"Success is to be measured not
so much by the position that one has reached in life as by the obstacles which
he has overcome while trying to succeed." ~ Booker T. Washington
How do entrepreneurs set priorities
when gathering resources? How do entrepreneurs and venture capitalists set priorities when they contract with each other? During the next two sessions, we will examine the venture capital financing process.
These readings are intended to be split over the next two sessions. The first session will be an interactive lecture by Alex about the important elements of venture finance and term sheets. The second session will be a mock term sheet negotiation run by attorneys from Cooley Godward. There is a lot of material here, and you are not expected to have digested all of it by the first session on October 17. That said, please allow plenty of time to complete all of the readings by October 22.
We highly recommend that you do the readings in order, paying close attention to our editorial comments. Only you can know how deeply you need to read and how many versions of something you need to consider before you have a grasp of the key issues.
Zider, Bob, "How Venture Capital Works," Harv. Bus. Rev. 131-139 (Nov.-Dec. 1998). (An excellent and concise intro to how VC works overall and sets up the material really well.) See Course Reader.
Look over recent venture capital industry statistics at http://www.nvca.org/ffax.html, paying close attention as you scroll down to the downloadable PDF files on VC investing activity and recent VC exits. Begin to get an idea of what the trends represent and how they interact.
Lerner, Josh, "A Note on the Private Equity Fundraising Process," Harvard Business School (March 4,2001) (Gives you an excellent sense of how VCs get the money to invest.) See Course Reader.
With #1 and #2 now behind you, your main objective is to become facile with actually DOING the IRR and ownership calculations that go with being either a VC or an entrepreneur who takes VC money, and to begin to get a good sense of how to navigate a venture capital term sheet.
3. VC Arithmetic
The following four documents are modern classics. You should read the "Note on Valuation" first as it is a nice introduction. The next two are two treatments of the same material -- the Harvard note is a bit more used, but I find the Stanford one a bit easier to follow -- whichever works for you. Finally, the TA Associates piece should solidify it all for you. Again, pick and choose, though, for what best suits your style... There are a lot of potential readings in this unit, but it is up to YOU to decide the ones that most help you -- I find that students often learn differently. For example, if you clearly understand liquidation preferences, you do not to read the fifth treatment of the topic... use some common sense instead of complaining that there are too many readings!
Josh Lerner, “A Note on Valuation in Private Equity Settings, Venture Capital and Private Equity,” Chapter 10 (2000). See Course Reader.
William A. Sahlman and Daniel R. Scherlis, “A Method for Valuing High-Risk, Long-Term Investments,” Harvard Business School, June 21, 1989.
See Course Reader.
Stanford GSB Valuation Primer
C. Kevin Landry, "Valuing Potential Investments," TA Associates.
Here are two popular press pieces on valuation that are interesting:
Grimes, Ann, "What is the Investment Really Worth," Wall St. J., Dec. 3, 2003 at C5.
VC Secret: Value Is In The Eye Of The Beholder
Finally, here is a great example of how a top VC firm internally summarizes valuation/capitalization table information for various deals:
“KPCB Financing Proposals” dated 5/4/2002, 8/15/2003, and 9/8/2004.
4. Term Sheets
Do NOT let the legal jargon get you down!!! The idea here is not to make lawyers out of you but rather to give you a schema to use to understand the key issues and to enable you to ask the right questions. The term sheet embodies all of the issues you studied in #'s 1-3 above and you should do these readings with that in mind.
Start with:
Venture Capital for High Technology Companies (Fenwick and West, 2002) (This is what Fenwick gives its own clients... read this one carefully and it will set the entire stage for you. There are also some great numerical illustrations toward the end.)
Now, you are prepared to focus in on the most complex term sheet provisions -- i.e. some of the preferences that make preferred stock, preferred.
For some overall excellent practical advice, please see:
Feld, Brad, “An Entrepreneur on Term Sheet Terms,” (2005-2006) (also available at www.feld.com) (Note: this is the most readable and pragmatic introductory guide to term sheets that I have ever seen.)
For some more clarity on the very important liquidation preference provision, see:
Gallo, Greg and Scott Stanton, “When a Business Changes Ownership After a Venture Transaction, Getting a Fair Share Means Negotiating a Favorable Liquidation Option" www.garage.com (1999).
For some more clarity on the very important anti-dilution provision, see:
O’Donnell, Michael J. and Anton T. Commissaris, “The Venture Capital Anti-Dilution Solution,” Wilson Sonsini Goodrich & Rosati (undated).
For a sense of how terms change with the times/the economy, see:
Bartlett, Joseph W., “Savage Deal Terms” and “Sea Change.” VC Experts, Inc. (2001).
Now, for a summary of recent market trends in venture financing terms, you can skim the following... Some of you might be much more interested if you are going on in this area, are starting a company, or whatever else:
Cooley Godward LLP, “Quarterly Report, Private Company Financings,” (August 2007).
Fenwick & West LLP, “Trends in Terms of Venture Financings in the San Francisco BayArea” (2nd Quarter 2007).
Although we will not get to cover this next issue in depth, you should have some familarity with the term "down round" -- i.e. when a round of financing is completed at a LOWER valuation than the prior round. This not only has financial/mathematical implications but legal ones as well. You have more than enough to read right now, so I will wait to post those readings.
Mo, Curtis L., "Venture Capital Financing: Current Terms, Down Rounds and Cram-Down Financings," Practising Law Institutee Venture Capital 2004? (Weil, Gotshal & Manges) (skim pages 1-44.)
Although there has been a variety of litigation surrounding VCs post-internet boom, the Epinions saga ensuing litigation, and the ultimate settlement are among the most interesting.