Venture Capital Investing: an OverviewPaulo de RezendeZone Venturespaulo@zonevc.com(213) 628-2400www.zonevc.comAgendaAbout Zone VenturesThe Business of Venture CapitalFinancing a Growing VentureAgendaAbout Zone VenturesThe Business of Venture CapitalFinancing a Growing VentureAbout Zone VenturesLA affiliate of Silicon Valley-based VC firm Draper Fisher Jurvetson$135 million under management (Zone Funds I & II)Focus on information technology, advanced materials, and micro-systemsOur job: fund entrepreneurs with energy, passion, vision, and experience to build great companies.Our role: help entrepreneurs achieve their maximum potential through team building, partnership, advice, support, and investmentsBioinformaticsQuantum ComputingWireless ChipsetsOptoelectronicsDistributed ComputingDigital Asset ManagementDistributed ComputingMEMSNext Generation Power CellsTunable LasersCommunication ProtocolsNetwork Load BalancingSoftware ToolsMicro-component FabricationSwitching ComponentsNetwork Operating SystemsDigital Media TechnologiesData ManagementDigital SecurityReprogrammable ChipsNext Generation InternetPhotonicsSemiconductorsNanotechnologyAdvancedMaterialsInformation technologyMicrosystemsInvestment OpportunitiesAgendaAbout Zone VenturesThe Business of Venture CapitalFinancing a Growing VentureThe Business of Venture CapitalFinance new and rapidly growing companies by purchasing equity securities in emerging private companiesAssist in the development of new products or servicesAdd value to the company through active participation and expert adviceHave a long-term orientation (5 to 7 years to maturity)RETURN CAPITAL WITH PROFIT TO VENTURE CAPITAL FUND INVESTORS!Recommended reading: “That Thing Venture Capitalists Do” by Mitchell Berlin, Federal Reserve Bank of PhiladelphiaGenerate deal flow and identify high potential startupsEstablish fundTarget investment opportunitiesRaise capitalfor investment fundCultivate relationship with limited partnersRaise capital for next fundScreen e evaluate business plansValuate, negotiate, and structure dealsADD VALUE: active board membership, contact to later round investors, management recruiting, relationships to other portfolio companies, etc.Craft and execute a “liquidity event”VC Business CycleWhat VCs are looking for……is the most valuable combination of four elements:Great people with passionate visionTerrific technology solving real customer problemsFast growing, unexplored marketsSound financials and attractive business modelsQualities of attractive business modelsCapital efficiency –Lower capital needs provide higher ROIFlexibility–Few fixed assets make it easy to change strategyLeverage–Reduce required capital by leveraging resources available in the industry, environment, competitors, partners, government, etc.Profitability–Margins (gross and net) must justify the investment“Quick cash”–Short cash collection cycles; ideally “get cash first, build afterwards”“Greed and Fear” dictate investment cyclesAs most asset classes, venture capital experiences investment cycles motivated by greed and fear (aka herd mentality)A few examples from my experience:–1999: Consumer Internet (B2C)–2000: Application Service Providers (B2B)–2001: Internet applications for Cell Phones (B2C & B2B)–2002: Nanotechnology and Fuel Cells–2003: RFID (Radio Frequency ID)–2004: Social Networks–2005: Digital Media and Search EnginesWhat’s hot today?The answer depends whom you ask, since VC firms have proprietary deal flowsFollowing markets or technologies have strong momentum right now (too late to invest as top players are well positioned)–Voice over IP–Digital Media related technologies–Biotech (drug discovery)–Enterprise Application Integration–Cell phones (chips, applications and infrastructure)–Clean energyAgendaAbout Zone VenturesThe Business of Venture CapitalFinancing a Growing VentureSeed/AngelRoundFirst RoundSecond RoundIPO or acquisitionManagement Milestones•Assemble founder team•Write business plan•Achieve proof of concept•Close initial foundingInvestors Activities•Identify entrepreneur•Help structure the company•Close the dealInstrument:Options, Common or Preferred StockAmount raised:$100,000Pre-money$400,000Post-money$500,000Source:•Entrepreneur•Family & Friends•Angels•Venture CapitalFinancing a growing venture (I)Seed/AngelRoundFirst RoundSecond RoundIPO or acquisitionManagement Milestones•Hire 3-5 key managers•Finalized product, refine marketing strategies and business model•Attract „serious“ capital (from VC)Investors Activities•Due diligence•Structure Board of