Early Exits Workshop Workbook PPTS - 2010-11-17

Early Exits
Workshop
Presented by:
Bill Payne
Content by:
Basil Peters
Thur. Dec. 2, 2010

A New York Angels Workshop
Planning and Executing Early Exits
Workshop
Part 1 – Angel Investing in the 21st Century _____________________________________________ 3
Part 2 – Exit Strategy _______________________________________________________________ 31
Part 3 – Exit Execution ______________________________________________________________ 49
Appendix _______________________________________________________________________________ 73
Early Exits Workshop
Angel Investing in the 21st Century
by Basil Peters
Thesis
• The world of seed/startup investing is changing
– The VC model seems to be broken
– The IPO market has all but disappeared
– Startup costs are much lower than in the past
– Big business has chosen acquisition over R&D
– Super Angels are very active in funding startups
– Increasingly, angel groups are syndicating deals
• This workshop addresses angel investing

strategies to accommodate these trends,
improving angel returns in this environment.
Early Exits Workshop Outline

• Part 1 - Introduction and Background
• Part 2 - Strategy
• Part 3 – Execution
• An e
exercise
e c se after
a e each
eac papart
• 10 minute breaks between parts
• Time allocated for questions in your workbook
• Will move fairly quickly
• Goals - ‘take home value’ and resources
Workbook Page 3 | 11/2010

Definitions
• Lifestyle versus High Growth Entrepreneurs

• Angels
ge Networks
• Angel e o sa and
d Angel
ge Funds
u ds
• Super Angels and Seed Stage VCs
• Traditional Venture Capital Funds
Disclaimers
In general, our discussion of Venture Capital is
directed at traditional VCs, not seed (smaller)
VCs, Angel Funds or Super Angels.
Seed VCs and Super Angels tend to invest with
(or compete with) angels in funding
seed/startup and early stage deals. For
purposes of this workshop, the exit strategies
of Super Angels and Seed VCs are similar to
those of angels.
Disclaimers
This workshop is focused on angel-funded

deals but is not necessarily applicable to
capital intensive life science and clean tech
deals.
dea s Nonetheless,
o e e ess, the e information
o a o p provided
o ded
herein is important food-for-thought for angels
considering investing in companies that will
eventually need to raise large amounts of
capital to achieve an excellent exit.

It’s a process: Start before investing
and stay focused on the exit.
Focus on strategic buyers from the

start. Who would buyy this company
p y
and why?
Pursuing strategic customers will

get the attention of the right
strategic buyers
Some thoughts…before we start
1) “Until the exit we’re all just donors, not investors!”

2) “Our great idea is only as great as the problem it
solves in the mind of the highest bidding acquirer.”
3) “Th
“The managementt off return
t iis iimpossible,
ibl ththe
management of risk is illusory, but PROCESS is the
one thing we can exert an influence over.” James
Montier, The Little Book of Behavioral Investing
4) There is no angel business without entrepreneurs, so

how do we make entrepreneurs more successful?
Great Exits MUST Start with Great Entrances!

Formalize your personal strategy on:
1) How much $ to invest per venture
2) Type of ventures you like/spurn
3) Type of paper you buy
4) Valuation range/Terms & Conditions
5) Ongoing involvement
6) To VC or not to VC
7) Rate of return hurdle
8) Financial vs. Strategic Buyers
9) Prefer to lead the syndicate, or follow
10) Define success

Introduction and Background
1.0 - Background
1.1 – The VC Model no longer works
1.2 – Outcomes when angels invest with VCs
1.3 – Most M&A transactions < $20 million
1.4 – Investing on “Internet Time”
1.5 – Exercise on Angel-only Deals
Section 1.0 Background
Successful Angel Investing

1. Investing Right:
• In the right companies
• At the right valuation
• With the right terms
2. Exiting Well
• At a good price
• In a reasonable time

Angel Group Investing Is Still New
• Organized angel investing is still quite new – first
groups formed in mid 1990s.
• Angel investing today is where traditional Venture
Capital was in the early 1980s
• We are still discovering the best practices and
don’t have enough hard data
• ACA, the Kauffman Foundation and academics
such as Rob Wiltbank and Josh Lerner are
providing invaluable service
What Angels Used To Do
1. Find a company
2. Write a check
3
3. Hope a venture capital fund followed
4. Wait for an exit
The World Has Changed
• Traditional venture capital is broken

• We angels must alter our investing strategy
particularly related to follow-on funding and
exits.

Section 1.1
For Most High Growth

Companies, The Traditional
V t
Venture C
Capital
it l Model
M d l Doesn’t
D ’t
Work Anymore
Venture Capital Is Broken

Summary:
1. VC funds are far too large
2. Too few IPOs and huge M&A exits
3. Start-ups need less money
4. Big companies and private equity funds
consider VCs competitors
Angels and VCs – Growing Apart

Today, we have a much clearer understanding of
the difference between angels and VCs. From
an exit perspective, there are three:
1. Minimum investment size
2. Minimum return required
3. Acceptable time to exit

Size of Average VC Firms
Source: US National Venture Capital Association, Thomson Financial
Average Capital per VC Principle
Source: US National Venture Capital Association, Thomson Financial
VC Investment Prior to M&A Exit
Amount of VC investment prior to M&A exit in millions. 2008 data for Q1

Source: Jeffries Broadview, Dow Jones VentureSource

VC Fund Math
• VC funds have gotten much larger
• Seldom write a check for under $5 million
• Traditional funds only invest money once
• All fund returns come from < 20% of deals
• Limited partners expect an IRR of 20%
• Simple math shows that VC’s winners must
produce a 30x returns
92% of M&As Don’t Work for VCs

VCs Need Exits over $100 million
Exits
E it that
th t also
l M&A Exits
work for that work for
Angels and VCs
Entrepreneurs 8%
92%
Data from Mergerstat
What Happened to IPOs?

