Lecture - Venture Capital Industry.pptx
9/28/14
F317 – Venture Capital & Entrepreneurial Finance Principals of Valua5on + Types of Securi5es
10,000 FT View Valua5on of start-‐ups is not science, it’s an art. The more you do it, the beDer you get at it. Today, we’re going to discuss the principals of early stage valua5on + Types of Securi5es.
4 Factors that affect Valua5on What’s a newly formed HPV worth?
Well, It all Depends Cash
Risk Ingredients to the valua5on of a start-‐up
Time Dilu5on
1
9/28/14
A FiTh Factor Euphoric enthusiasm +
Psychological
Fear of missing the boat =
Extraordinarily high valua5ons
4 Factors that affect Valua5on
Cash
Ingredients to the valua5on of a start-‐up
Cash Ex. Instagram raised $50MM from precisely a week before going into nego5a5ons to be acquired by Facebook for $1 Billion. WHY?????
2
9/28/14
Cash Entrepreneur's bargaining power based on when Company is out of Cash (OOC)
Cash
Rela5ve bargaining power (RBP) of the entrepreneur versus sources of capital
Nil Now
3 6 9 12+
Time in months to OOC
Cash Defini5on
Burn Rate
Example
Company A – Has $100,000 in cash is losing $30,000 per month on a cash basis
The rate at which a company uses its supply of cash over 5me before it breaks even
Investors’ Interpreta5on
Burn Rate -‐ $30,000 Per Month Company has 3 months before hifng the wall
Cash If have lots of cash and/or are genera5ng posi5ve cash flow, rela5ve bargaining posi5on with investors is high. Being in a posi=on to say “NO” drive up valua=ons!
3
9/28/14
4 Factors that affect Valua5on
Risk Ingredients to the valua5on of a start-‐up
Risk Risks associated with the business itself Liquidity Risk
Private equity is non-‐marketable and dependent on major transac5ons for exit.
Business Failure Risk
Due to bad management, unsuccessful products, or services
Funding Risk
Future funding may not be available (unpredictability of the market)
Management Risk
Start-‐ups dependent on lead management team with specific core competency
Risk Macro Risks Economic Risk
Recessions – difficult to grow business when customers are pessimis5c
Interest Rate Risk
Increases cost of capital, provide alterna5ves to poten5al investors
Infla5on Risk
Margins get squeezed, and wealth generated from product/service diminished
4
9/28/14
Risk Simply assess and add up the risks which will drive the Rate or Return (ROR) Requirement ex. Liquidity: 10% Failure: 10% Infla5on: 5% Management: 10% -‐-‐-‐-‐-‐ Required ROR 34%
Risk The higher the perceived risk, the higher the Rate of Return (ROR) Requirement.
De-‐risk your deal as much as possible before going out for money
ROR (Based on Stage of Investor) INVESTMENT STAGE
ROR
Seed & Startup
50-100%
HOLDING PERIOD 10+ years
First Stage
40-60%
5-10 years
Second Stage
30-40%
4-7 years
Expansion
20-30%
3-5 years
Bridge & Mezzanine
20-30%
1-3 years
Leveraged Buyouts
30-50%
3-5 years
Turnarounds
50+%
3-5 years
5
9/28/14
Time The amount of 5me an investor expects to hold the investment will impact valua5on. Why??? (a ROR is a compounded annual return….
Transla5ng ROR and Time into percentage ownership Ex. Suppose Ashton of Slane Ventures wants to invest $2MM in a company called Mobile Dynamics, a mobile commerce plaoorm for IU students. Ashton believes that Mobile Dynamics will get acquired for $100,000,000 in 5-‐7 years. At this investment level, Slane typically is looking for a 40-‐50% ROR.
Transla5ng ROR and Time into percentage ownership Depending on the ROR and the es5mated hold 5mes, the valua5on of Mobile Dynamics can vary widely.
