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1
Venture Capital Venture Capital and theand theEmerging Technology CompanyEmerging Technology Company
Hastings College of the LawHastings College of the Law
Mark BaudlerMark Baudler
Rob KornegayRob Kornegay
Spring 2008Spring 2008
2
Week 1: Introduction and Week 1: Introduction and OverviewOverview
Agency Theory to Agency Theory to
Financial ContractingFinancial Contracting
3
Introduction and Introduction and HousekeepingHousekeeping
Our backgroundOur background
Your backgroundYour background
4
Introduction and Introduction and HousekeepingHousekeeping
Class rosterClass roster
Class participationClass participation
5
Introduction and Introduction and HousekeepingHousekeeping
Course materialsCourse materials• Course syllabusCourse syllabus• Distributed readings and materials Distributed readings and materials
(required)(required)• ““Caselettes” and problem sets (required)Caselettes” and problem sets (required)• Course statutes and regulations (required)Course statutes and regulations (required)• Posted powerpoint presentations (pdf Posted powerpoint presentations (pdf
format)format) Class preparationClass preparation
6
Introduction and Introduction and HousekeepingHousekeeping
Meet Monday afternoons 4:30-6:30pmMeet Monday afternoons 4:30-6:30pm• See semester class schedule See semester class schedule • Evening routine (breaks, questions, etc.)Evening routine (breaks, questions, etc.)
Our accessibility: Our accessibility: • after each class, and at the office after each class, and at the office
650-320-4597 Mark650-320-4597 Mark 650-320-4533 Rob650-320-4533 Rob
Email: Email: • [email protected]@wsgr.com• [email protected]@wsgr.com
7
Introduction and Introduction and HousekeepingHousekeeping
Required course pre-requisite: Required course pre-requisite: • Business Organizations Business Organizations
Class communications: emailClass communications: email• Weekly postings and announcementsWeekly postings and announcements• Powerpoints will be posted before or Powerpoints will be posted before or
after each classafter each class
8
Introduction and Introduction and HousekeepingHousekeeping
Grade componentsGrade components• 100% final exam100% final exam• Discretion to recognize class Discretion to recognize class
participationparticipation Final exam Final exam
• Short answer/multiple choiceShort answer/multiple choice• Hypothetical fact situations with essay Hypothetical fact situations with essay
questionsquestions• 2 hours—open book (bring a calculator)2 hours—open book (bring a calculator)
9
Course ObjectivesCourse Objectives
A basic understanding of the legal A basic understanding of the legal and business issues that are and business issues that are involved in the growth cycle of the involved in the growth cycle of the venture-backed technology venture-backed technology companycompany
A mainstream view from the A mainstream view from the perspective of Silicon Valleyperspective of Silicon Valley
The corporate lawyer as business The corporate lawyer as business counselorcounselor
10
Course ObjectivesCourse Objectives
Multi-disciplinary approach: Multi-disciplinary approach: • Business judgment and evaluationBusiness judgment and evaluation• AccountingAccounting• TaxTax• PsychologyPsychology• ProcessProcess• LawLaw
11
Course OutlineCourse Outline
Theories of financial contracting Theories of financial contracting High level view of the venture capital High level view of the venture capital
industry industry Venture capital: basic fund structureVenture capital: basic fund structure Start-ups: basic organizational mattersStart-ups: basic organizational matters Stock in the start-up environmentStock in the start-up environment Valuation of start-upsValuation of start-ups
12
Course OutlineCourse Outline
Primer on federal and state Primer on federal and state securities lawssecurities laws
Equity incentive plans and Equity incentive plans and arrangementsarrangements
Venture financing: term sheets and Venture financing: term sheets and related issuesrelated issues
13
Guest SpeakersGuest Speakers
Venture CapitalistVenture Capitalist• To be determinedTo be determined
Entrepreneur/CEO Entrepreneur/CEO • Jason Knight and Mark Hedlund of Jason Knight and Mark Hedlund of
Wesabe, Inc.Wesabe, Inc.
