Slide 1
Class 10 Notes
Deal Structure: Ownership and Control
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 2
Agenda
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Homework due tonight
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Winning Angels – 179 - 222
Diligence B moved to next week
Global village discussion
Comparables
Ownership and control
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 3
Analyzing Comparables
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 4
The Difference…
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Comparable Analysis
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Are the assumptions and plan
REASONABLE?
Competitive Analysis
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70-397 Venture Finance
What are the STRENGTHS AND
WEAKNESSES vs. the competition?
Fall 2002
© Andrew W. Hannah
Slide 5
Comparables
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Allow us to assess a particular aspect of a
company
We use comparable in the sense of analogy
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“Resembles”, “parallels”, “corresponds to”
Good comparables
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70-397 Venture Finance
Are ANALOGIES along multiple dimensions
Are timely
Provide a clear answer to a question
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 6
Questions Comparables Ask
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Is this a reasonable product development schedule?
Does this marketing budget make sense?
Can this product be sold through wholesalers?
Does the exit strategy make sense?
What other companies are in similar businesses and is the plan
reasonable?
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Do 95% margins make sense in manufacturing?
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Is $500,000 of sales per sales person high or low?
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Is $200,000 of revenue per employee high or low?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 7
Some Types of Comparables
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Industry
Financial
Competitive
Managerial/Human Resources
Channel
Operational
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 8
Marks of “Good” Comparables
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It asks a single question
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The question
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Does this channel make sense?
Are this sales projections realistic?
How are the competitors marketing?
Addresses a risk or opportunity
Verifies a fact
Answers an unknown
Frames an uncertainty
Can be addressed in a timely and economic manner
70-397 Venture Finance
Fall 2002
© William Hulley
Slide 9
Finding Comparables – The Assignment
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Are the PolyTronics Financial Statements reasonable?
Choose a basis of comparison – see updated diligence B
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Revenue size (especially 2006)
Revenue growth rate (be careful to consider age of companies)
Gross margins
Gross margin growth rate
Operating margins
Revenue per headcount
Capital required to produce revenue
Others you believe to be relevant
Find a couple of companies (3 or 4) that look like PolyTronics
Set them up side-by-side
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 10
Deal Structure
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 11
Deal Structure – what matters?
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The basics:
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Control – mechanisms of governance
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Ownership
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Who owns what and when?
Price
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Who makes decisions?
Who pays what and when?
Term sheets – captures the basics
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 12
Control: Who makes decisions?
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What decisions matter?
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Who makes them?
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Hiring and firing
Raising money
Spending money
Choosing strategic direction
Making operating decisions
Employees
Management
Directors
Shareholders
Which decisions map to which group?
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 13
Control: How are decisions made?
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What determines who decides what?
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Default – someone just does it
Custom – what is normally done in a business
Law – legal and regulatory restrictions or process
Contract – binding agreements between parties
Basic rule: whatever isn’t required by law or contract
falls to the realm of custom or default
The term sheet divides the power between the
investors, board and management (by contract)
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 14
Ownership: Who owns what?
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Ownership can be divided among:
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Who owns what isn’t fixed until:
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Debt – asset financing, A/P, etc
Equity – preferred or common
Contingent equity – options and warrants
Someone wants to buy something
The price they are willing to pay is determined
Stakeholder rights to the cash are sorted out
The term sheet describes the stakeholder rights
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 15
Preferred vs. Common Stock
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Preferred
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Redeemable
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Convertible
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Choose between debt or equity
Advantage? Don’t have to decide today
Participating
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Get your bait back, participate in upside
Advantage? Downside protection
Get your bait back, participate in upside
Advantage? Downside, don’t have to decide
Common – what’s left over…
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 16
Price: How much is it worth?
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Valuation is an art not a science and sometimes
complicated…
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Typical valuation tools don’t work
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What do I do with debt?
What about options and warrants?
What are the value of preferences?
No cash flow
No revenue
No assets
Term sheets defines the valuation
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 17
Term Sheets
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Term sheets
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Always evaluate the term sheet by looking at
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divide power between investors, board and mgmt
describe the stakeholder rights to ownership
define the rules for setting valuation
create a sense of “the spirit” or “intent”
Control – who gets to do what
Ownership – who owns what
Price – how much is it worth
Always evaluate in context of today & future
70-397 Venture Finance
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 18
Covenants and Representations
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Positive Covenants – things you will do
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Negative Covenants – things you will not do
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Information rights, auditing requirements
Selling debt, raising money, hiring management
Representations
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70-397 Venture Finance
We’ve told you everything that is material to you in making
your investment decision
Looking for the “Gotcha’s”
Fall 2002
© William Hulley and Andrew W. Hannah
Slide 19
Term Sheet Review
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Two to three pages long:
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Amount of the investment
Pre- and post-money valuations
Option pool information
Rights and preferences
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70-397 Venture Finance
Anti-dilution
Liquidation (e.g., participation)
Warrants
Dividends
Redemption
Board seats
Voting
Fall 2002
© Andrew W. Hannah
Slide 20
Next Week
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Homework
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Diligence Card “B” – comparables
Syllabus review
Investment Recommendation Working Session
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70-397 Venture Finance
Your Investment Recommendation Draft is due on 11/12!
Fall 2002
© Andrew W. Hannah