Despite new signs of life in Silicon Valley, venture investing slowed in the first quarter.

http://bits.blogs.nytimes.com/2010/04/16/venture-capitalists-continue-to-take-it-slow/

This is very helpful for my New Venture Project timeline.

Quick summary:

1. Trying to raise money too late
2. Trying to raise money too early
3. Lacking a realistic assessment of the companys’ value
4. Not building enough substance before approaching investors
5. Not splitting the message into smaller chunks
6. Preparing poor pitch material
7. Pitching to the wrong investors
8. Not pitching at all
9. Getting too greedy
10. Not willing to share risk

Read the whole post at Arctic Startup via 10 Mistakes Entrepreneurs Often Make When Raising Capital.

January update 2010. HAPPY NEW YEAR!!!

= A must see.

= A firm dedicated mostly in early stage companies.

= Firm that invested in any startup in the last 3 months (from September 09). You can click the icon to see the news related to the investment.

= Firm that received fund or selected to participate or manage a province venture capital fund in the last 2 months. You can click the icon to see the news.

= Firm that sold or IPO a company in the last 3 months (from September 09).

VC firms only

Anges Québec

AVAC Ltd.
Avrio Ventures Management Corp.

Blackberry Partner Fund

Bootup Labs NEW INCLUSION!
Brightspark Capital
Business Development Bank of Canada (BDC) Venture Capital

Canadian Medical Discoveries Fund Inc.
CAPE Fund/Fonds CAPE

Celtic House Venture Partners
CentreStone Ventures Inc.

Covington Capital Corporation

Desjardins Capital de risque

Discovery Capital Management Corp.

Elgner Group Investments Ltd.

Emerald Technology Ventures

Fond de Solidarité FTQ

Foragen Technologies

Flow Ventures NEW INCLUSION!

Genesys Capital Partners

Greenstone

GrowthWorks

GTI Capital

Hargan Ventures

ID Capital Management Inc.

InNOVAcorp – Halifax

Innovatech Québec

iNovia Capital Inc.

Investeco Capital Corp.

J.L. Albright Venture Partners (JLA)

Jefferson Partners

JOG Capital Inc.

Lumira Capital

McLean Watson Capital Inc.

Mercator Investments Limited

Montréal Startup

MMV Financial Inc.

Multiple Capital Inc.

New Brunswick Innovation Foundation

Novacap

Ontario Venture Capital Fund (OVCF) 

Propulsion Ventures Inc

Rogers Ventures

RBC Venture Partners

Renewal2 Investment Fund

RHO Venture Capital

SAINT – Saskatchewan Angel Investor Network

Skypoint Capital Corporation

Springbank TechVentures

Société Innovatech Québec

Summerhill Venture Partners

Tandem Capital

Tech Capital Partners Inc.

TELUS Ventures

Trellis Capital Corporation

VanEdge Capital

Venture Coaches

Ventures West Capital Ltd.

Walsingham Fund

WesleyClover

Yaletown Venture Partners

I should be studying for my final exams, but I couldn’t resist reading posts from Startable. This time, they are sharing a neat and simple framwork to make a great business plan pitch. After reading it, it actually gives us tips to how to write and organize a business plan. I was very interested in the marketing part where it gives an idea of what VCs are looking for marketing data in the business plan.

Quick summary of the post:

1. Passion - training and training will lead to a passionate pitch.
2. Simple, Short and Concise - grab your audience attention in less than 10 minutes.
3. Pictures are worth a thousand words – avoid putting all your business plan in one slide, use images instead.
4. Convey what your business is in 90 seconds – tell your audience what you are offering to the market in 90 seconds.
5. Keep text in a slide to no more than three lines – don’t put all business plan in one slide!
6. Target market and market size – who you are selling to?
7. Marketing - how are you going to sell to those people?
8. Competition – list 3 competitors and why you are better then them and barriers to entry.
9. Product - what makes your product unique? Any IP?
10. Revenue potential – project and assume with pride, don’t be over consevative nor creative.
11. Costs - identify cost and provide scalability savings.
12. Team - why your team is the best to run the business?

InterClick is a company that provides traditional approach of supply chain methodology into optimization of ROI over advertising spending. I’m writing this post because I’m so impress that the market has so much appetite for advertising systems and tools and ad networks.

Traditional approach to online marketing

Basically, it treats publishers and ad inventory from ad networks as suppliers and the demand is generated from advertisers’ needs. interClick than provides a system that control, monitor, and optimize the ad spending.

It raised $18 million! It is not clear how different this system is from other well established players, such as Doubleclick, Atlas, etc. Most of this one-stop platform monitoring systems are also ad servers. The integration of ad server is an important technical aspect of the monitoring and optimization process of online marketing campaign.

The ad server provides the user, ad and result tracking. It tells us about where the ad was clicked and if that ad generated a sales or not. Most monitoring systems use those data and provides meaningful reports and some of them provide tools to manage campaigns more effective.

I’m not sure how if there’s a space for one more player.

InterClick Website

From Silicon Alley Insider:

via Nasdaq’s Only “Pure-Play” Ad Network Raises $18.1 Million (ICLK).

Zynga is the company responsible for all those spam like games, such as FarmVille or MafiaWars. All these games are targeted to Facebook and they make money by showing advertisements. All these social type of games target the very basic human emotion of achievement. Most people play these games because they want to receive a higher status or position in their character or their skill level. In Facebook, players can show off their “new virtual and acquired ability” and get recognition from friends and other players. This is a big driver for the success of these games.

Zynga

I wonder why Facebook doesn’t merger or buy these game companies. It is part of Facebook anyway. It should acquire and get the game revenue. Currently, game companies can show ads from AdSense or any other place. Facebook loses ads revenue because of this.

The impressive thing is that the company is receiving more $180 million. I wonder what they are going to use that money for.

More at http://www.businessinsider.com/zynga-takes-180-million-venture-round-from-dst-others-cue-russian-mafia-jokes-2009-12

This is a special blog post dedicated to Brazil’s venture capital firms.

Before getting into the list, I want to make it clear that private equity investments are much stronger than venture capital investments. There may be four reasons for a small venture capital market in Brazil:

High interest rate – competition for capital, government bonds are much safer and provide better return, the current real interest rate is over 8%.

Entrepreneur unwilling to exchange equity for capital – the idea of having a 3rd party controlling or on the verge of controlling someone’s company is not very common yet.

Venture capital is unknown – the word venture capital is not a very known word in Portuguese, some people call venture capital as Capital Empreendedor or Capital de Risco in Portuguese. A literal translation of those two words is  entrepreneur capital or risk capital respectively (capital risque in French and riskkapital in Swedish). The meaning of risk is too explicit in those words.

Capital competition from other source of funding – there are big private equity firms and very wealthy individuals that can take the risk of new ventures easily, the capital is highly concentrated.

Sao Paulo - Copan

That is why there are not many venture capital firms that have look and feel of a American or Canadian venture capital firm in Brazil.

Here are some of them:

Monashees Capital + – currently with 7 portfolio presented to the public, Monashees is one of the two firms that fit into the typical venture capital firm (early stage investment, nurturing startups).

Adrenax Capital – this is new for me. It is dedicated to early stage and high-tech investments. This is the second firm that fits into the definition of a typical venture capital firm.

FIR Capital – a hybrid of venture capital and private equity firm, linked to DFJ.

Ideiasnet – This is a hybrid of incubator and venture capital firm.

Rio Bravo - imagine Goldman Sachs + Carlyle + Sequoia in one single firm.

Green Capital – private equity in green tech. Green tech is usually related to agro and ethanol industries in Brazil.

Invest Tech – a fund that invests in technology firms.

DGF Investimentos – it is a venture capital and investment fund firm.

Brazil is such a big country and I am puzzled to see that the venture capital industry is still so small. If the Brazil’s economy continues to rise, maybe there will be market space for more venture capital firms. Also, Brazilian people are known to be very creative and talented. There is no lack of talents for development of new technology and companies.

Lastly, most of the venture and investment firms are located in Sao Paulo. If you are interested in investing in Brazil, this is your city.

If you have any interest to know more about current condition of investing in Brazil, please drop a comment and I will post more things about it.

http://squareup.com/

Square is a startup based in San Francisco and promised to revolutionize the payment for small and medium size companies. It provides an almost free add-on to your iPhone, so you can slide your customers’ credit cards and the iPhone will take care of the payment transfer from the credit card into your Square account.

They are offering the device for almost free because they gain money through each transaction.

The idea of mobile payment is not new, but this is a strange and somewhat innovative way to make payments. However, there will be more competition for micro-mobile-payment systems and I’m not sure if this is a definite winning proposition. The mobile payment system is really well developed in Japan and some parts of Scandinavia and they do not need to use any add-on system to make transaction. Most of the cellphones in those countries have microchips that register payments to the carrier. The carrier becomes the middle man in the business.

If that’s true, the mobile carriers could release a mobile payment system that avoids the use of the add-on device. That would block the development of this company.

But, maybe this company is just growing in a way that will sell itself to those big carrier companies. Who knows?

I read a very interesting article about HR Acquisition from “A VC” blog. It shows what a HR Acquisition is and how to calculate the acquisition of a target company in simple financial model. A must read for people who want to work in the VC world.

From A VC

via The HR Acquisition.

I cannot believe that Ad Networks are still a hot in the investment scene. An Ad Network is a marketplace where publishers and advertisers can meet and provide advertising. We have big players such as Google AdSense that allow broad and specific targeting experience. You could reach B2B customers or B2C customers in one of those big Ad Networks, but it seems there is still a huge market for niche Ad Network, such as the Bizo’s network focused on B2B.

Maybe I should investigate more on this area. There are still a lot of money in this industry.

VENTURE CAPITAL – DealBook Blog – NYTimes.com

via Bizo, the B2B Platform, Lands $6 Million.

This is another great post from Startable about pitching tips for venture capital meetings. Healy organized and shared all posts in one single place for easy access. I will remember to read this for my New Venture Project final meeting.

VC Pitch Tip #1 – Turn off your screen saver
VC Pitch Tip #2 – You won’t be eating much lunch during that “lunch” meeting
VC Pitch Tip #3 – Get to the venture capitalist’s office early
VC Pitch Tip #4 – You don’t need to wear a tie to meet with an early stage venture capitalist
VC Pitch Tip #5 – The Venture Capitalist will want to hear a lot about your team
VC Pitch Tip #6 – Bring a USB drive with your pitch saved on it
VC Pitch Tip #7 – Format your financial model for printing
VC Pitch Tip #8 – If you are going to use WebEx to during your venture presentation, send the slide deck over email ahead of time and have a direct phone line available
VC Pitch Tip #9 – Don’t show the VC the IRR they will get
VC Pitch Tip #10 – Technology venture capitalists love demos
VC Pitch Tip #11 – Keep the actual slide deck short but sweet
VC Pitch Tip 12 – Be able to complete your entire fund raising presentation in 10 minutes

Read more at Startable

via Pitch tips for venture capital meetings.

