Straightforward capital and advice for technical entrepreneurs

A view of US Venture CapitalTodd Warren

Managing DirectorDivergent Ventures

todd@divergentvc.com@toddwseattle

Todd Warren

• 26 years in software and information technology• 21+ years at Microsoft• 5 advising startups

• 17+ years as a early stage investor• 5 years at Divergent (2 years in the GP)• 17 years as an angel investor• 15 years as a fund LP

• 5 years as an entrepreneurship educator

The talk

• What are venture backed companies and venture firms• What has changed in how venture works for IT• What is the life cycle of a venture backed company• Basic economics for founders• How are ventures and startups changing• Divergent

Venture Backed Startups≠Small Businesses

• Scalable• Large Markets (Target markets in billions)• Capital Efficient (significant decreases in marginal cost)

• Exit Horizon• Scale to public market• Significant Acquisition activity• Assume 10x return on capital for early stages• 5-10 years

• Significant Upfront Risk• New Categories (e.g. private network access points / crowd funding networks)• New Technologies (e.g. flash storage)• Emerging Markets (e.g. cloud or geography like Africa or LatAm)

Venture Firms

• Raise money from limited partners• Wealthy Individuals or “Family Offices”• Endowments (e.g. Northwestern), Foundations (Kaufman), Retirement Funds

(CALPERS)• Fund of Funds

• Typically Invest a fund over 5 years; manage over 10• Managed by a partnership• Business model:

• Fee (% of total fund)• Carry (% of total return)

• Target returns on capital 3x+, IRR 15%+

General Venture Firm Types

Micro-VC / Seed Stage Early Stage Late

Example: 500 Startups E.g: First Round Capital Technology Crossover Ventures

Many seed investments of <$1m each. High Risk/High Return. May not reserve for follow on investments

Seed and Series “A”. Reserve for one or more future rounds.

May have a theme or geographic focus

Series “B” and later. Growth capital for scaling proven business models.

May or may not reserve capital.

Fund Size: Typically <$50m $50m+ $100m+

Many very large firms do all sizes, plus certain kinds of private equity (e.g. Sequoia, NEA, Andreesen/Horowitz)

Generic Venture backed firm funding cycle

Series B

• Venture Firms• Often “Strategic” Investors• Product Fit and Sales Traction• Clarity around how investment will

scale venture impact• ~$5m-~20m

Series A

• Venture Firms• Based on initial product or

prototype and ome Earlier Adopter sales/deployment

• Initial Revenue or User Growth• ~$2m-~10m round size

Seed

• Angels & FF• Sometimes Seed VC• Invest based on idea, market

opportunity and core team strength

• ~$500k-~2m round size• Should last for 18mos

Bootstrap

• Founder’s money and sweat• Sometimes friends and family• An idea and the founder

Basic Economics Example

7 pre10 post

Founders: 100% 67% 47% 24%

• Increasing Valuation (no “Down” or flat round)

• Options for employee part of “pre” money

• Declining Founder Percentage over time

• Increase in absolute value of founders shares.

• Other terms (Prefered preferences, liquidation preferences) affect founders gain on acquisition or liquidation

• Example does not assume investors take “pro-rata” shares to maintain % ownership.

Trends in US Business Startups

• Methodology Changes• Lean Startup / “Minimum Viable Product”• Business Model Canvas and Customer Development• NSF iCorp

• Funding• IT Startups Require Lower Capital Than Ever Before• Crowdfunding, Angels and Very Large Firms thriving• “Accelerators” (Y Combinator, TechStars) spread risk across regional financial firms and provide

mentorship

• Space• “Incubators” (sometimes with accelerators) house multiple firms, startup services, and programming• Remote or Distributed• “Maker” labs for prototyping• Rent by the desk

Example: Divergent Ventures

• On 3rd Fund• Grew out of angel syndicate in ‘99• Managing Funds II and Funds III: $22m in total capital• LP’s are high net worth individuals• “Early Stage” Micro-VC• Personnel: 3 Managing Directors

Our Firm: Divergent Ventures15+ Years Investing together, 40+ Years Product Development

MinicomputersPCs

Client ServerInternetMobileCloud

Angel InvestingProfessionally

Vulcan VenturesDivergent I & 2

Entrepreneurial Education

Software Development Development Management

Product MarketingFinance Management

Sales Management

Kevin OberPaul Allen’s Vulcan Ventures (1993 – 2000)Divergent Ventures I & II (2003 – 2013)Operating roles in Conner Peripherals & Inmac Corporation

Todd Warren 21 years at Microsoft VP development in OS, server, location, mobile. Adj prof in CS at Northwestern’s McCormick School of Engineering teaching software entrepreneurship and design.

Rob ShurtleffSuccessful Angel investor since 1996Divergent Ventures I & II (2005 – 2013)20+ technologist with DEC, HP and Microsoft

InvestingBusiness Disciplines Technology

Focus On Themes: Portfolio Companies

Data Driven AppsReadyPulse

StoragePliant

FlashsoftProximal Data

Big Data / IOTSpace CurveTempo.DB

CloudPiston

Union Bay NetworksShippable Iron.io

Trends within areas of focus

• Term is too generic• Über theme of Data

Infrastructure Upgrade• New tools for the new

NoSQL world• Most interesting

opportunities right now

• Opportunities Increasing

• Solutions must support many deployment options

• Strong growth in Docker and OpenStack communities

• Evolving: Flash is now mainstream

• Generic cloud vs. old-line enterprise: cloud is winning

• More challenging investment environment

What we look for at Divergent

• Is it in our themes?• Big Data, Cloud Infrastructure, Cloud Apps, Storage

• Is it a geography we can focus on?• Seattle and West Coast Primary, one Chicago investment• Meet with teams a minimum of once a month after investments

• Seed Investments• Proven Entrepreneurs• Addressing a growing problem• Team and solution have unique characteristics

• “A” Investments• Can we attract high quality co-investors• Small to Medium size rounds and valuations• Is it a business with strong growth potential• Is the team solid

• We sometimes track a company up to a year before investing. As few as 3 meetings as many as 10 or more.

• We reserve for 1-2 additional rounds of financing

For further reading

• Venture Deal Structure:• Venture Deals, Feld and Mendelson, 2012• Termsheets and Valuations, Wilmerding, 2006

• Venture Capital Trends• NVCA Website (www.nvca.org)• Why It’s Morning in Venture Capital (Mark Suster)

• Blogs• Avc.com (Fred Wilson, Union Square Ventures)• Feld.com (Brad Feld, Foundry Group/Techstars)