About Venture Capital

December 2012 Hervé Lebret

Stanford ecorner

How do venture capitalists decide what to invest in, and why?

Steve Jurvetson

Venture Capital Is a Time Bomb

David Heinemeier Hansson | 37signals

Some introductory numbers

VC USA UK CH Sweden India France China Total

Kleiner Perkins 16 16

Sequoia 12 12

NEA 7 1 8

Benchmark 7 1 8

IVP 7 1 8

Accel 6 6

Greylock 5 5

Oak 3 1 1 5

Venrock 5 5

Index Ventures 2 1 2 5

Mayfield 5 5

Sofinnova 1 3 4

Mohr Davidow 4 4

Atlas 1 1 2 4

USVP 4 4

Innovacom 4 4

3i 2 1 3

Bechtolsheim 3 3

TVI 3 3

Crosslink 2 1 3

MPAE 3 3

DFJ 1 1 1 3

Redpoint 3 3

Harbor Vest 1 2 3

Union Square 3 3

… …

Total 147 10 3 10 3 24 2 199

Extracted from data in http://www.startup-book.com/2011/08/15/more-data-on-ipo-and-founders

Agenda

Historical background

Economic perspective

The VC process

History of venture capital

Full story in:

You can also read chapter 4 Start-Up, what we may still learn from Silicon Valley

Laurence Rockfeller was interested in science and technology and less in his family business. He assembled a team of advisers, backed many entrepreneurs. In 1969, he structured a $7.5M fund into Venrock Associates.

Founded as the one of the first private equity firms in 1946 by "Jock" Whitney, J.H. Whitney & Co. provided capital and professional assistance to entrepreneurs.

He invested in MinuteMaid, Memorex, Genera Signals but also in movies (Gone with the Wind)

He coined the term “venture capital”.

It began as a hobby of the rich…

Arthur Rock, a banker on the East Coast, is contacted to help them raising $1.5M; an amount he will find in the person of Sherman Fairchild, the largest individual shareholder of IBM and owner of Fairchild Camera. In 1957, Fairchild Semiconductor is founded.

Fairchild Semiconductor was very successful and reached 12,000 employees but the founders were bought back their shares by Fairchild… they still became wealthy. Faichild bought back for $2.4M the stake of the 8 founders.

ARD financed High Voltage (a $1.8M return for a $200k investment) and Digital Equipment in 1957 (a $70k inv. worth $355M after 14 years).

ARD stopped in 1972. ARD biggest flaw was no incentive for associates (no carried interest).

The Ancestors’ investments

A genealogy

KP First Fund (1972-1984)

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Cost ($)

Value on

June

30,1984

$7M fund with $4M from Hilman (Wilmington), $1M from Rockefeller University. Both Kleiner and Perkins put $150k each. Tandem ($152M)

Genentech ($47M)

More on http://www.startup-book.com/2009/02/09/about-kleiner-perkins-first-fund-episode-3

Kleiner Perkins first fund

Agenda

Historical background

Economic perspective

The VC process

0

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Natural scale

Log scale

1974: the oil crisis and ERISA act

1990: US recession and

declining IRRs

1984: the HDD crisis

2001: the Internet crash

Source: Compilation HL

Nasdaq and the VCs

Although the data are not so easy to obtain (the numbers below are not fully consistent…), the VC world has generated exceptional returns. The individual success stories are known. Some previous slides give some more numbers. The reader can compare to the typical Wall Street numbers…

Some returns

Geography of venture capital

How do VC make money?

Today VCs manage funds of other financing institutions and usually not their own (this is BAs or syndicates of Bas).

A typical VC fund lasts 10 years with an investment period of 5-7 years

VCs have two sources of funding:

A management fee: usually 2% to 2.5% of the size of the fund per year

A carried interest: usually 20% of the fund net profits

Possibly a hurdle rate (6-8%)

Agenda

Historical background

Economic perspective

The VC process

You can read chapter 5 Start-Up, what we may still learn from Silicon Valley

“Some winning venture capitalists claim to look

almost exclusively at the backgrounds and

personalities of the founders; others focus mostly

on the technology involved and the market

opportunity the venture addresses”

from The New Venturers, Wilson (1984)

What do VCs look for?

“There are people risks, markets risks,

product development risks and finance

risks. We will not invest in a company

unless we understand and are comfortable

with three of these risks.”

“The components of success are product

differentiation, a fast-growing market, a

team of dedicated people and money.”

Don Valentine quoted in Wilson (1984)

The size of the investment and related valuation.

The pre- and post-money valuations differ by the size of the investment. The ESOP size also has an impact and the fully diluted valuation includes the

newly avalables stock options.

The price per share and the number of shares created.

The class of shares, usually preferred.

The structure of the board of directors.

The vesting and reverse vesting mechanism of the stock options and

founders’ shares.

The kind of liquidation preference.

The anti-dilution mechanism.

The redemption rights.

The priority rights, the restrictions on the sales and the transfer of shares.

The exit conditions, and in particular the clauses that may force a sale

(tag along, drag along).

The expenses linked to the investment.

The kind of decisions that investors control after their investment, usually

through veto rights (the protective provisions).

The main terms of an investment

Liquidation preference

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Common

Series A

Series B

Series C

Anti-dilution

1st round 2nd round

Price $2.00 $0.75

Amount $6'000’000 $750’000

Anti- Broad-based Narrow-based Full ratchet

dilution Shares % Shares % Shares % Shares %

Common 10'000’000 76.9% 10'000’000 70.7% 10'000’000 68.8% 10'000’000 52.6%

Series A 3’000’000 23.1% 3'140’187 22.2% 3'555’556 24.4% 8'000’000 42.1%

Series B 1'000’000 7.1% 1'000’000 6.9% 1'000’000 5.3%

Total 13'000’000 14'140’187 14'555’556 19'000’000

Investors protect their shares in case of a “down-round”, i.e. a new

financing round with a lower price per share.

There are three mechanisms (see excel-file):

Full ratchet

Weighted narrow-based average

Weighted broad-average

The full ratchet gives the new (lower) price to the previous preferred shareholders who receive new shares.

A weighted average is a combination of old and new price.

The narrow-based weighted average takes into account only the total number of outstanding preferred

shares for determining the new weighted average price for the old shares.

The broad-based weighted average accounts for all equity previously issued and currently undergoing issue.

Comments on terms

A term sheet follows the technical due diligence (3-6 months) and is

conditional to legal and accounting due diligence. If all is positive, an

investment should follow in 1-3 months.

Terms are seldom balanced and reflect investors’ power. There is a “no-

prisoner” approach!

There are however standard with not much deviation

Confidentiality/exclusivity/costs are the only binding terms

Avoid milestones!

Be prepared…

If you want to be part of the game…

Career Traits for the Aspiring Venture Capitalist

Steve Jurvetson