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Exam Questions

Context (VC environment in 2001):

1. Differences between VC in America and Europe?
London is a good spot to have a branch as it is neutral financial territory which means that all
the firms can have a presence here without being seen to poach on someone elses preserve
Advantages and disadvantages for Accel Partners to go to Europe (page 6 of the case) - Choice
of the current LPs; The opportunity to attract a significant member of new European LPs; A first
time buzz
Bad market at that time (why?)
Inexperience in large extent when it comes to European VC, which resulted in both bad and
good companies being overpaid. Bad market (market crush) was a consequence of that.
Non-US private equity funds received higher management and carried interest

2. Partnership versus own branch in Europe

Partnership: exchange of knowledge and information between two companies, although parttner
companies in Europe may often be a weaker side in that exchange process.

Own branch: could be set by transplanting current employees, or recruiting employees from
existing firms. In the case of transplanting current employees, the problem would arise
regarding the lack of connections they have. On the other hand, employees recruited from other
firms could happent to lack knowledge and experience.
3. What is Accels approach and strategy? Is it promising?
Finding a team
Raising money
Finding space
Cross-economies compensation system, splitting the carry and the fees between Europe
and the US to align the interests of the groups
Deal approval process: finding a deal a team would perform the initial due diligence, then
present it to more senior partners for review (in the Europe group Jim Schwartz and Joe
Schoendorf were in this position). A partner assessed the companies team, the technology the
due diligence and discussed it with domain experts. The senior partners and the team
presented it to the entire partnership if they thought it was promising. The presentation was
conducted by the portfolio company and the senior partners. All the presentations were given in
California (if European or American companies). The partnership needed to reach a consensus
on the investment decision. European countries normally needed to travel two times to
Socializing of deals was common. This was informal presentations of possible deals by
partners during their weekly meeting.

4. What changed in the VC sector over the years? (80s vs 90s
vs 2000s)
Mid 80s:
VC industry was staffed with too many bankers and accountants;
It was fine in term of structuring the deals but lacked expertise to assess trends and technologies
and to add value.
Large amount of money were raised but inesperience investors tended to do poorly deals at high
Venture capital in Europe returned being synonymous with private equity, later-stage investing
dominated by buyouts or transactions that involved a fair amount of financial engineering.
European firms closed their VC operations
U.S. firms closed or sharply reduced their european presence

End 90s - VC recovery in Europe
General public was becoming more aware of venture capital as a financing option;
Higher returns (than those on London Stock Exchange, by 10 to 20 percentage points)
Substantial pool of available capital began to accumulate - European institutions invested up to
10 % of their assets into PE and VC firms, although that percentage was not close to the 20 % of
some U.S. groups
U.S institutions seeking to diversify their portfolios;
Venture capitalism was more socially accepted;
Regulatory schemes were slowly being harmonized
Technological boom (it didnt achieve the scale of that in the U.S)
Lack of operational expertise
due in part to conflicting regulatory regimes, European countries established their own small.cap
exchanges (Germanys )
European institutions invested up to 10 % of their assets into PE and VC firms, while U.S.

Record-breaking amounts of money raised and invested
Collapsed from a high 82,000 to 14,000
EASDAQ was bought NASDAQ
Venture investing in Europe was in an uncertain state
Small firms that had sprung up over the past few years were struggling
Tax rates for capital gains were falling
Stock option became acceptable
Europes biggest VC is 3i

5. Private Equity vs Venture Capitalism

Private equity is usually when we talk about an existing company with existing products and CF,
that will going to be resctructered to optimize its finacial performance. When private equity
works properly it can save poorly-performaning companies from bankrupcy and turn them into
profitable entreprises.

