6182009

1
Changes in the VC Industry and Implications for
Start-upsSilicon Forest 2003
2
A Shifting VC Landscape on All Fronts

• Public disclosures increased transparency
• Limited Partners (LPs) are back to being the
  customer
• Impacting more on fund size, than on fee
  structures
• Near term issues
• Fund size cut backs
• Battles over claw backs and fees
• Collecting fees vs. making investments
• Asking for more formal fund policies bridges,
  cross-overs, etc
• Looking closer at partner make up, dynamics and
  board load
• Shake ups inside venture firms back to
  economics
• Figuring out what to do in all our 2000 vintage
  funds
• Rethinking fund size and in some cases LP
  composition
• Right sizing right skilling the partnership
• Rethinking the venture roles and areas of value
  add
• Investing in the practice and internal process

3
The Money Food chain
Sources of Capital
LPs The investors in VCs
VCs
Start-up

• Pension Funds
• Foundations
• Endowments
• Fund of Funds
• Individual Wealth
• Public Markets
• Still ample supply of money out there eager for
  VC oppties

• Stage focused
• Geography focused
• Sector focused
• Evaluated based on returns, the partners, and the
  strategy
• 3-4 years to put the money to work
• 5-7 years before liquidity (returns) a long
  term hold, no real way out
• 20-30 IRR ? 2-3X returns

• LP composition makes a difference
• Committed capital
• Capital calls

4
Size Matters In an Early Stage Fund
LPs The investors in VCs
VCs
Start-up

• 1Billion Early Stage fundhard if not impossible
• 1B IPO (a MEGA exit)
• You own 15
• Nets 150M
• Need 7 mega hits to pay back fund
• Need 14 to start generating venture returns
• Questionable scaling effects of more partners
• Not a transactional business
• Early Stage - putting 10-15M into each deal
• Ideal is 5-7 boards per partnergreat s creates
  issue of partner effectiveness
• Sweet spot seems to be 200-300M with 4-6 partners

• Expects a risk adjusted above stock market return
  rate
• Generally has a diversified portfolio with about
  5 in private equity
• Accepts the long term nature of private equities
• Repeat Investments in multiple funds
• ButThe increase in public reporting of VC
  results (transparency) now threatens
  underperforming name brand VCs

5
Current Market Conditions
LPs The investors in VCs
VCs
Start-up

• Managing expectations from entrepreneur,
  angels, co-investors, board members, etc
• Working together to plan out series B (the chasm)
• Priced right so you dont create a Series B
  challenge
• Balanced with keeping the team motivated
• Refocus on forming strong syndicates (insurance
  for inside rounds)
• Making sure there is good chemistry and ample dry
  powder in the syndicate
• Allocating 2-3x the first investment as reserve
• Current market
• Not being paid for seed level risk real issue
• Still too much capital in market huge exit
  bottleneck (CRV position)

6
Start-up Stages

• Its about funding to hit a stage
• Objective in each stage is to eliminate the
  risks
• Technology risk
• Market risk
• Team risk
• Business model and sales model risk

Seed
Series B
Series C
IPO
Series A

• Defining the it
• Idea
• Business plan
• Founders
• Ways to validate the market need

• Building the it and getting the first customers
  to use it
• Release product
• First betas or paying customers
• Putting the core team in place

• Scaling it
• Pricing and packaging nailed down i.e.,
  customers buy it that way
• Sales are repeatable

• Becoming a Company
• Profit
• Revenue ramp
• Sales scales
• V 2.0
• The team is in place

The Company and Market can Scale into a big
company (i.e., growth and profit oppty are clear
and the company executes)
7
Economics of Risk Managing Valuations

• Risk and reward - For the system to work, you
  need to get paid for taking riskand one pays
  more for fewer risks in the company

Seed
Series B
Series C
IPO or MA
Series A

• 1-4M post
• 500K seed round
• Warning a 1.5M seed round is effectively your
  Series A

• Less than 10M post
• e.g.5M invested on 5M pre-money value
• 2 VCs

• 20-30M post
• 1 to 3x forward revenue
• Pay for clear traction
• Add 1-2 new VCs

• 40-80M post
• Pay for revenue growth
• Pay for market leadership
• Pay for profitability

• 100-200M mkt value
• The historic range for a good IPO

7 Years
8
Implication for Start-ups

• Fund track record longevity does matter
• You want the VC firm around for the long haul
• Are you in their sector sweet spot?
• What value add do you really want from a VC firm?
• Spend the extra effort to build a powerful
  syndicate
• Capital efficiency is paramount
• Lots easier to make 10x on 10M invested than 10x
  on 30M invested
• Pay attention to the funding step functionsa
  step up is not a given
• Youre always fund raising its just a matter
  of degree and urgency