EAS 545 - Timothy Li Study Sheet VC Problem Set VC Method: Single round
Pre-Money Pre-Mo ney and Post-Money Post-Money Valuation Valuation Example Example
With a VC investment, unlike NPV calculation based on discounted cash flows, an investment is made in a lump sum at a defined time (Io) in exchange for shares of stock in the company. The ROI is realized at some time in the future, at the time of a liquidity event (acquisition / IPO / buyout).
Post-money Valuation = $1,500,000 / 0.304 = $4,934,210 Pre-money Valuation = $4,934,210 - $1,500,00 = $3,434,210
Company Value
warrants are similar to options except new stock is issued when warrants are warrants are exercised.
Terminal Value or V N = P/E x E N or VN = P/R x R N where P/E and P/R are multiples. They can be derived by examining comparable companies, such as companies with explicit market values.
Valuation Example
options are the right to buy a certain number of shares of existing stock options are at a certain price in i n the future.
Valuations that include options and warrants as if they had been Valuations exercised in the total number shares are fully diluted. diluted.
VC Method: Multiple rounds!
Find the value of a company in year 5, given income statement data
VI5 0
Sales projected in 5 years COGS Gross Margin Sales, G&A expenses, R&D expenses Taxes Net Income (earnings)
$30 MM top line revenue ($18 MM) $12 MM ($7.5 MM) ($2.0 MM) $2.5 MM bottom line earnings
Referring to financial references for comparable companies, we find a P/E = 15. V 5= 15 x $2.5 MM = $37 $37.5 .5 MM
Value of Investment time-value of money and risk/return tradeoff The VC must determine the value of an investment in N years (VIN) based off their ROI: ROI : VIN = I0 x (1 + ROI) N
Value of Investment Example Find the value of a $1.5MM investment in year 5, given required ROI of 50%. VI5 = $1.5MM x (1 + .50)5 = $11.4 MM
Ownership How to calculate % of a company VC must own to realize ROI / # shares. % shares. %N = (1+ROI) N x I0 / (P/E x E N )
1
2
I0 = $1.5 MM
3
4
Rnd 2 = $1 MM
5
Rnd 3 = $1 MM
Percentt Ownership Percen Round #1 #2 #3
Invested $ 1. 5 MM $ 1.0 MM $ 1.0 MM
Required ROI 50 % 40 % 25 %
Final % Acquired 30.4 % 7.3 % 3.3 %
Note: This would leave 59% for the founders, options, or the other shares used for negotiations.
Retention Percentag Percentage e For the Rnd 1 investor to end up with 30.4%, they must acquire more at the time of their investment. This is a result of the dilution that occurs in Rnd 2 and 3, decreasing the percentage of the company owned by the previous shareholders as new shares are issued for each round. Retention % = 100% - ∑(final % of later rounds) %acquired = Final% / (Retention % ÷ 100%)
Retention Percenta Percentage ge Example Example
How to calculate the # of shares the VC should own (new shares) %ownership = # of shares owned / total # of shares issued total # shares = old # shares (pre-invest) + news # shares (purchased) %ownership = new # shares / (old # shares + new # shares)
Ownership Example - Percent Ownership Required In 5 years, at the liquidity event, the VC must own: %5 = (1+.50)5 x $1.5MM / (15 x $2.5MM) = 30.4%
Round #1 #2 #3
Retention % 100% - 7.3% - 3.3% = 89.4% 100% - 3.3% = 96.7% 100%
% Acquired 0.304 ÷ 0.894 = 34.0% 0.073 ÷ 0.976 = 7.6% 0.033 ÷ 1.0 = 3.3 %
Number and Price Price of Shares Shares Using the new % acquired we can calculate the number of new shares that must be issued with each round and the price per share. # New shares = %ownership/(1-%ownernship) x # Old shares
Ownership Example - # Shares and Price/Share
price/share = investment / # new shares
Assume our company has issued 1,000,000 shares prior to the first round of investment
Number and Price of Shares Shares Example Example - New New shares ea round round
# New Shares = .304 / (1 - 0.304) x 1,000,000 = 436,782 shares investment Price/Share = = $1.5MM / 436,782 shares = $3.43/share # new shares
Pre-money Pre-mo ney and Post-money Post-money valuation valuation Post-money Valuation = Investment / % ownership = new price/share x (total # shares post-money) Pre-money Valuation = Post-money valuation - investment = New Price/Share x (# old shares)
Round #1 #2 #3
# New Shares 0.34/(1-0.34) x 1,000,000 = 515,055 shares 0.076/(1-0.076) x 1,515,055 = 124,077 shares 0.033/(1-0.033) x 1,639,132 = 56,522 shares
New shares issued at each round must be added to the old shares when calculating new shares of a subsequent round. You cannot issue fractional shares of stock.
