The reading level for this article is Novice

January 15, 2003

VC Valuation & Deal Structure

Mitch Mumma

Intersouth Partners

 Elements of Value

¨       "Back to valuing with PE rations and not hits on web sites."

¨       1991-1992 Biotech Bubble

¨       VC is illiquid

¨       Valuing private companies difficult

¨       VC is in the business of creating wealth

¨       Having good financial understanding is key

¨       Learn to use spreadsheet

¨       In VC firm, not a lot of stuff to do for inexperienced people.

¨       Time Value of Money is Key

 Creating Wealth: The Endgame Venture Capital Return Requirements

Great Deals

–         Bad Deals

–         Fees & Expenses

–         VC Participation (20%)

GOAL = 500 basis point premium to S&P 500 (5%)

S&P returned avg. of 12% since 1929

Minimum VC Goal 20% compounded

¨       In public market everyone has perfect information (theoretically) (rational expectations)

¨       VC is inefficient so they get unreasonable returns.

¨       Standard deviation of stock fund managers is small.

¨       Standard deviation of venture capital managers is large.

¨       Investors look for top 25% of VC firms based on returns

Returns Over Time

¨       Measured in Annual Internal Rate of Return (discount rate that causes the Net Present Value of Total Cash Flow to equal to 0)

Valuation and Ownership

% Equity Acquired by Venture Capital =                         Cash Involved

                                                           ———————————————————

                                                           Negotiated Premoney Value + Cash Invested

Two variables : value of company, how much money needed

Example:

            25% =            $1 Million

                       —————————

                       $3 million + $1 million

 

Seed Round         Series A Round   Series B Round   Series C Round Exit

Pre-Money                    1                      4                      15                     75                     550

Investment                     .5                     3                      10                     25

—————

Post-Monday                 $1.5                  $7                     $25                   $100
 

How much do you own at the end: about 8%

You take dilution at every new investment

 
Effect of Options and Option Pool

Other Valuation Techniques

Comparables

Net Present Value

Option Pricing

Venture Capital Method

Hard to value a company with no revenue/customers

Value of company is a function of how confident you feel in things needed to evaluate company

Factors

  1. Management – most important thing in a deal
  2. Financial
  3. Market
  4. Prodcut/Technical
  5. Economic
  6. Regulatory

Management – most important thing in a deal

  1. Entrepreneurial Leadership
  2. Completeness & Depth
    1. Right Player at right position
    2. Ability to attract additional talent
    3. Integrity, work ethic, likeability
  3. Relevant Experience
    1. Industry experience (domain knowledge, same customer set?)
    2. Entrepreneurial experience
  4. Marketing & Sales Orietation

Problem in bubble: VC’s didn’t meet with management team enough

VC is People business. We are betting on People. A great management team can take a B idea and make it work. No nepotism or family ties. I want the entrepreneurial spark. Founders must stay in or else their stock will not vest. We love it when the founders are financially involved.

Financial Drivers/Risk

  1. Valuation
  2. Value Creation Model
    1. Revenue (recurring?)
    2. Other
  3. Total capital requirement
  4. Financing strategy
  5. Syndication (finding other investing VC partners)
  6. Exit value and timing (what we think it will look like at the end)

Market Drivers

  1. Available size and growth &l t;/span>
  2. Timing
  3. Business model
    1. Scalability
  4. Sales Channels & Distribution
    1. Availability
    2. Cost
  5. Competition
    1. Barriers to Entry (patents, relationships)
    2. Number and quality of competitors

Hopefully entrepreneurs will understand market and distribution channels

Really important to stay up on competitors
 

Product & Technical Drivers/Risks

  1. Stage of Development (how long is it going to take, is there feedback from customers)
  2. Technical feasibility
  3. Maintenance and support
  4. IP protection

Today, if you don’t have revenue you do not get money.

Regulatory Drivers

Waiting for the FDA
 

Economic Drivers

How is the economy doing?
 

Fear & Greed

"Deal gets done when greed exceeds fear"
 

Evaluating Opportunities – Drivers of Value

Valuation of a Starting Point

Seed – <$3M

Series A – <$10M

Series B – <$25M

Series C – <$50M

 

 

This MBA Series Notes article was written by Dave Neal and Merrill Mason, taken by Ryan Allis on 2/28/2005

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