• There have been very few VC backed IPOs
since the tech equity bubble burst in 2000
• And it’s not likely that the IPO market will ever
return
t to
t what
h t it was iin AAmerica…unless
i l
Sarbanes Oxley is repealed or modified
• And NASDAQ is reformed or replaced

Changing Landscape for US VC Exits
700
600
Number off Issues
500
400
M&A
300 IPO
200
100
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: NVCA
What About Big M&A Exits?

• The media distorts our perception of multi-billion dollar
M&A deals, like YouTube and Skype
• But, corporate America is figuring that out those huge
transactions rarely work anymore
• So huge M&As aren’t happening as often either
• See Kopelman’s “Unintentional Moonshots - appendix
• Operating guys think Google overpaid for YouTube
More on the old VC Model
• If you are interested in reading more on why

the traditional VC model doesn’t work
anymore: http://www.angelblog.net/
http://www angelblog net/
The_VC_Model_is_Broken.html

Discussion on:
For Technology Companies,

The Traditional Venture Capital
Model Doesn’t Work Anymore
Section 1.2
What happens to Angels when

traditional VCs invest in our
companies?
Additional Years to VC Exit
10x Return 30x Return
To achieve a minimally acceptable VC fund return of 20% per year and

assuming all of the returns are from 20% of investments

Time from VC Financing to M&A Exit
Median Time from initial VC financing to exit in years. 2008 data for Q1.
Source: Jeffries Broadview, Dow Jones VentureSource
It Actually Adds About a Decade

• 7 years – it is really much longer for angels
• It’s 7 years across, A, B and C rounds
• A simple model shows this equates to
about 10 years longer for the angels
• But, aren’t most VC funds 10 years?
Lifetime of IT VC Funds
Source: Adams Street Partners 2006 analysis of funds then dissolved.

The chart shows the year a 10 year fund was actually dissolved.

How VCs Can Block Good Exits
• VCs have multiple mechanisms to block
– Board control
– Investment agreements for preferred shares
– Voting rights
– Other terms and conditions
• Significantly increases the risk of failure
Angel Investor Math

• Small Investments ($10-25K) can make sense
• Returns > 300% over a few years are attractive
• Can easily reinvest the gains (unlike VCs)
• Exit objectives much more aligned with
entrepreneurs than traditional VCs
Investor Time Horizons
• VCs wait a decade or more…

and often need to for their math to work
• Most angels today want an exit in 3 to 5 years
• A fundamental incompatibility between angels
and VCs in today’s exit environment

Angels or VCs But Not Both
• Research May 2008 - University of Maryland -

unique historical database of 182 Series A deals
from the bankrupt Brobeck law firm
• “Outcomes inferior if angels and VCs co-invest”
• Angels alone “as likely as the VC-backed firms to
have successful liquidity events”
• Does the current environment favor angels?
Angels, VCs and IPOs

• 2009 report by J. Sohl, Univ. of New Hampshire
analyzed 665 IPOs from 2001 to 2007
• 13% had only angels, 33% only VCs, 16% both
• VC b
backed
k d fifirms h
had
d “hi
“higher
h underpricing”
d i i ”
• “Angels’ incentives are more closely aligned with
(nonVC) pre-IPO shareholders”
• “managers (entrepreneurs) prefer early stage
funds from angels”
More Validating Research

• April 2010 - Kerr and Lerner from HBS
• Assisted by angels James Geshwiler, Warren
Hanselman, Richard Sudek and John May
• “A
“Angell ffunded
d d fifirms are significantly
i ifi tl more lik
likely
l
to survive at least four years and to raise
additional financing”
• “Angel funded firms also more likely to show
improved venture performance and growth”

Outcomes When VCs Co-Invest
(compared to angel-only returns)
More Fewer More Slight Increase

Failures 1x – 5x 5x – 10x in High Multiple
Exits Exits Exits
Source: Robert Wiltbank, PhD Willamette University with

Funding from the Kauffman Foundation
The Bottom Line

• When traditional Venture Capital funds follow
on in angel investments, statistically:
– It takes about a decade longer to exit
– The risks increase substantiallyy
• We don’t have data yet, but I believe today the

extra time, higher risks and dilution mean
lower average returns for both the angels and
entrepreneurs when VCs invest
What We Think Happens

to Returns and Probability of Exit
Without
VCs
With
VCs

Is Co-Investing with VCs Ever OK?
• What we have shown are statistics

• There are, of course, situations where the best
decision is to have VCs follow on
• It all depends on the type of company
When Do VCs Make Sense?

Angels only With VCs
Amount of capital Under $5 -10 Over $5 -10
required to prove the million million
business model
Years before being 2 to 5 years Over 10 to 12
able
bl tto exitit years
Most likely value of the Under $50 Over $100 million
company at the time of million
the optimum exit
Not an option, or preference, this is

pre-determined by the ‘type’ of company
Just say “No” to Moon Shots

• Don’t invest in companies that will need
subsequent investment from funds that
need ‘moon shots’
• Like most traditional Venture Capital funds
• Unless you really understand the risks

Discussion on:
What happens to Angels when

traditional VCs invest in our
companies?
Section 1.3
Most M&A Exits are under

$20 million
illi
We Hear Lots About The Big Exits

• Media always gushes over the really big exits
– Yahoo
– Google
• Those exits aren’t happening very often now

• The ‘new’ big story is the large number of
smaller exits

Most Exits Are Under $20 Million
• Mergerstat database shows the median price

of private company acquisitions is under $25
million, when price is disclosed
• But the price is not disclosed in most smaller
transactions
• Estimated the median price to be well
under $20 million
US M&A Transactions
(private sellers only)
90
80
Millions of Dollars
70
60
50 Average
Median
40
30
20
10
$18.2 Median.
0
2003 2004 2005 2006 2007
Mergerstat® Review - 2008
Examples of These Exits

• Google bought Adscape ($23 million), Blogger ($20
million - rumored) , Picasa ($5 million), Writely ($10
million) and MeasureMap (<$5 million)
• Yahoo bought Oddpost ($20 million - rumored), Flickr
($ million -rumored),
($30 ) del.icio.us ($30
($ – 35 million -
rumored), WebJay (~$1 million -rumored) and
Jumpcut ($15 million -rumored)
• Ask Jeeves bought LiveJournal ($25 million)
• AOL bought Weblogs Inc ($25 million -rumored)