14
Principal Legal ResourcesPrincipal Legal Resources
California Corporations CodeCalifornia Corporations Code• California General Corporation LawCalifornia General Corporation Law• Delaware General Corporations LawDelaware General Corporations Law• California Corporate Securities LawCalifornia Corporate Securities Law
– California Department of CorporationsCalifornia Department of Corporations
15
Legal Resources Legal Resources
Federal Securities LawFederal Securities Law• Securities Act of 1933Securities Act of 1933• Securities Exchange Act of 1934Securities Exchange Act of 1934
Other Legal Resources (but we Other Legal Resources (but we won’t cover)won’t cover)• Nasdaq Corporate Governance RulesNasdaq Corporate Governance Rules• Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002• SEC rules and releasesSEC rules and releases
The Players in the The Players in the Technology CommunityTechnology Community
The Public Equity MarketsThe Public Equity Markets
Venture CapitalistsVenture Capitalists
Angel InvestorsAngel Investors
AccountantsAccountants LawyersLawyers
Investment BankersInvestment Bankers
The UniversitiesThe Universities
Silicon Valley InfrastructureSilicon Valley Infrastructure
Technology, IncTechnology, Inc
16
Some Names of the Some Names of the Supporting CastSupporting Cast
Venture CapitalVenture Capital MayfieldMayfield
Sequoia CapitalSequoia Capital
Kleiner PerkinsKleiner Perkins
Accel PartnersAccel Partners
New Enterprise AssociatesNew Enterprise Associates
US Venture PartnersUS Venture Partners
Lightspeed VenturesLightspeed Ventures
Panorama CapitalPanorama Capital
Bessemer VenturesBessemer Ventures
Hummer WinbladHummer Winblad
Opus CapitalOpus Capital
Sutter Hill VenturesSutter Hill Ventures
Battery VenturesBattery Ventures
Draper Fisher JurvetsonDraper Fisher Jurvetson
Accounting FirmsAccounting Firms Pricewaterhouse CoopersPricewaterhouse Coopers
Deloitte & ToucheDeloitte & Touche
Ernst &YoungErnst &Young
KPMGKPMG
____________________________
Grant ThorntonGrant Thornton
BDO SiedmanBDO Siedman
Frank Rimerman + CoFrank Rimerman + Co
Investment BanksInvestment Banks Credit Suisse First BostonCredit Suisse First Boston
Goldman SachsGoldman Sachs
Morgan StanleyMorgan Stanley
UBS Investment BankUBS Investment Bank
Deutsche Bank SecuritiesDeutsche Bank Securities
Thomas Weisel PartnersThomas Weisel Partners
Bank America SecuritiesBank America Securities
Lehman BrothersLehman Brothers
Law FirmsLaw Firms Cooley GodwardCooley Godward
DLA Piper RudnickDLA Piper Rudnick
Fenwick & WestFenwick & West
Latham & WatkinsLatham & Watkins
Gibson Dunn & CrutcherGibson Dunn & Crutcher
Morrison & FoerrsterMorrison & Foerrster
OrrickOrrick
Pillsbury & WinthropPillsbury & Winthrop
Shearman & SterlingShearman & Sterling
Wilson Sonsini Wilson Sonsini Goodrich & RosatiGoodrich & Rosati
17
18
Agency Theory & Financial Agency Theory & Financial ContractsContracts
The corporation as a nexus of contractsThe corporation as a nexus of contracts
Agency theory focuses on the relationship Agency theory focuses on the relationship between the shareholder (principal) and the between the shareholder (principal) and the manager (agent).manager (agent).