I read so many venture capital and entrepreneurship books. All of them say to cap the legal fees that a start up should pay to the vc firm in the funding time. Startable has a neat and short post about the importance of doing and paying attention to it. Read more Term sheets and legal fees.

Thanks for Dan M., JS C., Mark E. and Tim T. for your suggestions!

This is a complete list of all the VC firms in Canada. JS made a good suggestion of adding of which firms invested in the last 12 months. I will add this info in the next update.

= A must see.

= A firm dedicated mostly in early stage companies.

= Firm that invested in any startup in the last 3 months (from September 09). You can click the icon to see the news related to the investment.

= Firm that received fund or selected to participate or manage a province venture capital fund in the last 2 months. You can click the icon to see the news.

= Firm that sold or IPO a company in the last 3 months (from September 09).

VC firms only

Anges Québec NEW INCLUSION!

AVAC Ltd.
Avrio Ventures Management Corp.

Blackberry Partner Fund NEW INCLUSION!

Brightspark Capital
Business Development Bank of Canada (BDC) Venture Capital

Canadian Medical Discoveries Fund Inc.
CAPE Fund/Fonds CAPE

Celtic House Venture Partners
CentreStone Ventures Inc.

Covington Capital Corporation

Desjardins Capital de risque

Discovery Capital Management Corp.

Elgner Group Investments Ltd.

Emerald Technology Ventures

Fond de Solidarité FTQ NEW INCLUSION!

Foragen Technologies

Genesys Capital Partners

Greenstone

GrowthWorks

GTI Capital

Hargan Ventures

ID Capital Management Inc.

InNOVAcorp – Halifax NEW INCLUSION!

Innovatech Québec

iNovia Capital Inc.

Investeco Capital Corp.

J.L. Albright Venture Partners (JLA)

Jefferson Partners

JOG Capital Inc.

Lumira Capital

McLean Watson Capital Inc.

Mercator Investments Limited

Montréal Startup NEW INCLUSION!

MMV Financial Inc.

Multiple Capital Inc.

New Brunswick Innovation Foundation

Novacap NEW INCLUSION!

Ontario Venture Capital Fund (OVCF) 

Propulsion Ventures Inc

Rogers Ventures NEW INCLUSION!

RBC Venture Partners

Renewal2 Investment Fund

RHO Venture Capital NEW INCLUSION!

SAINT – Saskatchewan Angel Investor Network

Skypoint Capital Corporation

Springbank TechVentures

Société Innovatech Québec

Summerhill Venture Partners

Tandem Capital NEW INCLUSION!

Tech Capital Partners Inc.

TELUS Ventures

Trellis Capital Corporation

VanEdge Capital NEW INCLUSION!

Venture Coaches

Ventures West Capital Ltd.

Walsingham Fund

WesleyClover NEW INCLUSION!

Yaletown Venture Partners

This is a complete list of all the VC firms in Canada.

= A must see.   = A firm dedicated mostly in early stage companies.

VC firms only

AVAC Ltd.
Avrio Ventures Management Corp.
Brightspark Capital
Business Development Bank of Canada (BDC) Venture Capital
Canadian Medical Discoveries Fund Inc.
CAPE Fund/Fonds CAPE

Celtic House Venture Partners

CentreStone Ventures Inc.
Covington Capital Corporation

Desjardins Capital de risque

Discovery Capital Management Corp.

Elgner Group Investments Ltd.

Emerald Technology Ventures
Genesys Capital Partners
Foragen Technologies
Greenstone
GrowthWorks

GTI Capital
Hargan Ventures

ID Capital Management Inc.

Innovatech Québec

iNovia Capital Inc.

Investeco Capital Corp.

J.L. Albright Venture Partners (JLA)

Jefferson Partners

JOG Capital Inc.

Lumira Capital

McLean Watson Capital Inc.

Mercator Investments Limited

MMV Financial Inc.

Multiple Capital Inc.

New Brunswick Innovation Foundation

Ontario Venture Capital Fund (OVCF)

Propulsion Ventures Inc

RBC Venture Partners

Renewal2 Investment Fund

SAINT – Saskatchewan Angel Investor Network

Skypoint Capital Corporation

Springbank TechVentures

Société Innovatech Québec

Summerhill Venture Partners

Tech Capital Partners Inc.

TELUS Ventures

Trellis Capital Corporation

Venture Coaches

Ventures West Capital Ltd.

Walsingham Fund

Yaletown Venture Partners

This is a complete list of all the Private Equity firms in Canada.

= A firm dedicated more to Private Equity or late stage startups.  = A mix firm with investment in VC and PE.

PE and VC firms

32 Degrees Capital

Aberdeen Gould

Annapolis Capital Limited

ARC Financial Corporation

Argosy Partners – Shotgun Fund & Succession Fund

AXIS Investments Fund

Balaton Group Inc.

Banya Capital Partners

Bedford Capital Limited

Birch Hill Equity Partners

BMO Capital Corporation

C.A. Bancorp Inc.

CAI Capital Management Co.

Caisse de dépôt et placement du Québec

Canada Pension Plan Investment Board

Canterbury Park Capital L.P.

Chadbourne & Parke LLP

Clairvest Group Inc.

Cobalt Capital Inc.

Coller Capital Limited

Cordiant

Corum Group

Crown Capital Partners Inc.

DAI Capital Advisors Inc.

EdgeStone Capital Partners

EnerTech Capital Canada Ltd.

Hilco Consumer Capital Corp.

Kensington Capital Partners Limited

KERN Partners Ltd.

Killick Capital Inc.

Kilmer Capital Partners Limited

Integrated Partners

Latitude Partners Incorporated

Lions Capital Corp.

Invico Capital Corporation

JMI Equity

Manvest Inc.

Mosaic Venture Partners

Novacap

OMERS Private Equity

ONCAP L.P.

Osprey Capital Partners

Penfund

PFM Capital Inc.

Pinnacle Capital

PRIVEQ Capital Funds

Scotiabank Private Equity

Stable Capital Advisors

Summer Street Capital Partners, LLC

TD Capital Private Equity Investors

Teachers’ Private Capital

Torquest Partners

Tricor Pacific Capital, Inc.

TriWest Capital Partners

Turtle Creek Private Equity

Vancity Capital

Victoria Park Capital Inc.

Whitecastle Private Equity Partners Fund LP

Wynnchurch Capital, Ltd.

Other Firms Related to PE & VC industry (Some of these companies may be venture capital and private equity firms but they were also investing heavily in other areas in finance, such as asset management, etc.)

This is a very interesting and basic book about Venture Capital industry. It does inform you some tips about what kind of skills and career path that you should take before joining in. Also, it provides and introductory level of terms and vocabulary for you to get used to before trying to get in a VC firm.

I do not recommend just to read this book alone as a way to have a strong idea of the industry. You should read a lot of other materials spread all over the Internet so you can really have a better idea if you really do want to invest your time and money into the career of a VC.

MIT Open Course Ware

Managing Innovation and Entrepreneurship

Managing Innovation: Emerging Trends

Managing Innovation: Emerging Trends

Early Stage Capital

Early Stage Capital

Designing and Leading the Entrepreneurial Organization

Designing and Leading the Entrepreneurial Organization

Law for the Entrepreneur and Manager

Law for the Entrepreneur and Manager

Entrepreneurial Marketing

Entrepreneurial Marketing

Entrepreneurial Finance

Entrepreneurial Finance

Listening to the Customer

Listening to the Customer

Pricing

Pricing

The Nuts and Bolts of Business Plans

The Nuts and Bolts of Business Plans

Technology Strategy

Technology Strategy

G-Lab: Global Entrepreneurship Lab

G-Lab: Global Entrepreneurship Lab

Compared to others

The Elevator Pitch Contest

The Elevator Pitch Contest – MIT 100K

Venture Investment Increases for Some Start-Ups

Venture Investment Increases for Some Start-Ups

Incredibly enough, this is a very similar book to Vault Career in Venture Capital book. They talk about the same introductory ideas for those who wants to pursue a career in the Venture Capital industry. It does provide a short story of the industry. Some basic concept about the industry, firms, Job, workplace, getting hired and other references. Again, this is not enough if you do really want to invest in this industry. You have to research and read more about the venture capitalist, you have to learn about Business plan, entrepreneurship, etc. It is not as easy as you think to get in the industry.

How to choose your co-founders?

5 tips for choosing a co-founder

Stanford and its $ 1 billion sell-off of private equity

Stanford Said to Offer Sequoia, Kleiner Funds as Prices Recover

US investment in VC decreases to new low levels

Investments in U.S. Venture Capital Funds Plunge

Potential recover for the VC industry

Signs of life in venture capital

TiE Young Entrepreneurs

I love this competition. It is one of the firsts business competition towards students from 9-12. This business plan is hosted by Carolinas – The Global Network of Entrepreneurs and the award for the winning team is USD 10K.

It is important to foster this type of competitions to children and teens. They will be able to learn and train their guts about the process of creating a new business.

For more information check it here.

The Foreign Affairs and International Trade Canada has a very interesting boot camp for entrepreneurs on September 10, 2009 in Saskatoon, Saskatchewan.

If you have a business plan and you want to meet with VCs from California, you should go there.

For more information, visit: http://www.infoexport.gc.ca/eng/sask/document.jsp?did=96015 and contact Alison.

I suggested to Alison to create a similar event but with video conferencing. Given the distances in Canada, the video conference would allow people from all over Canada to participate it with a minimum of cost and time. Also, more VCs could join in from the States and elsewhere.

For all of those interested in startups, there is going to have an interesting event for entrepreneurs and venture capitalists on October 15th 2009 in Montreal. Here are the details:

Date : October 15th, 2009
Time (Unconference session) : 3pm to 6pm EST
Time (Standard Conference) : 6pm to 11pm EST
Location : SAT – Société des arts technologiques
Address : 1195 Saint-Laurent boulevard, Montreal Google Map

For more information, click here.

The trouble with venture capital

There is an article from the Financial Posts (a prestigious finance newspaper in Canada) that backs the idea that there are too much money in the venture capital industry. It says almost the same thing from my older post that the VC industry must shrink in order to get a higher return to investor. Read the older post here: http://www.chimkan.com/2009/06/18/kauffman-foundation-says-u-s-venture-capital-industry-must-shrink/

Canada - USA - Niagara Falls

People in the venture capital industry know that the VC industry is not going well in Canada. That is why it is even more important to know the situation in a quatitative point of view.

The SME Financing Data Initiative is a government website that publishes quarterly reports about the venture capital industry in Canada. The summary is that the level of investment and funding is the lowest since 2003.

VC investment and fundraising, Q1 2008 and Q1 2009

There is an increase in the number of investment in the seed stage startups. However, all other stages of deals fell.

VC investment by stage of development, Q1 2008 and Q1

Also, you can see better how the distribution deals in Canada per provinces is.

Number of companies receiving VC by province, Q1 2008 and Q1 2009

I haven’t added all the number, but the impression that I have is that the venture capital activities in Canada is decreasing significantly. You can read the whole report here: http://www.sme-fdi.gc.ca/eic/site/sme_fdi-prf_pme.nsf/eng/h_02156.html

I took the report from the Money Tree Report from PriceWaterHouseCoopers and there is a lot of interesting results.