EAS 545 - Timothy Li Study Sheet VC Problem Set Number and Price of Shares Example - price/share each round Round #1 #2 #3
# New Shares = $1,500,000 ÷ 515,055 = $2.91 = $1,000,000 ÷ 124,077 = $8.06 = $1,000,000 ÷ 56,522 = $17.69
Post-Money Valuation (review)
Example
Post-money Valuation = Investment / % ownership = new price/share x (total # shares post-money) Round Investment % Acquired #1 $1,500,000 34.0% #2 $1,000,000 7.6% #3 $1,000,000 3.3%
Price/Share Total #Shares Post-Money Val $2.91 1,515,055 $4.41 MM $8.06 1,639,132 $13.21 MM $17.69 1,695,654 $30.00 MM
Final Price Per Share
Example
We calculate the final price/share at the time of liquidity using the same formula above (price/share = investment / # new shares). However we can also use an alternative version. Price/Share = Value of Company / Total # Shares (2.4MM x 15) (1,000,000 + 515,055 + 124,077 + 56,522) shares
=
$37.5MM 1,695,654 shares
= $22.12/share
Back-Check
Example
We can confirm the ROI equals our original desired terms: ROI = (Price per share sold / Price per share purchased) 1/N - 1 Round #1 #2 #3
The results do match the desired returns sought by our investors in each round.
ROI ($22.12 ÷ $2.91) - 1 = 50% p.a. ($22.12 ÷ $8.06)1/3 - 1 = 50% p.a. ($22.12 ÷ $17.69)1/1 - 1 = 50% p.a. 1/5
Participating Preferred Stock This security is like the Convertible Preferred Stock described above, but it has an additional benefit in that, at conversion (i.e. at the liquidity event), the entire original purchase is also repaid to the investor on a priority basis before any distribution to the shareholders are calculated. In the above example, if only the round 2 investor has Participating Preferred Stock, then the investor’s distribution at the time of the liquidity event would be: Distrb = I + ([val of cmpny-I] x (tot shares owned)/(tot shares issued) 143,633 = $1,000,000 + ($37,500,000 - $1,000,000) x 1,695,654 + 19,556 = $4,056,538
Cap Table Template shares
1.5MM
30.4 34% 1,518,055 $2.91 $14.41MM
515,000
R1 =100-7.3-3.3 = 89.4 Rough Calculations 5 RD1 -> VI5= 1.5MM(1.5) = 11.8MM / 37.5 MM= 30.4% / 89.4 = 34% invest rtn yr my val
mkt val
dilution own
Lessons 1. Seizing the Opportunity product + strategy leadership
Preferred shares have preference over common shares and any cash distributions owed to preferred shareholders are paid out before common stockholders. Preferred shareholders may also receive an annual dividend payment equal to a percentage of their investment. This dividend is usually “cumulative” (i.e. if the company cannot afford to pay the dividend in one year, any unpaid amount rolls over to the next year and is added to the dividend due in the next year). The dividend may either be “compounding” or “non-compounding” (i.e. treated as a compound interest or simple. non-compounding interest). At the time of a liquidity event, each share of preferred stock may be converted (Convertible Preferred Stock or Shares) into a new share of common stock and the accumulated dividends re converted to additional shares of common stock often at the original price-pershare paid by the investor. 3
Dividend = I [(1+i) - 1] = $1,000,000 [1.05 - 1] = $157,625 At the original share price of %8.06, this would convert to: Additional Shares = $157,635 / ($8.06/share) = 19,556 shares The Round 2 investor’s total holdings at the liquidity event would be: Total shares owned = 124,077 + 19,556 = 143,633 shares Their (Rnd 2 Invst) distribution from the liquidity event would then be: Dist
% 2.91 MM 1,000,000
Pre-money valuation Shares outstanding Founder Investor 1 Total shares Price/share Post-money valuation
Convertible Preferred Stock
N
Investment
= (value of cmpny) x (total shares owned)/(total # shares issued) = $37,500,000 x 143,633 / (1,695,654 + 19,556) = $3,140,625
Note: If the dividend had been cumulative, non-compounding:
