VCIC PREP SESSION
“VC 101”
Prepared by
P a t r i c k Ve r n o n
Dir. of Venture Initiatives
©2014 UNC Kenan -Flagler
What is Venture Capital?
Institutional equity investments
in high growth startups.
Institutional equity investments in high growth startups.
Institutional
Professional money managers
Equity
Investments
Private equity (not public, not debt),
shared ownership
High Growth
Hit-driven investment thesis
Startups
Debatable term, not mature businesses
What is a VC’s Job?
Return 20-25%
to Their Investors
(Limited Partners, or LPs)
Question?
• How is a VC similar to a mutual fund manager?
• Different?
What is a VC?
•
•
•
•
Professional money manager
Private equity
High risk/return
Portfolio of investments
What is Venture Capital?
•
•
•
•
Asset class
Subset of private equity
High risk, high return
Hit driven
Early Venture Firms
1962: Draper and Johnson Inv. Co.
1969: Venrock (renamed)
1972: Kleiner Perkins, Sequioa
1985: Draper Fisher Jurvetson
Example: Kleiner Perkins
•
•
•
•
1980: KPCB II $55M
1989: KPCB V $150M
2000: KPCB X $750M
2010: 3 funds closed: nearly $2B
VC Job Duties
1.
2.
3.
4.
5.
Fundraising
Sourcing deals
Investing
Growing ventures
Exiting
VC Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
VC’s Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
Raising a Fund
• VC fund is a partnership
• GPs (general partners) are the VCs who
actively invest the fund in startups
• LPs (limited partners):
– Financial investors with no active role
– “Institutional” - pension funds, university
endowments, insurance companies, etc.
VC Cash Flow
Startup
Startup
Startup
Startup
Startup
VC Firm
Startup
Startup
Startup
Startup
StartupStartup
Limited
Partner
VC Cash Flow
Startup
Startup
Startup
LP2
Startup
LP3
$$
VC Firm
(General
Partners
GPs)
Startup
Fund 1
$$$$
Startup
Startup
LP4
Startup
Startup
LPn
StartupStartup
Limited
Partner
Fund I
LP2
LP3
LP4
LPn
$$
Fund II
VC Firm
(General
Partners
GPs)
Fund
III
Fund
IV
Raising a Fund
LP1
LP2
LP3
LP4
LPn
Pledge $$
VC Firm
(GPs)
Fund 1
$$$$
UNC
Endowment
Raising a Fund
NC Pension
Fund
CalPERS
Example
Pledge $$
VC Firm
(GPs)
Fund 1
$$$$
Morgan
Creek
Capital
Commitments only.
No actual cash changes hands.
AIG
“Capital Call”
UNC
Endowment
NC Pension
Fund
CalPERS
Morgan
Creek
Capital
AIG
Capital Call
VC Firm
(GPs)
Fund 1
$$$$
Series A
Startup
VC’s Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
Source Deals: High Growth
• Tech
– Social media
– SaaS
– Hardware
• Media
• Cleantech
• Life Sciences
– Med Device
– Therapeutics
– Biotech
• Healthcare IT
Source Deals: Network
•
•
•
•
•
Lawyers, CPAs, CFOs, bankers
Other VCs (syndication)
Serial entrepreneurs
Conferences
Universities
– Technology transfer
– Teach, coach, mentor, judge
Due Diligence
• Research to decide whether or not to invest
• Includes meeting with the founders
• Rely on vast network of experts
VC’s Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
Equity Investing
• Buying % of startup
• Exchange cash for new “preferred” shares of stock
• Not debt
Typical Growth of Bootstrap Venture
Normal bootstrap business
grows steadily (if you’re lucky).
Rounds of
Equity Funding
Early
$2-3M
|
$5-15M |
Late
$25M+
(Gross Approximations)
$100,000 $1,000,000
$50,000-$250,000
VC Rounds
A, B, C…
(Institutional)
$1,000-$100,000
Friends/
Family
Seed or
Pre-Seed
Angel
IPO or
M&A or
Later Stage
PE
How Does a Round Work?
Pre-Money Valuation
$
+
+
Investment
$
=
=
Post-money Valuation
$$
Simplified Example: “1 on 2”
Investment
$1M
Pre-Money
Valuation
$2M
$2M Pre-Money
+ $1M Investment
= $3M Post
Simplified Example: 1 on 2
Investors
33%
Founders
67%
Mechanics Include Shares
1,000,000
Preferred Shares
at $1/ea.
Shares created in
articles of
incorporation
2,000,000
Founders Shares
@ $1/ea.
New shares created
and assigned to
investors
How Does a Round Work?
Negotiated Pre-Money Valuation
$
+
+
Negotiated Investment
$
=
=
Post-money Valuation
$$
VC’s Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
Growing Ventures
• On the Team
– “Active” participation = board seat(s)
– Advisors (connections, strategy, etc.)