Why This Is Happening Now
A Fortune 500 executive explained it this way:

– We (big companies) know we aren’t good at
new ideas or start-ups
– We basically suck at building businesses
from zero to $20 million in value
– But we think of ourselves as really good at
growing values from $20 million to $200
million or more
Under $20 Million Is Easy

– $100 million is out of our sweet spot to buy
– $100 million also requires board approval
– $20 million is easy – divisional approval
• Big companies spend more on M&A than R&D
• It’s the best way for them to grow in this economy
Big Companies Have Cash

Many big companies have so much cash that it’s
a problem – shareholders complain
– Cisco has $40 billion
– Google
g has $30 billion
– Microsoft has $35 billion
– Apple has $25 billion
– Oracle has $20 billion
– Intel has $18 billion

Big Companies versus VCs
• Big company corporate development and M&A
teams now consider VCs their competitors, a
fascinating new development
• They know VCs will hold on for huge exits and
don’t see VCs as adding a lot of value
• So they acquire exciting companies before
VCs invest
Google Wants Even Earlier Exits

Charles Rim one of the top Google M&A guys:
• “90% plus of our transactions are small
transactions. … less than 20 people, less than
$20 million and that is truly
$ y the sweet spot”
p
• “we do prefer companies that are pre-revenue”
• http://www.angelblog.net/Google_Wants_Even
_Earlier_Exits_Than_in_Early_Exits.html
Healthy Market - <$30 million

There is a robust market for exits <$30 million
• The familiar buyers are Fortune 500 companies
• Medium-size, public companies are also
aggressive buyers
• Private Equity funds are also coming back into the
market now that debt is available (roll-ups, etc.)
• Also many wealthy boomers are not ready to retire

Discussion on
Most M&A Exits are under

$20 million
illi
Section 1.4
Investing in Internet Time

andd St
Startup
t Economics
E i
Exits In Just 2 – 3 Years

• Flickr sold for $30 million at 1.5 years old
• Delicious sold for $30+million 2 years from startup
• Club Penguin for $350 million at 2 years old
• YouTube sold for $1.6 billion at 2 years old
• Playfish sold for $275 million at 2 years old
• Mint sold for $170 million at 3 years old
• AdMob sold for $750 million at 3.5 years old

How Early Can You Sell?
• A common misunderstanding about M&A exits
– You have to grow the company to be profitable
– Or grow it to be larger than $X millions of revenue
• Real threshold is to ‘prove the business model’

• For example, prove what a customer is worth
and what they cost to acquire
Proven Model and Value

• When you prove the model you can build a
credible projection that shows if:
1. New owners added $X millions of capital,
2. The business would have Y customers
3. And be worth $Z millions
• Then you can successfully sell the business
Early is Often the Optimum Time

• As soon as you prove the model is often the
best time to sell
• Always better to sell on an upward trend
• S
Sellll on th
the promise
i nott th
the reality
lit and
d often
ft
you can get the best price
• Most entrepreneurs wait too long to start and
then “stuff happens”
• http://www.angelblog.net/
Timing_Your_Exit_-_Dont_Ride_It_Over_the_Top.html

Don’t “Ride It Over the Top”
Optimum
Optimum time exit time
6 to start the exit IRR = 124%
Investment Return (times)
More typical time

5 to start the exit
4 More typical
exit time
3 IRR = 15%
2
Fastest
1 Growth
Phase
0
0 1 2 3 4 5 6 7
Years from Investment
Startup Economics Have Changed
• It costs very little to build tech companies today,

in many cases $100,000s.
p
• In the ‘90s, hardware and software companies
cost $10s millions.
• Which gave rise to the huge VC funds
Why It Costs So Little Today

• The Internet:
The most disruptive innovation of our times
s a access to
• Instant o the
eeentire
egglobal
oba market,
a e,
• Internet fundamentally changing how we work
• For example, open source software

Open Source Software
• Software systems that would have cost $100Ks
over a decade ago, now take $1,000s in weeks –
on the internet
• Imagine a large software project that is:
– Executed without managers and meetings, and
– Without paying developers or charging customers
• Can open source threaten Microsoft and Adobe?
Other Fundamental Changes
• Internet “guerrilla marketing” shortens time to

market and drastically reduces costs
• Crisis of Governance
– Difficult building an excellent board
– Litigation impacts cost of governance
Discussion on:
Investing in Internet Time

andd St
Startup
t Economics
E i

Summary: The New Angel Model
• Find promising companies, do due diligence
• Check the founders alignment on the exit
– Design a thrifty financing plan
– Term sheet designed to facilitate the exit
• Syndicate: Deeper pockets among angels

• Work with the company as a financial partner
• Exit in 3 to 5 years
Section 1.5
Exercise on Angel
Angel-only
only Deals
When Do VCs Make Sense?

Angels only With VCs
Amount of capital Under $5 -10 Over $5 -10
required to prove the million million
business model
Years before being 2 to 5 years Over 10 to 12
able
bl tto exitit years
Most likely value of the Under $50 Over $100 million
company at the time of million
the optimum exit
Not an option, or preference, this is

pre-determined by the ‘type’ of company

Categorize this Company:
A software company with a huge

opportunity as an iPad app
• An angel-only deal
• A deal that will likely require VC funding
Categorize this Company
A new pet thermometer
A drug development discovery for reversing

Alzheimer’s’ disease
• An angel
angel-only
only deal

A medical device company using invasive

technology
A wireless slip ring component for wind turbines
• An a
angel-only
ge o y dea
deal
A solar company with a new photo voltaic

materials composition

A solar company with a new photo voltaic

materials composition
A biotech software company to implement

Obamacare compliance within the HHS
New human energy monitor for Wii applications
• An a
angel-only
ge o y dea
deal

Categorize the Company
A wind energy field in Idaho
• An a
angel-only
ge o y dea
deal

A high fashion women’s shoe company
Discussion on:
Exercise on Angel-only Deals
Break

