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CEO Ventures Entrepreneur Resources . . . How Do Venture Capitalists Select Investments?

CEO Ventures Entrepreneur Resources . . . How Do Venture Capitalists Select Investments?. Full content credits to Catharine Merigold. Sources & Costs of Capital. Expensive!. Cost of Capital. Private Equity / Mezzanine. Venture Lending. Cheap!. Stage of Company. Seed. Early. Late.

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CEO Ventures Entrepreneur Resources . . . How Do Venture Capitalists Select Investments?

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  1. CEO Ventures Entrepreneur Resources . . . How Do Venture Capitalists Select Investments? Full content credits to Catharine Merigold

  2. Sources & Costs of Capital Expensive! Cost of Capital Private Equity / Mezzanine Venture Lending Cheap! Stage of Company Seed Early Late Mature Self FF&F Employer SBA, SBIR Banks - PG Banks - AB Strategic Investors Venture Capital & Incubators

  3. Venture Makes Sense for Very Few Companies • MOST successful companies are NOT funded by venture • Venture Capital ONLY makes sense for very few companies • My own advice: If there is any way to build a business without venture capital, you should • Venture capitalists are not risk-takers, they are risk managers

  4. 1st M: Money • How a VC “selects” investments is a function of: 1) “Whose” money they are investing; 2) What other rates of returns are available to those who invest in the fund (LPs) from other investment vehicles 3) The stage of company they invest in

  5. Where do VCs Get Their Money? Commitment Sources to US VC Funds

  6. Venture Returns by Type, Q1 ‘00 Rate of Return Time Horizon The Entire Fund Has To Return Higher Than Other “Less Risky” Investments • Consistently a higher rate of return than other investments • An “alternative” asset class

  7. If Fund to Return 30%, Avg. Investment Must Return More Depending on Number of Losers “Typical “ Early-stage Venture Portfolio Returns

  8. The Lesson: An Early-Stage Portfolio Return is Determinedby2-3 Winners Venture Fund Portfolio Model Assume fund = $ 100,000,000 Assume investments = 25 Lemons ripen early

  9. How Much Does Venture Capital Cost? Risk – Return Continuum

  10. 2nd M: Market • “Big” market • Ability for rapid growth up to a substantial sales level • The opportunity to deploy significant capital • For example, some funds want to invest $10-20 million over the life of a company to create an “impact” investment

  11. Market Part 1: Market Size • Market for the product/service should be more than $1B or small & growing rapidly • Why? Need for Exit • Remember, VCs get their money from someone else, and have to close out all investments in 10 years • A large share of a small market, even with profitability, means: • No one will pay a premium in an M&A situation • Can’t go public because growth limited

  12. Market Part 2: Rapid Growth • Ability for rapid growth up to a substantial sales level • $50M+ in 4 years • Why? Rate of Return • Therefore, VCs look for: • A company that solves a significant market “pain” • Sustainable competitive advantage • This means many good businesses are not fundable because they either cannot grow quickly enough or are not scalable – e.g.retail, many service-businesses

  13. Market Part 3: Ability to Deploy Capital • No matter what the rate of return, VCs will typically NOT invest if a company needs less than $5 million in capital • Why? Fund Size and Rate of Return • If a Fund has $300 million to invest, it would take 30 “home runs” of 10x return on a $1 million investment just to return the fund

  14. 3rd M: Management • VC mantra - management, management, management • At the end of the day (unless an irrational market lifts all boats), it is management that is responsible for success • Depending on the particular VC, they may look for: • “Recycled” entrepreneurs • Domain expertise • “Sticky” entrepreneurs • “Real” entrepreneurs

  15. Value Creation in Business and Product Tech/Prod Patent Ship Beta alpha PoC Idea Value Sticky Bus Plan Sr. Team Customers Partners Business Rev Ramp

  16. To Maximize Funding Potential and Valuation – Minimize Risk Vectors • Management risk • Market risk • Sales risk • Technology risk • Business strategy risk • Financing risk

  17. Finding the Right VC • Choosing the right VC firm as your “partner” is important • Look for help beyond capital • Industry expertise in your area • Good track record • Reputation for working well with entrepreneurs • Make sure the VC’s expectations on growth strategy, future fundraising, and investment time horizon are the same as yours

  18. How Do VCs Choose Investments? • Recap: The 3 M’s • Money • Market • Management Full content credits to Catharine Merigold

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