# Presentation: 079156

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

## 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

## VC HISTORY

**VC HISTORY**
_**The First 10 years - 1960’s - 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
- 	for deals
-      •  Hot issue market of early 1960s showed significance of  IPO
- 	“exiting” and timing

## The Second Ten Years - 1970’s - A U.S. Venture Capital Industry Created

- • Increased leverage to 3:1 and 4:1 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 1960’s to computers of 1970’s
- • 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

## •  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 1970’s

  Bob Noyce - Intel Corp
  Gene Amdahl - Amdahl Computers / Trilogy Investments
  Steve Jobs - Apple Computer
  Seymour Cray - Cray Research
  Fred Smith - Federal Express 
  Bob Swanson - Genentech

• Life Sciences deals begin, but falter

- 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 1970’s
-   Bob Noyce - Intel Corp
-   Gene Amdahl - Amdahl Computers / Trilogy Investments
-   Steve Jobs - Apple Computer
-   Seymour Cray - Cray Research
-   Fred Smith - Federal Express
-   Bob Swanson - Genentech
- • Life Sciences deals begin, but falter

## 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 - What’s debt and what’s 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

## 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

- •  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

## 
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
•  What’s Next ?????????

_**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
- •  What’s Next ?????????

## 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

## Slide 10

## 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

## 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

## 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

**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***

**Know Your Venture Fund Model**

## 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***

## 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

## 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***

## 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

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

**Company Profile:**
- · No history of earning
- ·	 Age similar to public / private company
- ·	 Technology and market similar
- ·	 Find like company, etc.

## 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

- ·	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**

## 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

- 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

## 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*** ***

## 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***

## 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**

## 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

## 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 ??***

## 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

## Bioscience Business Lifecycle and Montgomery College Life Science and Technology Park Ecosystem

**Timespan of Phase**

**MC Contribution in the Phase**

**MC Benefits in the Phase**

**MC Bioscience Park Percentage Occupancy**

**Zero Profit Line**

- Jerry Feigen, Lloyd Case

**New, startup seed-capital, promising, company**
- <<< 1-5 Years >>>
- *Technology Development
- *Entrepreneurial 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, 1****st****-2****nd**** round financed company**
- <<< 5-10 Years>>>
- *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)**

**$uccessful, public, acquisition, or merged anchor company**
- *Spinoff new companies
- *Mentorships 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)**

**Mature, Pre-IPO nth-round financed company**
**<<< **10+ Years >>>
- *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)**

## Macklin Partners 
Technology Council of Maryland
Dingman Center for Entrepreneurship
Montgomery County Department of
Economic Development

Potential Internships

Incubator Development

**Technology Council of Maryland**
**Dingman Center for Entrepreneurship**
**Montgomery County Department of**
**Economic Development**
**Potential Internships**
**Incubator Development**

## Center for Entrepreneurship
Jerry Feigen, Director
   51 Mannakee Street
   Rockville, Maryland  20850
Phone:  301 738-1702
Fax:  301 279-5149
Email:  jfeigen@mc.cc.md.us
Web:  www.macklin.org

For copies of this presentation or further information, contact kdroubi@mc.cc.md.us or 301 738-1707

**Jerry Feigen, Director**
**   ****51 Mannakee Street**
**   ****Rockville, Maryland  20850**
**Phone:  301 738-1702**
**Fax:  301 279-5149**
**Email:  jfeigen@mc.cc.md.us**
**Web:  *****www.macklin.org***
***For copies of this presentation or further information, contact kdroubi@mc.cc.md.us or 301 738-1707***