July 18, 2011

Venture Financing and Valuation

Quick Background

San Francisco Tech M&A Advisory

Tokyo

Class of 2012

AGENDA

Fina ncin g New Vent ures

Valui ng New Vent ures

The Term Shee t

Financing New Ventures

The Overview

So you have a business and you need financing Step 1: Profile your business

High

Capital Requirement

Capital Intensive, Proven Technologies Small Businesses

Capital Intensive, New Technologies

Low Low

New Technologie s / Business Model

Technology or Business Model Novelty
High

High Venture Capital Low Barriers High Barriers Venture Capital (Create Big Co.)

Scalability of Business

Boot Strap

Bootstrap (Create a small company) Low

Not Viable

Capital Required to Achieve Breakeven Cashflow Source: Get Venture, Mark Peter Davis. http://www.markpeterdavis.com/getventure/2010/07/how-to-raise-vcpresentation.html

Low

Medium

Investment Stage
Idea to Opportunity & Initial Product StartDev. Seed Launch to sustainability Growth

up

First Round

Secon Third d Round Round

Expan sion

Mgmt. Restru Buyou cturin t g

Turnarou nd

Family, Friends, Angel Investors

Venture Capitalists

Breakdown of Prominent VCs Portfolio

Source: HBS, Analysis by Professor William Sahlman based on 468 investments over the period 1990-2006

Two types of VCs

INDEPENDENT VCs CORPORATE VCs

VS.

Limitedyears 7-10 / None Stronger Limited Partners

(Pension Funds, Wealthy Individuals, Endowments)

Financial Monitoring Strategic Funding Time Discipline Synergies Horizon

Corporate Extensive Unlimited Weaker Treasury

Local Funding sources for Tech Startups

Valuing New Ventures

Valuation

Two things you need to know about valuation

Its an art, not a science

Its in the context of a financing negotiation

Venture Valuation

Assume StartUp needs $3.5mm in investment to carry its operations for the next five years In year 5, StartUp projects that it can generate $2.5mm in net income and be valued at a Price-to-Earning (PE) ratio of 15x StartUp visits Kawano Capital to ask for $$

Venture Valuation

Fact Summary Investment Term Year 5 Net Income Year 5 PER $3.5 million 5 years $2.5mm 15x

Required IRR for Kawano Capital 50%

Venture Valuation
Required future value of investment Required Ownership Stake

(1 + IRR) years x (investment) (1 + .50) 5 x (3.5) $26.6million

Future Terminal Value

= 70.9%
Entry Valuation

PER x Year 5 net income 15 x 2.5 $37.5mill ion

$3.5million

$4.9m $3.5m

= (Post$4.9m money) = (Pre$1.4m money)

That was easy (?)

In real life, investment are staged and rarely do entrepreneurs receive the full funding required in a single funding round Investors will most like would like to stage the investments to reduce risk

Multiple Rounds of Investment

Required future ownership stake

future value (investment) terminal value (company)

(1 + IRR) years x = (investment) net PER x Year 5 income

Final Ownershi p

= final %

Investme Term IRR nt Round 1 Round 2 Round 3 $1.5mm $1.0mm $1.0mm 5 yr 4 yr 3 yr

50% 30.4% 40% 7.3% 25% 3.3%

Multiple Rounds of Investment

Required future ownership stake

Retention % = 1 (total future final ownerships from subsequent rounds) Final Current Ownership % Retention Ownership =
Investme Term IRR nt Round 1 Round 2 Round 3 $1.5mm $1.0mm $1.0mm 5 yr 4 yr 3 yr Final Retentio Current Ownershi n Ownershi p p 89.3% 96.7% 100% 34.0% 7.6% 3.3%

50% 30.4% 40% 7.3% 25% 3.3%

Multiple Rounds of Investment

Entry Valuation

Investme Term IRR Current PrePostnt Ownershi money Money p Valuation Valuation Round 1 $1.5mm Round 2 $1.0mm Round 3 $1.0mm 5 yr 4 yr 3 yr 50% 34.0% 40% 7.6% 25% 3.3% $2.9m $12.2m $29.3m $4.4m $13.2m $30.3m

So which is better for the entrepreneur?

Single-staged investment

VS.

Staged investment

Less (29%) More

Founder Ownership Financial Security

More (59%) Less

Valuation Deadlocks
Valuation Deadlock

Stated discount to the Well put that aside Staged investments next round of for now investment

The Term Sheet

Valuation is only half the trouble

Sometimes more important than the valuation

ANOTHER key success factor

THE TERM SHEE T

Lesson One

Investor s rarely buy common equity

CONVERTIBLE PREFERRED STOCK Definition: Hybrid security that can be converted from subordinated debt into equity at the holders discretion

EXAMPLE Kawano Capital invests $4mm in convertible preferred stock in StartUp for 40% of the firm (Post-money valuation of $10mm)

Convertible Preferred Stock

VC stake Postmoney valuati on Firm Enterprise Value 60%

$4m m

40%

$4m

$10m

Firm Enterprise

Convertible Preferred Stock

VC stake Postmoney valuati on Firm Enterprise Value 60%

$4m m

Protect downsid e
40%

$4m

$10m

Firm Enterprise

 Pitch right for your type of company Deal terms have value, its easier to negotiate these than the value itself Do not run out of cash Demonstrate that you are capable of attracting the right team Who you raise money from is critical Local vs. abroad

EN D

Some Ending Thoughts

2011 LAUNCH Conference, SF Takahito Iguchi, CEO Tonchidot

Be ENERGETIC!!