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Center for Entrepreneurship Jerry Feigen An Anatomy of a Deal March 13, 2003 NIH Bio Business Group

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Major hits - Apple Computer, Cray Research, Federal Express, Intel ... Fred Smith - Federal Express. Bob Swanson - Genentech. Life Sciences deals begin, but falter ... – PowerPoint PPT presentation

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Title: Center for Entrepreneurship Jerry Feigen An Anatomy of a Deal March 13, 2003 NIH Bio Business Group


1
Center for Entrepreneurship Jerry Feigen An
Anatomy of a Deal March 13, 2003 NIH Bio
Business Group
2
Anatomy of a Deal
  • VC History
  • Assessing Traditional Entrepreneurs Vs. The
    Scientific Research
  • What is a deal - Sources of Capital?
  • How is a deal put together - Venture Investors
    and Deal Expectations?
  • Role of a Business Plan in Structuring a Deal
  • Making the Presentation You are the Team All
    Alone
  • Letter of Intent
  • Due Diligence
  • Valuation Negotiation
  • Term Sheet / Investment Agreement
  • Deal Closing
  • Post Closing Relationships Danger Signals
  • Exit
  • Where are we going with Biotechnology and Life
    Science Deals?
  • Montgomery College Bio Science Technology Park
    An Ecosystem
  • Macklin Partners, Potential Internships,
    Incubator Development

3
  • VC HISTORY
  • The First 10 years - 1960s - Chaos and
    Experimentation
  • Small Business Investment Act of 1958
  • Direct equity investments by SBICs
    permitted
  • Organization of NASBIC (1958) - National
    Association of Small Business
  • Investment Companies
  • Funding of SBICs when licensed - misuse
    of too much cash
  • Lack of significant oversight creating
    fraudulent transactions,
  • bootstrapping, conflicts
  • More focus toward venture capital than
    lending
  • Cyclical nature to managing SBIC
    portfolio evolved
  • Average rate of return of SBICs, March
    1969 - 9.5
  • Top 25 SBICs averaged 30 on invested
    capital
  • Data on portfolio growth showed
    employment increase of 25,
  • gross revenues increase by 27 and profits by
    27
  • SBICs flowed 1.7 billion in 35,000
    transactions
  • 40 million invested in technology deals
  • Creation of new equity transaction
    structures and legal precedence

4
The Second Ten Years - 1970s - A U.S. Venture
Capital Industry Created Increased leverage to
31 and 41 for SBICs to target venture
financings and total leverage available to
single SBIC increased Legislative authority to
raise private institutional and individual
investor funds through Wall Street instead of
government direct funding - Full faith and
credit of U.S. - 100 guarantee - Timely
payments National Venture Capital Association
formed in 1973 70 members including majority
of the largest SBICs First Annual Venture
Capital Institute was created in 1974 Investor
funds from outside the U.S. to capitalize SBICs
began to emerge basically European Major
hits - Apple Computer, Cray Research, Federal
Express, Intel Bio Deals Begin Amgen Pitch
Johnson, Brook Byers First VC Leap into
Biotech Shift from electronics of 1960s to
computers of 1970s 1977 SBA Task Force Report
- Life Cycle of Growth Companies - Regulatory
Impact on Growing Firms - SEC, pension, tax,
etc. ERISA and Prudent Man Pension Fund
Restrictions
5
  • Between 1970 1980
  • SBICs disbursed 1.8 billion in more than 21,000
    transactions
  • SBICs invested almost 193 million in 556
    technology deals
  • with another 199 million from co-investors
  • Non SBIC private venture funds invested 1.7
    billion with
  • pension funds providing 31 of funds raised by
    venture capital
  • funds in 1979
  • Capital Gains tax reduction from 49 1/2 to 28
    - 1978
  • Entrepreneurs of 1970s
  • Bob Noyce - Intel Corp
  • Gene Amdahl - Amdahl Computers / Trilogy
    Investments
  • Steve Jobs - Apple Computer
  • Seymour Cray - Cray Research
  • Fred Smith - Federal Express