Legal Entity
SuppliersSuppliers Management
Management Shareholder
s
Shareholders
Customers
Customers
Creditors/Lenders
Creditors/Lenders
Employees
Employees
19
Agency Theory & Financial Agency Theory & Financial ContractsContracts
““The directors of such [joint-stock] companies, however, The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than being the managers rather of other people’s money than of their own, it cannot be well expected, that they should of their own, it cannot be well expected, that they should watch over it with the same anxious vigilance with which watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their consider attention to small matters as not for their master’s honour and very easily give themselves a master’s honour and very easily give themselves a dispensation from having it. Negligence and profusion, dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the therefore, must always prevail, more or less, in the management of the affairs of such a company.”management of the affairs of such a company.”
Adam SmithAdam SmithThe Wealth of Nations The Wealth of Nations
(1776)(1776)
20
Agency Theory & Financial Agency Theory & Financial ContractsContracts
Agency relationship exists where a Agency relationship exists where a principalprincipal delegates decision-making authority to an delegates decision-making authority to an agentagent..
Shareholder/Manager is example of principal Shareholder/Manager is example of principal agent relationshipagent relationship
Challenge is to create financial contract Challenge is to create financial contract structures that align interests of structures that align interests of shareholders/managers in order to minimize shareholders/managers in order to minimize agency costsagency costs..
Agency costs refer to the lost benefit to the Agency costs refer to the lost benefit to the principal because the interests of the agent may principal because the interests of the agent may diverge from those of the principal. diverge from those of the principal.
““Shirking” – actions by managers that diverge Shirking” – actions by managers that diverge from the interests of shareholders.from the interests of shareholders.
21
Agency Theory & Financial Agency Theory & Financial ContractsContracts
Corporation’s capital composed of Corporation’s capital composed of generally alienable, divisible claims generally alienable, divisible claims on the assets and cash flows of the on the assets and cash flows of the corporationcorporation• Equity Claims of StockholdersEquity Claims of Stockholders• Debt Claims of CreditorsDebt Claims of Creditors
22
Agency Theory & Financial Agency Theory & Financial ContractsContracts
Problem of Information AsymmetriesProblem of Information Asymmetries• Economic impact on markets where one party Economic impact on markets where one party
has more or superior informationhas more or superior information Used Car Market As Classic ExampleUsed Car Market As Classic Example
• George A. Akerlof, “The Market for Lemons: George A. Akerlof, “The Market for Lemons: Quality Uncertainty and the Market Quality Uncertainty and the Market Mechanism,” Mechanism,” Quarterly Journal of EconomicsQuarterly Journal of Economics (August 1970)(August 1970)
Impact on Market Pricing → Bad Drives Impact on Market Pricing → Bad Drives Out the GoodOut the Good
23
Agency Theory & Financial Agency Theory & Financial ContractsContracts
Adverse Selection / “Rational Paranoia”Adverse Selection / “Rational Paranoia”• Common knowledge that someone (the Common knowledge that someone (the
informed party), knows more than someone else informed party), knows more than someone else (the uninformed party), and the uninformed (the uninformed party), and the uninformed party will draw inferences from the actions party will draw inferences from the actions taken and decisions made by the informed partytaken and decisions made by the informed party