Part 2
Exit Strategy
gy
by Basil Peters
Agenda
2.0 Overview of Exit Strategy

2.1 Building Alignment on Exit Strategy
and Secondary Sales
2.2 Financing Today’s Startups
2.3 Term Sheets and Exits
2.4 Angels as Financial Partners
2.5 Term Sheet Exercise
Section 2.0
Overview of Exits

Focusing on Exits is Healthy
• A focus on exits is healthy

– Need not distract the team from maximizing
shareholder value (a popular myth)
• For companies with external investors

– Build to last is an operating necessity
– Driving to an optimum exit is strategic objective
Investors’ Model of a Company
Entrepreneur’s Investors’
Sweat Equity Capital
Company Capital
Gains
Planning for Early Exits
• Building more companies for early exits

– Better returns
– More fun For entrepreneurs and investors
• Works particularly well in today

today’ss environment
• What are the steps?
• Where do we start?

Early Exits versus Build to Flip
• Perhaps the difference is subtle

• Build to Flip focuses on building an business to
attract an acquirer
• Seek Early Exits focuses on building a quality
company with an eye towards an optimum exit
– Strategic alignment of investors including founders
– Management team focused on building business
– Exit Team focused on exit issues
Exits Are Not Well Understood

• Least understood part of being an entrepreneur
• Many investors are equally inexperienced
• Why? Exits don’t happen very often
• F
From Scott
S tt Shane,
Sh author
th off Fools
F l G Gold:
ld
– 1 to 1.5% of angel-backed companies exit
– 5.9% of angel group deals exited in 2008
• Is this a trend?
Companies Are Sold, Not Bought

• Most believe the reverse
• Principal theme of Tom McKaskill’s book
• Don’t wait until an acquirer knocks on the door
– It is usually too late
– One bidder decreases both price and probability
• Optimum exits dictate an active sales process

The Exit:
Just Another Business Process
• Financing, product development, marketing or
sales plans, exits!
• The chances of success increase with a plan
• The exit strategy is the plan for the business –
the entire business
• Every investor-funded company must have an
exit strategy
– The plan should start at the end (the goal)
– The planning should begin with the term sheet
Planning for Successful Exits

Initiate Discussions of Exits at the Outset
1. Company selection (by type)
2. Understand the exit strategy
3. Test the exit alignment
g
4. Design the term sheet to facilitate the exit
5. Especially the vesting
6. Don’t let VCs change the exit strategy
7. Help maintain focus and execute the exit
What Type of Company Is It?

Angels VCs
Amount of capital required to Under $5 -10 million Over $5 -10 million
prove the business model
Years before being able to 2 to 5 years Over 10 to 12 years

exitit
Most likely value of the Under $50 million Over $100 million
company at the time of the
optimum exit
This is not easy – can you pick them?

Section 2.1
Building Alignment on
E it St
Exit Strategy
t & Secondary
S d Sales
S l
Developing an Exit Strategy
• Most important element in the business plan

• Every company has an exit strategy
(even if nobody realizes it)
• It affects many daily business decisions
The Exit Strategy

• An Exit Strategy can be as simple as:
– “Our exit strategy is to [sell the company] in about
__ years for around $ __ million.
– We plan to execute the exit by engaging a [mid
market M&A advisor] by _[date]_.
[date] ”
• Entrepreneurs and most investors don’t

acknowledge the need for an early exit plan.
• Most investors wait for someone to knock on
the door

Check The Alignment
• Determine if there is serious mis-alignment
between key stakeholders on the exit strategy
• Get a ‘buy in’ on a written exit strategy
• Usually takes at least one offsite planning
retreat to build full alignment
• Then, recheck alignment annually
Consider a Secondary Sale

• But not using SharesPost or SecondMarket
• New investors buy some or all of founders’
and early investors’ shares
• Can
C b be almost
l ‘‘magical’
i l’
– finalizing alignment
– resolving structural defects
• Unheard of a decade ago, easy today
Secondary Buyers
• Angels
• Smaller Funds
• New Markets

Secondary Sales Solve Problems
• Example of finalizing alignment
– Resolving disagreement on timing of exit
• See Parasun case study in Appendix
– Liquidating early or disgruntled investors
– Liquidating former employees (option holders)
who want out
• Example of fixing structural problem

– Too many small or unaccredited investors
Discussion on:
Building Alignment on
E it Strategy
Exit St t & Secondary
S d S
Sales
l
Section 2.2
Financing Today
Today’ss Startups

Who Actually Finances Startups?
• The media promotes the myth that VCs finance
most startups
• The data* shows that
– Angels make 50,000 investments per year
– Angel Investors finance 20,000 startup/year
– VCs make 1000 first-time investments/year
– VCs fund less than 100 seed/startups/year
* from Scott Shane’s Fool’s Gold, NVCA and J. Sohl, University of New Hampshire
Financing* Today’s Startups

• US VCs fund invest about $20 billion/year – and
this is declining
• Angel investors invest about $20 billion/year and
this number appears to be growing
• Friends and Family investors invest about 3 to 5
times more than either VCs or Angels
• Some predict Angels will be 4X $ VCs in 10 years
* Scott Shane, Fool’s Gold (2009)
Getting the Sequence Right

• Define the exit, then finance the company
– Most angels reverse the order
– In other asset classes, we understand the exit
before investing
• Determine the type of business

• Build alignment on the exit strategy
• THEN develop the financing plan and begin
contact investors

Why The Exit Strategy Comes First
• Different types of investors are compatible with
different types of exit strategies!
• Misalignment among investors (including the
entrepreneurs) can
– Impact timing, therefore reducng returns
– Make any exit difficult
– Has killed companies
Check Financial DNA Before Investing
Entrepreneurial
DNA Resulting Corporate
DNA is a Hybrid of
Combined with Entrepreneurs’ and
Investors’ DNA
Investors’
DNA
Check the compatibility first
Angel Syndication
• Conventional wisdom:
– Most angel rounds top out at $0.75 to $1 million
– Larger groups or affiliated groups: $2 million
• ACA groups began syndication in 2007