5 Years
6 Years
7 Years
40%
$18,593,443
$13,281,031
$9,486,451
45%
$15,601,271
$10,759,497
$7,420,343
50%
$13,168,724
$8,779,150
$5,852,766
Present Value Formula:
Future Value / (1 + ROR)^Years Investment is Held
6
9/28/14
Transla5ng ROR and Time into percentage ownership Let’s suppose Ashton believes that ROR should be 50% and the es5mated hold 5me will be 7 Years. At a $2MM investment, here’s how much equity she’s seeking today:
34.17% $5,852,766 Formula:
Investment / Present Value
4 Factors that affect Valua5on
Ingredients to the valua5on of a start-‐up Dilu5on
Dilu5on Defini=on: Ownership % of exis5ng shareholders decreases in propor5on to the percent of the company the new investor purchases. Time of Investment
% Ownership
ATer more investors purchase equity ATer more investors purchase equity
Time
7
9/28/14
Dilu5on Good Dilu=on – When the value of an investors’ ownership increases at subsequent capital raises. Ownership
Valua=on
Value of Ownership
At Investment 25%
$5,000,000
$1,250,000
$15,000,000 $45,000,000 $135,000,000
$2,250,000 $4,500,000 $6,750,000
Post Series A Post Series B Post Sereis C
15% 10% 5%
Dilu5on Bad Dilu=on – When the value of an investors’ ownership decreases at subsequent capital raises Ownership
Valua=on
Value of Ownership
At Investment 25%
$5,000,000
$1,250,000
Post Series A Post Series B Post Sereis C
$15,000,000 $12,000,000 $10,800,000
$2,250,000 $1,200,000 $540,000
15% 10% 5%
Dilu5on For Venture Capital investors, however, their problem is that future dilu5on “lowers” the ROR they were seeking when they ini5ally invested. Let’s go back to Ashton of Slane Ventures seeking 34.17% of Mobile Dynamics (based on a 50% ROR, held over 7 years).
8
9/28/14
Dilu5on If Mobile Dynamics is sold in year 7 (as expected) and without having to raise addi5onal capital, then Slane Ventures will get its ROR. EXIT $100,000,000 34.17% INVESTMENT ROR YRS $2,000,000 50% 7
$100MM * .3417
$34,171,875
$2MM*(1+.5)^7
Dilu5on But what happens if Slane Venture’s ownership has been diluted down to 20% (because of company raising addi5onal equity capital)? EXIT $100,000,000 20.00% $20,000,000 INVESTMENT ROR YRS $2,000,000 50% 7
Actual Outcome
$34,171,875 Expected Outcome
Dilu5on To bake “future dilu5on” into the valua5on cake, Investors may apply a Reten=on Ra=o prior to placing a final value on the company. It requires “forecas5ng” when dilu5on will occur + “es5ma5ng” how much dilu5on will occur. (Yep, more Assump5ons).
9
9/28/14
Dilu5on Let’s suppose the Ashton es5mates that, 3 years following Slane’s Investment, Mobile Dynamics will raise an addi5onal $10MM and predicts the Post Money Valua5on will be $40MM.
$10,000,000 / $40,000,000 = 25% New Equity
Dilu5on This translates into Slane’s Investment being diluted down to 25.62%......(34.17% * .25). Thus, Slane would not achieve its ROR. EXIT $100,000,000 25.63% $25,628,906 INVESTMENT ROR YRS $2,000,000 50% 7
$34,171,875
Dilu5on Based on this informa5on, Ashton can apply a reten5on ra5o. It will ar5ficially increase her equity today know that she’ll be diluted later.
34.17 / (1-‐.25) = 45.56% Diluted down by subsequent investor in year 3
34.17% Ownership at Exit (Hits ROR of company sells for $100MM within 7 Years).
10
9/28/14
Predic5ng a Future Exit Trying to predict a future exit is almost impossible. It’s just another assump5on. However, if the start-‐up reaches a point of genera5ng meaningful revenue and profits, then an investor can look at “Market Comparables” to determine a poten5al future exit. In most cases, Investors will look at more simplis5c metrics to assign a value.
Predic5ng a Future Exit Example: How to price a new monolithic social media site (Social Media Site #2)? Look at Facebook as a comparable. Ex. Facebook at 1.23 Billion Ac5ve Monthly Users. Market Capitaliza5on is: $202 Billion. Could assign a value of $164 Per Monthly User in Market Cap. (Next Page)
Predic5ng a Future Exit If Social Media Site #2 reaches 10,000,000 ac5ve monthly users by Year 7, then, perhaps: $164 * 10 Million Monthly Users = $1.64 Billion The problem is that Social Media Site #2 is not Facebook and 10 Million Ac5ve users is much different than 1.23 Billion Ac5ve users. But you get the point.
11
9/28/14
The Venture Game Valua5on Model Now that you have the fundamentals of Start-‐ up Valua5on, make sure you understand the Venture Game™ Valua=on Model. You will be handed a set of facts at the beginning of class and your team will turn in a valua5on. We’ll spend that last 10-‐15 Minutes going through the valua5on.
Types of Securi5es
Types of Securi5es Strongest posi5on as an investor
• Secured Debt with Warrant Combina5on. • Conver5ble Subordinated Debt with Warrant Combina5on. • Par5cipa5ng Preferred Stock, Cumula5ve Dividends. • Conver5ble Preferred Stock with Cumula5ve Dividends. • Common Stock with Liquida5on Rights. • Common Stock (Straight Equity).
Weakest posi5on as an investor
12
9/28/14
Next week, we’ll discuss how VCs value investments Any Ques5ons?
