Overview of Venture Capital

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Overview of Venture Capital and why it matters !

Jerome S. Engel September 2005
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Jerry Engel

• UC Berkeley
• Founder and Executive Director of the Lester
  Center for Entrepreneurship and Innovation
• Chair of the Entrepreneurship Faculty
• Teach Entrepreneurship, Venture Capital Private
  Equity, Technology Commercialization in the MBA
  and Executive Education programs
• Outside of Academe
• Monitor Venture Partners, General Partner
• Co-founded Kline Hawkes Capital,
  AllBusiness.com, ElectraScan Inc., Maxis,
  CardioProfile, and more
• Angel Investor, Board member, Advisor
• 1980s
• ErnstYoung, Managing Partner
• Entrepreneurial Services
• Apple, Intel, Genentech, Sun, Autodesk, more..
• 1970s KPMG
• Academic - Wharton

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Probing upper thermospheric neutral densities at
Mars using electron reflectometry
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Overview of Venture Capitaland why it Matters!

• Entrepreneurship is a key driver of value
  creation in the 21st century American economy
• An approach to that starts with the recognition
  and pursuit of opportunity
• The opportunity must be compelling to enable the
  entrepreneur to attract the necessary resources
• Special mechanisms exist to enable resource
  alignment with the best opportunities
• Venture Capital is such a mechanism
• Venture Capital is more than money
• It is a market mechanism
• It is this subtlety that makes rare

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Entrepreneurship Bridges the Gap
Entrepreneurship
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Entrepreneurship

• The pursuit of Opportunity beyond the Resources
  you currently control

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Entrepreneurial Process

• Identify
• Need
• Solution
• Unfair Advantage

Opportunity

• Acquire
• Technology rights
• People
• Money

Resources
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Entrepreneurial Process

• Key Mechanism
• Mobile Technology
• Mobile People
• Mobile Money

People
Money
Technology
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The Entrepreneurial Venture FOUR PERIODS of
DEVELOPMENT
I
II
III
IV
Cash Flow
Time
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The Entrepreneurial Venture FOUR PERIODS of
DEVELOPMENT
Pure entrepreneurship
Cash Flow
Time
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The Entrepreneurial Venture PERIOD I Pure
Entrepreneurship

• Defining the concept of the business
• Gathering financial resources
• Assembling the startup team
• Identifying customers
• Analyzing the competition
• Building the prototype
• Getting your first customer

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The Entrepreneurial Venture FOUR PERIODS of
DEVELOPMENT
Strategic focus
Cash Flow
Time
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The Entrepreneurial Venture PERIOD II
Strategic Focus

• What business arent we in?
• IMPLEMENTING the business are we in!
• Knowing better than ANYONE else
• What will people pay
• How many will they buy
• How to distribute
• How to service the customer
• Identifying strategic partners
• Developing relations with suppliers
• Going beyond the prototype to a truly scaleable
  product
• Recruiting a complete team
• Raising institutional money

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The Entrepreneurial Venture FOUR PERIODS of
DEVELOPMENT
Systems building
Cash Flow
Time
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The Entrepreneurial Venture PERIOD III Systems
Building

• Financial controls
• Stable division of labor
• Reporting relationships and authorities
• Developing systems of internal control
• Formalizing the terms of a sale
• Operational systems
• Production, outsoucing
• Distribution, sales
• Service, warraties

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The Entrepreneurial Venture FOUR PERIODS of
DEVELOPMENT
Corporate management
Cash Flow
Time
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The Entrepreneurial Venture PERIOD IV
Corporate Management

• Hiring outsiders
• Going public
• Adding the follow-on products
• Shedding those who cant keep up
• Formalizing the culture
• Rationalizing the strategy

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The Professional Entrepreneur
I
II
III
IV
Visioning the Future into the Present
Cash Flow
Time
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New Venture Funding Stream
Sales

Cash Flow
80 IPO
40
20
8
1
Time
Venture Capital Rounds Financing to Milestones
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New Venture Funding Stream
Sales

Cash Flow
80 IPO
40
20
8
1
Time
Venture Capital Rounds
Investment
Corporate Window and Spin-outs
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New Venture Funding Stream
Sales

Cash Flow
80 IPO
40
20
8
1
Time
Venture Capital Rounds
Investment
Corporate Window and Spin-outs
Acquisition
Corp Growth
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U.S. ExamplePrivate RD Spending Increasing
TOTAL
PRIVATE
FEDERAL
Note Expenditures are deflated using the GDP
implicit price deflator. Source National
Science Board (2000) and Economic Report of the
President (2002)
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The Proportion of Research Expenditure atOur
Largest Corporations is Decreasing
Original - H. Chesbrough, 2003 Updated J. Engel
2003 Source National Science Foundation,
Science Resource Studies, Survey of Industrial
Research Development, 1991,1999 and 2000.
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The State of the Venture Capital Industry

September 2005 Jerome S. Engel Venture Capital
Private Equity
Reminder Entrepreneurs Forum Thursday night
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Venture Capital and Private Equity require a
convergence of interests
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Instutional Investors PerspectiveVC is a
sub-category of Private Equity

• What is Private Equity?
• Venture Capital our principal focus
• Leveraged Buyouts
• Mezzanine Investments
• Build-ups/Roll-ups
• Distressed Debt
• Characteristics
• Generally structured as a partnership
• Huge growth in funds 5b in 1980 to over 250b
  today
• Still a relatively small allocation only 1 for
  every 40 in public equities
• Instability and volatility in valuations and
  funds flows
• Demand and Supply likely to expand, especially
  overseas