• Not uncommon to see syndicated angel round
above $5 million today
• Enough to exit many companies today

Discussion on:
Financing Today
Today’ss Startups
Section 2.3
Term Sheets and Exits
Term Sheets and Corporate Structure

• Most important agreement between the
company and investors
• Establishes the framework for
– their interaction
– company governance
• Impacts on the success of company and exit

• The reference document for most investors

Term Sheets Can Kill
• You find an exciting prospect
• But, earlier investors have agreed to an
inappropriate or detrimental term sheet
– It is usually difficult and time-consuming to change
– You know you should not agree to these terms
• Walk away
– After explaining why to entrepreneur, if you choose
Capital Structure Alternatives

• Some angels have been using the National
Venture Capital Association Preferred term sheet
• Angels also used convertible debt – which is
almost never fair to the investors
• C
Common shares
h create
t the
th best
b t alignment,
li t
governance and KISS, but are dangerous
• Exchangeable shares – an interesting alternative
– See article in Appendix
• Many angels are using Dan Rosen’s “preferred

light” term sheet
Rosen’s Light Pref for Angels

• Dan Rosen is the Chair of the Alliance of
Angels in Seattle
• He’s been working with Angels in the North
West to build a ‘light preferred’ term sheet
optimized for today’s angel investments
• Consensus is building in the US
• See complete document in Appendix
Angel_Term_Sheet_Evolution_Video.html

Key Terms for Early Exits
• Share and option vesting

• Drag Along rights
• Boards of Directors
Discussion on:
Term Sheets and Exits
Section 2.4
Angels as Financial Partners

After Angels Invest
• To facilitate Early Exits:
– Young entrepreneurs don’t have the experience
drive to exits
– Entrepreneurs needs to focus on building business
– Angels/directors provide the perspective required a
to achieve early exits
• As Josh Lerner has demonstrated:

Angels make an invaluable difference
Where Angels Can Help Most

• Aspects of building, financing and exiting
companies are often similar
• Angels have built and exited many
companies
• Angel/directors can help the most in:
– Financing and structure
– Governance and mentoring
– Exiting
Videos on Planning Exits

• Exit Strategies for Angel Investors
North West Energy Angels, Seattle
• Exit Early – Exit Often
South East ACA / Capital Connects, Greenville
• M&A Exits for Angels
North West ACA Seattle, (coming soon)
• All available from www.AngelBlog.net

Discussion on:
Angels as Financial Partners
Section 2.5
Term Sheet Exercise
Select the version of the

investment term most
accommodating to Early Exits

Board of Directors
Option 1: At the time of the closing of this financing, the board of
directors shall be five members: the three founding
shareholder/employees, one elected by a majority of the Series
A Preferred shareholders, and one independent director
acceptable to both CEO and Series A director.
directors shall be three members: the CEO, the corporate
attorney and one elected by a majority of the Series A Preferred
shareholders.
directors shall be three members: the CEO, one elected by a
majority of the Series A Preferred shareholders, and one
independent director acceptable to both CEO and Series A
director.
Board of Directors (continued)

directors shall be seven members: the CEO, another employee
selected by the CEO, two elected by a majority of the Series A
Preferred shareholders, and three independent directors
acceptable to both CEO and Series A directors.
directors shall be five members: the CEO, one elected by a
majority of the Series A Preferred shareholders, and three
independent directors acceptable to both CEO and Series A
director.
Option Vesting
Option 1: All share options granted to employees shall vest two
years after the date of the grant.
Additional subsequent share options granted to employees shall
vest according to the same schedule
Option 2: All share options granted to employees shall vest on
the following schedule: 4% of share options shall vest per
month beginning immediately after the grant.
Additional subsequent share options….

Option Vesting (continued)
the following schedule:
14% of option shares shall vest one year after granted
1.5% of option shares shall vest monthly between
the 13th and 36 month after granted
50% of option shares shall vest upon a sale of
controlling interest in the company

the following schedule:
20% of option shares shall vest one year after granted
The remaining share options shall vest at a
rate of 4% of the original grant per month
Drag-along
Option 1: If the Company’s Board of Directors and a majority of
the Common shareholders approve a Change of Control
Transaction or issuing New Securities, each Preferred and
Common shareholder agrees (i) to vote all shares held by such
shareholder in favor of such Change of Control Transaction or
issuing New Securities,
Securities and (ii) to sell or exchange all shares of
Common Stock then held by such shareholder pursuant to the
terms and conditions of such a transaction.
Option 2: If the Company’s Board of Directors and a majority of
the Series A Preferred shareholders and Common
shareholders approve a Change of Control Transaction or
issuing New Securities, each Preferred and Common
shareholder agrees… (same as Option 1).
Drag-along (continued)
Option 3: If the a simple majority of all the shareholders
(Preferred and Common) approve a Change of Control
Transaction or issuing New Securities, each Preferred and
Common shareholder agrees…(same as Option 1).
Option 4: If the a majority of the Series A Preferred shareholders
approve a Change of Control Transaction or issuing New
Securities, each Preferred and Common shareholder
agrees…(same as Option 1)
Option 5: If the Company’s Board of Directors approve a Change
of Control Transaction or issuing New Securities, each
Preferred and Common shareholder…(same as Option 1)

Share and Option Vesting
• All stock options, and all nominally priced
previously issued shares, will vest on the
following basis:
– 50% of the shares will vest daily and linearly over a
three year period; or
– 50% of shares vest over three year period with cliff
vesting after 12 months on first 1/6th, and
– The other 50% will not vest unless and until there is
a sale of the Company
– All vesting accelerates on a sale
• http://www.angelblog.net/Share_Vesting.html
Liquidity Event – Drag Along

• To allow the holders of 51% of all the issued
shares of the Company to approve a sale
– Cannot be blocked by minority shareholders
– Cannot be blocked by a class of shareholders
• To ensure return for all of the shareholders

• Investors should insist on this provision
• Only applicable to vote on ownership change
– Need not apply to other class voting rights
The Board of Directors

