EAS 545 - Timothy Li Study Sheet VC Problem SetVC Method: Single round 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). Pre-Money and Post-Money Valuation Example Post-money Valuation = $1,500,000 / 0.304 = $4,934,210 Pre-money Valuation = $4,934,210 - $1,500,00 = $3,434,210 options are the right to buy a certain number of shares of existing stock at a certain price in the future. warrants are similar to options except new stock is issued when warrants are exercised. Valuations that include options and warrants as if they had been exercised in the total number shares are fully diluted. Company Value Terminal Value or VN = P/E x EN or VN = P/R x RN 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 Find the value of a company in year 5, given income statement data VC Method: Multiple rounds! VI5 0 1 2 3 4 5 Sales projected in 5 years $30 MM COGS ($18 MM) Gross Margin $12 MM Sales, G&A expenses, R&D expenses ($7.5 MM) Taxes ($2.0 MM) Net Income (earnings) $2.5 MM top line revenue I0 = $1.5 MM Rnd 2 = $1 MM Rnd 3 = $1 MM Percent Ownership bottom line earnings 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 % Referring to ﬁnancial references for comparable companies, we ﬁnd a P/E = 15. V5= 15 x $2.5 MM = $37.5 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: VIN = I0 x (1 + ROI)N Note: This would leave 59% for the founders, options, or the other shares used for negotiations. Retention Percentage 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%) 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. %N = (1+ROI)N x I0 / (P/E x EN) 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) Retention Percentage Example 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 of 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 price/share = investment / # 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% Ownership Example - # Shares and Price/Share Assume our company has issued 1,000,000 shares prior to the ﬁrst round of investment # 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 Number and Price of Shares Example - New shares ea round 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 Pre-money and Post-money 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) 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. price/share each round Round #1 #2 #3 # New Shares = $1.Timothy Li Study Sheet VC Problem Set Number and Price of Shares Example .91)1/5 . Lessons 1.12 ÷ $8. This dividend is usually “cumulative” (i.000 . this would convert to: Additional Shares = $157.000 x 143.EAS 545 .a.1 = 50% p.12 ÷ $17.654 + 19.000. In the above example.077 + 56.06)1/3 .equity is more expensive than debt.8MM / 37.1] = $157. seed/early vc funding is usually highest reward.077 = $8.1 Round #1 #2 #3 ROI ($22.3-3. You may not always get a positive response.000.69 Participating Preferred Stock This security is like the Convertible Preferred Stock described above.140. Price/Share = Value of Company / Total # Shares (2.695. At the time of a liquidity event.695.69)1/1 .open to adjacent markets Financial foresight .000.12/share (1.000 30.000 x 0.91 $14.$1.625 Note: If the dividend had been cumulative.outside advice+mentor / strengths HP .518.500.633 = $1.3% Price/Share Total #Shares Post-Money Val $2. Drucker’s New Venture .06 = $1. ﬁnancial foresight due to early mistakes.4 34% 1.5MM = = $22. 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.a.000.654 + 19.69 1.633 / (1.06/share) = 19.625 At the original share price of %8.077 + 19.000. Preferred shareholders may also receive an annual dividend payment equal to a percentage of their investment.41MM shares We calculate the ﬁnal price/share at the time of liquidity using the same formula above (price/share = investment / # new shares).654 $30.91 1.000 Back-Check We can conﬁrm the ROI equals our original desired terms: ROI = (Price per share sold / Price per share purchased)1/N . .000. if the company cannot afford to pay the dividend in one year.556 shares The Round 2 investor’s total holdings at the liquidity event would be: Total shares owned = 124.000. ($22.556 = $4.053 .000 ÷ 56. non-compounding: Dividend = I x i x N = $1.1 = 50% p.000 34. open to new opportunities Venture Finance . if only the round 2 investor has Participating Preferred Stock. ($22.4% / 89.12 ÷ $2.5MM 515. the entire original purchase is also repaid to the investor on a priority basis before any distribution to the shareholders are calculated.500.a.695.6% #3 $1. capital. treated as a compound interest or simple.4MM x 15) $37. highest risk. any unpaid amount rolls over to the next year and is added to the dividend due in the next year).500.055 + 124. control Building a management team .e.000 3.056. 