1. VCIC P REP S ESSION “VC 101” Prepared by Patrick Vernon Dir. of Venture Initiatives ©2014 UNC Kenan-Flagler

2. What is Venture Capital? Institutional equity investments in high growth startups.

3. Institutional equity investments in high growth startups. InstitutionalProfessional money managers Equity Investments Private equity (not public, not debt), shared ownership High GrowthHit-driven investment thesis StartupsDebatable term, not mature businesses

4. What is a VC’s Job? Return 20-25% to Their Investors (Limited Partners, or LPs)

5. Question? How is a VC similar to a mutual fund manager? Different?

6. What is a VC? Professional money manager Private equity High risk/return Portfolio of investments

7. What is Venture Capital? Asset class Subset of private equity High risk, high return Hit driven

8. Early Venture Firms 1962: Draper and Johnson Inv. Co. 1969: Venrock (renamed) 1972: Kleiner Perkins, Sequioa 1985: Draper Fisher Jurvetson

9. Example: Kleiner Perkins 1980: KPCB II $55M 1989: KPCB V $150M 2000: KPCB X $750M 2010: 3 funds closed: nearly $2B

10. VC Job Duties 1.Fundraising 2.Sourcing deals 3.Investing 4.Growing ventures 5.Exiting

11. VC Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

12. VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

13. Raising a Fund VC fund is a partnership GPs (general partners) are the VCs who actively invest the fund in startups LPs (limited partners): –Financial investors with no active role –“Institutional” - pension funds, university endowments, insurance companies, etc.

14. VC Cash Flow Startup $$

15. VC Cash Flow LP 2 LP 3 LP 4 Fund 1 $$$$ Limited Partner Limited Partner LP n $$ Startup $$

16. LP 2 LP 3 LP 4 Limited Partner Limited Partner LP n $$ Fund I Fund II Fund III Fund IV

17. Raising a Fund LP 2 LP 3 LP 4 VC Firm (GPs) Fund 1 $$$$ LP 1 LP n Pledge $$

18. Raising a Fund CalPERS Morgan Creek Capital Morgan Creek Capital VC Firm (GPs) Fund 1 $$$$ UNC Endowment AIG Pledge $$ Example NC Pension Fund Commitments only. No actual cash changes hands.

19. “Capital Call” CalPERS Morgan Creek Capital Morgan Creek Capital VC Firm (GPs) Fund 1 $$$$ UNC Endowment AIG Series A Capital Call NC Pension Fund Capital Call Startup

20. VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

21. Source Deals: High Growth Tech –Social media –SaaS –Hardware Media Cleantech Life Sciences –Med Device –Therapeutics –Biotech Healthcare IT

22. Source Deals: Network Lawyers, CPAs, CFOs, bankers Other VCs (syndication) Serial entrepreneurs Conferences Universities –Technology transfer –Teach, coach, mentor, judge

23. Due Diligence Research to decide whether or not to invest Includes meeting with the founders Rely on vast network of experts

24. VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

25. Equity Investing Buying % of startup Exchange cash for new “preferred” shares of stock Not debt

26. Typical Growth of Bootstrap Venture Normal bootstrap business grows steadily (if you’re lucky).

27. Rounds of Equity Funding (Gross Approximations) Friends/ Family $1,000-$100,000 Seed or Pre-Seed $50,000-$250,000 Angel $100,000 - $1,000,000 IPO or M&A or Later Stage PE $2-3M | $5-15M | $25M+ Early Late VC Rounds A, B, C… (Institutional)

28. How Does a Round Work? Pre-Money Valuation + Investment = Post-money Valuation $ $ $ $ $$ + =

29. Simplified Example: “1 on 2” Investment $1M Pre-Money Valuation $2M $2M Pre-Money + $1M Investment = $3M Post

30. Simplified Example: 1 on 2 Investors 33% Founders 67%

31. Mechanics Include Shares 1,000,000 Preferred Shares at $1/ea. 2,000,000 Founders Shares @ $1/ea. New shares created and assigned to investors Shares created in articles of incorporation

