How VCs Eval Pot. Venture Opps 1. Eval of potential venture opps 2. Eval of biz model 3.

Due diligence 4. Process through which funding decisions are made 5. Financial analysis 6. Risk 7. Potential exit route Siegelman with Kleiner Perkins Caufield Eval of potential venture opps Goal invest in a co if it is big enough to turn into a successful, sustainable IPOable co. They do not want cos built to be acquired or sold. They want very high RT, very high risk projects #1 thing is large mrkt opp in a fast growing sector with explosive growth such that it makes it difficult for somebody to catch up or incumbents to respond. A co to have $100M to $300M rev stream in 5 yrs Active mrkt pot of at least 500M and achieve at least 25% of mrkt share #2Seek a competitive edge that is long lasting They avoid scientific breakthroughs and engineering challenges, and look for network effects Patents dont matter so much. Only a couple of cos hold patents worth much #3 Team. Want a strong technical founder and a sales-oriented entrepreneur. In early stages, invest in an entrepreneur, not a professional manager or CEO The entrepreneur must be able to amble around and find something good Eval of ventures biz model Look for an understood market or prod vs. explosive growth and potential network effects (hello esp in the fuel industry) and unclear biz model. There are rounds of investment. Too early vs. too late Due diligence Technical due diligence necessary when there are engineering innovations Check out customers easiest when there is both customers and revenue to eval, but IT IS NOT SWEET SPOT when there are already a lot of customers and a lot of revenue. Industry due diligence talk to experts about the idea and the team, the market, and the market need Check out entrepreneur and team call refs and blind refs. How have they executed? Are they honest? But you also must make a judgment based on experience Process through which funding decisions are made A two week to 1 mo typical ideal time for Siegelman What 3-4 risks do you want to mitigate?

Financial analysis Software side vs. hardware side and bill of materials with 50% gross margin at reasonable volumes and established channels But the financials are usually not even close, yet somehow its sill a credibility test, which is a check for a complete or incomplete entrepreneur. An incomplete entrepreneur is someone is a technical entrepreneur with no biz experience. Complete = understands both the technical and biz opps and how to flesh out numbers behind it. If its a CONSUMER RETAIL PROD, need to understand how much inventory to build to calculate carrying costs Risk Consider the risk to rewards ratio We will write the contents of the book together Potential exit route Get very high RT, very high risk projects b/c those have worked well for the firm in the past

Hoel: Menlo Ventures they encourage partners to have patents because the market is more litigious than 10 years ago Eval of biz model Telesales and 3rd party channels biz are the best, b/c direct sales can be too expensive Due diligence Talk to customers Eval of potential venture opps Market criteria and a developed prod> valuation criteria SO THEY HUGE ISSUE IS THE MARKET AGAIN They seek out cos themselves Market growth Market size Mrkt competition Eval customer adoption rates ALL ABOVE vs. the details of the team (b/c some VCs only want the best team), because the corporate details can be filled in later. Fav co = the kind of co that is doing well despite itself Use SYSTEMATIC EMERGING MARKET SELECTION PROCESS (SEMS PROCESS), discussing new mrkts or problems that need to be solved Where is the technology pool in the country? Are they where the action is? Its important to getting noticed.

Process through which funding decisions are made Their deals take a lot longer a 2-3 mo period Financial analysis Companies that think they will have a 40% after tax margin in 5years are wrong b/c they dont understand the costs of running a biz Turned down due to valuation? 10% error rate. Turned down due to market? 1% error rate. But considering both, you have a higher specificity. Thats why you use so many metrics. Risk Invest in cos that are the market share leader or are going to become it. Market leaders typically have greater margin and a larger cushion to make mistakes and are the first ones to get an IPO and can hire the best people. The opp must return at least 5x the investment, 7-10x if its high risk Potential exit route IPO is the exit route but Hoel is not anti-acquisition. HOWEVER, it is becoming increasingly difficult for small cos to go public due to increasing regulation.

