Professor Sandeep Dahiya Georgetown University Accel Partners VII Professor Sandeep Dahiya Georgetown University

Road Map Last Class Today’s Class Tomorrow’s Class View of a prominent LP Role of VC investments in Broader portfolio management of LPs Trends in Private Equity Today’s Class Detailed look at Private Equity Partnership Agreement Move to Investment part of VC Cycle How do VCs Value investment – Cap Tables Tomorrow’s Class Term-Sheets!!! Features of Private Equity Securities

Accel Partners – High Level Questions How are VCs compensated? How does the compensation structure of VCs differ from CEOs or Fund managers Why do we observe the partnership structure? Why do GPs need to put down 1%? Why not Take down the entire capital at one go? Why do we see the various restrictions on size and co-investment in previous deals?

Accel Partners – More General Issues How do Management Fee and Carry interact with Fund size? $20 million fund with 2 partners(2.5% Mgmt fee) $400 million fund with 4 partners (2.5% Mgmt fee)

Accel Partners VII Would you invest in Accel Partners VII Would David Swensen invest ? How they done in the past? How are they likely to do in the future?

Accel Partners Now Did close Fund VII with 30% carry Accel VIII – mother of all funds $1.6 BILLION proposed in 2000 scaled back to $950 million later Accel IX 400 million Accel X $520 million No Idea how the funds are doing but was Series A investor in FACEBOOK.

VC Method For Valuation Professor Sandeep Dahiya Georgetown University

VC Method Information you would almost always have I – Amount being raised from VC X- Number of Shares currently owned by entrepreneur Information that requires judgment call R – VC’s required return (IRR) usually between 25% to 80% T – Time to exit (When VC gets money back) V – Value of the company at time of exit Numbers you need to calculate F – Fraction of company VC would need to get the return Post-Money Valuation – Value of company after funding is received Pre-money Valuation - Value of company before funding is received P – Price per share. Y – Number of shares to be issued to the VC

An Example Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. Comapny currently has 1 million shares all owned by the entrepreneur. What share of company would a VC require today if VC’s required return is 50%? Exit Value = $4 x 25 = $100 million POST MONEY VALUATION = 100/(1+50%)5 = 13.17 million PRE MONEY VALUATION = 13.17 – 5 = $8.17 million Since 1 million shares outstanding Price per share = $8.17 Alternatively VC must get 5/13.17 = 38% of the company Let us assume Y is the number of new shares that must be issued to the VC, X are the existing number of shares Y/(X+Y) = F =38% algebraic manipulation yields Y = 612,000 shares. Price per share = 5/0.612 = $8.17 What if VC required 30%? What if need was for $12 million?

An Example Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. Comapny currently has 1 million shares all owned by the entrepreneur. What share of company would a VC require today if VC’s required return is 30%? Exit Value = $4 x 25 = $100 million Value of VC’s 5 million investment at 30% = 5*(1+.30)5 = $18.6 million VC would ask for 18.6/100 = 18.6% of the firm! How many shares if VC needs 50% return (would ask for 38% of the firm). X original number of Shares, Y new shares Y/(X+Y) =0.38, since X =1, Y=0.612 How many shares if VC needs 30% return (would ask for 18.6% of the firm). Y = X(F/1-F) = 1*(0.186/1-0.186) Y = 0.2285 million shares

Multiple Rounds/ Exit Dilution Imagine that you need 15% of the company at the exit to get your mandated return. Simple case – 100 shares would want 15 shares What if along the way company issues another 50 shares (option/new investor) what happens to your stake? New total shares = 100+50= 150 You interest = 15/150 = 10%!! – you have been diluted You would insist on more than 15% today to end with 15% eventually – how to figure that out Expected dilution = 50/150 = 0.333 Fraction needed today = Final ownership/(1-dilution) =15%/(1-0.333)= 22.5% implying 22.5 shares today Check>>> at the end 22.5/150 = 15%

Example Contd. Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%? Need to reserve 15% of the firm in terminal year for the option pool for mangers. VC still needs to get $5 million*(1.5)5 = 38 million Only 85 million available after the option pool VC would want 38/85 = 44.7% of the company. 5 million for 44.7% of the company imply Post money valuation of 5/0.447= 11.19million and pre-money valuation of 11.19 -5=6.19 million New number of shares>>> Y = X[F1/(1-F1-OP)] = 1 million(0.38/(1-0.38-0.15)] =0.8085 million

Multiple Rounds of Financing Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%? Need to reserve 15% of the firm in terminal year for the option pool for mangers. Would need another $ 3 million at the beginning of year 3 – round 2 investors require 30% return Round 2 investor need 30% on its 3 million i.e. 3(1.30)3 = 6.59 million Amount available after option pool is 85 million implying 6.59/85 = 7.75% Round 1 still needs $38 million to generate 50% but only has (100-6.59-15) million to get it out of implying initial stake = 38/(100-6.59-15)=0.485 or 48.5% stake. What is the Post and Pre Money Valuation at round 1? How many shares need to be issued to Round 1, Round 2 and option pool? 5/0.485=10.32; 5.32 Round 1 = 1x[0.485/(1-0.485)] =941,748 Round 2 = 1.941748x[0.0775/(1-0.0775)]=163,128

For Practice Recalcualte the numbers detailed in “The Basic Venture Capital Formula”

Capitalization Tables Page 10 (Bottom) of ONSET ventures case describes the financing history of TallyUp. Onset offered to invest $750,000 at a price $1 per share in return for 31.6% of the company. Later, ONSET invested another $250,000 at the same price ($ 1 per share) when Reed Tausig as the CEO. Please draw up the capitalization tables, pre-money and post money valuations for tally before and after each round of financing.

After Next Investment of $250,000

After option Pool Creation of 750,000 Shares

What if Mann is able to do a $3. 5 million round at 2 What if Mann is able to do a $3.5 million round at 2.5 times step up (ONSET invests $1 million in this round)

Tomorrow How Do VCs Evaluate Investments Term sheet for Trendsetter HW 2 is due on Monday

VC Framework Critical Issues Responses by investors Uncertainty Asymmetric Information Nature of Firm’s assets Conditions of relevant financial and product markets Responses by investors Active Screening Stage financing Syndication Use of Stock options/grants with strict vesting requirements Contingent control mechanisms – Covenants and restrictions Strategic composition of Board of Directors