What do Venture Capital’s look for in an investment?

1.       Attractive market/industry

How to assess if a market is attractive?	Characteristics of an attractive market
Market size	Large market with many potential customers
Market rate of growth	High growth markets help businesses to grow revenues and are often positively correlated with profitability
Demographic, lifestyle or other trends	Trends which support the growth of the market
Regulations	Low regulation (but note regulation can also be a positive factor)
Impact of technology on the market	Market supported by technology trends (Sustaining vs. disruptive innovations)
Porter’s five forces	Generally low level of forces (customer bargaining power, supplier bargaining power, threat of substitutes, threat of new entrants and intensity of rivalry)

2.       Attractive business model

How to assess if a business model is attractive?	Characteristics of an attractive business model
Market position/competitive advantage	Defensive market position with clear competitive advantages. Potential for market leadership
Sustainability – Barriers to replication	Strong barriers to replication
Financial characteristics	Strong cash flow and working capital characteristics

3.       Experienced and entrepreneurial management team

How to assess if a management team is suitable?	Characteristics of a suitable management team
Experience and suitability	Business and technical experience to deliver on business plan
Entrepreneurial track record	Serial entrepreneurs or first time entrepreneurs with strong credentials
Appropriate alignment of interest	“Skin in the game” (E.g. significant shareholding in business, performance-based compensation)

·                           Are serial entrepreneurs more likely to succeed than first-time entrepreneurs?

o   First time entrepreneurs:

­   Driven by a personal passion

­   Can be obsessive and stubborn

­   May struggle to build a company around the product

o   Serial entrepreneurs

­   Experienced at building and running a company

­   May not be driven by a personal passion

­   May suffer from the “second album effect” (E.g. Puff Daddy)

o   There’s no difference, however industry experiences helps

4.       Attractive valuation/returns potential

·         Methods to value a company?
1.       NPV of discounted CFs (DCF): details way to look at a company, building a company in an excel model

Advantages	Disadvantages
Because DCF are so details, startups usually lose money and eventually it will make money – with a 10 year DCF a company can look at when will the company break-even (Make money)	It is really the product of your input – if put garbage into the DCF and garbage is going to be coming out
Sensitivity	Hard to predict short term for a startups so it will challenging to forecast the future
Good for infrastructure such as toll roads (where you have 20-30 years period and the owner is entitled to all the tolls that come to them – can be roughly valued)
Useful for resource companies (determining the amount of gold an metal and a certain percentage that can be extracted and the resources won’t last forever, so DCF can be used)

2.       Option methods: takes uncertainty into account

Advantages	Disadvantages
Can take uncertainty into account which you can’t explicitly with the other methods	Not really used in a particle investment world and it is really hard to explain to a startup founder

3.       Multiples: standardized the value of a dollar – compare companies across the industries (easiest method for startups always)

­   Enterprise value/EBITDA  (a negative value)

­   Price/Earnings (P/E) (also a negative ratio)

­   Enterprise value/Revenue (Mainly use this to value because startups earnings are generally negative so we don’t want to add more negative value to earnings)

·         VC valuation – Pre-money and Post-money:

o   Companies raise VC funding through issuing new shares to VC firm

o   Funding occurs in “funding rounds” (E.g. Round A, Round B, Round C; or Series A, Series B …)

o   Each funding rounds has a pre-money and a post-money valuation:

a)      Post-money valuation = the value of the company after the funding round

 (# of existing shares + # newly issued shares) * share price of funding round

b)      Pre-money valuation = the value of the company before the funding round

Post-money valuation – funding amount

o   Example 1: If a company has a pre-money valuation of $5million, and raises $3million in VC funding, it has a post-money valuation of $8million.

o   Example 2: Wizztech.com currently has 100, 000 shares on issue. It is seeking a raise $2.25 million in new VC funding at $150 per share in a series A funding round.

                                                              I.      How many new shares will Wizztech.com be issuing?

=$2.25m/$150 = 15, 000 new shares

                                                            II.      What % of ownership will the VC firm have in Wizztech.com?

= 15, 000/(100, 000 + 15, 000) = 13.4%

                                                          III.      What is Wizztech.com’s series A post-money valuation?

= (100, 000 + 15, 000)*150 = $17, 250, 000

                                                          IV.      What is Wizztech.com’s series A pre-money valuation?

=$17, 250, 000 - $2, 250, 000 = $15, 000, 000

5.       Clear exit path

·         VCs often look to sell their shareholding in a portfolio company within three to seven years

·         Exit timing may be driven by the requirements of the VC fund – many funds are 10 years closed-end funds

·         Exit options:

a)      IPO *

b)      Trade Sale/Merger *

c)       Wind-up/Liquidation (last resort)