13
F317 – Venture Capital & Entrepreneurial Finance Principals of Valua5on + Types of Securi5es
10,000 FT View Valua5on of start-‐ups is not science, it’s an art. The more you do it, the beDer you get at it. Today, we’re going to discuss the principals of early stage valua5on + Types of Securi5es.
4 Factors that affect Valua5on What’s a newly formed HPV worth?
Well, It all Depends Cash
Risk Ingredients to the valua5on of a start-‐up
Time Dilu5on
1
9/28/14
A FiTh Factor Euphoric enthusiasm +
Psychological
Fear of missing the boat =
Extraordinarily high valua5ons
4 Factors that affect Valua5on
Cash
Ingredients to the valua5on of a start-‐up
Cash Ex. Instagram raised $50MM from precisely a week before going into nego5a5ons to be acquired by Facebook for $1 Billion. WHY?????
2
9/28/14
Cash Entrepreneur's bargaining power based on when Company is out of Cash (OOC)
Cash
Rela5ve bargaining power (RBP) of the entrepreneur versus sources of capital
Nil Now
3 6 9 12+
Time in months to OOC
Cash Defini5on
Burn Rate
Example
Company A – Has $100,000 in cash is losing $30,000 per month on a cash basis
The rate at which a company uses its supply of cash over 5me before it breaks even
Investors’ Interpreta5on
Burn Rate -‐ $30,000 Per Month Company has 3 months before hifng the wall
Cash If have lots of cash and/or are genera5ng posi5ve cash flow, rela5ve bargaining posi5on with investors is high. Being in a posi=on to say “NO” drive up valua=ons!
3
9/28/14
4 Factors that affect Valua5on
Risk Ingredients to the valua5on of a start-‐up
Risk Risks associated with the business itself Liquidity Risk
Private equity is non-‐marketable and dependent on major transac5ons for exit.
Business Failure Risk
Due to bad management, unsuccessful products, or services
Funding Risk
Future funding may not be available (unpredictability of the market)
Management Risk
Start-‐ups dependent on lead management team with specific core competency
Risk Macro Risks Economic Risk
Recessions – difficult to grow business when customers are pessimis5c
Interest Rate Risk
Increases cost of capital, provide alterna5ves to poten5al investors
Infla5on Risk
Margins get squeezed, and wealth generated from product/service diminished
4
9/28/14
Risk Simply assess and add up the risks which will drive the Rate or Return (ROR) Requirement ex. Liquidity: 10% Failure: 10% Infla5on: 5% Management: 10% -‐-‐-‐-‐-‐ Required ROR 34%
Risk The higher the perceived risk, the higher the Rate of Return (ROR) Requirement.
De-‐risk your deal as much as possible before going out for money
ROR (Based on Stage of Investor) INVESTMENT STAGE
ROR
Seed & Startup
50-100%
HOLDING PERIOD 10+ years
First Stage
40-60%
5-10 years
Second Stage
30-40%
4-7 years
Expansion
20-30%
3-5 years
Bridge & Mezzanine
20-30%
1-3 years
Leveraged Buyouts
30-50%
3-5 years
Turnarounds
50+%
3-5 years
5
9/28/14
Time The amount of 5me an investor expects to hold the investment will impact valua5on. Why??? (a ROR is a compounded annual return….
Transla5ng ROR and Time into percentage ownership Ex. Suppose Ashton of Slane Ventures wants to invest $2MM in a company called Mobile Dynamics, a mobile commerce plaoorm for IU students. Ashton believes that Mobile Dynamics will get acquired for $100,000,000 in 5-‐7 years. At this investment level, Slane typically is looking for a 40-‐50% ROR.
Transla5ng ROR and Time into percentage ownership Depending on the ROR and the es5mated hold 5mes, the valua5on of Mobile Dynamics can vary widely.