According to the report, the number of deals remained flat but the value increased slightly compared to Q1. But if we compared to Q2 2008, the value of investment drop 48.6%. In this perspective, Canada is not doing that bad at all.

Number of deals in US

Another interesting fact is that the number of seed stage investment increased as in Canada.

Seed investing increasing

This is actually good news. The more we invest in early stage company, the more growth we can expect in 3 – 5 years. So, those who want to gain fast money should not get into the venture capital industry now. But, it is important to get into this industry now to invest in new companies and expect a good exit in 3-5 years; this is the average needed time for a company to mature for an IPO.

The current situation in the VC industry is not good. But, actually, this is a good opportunity to have a readjustment in the industry, lower the valuations and we may have a better return from the portfolio companies in the next 3 -5 years.

I’ve just read news from Revista Exame, a prestigious Brazilian weekly magazine, which talks about the new generation of entrepreneurs in Brazil. According to it, there are 10 million of Brazilian entrepreneurs and the new generation of entrepreneurs are creating companies because they believe they have the skills and will to do it. Compared to the older generation, a lot of self-described entrepreneurs had to open a company because they were not able to get into the job market.

10 million of entrepreneurs in Brazil

Then I went to the Global Entrepreneurship Monitor website and I downloaded the GEM 2008 report. It is a comprehensive survey about entrepreneurs in 43 countries. It separates these countries in 3 categories: Factor-Driven Economies (economies that depend on natural resources mainly), Efficiency-Driven Economies (economies that rely on the economy of scale or comparative advantage in production) and Innovation-Driven Economies (economies that rely on the invention of new technology).

There are some interesting data.

For instance, it seems that the less developed the country, the stronger entrepreneurial activity in that country.

Early-Stage Entrepreneurial Activity Rates and Per Capita GDP, 2008

Early-Stage Entrepreneurial Activity Rates by Gender, 2008

However, the entrepreneurial activity in Technology sector is stronger in more developed countries such as Canada. Although the GEM report doesn’t explain why this happens, it is intuitive to know that the development of high technology needs a strong education system in the country. That is why that you can see that countries such as Australia, Ireland, Denmark and Canada have the strongest entrepreneurial index in the Technology sector.

Percentage of Early-Stage Entrepreneurial Activity Active in Technology Sector, 2002-2008

The Ex Post Facto blog commented about a report from the Center for Economic and Policy Research August 2009 about the percentage of total computer-related employment in companies with fewer than 100 employees. It is interesting to see United States in the bottom of the graph. You can find that Italy, New Zealand and Austria have more small companies in the computer-related services than the US.

Ex Post Facto - Entrepreneurs in the US

Definitely, this doesn’t mean that United States lag behind in the entrepreneurial activity. It is totally the opposite. United States have the Silicon Valley.

All these data do not account other many particularities for the US entrepreneurs. Even though the US main not be in the top position for any entrepreneurial index, it does have a strong entrepreneurial culture and environment.

In my experience, there are some strong cultural traits that you can only see in the Silicon Valley:

-          Belief that one can get rich by starting up a new Google or Apple.

-          Low opportunity cost for entrepreneurs.

-          An unusually high concentration of venture capitalists per square foot in the region.

-          A lot of stories of very successful entrepreneurs.

-          Great universities and culture for innovation.

-          Local culture that see failure as a good thing instead of a bad thing.

-          Also, a lot of young people want to follow the entrepreneurship path, instead of going for the traditional and stable way of life/ career (medicine, lawyer, corporate life, etc.)

In comparison to Brazil, most university students and young people don’t have the same type of culture or thinking. Maybe, there is a huge difference of opportunity cost in becoming entrepreneurs.

-          Most university student aim to get to work in a big multinational or for the government.

-          Most jobs don’t pay enough for young people to sustain themselves, so most young people live with their parents until late stage of their lives.

-          Families pressure their sons to follow a more stable career path.

-          There are not a lot of successful entrepreneurs stories to tell, or those who are successful have some kind of special background that most Brazilian don’t have (rich family support, family have money to send children abroad, etc.)

-          Universities in Brazil are followers or they don’t have great innovation in high growth industry such as internet.

-          Venture capital industry in Brazil is still in its infancy (Private Equity is much stronger in Brazil, GP Investimentos is the top firm in Brazil)

As you can see, these “soft” attributes cannot be accounted in any of the researches you have on the market. I believe they can make a significant difference in determine if a country or region will have its own Silicon Valley.

After having to explain to my friends so many times about what a venture capital firm does, I created a simple and quick way to segment different kinds of VC firms.

Basically, we can classify venture capital firms with 3 criteria: industry target, fund’s size and preferred investment stage.

Most of the VC firms are specialized in a set of industries. Some firms are dedicated into internet startups such as Brightspark and some others that invest in proven general technology companies such as EdgeStone. Usually, VC firms specialize in specific sectors because they can build a strong knowledge of an industry and they can spot good opportunities and support portfolio firms easily.

Size of a fund is an important metric to classify VC firms. VC firms make money in two main ways: management fees and carried interests. The bigger the fund’s size, the bigger the reward for a VC firm. Also, for entrepreneurs, the fund’s size is a good indication of the amount of money the firm is able to invest. If an entrepreneur has a project that needs $10M, so an ideal VC firm would have a fund with over $100M (I will explain the rationale for this later in other posts).

Then, different firms have different investment strategy. Usually (though not a rule), small VC firms tend to invest in seed stage companies and bigger firms invest in growing and pre-IPO companies. If I were an internet entrepreneur and I don’t need that much money, I would go for a VC firms that specializes in seed stage internet company with a fund size under $ 100M.

This framework is important for entrepreneurs. Knowing how to differentiate VC firms can show readiness to a venture capitalist and you can easily explain why you are approaching that VC firm instead of the other.

I’m glad that I’m resuming my VC posts!

Happy Faces - I'm resuming my VC posts

Invest Now! - from Flickr

My last post from the Entrepreneurial Finance course is here.

Today, I want to share my summary of the Horizon Communications Corporation (A) case study.

This document basically shows the industry background of telecommunication in the 90′s. Basically, it highlights the Telecommunications Act of 1996 and how it changed the market.

With the Act, there was a new market opportunity for companies to provide transmission facility to customers. Basically, there was an opportunity for new companies to serve as a hub connecting a telecommunication facility for big clients to other local telecom providers and to long distance providers.

Along the case, it explains the who the founders are, what the Horizon’s operating strategy is and what the product and service are.

The case presents a serious of challenging questions to the Horizon’s management. It wants to students to think what amount of financing should they ask for and which venture capital firms they should approach.

Again, this case presents challenging questions for VCs and entrepreneurs.

Assignment from MIT OpenCourseWare:

Horizon Communications

1.Would you have started this company? Would you invest in this company? Why or why not? What do you think of the economics of the idea? Of the management team? How does this investment differ from that in Technical Data Corp.

2.What pre-money value would you place on the company? I.e., what value should the Horizon team place on the company when they try to raise money? How much money should they attempt to raise?

3.How should Horizon approach their fundraising process? Should Horizon go to a venture capital firm or to family and friends? If Horizon decides to go to a venture capital firm, which firm or firms should they target?

4.Can a venture capitalist add value to the Horizon team? How?

Assume:

. Horizon’s marginal tax rate is 36%
. Expected inflation is 3%.

Read the Case Study: Horizon Communications Corporation (A)

Please, add your answers in the comment section below!

Invest - from Flickr

I’ve started studying the Entrepreneurial Finance at MIT OpenCourseWare by myself a month ago. I wrote my first post about the first case study here (Technical Data Corporation Business Plan).

Until now, I think the selection of the case studies are awesome. It presents many cases where the student is put in the position of a venture capitalist and an entrepreneur. For instance, you have to learn how to valuate a business and decide if you want to invest in a specific company. Plus, you must provide your analysis to decide what you want to do next.

Today, I’m want to present my summary and my recommendations about the Centex Telemanagement, Inc. case study.

Centex Telemanagement, Inc.

- The case starts with the story of Sierra Ventures and its found Peter Wendell. Then, it talks about how Wendell met with Jeffrey Drazan. Drazan was a VC associate hired by Wendell. In this part of the case, it gave me a very interesting vision of how VC hires an associate to work with. Wendell wanted to invest in the telecommunication industry after the break-up of AT&T’s monopoly and he wanted to find a person with experience in telecommunication industry. Luckly, Drazan, who was in that industry, wanted to go to the VC industry. They had the chance to meet each other and the relationship developed.

- Later, it shows quickly the Centex Telemanagement formation, but the focus is how Drazan found and brought this opportunity to Wendell. Drazan worked with the Centex Telemanagement by acting as the CFO of the company. However, Centex and Sierra hadn’t formed any formal and legal relationship yet. Drazan was supporting the financial projections and planning the growth of the company. Everyone was expecting the Sierra would make an investment to Centex. When they were almost closing the details of the investment, the Sierra founders decided not to continue to the plan. Drazan was shocked because he dedicated an amount of effort to the company and it would ruined all his efforts. However, after some negotiation, they closed the deal in a staged/milestone-oriented approach to the deal.

- To get higher valuation, Centex would need to achieve some milestone, such as hiring the CEO and some other people in the senior management and also Centex would need to achieve an X amount of revenue by a deadline.

Assignment from MIT OpenCourseWare:

Centex Questions:

1. Sierra Ventures and Centex:

-Describe the deal structure:
-What role does Series C Preferred play?
-What value does right of first offer have?
-What valuation is Sierra offering to Centex? How can Sierra justify this valuation?

2. Private (initial) investors:

-How much dilution do the initial investors experience?
-How much dilution would the initial investors have experienced, if they had anti-dilution protection on their initial investment of $499,999? (Full ratchet? Weighted ratchet?)

Assume that by May 1985 the private placement offering has raised the full $499,999 for Centex at $2.25 per share

Read the Case Study: Centex Telemanagement, Inc. – 286059p2

Please, add your answers in the comment section!

Mr. & Mrs. Pump from Flickr

Summary:

The number of new funds focused on bankrolling early-stage startups appears to be growing.

Data from The Deal and other sources that focus on venture capital concluded that in the last six weeks that about $1.2 billion has been raised by firms for dedicated venture capital investment, with another $3.3 billion for funds-of-funds that will back new venture capital (and private equity) vehicles in the future.

VCs are planning to concentrate on finding IT startups with limited capital needs rather than late-stage companies that may need significant sums to ramp up production or to weather a downturn in business until the recession is over.

It’s not only entrepreneurs targeting the next generation of startups: Venture capital firms Spark Capital and Sequoia Capital each made moves toward increasing their funding, specifically for seed-stage companies, in late March.

