E145 Winter 2008 Copyright ©2008 by the Board of Trustees of the Leland Stanford Junior University...

E145 Winter 2008

Copyright ©2008 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for

educational purposes only.

E145 2008 Workshop B

Venture Finance

Presented by Ann Miura-Ko and Austin Rachlin(with Thanks to Professor Tom Byers)

Stanford University

Special Thanks to Eric Carr, Scott Bowie and Mike Rosenbluth, Past E145 TAs

E145 Winter 2008

Some fundamentals...• What is a V.C.?• Why would I want to take their

money? and what will I have to give up?

• Would they want me to take their money?!?

E145 Winter 2008

What is Venture Capital?

VENTURE CAPITALISTS(Finding and Funding

Entrepreneurial Companies)

ENTREPRENEURS(Starting and Building

Companies)

INSTITUTIONAL INVESTORS(Limited Partners – e.g.

Endowments, Pension Funds)

High Risk Equity Return (30%+)Diversification

Management FeesShare of Profits

Management HelpFinancing Credibility

Capital Capital, TimeHelp

“Liquid” Stock Preferred Stock

Limited partnerships, governed by partnership agreement covenants, of finite life, with substantial profit sharing ...

E145 Winter 2008

Typical Asset Allocation for LP

• Asset allocation for Stanford– Endowment Size: $17.2B

40%

16%10%

7%

15%

12%

Public Equity

Real Estate

Private Equity

Natural Resources

Absolute Return

Fixed Income

E145 Winter 2008

Typical Asset Allocation for LP

• Asset allocation for Calpers– Fund size: $239.2B

53%

29%

9%

8%

1%

Global Equity Fund

Fixed Income

Private Equity

Real Estate

Inflation Linked Fund

Slice 6

E145 Winter 2008

How does a VC work• Size of VC fund: $500M

– Institutional 20-40 @ $10-50M– Individuals 50-200 @ $0.5-5M

• Invests over 3-5 years, return within 10• On average delivers 30% per year

return• 10 partners, 30-40 companies per fund

What size deal would be interesting?

E145 Winter 2008

Which do you like?• Suppose you were to invest $10M

– Fund 1:• 2x return on all 10 $1M investments

– Fund 2:• Loses all $1M investments in 8 deals• Wins 20x on the remaining 2 $1M

investments

Source: Andy Rachleff

E145 Winter 2008

So, what do I have to give up?

E145 Winter 2008

That’s not the right question

• It ain’t the angle of the slice - it’s the size of the PIE– Goal: Trade shares to grow the pie– Is worth more than the whole pie that never grows– Is not easy to achieve, even with lots of financing– Requires a good relationship between entrepreneur and

investors

E145 Winter 2008

A Real Life Example: Chemdex*

• How much money do the founders need?• How long until significant revenue?• How long until profitability?• What’s the going rate for 1st round deals?

Valuation is an art, not a science.

*Chemdex is now called NexPrise (NXPS)

E145 Winter 2008

Chemdex in 1997: Series A

1. How much does the company need to raise?

E145 Winter 2008

Series A

2. Negotiate a pre-money valuationpost $ = pre $ + amount raised = $2.7 M + $1.9 M

% of company sold = amount raised / post $ valuation = $1.9 M / $4.6 M

How much do the founders own at this point?

E145 Winter 2008

Series A3. Determine share price and total

number of sharesIn Round A, share price is set so total shares = 5-10 million

Total Shares = post $ / share price = $4.6 M / $0.54 = 8.5 M shares

E145 Winter 2008

Series B1. How much does the company

need to raise?

E145 Winter 2008

Series B2. Negotiate a pre-money valuation

post $ = pre $ + amount raised = $11 M + $13 M

% of company sold = amount raised / post $ valuation = $13 M / $24 M

E145 Winter 2008

Series B3. Determine new share price

Share price = (pre-money valuation) / (total pre-money shares)

= $11M / 8.5 M

E145 Winter 2008

4. Determine total number of shares

Total Shares = pre $ shares + amount raised / share price

= 8.5 M + $13 M / $1.29

Series B

E145 Winter 2008

Chemdex - Series C

3. Determine new share price

4. Calculate total number of shares

1. Decide how much you need to raise

2. Negotiate a valuation

E145 Winter 2008

Chemdex Financing

E145 Winter 2008

Calculating DilutionPercentage owned = owned shares / total shares

Founders’ shares = 59% of 8.5M = 5.02M shares

Series B Dilution: 5.02M / 18.6M = 27%

Series C Dilution: 5.02M / 24.2M = 21%

IPO Dilution: 5.02M / 31.8M = 16%

Post-$ Valuation

$471$24 $130$4.6

Could Chemdex

founders get to this size on

their own?