Directors•Identify key management candidates•Structure employee comp. and poolInstrument:Preferred StockAmount raised:$2,000,000Pre-money$6,000,000Post-money$8,000,000Source:•Venture CapitalFinancing a growing venture (II)Seed/AngelRoundFirst RoundSecond RoundIPO or acquisitionManagement Milestones•Complete key management team•Reassess marketing strategy•Generate revenue•Redefine company strategyInvestors Activities•Help recruit and select management •Help identify additional board members•Attract co-investor•Attract business partnersInstrument:Preferred StockAmount raised:$10,000,000Pre-money$35,000,000Post-money$45,000,000Source:•Venture CapitalFinancing a growing venture (III)Seed/AngelRoundFirst RoundSecond RoundIPO or acquisitionManagement Milestones•Achieve revenue and earnings growth objectives•Conduct IPO road showInvestors Activities•Choose investment bankers•Help identify acquirerInstrument:Common StockAmount raised:$ 50,000,000Pre-money$200,000,000Post-money$250,000,000Source:•Public Investors or acquirerFinancing a growing venture (IV)How to approach VCsIntroduction and Networking–Try to get your plan referred by someone close to a VCSubmit a Business Plan–Remember: VCs usually do not sign NDAs2! Pitch your plan–Well prepared, short, and clear presentation–Remember: talk AND listen! Visit –Visit for a demo or meeting–“Air-plane test” and the “chicken and pig” commitment(2) NDA: Non-Disclosure AgreementBe patient but also insist!Priorities may change rapidly within a VC firm.How to deal with VCsDue diligence–Prepare your contacts for reference calls during the due diligence–Help the VC in the process (time is precious!)Negotiating the term sheet–Valuation is a combination of many things…–Expect little room for valuation negotiationBefore investing, VCs perform due diligenceCheck:–Interest and/or commitments by potential customers to buy the new product or service–Ability to take control of the knowledge and value generated by an innovation–Ability to control the assets necessary to exploit the innovation–Porter Five Forces: Understanding the dynamics of power in the value chain (Suppliers, Buyers, Substitutes, Potential entrants, Rivalry)–Reference on the management team (professional and personal)•Passive: web, conferences, referrals, etc.•Pro-active: analyze technology sectors and prospect specific deals•Identify interesting plans•Analyze, meet, investigate good plans, teams, and technologies•Reply to all•Analyze all aspects of deal•Diligence by lead partner•Formal process•Industry and customers feedback•Negotiate terms•Interact with co-investors, company, and legal counsel•Review closing docsDeal FlowBus PlanScreeningDue DiligenceDeal StructuringOngoing2 –6 weeksAs long as needed…As long as needed…Investment Round TimelineRecommended reading materials and sources1.New Venture Creation : Entrepreneurship for the 21stCenturyby Jeffry A. Timmons (ISBN: 0072443014)2.“That Thing Venture Capitalists Do”by Mitchell Berlin, Federal Reserve Bank of Philadelphiahttp://www.phil.frb.org/files/br/brjf98mb.pdf(free download)3.Larta web siteTo stay tuned in Southern California!http://www.larta.org/4.Small Business Administration web siteThe site has a lot of interesting content!http://www.sba.gov/(free downloads)Paulo de RezendeZone Venturespaulo@zonevc.com(213) 628-2400www.zonevc.comBack-up SlidesThe business plan plays important rolesWhile fundraising–Provides potential investors with all relevant information about the team, the technology, the problem solved, the market and growth potential, and the funding strategy–Demonstrates entrepreneurs’ understanding of the market dynamics and competition–Explains how the entrepreneurs will build a successful businessesWhile building the business–Helps entrepreneurs to clarify the driving vision behind the business–Provides an opportunity to review assumptions and refine strategy–Offers an ongoing self-evaluation toolWhen I read a business planI am looking for an…Innovative solutionto a hard-to-solve problemthat inflicts costly painin the target customersis surrounded by a well balanced teamof managerswho are candidabout the business weaknesses and strengthsand have a clear vision of how to change the worldI see a red flag when…… there is a technology looking for a problem to be solved… there are many other companies competing for the same customer’s budget… pro-forma financials are unrealistic… nobody in the team has relevant experience in the technology and target market… team does not have a clear understanding of the many existing competitive offerings