• Total of five members
– CEO plus one nominee of the investors
– Three independent of management
– Usually a non-executive chair
• Each director is an investor

• No “telephone-only” participants
• No observers

“The Fifth Director”
• Has often been a vertical or technical specialist
• OTAF believes
– 5th Directors should be focused on exits
– Good startup p experience
p
– But…with several private company exit experience
• See job descriptions in appendix
Discussion on:
Term Sheet Exercise
Break

Part 3
Exit Execution
by Basil Peters
Agenda
3.0 Introduction
3.1 Exit Team
3.2 Exit Timeline
3.3 Preparation
3.4 Maximizing the Selling Price
3.5 Currency, Closing and Life Options
3.6 Early Exits: Examples and Discussion
Increasing The Number of Exits

Improved exits means
– Increased likelihood of exits
– Optimized time to exit and time to exit
I
Improving
i our successful
f l exits
it by
b
– Focusing on exits before we invest
– Helping entrepreneurs build exit alignment
– Designing our term sheets to facilitate the exit
– Really understanding VC follow-ons

Steps to Completing an Exit
1. Build alignment on exit strategy

2. Engage the best professionals
3. Clean up the corporate structure
4
4. P
Prepare ffor d
due dili
diligence
5. Do a secondary sale (in some cases)
6. Build the sales funnel
7. Manage the auction (multiple bidders)
8. Negotiate and close
Section 3.1
Exit Team
Ideal Exit Team

• Exit Team focus
– Maximizing price
– Ensuring the transaction closes
• The ideal exit team is:
– CEO
– Knowledgeable and experienced director(s)
– An M&A Advisor
– Possibly an Exit Coach
– Legal and Accounting Professionals

Role of the Professionals
• The most important jobs of the M&A advisor:
1. Maximize the price and terms
2. Protect the time of CEO and mgt team
3. Add the experience and strategy
4. Be the bad guy
Why The CEO Should Not Lead

• Needed to maximize the financial results
• Rarely have the exit experience
g
• Held in reserve for the final negotiation
• Are often conflicted
• Need a good relationship with the buyer
(cannot be the ‘bad guy’)
Exit Coach – A New Idea

• Few CEOs exit experience
• Startups should start on the exit just a year, or
two, after startup
• Exit knowledge and experience is even more
critical for these young companies
• If a Director has M&A experience….

Exit Coach
• Changing environment
– New type of professional
– Good knowledge of M&A transactions
• Engagement with CEO
– Typical of a ‘coach’ ($0.5 to 2k /month)
– Less intensity/longer duration than M&A advisor
– Teeing up CEO for M&A advisor
– Help select M&A advisor
• http://www.angelblog.net/The_Exit_Coach.html
Selecting The M&A Advisor

• Little available to help
• Most make sub-optimum choices
• Relationships are always exclusive
• The most important criteria are:
– Transaction completion rate
– Track record of maximizing price
– Familiarity with vertical
– Proximity, knowledge and compatibility
M&A Advisor’s Function

• The sales guy
• Their important functions are to:
– Plan and coordinate process
– Reduce time to closing
– Improve probability of success
– Protect CEO (for as long as possible)
– Maximize price and terms
– Do selling and be the ‘bad guy’

Every Deal Needs A Bad Guy
• M&A transactions are usually fun
• Involve big money
• Both sides want best price
• But:
– Every transaction gets tense – or worse
– Every transaction needs a great bad guy
– CEO cannot be the bad guy
M&A Advisory Fees

• Fees
– Not published but surprisingly uniform
– Not based on the old Lehman formula
• Engagement
g g fees - $50,000
,
• Success fee, including the work fee, from:
– 7 to 10% for sales under $5 million
– 4 to 6% for sales from $10 to 30 million
– 2 to 3% in the $100 million range
• http://www.angelblog.net/M&A_Advisor_Fees.html
Failure is Quite Common
• There are no hard statistics on this and the

professionals rarely talk about it
• Basil Peters believes at least 30% fail
• One industry expert suspects over 90% fail
• Due diligence should include ascertaining
failure rate of advisor candidates

M&A Advisors Should Be Local
• Most Boards look in big financial centers
• Failure is most often the company’s fault
• Cause: lack of communication
• The failure rate increases as the distance to
the M&A advisor increases
• An M&A advisor relationship is intimate and
intense – it requires a lot of face time
M&A Advisors Should Be Local

• Nearing closing, M&A advisor will live with CEO
• Some advisors say they can do this remotely
• But for small transactions, the fees do not justify
the travel commitment
• Local M&A advisors
– protect their reputations
– easier to do due diligence on
M&A_Advisers_Should_be_Local_to_Reduce_Transaction_Failures.html
Legal and Accounting Fees

• Legal and accounting fees vary widely
– depending on complexity
– not size
• Simple transaction - $50,000

$50 000
• Complex deal > $1 million
• Accounting costs
– can be a few thousand
– >$100,000 if audits haven’t been done

Discussion on:
Exit Team
Section 3.2
Exit Timeline
Two Important Questions
• How much?
• How soon?

It Usually Takes….
• 6 to 18 months from M&A Advisor

engagement
• Often much longer
g
– if the company isn’t ready
– if the structure needs to be cleaned up
– if the financials need improvement
When To Tell The Team

• Difficult for most CEOs
– Some worry about the employee anxiety
– Others think it is ‘none of their business’
• But…most
But most of the time
– Internal grapevine is so efficient
– They know before you tell them
• Best practice is to tell everyone fairly early

• Then, deal directly with their fears
– Do I have a job, will the company move, etc.
Timing is important
• Don’t “ride it over the top” (earlier slide)
• Sell is when all is going well
– highest price
– even if the
th business
b i can grow further
f th
• Most difficult decision: Starting the process

two years before the value peaks

Before You Start Selling
• One-third of the work includes:
1. Building alignment
2. Financial history and projections
3 Selling document
3.
• see Appendix for example
4. Cleaning up the corporate structure
5. Preparing the due diligence
• Usually takes 1 to 5 months
Building The Sales Funnel