Dividend = I x i x N = $1,000,000 x 0.05 x 3 = $150,000
Seize the Opportunity
team
harvest + give back
growth
vision culture motivation
cash
product + strategy
team
cash
IP Strategy Product Strategy Pricing Strategy Operating Strategy Marketing Strategy
Vision Hire execution Cultural fit Mentor(s) Strategic partners Customers
Bootstrap Angel investors Venture capital Strategic investors Public offerings Recapitalizations
2. Lou Aggasiz / Drucker’s New Venture / HP Case Aggasiz - Look at the fish! Look beyond the obvious. Determination is needed in observation. You may not always get a positive response, you may not always get direction, and you do not need expensive or complicated tools in order to succeed. Drucker’s New Venture - entrepreneurial management Need for market focus - open to adjacent markets Financial foresight - cash, capital, control Building a management team - allows focus on all fronts Understanding their role - outside advice+mentor / strengths HP - early mistakes (next-bench syndrome) but had great mentors, financial foresight due to early mistakes, knew their role, open to new opportunities Venture Finance - equity is more expensive than debt. seed/early vc funding is usually highest reward, highest risk.
EAS 545 - Timothy Li Study Sheet Lessons 3. High-Tech / Winning Strat / Vermeer A, A-1, B, C
7. Crossing the Chasm / Palm Case
Winning Strategy, Davidow - (1) Create whole products, not devices. Devices are what we invest...complete products are what customers buy. [service, packaging, find a need](2) Establish a commanding position. Segment market into small ponds, don’t attack a fortified hill [threat of new entrants + substitutes, bargaining power of suppliers + buyers and rivalry of incumbents], focus on the segment [cost to switch, loyalty, IP, distribution, cost to enter], create a defensible position [position = segmentation + differentiation], reposition as customer base evolves.(3) Adapt strategy and plan for high tech marketing. Vermeer - started with 3 products; Culture - high performance, trust, sense of urgency, teamwork, paranoia, flat org chart. Strategy - winning protoype+demo, 1st to market, industry std. team: mandile: execution, germano: task master, forgaard: empathetic,ferguson:operations. clashed sometimes. sold to microsoft (frontpage)
Rogers’ Crossing the Chasm - Diffusion of innovation, revenue in opportunity of the majority. different focus on each segment. WOM innovators - focus on tech: enthusiasts, give objective feedback, recognize competitive advantage, endorsement reassures others that it works. early adopters - focus on comp advantage: visionaries view tech as strategic opportunity, willing to take risk, least price sensitive, easy to sell, hard to please, inclusive, they find you, understand and mkt the dream. early majority - large revenue opp/less risk tolerance, loyal once won, standardization benefits. late majority - significant profit opp: conservatives will wait for it, follow the early majority.
4. IP / Palm Case IP - types: trade+service marks, copyrights, trade secrets, patents considerations: purpose, terms and protection, notice, process patents - new+novel, useful, non-obvious Forming of Palm - decision to be independent or part of Tandy. problems faced- tandy owned improvements on palmprint, hawkins owned original patent. had many partners from existing reputation, tandy had a huge bureaucracy, existing brand to uphold, couldn’t attract talent without equity / stock options.
window of opportunity, segment! segment! segment!, secure beachead
Palm - first to market with right product, right customer, right time, right price. talking to customers and learning from other people’s mistakes. keeping costs low, and pivoting to a market segment. negotiated on their vision with partners instead of giving in.