E145 Winter 2008

What besides cash do they offer?

• (Picture of Randy) Randy Komisar– Expertise– Contacts (their and the firm’s rolodex)

Your due diligence of the VC firms you interact with should be at least as in depth as their due

diligence of you

E145 Winter 2008

Chemdex and Dilution

E145 Winter 2008

Andy Rachleff

Juniper Networks - First

$2,000,000

$2,000,000

$4,000,000

Price/Share $1.00

2,000,000

Pre-Money

Seed Investor

Post-Money

Amount Shares Percentage

50.0%

Founders

Employee Pool

Total Employees

1,500,000

500,000

2,000,000

37.5%

12.5%

50.0%

Total Shares Outstanding

4,000,000

E145 Winter 2008

Andy Rachleff

Juniper Networks - Second

$32,000,000

$4.80

2,312,500

1,354,167

34.7%

20.3%

1,500,000

1,500,000

3,000,000

22.5%

22.5%

45.0%

$24,000,000

$1,500,000

$6,500,000

$2,000,000

$2,000,000

$4,000,000

Price/Share $1.00

2,000,000

Pre-Money

Seed Investor

Venture Investor

Post-Money


50.0%

Founders

Employee Pool

Total Employees

1,500,000

500,000

2,000,000

37.5%

12.5%

50.0%


Total Shares Outstanding

4,000,000 6,666,667

E145 Winter 2008

Juniper Final Cap Table

Milestone Start Early Team POC

Round 1 2 3Amount Shares % Amount Shares % Amount Shares %

Founders 1,500,000 37.50% 1,500,000 22.50% 1,500,000 14.82%Pool 500,000 12.50% 1,500,000 22.50% 2,500,000 24.71%Total Employees 2,000,000 50.00% 3,000,000 45.00% 4,000,000 39.53%

Seed Investors 2,000,000 2,000,000 50.00% 1,500,000 2,312,500 34.69% 0 2,312,500 22.85%Venture Investors 0 0 0.00% 6,500,000 1,354,167 20.31% 0 1,354,167 13.38%Corporate Investors 0 0 0.00% 0 0 0.00% 40,000,000 2,452,483 24.24%Total Investors 2,000,000 2,000,000 50.00% 8,000,000 3,666,667 55.00% 40,000,000 6,119,150 60.47%

Total Shares Outstanding 4,000,000 6,666,667 10,119,150

Price/Share $1.00 $4.80 $16.31

Post money $4,000,000 $32,000,000 $165,043,333

E145 Winter 2008

Valuing Public Companies

E145 Winter 2008

Ratios & Valuing Public Companies Today

• Market Cap = # shares outstanding x Share price– Answers “What does the market think the

company is worth?”– Examples

• GOOG with 306M outstanding shares @ $467.29 / share = $143B market cap

• YHOO with 1.36B outstanding shares @ $28.56 / share = $48.9B market cap

E145 Winter 2008

Ratios & Valuing Public Companies Today

• Ratios– EPS = Earnings per share

• An indicator of value created for shareholders – P/E = Market Cap / Annual Earnings = Stock Price /

EPS• How much does $1 of earnings cost an investor?

– P/S = Market Cap / Annual Sales

• Similar companies facing similar risks should have similar ratios (Comparables / Comps)

• “Enterprise Value” - Market Cap + Debt

E145 Winter 2008

Metrics in Action

Market Cap

Net Income: $10 M

P/E: 30

$300 M

Share Price: $15

# Shares: 20 M

$300 M

Sales: $100 M

P/S: 3

$300 M

E145 Winter 2008

A Sampling of Public Companies

Note: Updated Feb 6, 2006 Close

Stock Price($/share)

Market Cap ($B)

EPS ($/share)