5 Years
6 Years
7 Years
40%
$18,593,443
$13,281,031
$9,486,451
45%
$15,601,271
$10,759,497
$7,420,343
50%
$13,168,724
$8,779,150
$5,852,766
Present Value Formula:
Future Value / (1 + ROR)^Years Investment is Held
6
9/28/14
Transla5ng ROR and Time into percentage ownership Let’s suppose Ashton believes that ROR should be 50% and the es5mated hold 5me will be 7 Years. At a $2MM investment, here’s how much equity she’s seeking today:
34.17% $5,852,766 Formula:
Investment / Present Value
4 Factors that affect Valua5on
Ingredients to the valua5on of a start-‐up Dilu5on
Dilu5on Defini=on: Ownership % of exis5ng shareholders decreases in propor5on to the percent of the company the new investor purchases. Time of Investment
% Ownership
ATer more investors purchase equity ATer more investors purchase equity
Time
7
9/28/14
Dilu5on Good Dilu=on – When the value of an investors’ ownership increases at subsequent capital raises. Ownership
Valua=on
Value of Ownership
At Investment 25%
$5,000,000
$1,250,000
$15,000,000 $45,000,000 $135,000,000
$2,250,000 $4,500,000 $6,750,000
Post Series A Post Series B Post Sereis C
15% 10% 5%
Dilu5on Bad Dilu=on – When the value of an investors’ ownership decreases at subsequent capital raises Ownership
Valua=on
Value of Ownership
At Investment 25%
$5,000,000
$1,250,000
Post Series A Post Series B Post Sereis C
$15,000,000 $12,000,000 $10,800,000
$2,250,000 $1,200,000 $540,000
15% 10% 5%
Dilu5on For Venture Capital investors, however, their problem is that future dilu5on “lowers” the ROR they were seeking when they ini5ally invested. Let’s go back to Ashton of Slane Ventures seeking 34.17% of Mobile Dynamics (based on a 50% ROR, held over 7 years).
8
9/28/14
Dilu5on If Mobile Dynamics is sold in year 7 (as expected) and without having to raise addi5onal capital, then Slane Ventures will get its ROR. EXIT $100,000,000 34.17% INVESTMENT ROR YRS $2,000,000 50% 7
$100MM * .3417
$34,171,875
$2MM*(1+.5)^7
Dilu5on But what happens if Slane Venture’s ownership has been diluted down to 20% (because of company raising addi5onal equity capital)? EXIT $100,000,000 20.00% $20,000,000 INVESTMENT ROR YRS $2,000,000 50% 7
Actual Outcome
$34,171,875 Expected Outcome
Dilu5on To bake “future dilu5on” into the valua5on cake, Investors may apply a Reten=on Ra=o prior to placing a final value on the company. It requires “forecas5ng” when dilu5on will occur + “es5ma5ng” how much dilu5on will occur. (Yep, more Assump5ons).
9
9/28/14
Dilu5on Let’s suppose the Ashton es5mates that, 3 years following Slane’s Investment, Mobile Dynamics will raise an addi5onal $10MM and predicts the Post Money Valua5on will be $40MM.
$10,000,000 / $40,000,000 = 25% New Equity
Dilu5on This translates into Slane’s Investment being diluted down to 25.62%......(34.17% * .25). Thus, Slane would not achieve its ROR. EXIT $100,000,000 25.63% $25,628,906 INVESTMENT ROR YRS $2,000,000 50% 7
$34,171,875
Dilu5on Based on this informa5on, Ashton can apply a reten5on ra5o. It will ar5ficially increase her equity today know that she’ll be diluted later.
34.17 / (1-‐.25) = 45.56% Diluted down by subsequent investor in year 3
34.17% Ownership at Exit (Hits ROR of company sells for $100MM within 7 Years).
10
9/28/14
Predic5ng a Future Exit Trying to predict a future exit is almost impossible. It’s just another assump5on. However, if the start-‐up reaches a point of genera5ng meaningful revenue and profits, then an investor can look at “Market Comparables” to determine a poten5al future exit. In most cases, Investors will look at more simplis5c metrics to assign a value.
Predic5ng a Future Exit Example: How to price a new monolithic social media site (Social Media Site #2)? Look at Facebook as a comparable. Ex. Facebook at 1.23 Billion Ac5ve Monthly Users. Market Capitaliza5on is: $202 Billion. Could assign a value of $164 Per Monthly User in Market Cap. (Next Page)
Predic5ng a Future Exit If Social Media Site #2 reaches 10,000,000 ac5ve monthly users by Year 7, then, perhaps: $164 * 10 Million Monthly Users = $1.64 Billion The problem is that Social Media Site #2 is not Facebook and 10 Million Ac5ve users is much different than 1.23 Billion Ac5ve users. But you get the point.
11
9/28/14
The Venture Game Valua5on Model Now that you have the fundamentals of Start-‐ up Valua5on, make sure you understand the Venture Game™ Valua=on Model. You will be handed a set of facts at the beginning of class and your team will turn in a valua5on. We’ll spend that last 10-‐15 Minutes going through the valua5on.
Types of Securi5es
Types of Securi5es Strongest posi5on as an investor
• Secured Debt with Warrant Combina5on. • Conver5ble Subordinated Debt with Warrant Combina5on. • Par5cipa5ng Preferred Stock, Cumula5ve Dividends. • Conver5ble Preferred Stock with Cumula5ve Dividends. • Common Stock with Liquida5on Rights. • Common Stock (Straight Equity).
Weakest posi5on as an investor
12
9/28/14
Next week, we’ll discuss how VCs value investments Any Ques5ons?
13