• Future rounds
– Valuation
– Milestones
– Syndication
Board Seats
• Board of directors controls the venture
(unlike board of advisors)
• Small ventures have small boards that meet
often (quarterly), 3-7 members
• Odd number to prevent ties
• % ownership of stock should be
(approximately) reflected in % of board
seats
– E.g. own 60% of stock, control 3 of 5 seats
Advisors
• Even if not on board, VCs will have
strategic input
• VC network benefits
–
–
–
–
Management team additions
Customers
Partners
Competitors
Future Rounds
• Future rounds are the norm, not the
exception (most entrepreneurs do not realize this)
• VCs help find “syndicate” investors
– Later rounds can be much larger
– New network benefits
• Up round: valuation is higher and
investment is (usually) higher
• Down round: valuation is lower
Fund Life: 10 Years
Harvest
Follow-On Rounds
Invest and Reserve
“Raise” Fund
Year
0
5
10
Due
Diligence
Hit
Milestones
EXIT
Series B
Series A
Find Deal
Example Successful Investment
Hit
Milestones
Harvest
Follow-On Rounds
Invest and Reserve
0
2
3
5
8
10
Exit
2
B
0
A
A Pattern That Repeats
3
5
8
10
0
2
Exit
B
A
One of Many
3
5
8
10
0
2
3
5
Bust
B
A
Exit
B
A
B
A
Exit
B
A
Exit
B
A
Big Exit
C
B
A
Bust
A
Bust
A
Bust
B
A
B
A
D
C
B
A
Portfolio of 10-25 Investments
8
10
Invest
LP1
Portfolio
Startup
Startup
Startup
LP2
Startup
LP3
Capital Call
$$
VC Firm
(GPs)
Startup
Fund 1
$$$$
Startup
Startup
LP4
Startup
Startup
LPn
StartupStartup
Future Rounds
• VCs in Series A almost always join Series B
– “Pro rata” means they invest to keep same %
ownership
– aka, “maintain position”
• In a hits-driven business, not maintaining a
position is the third rail
– “Last money in” dictates the terms
Future Rounds
It is absolutely imperative that you reserve
funding for future rounds!
Your analysis of the deal at VCIC must include
assumptions about future rounds and the exit.
VC’s Job Cycle
1. Close
Fundraise
1. Close Fund
Source Deals
Fund
Fundraise
Source
Deals
2. Invest
Grow Ventures
3. Exit
3. Exit
2. Invest
Fundraise…
Grow
Ventures
VC Return
• “Top Quartile” venture firms return >20% average ROI to
LPs
• Fund has life of 10 years
• Average investments are 5-7 years
0
2
1
3
8
5
B
A
Exit
Big Exit
7
B
B
C
A
Exit
A
6
Bust
B
4
B
Bust
A
Bust
B
A
5
A
A
A
2
Exit
B
A
A
9
10
Bust
D
3
B
C
B
A
Portfolio of 10-25 Investments
11
8
10
0
2
3
5
Bust
B
A
B
A
Exit
B
A
Exit
B
A
Exit
B
A
Big Exit
C
B
A
Bust
A
Bust
A
Bust
B
A
B
A
D
C
B
A
Exit Scenario
Bust
Exit
8
?
?
?
?
10
Invest
LP1
Portfolio
Startup
Startup
Startup
LP2
Startup
LP3
Capital Call
$$
VC Firm
(GPs)
Startup
Fund 1
$$$$
Startup
Startup
LP4
Startup
Startup
LPn
StartupStartup
Exits
LP1
dud
Single dud
Triple
dud
dud
LP2
dud
Single
dud
dud
dud
LP3
$$
VC Firm
(GPs)
Fund 1
$$$$
$$
Single
Single
LP4
LPn
Double
Home
Run
Fund Return Examples
•
•
•
•
150M fund
Fees: 3M/year (salaries, rent, travel)
12 portfolio ventures at $10M avg. investment
To get 20% ROI, we need ~$450M
(20% of 150M = $30M x 10 years)
– That’s two ventures going 20X!!
Getting to 20% ROI
• Rule of thumb: 3X on entire fund
• However, each investment is not 10 years
– Money not “put to work” until a capital call
– Exit could happen before end of fund
• You could reach 20% with only 1.5X
Deal Return Example
• VCIC Round A: Negotiate 1 on 2
– $1M investment on $2M pre, post-money = $3M
– Ownership for VCIC firm, 33%
• Assume B Round: 3 on 9
– $3M investment on $9M pre, post-money = $12M
– Ownership for VCIC firm: 25% + (33% of 75%) = $50%
• Assume Exit of $80M at acquisition
• VCIC fund return: $40M/$4M = 10X
See “VCIC Math Help.ppt” for
more about deal structure.
What is a VC’s Job?
1. Close
Fund
Return 20-25%
to investors
(LPs)
Fundraise
Source
Deals
3. Exit
2. Invest
Grow
Ventures