8. Busieness Model Canvas / Dell / Open Innovation (ches) BMC Key Partners
Key Activities
Value Prop
Key Resources Cost Structure
Customer Customer Relations Segments
Channels
Revenue Streams
5. Financial Statements / X-IT Financial - Income statement (P&L): net sales, cost of sales, selling expenses (salaries, ads), G&A expenses (office staff salaries, expenses). How well is the business running. Balance sheet [Assets(own) Liabilities(owe) = Shareholder’s Equity (net worth)]. Sources & Uses Statement. Statement of Cash Flows. Do you have cash? X-IT - IP litigation with Kidde. violation of NDA and copyright on packaging. patents not issued yet. Kidde violated NDA in order to find loop hole in the patent (not published at the time). Packaging was a direct copy. IP litigation is long and expensive. X-IT just recently won.
6. Innovation & Sales Learning Curve / Palm right product, right customer, right time, right price understand all stakeholders (aside from customers) 4 criteria for segmentation: psychographic homogeneity, identifiable, accessible, significant potential concept testing, conjoint analysis, perceptual mapping Innovation: A Customer Driven Approach - Stage-gate approach. customer research, latent need (delighters), concept generation, prototyping+feedback loop. Sales Learning Curve - Need to give company time to travel up the curve. Craft sales team towards early adopters to allow you to modify your product, then change sales as you grow your user base. Understand new-product sales challenges -> Adjust your sales strategy as you learn. communicate well with teams from other functions / tolerate ambiguity. (1) initiation, (2) transition (3) execution Palm Computing - focused on the product as a whole. searched for critical features (mvp/mdp). understood stakeholders involved and removed barriers. learned from bad examples in past (momenta) Innovators Dilemma - disruptive tech bring a new value prop to mkt. product attributes initially only valued only in emerging mkg, unimportant in mainstream
Dell - vert intgrtn = low cost direct partnerships with sony and intel, zero stock on hand, pull system, customer partnerships, Dell Platinum Councils, direct sales, problems with laptop market, battery choice. future value F = P (1+i) n
Operational Strategies -Integrator - incremental innovtn, position strong, Orchestrator - innovtn breakthru, intense comp, substitutes strong, tech early stges, time-to-mkt critical, Licensor - mkt is new to innovator, brand importances low, IP protected, signif infrastruct
9. FDA / USDA / Nucleon FDA regulatory approval and insurance reimbursement add time, cost, and risk to a venture. Each aspect of business has added complexity. Product development and regulatory approval time frames leave little time left to capitalize on IP protection. Operational strategy choices have dramatic financial impacts (Nucleon). Product strategy can leverage the benefits of mankind but carry higher risk (Sirtris). Multiple stakeholders, payors, and regulatory requirements impact marketing strategy. Nucleon - multiple options for manufacturing. calculate cash flows and then add the discount rate across all numbers to determine final value.
10. VC Method / Bootstrap Finance / Angel Investing bootstrappers axioms for success: operational quickly...look for quick cash flow... offer high value products/services...forget about the crack team...keep growth in check... focus on cash...cultivate banks optimizing other people’s money : don’t over or under capitalize. use proceeds to create a step up in value.
11. Onset Ventures All high-tech investors look for a visionary leader & capable team , market leadership, fundamental, compelling tech advantage, capitalefficient business plan, de-risking. It’s all about managing risk. Tech/ mkt/operating/distribution/team.
EAS 545 - Timothy Li Study Sheet Lessons 12. Communications / Walnut A
22. Mark Palatucci
Walnut A was about investing in Bob O’Connor and RBS Group. issues with some of the details in the business plan: forcasting scaling sales costs, early commitment to international before domestic expansion, customer segment mismatch (size / cost), is answer to profitability scale? evidence to understand all costs. also beyond typical Walnut investment
Follow your dream... but its hard and you may have to swallow your pride; The allure and pitfalls of consulting to bootstrap; Watch your IP when you’re a grad student; They call it hardware for a reason... its hard; The stealth startup; Story yet to be written
13. Negotiation / Walnut C+D
Level 5 Leaders: humility, come from within, have the will, vision Disruptive Technologies bring a new value proposition to a defined market segment, typically falls short and unimportant but eclipse sustaining technologies eventually, they are not simply substitutes for existing products, establish companies bound by risk, competencies, vision, assets, infrastructures, business models and expertise. Spoiled Startup - pretend you don’t have it, stay strategic, find customers first, then look for funding, don’t sell yourself too soon. MIPS - had a compelling, unique and protected tech, but MIPS had a lack of a focused vision, leadership, product (risc microprocessors, risc wrkstations, sw), customer.
