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The Art and Science of Valuation

Prepared for Faegre & Benson April 19, 2006

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Overall Agenda Part 1: Capturing the Attention of the

Venture Capitalist Part 2: Understanding the state of the

Venture Capital Industry Part 3: Valuation Overview

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Part 1 Agenda Part 1: Capturing the Attention of the

Venture Capitalist Finding the right VC Courting the right VC Management Team Market Characteristics How hard can it be?

Part 2: Understanding the state of the Venture Capital Industry

Part 3: Valuation Overview

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Finding the Right VC

Do Your Homework

Buying Criteria Just Like a

Customer

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Courting the Right VC

Online Dating Anonymous Highly

Competitive 1 Chance

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“As a founder, think hardest about the team. Are these the people I want to be in trouble with for the next 5, 10, 15 years of my life? Because as you build a new business, one thing’s for sure: you will get into trouble.”

John Doerr, Kleiner Perkins Caufield & Byers

Management Team

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Investing In TalentFactors considered most important by investment professionals(Weighted importance out of 100*)

Management Team

Market Sector

Business Model

Proprietary Product/Service

37

24

20

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Source: Spencer Stuart/NVCA VC-backed Leadership survey

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Market Characteristics Worth Winning

$250 million Sustainable

Drivers Y2k

Well Defined Sub-segment

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How Hard can it Be?

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A Rapidly Evolving World

Yahoo raises $2 million Amazon goes live Netscape goes public 45% heard of www AltaVista 16 million

pages

1995

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Technology is only the Ante

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Sustaining vs. Disruptive Technologies Sustaining Technology

Foster improved product performance Disruptive Technology

Bring to the market a very different value proposition

The Innovator’s Dilemma – Clayton Christensen

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Sustaining vs. Disruptive Technologies

Sustaining Technology Improves

performance along an existing utility curve

A

BSustaining Technology

Cost

Performance

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Sustaining vs. Disruptive Technologies

Disruptive Technology Moves the market

to new utility curveA

Disruptive Technology

B

Cost

Performance

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Explicit Need / Compelling ROI

IT Budgets and ROI:“Purse strings are loosening ever so slightly, but that won’t slow the quest for better metrics”

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Part 2 Agenda Part 1: Capturing the Attention of the

Venture Capitalist Part 2: Understanding the state of the

Venture Capital Industry Locations: East Coast / West Coast and everywhere else State of Emerging Market Funding US Market Trend Minnesota Market Trend Pre-Bubble Normal

Part 3: Valuation Overview

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Locations: CA, MA and then the Rest

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State of Emerging Company Funding(Hint: Small VC Funds are Disappearing )

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U.S. Venture Capital Market Trend Info

% of U.S. VC

0%

10%

20%

30%

40%

50%

60%

70%

1995

-1

1996

-1

1997

-1

1998

-1

1999

-1

2000

-1

2001

-1

2002

-1

2003

-1

2004

-1

2005

-1

Expansion Later StageEarly Stage Seed Stage

Group Median Expansion – 53% Later Stage –

18% Early Stage –

22% Seed Stage – 4%

Source: PWC MoneyTree

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Minnesota vs. U.S. Venture Capital Market Trend Info

Source: PWC MoneyTree

% of MN VC vs. U.S. VC

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

1995

-1

1996

-1

1997

-1

1998

-1

1999

-1

2000

-1

2001

-1

2002

-1

2003

-1

2004

-1

2005

-1

Average MN vs. U.S VC Investment = 1.54%

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A Pre-Bubble NormalValution Trends

0

20

40

60

80

100

120

140

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

$ i

n M

illi

on

s Seed

Early

Expansion

Later

BuyOut

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Part 3 Agenda Part 1: Capturing the Attention of the

Venture Capitalist Part 2: Understanding the state of the

Venture Capital Industry Part 3: Valuation Overview

Valuation Start-Up Stages Equity Financing Food Chain Sherpa Guide to Success Valuation Methodology A Lesson from Charles Darwin

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Valuation is Chess Not Checkers

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Stages of a Startup

Definition and Validation

Prove Solution is Repeatable

Grow the Channel to Capture Opportunity

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Seed Stage

100% – 30% IRR

Early Stage – (Sherpa)

50% - 20% IRR

Expansion Stage

25% - 15% IRR

Late Stage

20% - 12% IRR

Early Adopter Customers

Early Majority Customers

Late Majority Customers

Innovation Customers

Friends/Family

Angels Institutional - VCs Public Market

Equity Financing Food ChainReturn Expectations

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Return Expectations

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Return Expectations

5-10x your investment

or30%+ IRR

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Sherpa Pocket Guide to Success

Quick Go vs. No Go Decision

(4x in 5 Years = 32% IRR)

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Valuation Methodology1. Determine valuation

in an out year

Revenue in year 5 is $20 million

Use a multiplier (i.e., revenue, operating income, earnings, subscribers, locations, etc.) to determine value

A revenue multiple of 2x would make the company value $40 million in year 5

 

2. Compare future value with current value

Divide the future value ($40 million) by the post-money valuation

Post-money value of $10 million means this investment increased in value by 4x ($40 million / $10 million)

4x in 5 years equals a 32% IRR

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“It is not the strongest of the species that survives, nor the most intelligent; it is the one that is most adaptable to change.”

- Charles Darwin, British Naturalist

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Recap Part 1: Capturing the Attention of the

Venture Capitalist Part 2: Understanding the state of the

Venture Capital Industry Part 3: Valuation Overview

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Rick BrimacombFounder, Brimacomb & AssociatesGeneral Partner, Sherpa PartnersBoard Member, Minnesota Venture Capital

Association

612.803.3169rick@brimacomb.com

Jason VoiovichPrincipal, Ecra Creative Group651.209.2778jason@ecracreative.com