P/E P/S

GE 32.75$ 346.04$ 1.54 21.25 2.09 Microsoft 27.17$ 280.76$ 1.21 22.45 7.27 Walmart 45.08$ 187.69$ 2.57 17.55 0.62 Google 385.10$ 113.82$ 5.02 76.70 21.48 Cisco 17.83$ 109.52$ 0.86 20.68 4.39 Coca Cola 40.94$ 97.40$ 2.17 18.88 4.23 Ebay 40.77$ 56.82$ 0.78 52.54 12.42 Apple 67.30$ 56.72$ 1.85 36.30 4.35 Sony 48.83$ 48.72$ 1.09 44.80 0.79 Disney 24.96$ 48.01$ 1.22 20.41 1.51 Yahoo! 32.92$ 46.70$ 1.28 25.80 9.84 Gap 18.74$ 16.30$ 1.27 14.79 1.01 Sun 4.36$ 14.89$ (0.10) 1.35 Alkermes 23.04$ 2.11$ (0.28) 17.91 Palm 39.84$ 2.01$ 5.83 6.84 1.37 BioTransplant 0.02$ $380.78k (1.97) 0.23

E145 Winter 2008

Metrics Calculation

Sales: $100 MNet Income: $10 MShares Outstanding: 20 MStock Price: $15

Public Company Info:(must be filed with SEC)

EPS:P/E:P/S:Market Cap:

We can calculate:

E145 Winter 2008

Metrics Calculation

Sales: $100 MNet Income: $10 MShares Outstanding: 20 MStock Price: $15

Public Company Info:(must be filed with SEC)

EPS: 0.50$ P/E: 30P/S: 3Market Cap: 300$

We can calculate:

E145 Winter 2008

Valuing Startups

E145 Winter 2008

Capital

Risk (ß)

Valuation

Idea isFeasible

TechnologyWorks

A CustomerBuys

SeedFunding

R&DCapital

Go-to-MarketCapital

ExpansionCapital

P(success) = 30%Req’d IRR = 100%




Source: Jim White (SHV)

VC Discount Rates and Risk Reduction

MilestoneFunding

E145 Winter 2008

VC Milestone Staged Timeline

SeedSeed ““A”A” ““B”B” ““C/D”C/D” IPO/IPO/M&AM&A

SizeSize ~$1m~$1m $3-8m$3-8m $10-20m$10-20m ~$20m~$20m ~$50m~$50m

SourceSource AngelAngel VCVC VCVC MezzMezz IBIB

RunwayRunway 6-12 months6-12 months 12-18 months12-18 months 18-24 months18-24 months 2+yrs2+yrs

# Empl.# Empl. <10<10 ~30~30 ~50~50 ~100~100 >100>100

MilestoneMilestone Clear plan & Clear plan & TeamTeam

Beta product & Beta product & customerscustomers

Sales, mkt Sales, mkt size, size,

competitioncompetition

Strategic, Strategic, financial financial

executionexecution

Growth, Growth, profitprofit

36E145 Winter 2008

“Venture Capital” Method

Valuing Cash, Time and RiskThis method defines one simple valuation approach:

1. Forecast Future Results (Financial Statements)

2. Determine likely value at that point (P/E Ratio)

3. Determine Dilution (Capital, Stock Options)

4. Determine share of pie demanded given required rates of return

5. Convert future values to present to derive share prices, ownership percentages

Source: Prof. Doug Mackenzie (KPCB)

37E145 Winter 2008

“Venture Capital” Quick Example

1. Forecast Future Results (Financial Statements)

• Net Income of $10M in Year 5

2. Determine likely value at that point (P/E Ratio)

• Industry currently demanding P/E ratios of 30, future value of $300M (year 5)

3. Determine Dilution (Capital, Stock Options)

• See Chemdex example (identify capital needs and shares required for management and employees)

38E145 Winter 2008

“Venture Capital” Quick Example

4. Determine share of pie demanded given required rates of return

• Each investor class (VC Round) will require a rate of return, lower over time as risk is mitigated through successful milestones

5. Convert future values to present to derive share prices, ownership percentages

• Chemdex shows share valuation and issuance of new shares

• If a VC invests $5M today with expected IRR of 70%, would require ownership stake of $71M (23%) in year 5 at exit / IPO.

E145 Winter 2008

Position Pre-RevPost-Rev

CEO 5-10% 3-8%VP Engineering 3-5% 1-3%VP Marketing 3-5% 1-3%

VP Sales 1-2% 1%CFO 2-3% 1-2%

Other VPs 1-2% 1%Key Individuals 0.5-2% 0.3-1%

Ranges of Grants

E145 Winter 2008 Copyright ©2008 by the Board of Trustees of the Leland Stanford Junior University...

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