Company Types: PE firms buy companies across all industries, whereas VCs usually
are focused on technology, bio-tech, and clean-tech.
% Acquired: PE firms almost always buy 100% of a company in an LBO, whereas VCs
only acquire a minority stake less than 50%.
Size: PE firms make large investments at least $100 million up into the tens of billions
for large companies. VC investments are much smaller often below $10 million for
early-stage companies.
Structure: VC firms use only equity whereas PE firms use a combination of equity and
Stage: PE firms buy mature, public companies whereas VCs invest mostly in early-stage
sometimes pre-revenue companies.
Risk & Return
VCs expect that many of the companies they invest in will fail, but that at least 1 investment will
generate huge returns and make the entire fund profitable.
But it would never work in PE, where the number of investments is smaller and the investment
size is much larger if even 1 company failed, the fund would fail.

6. Valuation

Some very rough and sketchy calculations:
Valuation of Cape Clear:
Venture Capital Method:
Harvest Year: 3
EBITDA: 9,628,677 + 523,693 (deprecation) = approximately 10
Debt: 2,470,322
Expected EV/EBITDA of comparables: I calculated this by dividing market cap by revenues of
compepitors (see exhibit 5). Then take the average. (e.g. 1140/150.6)
Expected EV/EBITDA: approximately 10

1. Valuation: EV/EBITDA * EBITDA = 10*10 = 100 Million - 2,470,322 Debt = 97,5 Million
2. At a discount rate of 30% the Present Value = 97,5/(1,3^3)= 44,4 Million

They are asked to invest at least 15 Million

3. 44,4x - 15 = approximately 35% of Equity.

This means: they would get 28,5 M shares.
x / (53M shares + x) = 0,35 x = 28,5
At a price of: 1.9 per share. (28,5 / 15)

Ninja edit: We just calculated the P/E of the two competitors with postive incomes and averaged
the valuations that came up. We did it by
1. calculate the P/E of the competitors: market cap / net income / (IPO market cap / IPO
share price)
2. average the P/E and multiply by net income of Cape Clear
3. Take the average of that valuation and the EV valuation.
4. Should be pretty close to what resulted from the calculations above since P/E valution is
pretty similar.

The problem with this might be high P/E ratio of one company that was given as a comparison,
BEA Systems, since its PE ratio on 31/12/2001 was 578.29 (http://www.quandl.com/OFDP-
Ratio), and in April of 2001, around 450. Given that in this case, only two companies can be
taken for their PE ratio (due to the fact that others have negative earnings), average is around
250, which then results in an unrealistically high valuation.
Comment: You still have to divide by the number of shares, then P/E gets more realistic!

7. Why should Greylock also invest? Advantages and
disadvantages of a second (top tier VC):

Would able to contribute with additional value and network contacts to the company
They work in the same industry: focus in enterprise software and communication
Good contacts in USA in this industry; Experience
Diversifying risk
If further series were needed Accel would not be the only one who would need to invest

Never worked outside USA
Accel would have to give enough of the company to make it worth for Greylock

8. Which term sheet should we offer to?
If the term sheet is nod good enough Cape Clear will take decide for another VC but if the term
sheet is too good the rendit of this investment will be lower than possible. Never-the-less...as
Cape Clear is not willing to move the company to the US we can give them a worse term sheet.
Less US VC companies are willing to invest outside of the US (e.g. Sequoia)

Security type: Convertible preferred stocks
At year 5 preferred shareholders may convert to common stock or choose to collect liquidation payment

This class of preferred has the option to be redeemed or converted into ordinary shares
During a pre-specified period
Redemption gives downside protection while conversion provides the upside benefits
Conversion may be required at certain events (IPO or trade sale) if the value of firm is sufficiently
high (thus making that option in the money)
May have anti-dilution clauses to protect investors in future financing rounds

Dividends: Dividend to be paid at exit event before shareholder exercise conversion rights
Preferential Dividend to be paid in case of liquidation or conversion: 8%
Maximum cumulative dividend: 25%
No dividend will be declared or paid on Common without the consent of i) the holders of at least 60% of the
then outstanding shares of Series A preferred

Anti-dilution rights Full ratchet

Person to be designated as companys CEO OToole
Co-founder and CTO at IONA (more contacts; more experience)
Clarke would stay as CTO (experience in the industry; knows the product)
(Is this really a good idea? Clarke could leave the company because is not happy with this

Investor demands right to participate pro-rate in future financing rounds - Yes
Investor demands right to impose Founder Termination in the future Yes
Other special conditions: Drag Along provision
(obligation on all shareholders of the company to sell their shares to a potential purchaser if a certain
percentage of the shareholders vote to sell to that purchaser.

9. Has Accel the right team / the right skills for entering and
Italian. Was a Partner at Dought Hanson & Co (European leading
private equity firm). Also Europe?
Kevin Comolli engineer and Mathematics background (with highest distinction from
Northwestern University) and a MBA from Harvard Business School. Speaks advanced German
worked as Executive Director for Goldman Sachs International
Feargal Rordin engineer with a summer internship at Goldman Sachs and a MBA
Joe Golden, was leading the Ciscos European Investment and Acquisition Group,
managing 5 billion in 2000, on the hand guy with a sense to do things right,
Kaj-Erik Relander, Finn, significant operating experience, former entrepreneur,
management consulter, doing deals for a Finnish Venture Capitalist firm which invested in
technology, MBA at Wharton and the Helsinki School of Economics, served as a CEO in
Telecom Finland (later Sonera)

10. Will companies be influenced by the fact that they have to
go to the USA? Will it be less likely that they choose Accel as an

11. Analyse the Opportunity


Comolli said that Cape Clear has ...everything Accel soughta strong team, a good technology in
a new growing space and a defined path to reveues that included a strong focus on international
growth. Also the macro-level was good. There was no sign of slowing down in the sector. But
the time was not ideal. Accel was still raising the European Fund; not the right team yet of Accel
Europe, searching for a office location and trying to set up the process of orking together with the
head office in California.

The product: software that facilitates the creation and integration of business applications on the
Cape Clear Software develops and markets Web Services products that enable corporations to link their
internal IT systems and applications quickly and easily over the Internet. Cape Clear is supporting a new
generation of business applications by making back-end systems available to third parties over the
Internet. This removes the traditional barriers to creating business-to-business applications.

Create value to: employees and companies.
To less specialized individuals because they would be able to perform these tasks (it wouldnt be
necessary anymore to hire highly skilled technologists).
The company would also benefit because it would be much more productive, it would save time
and money, and avoid mistakes in data entry.

An interesting Market: The market is looking for standards-based technology that can be used by
mainstream developers to bring different applications together on the internet. Cape Clear has that
technology. They were exploring an opportunity that it wasnt being filled yet by anyone.
It was a new and growing market
Investment in a Hot Sector (at the time web services were a novelty)

Only six months away from competitors.

IP protection? Any other type of protection?

12. Analyse the Cape Clear Team. Is this a good team?
The skills and experience of the combined management team
They had the right skills for this opportunity:
The Trio already knew each other, and had work together in IONA
They came from IONA - one of Irelands first technology superstars.
Competences in management and in the industry
Anrai OToole was IONAs co-founder and CTO
Colin Newman head marketing
They left a perfectly safe job to build a new their own company, so they were committed with this
The fact that Newan and OToole left their job draged US VC firms attentio immediately n
They took ACT investment because they knew ACT could act as a mentor. The Trio didnt have enough
knowledge concerning Venture Capital.
Conclusion - The team had:
Strong management experience
Strong marketing and sales experience
Have strong scientific knowledge in the relevant innovation
Have the relevant contacts
Ready to establish the right partnerships on order to get access to relevant strategic resources
(We want Silicon Valley money; They reject some investors)

Reasons why U.S. VCs entered Europe
Avoid competition in the US which drove the deal prices up
Diversifying investment portfolio
Salaries in Europe were lower
UK spoke same language
No serious competition in Europe (most European companies focused on financial s and not on
supporting the firms) - Adding value

Worries about Europe
Does not offer sufficient diversification because its highly correlated with US economy
Europe was focuses about wireless & telecommunication
Less experienced stuff

