teamwork Understand Personalities of Key People Develop Open Internal Communication Remain Open to Ideas & Suggestions from Anywhere Be the Customer Be Willing to Experiment Include Creative and Unusual People Address the Issue of Autonomy Reference: Collins & Lazier, Beyond Entrepreneurship 15
Recall The Success Formula for E145/STS173 (Our Culture) 4 Show up on time (with cell phones and other stuff turned up really loud please). 4 Be nice to people (e.g., constructive comments only, listen carefully. and only one speaker at a time please). 4 Do what you say you will do and deliver more than you promise (both in class and out). 4 Do it with energy and passion. The teaching team commits to these items; we respectfully ask you to do the same. Reference: JM Perry 16
Part III: ABCs of Financing A. Amount of Cash Needed and Purpose B. Sources of Capital C. Deal Structure and Terms 17
A. Amount of Cash Two Key Questions #1 How much money is needed for this round of financing? Typical Financing Stages (or Rounds): Seed " Early " Mezzanine " Late (e.g., IPO) 18
#2 Which risks are to be reduced with this money in this round? Team Risk Capital Risk Technology Risk Market Risk 19
B. Raise Money From Where? Sources of Capital for High-Technology Entrepreneurs Angel Investors Corporate VC Traditional VC Bootstrapping Other 20
VC Historical Data United States 21
US and European Venture Capital: Historically Different Approaches? US Model European Model People Stage Provide Style Objective Philosophy Returns company founders and builders seed value added hands on create very large companies maximise upside target a small number of big winners home run investing consultants and bankers early (A Round), but not seed just money hands off create medium sized companies minimise downside believe returns can be earned across the portfolio Reference: Mowbray Capital, London
C. Key Questions Regarding the Deal 1.What percentage of the company do the investors receive for their cash? 2.What special terms and conditions are necessary to compensate them for the risk? 23
(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 (Success): Company files for IPO or gets acquired (M&A) A viable enterprise has been created (maybe public) Entrepreneur, investors, and employees can cash in stock for money (eventually) Each party continues to build the company, starts the game again, or something else Further growth is delayed until milestones are reached and risk of failure is reduced Reference: 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 24
A Simple Venture Finance Example Roma s hot startup requires $10 million in order to form its business. She expects to earn $10 million in its fifth year. Randy s VC firm has reviewed the company's business plan and believes that he is entitled to a 50% return on his investment. (Hint: how many times must his money grow in 5 years?) Publicly traded companies in this category and industry trade at approximately 15 times earnings (PE ratio). There is no material difference between these companies and the startup. What portion of the company should Randy s VC firm receive today? (Hint: what is future value of that investment?) 1. Value of VC Investment in Year 5 = $10 m*(1+50%)^5 = $76m 2. StartUp s Value in Year 5 = $10 m*(p/e of 15) = $150m 3. VC Firm s Share Today = Step 1/Step 2 = $76 m/$150m = ~ 50% 4. Post-Money Value Today = $10 m /.50 = $ 20 mm 25
A Multi-Stage Venture Finance Example Time I II III IV V 10 % 10 % 10 % 20 % 20 % 10 % 10 % 33 1/3 % 20 % 33 1/3 % 33 1/3 % 20 % 20 % 50 % 1mm shares for each founder #=3mm shares @ $0.001 ea. Value=$3k +1mm shares each for CEO & employees #= 5mm shares @ $0.01 each Value=$50k +5mm shares for first VC firm #=10mm shares @ $1.00 each Value=$10mm Note: not to scale Use of $: R&D 26
33 1/3 % Time I II III IV V 33 1/3 % 33 1/3 % A Multi-Stage Venture Finance Example 20 % 20 % 20 % 20 % 20 % 10 % 10 % 10 % 10 % 50 % 10 % 33 1/3 % 6 2/3 % 6 2/3 % 6 2/3 % 33 1/3 % 6 2/3 % 6 2/3 % 25 % 5 % 5 % 5 % 25 % 25 % 5 % 5 % 1mm shares 1mm shares for each each for CEO founder & employees #=3mm #= 5mm shares @ shares @ $0.01 $0.001 ea. each Value=$3k Value=$50k Note: not to scale 5mm shares for first VC firm #=10mm shares @ $1.00 each Value=$10mm Use of $: R&D +5mm shares for second round VCs #=15mm shares @ $5 each Value=$75mm Use of $: Mktg. +5mm shares for sale to public in IPO # = 20mm shares @ $15.00 each Value=$300mm Use of $: Operations 27
Meet the VCs! Trae Vassallo Kleiner Perkins www.kpcb.com Ping Li Accel Partners www.accel.com 28