Read more at: http://www.thedeal.com/dealscape/2009/05/new_venture_funds_focus_on_the.php

My comments:

1. Comparing the latest bad news related to VC industry with this one, it seems that some problem may arise.
2. VC firms are raising a lot of money, they will need to invest in many more companies.
3. Many firms with more money means that entrepreneurs may drive up the valuation.
4. However, given the economic crisis, people are more conservative in taking risky ventures (less people going for entrepreneurship).
5. The end result may that the current rate of return from VC firms may stay the same, but the amount of deals may shrink.
6. There is also a bad news from Obama’s new financial revamp which may limit the size or the freedom of how VC may work.

A new study by the Ewing Marion Kauffman Foundation, Right-Sizing the U.S. Venture Capital Industry, states that venture capital industry’s return is under performing because of the current size of the industry. It says that by reducing the it, this industry may increase its return.

The logic is that the VC firms won’t have that much money to make high valuations in startups, so the return will be higher naturally.

Kauffman says The US VC industry must shrink

This report is in tune with what I am reading from The Money of Invention, How Venture Capital Creates New Wealth: Paul A. Gompers, Josh Lerner. Josh Lerner’s book states clearly that if the supply of money from limited partner is high, while the demand of investment from startups is the same, the consequence is lower return.

This is incredible.

You can read more about the Kauffman’s paper here: http://www.kauffman.org/newsroom/venture-capital-industry-must-shrink-to-be-an-economic-force-kauffman-foundation-study-finds.aspx

‘Super Angels’ Shake Up Venture Capital

Business Week has a great article about a type of angels investors called “super angels”. Although, the magazine didn’t state exactly in this way, super angels are high net worth individuals and small venture capital firms that invest around $ 1 million dollar in seed stage companies.

It illustrates the super angels with Josh Kopelman and his First Round Capital’s story.

The importance of this article is the visibility it gives to the venture capital industry and specially in this economic downturn.

I recommend reading it.

Read more here:

http://www.businessweek.com/magazine/content/09_22/b4133044585602.htm

The Technical Data Corporation Business Plan is the first case study from the Entrepreneurial Finance course from MIT OpenCourseWare. It is a business plan prepared by Jeffrey P. Parker in late 1980.

The case describes that Technical Data wants to raise $100,000 before the end of 1980 in the form of 20 Units. Each Unit would have 50 shares of common stock offered at $10 per share and a promissory note (debt) of $4500.

Technical Data Corporation: Business Plan

You can read the case study here: http://utopia.duth.gr/~gk7844/moustakis/M1-2007-08/business_plan_example_1.pdf

Then, in this lecture, there are some questions regarding about this case from the open course. I answered them in bold.

Technical Data Corporation: Business Plan The case contains excerpts from a business plan prepared in late 1980.

The entrepreneur, Jeff Parker, proposes to start a company that will supply information to professional investors in the bond market. Among the issues you might address are the following:

1. Should Parker enter the business?

Parker is asking for $100,000 to start up the company. He will create a business based on an existing market of Telerate customer. If he secures, as he stated, the deal of promotion to Telerate’s customer, he is able to attract customer to his financial product and earn a stable source of revenue through the monthly subscription of the service. So, he should enter the business.

2. Would you invest in this deal?

He structure his deal in a promissory note and a few shares of his company. This type of structure is not ideal for a venture capitalist nor private equity partner. First, there is no incentive of high payoff in the $4500 from promissory note even if the interest rate is 15%. Second, the percentage of ownership is small, thus the active investors do not have a great say in the company. Lastly, the company’s grow depends on the Telerate customer base, so there is not a huge or exponential growth rate for the business in the future.

3. How has the deal been structured? Why? (Note that Parker is selling equity for 10% of the company in the units. The two directors with 1.5% each are buying 3 units each.)

The deal is structured in this way:

- 20 Unit
- Each unit having $ 5000 in value
- $ 5000 X 20 = $ 100,000

Each Unit:
- 50 shares of common stock at $ 10 / share
- promissory note of $4500

This is a great exercice. The next case I’m studying is the Horizon Communications Corporation (A), this one is much harder.

15.431 Entrepreneurial Finance

There is an amazing course for people seeking to work in the private equity, venture capital industry and entrepreneurship. The Entrepreneurial Finance is an open course that focus on the finance of start-up ventures.

It addresses some of the important questions such as:

- how much money can and should be raised
- when should it be raised and from whom
- what is a reasonable valuation of the company
- how funding should be structured.

I am self-studying this course and it is great to read case studies that make me aware of the issues that I will be facing in the VC/PE industry.

You can read more about this open course here: http://ocw.mit.edu/OcwWeb/Sloan-School-of-Management/15-431Entrepreneurial-FinanceSpring2002/CourseHome/index.htm

Wow, this is increadible. 

Facebook is receiving $ 200 million for 1.96%!
 To calculate the post valuation, we just need to do this:

X = post-valuation
X = 200 million / 0.0196 = 10 204 million = $ 10 billion roughly.

Amazing how this company is able to draw more investment. 

Read more news about this event here:

Russian firm invests $200 mln in Facebook
What Is Facebook Actually Worth?
Why Facebook needs DST in Russia

There is a very interesting article about this question: http://bits.blogs.nytimes.com/2009/05/14/do-web-entrepreneurs-still-need-venture-capitalists/

It basically says that given the lower cost to create web companies, the current venture capital model may not be attractive enough for those web entrepreneurs. It gives some examples such as the iPhone Apps developers that do not need a huge  amount of money to create their products. 

However, it ends the article saying that is why some venture capital firms are changing its strategy by creating special funds for this type of development or some VCs creates smaller fundings specially designed for these web entrepreneurs.

I believe it is a must read for web VCs and entrepreneurs.

In a academic view, we could define venture capital as those firms that invest in early stage startups and private equity are firms that invest in later stage companies or public companies. However, both have the same investment style. They invest in companies in exchange for equity of a company. Also, venture capital is a subset of private equity investment. Private equity investments include leverage buyouts, distressed investments and mezzanine capital. With the economic crisis, venture capital firms  are more conservative, so a lot of venture capitalists are investing more in later stage companies which the risks are lower.

This is a rough view of the venture capital investment stages. These stages are for guidance only. In the real world, there is no standard in the classification of the investment stage. Sometimes, you can read number of rounds of investment. Other times, people will use the classification as stated below.

Angels investors

Angels investors are wealthy individuals who can invest in ranges from $50,000 to $1 million or more. They also provide expertise, experience and networking. They may perform the same roles as a venture capitalist.

News related to Angels investments

Getting Your Due
Angel investors commit less, but stay active in 2008
Houston tech startup wants to be all about you
Hoosier startups a bright spot in venture capital market

Seed stage

It is also a concept stage financing. The VC invests to allow the entrepreneur to spend on marketing research, patent application, incorporation, formation of the senior team and the company. Most VCs do not invest startups at this stage.

Funding value range around: US$ 100K to US$ 4 million (internet companies receive the least amount and the medical/green tech/energy companies receive the most)

News related to Seed investments

Burnaby startup finds inspiration in the sun
Automation Alley Invests $350K In Two Firms

Startup or Early Stage

In this stage, the entrepreneur already incorporated the business, but it has not yet started the commercial operation. Usually, it has the prototype or the final product developed.

Funding value range around: US$ 500K to US$ 5 million

News related to Startup investments 

Providence DNA research company receives $4 millioin
Tech new engine of Central Canada
Monica Healthcare, neonatal care startup, gets $1.6M
Investing dropoff hurting biotechs
Capital Factory Invests in Five Startups for 2009 Fund; Early Stage Technology Incubator in Austin, Texas AlsoRecognizes 5 Additional Finalist Startups
Prize CapitalTM Announces Due Diligence Phase for $10 Million Algae Fuel Prize 

First Stage or Round/Series 1/A or Formative Stage

Most startups in this stage already commercialize their products and have less than 3 years of existence. There is already a management team. Some companies have reached the breakeven point.

Funding value range around: over US$ 1 million (depending on the industry, the value can change drastically, the focus is on the company’s organization and the commercial stage)

News related to Series A investments 

Weekly Investor Round Up
Burnaby startup finds inspiration in the sun
AXIGEN Announces 2 Million EUR Investment
WebEx Founder Backs Chint Solar, Contributes to $50M Round
Energy Storage Rumors: Deeya Raises a Round; Bloom Piles Up Customers
Photovoltaic cell co B-Solar raises $3 million

Second stage or Round/Series 2/B

The startups at this stage already have a clear business model and they are already making some money. It has the management team and some employees. Usually, companies at this stage need capital to advance quickly the marketing and commercial efforts.

Funding value range around: over US$ 5 million (depending on the industry, the value can change drastically, the focus is on the company’s organization and the commercial stage)

News related to Series  B investments 

Auditsolutions is now Lavante, closes $5M in series B financing
May 2009 BUSINESS BRIEFS 
Microsoft: Restart or Logoff?
Turning Out The Lights: Ugobe, Maker Of Robotic Dinosaur
10-K/A: VANDA PHARMACEUTICALS INC

Third stage or Round/Series 3/C

If the company reaches this stage, it has a strong sales and customer base. Sometimes, it also has mid-level managers. The fund is used to increase more marketing, working capital, product development and expansion.

News related to Series  C investments 

Australia snares Silicon Valley wireless start-up

Mezzanine or Bridge or Expansion or Later stage

At this point, the company is going to IPO. The money is used to clean the balance sheet, remove debt and buy out any problematic investors or founders.

Initial Public Offering (IPO)

This is the checkpoint that all venture capitalists want to reach. The company’s shares are totally liquid. It means that they can sell the equity / shares they bought from the founders in the early stages of the company.

Shrinking Canada VC market

The Canada’s Venture Capital & Private Equity Association released a report yesterday (May 12th) that the venture capital market continues to fall in the first quarter of 2009, continuing the shrinking trend from 2008.

In the Canadian landscape, only $ 275 million was invested, down from 25% from the $367 million from the first quarter of 2008. Also, the number of deals shrink from 136 to 102 (Q1 09′/Q1 08′) and the average value per deal is $2.7 million.

The US venture capital market raised $US 4.3 billion in Q1 2009, however Canada’s market only raised $ 149 million.

This is a great signal that something should change in the Canadian venture capital market. 

Read the CVCA’s report here: http://www.cvca.ca/files/News/CVCA_Q1_2009_VC_Release_FINAL.pdf

This is a very good and concise presentation about venture capital, the three phrases of venture capital investing, SBICSs and SSBICs (types of small business programs), state government initiatives, key challenges and best practices.

VC Management Challenges and Best Practices

Download the presentation here: http://ocw.mit.edu/NR/rdonlyres/E8256F94-7B44-4E02-8511-7366DE6B20CA/0/class16_vc.pdf

In many text books and even some Harvard cases, you can see that venture capitalists ask for a lower discount rate for later stage startups.

This can be represented here:

Main Reasons For a High Discount Rate From VC (made by chimkan.com)

The reason why the discount rate decreases over time is the increasing information about the company’s performance. Not only, the mature startups have some historical data to support their future performance, the startups already have customers and some kind of revenue.

