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VC Exits, Early Exits, and No Exit

VC Exits, Early Exits, and No Exit. Presentation by Kieran McCarthy Kieran@ColoradoStartupLawyer.com. Hypothetical Breakout.

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VC Exits, Early Exits, and No Exit

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  1. VC Exits, Early Exits, and No Exit Presentation by Kieran McCarthy Kieran@ColoradoStartupLawyer.com

  2. Hypothetical Breakout Samuel, Bob, and Tina are all avid tennis players at the Galvanize Country Club. Samuel is an engineer at AthleticoTechCorp with a real knack for coming up with great inventions and bringing them to life. He enjoys inventing not just at work, but in his spare time, too. During his lunch breaks and at home, with some cash sprung from his cousin in Italy, Vicente, he’s developed a device that monitors your swing and tells you when you’re developing tennis elbow. Samuel calls the device The Elbometer. Bob, a watch salesman who frequents the club, hears about the Elbometer and asks Samuel if he can sell the product in his spare time in exchange for half the profits (the device sells for $100 but costs just $20 to make). There’s so much interest in The Elbometer, Samuel and Bob can’t keep up with demand. Tina, a C-level executive at a late-stage startup, volunteers to help them with a comprehensive business development plan. According to Tina, an entrepreneur with VC and angel connections, selling to tennis fanatics is a niche market. But if they can show annual gross revenue of a million dollars or more, they could sell the company for $10-20 million to a sports equipment company. Samuel and Bob think it might take them two or three years to get to that point, but think it’s doable. They’ll need $500K to $800K to ramp up production and keep up with initial demand.

  3. Issue Spotting • What are some issues that you see with the business as its developing? • What should the team do before it decides to move forward as a team? • How should the team divvy up equity? • What type of formation documents should the business have in place? • Where should the team look to raise capital?

  4. Point of the Presentation • Presentation inspired by three books: Venture Capitalists at Work, by Tarang Shah, Early Exits, by Basil Peters; Rework, by Jason Fried and David Heinemeier Hansson • Literature on startups and startup legal issues is very VC focused. • Few startups have realistic chance to acquire VC funding and most are better off avoiding it. • Each startup should tailor its business and formation strategy to a plan that makes sense for its business, potential growth expectations, and long-term goals. These strategies may be very different depending on the business you expect to be.

  5. The VC’s World I look at Mint -- $170 million exit. That is 10 percent of SolarWinds. I do not mean to cast aspersions on CubeTree or Mint or any of those. I am just saying that as a student of the economics of the tech business, to me, that is not where the action is. That is sort of a sideshow, where the main event is Facebook, Google, Twitter, Microsoft . . . . Some people will say, “Can’t you get excited about the $150-million exit?” I can make money on those deals, but I can’t get excited about them. -Mike Maples, Jr. Managing Partner, FLOODGATE

  6. VC Math • VC funds expect to earn investors in the neighborhood 20% compounding per year. • This means over a ten year period of a fund, investors will have to get 6 times their initial investment to achieve the results of an acceptable VC fund. • Only 20% of VC-backed companies are “winners.” • Each of those two winners must return 30x the VC’s investment to help the VC achieve minimally acceptable results.

  7. What Happens When VCs Invest • According to the Kaufmann Foundation, companies with VC investment fail 12% more often than companies with just angel investment. • Companies with VC investment have nearly 20% fewer 1x-5x exits. • VC-backed companies have 5-10% greater chance of achieving 5-10x return. • VC-backed companies have 1% greater chance of achieving >10x return.

  8. Time from Financing to Exit • From 1996 to 2001, the average time from VC financing to M&A exit was 2-4 years. • From 2008 to 2013, average time from VC financing to M&A exit was 7-9 years. • Most companies take a few years before they get to the point where they interest VCs. • Expected start to exit for a VC-centric company today is well in excess of ten years.

  9. Know Thyself • None of this to discourage those with visions of “the next big thing” from seeking VC money. • More options today than ever before. • Ask yourself: • If all goes according to plan, how big will this be? • How much money do I need to get this started? • How long do I want to do this?

  10. If Not Venture Capital, Then What? • Bootstrapping • Build Business on Immediate Revenue • Kickstarter/Indiegogo Donation-Based Crowdfunding • Title III Crowdfunding • Title II Crowdfunding • Angel Investment

  11. Different Business/Different Structure • Most of early meetups have been about entity structure. • Many of the presentations assume you want investment, rapid growth, and acquisition. • Precisely the structure you choose depends on the type of business you want to become.

  12. Ideal Structure VC-backed company • Delaware-based C-Corporation • IP assignments lock up all ownership from the beginning. • Vesting schedules allow company to buy back ownership of any founder who leaves over the first four to five years of company development. • Strong company-oriented foundation that gives protections from company given eventuality that will see turnover of many initial key players over time.

  13. Company Seeking Early Exit • Structure centered around type of investment sought and opinions of prominent investors (if any) • Company structure possibly different depending upon relationships of the early founders. • Vesting schedules still advisable, but perhaps with shorter duration (three years vs. five years) • Stronger protections for early founders in event of departure without cause.

  14. No Exit • Greater flexibility for founders to choose whatever business entity they want. • LLCs provide greater flexibility to structure your company – likely more appropriate for a business that plans to keep its early founders and not transition to different structure later, bring on many subsequent investors. • The most important thing when you are starting this type of business is that everyone knows where they stand and that there is clear, written documentation of everyone’s status in the company. • Still important to provide for eventualities such as founder disability, departure, death, etc., but more important to resolve the conflicts from the founders’ perspective, rather than the company’s perspective.

  15. Hypothetical Revisited Samuel, Bob, and Tina are all avid tennis players at the Galvanize Country Club. Samuel is an engineer at AthleticoTechCorpwith a real knack for coming up with great inventions and bringing them to life. With some cash sprung from his cousin in Italy, Vicente, he’s developed a device that monitors your swing and tells you when you’re developing tennis elbow. Samuel calls the device The Elbometer. Bob, a watch salesman who frequents the club, hears about the Elbometer and asks Samuel if he can sell the product in his spare time in exchange for half the profits for half the profits (the device sells for $100 but costs just $20 to make). There’s so much interest in The Elbometer, Samuel and Bob can’t keep up with demand. Tina, a C-level executive at a late-stage startup, volunteers to help them with a comprehensive business development plan. According to Tina, an entrepreneur with VC and angel connections, selling to tennis fanatics is a niche market. But if they can show annual gross revenue of a million dollars, they could sell the company for $10-20 million to a sports equipment company. Samuel and Bob think it might take them two or three years to get to that point, but think it’s doable. They’ll need $500K to $800K to ramp up production and keep up with initial demand.

  16. Issue Spotting • What are some issues that you see with the business as its developing? • What should the team do before it decides to move forward as a team? • How should the team divvy up equity? • What type of formation documents should the business have in place? • Where should the team look to raise capital?

  17. Thanks for Coming! • For more questions, please feel free to contact me at Kieran@ColoradoStartupLawyer.com. • Special thanks to Galvanize and Cooley LLP for co-hosting.

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