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20 Years of Venture Capital ?
279
Sources Asset Alternatives, Cambridge
Associates, CSI, Inc.
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VC Investment1980 The Long View
( in billions)
Annual Venture Capital Investments 1980 to YTD
Q3 2004
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U.S. Fundraising
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Fundraising Running at 96-97 levelsCommitments
to Venture Capital Funds
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Median Fund Size Continues to increase after the
shake-out Median VC Fund Size (for funds greater
than 20M)
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Half of Funds Closed gt 100M in Size Allocation
of Fund Size by Number of Funds Raised per
Vintage Year
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U.S. Investment Overall
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Deal Flow and Investment On Track with 2004Deal
Flow and Equity into Venture-Backed Companies
Amount Invested (B)
Number of Deals
Source Dow Jones VentureOne/Ernst Young
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IT dominates VC Investing Health Care 2 Deal
Flow Allocation by Industry Sector
of Total VC Rounds
Source Dow Jones VentureOne/Ernst Young
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Investment in IT Steady in 2Q05Equity
Investment in Information Technology Companies
Amount Invested (B)
Number of Deals
Source Dow Jones VentureOne/Ernst Young
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Comms Share of IT Dollars Highest Since 4Q02IT
Investment Allocation by Sector
of Dollars Invested
Source Dow Jones VentureOne/Ernst Young
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Healthcare Activity Strong and SteadyEquity into
Venture-Backed Healthcare Companies
Amount Invested (B)
Number of Deals
Source Dow Jones VentureOne/Ernst Young
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Biopharm Devices Dominate HC InvestmentHealthca
re Investment Allocation by Sector
of Dollars Invested
Source Dow Jones VentureOne/Ernst Young
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More than half of VC deals are seed or first
roundDeal Flow Allocation by Round Class
of Total VC Rounds
Source Dow Jones VentureOne/Ernst Young
Seed and First Rounds Combined
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Round Allocation Mirrors Mid-90s LevelsDeal
Flow Allocation by Round Class (Annual)
of Total VC Rounds
Seed and First Rounds Combined
Source Dow Jones VentureOne/Ernst Young
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More than ½ of Dollars Go To Later
RoundsInvestment Allocation by Round Class
(Annual)
of Dollars Invested
Source Dow Jones VentureOne/Ernst Young
Seed and First Rounds Combined
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Median Deal Sizes Relatively ConsistentMedian
Amount Invested Per Financing Round
Median Amount Invested (M)
Source Dow Jones VentureOne/Ernst Young
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Median Round Sizes Steady in 2Q05Median Amount
Invested Per Financing Round, VC Only
Median Amount Invested (M)
Source Dow Jones VentureOne/Ernst Young
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Early Stage Deals are ½ Size of Later
RoundsMedian Amount Invested by Round Class , VC
Only
Median Amount Invested (M)
Source Dow Jones VentureOne/Ernst Young
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Amount Invested in Rounds at Late 90s
LevelsMedian Amount Invested by Round Class
(Annual), VC Only
Median Amount Invested (M)
Source Dow Jones VentureOne/Ernst Young
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U.S. Investment Regions
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Bay Area Draws Most Dollars, NY Metro
2ndRegional Investment in the United States 2Q05
Source Dow Jones VentureOne/Ernst Young
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2 Out of 5 Deals in CaliforniaRegional Deal Flow
in the United States 2Q05
Source Dow Jones VentureOne/Ernst Young
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Most Deals are SyndicatedNumber of Investors Per
Round
Source Dow Jones VentureOne/Ernst Young
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U.S. Investment Valuations
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Valuations Continue Upward TrendMedian Premoney
Valuation by Year
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Valuation has a strong corellation to
roundMedian Premoney Valuations by Round Class
(All Industries)
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U.S. Liquidity
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MAs Remain Primary Exit OptionPercentage
Breakdown of Venture Backed Liquidity Events IPO
vs. MA
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IPO Activity slows in 1H05 after a strong
04Deals and Amount Raised Through IPOs
Amount Raised (B)
Venture-Backed IPOs
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Fewest Venture-Backed IPOs in 7 QuartersDeals
and Total Amount Raised Through IPOs
Amount Raised (B)
Venture-Backed IPOs
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Half of 2005 IPOs from Vintage Years 99-00
Median Time From Initial Equity Funding to IPO
Number of Years
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IPOs have raised Greater amounts of VCbefore
going publicMedian Amount Raised Prior to IPO
Median Amount Raised Prior to IPO (M)
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European Investment Overview
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Perspective on European MarketEquity Investment
in Venture-Backed Companies, US vs. Europe ()
Overall Investment
Amount Invested (B)
Source Dow Jones VentureOne/Ernst Young
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Biopharm Software Lead 1Q05 InvestingEquity
Investment in European Venture-Backed Companies
by Industry, 1Q05
Source Dow Jones VentureOne/Ernst Young
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UK Leads 1Q05 European InvestmentInvestment in
Europe by Country, 1Q05
Source Dow Jones VentureOne/Ernst Young
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Top European Investors, 1Q05Number of Equity
Investments in European Venture-Backed Companies
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So What Have We Learned?