DFJ

Understanding Venture Capital September 2009

2009 Simon Olson

What are venture capitalists?

Venture capitalists (also known as VCs) are professional investors who invest money in young, privately-owned companies and work with them to help them succeed

Important things to remember

Venture capital is equity, not debt The companies are private, not public The companies are young, but usually have more than just an idea* The companies are growing exponentially, not arithmetically The companies are usually technologyrelated, but not always
*An idea would normally be seed capital, not venture capital

How does it work?

Entrepreneur has an idea Gets seed capital from friends and family, bootstraps the idea using his or her own money, or gets money from an angel investor Builds a proof of concept Approaches venture capitalist

How does it work?

Venture capitalist receives a short executive summary (1-4 pages) or Power Point presentation (10-15 slides) describing the opportunity Analyzes the materials, rejects 90% Talks to the remaining 10% Invests in 1 out of the remaining 10%

What does the VC look for?

Investment criteria: Entrepreneur Team Market size Timing Company growth characteristics Exit potential

Venture capitalists objective

To earn at least 10 times the value of the initial investment in 4-5 years Ex. If I invest R$1 million in a company, I want to be able to sell my stake in it four years later, for at least R$10 million

Why is such a large return necessary?

Because, for every Google in a VCs portfolio, there were 18 companies that failed!

Portfolio strategy
Invest in 20, and pray for 2 13 companies fail, 5 break even, 2 big hits Out of 2 big hits: one returns capital for the entire fund, the other accounts for the return*
*In the best funds, the ratio is more like 33% succeed, 33% break even, and 33% fail.

Portfolio distribution
R e t u r n
2 great successes: one returns the funds capital and the other provides the return

A few companies break-even Majority of companies fail

= portfolio company

= break-even

After the decision is made to invest, whats next?

Services venture capitalists provide

Advice on strategy Help recruiting Introductions to key customers/partners Professionalization (management and corporate governance) Internationalization Help with sale of the company or IPO Provide capital

How do VCs make money?

Annual management fee Performance fee

Simon Olson