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. The dividend may either be “compounding” or “non-compounding” (i.000 ÷ 124.633 shares Their (Rnd 2 Invst) distribution from the liquidity event would then be: Dist = (value of cmpny) x (total shares owned)/(total # shares issued) = $37. and you do not need expensive or complicated tools in order to succeed.132 $13.5 MM= 30.000) x 1.000.000 ÷ 515. Dividend = I [(1+i)N .early mistakes (next-bench syndrome) but had great mentors.538 Post-Money Valuation (review) Example Post-money Valuation = Investment / %ownership = new price/share x (total # shares post-money) Round Investment % Acquired #1 $1.522) shares 1.500.Look at the ﬁsh! Look beyond the obvious.654 shares 1.000 [1.522 = $17. However we can also use an alternative version.695.000 + ($37.639.515.91 MM 1.1 = 50% p.e.41 MM $8. but it has an additional beneﬁt in that.06.21 MM $17.1] = $1. Seizing the Opportunity product + strategy leadership Seize the Opportunity growth vision culture motivation Convertible Preferred Stock Preferred shares have preference over common shares and any cash distributions owed to preferred shareholders are paid out before common stockholders.055 $4. at conversion (i.entrepreneurial management Need for market focus .00 MM Final Price Per Share Example Cap Table Template Investment Pre-money valuation Shares outstanding Founder Investor 1 Total shares Price/share Post-money valuation % 2.0% #2 $1.556 = 143. Lou Aggasiz / Drucker’s New Venture / HP Case Aggasiz .055 $2. non-compounding interest).91 = $1.5)5 = 11.055 = $2.cash. Example R1 =100-7. at the liquidity event).556) = $3.06 1. you may not always get direction.5MM(1.000.000 + 515.000 harvest + give back team IP Strategy Product Strategy Pricing Strategy Operating Strategy Marketing Strategy cash team product + strategy Vision Hire execution Cultural ﬁt Mentor(s) Strategic partners Customers cash Bootstrap Angel investors Venture capital Strategic investors Public offerings Recapitalizations 2.e.635 / ($8.3 = 89.000 7.4 Rough Calculations RD1 -> VI5= 1.000.4 = 34% invest rtn yr my val mkt val dilution own The results do match the desired returns sought by our investors in each round. knew their role. Determination is needed in observation.05 x 3 = $150.allows focus on all fronts Understanding their role . Do you have cash? X-IT . understand and mkt the dream. Kidde violated NDA in order to ﬁnd loop hole in the patent (not published at the time). High-Tech / Winning Strat / Vermeer A. industry std. cost of sales.. secure beachead Palm . Strategy . notice. right price. IP litigation is long and expensive. focus on cash. identiﬁable. Davidow . substitutes strong. X-IT just recently won. fundamental. capitalefﬁcient business plan.high performance.(1) Create whole products.. (2) transition (3) execution Palm Computing . keeping costs low.. calculate cash ﬂows and then add the discount rate across all numbers to determine ﬁnal value. VC Method / Bootstrap Finance / Angel Investing bootstrappers axioms for success: operational quickly. concept generation. C Winning Strategy.Timothy Li Study Sheet Lessons 3. not devices. right customer. (1) initiation. revenue in opportunity of the majority. teamwork. Licensor . and pivoting to a market segment.forget about the crack team. IP..started with 3 products. negotiated on their vision with partners instead of giving in. offer high value products/services.. pull system. selling expenses (salaries. forgaard: empathetic. don’t attack a fortiﬁed hill [threat of new entrants + substitutes..focused on the product as a whole. sold to microsoft (frontpage) 7. focus on the segment [cost to switch. cost. copyrights. sense of urgency.signiﬁcant proﬁt opp: conservatives will wait for it. de-risking.Need to give company time to travel up the curve.. easy to sell. create a defensible position [position = segmentation + differentiation]. hawkins owned original patent. follow the early majority.ﬁrst to market with right product. future value F = P (1+i)n 5.. germano: task master. Product development and regulatory approval time frames leave little time left to capitalize on IP protection.. loyalty. .Income statement (P&L): net sales.focus on tech: enthusiasts. searched for critical features (mvp/mdp). B. Onset Ventures All high-tech investors look for a visionary leader & capable team. trade secrets. early majority .focus on comp advantage: visionaries view tech as strategic opportunity. trust. WOM innovators . Tech/ mkt/operating/distribution/team.Stage-gate approach. hard to please. direct sales. brand importances low. payors.vert intgrtn = low cost direct partnerships with sony and intel. Balance sheet [Assets(own) Liabilities(owe) = Shareholder’s Equity (net worth)]. Product strategy can leverage the beneﬁts of mankind but carry higher risk (Sirtris). bargaining power of suppliers + buyers and rivalry of incumbents].look for quick cash ﬂow. ﬂat org chart. and regulatory requirements impact marketing strategy. ads). IP protected. Packaging was a direct copy. willing to take risk. they ﬁnd you. perceptual mapping Innovation: A Customer Driven Approach . least price sensitive.complete products are what customers buy. right price understand all stakeholders (aside from customers) 4 criteria for segmentation: psychographic homogeneity.incremental innovtn. problems faced. FDA / USDA / Nucleon FDA regulatory approval and insurance reimbursement add time. existing brand to uphold.mkt is new to innovator. useful. Sales Learning Curve . patents considerations: purpose. talking to customers and learning from other people’s mistakes. zero stock on hand. A-1. Operational Strategies -Integrator . accessible. loyal once won. inclusive. position strong. tandy had a huge bureaucracy.Diffusion of innovation. Segment market into small ponds. expenses).new+novel. process patents . cost to enter]. window of opportunity. conjoint analysis. Nucleon . non-obvious Forming of Palm . Innovation & Sales Learning Curve / Palm right product. terms and protection. 6. tech early stges. customer research. prototyping+feedback loop.multiple options for manufacturing.winning protoype+demo. market leadership. couldn’t attract talent without equity / stock options. unimportant in mainstream 10. Financial Statements / X-IT Financial . late majority . right time. G&A expenses (ofﬁce staff salaries. team: mandile: execution. Multiple stakeholders. IP / Palm Case IP . How well is the business running. customer partnerships. compelling tech advantage.types: trade+service marks.ferguson:operations. 11.(3) Adapt strategy and plan for high tech marketing.. communicate well with teams from other functions / tolerate ambiguity. endorsement reassures others that it works.IP litigation with Kidde. problems with laptop market. battery choice. [service. Statement of Cash Flows. Vermeer . 8.decision to be independent or part of Tandy.EAS 545 . Dell Platinum Councils.keep growth in check. and risk to a venture. then change sales as you grow your user base. ﬁnd a need](2) Establish a commanding position.tandy owned improvements on palmprint. Culture . understood stakeholders involved and removed barriers. Craft sales team towards early adopters to allow you to modify your product.. patents not issued yet. Devices are what we invest. clashed sometimes. intense comp. distribution. time-to-mkt critical. give objective feedback. segment! segment! segment!.cultivate banks optimizing other people’s money: don’t over or under capitalize. Understand new-product sales challenges -> Adjust your sales strategy as you learn.. Busieness Model Canvas / Dell / Open Innovation (ches) BMC Key Partners Key Activities Value Prop Customer Customer Relations Segments Key Resources Cost Structure Channels Revenue Streams Dell .disruptive tech bring a new value prop to mkt. Crossing the Chasm / Palm Case Rogers’ Crossing the Chasm . Each aspect of business has added complexity. right customer.. learned from bad examples in past (momenta) Innovators Dilemma . Orchestrator . use proceeds to create a step up in value. Sources & Uses Statement.. Operational strategy choices have dramatic ﬁnancial impacts (Nucleon). paranoia. early adopters . product attributes initially only valued only in emerging mkg. standardization beneﬁts. recognize competitive advantage. signif infrastruct 9. reposition as customer base evolves. 1st to market. packaging. 4.innovtn breakthru. different focus on each segment. latent need (delighters). violation of NDA and copyright on packaging. right time. It’s all about managing risk.large revenue opp/less risk tolerance. had many partners from existing reputation. signiﬁcant potential concept testing. price high = skim. Didn’t ﬁnd people that shared his vision (they were very talented tho). and prepare for an impasse 14. keep changing. 13. culture matters: missionary vs mercenary. isn’t all about the money. leadership. establish companies bound by risk. Message. held on to external motivators. brevity+empathy. Leaders & Managers consensus building vs vision driven. liquidation pref. MIPS / Spoiled Startup / Disruption Level 5 Leaders: humility. ﬁnancial key to term sheets .. 18. Crazy cap table.Kamran Elahian Great ingredients without clear and strong strategy. acquistion. Competition. Perks. early commitment to international before domestic expansion. MVP 17.