6
Decade Three - 1980s - Era of Not So Benign
Neglect
  • From Computers to Biotechnology
  • Small Business Innovation Research Grants - 1982
    - Prototype / commercial
  • feasibility of U.S. technology
  • Capital Gains tax reduction 26 to 20
  • SBICs cover most of the states
  • Small Business Investment Incentive Act of 1980
    gives rise to Business Development Companies -
    some are SBICs - tapping public investors
  • Section 385 of IRS Code - Whats debt and whats
    equity?
  • SBA raises private capital for SBICs to 1
    million
  • SBA oversight becomes limited because of lack of
    resources
  • Proposal to eliminate SBA in 1985
  • Stock Market collapse in 1987
  • Lack of interest in SBIC formations by private
    sector
  • In 1990 - SBICs had 1.7 billion in private
    capital and SBA leverage of
  • 790 million
  • Between 1981-1990 - SBICs invested 4.4 billion
    in 24,000 transactions with more than 1.2
    billion provided to technology firms
  • Pension funds provided almost 40 of the 24
    billion committed to independent
  • venture funds in the decade
  • Entrepreneur of the Decade - Bill Gates -
    Microsoft

7
  • The Roaring 1990s
  • Venture Capital in Retreat
  • SBICs - Revisited and Restructured - A Counter
    Cyclical Force
  • Internet Emerges - Government / Private Sector
    Partnership Explodes
  • Longest Growth Cycle in History
  • Financial Deregulation After 60 Years
  • Global Merger Mania
  • Largest VC Returns Ever - Millionaires Abound
  • NASDAQ Goes Global
  • A New Entrepreneurial Economy

8
  • 2000 and Beyond - A New Millennium Begins
  • IPOs and Dot Coms and the Economic Cycle
    Clash
  • Stock Market Down
  • VCs Freeze Investing - Limiteds Change
    Interests
  • U.S. Economy in Retreat
  • Geographic Shift in U.S. Focus for Funds /
    Angel Networks Grow
  • VC Activity Outside U.S. Taking Leads in
    Early Stage Deals
  • First Round Venture Funding to Just 1.04
    Billion During
  • 2nd Quarter 2001 - Down 87 from last year
  • Terrorists Hit World Trade
  • Acceleration of Global Impact on Markets
  • Enron and the Fall Out for VC Deals
  • Whats Next ?????????

9
Assessing Traditional Entrepreneurs Vs. The
Scientific Research
  • Total commitment, determination and perseverance
  • Drive to achieve and grow
  • Opportunity and goal oriented - realistic goal
    setting
  • Taking initiative and personal responsibility
  • Persistent problem solving / self imposed
    challenges
  • Awareness of self with sense of humor -
    optimistic
  • Seeks and uses feedback - good talkers /
    listeners
  • Internal locus of control - belief in themselves
  • Tolerance for ambiguity, stress and uncertainty
  • Calculated risk taker and risk sharer
  • High integrity and reliability
  • Copes with failure

10
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11
Life Cycle of a Start-up
  • Basic Steps and Pitfalls to Growing a Business
  • The Agony and Ecstasy at Each Stage of Growth - A
    lonely existence
  • Moving to Professional and Personal
    Rewards/Disappointments
  • Bottom Line Measurements of Success or Failure -
    Economic vs. Personal Goals

12
Capital Sources for Growing Enterprises -
Cyclical Challenges
  • Friends / Family / Angel Investors and Network
  • Government - Prototype and Feasibility - ATP,
    SBIR, State Programs (MIPs), etc.
  • Venture Capital Firms - Which are the right ones?
  • Endowments/Fund of Funds - Bio/Health related
  • Licensing Options - Pros and cons
  • Joint Venturing - Pros and cons
  • Corporate and Corporate Venturing Groups
  • International Balancing Acts

13
Deal Expectations
  • Expectations
  • Know and Keep Focus
  • What is a VC Investment Policy
  • Return on Investment
  • Economic Development
  • Technology
  • Deal Stage of Development
  • What Do Investors Expect
  • Timely Information - Truth
  • Regular Contact - No Surprises
  • What Do Entrepreneurs Expect
  • Money and Confrontation
  • Free Hand

14

Know Your Venture Fund Model
  • Deal Flow
  • Marketing - What Fund is or is Not
  • Sourcing The Right Deals
  • Referrals - Who do you Trust
  • Board Members / Advisors
  • Service Providers
  • Other Funds - Syndicators
  • Banks ??????
  • Internet - Company and Data Base Linkages
  • Focused Conferences and Networking
  • Trade Shows - Suppliers
  • Business, Technical and Trade Periodicals
  • University Affiliations - Incubators / Professors
  • Good Web Sites
  • Venture Capital Associations