A little bit more of explanation

The Base Rate is not something that venture capitalist nor do entrepreneurs have control. It is mainly influenced by the FED’s basic interest rate. If FED lower its interest rate, all other investments will be more attractive because their return will be automatically higher.

Liquidity increases over time. When the company is getting more and more famous, more people will be willing to buy stocks from the company. This increase in interest will eventually reach the IPO stage when the venture capitalist will reap the investment’s reward.

Value added from the venture capitalist decreases over time because the company will have already established a senior management capable of taking care of itself. The venture capitalist will shift to a more strategic and big-picture command of the company in the boards of directors.

Cash Flow Adjustment decreases over time because venture capital firms make money by selling their share of the company in an IPO or an acquisition. When that event approaches, there are more information about the company and the market, so the discount rate for this issue decreases too.

These are the main reasons why the discount rate given by a VC decreases over time. If I were an entrepreneur, I would use this information in my deal negotiation with a VC firm.

In my last post about “Venture Capital Funds Return Still High“, you read that in general the venture capital funds are performing better then public companies indexes.

However, the performance rate is extremely low compared to the discount rate used by venture capitalists during a startup valuation. Why there is such a high discount rate?

There are basically five main reasons for a high discount rate:

Base Rate Return

In any investment, investor asks at least the risk-free investment rate. Currently, investors use the American Treasury Bonds rate as the base rate return because they believe the US government will pay them. Also, the government interest-rate is enough to compensate inflation and give a little bit more return. Any institution, company and individual have to give interest or return above the risk-free US Treasury bond’s rate.

Risk Premium

The return above the risk-free US Treasury bond is the risk premium. If the investors perceive that a company or individual has high risk o default, they will demand a “risk premium” for the perceived risk.

Liquidity Premium

In private companies, such as startups, it is very hard for investors to buy or sell private companies’ stocks. The main reason is the lack of information about the company performance. Because of this, less people are willing to invest. The little demand for company’s stocks means that venture capitalist cannot quit their investment at their will. The lack of opportunity of quitting an investment is compensated with a liquidity premium.

 Compensation for Venture Capital Expertise

Venture Capitalists are active investors. This means that VCs will shape the management and the strategy of the company. Also, VCs will spend their time helping entrepreneurs to give advice, to hire key people and even to bring some customers to the company. This support requires an extra discount rate.

Cash Flow Adjustment

 Given the way venture capitalist do valuation, VCs believes that the startups should provide higher return than the market rate.

 This graph shows the main factors for the venture capitalists’ discount rate:

Main Reasons For a High Discount Rate From VC (Made by ChimKan.com)

As you can see, the discount rate decreases over time (late investment rounds). In the next post, I will explain why it decreases.

National Venture Capital Association (NVCA) reported that venture capital performance showed positive returns across all investment horizons 3 years and longer for the period ending December 31, 2008.

As you can see in the table, venture returns across all horizons outperformed public market indices, NASDAQ and the S&P 500, through December 31, 2008.

Venture Capital Funds Return Are Still High Compared to NASDAQ or S&P 500

You can read more from NVCA website:

http://www.nvca.org/index.php?option=com_docman&task=doc_download&gid=424&Itemid=93

Second Market A new way out for VC and PE

Today, I just read an interesting article about a possible new exit event that venture capitalists, startups employees and other investors could do. 

SecondMarket is a marketplace where people can sell and buy “illiquid assets”. Illiquid assets are anything that people cannot easily for money. In our case, we are referring shares that entrepreneurs  issue to investors (VCs, Angels investors, employees, management, etc.)

It looks there is a new possible way for VC and other investors to quit their investment in places such as SecondMarket. 

The VC could sell his stocks from a startup to other investors, instead of relying in IPOs or acquisitions.

You can read more this interesting article about this: With Private Trades, Venture Capital Seeks a New Way Out

http://www.secondmarket.com/

Origins of the Colors

This is the post for all the current material about Venture Capital Method!

Venture Capital Method: Valuation Considering Schedule Slip in the Startup

Venture Capital Method: Valuation Considering Multiple Rounds of Investments

Venture Capital Method: Valuation Considering Granting Stock Options to Management Team

Intro to Finance & Valuation PPT

The Early Stage Valuations by Venture Capital Method

Solution: Leonardo needs return of 30% instead of 50%

To start this post, I recommend you to read my last post:

http://www.chimkan.com/2009/05/05/venture-capital-method-valuation-considering-granting-stock-options-to-management-team/

Now, imagine that at the start of year 3, John project that his startup will not meet the financial targets, but not until the end of 8 year. What share should Ada seek today? And what the equity stake will round 2 investors seek?

So, it means that the financial schedule will slip for 3 years.

Observation 1: Ada will be able to change her investment because she already has done it. (She invested $ 10M for 45.3% of the company).

Observation 2: Now that Ada’s investment lasts 8 years instead of 5 years, what is her Internal Rate of Return*?
*IRR: http://en.wikipedia.org/wiki/Internal_rate_of_return
We can say that IRR is the opposite calculation of the Rate of Return.

First, you have to lay out the investment in years:

Year 1: -$5M (how much she needed to pay)
Year 2: 0 (No money given to her from the company)
Year 3: 0 (No money given to her from the company)
Year 4: 0 (No money given to her from the company)
Year 5: 0 (No money given to her from the company)
Year 6: 0 (No money given to her from the company)
Year 7: 0 (No money given to her from the company)
Year 8: +$53.56M (She should receives 42.18% of the total value of the company $127M)

You can use this formula in Excel >>> =IRR([ARRAY OF THE CASH FLOW])

Ada’s IRR is 23% instead of 50%.

The new investors will want:

$ 4Mx(1.3)^5=$14.85M

It means they will want:

$14.85M/$127M =  11.69% of the equity. The $127M is the value of the company in 7 years discounted the management shares, look the previous posts for more information.

To calculate the number of shares:

Let’s pick up the total shares from John’s and Ada’s:

1,823,636

Let’s calculate how many shares they have to issue to the new investors:

X/(1,823,636+X) = 11.69%

X = 0.1169X + 159750

X = 241,403 new shares

The price is given as this:

P/S = $ 4M/241,403 new shares = $16.56/share

The new investors should pay $16.56/share for 241,403 new shares of the company.

Hard Math from Flickr

In my last post – Venture Capital Method: Valuation Considering Granting Stock Options to Management Team: http://www.chimkan.com/2009/05/05/venture-capital-method-valuation-considering-granting-stock-options-to-management-team/

I showed how to calculate the needed number of share if we give at least 15% of stock options to the management at the end of 5 years.

Remember the imaginary story from John and Ada from the last post?

John Doe is an entrepreneur who wants to raise $ 10 million so he can launch his clean energy product for the energy industry. He conservatively analyzed that the net income will be 10 million in five years. Also, the price earnings ratio is 15X in comparable companies.

Ada Li, Dream Capital, loved Doe’s plan, but she recommended that the management team should be rewarded at least 15% share of the company at the end of 5 years. Also, she needs a rate of return of 40%.

Now, Ada and John think that they will need another round of financing at the beginning of the third year. John probably will need another $ 4M.  Ada still wants to keep her rate of return at 50%, but she believes from her experience that the second round of investors will requires only a 30% of rate of return because of the progress made in the company. Keep in mind that Ada still wants to reserve 15% share of the company to the management.

• Ada wonders what the share she needs today is.
• On the other hand, what will the second round investor look for?

To answer these questions, let’s do some step-by-step work:

Steps 1 – 8 were taken from the last post:

Step 1 – John’s company has currently 1,000,000 shares.

Step 2 – John needs $ 10 M

Step 3 – Value of the company in 5 years: $ 10 M X 15 = $ 150 M

Step 4 – Ada wants a rate of return of 40% = $ 10M(1.5)^5 = $ 53.78M

Step 5 – Ada wants that the management has 15% of the company in 5 years: 15%

Step 6 – Given that at the end of five years, the management will have 15% of the shares, so this left $ 22.5 M for the management and the remaining value to John and Ada, which is $ 127M.

Step 7 – Ada hopes to receive $ 53.78M regardless of the 15% given to the management.

Step 8 – So, she decides that she needs to own: 42.18% of the company. [Calculation: $53.78M/$ 127M = 42.18%]

Step 9 – What is the amount of ownership the round 2 investors needs? (They need a rate of return of 30% for 3 years and investing $ 4M) >>> $ 4M*(1.3)^3 = $ 8.78M

Step 10 – Remember, that we need to give 15% of the company to the management, so the required share for round 2 investors are based on this: $ 8.78M/$127M = 6.9%

Step 11 – What is the percentage Ada needs to keep her investment fine knowing that her equity will be diluted by the next round of investors and the management?

42.18%/(1-6.9%) = 45.3%

Instead of 42.18%, Ada will need 45.3% percent of the company now.

Step 12 – John will need to issue …

X(1,000,000 + X) = 45.3%

0.55X = 453,000

X = 823,636 shares

Price per share >>> $ 10 M/823,636 shares = $12.14/share 

Step 13 - Let’s add John’s and Ada’s number of shares = 1,000,000 + 823,636 = 1,823,636 shares

Step 14 - Round 2 investors will need:

X/(1,823,636+X) = 6.9%

0.931X = 125,830

X = 135155 shares

Step 15 – The new investors will need to pay…

$4M/135155 shares = $ 29.6/share

The answer:

Ada wonders what the share she needs today is.

A: Ada will need 823,636 shares at $12.14/share

On the other hand, what will the second round investor look for?

A: Round 2 investors will need 135,155 shares at $29.6/share

The next post will show further dilution of John’s equity if the something goes wrong with the company.

The Math Munching Monster from Flickr

In the very beginning of my blog, I wrote two articles that explain the Venture Capital Method:

1 – http://www.chimkan.com/2009/04/05/the-early-stage-valuations-by-venture-capital-method/

2 – http://www.chimkan.com/2009/04/06/solution-leonardo-needs-return-of-30-instead-of-50/

I also found a presentation the same subject here:

3 – http://www.chimkan.com/2009/04/07/intro-to-finance-valuation-ppt/

Today, I’m going to show how we can calculate different rounds of investments with a venture capitalist.

Imagine this following story:

John Doe is an entrepreneur who wants to raise $ 10 million so he can launch his clean energy product for the energy industry. He conservatively analyzed that the net income will be 10 million in five years. Also, the price earnings ratio is 15X in comparable companies.

Ada Li, Dream Capital, loved Doe’s plan, but she recommended that the management team should be rewarded at least 15% share of the company at the end of 5 years. Also, she needs a rate of return of 40%.

How many shares would Ada require for this investment?

What will the percentage of ownership John be at the end of five years, including the dilution to the management?

 

Let’s digest the problem:

Step 1 – John’s company has currently 1,000,000 shares.

Step 2 – John needs $ 10 M

Step 3 – Value of the company in 5 years: $ 10 M X 15 = $ 150 M

Step 4 – Ada wants a rate of return of 40% = $ 10M(1.5)^5 = $ 53.78M

Step 5 – Ada wants that the management has 15% of the company in 5 years: 15%

Step 6 – Given that at the end of five years, the management will have 15% of the shares, so this left $ 22.5 M for the management and the remaining value to John and Ada, which is $ 127M.