• “’“’Rational paranoia” because when there is a Rational paranoia” because when there is a conflict of interest, it often involves drawing the conflict of interest, it often involves drawing the conclusion that the informed party might be conclusion that the informed party might be taking an action that is not helpful to the taking an action that is not helpful to the uninformed partyuninformed party
AKA – the Groucho Marx theoremAKA – the Groucho Marx theorem Examples: InsuranceExamples: Insurance
24
Agency Theory & Financial Agency Theory & Financial ContractsContracts
Moral HazardMoral Hazard• The risk that one party to a contract The risk that one party to a contract
may change their behavior to the may change their behavior to the detriment of the other party once the detriment of the other party once the contract has been concludedcontract has been concluded
Examples: Automobile InsuranceExamples: Automobile Insurance
25
GOLDMAN SACHS IPOGOLDMAN SACHS IPO
26
Review – Agency Theory and Review – Agency Theory and Financial ContractingFinancial Contracting
Agency Cost – diminution in value of Agency Cost – diminution in value of enterprise relative to the value realized enterprise relative to the value realized if agent acted solely in the interest of if agent acted solely in the interest of the principalthe principal
Impact of Information AsymmetriesImpact of Information Asymmetries Moral HazardMoral Hazard
27
Venture Capital Venture Capital Industry Industry OverviewOverview
Powered
By:
28
U.S. FundraisingU.S. Fundraising
29
U.S. Fundraising Slows in 1H’07Commitments to Venture Capital Funds
$6.4
$24.7$25.4
$17.9
$9.9$13.1
$50.2
$83.2
$57.3
$26.7
$17.2
$0
$20
$40
$60
$80
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07
Funds
Rai
sed
($B)
30
Fund Sizes on Track Through 1stHalf 2007 Median VC Fund Size (for funds greater than $20M)
$201$194 $190
$156
$100
$75
$112$100
$118
$100
$83
$0
$50
$100
$150
$200
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07
Med
ian F
und
Siz
e ($
M)
31
Funds Continue to Get LargerAllocation of Fund Size by Number of Funds Raised per Vintage Year
24%
23%
31% 29%
67%
32%
13%
26%29%
7%
71%
34%
0%
20%
40%
60%
80%
100%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07
Under $100M
$100M-$249M
$250M-$499M
$500M-$999M
$1B+
32
U.S. Investment: U.S. Investment: OverallOverall
33
$13.1$17.9
$49.5
$94.8
$36.5
$22.1 $19.7 $22.4 $24.2 $27.2$22.7
1976
25772477235422262432
3321
6351
4590
2547
2211
$0
$25
$50
$75
$100
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
0
1,000
2,000
3,000
4,000
5,000
6,000
Amount Invested ($B) Number of Deals
Am
ount
Inve
sted
($B
) Num
ber of D
eals
2007 Investment On TrackDeal Flow and Equity into Venture-Backed Companies
Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07
34
$8.1$7.5$7.2
$6.3
$7.5$7.0
$6.5$6.1$6.1
$6.7
$5.2$5.4$5.3
635
727
614603
676676622
664621636
556614
546
$0
$3
$6
$9
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
0
150
300
450
600
Amount Invested ($B) Number of Deals
Equity Jumps in 3Q07Deal Flow and Equity into Venture-Backed Companies
Am
ount
Inve
sted
($B
) Num
ber of Deals
Source: Dow Jones VentureOne/Ernst &Young
35
Early Stage Investing Steady in 3Q’07Deal Flow Allocation by Round Class
0%
20%
40%
60%
80%
100%
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
Restart
Later
Second
First
Seed% o
f Tot
al V
C R
ounds
*Seed and First Rounds Combined
*36%
20%
37%
7%
*38%
37%
22%
*41%
Source: Dow Jones VentureOne/Ernst &Young
4%
23%
38%
9% 4%
31%
17%
*34%
36
Seed and First Round Allocation Increases Deal Flow Allocation by Round Class (Annual)
0%
20%
40%
60%
80%
100%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Restart
Later
Second
First
Seed
% o
