The duty of privilege is absolute integrity - towards ourselves, towards our possibilities and to...

“The duty of privilege is absolute integrity -

towards ourselves, towards our possibilities and

to live to the full the life that we’d love.”

John O’Donohue

2007

Positioning Your Company

For Exit

SBIR Phase II Conference

June 2017

2

Disclaimer

I am not an attorney

I am not a financial advisor

Please make sure you get advice from excellent paid professionals

3

Crossing a threshold

BEFORE AFTER

4

Thank you: National Pharmaceutical Council, American Pharmaceutical Association, Merck

Today’s Presentation

Part 1: Avoid founder frustration

Part 2: Begin with the end in mind

Part 3: The M&A Process

5

Part 1: Avoid founder frustration

6

What people say:

7

“The investors

screwed us”

“Venture

capitalists are

evil”

“Why don’t they

understand – it’s OUR

money.”

“It was my

idea”

“This is SO

unfair”

BUSINESS & TECH.

Tuesday, May 31, 2016

Mr. Nord says, “Then founders look around three years in, and they have 45 people and no real business model and own 4.5% of their business and are asking themselves what happened”.

8

Avoid Founder Frustration:Know the rules

Willett wins with the lowest score Giants win with the highest score

Both sports are played with a stick and a small ball.

9

Liquidation Preference:

Which is better 1x or 2x?

It depends.

Make sure you have the right experts

on your deal team.

10

Avoid Founder Frustration::Know who is at the table

Understand their incentives

YOU

Directors

Investors

Management team

Employees

Advisors

Acquirer11

Avoid Founder Frustration:Understand how you can

add value

• What is the job of the acquirer/investor?

• What is your job?

– “Advance the science”

– “Publish papers”

– “Build the company”

– “Generate (superior) return for our

investors/limited partners/shareholders”12

Avoid Founder Frustration:Manage Conflicts

There will be conflicts.

Figure out how to manage them.

Figure out if it is time to recuse yourself.13

Avoid Founder Frustration:Understand Business Value

Idea versus Execution

What is your relationship to the company?

Pick your role carefully:

Founder

Employee*

Officer

Director

Investor

Advisor*

Consultant14

http://www.sportingnews.com/nba/

~2003 - Charlotte Christian High School 2015 – NBA MVP

Stephen Curry Rookie (2009): $2.7m

Stephen Curry MVP (2016): ~$22m

https://en.wikipedia.org/wiki/Stephen_Curry

15

Avoid Founder Frustration:Understand Business Value

Idea versus Execution

Avoid Founder Frustration:Understand the Business Value

$1b of sales potential versus $1b in sales

16http://www.bizjournals.com

$2.8B

Valuation

Avoid Founder Frustration: Avoid envy

You don’t need to be envious of someone who won the lottery or had an IPO that went up. You have to figure out what makes sense and follow your own course.

Warren Buffett, April 30, 201617

18

Part 2: Begin with the end in mind

The M&A Process

19

Investor Math – Founder Math

What do I/We get?

Two things:

What percent of the pie do I/We own?

What is the pie worth?

(Valuation)

20

Investor Math – Founder MathThe Cap(italization) Table

The start-up book.com21

Investor Math – Founder Math

The Cap(italization) Table

What percent of the pie to I/We own?

CSE: Common Stock Equivalents

15%

YOU

Everybody else

85%

22

15%YOU

Everybody

else85%

Investor Math – Founder Math

What’s the pie worth?

What do I get?

Pie is worth I/We get

$50 million $7.5 million

$250 million $37.5 million

CSE: Common Stock Equivalents 23

Avoid Founder Frustration:Understand the specific scenarios

15%YOU

Everybody

else85%

YOU

Everybody

else

2%

98%

Pie = Even a penny below

$50M

Pie = “$50M or above”

CSE: Common Stock Equivalents 24

Avoid Founder Frustration:Understand the intricaciesof YOUR liquidation stack

25

THE NEW YORK TIMES BUSINESS THURSDAY, JUNE 2, 2016

ENTREPRENEURSHIP

In their haste to get financing, start-up founders often fail to read the fine print and later discover that they have signed away huge shares of the profits.

26

Liquidation Stack

Where do you sit?

Sale Price: $400,000

Mortgage: $150,000

27

Liquidation Stack

Where do you sit?

Equity

Debt $150,000

$250,000

Valuation: $400,000

28

Liquidation Stack

Where do you sit?

Sale Price: $130,000

Mortgage: $150,000

29

Liquidation Stack

Where do you sit?

Equity

Debt

$150,000

$-20,000

Valuation: $130,000

30

Investor Math – Founder Math

Series A

Exit

2016 2018 2023

Define Key Milestones

or

Key Financing Milestones

Capital required/financing need for Series A

Total capital required/total financing need

Series B

DebtSeries

C

Debt

Preferred

Common

Other

Liquidation

Stack

Where do

you sit?

32

Liquidation Stack

Where do you sit?

Series C

Common

Series B

Series A

Series C

Common

Series A,B Pari Passu

33

Liquidation StackWhat happens when there IS

enough to pay out the whole stack?

Series C

Common

Series B

Series A

Series C

Common

Series A,B

34

Liquidation StackWhat happens when there is NOT

enough to pay out the whole stack?

Series C

Common

Series B

Series A

Series C

Common

Series A,B

35

36

Avoid Founder Frustration:Gains and Losses

Plan for Your Transition

What is your role (if any) in the surviving entity?

Founder

Employee

Officer

Director

Investor

Advisor

Consultant

37

38

Part 3: The M&A Process

The M&A Process

Close

Plan Shop Bids Term sheet Diligence

39

Plan: Assess the state of the current market

• What is more likely – IPO or sale?