Step 7 – Ada hopes to receive $ 53.78M regardless of the 15% given to the management.

Step 8 – So, she decides that she needs to own: 42.18% of the company. [Calculation: $53.78M/$ 127M = 42.18%]

Now, let’s answer the questions:

How many shares would Ada require for this investment?

Ada will need:

X / (1,000,000 + X) = 42.18%

X = 421,800 + 0.4218.X

0.5782X = 421,800

X =  729,505 shares

Pricing for each share:

$ 10M / 729,505 = $ 13.7/share

If John accepts this deal, he will need to issue 729,505 new shares at $13.7/share to Ada.

Launch Silicon Valley 2009 Website

When:  Tuesday, June 9, 2009

Where: Microsoft Campus in Mountain View, CA

It is an event to showcase the latest startups from the information technology, mobility, security, digital media, next generation internet, life sciences and clean energy industries.

Entrepreneurs who are interested should send an Executive Summary of no more than 2 pages to Launchsv@svase.org by latest May 8, 2009.

You can read more about the event here: http://launchsiliconvalley.org/index.htm

Some pension funds and university endowments, which have been major sources of venture capital, have scaled back VC investments in the wake of market downturns. The $129 billion California State Teachers’ Retirement System (CalSTRS), the second-largest pension fund in the US, reduced its allocation for venture capital from 1.3 percent to 0.5 percent of its total portfolio in February 2009, according to Forbes. Reduced participation from institutions will hamper some VCs’ efforts to raise funds.

More news about this

Venture Capital Investment Sinks

State venture capital drops 70% in quarter

*** Venture investments fall 61 percent in 1st qtr

Fewer Venture Capital Funds Are Raising Money

The lessons of adversity

How to attract venture capital funding

Saturday News Briefs

O’Brien: Venture capital needs transparency, not regulations

President Obama’s budget proposal, announced in February 2009, aims to raise taxes on carried interest, which could cause taxes on venture capital profits to more than double.

The proposal calls for taxing carried interest as ordinary income, which could result in a significantly higher rate than the current capital gains tax rate of 15 percent, according to Dow Jones News Service. Proponents of the change argue that VCs should pay the same tax rate on their income as wage-earning workers; opponents argue that higher rates would discourage innovation and entrepreneurship.

More news about this

Say yes to liberty, no to left-wing agenda

GrowthWorks Capital Ltd.: Retail Venture Capital Funds Get Boost …

It is quite impressive the amount of bad news from Venture capital industry. And at the same time, it is expected that this industry may suffer from the economic downturn. 

As many of you can recall, the dot-com burst impacted the venture capital industry much more than the current situation. After the burst, the VC industry grew back again and it was very healthy as before 2008.

Based on this, I think the VC industry will have a nice come back after we solve this economic recession mess.

The article I want to talk about is this Venture Capital and Startups Feel More Pain, Study Says from Business Week.

It talks about the “down rounds”, “multiple liquidation” and “play-to-play” concepts.

I will talk about more about these three concepts separately in this blog. Search for these keywords!

I was searching for more news about venture capital industry and I found out this bad news from Boston.com.

Venture capital sector makes adjustments

Highlights from this news:

- Last year, our industry raised about $28 billion in new investment capital, but VC industry will raise around $8 billion and $12 billion, nationally

- The shrinkage of Boston’s venture capital sector will be tough for the venture capitalists (It was expected anyway, it is losing pace against Silicon Valley and other places)

- The upshot is that venture capital firms will be managing smaller funds, and some firms will go out of business.

- Fewer firms and smaller funds will obviously mean fewer jobs for venture capitalists and the staffers who support them.

Check out the complete report about VC industry in the US here:

https://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/National_MoneyTree_full_year_Q4_2008_Final.pdf

A guide in Tibet

This is a complete guide of all the most important resources about venture capital industry in Canada.

It is a good way to start your research about VC industry if you are in Canada. 

What Venture Capital is?

http://en.wikipedia.org/wiki/Venture_capital

Associations, Networking and Groups

The National Venture Capital Association (NVCA), comprised of more than 450 member firms, is the premier trade association that represents the U.S. venture capital industry.

The CVCA – Canada’s Venture Capital & Private Equity Association – represents the majority of private equity companies in Canada, with over 1700 members.

Ottawa Centre for Research and Innovation (OCRI) is Ottawa’s leading member-based economic development corporation for fostering the advancement of the region’s globally competitive knowledge-based institutions and industries. 

The Institutional Limited Partners Association is a not-for-profit association committed to serving limited partner investors in the global private equity industry by providing a forum for: Facilitating value-added communication, Enhancing education in the asset class and Promoting research and standards in the private equity industry.

The Emerging Markets Private Equity Association (EMPEA) is an independent, member-based global industry association that promotes greater understanding of and a more favorable climate for private equity and venture capital investing in the emerging markets of Africa, Asia, Central/Eastern Europe and Russia, Latin America, and the Middle East.

Venture Capital Firms in Canada

http://www.chimkan.com/2009/04/20/venture-capital-firms-in-canada/

News about latest deals

http://www.canadavc.com/Default.aspx

Other Resources

British Columbia Venture Capital Programs - http://www.cse.gov.bc.ca/MIT/SBIIO/VCP/Pages/default.aspx

BDC Venture Capital - http://www.canadabusiness.ca/servlet/ContentServer?cid=1081944191273&pagename=CBSC_FE/display〈=en&c=Finance

Entrepreneur first - http://www.bdc.ca/en/home.htm

Strengthening Venture Capital in Canada - http://www.fin.gc.ca/toc/2003/svcc_-eng.asp

How Startups will save Venture Capital in Canada

Terms and Conditions for the Venture Capital Exemption - http://investcan.ic.gc.ca/en_terms.htm

Some important highlights:

- Venture Capital firms invested only $ 3 billion in 549 young companies in the first quarter

- Investment was down 47% from Q4 2008

-  Investment was down 61% from Q1 2008

- Internet companies raised $ 556 million, down 31%

- But VC firms raised $ 4.3 billion in Q1, just not investing that much.

Read more in the New York Times’ site: http://www.nytimes.com/2009/04/18/business/economy/18venture.html?hpw

Screenshot of the Introduction to Venture Capital online course

I registered for the Introduction to Venture Capital (Online) course at UCLA Extension course.

This is a self-study online course for $45. Not expensive.

Let’s see what it has. More comments in the next posts.

Actually, after 1 hour of reading the self-learning material, I finished the whole course.

The material is direct though it is very basic. It explains the sources of venture capital, the differences of angels and VC firms, then it explains briefly the due diligence process, the type of startups (lifestyle, middle, high-potential), when to startup finding financing and that’s it.

It has quizzes to see if you learned something and there’s nothing else.

I was expecting something more.

Have fun with your friends!

If you want to read the whole Accel And Facebook case about valuation, please check the posts in this sequence.

A VC firm makes money – Accel and Facebook case – Part 1

A VC firm makes money – Accel and Facebook case – Part 2

A VC firm makes money – Accel and Facebook case – Part 3

A VC firm makes money – Accel and Facebook case – Part 4 (Final)

Have fun!

A girl sitting on a street in Sweden. See more Sweden's pictures here: http://www.flickr.com/photos/swedish_institute/351742030/

In the last post, I promised that I was going to explain the four “exiting events”:

- IPO

Initial public offering (IPO) is the act of issuing a company’s shares to the public. There are other names for this such as public offering, flotation or publicly traded company.

When a company lists its shares on a public exchange, the money paid by investors for the newly-issued shares goes to the company.

This is the best way a venture capitalist can exit his investment in a startup.

Read more about IPO here.

- Acquired / Merger

Mergers and acquisitions can be abbreviated to “M&A”. Mergers mean that two or more companies are joining to become one entity. Acquisitions (takeover or buyout) mean that a company is “buying” another company. This is the second way a venture capitalist can exit his investment. 

Big companies acquire a lot of startups to expand its own set of products, to buy talents, users and technology.

Read more about M&A here.

- Bankruptcy

Bankruptcy is a declaration that a company or a person cannot pay its debts. Simply saying, a company is bankrupt when it is “out of business”.

This is definitely a situation that every venture capitalist wants to avoid.

Read more about bankruptcy here.

- Staying private

A company that does not release shares into a stock market or it is not acquired is a privately-held company. Most of the small and medium size companies are privately-held companies. Usually, they don’t have a lot of shareholders. A startup usually starts as a private company and in the long term becomes a public company.

Sometimes, the shareholders of a startup may decide that the best way to keep a profitable business is to remain private. Depending on the type of technology or market, investors do not want to attract the attention of competitors or other companies in its market. A private company does not have to release quarterly earnings to the public.

Now, let’s see what the exits for Accel’s investments are. 

1 – Yahoo! Microsoft etc… buy Facebook for XXXXX money

Read the news about Facebook rejecting acquisition offers here.

This is our second type of exiting that Facebook and Accel could decide to go for. However, it is not the reality because Facebook didn’t sell itself yet. This is not an ideal situation because it is not very easy for any company to buy Facebook in the price range of 5 or 15 billion in this economic crisis. However, we could list some potential buyers given their amount of cash in hand: Microsoft, Google, etc.

2 – Facebook goes IPO

As you know, this is the best way to reward a VC’s investment. The VC buys the shares cheaply in the beginning of the startup life and sells it high after the IPO. Imagine that Facebook would get a market value of $ 15 billion, Accel and all other investors stated on my previous post would literally get those amounts of money. In case of Accel, they would get almost 130 times of their investment.

3 – Facebook stays private

Most of the VCs would avoid staying private. When a company is private, the shareholders cannot sell their shares easily to other investors. Moreover, the price given is not as high as a VC could expect in his shares. In case of Facebook where they have a lot of shareholders, almost nobody would want to have the company private. Instead, they want to do an IPO and cash in their stocks.

4 – Facebook goes bankrupt

This would happen if the company makes a major mistake or loses market shares or runs out of money and investors. In this worst case scenario, all investors, founders and employees lose money. In this case, the investors can “liquidate” the company which means they want to sell everything the company has, like a garage sale, and all the money they get is redistributed among all the investors. In this case, VCs have some special clauses in their shares that give them preference to receive this pool of money. 

Wow! That’s a lot of posts about this.

The next series of posts I will talk more about valuation (I’m not a valuation freak yet), some common questions about VC, news, etc!

venture-capital-courses

 

News about series funding or staged investments from venture capitalists

 In this third post, I’m going to explain why venture capital firms invest in stages and not in a one-time-big-investment and why Facebook is receiving rounds of investments.

Venture capitalists want to have some control in their investments. By staggering their investments in rounds, they can evaluate if the startup should receive more money or not. In this way, the VCs can monitor the entrepreneur’s progress and gather additional information to make a sound investment.