15
Presentation, Screening and Analyzing
  • Screening - Limit Time and Costs - 1 Make It
  • Establish Formal Criteria and Process - In,
    Out, Maybe
  • Establish Log- Acknowledge Receipt of Plan
    Quickly
  • Out / Rejected Plans - Reasons - Market Too
    Small, Return Inadequate, No Personal Risk
  • In / Maybe - Good reference, Solves Big Pain,
    Experienced Management
  • Initial Interview - Gut Reactions to Team -
    Negotiations Begin
  • Provide Feed Back- Be Straight
  • Move to Due Diligence - Check Existing
    Portfolio for Conflicts

16
Letter of Intent
  • Used in Early Days of Venture Capital
  • Pre Term Sheet Negotiations
  • Informal nonbinding letter agreement on the
    sticky issues
  • Entrepreneurs and VC resolve business and
    personality conflicts

17
Due Diligence
  • Verifying the Market - Whose Numbers ? /
    Related Markets
  • Who and Where are the Customers ?
  • Is Management for Real ? - Going Beyond
    Official References
  • Can Management be Coached as the Company Grows
    ?
  • Do Financial Numbers and Assumptions Make
    Sense - Valuation?
  • Are the market and financial strategies Simple
    to Understand ?
  • Does the idea ease a Big Enough Pain ?
  • Always Kick the Tires - site visits, wheat
    in the silos?
  • Talk to Management and Employees Separately -
    Employees Know
  • A Lot - Ask Every Question You Can To All
    Related Parties
  • Check Former Bankers (Personal and Business)
    and Suppliers / Creditors

18
VC Variables in Valuation
  • ROI need
  • Amount to be invested
  • Number of years to hold investment
  • Actual after-tax profits in harvest / exit year
  • Price / earnings multiples at time of harvest /
    exit
  • Seed / start-up 50-100 ROI in 10 years
    Hold Period
  • First Stage 40-60 ROI in 5-10 year Hold
    Period

19
  • Example
  • Company Profile
  • No history of earning
  • Age similar to public / private company
  • Technology and market similar
  • Find like company, etc.

20
  • Formula
  • Investment 1,500,000
  • VC rate of return expected 40
  • After-tax profits in Year 3 550,000
  • Similar companies, etc.
  • 6x 8x Net Income in Year 3
  • Value in Year 3
  • 550,000 x 6 3,300,000
  • 550,000 x 8 4,400,000
  • Present Value Formula
  • (PV present value, FV future value, i
    investment rate
  • of return, and n number of years the investment
    is held)
  • PV FV
  • (1 i) n
  • 1,500,000 FV FV
  • (1 0.40) 3 2.744
  • FV 4,116,000 or 40 for 3 years

21
  • Determination of VC Equity Ownership
  • For the investor to receive its return objective,
    it needs to receive
  • for its investment a portion of the company. For
    example, if the
  • venture is worth 3,300,000 to 4,400,000 at the
    end of year
  • three, the 1,500,000 put into the venture by the
    investor today
  • should buy from 34 percent to 45 percent of the
    company
  • 1,500,000 34
  • 4,400,000
  • or
  • 1,500,000 45
  • 3,300,000

22
Post Closing VC Strategies
  • Verifying Use of Proceeds - Follow the Money
  • Open Communication with Management on Regular
    Basis
  • Monthly Reports - Short Narratives Essential
  • Quarterly Financials - Highlighting Changes
    from the Plan, Cash Flow Position, Cost of
    Operations, Marketing
  • Anticipate Next Rounds - Check the Term Sheet
    Milestones
  • Verify Strength of Management and Ability to
    Work as a Team
  • Test Morale of Employees
  • Check How Fast Competitors are Growing

23
Danger Signals and Red Flags
  • Weakening Management - Losing Top People
  • Production Schedules Off - Quality Down
  • Contracts / Sales Not Booked Timely
  • Bank Debt Being Restructured
  • Supplier Terms Being Extended
  • Change in Auditors
  • Margins Narrowing
  • Significant Meetings Changed or Postponed
    Becoming a Pattern
  • Top Managers Taking on New Duties without
    Delegations
  • High Percentage of Milestones Being Missed
  • Need to Change CEO - A Delicate Balance