3 provisions: valuation, governance, capital structure. > just valuation know both positions (objectives / must haves). Identify BATNA and evaluate the ZOPA. Build trust, and prepare for an impasse
14. Exits / Teleswitch IPO, recap, acquistion. depends on capital needs, management, resources,external-ipo market, product demand, alternatives. Underwriter takes charge of IPO process Teleswitch - wanted to IPO to raise capital for their GSM tech push. Teleswitch did not do due diligence to understand their underwriter, intead went with a “strong” firm. Lack of alignment led to missteps, lost time opportunity and ultimately a lower valuation
15. Andy Seidel Power of techical breadth, presentation skills are critical, ask for high value, surround yourself with A players, engineering skills to problem solve, quant skills so numbers tell a story, try to learn on someone elses dime, build a great company...exits will come naturally
16. Brian Roddy People are everything. Results != No results+Excuses, keep learning, keep changing, best time to start is when no one else is, take action
17. Nanogene / Innovators DNA / Paige Miller skills: questioning, observing, experimenting, networking, associating hire ahead of curve, isn’t all about the money, business plans don’t survive customer contact, careful what you say..
18. Conjoint / Palm Financing Palm faced with fincing thru Alpha, ABC, international or USR
19. Pricing / Sirtris 8 steps: how do customers value our product, does value vary across segments,assess customer price sensitivity, optimize pricing structure, anticipate competitor reaction, know the real price, assess customer’s emotional response; price high = skim; price low = penetrate; me too. Sirtris - odds of early-stage pharma companies succeeding small. Requires alot of capital to find out, focus is progress an value at each milestone.. balance intrinsic vs extrinsic but investors only care of ext.
20. Leadership + Motivation / VDS VDS - motivations changed as VDS grew, PDM varied from VDS sales people incentive structure. Leadership dangled investment only if concrete goals were met, but under-invested in their success. Leadership did not change vision with new team, held on to external motivators, did not give freedom / autonomy. hands off leadership = no
21. Philip Yanni Top startup mistakes: Titles...too senior, Perks... too many, Inclusiveness...overdone, Buddies on the Board, Crazy cap table, late to focus, late to listen, ignoring the voice of the customer. Value your financial model!
23. MIPS / Spoiled Startup / Disruption
24. Hiring / Sun Microsystems First who then what : start with the right people, intrinsically motivated, inspirational leaders, A’s attract A’s. More than just intelligence. Sun Microsystems - Started with failed computervision deal. Hired a great team of motivated individuals to steer the company in the right direction. Level 5 leaders. complimentary skills, “It was all based on trust.” - Vinod Khosla
25. Michael Zisman Capital...financial vs human; Control is about cash; Comfort comes from trust; Confidence vs arrogance; Competition...this is war; Certainty...there isn’t any; Complete product; Communication... brevity+empathy; Mgmt team..complementary skills; Momentum = product x mktg; Message...succinct + branded; MVP
26. Momenta - Kamran Elahian Great ingredients without clear and strong strategy, execution, and culture can lead to failure. Didn’t find people that shared his vision (they were very talented tho). Did a technology push. Unrealistic goals. no room for failure. lack of flexibility and overpriced.
27. Ted Schlein 4 key risks - market, technical, people, financial key to term sheets - pre/post valuation, liquidation pref, voting rights, board constitution / rights career advice - always look to learn; foundation- sell, launch a product, manage employees; develop personal / lifelong network; swing for the fences; culture matters: missionary vs mercenary. Ideas are easy, execution is everything. it takes a team to win.
28. Leaders & Managers consensus building vs vision driven. Leaders, like artists, tolerate chaos and lack of structure. Managers seek order, control, and rapid resolution of problems. stewards are bottom-line oriented, while creators are creative technical employees. must be managed well to encourage innovation