From the book “The Venture Capital Cycle – 2nd edition” on page 173, we have the Apple Computer’s story that illustrates this well:

“Apple Computer received three rounds of venture capital financing. In the first round, venture capitalists invested $518,000 in January 1978 at  a price of $0.09 per share. The company was doing well by the second round of venture financing in September 1978. Venture investors committed an additional $704,000 at a price of %0.28 per share, reflecting the progress the firm had made. A final venture capital infusion of $2.331 million was made in December 1980 at $0.97 per share. At each stage the increasing price per share and the growing investment reflected resolution of uncertainty concerning Apple’s prospects.”

Besides, these rounds of investments may have some names such as Series A round or B or C or even D rounds.

From the entrepreneur’s side, these round of investments may mean that they achieved a milestone event such as breakeven, getting their 1,000,000 customer, having the patent granted, having the drug trial phase IV passed, etc.

Back to the Facebook and Accel example:

“Facebook received its first investment of US$500,000 in June 2004 from PayPal co-founder Peter Thiel.[25] This was followed a year later by $12.7 million in venture capital from Accel Partners, and then $27.5 million more from Greylock Partners.[25][26] A leaked cash flow statement showed that during the 2005 fiscal year, Facebook had a net loss of $3.63 million.”

So, in this little paragraph, we see that Facebook had at least 3 rounds of investments until 2005.

- Peter Thiel: US$ 500,000
- Accel Partners: US$ 12.7 million (Accel invested probably because Facebook achieved some milestone)
- Greylock $27.5 million (Greylock invested probably because Facebook achieved some milestone, but probably it had to pay more for less share)

Much later, we had the Microsoft’s investment of $240 million.

Let’s pick up Accel’s investment and see how its investment increased in value.

“Among venture capitalists it’s a poorly kept secret that Facebook’s valuation came in just shy of $100 million. Assuming that’s true (Mr. Breyer declined to say), Accel paid a little more than $12 million for roughly a 15 percent share.”

Usually, when a company receives a round of fund with increasing value (a higher price-per-share), no previous investors requires more shares of the company. If the company has a “down-round” which means that the price-per-share of the latest round is lower than the previous one, usually the VCs requires more new shares to compensate for their loss in the valuation. I will explain this in other posts.

So, in later reports, Accel still has 11% of the company. This means at the time of Microsoft’s investment, Accel’s investment was valued from US$ 12.7 million to US$ 1.65 billion. That’s an increase of 130 times of their initial investment!

Other VCs and investors invest in Facebook because they hope that their shares will have a similar increase value of their investments.

You wonder if this is the way VC makes money. This is simply the value of their investment; however, they need to “transform” their shares of the company into money.

This transformation is what VCs call “exiting event”.

The “exiting event” can be divided into four types:

- Staying private

- IPO

- Bankrupt

- Acquired / Merger

In the part 4 of this post, I will show what would happen to Accel’s investment for each of the exits. Then, we conclude how VC firms make money.

The news that you saw from the image were taken from these pages:

Twitter Raises $35 Million Series C From Benchmark and IVP

MARINUS PHARMACEUTICALS RAISES $20 MILLION IN SERIES B FINANCING

Wozniak’s storage startup Fusion-io raises $47.5M more

Irvine Chip Startup WiSpry Nabs $10M Funding

Irish Venture Capital Association - A Guide to Venture Capital

I found a very interesting book about venture capital. It was written by the Irish Venture Capital Association (http://www.ivca.ie) and it’s completely free. 

It is a quick reading ( I read in less than 4 hours) and it explains what venture capital is and it shows some information about business plan and how to attract a VC.

Click here for a Guide to Venture Capital PDF

Math is not as complex as it looks

Remember from the last post:

“At the end, we see that Peter Thiel got XXXX % (I can’t find the info, but this does not matter in our discussion of how a VC firm makes money rfom now) of Facebook with US$ 500,000 in June 2004,Accel Partners invested $ 12.7 million for 15 % (let’s say that New York Times is right) and Greylock Partners invested $27.5 million for XXXXX %.

Tomorrow, I will post the calculation of what is the percentage that Greylock Partners got with $ 27.5 million.”

So, today I will show how we can estimate the percentage of equity that Greylock had after investing $ 27.5 million.

US$ 27.5 million is Y% of the post-money valuation.

The post-money valuation was given from this news:

“Venture capital funding provided by Greylock Partners and other firms totaling $25 million placed a value of $525 million on Facebook, which reportedly turned down $750 million from Viacom.”

Chim’s comment: What I really want you to focus is the first paragraph. Greylock Partners and other firms valued the company at $525 million! This number is important to establish the pre-money and post-money valuation. With this info, we are able to estimate the approximate percentage of the company’s equity being sold.

So, we have $ 525 million of post-money and the new money is US$ 27.5 M.

This means that Greylock got probably  in exchange of 19% of Facebook.

Now, let’s see what is the pre-money valuation!

As you can remember, the pre-money + new money is post-money.

Pre-money (what Peter, Accel, founders, management, employees and other not-known investors) + $ 27.5M = $ 525 M

So, the pre-money valuation was at that time: $ 497.5 million, almost half a billion!

In the next post, I will tell you about the differences of Round A, B, etc rounds of investment. A startup usually receives more than one round of investment and that can affect the number of shares a VC needs to have. I will keep the explanations simple and in case I need to explain more, I will create more posts!

Background information:

Accel Partners is a private equity and venture capital firm. It invests in many industries such as Computing, Consumer Internet, Engergy, etc (there are 11 industries).

Increadibly, Accel has invested in 197 companies (I did not count one by one but I use a smarter way to count). It is based in Palo Alto, Californa and it also has in London, China and India. It was created on 1984 and there are some famous companies invested by them, Real Networks, Facebook, Veritas, Comscore, BitTorrent and Macromedia (the creator of Dreamweaver, Flash, etc.)

Also incredibly, Accel was able to raise almost 1 billing of dollar at the end of 2008, when the Global economic downturn started.

Read more at its website

Facebook is a social network website. Basically, it is a virtual place where people communicate and share their lives in an easy way. It was created by Mark Zuckerberg and his classmates in Harvard University in 2003.

You can read more about Facebook here.

Now we are ready to visualize how a VC firm can make money (I will need to write more than a post for this, be ready).

If you read from the Wikipedia page at the Financials section, you read that:

“Facebook received its first investment of US$500,000 in June 2004 from PayPal co-founder Peter Thiel.[25] This was followed a year later by $12.7 million in venture capital from Accel Partners, and then $27.5 million more from Greylock Partners.[25][26] A leaked cash flow statement showed that during the 2005 fiscal year, Facebook had a net loss of $3.63 million.”

We are not going to focus on the net loss this time. I may discuss this later posts.

Searching a little bit the Internet, we get:

From New York Time, Facebook and Venture Capital Firms

“Among venture capitalists it’s a poorly kept secret that Facebook’s valuation came in just shy of $100 million. Assuming that’s true (Mr. Breyer declined to say), Accel paid a little more than $12 million for roughly a 15 percent share.”

Chim’s comment: I added some other paragraph just to give you a glimpse of what was being discussed there. You can click the paragraph to the news directly.

As you can see, Accel paid, very probably (you can see from the last post that this is almost exactly what Accel had with the Microsoft valuation), $ 12M for 15% of Facebook that time.

“And back in 2006, social-network valuations sky-rocketed accordingly.

There was the $800 million acquisition offer from Yahoo that Facebook reportedly rejected, the $2 billion Facebook wanted and the $25 million in venture capital Facebook got from Greylock Partners in April. In September, RBC Capital markets analyst Jordan Rohan said MySpace might be worth $15 billion in three years. The same month, Google bought video-sharing site YouTube, with is social features such as profiles and friends lists, for $1.6 billion.”

Chim’s comment: Something is impressive here. Big companies, such as Yahoo!, were buying social networks for about $500 – $800 million at that time. This means that the value of social network sites were in this range price. One very interesting thing is the Jordan’s (from RBC Capital) comments “MySpace might be worth $ 15 billion in three years”. He missed, it was Facebook that was going to be valued at $ 15 billing in less than 3 years.

Venture Beat - Facebook and VC firms

“It has never been our intention to sell the company,” said Melanie Deitch, Facebook’s director of marketing, adding that the latest funding puts the rumors of such a sale to rest. Late last month, Business Week reported the company had turned down a buyout offer for $750 million and was looking for as much as $2 billion, citing analysts saying that Viacom, owner of MTV, might make a good match.

David Sze, the venture capitalist who led the investment for Greylock, said earlier statistics from comScore showing a decline in unique visitors in February were an aberration, and that the company’s internal statistics show continued robust growth. Indeed, the March statistics showed resumed growth on this metric too.”

Chim’s comment: As you can think, big companies were trying to buy Facebook for $750 M range. The second paragraph is interesting about the statistics from comScore. It is not the first time that comScore misreport numbers about visitors for a site. Sometimes, misleading news are spread to push negotiation… not in this case, I guess.

WebProNews - Facebook and VC firms

“Venture capital funding provided by Greylock Partners and other firms totaling $25 million placed a value of $525 million on Facebook, which reportedly turned down $750 million from Viacom.”

Chim’s comment: What I really want you to focus is the first paragraph. Greylock Partners and other firms valued the company at $525 million! This number is important to establish the pre-money and post-money valuation. With this info, we are able to estimate the approximate percentage of the company’s equity being sold.

Seattlepi.com - Facebook and VC firms

“New York-based News Corp., whose far-flung media properties include Fox Broadcasting and 20th Century Fox, spent $3.5 million for an undisclosed stake in Mountain View, Calif.-based SimplyHired. It bought MySpace.com last year for $580 million.”

Chim’s comment: So, on 2005, Fox bought MySpace for $580 million. Again, this reinforce the probable value range ($400M – $800 M) of a famous social network site.

At the end, we see that Peter Thiel got XXXX % (I can’t find the info, but this does not matter in our discussion of how a VC firm makes money rfom now) of Facebook with US$ 500,000 in June 2004, Accel Partners invested $ 12.7 million for 15 % (let’s say that New York Times is right) and Greylock Partners invested $27.5 million for XXXXX %.

Tomorrow, I will post the calculation of what is the percentage that Greylock Partners got with $ 27.5 million.

R.I.P Good Times from Sequoia Capital

In this time of crisis, it is always easy to promote cost-cutting measures as a way to save the company or bring the company back to profitability. Even though, this is a great way to make to companies leaner and more efficient, cutting the wrong costs can actually bring more problems later.

I’ve just read the article “Start-Up Gets Course in Survival” from New York Times’ website and it tells us a successful story of cost cutting from a start-up called Jive Software (one of many companies invested by Sequoia Capital). It tells a little bit of the Jive’s history, success and how it laid off its 25 employees. After all the cost-cutting measures the company got back to profitability.

Actually, everybody knows that any cost-cutting measure can bring a fast increase in productivity metrics and by saving more, with other metrics of the company the same (ceteres paribus condition), the company certainly will get more profitable.

Shouldn’t start-ups focus on cost from start?

They should. By creating an economical company from day 1, the founders of the company establish not only more efficiency but also a culture that will be less prone to waste resources. Dell is a good example of how this can be beneficial.

There is another example of how cost-cutting can make a company survive long enough to be “profitable”.

For example, from the book “Founders At Work – Stories Of Startups’ Early Days“, we can read that Twitter and Blogger.com’s founder, Evan Williams, had to run Blogger with no expenses when the founders and employees had disagreements.

“Yeah, it was just the craziest bad time. The good news about all that was Blogger was still running and, with no employees, we didn’t have expenses. So we went from having $ 50,000 a month worth of payroll, to a couple of thousand for our server infrastructure and our rent. It is probably closer to ten between five and ten, but a manageable number, not paying me anything. I took some money every once in a while to pay rent, and I had long since put all my money in  and credit cards and everything else, but that was actually a much more reasonable place to be because we didn’t have to make $ 50,000 a month to pay people. We had to make a few thousand dollars a month.”

In this case, Evan got cost cut because all the employees and the other founder quit the company. He was able to run Blogger without further loss and eventually, as all of us know, he sold it to Google. Certainly, cutting cost in any company can buy more time for the company to survive any downturn.

Even though the NY Times’ article doesn’t say anything about how to cut cost, it is important to note that cutting the wrong costs can actually have the opposite effect. “BP’s oil spill in Alaska blamed on cost-cutting“. “It was forced to replace 16 miles of pipeline at a cost of $250m.” That is definately a not a good way to cut cost.

So, cost-cutting is not as simple as it sounds. It is not just a matter of laying off people who don’t contribute directly to the bottom line of the company or not investing enough money to the maintanance, but it is a delicate balancing act of revenue and costs.

Take a look at Sequoia’s 2008 Presentation about cost cutting measures.

I was searching for anything from the net and I found an interesting introductory deck about venture capital. If you are interested in the basics of VC, this is a good starting point. It also has a more “equational” view of the venture capital method.

Intro to Finance& Valuation - This is a lecture on valuation and some business formation issues from http://www.buec.udel.edu/jones/Courses/VentureCapital/index.html.

15 Billion - Facebook and Microsoft Case

Many of you remember that Microsoft paid $ 240 million for 1.6 percent of Facebook . That was a huge amount of money for a company that is not generating THAT much money for the valuation.

Sometimes, a company invest in a startup for strategic reasons.

Anyway, let’s use the Venture Capital Method to see what is the post-money valuation (don’t remember what’s post-money valuation? read my past article about it again.)

Information that we have:

- Microsoft paid $ 240 million for 1.6%

The math is very simple to calculate the post-money valuation: 1.6%(TOTAL) = $ 240 M then, TOTAL = $240M/0.016

We have a whooping $ 15 000 million or $15 billion post-money valuation! 

When a reporter says that the company was valued at $15 B, he was saying the post-money valuation.

In this case, we didn’t need to know the number of shares held by the existing shareholders because we know the percentage Microsoft got from this transaction which was 1.6%. However, we do not know the real number of shares.

I found another website that has more information about the percentage each of the shareholders has of Facebook.

“That’s obvious too with the $240 million cash investment (with more to come from other greedmonger private investors, of course, in another round now being arranged by Facebook) that bought Microsoft exactly 1.6% of Facebook.

That puts Microsoft behind Greylock Partners’ and Meritech Capital Partners’ 1.7%, Founders Fund’s 5% and Accel Partners’ 11%–Accel partner and Facebook board member Jim Breyer also has a personal 1% stake, now valued at $150 million–and Zuckerberg’s 20% (not the 30% that has been widely reported), which is now worth $3 billion.”

Organizing the information:

- Greylock Partners’ and Meritech Capital Partners’ 1.7%

- Founders Fund’s 5%

- Accel Partners’ 11% (Chim’s comment: pay attention to this, in the next posts I will show you why this number decrease from 15% to 11%, but they got a lot of money!)

- Accel partner and Facebook board member Jim Breyer also has a personal 1%

- Zuckerberg’s 20%

If the information is correct, then each of their pre-money valuation would be:

- Greylock Partners’ and Meritech Capital Partners’ 1.7% (of $ 15B) = $ 255M

- Founders Fund’s 5% = $ 750M

- Accel Partners’ 11% = $1.65B (Chim’s comment: again pay attention on this. They invested $XXXX amount and they ‘got’ this billion here, more info in the next posts.)

- Accel partner and Facebook board member Jim Breyer also has a personal 1% = $ 150M

- Zuckerberg’s 20% = $ 3B

Let me check for one thing: $240M + $255M + $750M + $1.65B + $150M + $3B = $ 6 billion.

Where or who is holding the remaining 9 billion? Who knows.

In the next post, I will share some findings about how VC makes money with concrete information.

Valuation: the money that you have

Remember from our last post. 

- Carlos told us that his company has 5,000,000 shares outstanding.

Leonardo wants 30% of return rate instead of 50%.

Let X be the number of shares purchased by the VC.

Let’s figure out the TOTAL number of shares once Leonardo invested.

 X / (5,000,000 shares + X) = VC’s share which is 24.7% of the company

A quick explanation: after the VC invested in the company, we will have the 5,000,000 shares and the VC’s shares of the company which we call it TOTAL now. Leonardo needs to have 24.7% of the TOTAL.

X = 0.247(TOTAL)  ,  TOTAL means 5,000,000 shares + X

X = 0.247(5,000,000 shares + X)

X  = 1,235,000 + 0.247X

X – 0.247X = 1,235,000

0.753X =  1,235,000

X = 1,640,106 shares

Leonardo needs to have 1,640,106 shares of the company. Actually, the company issues 1,640,106 new shares to get the $ 2 M.

Now, how should we calculate the price per share?

We need to assume that the shares do not gives dividends and we have a conversion of common stock of 1:1.

$ 2,000,000 / 1,640,106 shares = $ 1.22/ share

If Leonardo agrees with everything else, he will state in his contract that he will pay $1.22/share for 1,640,106 shares of the company. Carlos will issue 1,640,106 shares to have $ 2M.

Imagine that this deal was done and everyone is happy, how Carlos can brag how much his company was value at?

Carlos has 5,000,000 shares, just because he succeed in selling his new shares at $ 1.22, so his shares value at 5,000,000 X $ 1.22 = $ 6,100,000 - This is what we called pre-money valuation.

OK, this is much better the valuation with 50% of rate of return from Leonardo! Remember that the pre-money was only $ 1,950,000!!!

What is the value of the company after all of this calculations?

This is what we call it post-money valuation. 

We add simply the pre-money valuation and the VC’s investment: $ 6,100,000 + $ 2,000,000 = $ 8,100,000

As you can see, the rate of return is extremely important for valuation purpose. The new value is double the amount of the last valuation.

This is one of the reason Finance skill is so important.

In the next posts, I will use some real world news and apply this Venture Capital method to see some “hidden” information.

A small Article from Mark Davis from CFJ Gotham Ventures was explaining the needs to protect the investors money by adjusting the risk of a venture with the amount of equity needed to compensate the risk.

There is one exercise from the Harvard Busienss School case that shows the basics of how a startup is evaluated by a VC. (The name of the case is “Venture Capital Method – Valuation Problem Set”. There is the exercise and there is another file which is the solutions sheet).

Given that I can’t show the content of the PDF because of copyright issue. I am going to give a similar problem and how a VC can calculate how much equity he should take of a startup.

——————————– Chim’s example —————————–

Carlos, CEO of Fiction Co., needs to raise $ 2 million for his company. He projects that the net income will be $ 2 million in five years. He also knows that similar companies traded at a price earning ratio of 15X.

On the other hand, Leonardo, VC of BlueGreen Capital, wants to have a rate of return ranging from 30% to 50%. He wonders how many shares he needs for that rate of return.

** Solution **

We have:

- $ 2 million from Leonardo

- Value of the company in 5 years (this is an important assumption, the valuation of a company can very a lot according to the market situation):    2 M X 15 = $ 30 million

If Leonardo wants a return of 50% then:

$ 2 M (1.5)^5 = $15.18 M  >>> 50.6% of the company (of $ 30 M value of Carlos’ company)

Basic explanation of this calculation: 2 million is the money that Leornado is going to give to the company. The 1.5 is the rate of return of 50%. For example, if you give me 100 dollars with a expected return of 50% in one year, I will need to give you back 150 dollars back at the end of next year.

Now imagine, that this happens five times (five years), so we multiply 1.5 by 1.5 by 1.5 by 1.5 by 1.5. Easy job to calculate.

The result is basically the amount of money that the VC is expecting to get in five years from now.

If we know the expected value of the company in five years, then we will know what is the percentange of the company a VC needs to have today.

Now let’s see what is the percentage for a 30% of return.

$ 2 M (1.3)^5 = $ 7.42 M >>> 24.7% of the company (of $ 30 M value of Carlos’company in five years)

There is another issue for Leonardo. He knows what is the percentage he needs to have in the company, but he doesn’t know how many shares he needs to have.

For that we need to know the number of shares that the company currently has.

Carlos told us that his company has 5,000,000 shares outstanding.

Let’s see how many shares Leonardo needs to have with 50% of return rate.

Let X be the number of shares purchased by the VC.

Let’s figure out the TOTAL number of shares once Leonardo invested.

X / (5,000,000 shares + X) = VC’s share which is 50.6% of the company

A quick explanation: after the VC invested in the company, we will have the 5,000,000 shares and the VC’s shares of the company which we call it TOTAL now. Leonardo needs to have 50.6% of the TOTAL.

X = 0.506(TOTAL)  ,  TOTAL means 5,000,000 shares + X

X = 0.506(5,000,000 shares + X)

X  = 2,530,000 + 0.506X

X – 0.506X = 2,530,000

0.494X = 2,530,000

X = 5,121,457 shares

Leonardo needs to have 5,121,457 shares of the company. Actually, the company issues 5,121,457 new shares to get the $ 2 M.

Now, how should we calculate the price per share?

We need to assume that the shares do not gives dividends and we have a conversion of common stock of 1:1.

$ 2,000,000 / 5,121,457 shares = $ 0.39/ share

If Leonardo agrees with everything else, he will state in his contract that he will pay $0.39/share for 5,121,457 shares of the company. Carlos will issue 5,121,457 shares to have $ 2M.

Imagine that this deal was done and everyone is happy, how Carlos can brag how much his company was value at?

Carlos has 5,000,000 shares, just because he succeed in selling his new shares at $ 0.39, so his shares value at 5,000,000 X $ 0.39 = $ 1,950,000 - This is what we called pre-money valuation.

OK, it is not that much, but if he just had incorporated the company with $1000, he is actually getting a value of $ 1,949,000!

What is the value of the company after all of this calculations?

This is what we call it post-money valuation.

We add simply the pre-money valuation and the VC’s investment: $ 1,950,000 + $ 2,000,000 = $ 3,950,000

Fantastic! This is one of many ways a VC can value the company.

I challenge you: if Leonardo wants a rate of return of 30% instead of 50%, what is the amount of shares Carlos will need to issue and what is the price per share ? What are the pre-money and post-money valuations?

In the next post, I will give you the answer.