24
Summary Deal Breakers vs. Makers
  • Deal Breakers
  • - Different Stories Management vs. Employee
  • - Critical Misrepresentation
  • - Team Never Worked Together
  • - Founders Not Coachable
  • - Inflexibility
  • - Need 100 of Company Even if not growing
  • Deal Makers
  • - Consistent Pitch
  • - Clean Due Diligence
  • - History of Making Goals
  • - Skin is in the Game
  • - Flexibility
  • - Accept 60-40 of a Large Valued Jointly Built
    Company

25
Term Sheet / Investment Agreement
  • Valuation Terms
  • Investment Instruments
  • - Common Stock
  • - Preferred Stock (Series A, B, C)
  • - Convertible Preferred
  • - Convertible Debenture
  • - Debt with Warrants/Options
  • Positive/Negative Covenants
  • Reporting Requirements Milestones?
  • Board Seat
  • Reserve Shares for Employee Incentives
  • Stock Options In or Out
  • Public Offering Rights, Rights of First Refusal,
  • Tag Along Rights

26
Exiting Getting Out - VCs and Founders
  • Structure Up Front - Timing Options / Reality
    Bites
  • Management Buy Backs - Basis Realistic ??
  • Purchase Arrangement - Cash Vs. Stock Vs. Debt
  • Merger Potential - Terms and Conditions - Who
    wins ?
  • Exchange Listing - Timing Essential / NASDAQ /
    GDRs
  • Distribution Needs of Investors - Supersedes
    Portfolio and VC Management Needs ??

27
Where are we going with Biotechnology and Life
Science Deals?
  • Breakup Of Early Biotech
  • Mergers / Acquisitions / Sales
  • Spin Off Of New Niche Products / Services
  • Young Ph.D.s And New Enterprise
  • Development Of Scientist VC
  • New Deal Structures Based On Science Business
    Life Cycle
  • International Nuances

28
Bioscience Business Lifecycle and Montgomery
College Life Science and Technology Park Ecosystem
uccessful, public, acquisition, or merged anchor
company Spinoff new companies Mentorship
s for businesses and students Increased rental
income Educational cooperation Pipeline of
education, opportunity Community advocacy 35
( 350,000 sf of 1,000,000 sf) or (2-3 companies
at 75,000-120,000 average sf)
New, startup seed-capital, promising, company ltltlt
1-5 Years gtgtgt Technology Development Entreprene
urial training of staff Incubator support
space, VC contact, business networking Students
for jobs, interns Pipeline to labor
pool Student intern experience Student
entrepreneurial education Educational
cooperation Pipeline of education,
opportunity Equity in early, new company 3 (
30,000 of 1,000,000 sf) or (25 companies at
1,200 average sf)
Young, growing, 1st-2nd round financed
company ltltlt 5-10 Yearsgtgtgt Technology
Transfer VC contacts, education Support space,
business networking Students for jobs,
interns Pipeline to labor pool Student
intern experience Student entrepreneurial
education Rental revenue Educational
cooperation Pipeline of education,
opportunity 22 ( 220,000 sf of 1,000,000 sf) or
(27 companies at 8,000 average sf)
Mature, Pre-IPO nth-round financed company ltltlt
10 Years gtgtgt Technology Commercialization VC
contacts, education Space, business
networking Students for jobs, interns Pipeline
to labor pool Student intern
experience Student entrepreneurial
education Rental and partnership revenue (return
on equity) Educational cooperation Pipeline of
education, opportunity 40 ( 400,000 sf of
1,000,000 sf) or (26 companies at 15,000 average
sf)
Timespan of Phase
MC Contribution in the Phase
Zero Profit Line
MC Benefits in the Phase
MC Bioscience Park Percentage Occupancy
Jerry Feigen, Lloyd Case
29
  • Macklin Partners
  • Technology Council of Maryland
  • Dingman Center for Entrepreneurship
  • Montgomery County Department of
  • Economic Development
  • Potential Internships
  • Incubator Development

30
  • Center for Entrepreneurship
  • Jerry Feigen, Director
  • 51 Mannakee Street
  • Rockville, Maryland 20850
  • Phone 301 738-1702
  • Fax 301 279-5149
  • Email jfeigen_at_mc.cc.md.us
  • Web www.macklin.org
  • For copies of this presentation or further
    information, contact kdroubi_at_mc.cc.md.us or 301
    738-1707
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