32. How Does a Round Work? Negotiated Pre-Money Valuation + Negotiated Investment = Post-money Valuation $ $ $$ + =

33. VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

34. Growing Ventures On the Team –“Active” participation = board seat(s) –Advisors (connections, strategy, etc.) Future rounds –Valuation –Milestones –Syndication

35. Board Seats Board of directors controls the venture (unlike board of advisors) Small ventures have small boards that meet often (quarterly), 3-7 members Odd number to prevent ties % ownership of stock should be (approximately) reflected in % of board seats –E.g. own 60% of stock, control 3 of 5 seats

36. Advisors Even if not on board, VCs will have strategic input VC network benefits –Management team additions –Customers –Partners –Competitors

37. Future Rounds Future rounds are the norm, not the exception (most entrepreneurs do not realize this) VCs help find “syndicate” investors –Later rounds can be much larger –New network benefits Up round: valuation is higher and investment is (usually) higher Down round: valuation is lower

38. Year0510 Fund Life: 10 Years Invest and Reserve Follow-On Rounds Harvest “Raise” Fund

39. Example Successful Investment Invest and Reserve Follow-On Rounds Harvest Series A Due Diligence Hit Milestones Hit Milestones Series B EXIT 0235810 Find Deal

40. A Pattern That Repeats AA BB Exit 0235810

41. One of Many 0235810 AA BB Exit

42. 0235810 AA BB AA BB Portfolio of 10-25 Investments AA BB AA BB CC AA BB AA BB Bust AA BB AA AA AA BB CC AA DD BB Exit Big Exit Exit

43. Startup Invest Startup Portfolio VC Firm (GPs) $$ Fund 1 $$$$ Capital Call $$ LP 2 LP 3 LP 4 LP 1 LP n

44. Future Rounds VCs in Series A almost always join Series B –“Pro rata” means they invest to keep same % ownership –aka, “maintain position” In a hits-driven business, not maintaining a position is the third rail –“Last money in” dictates the terms

45. Future Rounds It is absolutely imperative that you reserve funding for future rounds! Your analysis of the deal at VCIC must include assumptions about future rounds and the exit.

46. VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise

47. VC Return “Top Quartile” venture firms return >20% average ROI to LPs Fund has life of 10 years Average investments are 5-7 years

48. Big Exit 0235810 AA BB AA BB Portfolio of 10-25 Investments AA BB AA BB CC AA BB AA BB Bust AA BB AA AA AA BB CC AA DD BB 3 2 5 6 8 9 11 10 Exit 4 1 7

49. 0235810 AA BB AA BB Exit Scenario AA BB AA BB CC AA BB AA BB Bust AA BB AA AA AA BB CC AA DD BB Exit Big Exit Exit ? ? ? ? ? ? Bust Exit ? ?

50. Startup Invest Startup Portfolio VC Firm (GPs) $$ Fund 1 $$$$ Capital Call $$ LP 2 LP 3 LP 4 LP 1 LP n

51. Single Exits Home Run dud Triple VC Firm (GPs) Fund 1 $$$$ $$ dud Single Double dud $$$$$ $$ $$$ $ $ $ $$ Single LP 2 LP 3 LP 4 LP 1 LP n

52. Fund Return Examples 150M fund Fees: 3M/year (salaries, rent, travel) 12 portfolio ventures at $10M avg. investment To get 20% ROI, we need ~$450M (20% of 150M = $30M x 10 years) –That’s two ventures going 20X!!

53. Getting to 20% ROI Rule of thumb: 3X on entire fund However, each investment is not 10 years –Money not “put to work” until a capital call –Exit could happen before end of fund You could reach 20% with only 1.5X

54. Deal Return Example VCIC Round A: Negotiate 1 on 2 –$1M investment on $2M pre, post-money = $3M –Ownership for VCIC firm, 33% Assume B Round: 3 on 9 –$3M investment on $9M pre, post-money = $12M –Ownership for VCIC firm: 25% + (33% of 75%) = $50% Assume Exit of $80M at acquisition VCIC fund return: $40M/$4M = 10X See “VCIC Math Help.ppt” for more about deal structure.VCIC Math Help.ppt

55. What is a VC’s Job? Return 20-25% to investors (LPs) 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise