Venture Capital and Private Equity Session 4

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Venture Capital and Private Equity Session 4

• Professor Sandeep Dahiya
• Georgetown University

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Course Road Map

• What is Venture Capital - Introduction
• VC Cycle
• Fund raising
• Investing
• VC Valuation Methods
• Term Sheets
• Design of Private Equity securities
• Exiting
• Time permitting Corporate Venture Capital (CVC)

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Quick Review of VC Valuation Method

• Remember - In venture capital all valuation is
  implied valuation. Simply put the value arises
  because VC(s) is(are) willing to finance the
  company!
• The terms (amount invested, fraction of ownership
  received) fix the post-money and pre-money value
  of the business
• This process is made transparent by reporting of
  Capitalization Table or simply Cap Tables
  Let us see how these are created

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Capitalization Tables
Page 10 (Bottom) of ONSET ventures case describes
the financing history of TallyUp. Onset offered
to invest 750,000 at a price 1 per share in
return for 31.6 of the company. Later, ONSET
invested another 250,000 at the same price ( 1
per share) when Reed Tausig as the CEO. Please
draw up the capitalization tables, pre-money and
post money valuations for tally before and after
each round of financing.
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After Next Investment of 250,000
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After Option Pool Creation of 750,000 Shares
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What if Mann is able to do a 3.5 million round
at 2.5 times step up (ONSET invests 1 million in
this round)
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TallyUp What Happened

• Was able to raise 4 million in the next round at
  post-money value of 13 million (gt2.5x step-up)
• Raised 4 more rounds changed name to Callidus
  Software
• Did IPO in 2003 at 13.5 share
• ONSET owned 17 of the company at the time of IPO

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Term SheetsLet us look at Trendsetter
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Term Sheet

• Getting first Term Sheet is MAJOR break through!
• Validates entrepreneur/idea
• Establishes a price
• Can be shopped around (especially in later rounds)

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Term Sheets in Venture Financing

• Critical Issues
• Uncertainty
• Asymmetric Information
• Nature of Firms assets
• Conditions of relevant financial and product
  markets

• Responses by investors
• Active Screening
• Stage financing
• Syndication
• Use of Stock options/grants with strict vesting
  requirements
• Contingent control mechanisms Covenants and
  restrictions
• Strategic composition of Board of Directors

Got a Term Sheet
Multiple Rounds, Multiple Tranches
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Trendsetter is Lucky!

• If you were advising Trendsetter which offer
  would recommend?
• Valuation
• Liquidation Preference (and Antidilution)
• Vesting
• Corporate Governance

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Valuation (Cap Tables)
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Liquidation

• Deemed liquidation event
• Liquidation preference (2X, 3X, etc.)
• Non Participating
• Fully Participating
• Qualified public offering (QPO)

Will See in Details Later
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What Type of Security?

• Alpha
• Convertible Preferred (CP) Stock
• Mega
• Participating Convertible Preferred (PCP) Stock

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Exit Values
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Anti-Dilution Protections
Read the Note on Anti-dilution provisions
Typology and Numerical Example

• Down round
• Full-ratchet vs. weighted average
• Adjusted conversion price, adjusted conversion
  rate

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Broad-base weighted average anti-dilution

• NCP OCP (OBNM/OCP) / (OBSI)
• NCP New Conversion Price
• OCP Old Conversion Price in effect immediately
  prior to new issue
• OB Number of shares of shares outstanding
  immediately prior to this round
• NM New Money received by the Corporation
• SI Number of shares of stock issued in this
  round

Another way of writing it
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Why do we see these features?

• Convertible preferred
• Participating Convertible Preferred
• Full Ratchet/ Weighted Average Ratchet
• Registration rights

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Challenges for VCs

• Private Equity Partnerships (PEP) have become the
  dominant organization form as it addresses
  challenges faced by LPs (Investors) and GPs(VC,
  Buyout Firm).
• Are there issues between GPs and the portfolio
  companies?

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Challenges of Venture Financing

• Critical issues involved in financing young firms
• Uncertainty
• Asymmetric Information
• Nature of Firms assets
• Conditions of relevant financial and product
  markets

• Responses by VCs
• Active Screening
• Stage financing
• Syndication
• Use of Stock options/grants with strict vesting
  requirements
• Contingent control mechanisms Covenants and
  restrictions
• Strategic composition of Board of Directors

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Securities used by VCs

• Common Stock
• Debt
• Preferred Stock

• Never why not?
• Never why not?
• Interesting- why?

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VCs response 1 Security Design

• Redeemable Preferred (RP)
• Convertible Preferred (CP) - Forced Conversion
  Clause
• Participating Convertible Preferred (PCP)

DO NOT WORRY! WILL DEVOTE TIME TO THESE LATER!!
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VCs response 2 Vesting

• Vesting creates Golden Handcuffs for key
  employees
• Idea being that you have to Earn your share of
  the company!
• Also keeps the option pool from being depleted if
  employees leave

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VCs response 3 Covenants

• Covenants
• Positive Covenants
• Example Provide regular information
• Negative Covenants
• Example Sale of assets
• Others
• Mandatory redemption
• Board Seats