f Tot
al V
C R
ound
s
*49%
*Seed and First Rounds Combined
*39%
24%
33%
26%
35%
4%
*54%
22%
36%
2%8%
Source: Dow Jones VentureOne/Ernst &Young
20%
20%
*31%
YTD07: 1Q07 –3Q07
37
Dollars Allocated to Later Stage Remains StrongInvestment Allocation by Round Class
0%
20%
40%
60%
80%
100%
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
Restart
Later
Second
First
Seed
% o
f Dol
lars
Inve
sted
*Seed and First Rounds Combined
5%
*23%
51%
21%
*26%
45%
23%
27%
52%
10%
Source: Dow Jones VentureOne/Ernst &Young
6%
*27%*21%
42%
38
Median Deal Size Increases in 3Q’07Median Amount Invested Per Financing Round
$6.0
$6.7$7.0
$6.3 $6.2
$7.0 $7.1 $7.0 $7.0
$7.6 $7.5$7.9
$7.0
$0
$3
$6
$9
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
Med
ian A
mou
nt
Inve
sted
($M
)
Source: Dow Jones VentureOne/Ernst &Young
39
Later Rounds Climb in 3Q’07Median Amount Invested by Round Class , VC Only
$12.4
$8.8$8.4
$9.0
$5.4
$4.3
$0.9$0.9
$0
$2
$4
$6
$8
$10
$12
$14
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
Later Round Second Round First Round Seed Round
Medi
an A
mou
nt
Inve
sted
($M
)
Source: Dow Jones VentureOne/Ernst &Young
40
Median of Later Rounds Continue To IncreaseMedian Amount Invested by Round Class (Annual), VC Only
$8.4
$5.0
$1.0
$11.5
$5.8
$5.1$3.5
$1.0
$0
$5
$10
$15
$20
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Later Round Second Round First Round Seed Round
Medi
an A
mou
nt
Inve
sted
($M
)
Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07
41
Number of Deals with 2 or Fewer Investors Continues to RiseNumber of Investors Per Round
34% 32%
22%
16% 16%
10% 12%
18% 18%
28%
22%
22%
20%
15%
30%
0%
20%
40%
60%
80%
100%
1997 1999 2001 2003 2005 YTD07
5+ Investors
4 Investors
3 Investors
2 Investors
1 Investor
Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07
42
U.S. Investment: U.S. Investment: RegionsRegions
43
West Coast Dominates Venture InvestmentRegional Investment in the United States YTD07
New England12%
Southern California
14%
Texas4%
Bay Area 31%
All Other US23%
New York Metro7%
Potomac3%
Washington State4%
Research Triangle
2%
Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07
44
West Coast Leads Venture DealsTotal Number of Deals in the United States YTD07
Bay Area 31%
New England12%
Southern California
11%
Texas4%
Potomac4%
All Other US24%
New York Metro 8%
Research Triangle
2%
Washington State4%
Source: Dow Jones VentureOne/Ernst &YoungYTD07: 1Q07 –3Q07
45
U.S. Investment: U.S. Investment: ValuationsValuations
46
Valuations Dip in 1H’07Median Premoney Valuation by Year, VC Financings Only
$9.3
$12.9
$15.4
$21.0
$25.2
$15.8
$10.8 $10.0
$12.9
$15.0
$18.0$16.3
$0
$5
$10
$15
$20
$25
1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1H07
Med
ian P
rem
oney
Val
uation
($M
)
47
2Q’07 Valuations FlatMedian Premoney Valuation, VC Financings Only
$13.6$12.5 $12.0
$15.0$15.8
$11.9
$16.0 $16.6$17.8 $18.0
$21.0
$16.1 $16.3
$0
$5
$10
$15
$20
$25
2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07
Med
ian P
rem
oney
Val
uation
($M
)
48
First & Second Round Valuations Climb in 2Q’07Median Premoney Valuations by Round Class (All Industries)
$31.5
$29.8
$16.1$15.0
$8.7$5.4
$0
$10
$20
$30
$40
2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07
Later Stage Second Round First Round
Medi
an P
rem
oney
Val
uat
ion ($M
)
49
U.S. LiquidityU.S. Liquidity
50
Exit Via IPO Increasing Vs. M&APercentage Breakdown of Venture Backed Liquidity Events: IPO vs. M&A
0% 20% 40% 60% 80% 100%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
YTD07
IPOs M&AsYTD07: 1Q07 –3Q07
51
M&A Transaction Count Down in 2007Transactions and Amount Paid in M&As
$28.4$31.9$30.5
$24.0
$13.3$11.0
$22.4
$98.6
$43.3
$14.8$12.7
279
420414422
346383
407
307
253232
462
$0
$25
$50
$75
$100
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
0
150
300
450
Amount Paid ($B) Number of Transactions
Am
ount
Paid
($B
)Num
ber of T
ransactions
YTD07: 1Q07 –3Q07
52
Median Amount Paid Soars in 2007 Median Amount Paid in M&As vs. Median Amount Raised Prior to M&A
$6 $7
$21$22$20$20$19$17
$15$10$11
$33 $31
$55
$100
$28
$19$24
$39
$47$51
$89
$0
$25
$50
$75
$100
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
$0
$25
$50
$75
$100
Median Equity Raised Prior to M&A Median Amount Paid ($M)
Med
ian A
mou
nt
Rai
sed P
rior
to
M&
A ($M
)M
edian A
mou
nt Paid ($M
)
YTD07: 1Q07 –3Q07
53
Age of Acquired Companies Continues to RiseMedian Time From Initial Equity Funding to M&A
3.5
3.0 2.82.4
2.0
2.7
3.7
4.6
5.4
6.0
6.6
0
2
4
6
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Num
ber
of Y
ear
s
YTD07: 1Q07 –3Q07
54
Amount Raised in IPOs Highest Since 2004Deals and Amount Raised Through IPOs
Am
ount
Rai
sed ($B)
Ven
ture-B
acked IPO
s
$4.7$4.6 $3.7
$19.5 $19.0
$1.8 $1.6 $1.5
$5.0
$2.4$3.7
201
250
120
68
22 20 23
67
4356 48
$0
$5
$10
$15
$20
$25
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
0
50
100
150
200
250
Amount Raised ($B) Venture-Backed IPOsYTD07: 1Q07 –3Q07
55
IPO Activity Declines in 3Q’07Deals and Amount Raised Through IPOs
$1.7
$1.2
$0.5$0.2
$1.0
$0.7 $0.6 $0.7
$2.8
$1.2$1.2
$0.6
$1.3
14
19
9
5
17
1213
16
9
18
13
24
11
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07
0
5
10
15
20
Amount Raised ($B) Venture-Backed IPOs
Am
ount
Rai
sed ($B
)Ventu
re-Backed IPO
s
56
Time to Liquidity Continues to IncreaseMedian Time From Initial Equity Funding to IPO
6.86.3
5.65.75.7
3.6
4.5
3.12.82.8
3.1
0
1
2
3
4
5
6
7
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Num
ber
of Y
ears
YTD07: 1Q07 –3Q07
57
Equity Raised Prior to IPO Continues AscentMedian Amount Raised Prior to IPO
$13
$22
$31
$47 $48 $49$55
$73
$52
$68
$58
$0
$25
$50
$75
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Med
ian A
mou
nt
Rai
sed P
rior
to
IPO
($M
)
YTD07: 1Q07 –3Q07
58
Valuations for 2007 IPOs SkyrocketMedian Pre-Valuation at IPO
$314
$202
$167
$224$226$229
$281
$362
$314
$172
$105
$0
$75
$150
$225
$300
$375
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD07
Medi
an P
re-V
alua
tion
at
IPO
($M
)
YTD07: 1Q07 –3Q07
59
European European Investment: Investment: OverviewOverview
60
Perspective on European Perspective on European MarketMarketEquity Investment in Venture-Backed Companies, US Equity Investment in Venture-Backed Companies, US vs. Europe (vs. Europe ($$))
Overall Investment
3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07$0
$1
$2
$3
$4
$5
$6
$7
$8
European Equity Investment
U.S. Equity Investment
Am
ou
nt
Investe
d
($B
)
Source: Dow Jones VentureOne/Ernst &Young
61
Industry TrendsIndustry Trends
The good news...The good news...• There clearly has been a recovery in activity and There clearly has been a recovery in activity and
investment levels in the US venture capital investment levels in the US venture capital industry from the first half of the decadeindustry from the first half of the decade– Dollars and # of deals have modestly but steadily Dollars and # of deals have modestly but steadily
increased since 2002; activity levels map back to 1995-increased since 2002; activity levels map back to 1995-1996 timeframe1996 timeframe
– Importantly, the number of seed/first round deals has Importantly, the number of seed/first round deals has increased: innovation rates are returning, as VCs are increased: innovation rates are returning, as VCs are able to focus less energy on triaging existing companiesable to focus less energy on triaging existing companies
– Top tier venture funds are willing to invest modest Top tier venture funds are willing to invest modest amounts (i.e., <$1 million) to get in early on “good deals“amounts (i.e., <$1 million) to get in early on “good deals“