Comparing Europe vs. US
European VCs came form financial background and solely focus on revenue forecast (American
focus on Businesses, product, customers , market conditions, value proposal. Etc. )
Europe: industry is staffed with bankers and accountants (don't anticipate trends and
technologies to invest in)
Due diligence after offering a term sheet
Harder to exit investment (hard to do IPO)
US companies usually had more money, more expertise and a brand-name cachet with limited
partners, entrepreneurs, other VC firms and potential customers and acquires of portfolio companies.
They would provide a bridge to the biggest market

Accel Abroad
Only one office in Europe
Leverage cooperation between offices
Separate fund for Europe
o 1. Give choice to current LPs
o 2. Attracting new European LPs
o 3. First time fund excitement
hard to educate European LPs about the industry
management fees at carry is larger in the US (Europes smaller fee p.6/7 for numbers )
Milestone: December 200, $250 Million raised, no team, no office, markets falling,

Relationship of European & US offices
London and California ppl would see each other deals
Weekly investment meetings
Offside meetings
CEO summits for portfolio companies
High travel and time costs
European companies usually had to fly twice to the US
Cross economics: Both offices Shared carries and fees to align interest
Consensus needed for investment decision

The Deal approval process
after conducting due diligence, GPs fly to US to present; if accepted fly with portfolio company
deal approval like in the US ( p. 9)
vise versa supervision
informal networks: weekly informal meetings , software and network teams, called socializing the
everyone was responsible for the deal

Cape Clear Investment
founded June 1999 by professors
Three guys from IONA technologies
Keen to start something new
Team very motivated and left a lot of options
on the table (Cortez Rule)
Irelands First technology superstart
Very experienced team
Previous success of IONA ($40 Million at
IPO in US)
Three months spend on studying the marker
to spot niche
Software integrates business applications
Easy to implement, by less specialized stuff

Reasons why they want American VC
-Little time, need for financing
-Cape Clear focused on the US. Market
-But important to stay in Ireland

In 2000 raised $1.5m in angel financing to
have someone experienced in the VC industry
on the team.
NO government financing
Set up a subsidiary in California (just to
have presence)
In October 2000 hired two superstar
executives from IONA OToole and Newman
They invested $1.5m
Acquisition of small UK company for
application server (got footprint in UK)
Launch in December 2000 (increased
attention from US VCs)
In March 2000 Microsoft published SOAP
and competition increased
In February 2001 they met with Accel
American VSc were only interested in doing
business with companies with HQ in US
(besides Accel)

Why Greylock is good for Accel
Aneel Bhursi (GP at Greylock) had been on
board of PeopleSoft ( similar democratizing
effect on HR systems)
Greylock provides networking in the US
Never invested outside the US
Wanted big stake in the company (at least
20%) to make investment worthwhile with
traveling to Dublin
Greylock understood what Cape Clear
They had expertise, experience in driving
such a product to the market

Valuing Cape Clear
Cape Clear is 6 months ahead of any firm in
the US
Accel wanted to lead the project, but also
wanted Greylock in the company
ACT ventures (business Angel investor from
first round) had to keep ownership
Only way to do it: dilute ACT ventures and

Cheap to buy
Ahead of competition
Excellent team (motivate skilled,
experience), know how to develop a product, the
know the industry and its needs, know how to
build a company for an IPO,
Sales in the US production/research in
Europe (less costs, at the same time creates
problem for the VC in terms of exit options,

1)Should Accel dilute ACT ventures and Management?
2) What is the best for the company?
3) Download package vs. enterprise wide sale
4) No HQ in the US makes it harder for an IPO
5) What does Greylock add to the option pool?
6) What would adding Greylock mean for pricing and potential returns?

Who is who
Comolli, Kevin : Managing general partner of Accel Partners London office
Rordin, Fearghal: principal at Accel Partners London
Swartz, Jim: co-founder and general partner, working half-time on Accel VIII and half-time on Accel
Schoendorf, Joe: partner at Accel, who works half-time for Accel Europe
Golden, Joe: staff of Accel Europe
Relander, Kaj-Erik: staff of Accel Europe