The Deal: Valuation, Structure & Negotiation Venture Planning Chapter 15 Dowling Fall 2005

Valuation, Structure & Negotiation Ingredients to the entrepreneurial valuation Ingredients to the entrepreneurial valuation Cash Cash Time Time Risk Risk

Valuation, Structure & Negotiation The core mission … is to build the best company possible. This is the single surest way of generating long-term value for all the stakeholders and society. -Timmons “ ”

Valuation, Structure & Negotiation Determining Value: At least a dozen ways Determining Value: At least a dozen ways A Key Consideration: A Key Consideration: Investor’s Required Rate of Return (ROR) (IRR) Investor’s Required Rate of Return (ROR) (IRR)

Valuation, Structure & Negotiation Inherent conflicts between users and suppliers of capital Inherent conflicts between users and suppliers of capital Entrepreneur Wants : As much time as possible for financing Entrepreneur Wants : As much time as possible for financing Investor Wants : To supply capital just in time Investor Wants : To supply capital just in time Entrepreneur Wants : As much $$$ as possible Entrepreneur Wants : As much $$$ as possible Investor Wants : To invest just enough $$$ Investor Wants : To invest just enough $$$ Entrepreneur Wants : Control of Board-o-Directors Entrepreneur Wants : Control of Board-o-Directors Investor Wants : Control of Board-o-Directors Investor Wants : Control of Board-o-Directors

Valuation, Structure & Negotiation Staged Capital Commitments Staged Capital Commitments Delivers funding in stages, rather than in lump sum Delivers funding in stages, rather than in lump sum Allows investors to evaluate company as time passes Allows investors to evaluate company as time passes

Valuation, Structure & Negotiation Conservation of capital Conservation of capital To “encourage” managers to conserve, VCs apply strong sanctions if capital is misused, by: To “encourage” managers to conserve, VCs apply strong sanctions if capital is misused, by: Diluting management’s equity share at punitive rate Diluting management’s equity share at punitive rate Shutting down operations completely Shutting down operations completely

Valuation, Structure & Negotiation Structuring the deal Structuring the deal Deals involve allocation of cash flow streams, allocation of risk and allocation of value between different groups Deals involve allocation of cash flow streams, allocation of risk and allocation of value between different groups

Valuation, Structure & Negotiation Characteristics of Successful Deals Characteristics of Successful Deals Simplicity Simplicity They are robust They are robust They take into account incentives of all involved under variety of circumstances They take into account incentives of all involved under variety of circumstances They provide mechanisms for communications and interpretation They provide mechanisms for communications and interpretation They are based primarily on trust rather than legalese They are based primarily on trust rather than legalese They do not make it too hard to raise more capital They do not make it too hard to raise more capital

Valuation, Structure & Negotiation Lessons Learned: Lessons Learned: Raise money when you don’t need it Raise money when you don’t need it Learn about the process and how to manage it Learn about the process and how to manage it Know your relative bargaining position Know your relative bargaining position If all you get is money, you’re not getting much If all you get is money, you’re not getting much Assume the deal will never close Assume the deal will never close

Valuation, Structure & Negotiation Lessons Learned: Lessons Learned: Always have a backup source of capital Always have a backup source of capital The experts can blow it – sweat the details yourself The experts can blow it – sweat the details yourself Users of capital are at a disadvantage when dealing with suppliers of capital Users of capital are at a disadvantage when dealing with suppliers of capital If you are out of cash when looking for capital, suppliers of capital will eat your lunch If you are out of cash when looking for capital, suppliers of capital will eat your lunch Startup entrepreneurs are raising capital for the first time; suppliers do it for a living. Startup entrepreneurs are raising capital for the first time; suppliers do it for a living.

Valuation, Structure & Negotiation Sand traps Sand traps Legal circumference

Valuation, Structure & Negotiation Sand traps Sand traps Attraction to Status and Size Attraction to Status and Size

Valuation, Structure & Negotiation Sand traps Sand traps Unknown territory Unknown territory

Valuation, Structure & Negotiation Sand traps Sand traps Opportunity Cost Opportunity Cost Underestimation of other costs Underestimation of other costs Greed Greed

Valuation, Structure & Negotiation Sand traps Sand traps Being too anxious Being too anxious Impatience Impatience Take-the-money-and-run myopia Take-the-money-and-run myopia