• Second phase includes:
1. Searching for prospects
See OTAF Strategic Bidder pieces in Appendix
Strategic buyers is the theme of McKaskill’s book
2. Develop tactics on strategic value
3. Initial contacts to 50 - 100
4. Responding to 10 - 20 interested
5. Starting due diligence with 5 - 8
6. Get a stable short list of 3 quickly
• Takes 2 to 6 months
Bidding Process – 3rd Phase

• Most exciting and most intense
• Ideally three buyers will be in due diligence
y negotiating,
• Actively g g simultaneously
y
• The CEO will become the limiting factor
– even if the M&A advisor is doing well
• 2 to 4 months

Negotiating and Closing
• After there is a binding term sheet (deposit?)
• Months to complete the definitive agreement
pp
• And obtain all of the approvals from boards
(and shareholders? and regulators?)
• 1 to 3 months
Timeline Summary
• After M&A advisor engagement
– Exit takes 6 to 18 months
– Depends mostly on the company
– Most of the time
• Preparing the due diligence
• Sales collateral
• Scheduling
• Waiting on lawyers
Discussion on:
Exit Timeline

Section 3.3
Preparation
Before Contacting Buyers
• Common mistake: Engaging too early

• Then realizing that there is a lot to be done
– At worst, buyer loses interest
– At best, lots of rush-rush professional fees
Clean Up The Structure

• Almost always structural defects
– Built into corporate structure
– Contracts with unforeseen consequences
– Lack of contracts with employees
• Fix these before contacting buyers

Employment and IP Agreements
• Complete IP work early
• IP Ownership issues
– Robust employment agreements
– Contractor
C t t relationships
l ti hi
• Don’t get held for ransom at the closing by

an employee who doesn’t want to sign!
Corporate Records and Taxes

• Maintain corporate records with M&A
attorney
– Shareholder/board minutes are critical
• Be prepared to warrant taxes

– Careful documentation pays dividends
• The option
– Huge professional expenses
• See OTAF checklist in appendix
Shares and Share Register

• Maintain careful cap table records
• Detail every share transaction in register
g confirmations early
• Get shareholders to sign y
• Option
– Huge professional fees and delayed exits

Review or Audited Financials
• Put an audit committee in place early
• Move to audited financials early, with a plan
– Recognize that post Enron
• Audited
A dit d financial
fi i l costs
t have
h skyrocketed
k k t d
– Most buyers will want audited financials
• Don’t pay your outside accountants double

at the end to do an audit
The Sales Collateral

• Should all be complete before first contacts
– Due diligence (on a secure website)
– Teaser document (2 pages)
– Selling document (20 pages – see appendix)
– Financial history and projections (Excel)
– PowerPoint for online and boardroom
– Possibly an online video
Discussion on:
Preparation

Section 3.4
Maximizing the Selling Price
Building Shareholder Value

100
90
Exit strategy,
find buyer,
80 structure,
negotiate
But Mentors
Shareholderr Value
and close
add much transaction
70 higher value at
inflection points
60
Mentors assist
company during
50 periods of growth
40
Develop product
and make the
30 first sale
A well designed
and executed exit
20
Founders start
company
can create as
10 much value as all
of the other work.
0
Time
Plan to Over-Achieve
• To get the best price for the business
– Multiple bidders
– Professional ‘auction’ process
– Deliver results that exceed projections
• Clearly, CEO shouldn’t lead Exit Team

Maximizing Exit Value
• Several non-operational ways to maximize
the final selling price:
1. Structural value increase
2 Illuminating strategic value
2.
3. Capitalizing on Inefficient Markets
4. Maintaining multiple bidders
5. Sales and negotiating skill
Structural Value Increase

• Small tweaks increase price 10 to 35%
– Balance sheet changes
– Asset vs. share sales
– Financing mechanisms like sub debt
– Tax innovations
• Opportunities endless but can add $ millions
Illuminating Strategic Value

• Identifying strategic value often creates the
largest fundamental increase in selling price
• Illuminating existing strategic value (also
see McKaskill
McKaskill’s
s book)
• Help buyers understand “synergies”
• This can often be the most valuable
contribution from the M&A professional
• http://www.angelblog.net/Exit_Strategy_Creating_Strategic_Value_Wh
en_You_Sell_A_Business.html

Capitalizing on Inefficient Markets
• Markets for selling are very inefficient:
– Especially for smaller transactions
– Information is difficult to access
– Smaller number of buyers
– The market is illiquid
– Often very few for sale (like yours)
• Big advantages for the seller
• http://www.angelblog.net/Exit_Strategy_
Selling_a_Business_and_Inefficient_Markets.html
Benefits of Multiple Bidders

• Unsolicited offer can be a lost opportunity
• Exits must have multiple bidders to:
– Maximize the final selling price
– Increase the probability of completion
– Close the transaction sooner
• Clearly…a best practice!
• http://www.angelblog.net/Exit_Strategy_
Every_Company_Sale_Needs_Multiple_Bidders.html
Selling and Negotiating Skill

• Some people of much better than others
• Selling a company is just like any other sale
– but bigger and more complex
• An outstanding M&A advisor can often help
to increase the final price by 50% or more
Great_M&A_Advisors_Sell_Companies_for_More.html

Discussion on:
Maximizing the Selling Price
Section 3.5
Currency, Closing and Life

O ti
Options
Currency of the Sale
• Cash (usually preferred)

– Single payment at closing
• 5-20% in Escrow
– Installment
I t ll t sale
l
– Earn-out
• Shares
– Private company
– Public company

Ask any Selling CEO:
Reps and Warranties are tough
• M&A transactions fail more often on reps
and warranties than price and terms
• Basically
yap
personal guarantee
g from the
CEO and other major shareholders
• To protect the buyers against future
liabilities or misrepresentations
• Start coaching the team early in the
process
Closing and The Party