– Term sheets are back to historical conventions, i.e., fair Term sheets are back to historical conventions, i.e., fair and even handed (relatively speaking)and even handed (relatively speaking)
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Industry TrendsIndustry Trends
The good news...The good news...• 2006 was the fourth largest year ever 2006 was the fourth largest year ever
in VC investments in the U.S.: $27 in VC investments in the U.S.: $27 billionbillion
• 2007 is on track2007 is on track– Somewhat higher from pre-bubble yearsSomewhat higher from pre-bubble years
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Industry TrendsIndustry Trends
The good news...The good news...• VC money for investment is abundantVC money for investment is abundant
– Silicon Valley has “market share” over #2 Silicon Valley has “market share” over #2 region, New England by a ratio of 3-to-1region, New England by a ratio of 3-to-1
– California (Silicon Valley + Southern California (Silicon Valley + Southern California) has over 40% of all VC California) has over 40% of all VC investments in the U.S.investments in the U.S.
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Industry TrendsIndustry Trends
The bad news...The bad news...• Spending by the Fortune 500 on IT Spending by the Fortune 500 on IT
requirements is flat, with bias against requirements is flat, with bias against purchases from startupspurchases from startups
• Startup valuations are climbingStartup valuations are climbing– Basic supply and demand: more money Basic supply and demand: more money
chasing fewer dealschasing fewer deals
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Industry TrendsIndustry Trends The bad news...The bad news...
• Liquidity event is taking longer from Liquidity event is taking longer from the date of first fundingthe date of first funding– 2.8 years (1999) vs. 6.6 years (2007) for 2.8 years (1999) vs. 6.6 years (2007) for
an IPOan IPO– 2.0 years (2001) vs. 6.6 years (2007) for 2.0 years (2001) vs. 6.6 years (2007) for
M&AM&A– Result: more capital is required to carry Result: more capital is required to carry
the company to an exit event (e.g., $17 the company to an exit event (e.g., $17 million in 1997 to $68 million in 2007)million in 1997 to $68 million in 2007)
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Industry TrendsIndustry Trends The bad news...The bad news...
• U.S. IPO market in general not a U.S. IPO market in general not a viable exit to most VC-backed viable exit to most VC-backed companiescompanies– Ratio of M&A:IPO exits in 2007 is Ratio of M&A:IPO exits in 2007 is
approximately 10:1. In 2001-2005, it was approximately 10:1. In 2001-2005, it was as high as 20:1. In 1999-2000, it was as high as 20:1. In 1999-2000, it was almost 1:1. almost 1:1.
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Industry TrendsIndustry Trends
The bad news...The bad news...– IPO market open only to companies with IPO market open only to companies with
substantial and predictable revenues and substantial and predictable revenues and economic fundamentals economic fundamentals
– General wisdom: minimum annual revenues General wisdom: minimum annual revenues of $100 million to absorb compliance costs of $100 million to absorb compliance costs ($2-3 million/year) under Sarbanes Oxley($2-3 million/year) under Sarbanes Oxley
– Sarbanes Oxley not likely to be modified by Sarbanes Oxley not likely to be modified by Congress anytime soonCongress anytime soon
– Scarcity of directors willing to sit on boards in Scarcity of directors willing to sit on boards in the wake of Enron, Worldcom, et al.the wake of Enron, Worldcom, et al.
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Week 2: The Venture Capital Week 2: The Venture Capital Industry and Related TopicIndustry and Related Topic
Anatomy of a Venture FundAnatomy of a Venture Fund