From Invention to Start-Up:Money - Angels and Strategic

Partners

November 28, 2006

Susan PrestonEntrepreneur-in-Residence

Ewing Marion Kauffman FoundationAND

Director of Attorney Training and Professional DevelopmentDavis Wright Tremaine

Financing Life Cycle

DiscoveryProof-ofConcept

ProductDesign

ProductDevelopment

Manufacturing/Delivery

Fin

anci

ng

Idea Pre-seedFunding

Seed Funding

Expansion/Mezzanine

Operating Cap.

Friends and Family

Angels

Seed Funds

Venture FundsFounder

Institutional Equity

Loans / Bonds

Pro

du

ct D

ev

Angel Groups

Start-up Funding

Government Grants/Loans

Venture Capital Statistics: Investments in US

2005 – invested $21.7 billion (2,939 deals) 2004 – invested $20.9 billion (2,876 deals) 2003 – invested $18.9 billion Increase due largely to late stage investments:

$9.7 billion in 2005 $7.2 billion in 2004 $4.9 billion in 2003

Less than 2% in early/seed stageSource:

NVCA

Venture Capital Investments by Stage of Development ($s in Millions)

0

5000

10000

15000

20000

25000

2003

2004

2005

Source: MoneyTree

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Dollars (in $B) No. of Deals

Venture Capital Investment:

Historical and 2006 Projected

Source: MoneyTree

$7.4 $7.2$7.6 $7.4$7.8

$7.1$7.2$7.2$7.2$7.4$7.4$7.3$6.8

$6.3$6.3$6.6

$7.1

$0

$2

$4

$6

$8

2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06

Average VC Deal Size

Per Financing Round ($ Million)

Source: NVCA

US Angel Investments

2005 – invested $23.1 billion (49,500 deals) Increase of 2.7% in $’s over 2004 Increase of 3.1% in deals over 2004

2004 – invested $22.5 billion (48,000 deals) 2003 – invested $18.1 billion 227,000 active angels

20% Healthcare/medical devices and equipment 18% Software

55% in seed/start-up 43% in post-seed/start-up (10% increase over 2004)

Source: Center for Venture Research

Who Are Angels?

Angels are accredited investors who: Expect a financial return Believe in giving back to their communities Invest locally and regionally Participate in the investment process Show interest in personal relationships with

companies and employees Offer wisdom and guidance to entrepreneurs

Financial Attributes of Angels

Provide early-stage investment dollars Invest smaller dollar amounts per investment Partially fill funding gap left by venture

capitalists (VCs) Invest individual wealth Can tolerate loss of entire investment Have diversified portfolios Invest with “patient money”

Angels and VCs – Similarities

Selective in investments Requirements for an investable company Expectation of return on investment -

scalable Similar investment terms (though angels can

and often are – or must be – simpler) Bring the attributes of a professional investor

Angels and VCs –Differences Venture capitalists:

Invest on “home-run” theory ROI is ultimate goal Investing 3rd party money Often more demanding and actively involved than angels:

Control often issue Can requirement board and advisor approval and corporate

actions Angels:

Invest for returns – may be more modest expectations Social /community aspect to investments Individuals investing their own wealth Patient money

Investment Preference

0 5 10 15 20 25 30 35

Telecommunications

Software

Semiconductors

Retail/ Distribution

Other

Networking & Equipment

Medical Devices & Equipment

Media & Entertainment

IT Services

Industrial/ Energy

Healthcare Services

Financial Services

Electronics/ Instrumentation

Consumer Products/ Services

Computers & Peripherals

Business Products/ Services

Biotechnology

39 groups reporting

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

*2006 Estimated Value

Startup/Seed

Valuations Of Venture Capital Seed/Startup Rounds ($Millions)

Valuation: Expected ROIs ROI Five Year ROI

Seed 60%+/year 10X+

Start-up 50% 8X

Early stage 40% 5X

2nd stage 30% 4X

Near exit 25%/year 3X

Finding Angel Investors Angel Organizations:

Several in Puget Sound area including: AoA, PSVC, Seraph Capital Forum, Zino Society, Keiretsu Forum, Tacoma Angel Network, Bellingham Angel Network

Professional Service Providers Investment Forums Business Plan Competitions Professionally-funded Start-ups Venture Capitalists Corporate Boards

Forms of Investment

Debt (note) Equity (stock)

Options Warrants

Debt: collateralized, non-collateralized, interest in cash or stock (deferred?), convertible (at election or automatic?), length of time, etc.

Equity: common vs. preferred, dividends, many other terms discussed below

Professional Investors

Angels, venture capital, corporations typically receive: Preferred stock Convertible debt with warrants or additional stock

Provide more than money: Can be proactive in developing business through (“win together”): Company building experience Company functionality experience Industry experience Contacts for partners, customers and follow-on financing

What Professional Investors Are Looking for: Investable Companies Clear path to profitability Solid management Realistic business concept and plan Scalable business Competitive edge/Technical superiority Market acceptance Realistic financial projections Realistic valuation Clear, well-articulated exit strategyBottom line: Opportunity for financial return

What Professional Investors Are Looking for: Investable Companies

How does an investor make this determination? Passion of entrepreneur (presentation) Team track record – individually and together

Entrepreneur’s ability to succinctly articulate vision and mission

Entrepreneur seeks advice of trusted, experienced, honest advisors

Coachable entrepreneur

What Professional Investors Are Looking for: Investable Companies

How does an investor make this determination? Competitors researched and understood Clear market differentiator Value proposition for customer clearly evident Market access strategy clear and realistic Comprehensive summary of risks (and plans to

cope/address) Profit potential – good margins Marketability of company – M&A exit

Type, timing and realistic purchasers

Term Sheets: Debentures Convertible Debentures (Notes):

Automatic upon event or investor controls conversion

Note term Interest: cash or stock; payment schedule;

part of conversion Security interest/collateralized?

Term Sheets: Preferred StockRights, preferences and privileges of preferred stock

Price Use of Proceeds Dividends Liquidation

preference Anti-dilution

provisions Redemption Protective provisions

Information requirements

Registration rights Right of first refusal Co-sale rights Option pool Founder vesting Inventions agreements

Summation Angels invest primarily in seed/start-up rounds Angels represent patient money Angels are becoming sophisticated investors Angels make excellent advisors and mentors Many companies will need only angel investors Be open, coachable and realistic Show your commitment, passion and drive The essence of due diligence:

So what? Who cares? Why you?