Wang: Trinity Ventures you know after a 5-7M investment whether or not youre going on the right track. They do revisits too, meaning, in 6 mo or a year, I suppose, is it still interesting? (In order to see if you were too early) - Eval of potential venture opps - The new idea is CVP and diffn into tech or biz models. With CVP, its considering how high up the pain ladder is it? - Ideal = CEO takes it to glory - They also actively seek cos that are answers to problems - No weight is placed on market projections. B/c everything looks like its going to be a multibillion dollar thing - If there is a wide-eyed technologist whos not biz savvy, they wont care b/c the hit rate and the time it takes to constantly arm wrestle with the technologist is what they try to avoid - Eval of biz model - Working capital (abbreviated WC) is a financial metric that represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities. It is a derivation of working capital and is commonly used in valuation techniques such as DCFs (Discounted cash flows). If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. - A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash.

So, be careful about working capital, b/c it can be a cash drain. IDEAL = Salesforce.com model, where its 7-8M in investment to get to a decent level of revenue and its 3 guys and a biz plan. But their dilution of ownership is really not a fundable biz model, so theyre trying to recraft it.

Due diligence What kinds of liabilities are around? Have employees been getting paid? What is the status of their top 20 accts? (Basically, they are acting like the VP of sales) - Process through which funding decisions are made - They dont do tranche investments (part/division/installment) b/c of legal issues - Looking for an 18 mo window. Be careful about giving too little or too much monies - Financial analysis - The financial model discussion is an insight to how smart a team is. Use a bottom up model tried this and this is what we got. And from there, you can do a bottom up projection with empirical data about an analogous problem and soln and what the customer was willing to pay. - Risk - The management team must be on board, b/c they will execute against it. - Milestones are tracked around product, first beta customer, and first revenue customer. In the software industry before releasing a product commercially to the market the solution is to be given to so-called beta customers. The idea is that these companies or users will test the software thoroughly in real life situations experiencing real life events in the hope to debug the application as much as possible and to test have real life strain tests. - Competitive dynamics is the analysis of competition at the action and response level to predict how a firm will act or react against opponents. Understanding engagements at this level is essential because this is where firms enact their strategies, test their opponents' mettle and capabilities, defend their reputations, and signal their toughness--that is, where business rivalry occurs. The dyadic or pair-wise approach of competitive dynamics makes possible focused analysis that complements Michael Porter's conventional industry structure and its extension, the strategic groups approach. - Warning though: inc success rate: decrease rate of RT due to dec risk - Potential exit route - Really, the bulk of cos get acquired, so theyre realistic about that - Cos need to be sustainable on their own rather than have timing such that s/o else acquires them before they need more cash - An IPO is always the best outcome. If we put in 3M and it gets bought for 150M and we own half thats a huge outcome. Simon: Alta Partners - Eval of potential venture opps

Similar to whats been said before, its all about the (#1) market. Is what you have a brave new world model or a better/cheaper/faster model. Its a question of having a smart market you cannot fix this #2 smart tech/ intellectual tech #3 smart people you can fix this markets>people>tech. WOW. This was seen/experienced both on entrepreneur side and the venture side. Again, avoid direct sales b/c the margins are slim, marketing costs are high, and its hit-driven. VCs are not good at predicting consumer behavior. But, internet deals might work. Ideal case = 4 PhDs whove been working on a soln for a yr or two and found the magic bullet and its 2 orders of magnitude better than everyone elses. Keep existing team and entrepreneur must be in it even in the tough times Be careful about timing b/c if youre too early theres no D and youll have to weather the course until D reaches you Eval of biz model Due diligence Do reference checks and check with another VC partner in firm if you really like them Does the customer have pain? How effective is the team at delivering the message? Process through which funding decisions are made Overall, there are a lot of brave new world cos that are visited, but only a few are actually in the portfolio How much do they actually need vcs? If owners are making 10M /year and own 90% of the co, then they dont need an outside investor to give up half of their co to! Once they take an investment, they are getting on the treadmill. Some deals take a year! Financial analysis How much money does the opp take to get CF breakeven? You have to do a bottom up approach not have a top down analysis Risk Technical risk Competitive risk Market risk Make a 2-5 pg investment memo with the only financials listed are revenue over the next 4-5yrs and expenses Potential exit route It can be difficult to know when to leave b/c there may still be a lot more money that can be made. However, quantitatively and objectively, if the mrkt size is 200M + and your cos revs are 60-80M (30-40% pre-tax) then its safe to exit.