• Once everything is completely agreed to
– It still takes forever to close (4 to 8 weeks)
– There are hundreds of small sticking points
– And fate will have it that their lawyer is working
on three closings simultaneously
• M&A closing parties are always the best

parties
Exits and Life Options

• Exits can be the best part of being an
entrepreneur and investor
– Getting paid our hard work and risk capital
– Entrepreneurs
p and angels
g can then do it again
g
– Or, something entirely different

Discussion on:
Closing and Life Options
Videos on Executing Exits

• Selling a Company – Guide for Angels
National Angel Capital Organization,
Toronto
• How Not To Sell a Business
Entrepreneurs Organization, Vancouver
• Maximizing Exit Value Workshop
Angel Capital Association Summit, Atlanta
• All available from www.AngelBlog.net
Section 3.6
Early Exits:
Examples and Discussion

Two Early Exits
• Parasun
• Brightside
Parasun Case Study

• High-speed internet cable to140 communities
• 2003 Revenues - $3.8 million with a $500k
profit
• Needed investment to expand
• Angels $500,000 in April 2004 at a $3.4 million
valuation = 0.9X Revenues
Alignment Problems
• Founders and some investors wanted
immediate exit
• Management team wanted to wait and
implement innovations
innovations.
• Secondary sales at 30-40% discount
satisfied those looking for immediate exit
• Total alignment on an exit 2-3 years
(achieved at strategic planning retreat)

Fast-forward to Early 2007
• Revenues $8.2 million, profit $781k with
30% growth rate by 2006
• Approached 100 companies, short listed
10
• Had several bidders through the final
stages
• Sold the company in Jan 2007
• Total time for sale: 16 months
What was Parasun’s Selling Price?

• $10 million
• $12.5 million
• $15
$ million
• $20 million
Parasun Sale
• $14.8 million
– IRR = 58%
– ROI = 3.5X in 32 months
– 1.8X Revenues, P/E = 19
• Hypothetical:
– 20X at 58% IRR would have taken seven years
• Questions: What if Parasun raised VC

funding
– What is likelihood of an exit with IRR = 58%?
– Is likelihood of any exit increased or decreased?

Brightside Case Study
• Spin out from the University of British
Columbia
• Technology
T h l to
t make
k LCD di
displays
l
– brighter with higher contrast
• $15 billion/yr market – large screen displays
Angel Investment in Brightside

• Still in development
– just two people
– a few patents
• First
Fi t angell investment
i t t iin JJune 2004
– $100,000 at
– $3.2 million valuation
• Raised $7 million from private sources

• No venture capital
The Brightside Exit

• Still in R&D in 2006
– No revenues
– 8 patents covering exciting technology
• Strategic
St t i d decisions
i i
– Required too much capital to commercialize
– Seek early exit
– Sell to large consumer electronics mfgr
• Total time for sale: 18 months

How much did Brightside Sell For?
• $5 million
• $7.5 million
• $9 million
• $12 million
• $15 million
Brightside Sale
• $9 million
– IRR = 66%
– ROI = 3.9X in 33 months
• Hypothetical:
H th ti l
– 20X at 66% IRR would have taken six years
• Questions: What if Brightside raised VC

funding
– What is likelihood of an exit with IRR = 66%?
– Is likelihood of any exit increased or decreased?
Discussion on:
Early Exits:
E
Examples
l and d Di
Discussion
i

Summary
• It is usually necessary to do some clean up
before exiting
• Early exits require an excellent team
• Early exits increase likelihood of an exit
• Early exits are unlikely in VC funded
companies
• Early exits can produce wonderful returns
• Early exits take 12-18 months to execute
Resources on Exits
• www.Early-Exits.com – Basil’s book on exit
strategies for angels and entrepreneurs
• www.AngelBlog.net – Basil’s blog for
entrepreneurs and angel investors
• www.BasilPeters.com – for videos of my
previous talks on exits (free and in high def)
• The Exit Strategies Newsletter (free) from
the AngelBlog homepage

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Early Exits

Thur. Dec. 2, 2010

• This workshop addresses angel investing

Early Exits Workshop Outline

Workbook Page 3 | 11/2010

• Lifestyle versus High Growth Entrepreneurs

This workshop is focused on angel-funded

Workbook Page 4 | 11/2010

Focus on strategic buyers from the

Pursuing strategic customers will

Some thoughts…before we start

1) “Until the exit we’re all just donors, not investors!”

4) There is no angel business without entrepreneurs, so

Great Exits MUST Start with Great Entrances!

Workbook Page 5 | 11/2010

Section 1.0 Background

Successful Angel Investing

Workbook Page 6 | 11/2010

What Angels Used To Do

The World Has Changed

• Traditional venture capital is broken

Workbook Page 7 | 11/2010

For Most High Growth

Venture Capital Is Broken

Angels and VCs – Growing Apart

Workbook Page 8 | 11/2010

Source: US National Venture Capital Association, Thomson Financial

Average Capital per VC Principle

Source: US National Venture Capital Association, Thomson Financial

VC Investment Prior to M&A Exit

Amount of VC investment prior to M&A exit in millions. 2008 data for Q1

Workbook Page 9 | 11/2010

92% of M&As Don’t Work for VCs

Data from Mergerstat

What Happened to IPOs?

Workbook Page 10 | 11/2010

What About Big M&A Exits?

More on the old VC Model

• If you are interested in reading more on why

Workbook Page 11 | 11/2010

For Technology Companies,

What happens to Angels when

Additional Years to VC Exit

10x Return 30x Return

To achieve a minimally acceptable VC fund return of 20% per year and

Workbook Page 12 | 11/2010

It Actually Adds About a Decade

Source: Adams Street Partners 2006 analysis of funds then dissolved.

Workbook Page 13 | 11/2010

• Significantly increases the risk of failure

Angel Investor Math

Investor Time Horizons

• VCs wait a decade or more…

Workbook Page 14 | 11/2010

• Research May 2008 - University of Maryland -

Angels, VCs and IPOs

More Validating Research

Workbook Page 15 | 11/2010

More Fewer More Slight Increase

Source: Robert Wiltbank, PhD Willamette University with

The Bottom Line

• We don’t have data yet, but I believe today the

What We Think Happens