ﬁnancial vs human.. me too. control. complimentary skills. competencies. hands off leadership = no 28. MIPS .market. come from within. Lack of alignment led to missteps..odds of early-stage pharma companies succeeding small. surround yourself with A players. Value your ﬁnancial model! . observing. Spoiled Startup . optimize pricing structure. ABC. 20. intead went with a “strong” ﬁrm. no room for failure. is answer to proﬁtability scale? evidence to understand all costs.. Conjoint / Palm Financing Palm faced with ﬁncing thru Alpha. Nanogene / Innovators DNA / Paige Miller skills: questioning. They call it hardware for a reason. execution is everything. The allure and pitfalls of consulting to bootstrap. too many. Michael Zisman Capital. A’s attract A’s. late to focus. and rapid resolution of problems.. Results != No results+Excuses. but under-invested in their success. develop personal / lifelong network.. networking. assets.had a compelling. PDM varied from VDS sales people incentive structure. execution. Mark Palatucci Follow your dream. Teleswitch did not do due diligence to understand their underwriter. Unrealistic goals. manage employees. swing for the fences. quant skills so numbers tell a story. Comfort comes from trust. management.EAS 545 . build a great company. Conﬁdence vs arrogance. did not give freedom / autonomy.there isn’t any. The stealth startup. Communications / Walnut A Walnut A was about investing in Bob O’Connor and RBS Group. like artists.. business models and expertise. Ted Schlein 4 key risks . alternatives.complementary skills. “It was all based on trust. then look for funding. customer. international or USR 26. customer segment mismatch (size / cost). depends on capital needs.. Ideas are easy. Sirtris . Leadership + Motivation / VDS VDS . Sun Microsystems . ﬁnd customers ﬁrst. governance.. Brian Roddy People are everything. must be managed well to encourage innovation 21.pre/post valuation. Momenta .pretend you don’t have it. but its hard and you may have to swallow your pride. issues with some of the details in the business plan: forcasting scaling sales costs. resources. Identify BATNA and evaluate the ZOPA.assess customer price sensitivity. focus is progress an value at each milestone.succinct + branded. they are not simply substitutes for existing products. presentation skills are critical.. keep learning.. balance intrinsic vs extrinsic but investors only care of ext. also beyond typical Walnut investment 22. it takes a team to win. its hard.. does value vary across segments. sw). Communication. Philip Yanni Top startup mistakes: Titles. tolerate chaos and lack of structure... launch a product.. risc wrkstations. Complete product. and culture can lead to failure.. Leadership dangled investment only if concrete goals were met. know the real price. Exits / Teleswitch IPO.Vinod Khosla 15. Pricing / Sirtris 8 steps: how do customers value our product. while creators are creative technical employees.. Story yet to be written 23.Started with failed computervision deal. 27. have the will. Did a technology push. experimenting. Requires alot of capital to ﬁnd out.exits will come naturally 16.. but MIPS had a lack of a focused vision. lost time opportunity and ultimately a lower valuation 24. recap. Watch your IP when you’re a grad student..motivations changed as VDS grew. Inclusiveness. Leadership did not change vision with new team.overdone. don’t sell yourself too soon. capital structure. Negotiation / Walnut C+D 3 provisions: valuation. Build trust. More than just intelligence. Level 5 leaders. careful what you say. Buddies on the Board.always look to learn..Timothy Li Study Sheet Lessons 12.this is war. stewards are bottom-line oriented. late to listen. Mgmt team. foundation.sell. board constitution / rights career advice . try to learn on someone elses dime. unique and protected tech.. vision Disruptive Technologies bring a new value proposition to a deﬁned market segment. associating hire ahead of curve. Underwriter takes charge of IPO process Teleswitch . ask for high value.. business plans don’t survive customer contact. anticipate competitor reaction.too senior. engineering skills to problem solve. price low = penetrate. take action 25. voting rights. ignoring the voice of the customer. product demand. best time to start is when no one else is.external-ipo market.wanted to IPO to raise capital for their GSM tech push. product (risc microprocessors. assess customer’s emotional response.. Control is about cash. vision. Andy Seidel Power of techical breadth. lack of ﬂexibility and overpriced.. Certainty. technical. intrinsically motivated. Leaders. Managers seek order.. inspirational leaders. > just valuation know both positions (objectives / must haves). Hired a great team of motivated individuals to steer the company in the right direction. people.” . infrastructures. Momentum = product x mktg. 19. stay strategic. typically falls short and unimportant but eclipse sustaining technologies eventually. Hiring / Sun Microsystems First who then what: start with the right people.