• What were the multiples in recent transactions?

– Industry specific

– Stage specific

• Assess the risk of now versus later:

– Take the bird in hand

– Hold out for a higher valuation later

• Past results or previous offers are not comparable

40

Plan: Sale versus IPO requirements

• Product “complete”

• Revenue

• Path to profitability

• Full management team

• Developed salesforce

• Growth story

• SOX-compliant systems

• Audited financials

� �

�

�

�

�

�

�

��

�

�

�

�

�

�

Needed for Sale Needed for IPO

Nice to

have

In most situations, M&A is the more attainable exit

41

Plan: Understand Markets Dynamics

42

43

44http://www.wsj.com/articles/the-cloud-deal-wave-hasnt-crested-yet-1465143376

June 5, 2016

New York Times45

2015: Biggest M&A Year Ever

46The Wall Street Journal

New York Times47

48http://info.kpmg.us/ma-survey/index.html

Valuation

49

50http://info.kpmg.us/ma-survey/index.html

51http://info.kpmg.us/ma-survey/index.html

Valuation

An art and a science

52

53

“The whole process

was crazy-making,

because it was

imprecise. The was no

right number. It was all

a matter of opinion,

feeling, selling.”

Understand Valuation MetricsWhat is Your Company Worth?

Many Valuation Methods:

• Price/Sales Multiple

• Price/Earnings Multiple

• Tops down meets bottoms up

• Industry specific

54

Understand Valuation MetricsWhat is Your Company Worth?

55

Use many methods and develop a range

Be realistic

Investor Math – Founder Math

Series A Exit

2016 2018 2023

Define

Key Milestones

or

Key Financing Milestones

Capital required/financing need for Series A

Total capital required/total financing need

Series B Debt Series C

57

Company

Name

Series A

Req’d

Series A Milestone Total

Capital

Req’d

Long-term

revenue

potential

Potential

valuation

$500K Three contracts: to

establish “track record”

$1.0M $2.25M $5.0M

$1.5M Commercial readiness $1.5M $2.5M $5.5M

$2.3M Two contracts:

“proof of concept”

$2.5M $40.0M $100M

$2.5M Demonstrate efficacy –

(xx) indication

$87M $2.1B $8.0B

$5.0M Two collaborations +

identify own compound

$125M $1.0B $4.0B

$1.5M IND filed for resistant

(xx) cancer

$4M $35M $200M

Investor Math – Founder Math

58

Plan/Prepare

• Know your ecosystem:– Most likely acquirers, alternative targets (your

competitors), existing alliances, consolidation

– Assess the potential buyers for cultural fit

• Know your company’s situation:– Cash out date, burn rate, ability to raise more capital,

money and team to get to the next milestone

• Consider type of sale– What: Asset sale, stock acquisition, merger, tender offer

– How: Targeted sale, auction

– Transact for cash or stock?

59

60http://info.kpmg.us/ma-survey/index.html

Avoid Founder Frustration:Understand You are Part of a Pipeline

61http://info.kpmg.us/ma-survey/index.html

Business Day

62

SATURDAY, JUNE 4. 2016

The sharpest attack came from Greg Duffy, the founder and former chief executive of

Dropcam, the home video camera and cloud-computing service that Nest acquired for $555

million in 2014, about six months after Google bought Nest. Mr. Duffy clashed with Mr.

Fadell, remained at Nest for eight months and briefly moved to another post at Google

before departing last September.

Writing on Medium in late March, Mr. Duffy said he regretted selling Dropcam to Nest and

noted his “extreme differences on management style with the current leadership at Nest.”

63

Which factors are most important when evaluating a target?

Target Valuation and Investment Return

Strategic Fit

Growth Potential

67%

56%

44%

Cultural Fit 15%

http://info.kpmg.us/ma-survey/index.html

Plan/Prepare

• Assemble the deal team– Lawyers, accountants, bankers

• Prepare due diligence materials– Organize the books and records (legal, contracts, IP,

financial statements, NOLs)

• Document the operation– Product description, roadmaps, employees, sales pipeline,

customer listsDocument the operation

• Develop Presentation/Pitch Deck– Non-confidential

– Confidential

64

Documentation for a merger

65

Plan/Prepare:Get Stakeholder Alignment

• Understand the transaction implications

– Change of control provisions

– Vesting, who gets what at different valuations

– Executive compensation

– Retention of key employees

– Effect of recaps or restructurings

• Understand the terms for different “series”

66

Plan: Evaluate the constituencies

Acquirer

� Acquiring business unit

� Executive Management

� Board of Directors

� Shareholders

� Customers

� Wall Street (if public)

� Current Employees

Target - YOU

� Management

� Board of Directors

� Shareholders – by series

� Advisors

� Employees

� Customers

…who are involved at various levels and often have different motivations.

Management needs to understand the shareholder dynamics and proactively influence.

67

68http://info.kpmg.us/ma-survey/index.html

Plan: Before you go

• Establish one spokesperson

• Set fallback plans and walk away points

69

The M&A Process

Close

Plan Shop Bids Term sheet Diligence

70

Shop

• Do’s and Don’ts

– Confidentiality

– Keep the business going

– Management shows concern for employees

– Be able to back-up your forecasts

– Focus on the whole transaction, not just the price

– Robust documentation

71

The M&A Process

Close

Plan Shop Bids Term sheet Diligence

72

Term Sheet/Due diligence:

Process Steps

• Letter of intent/term sheet

• Due diligence

• Definitive agreement

• Board approval

• Shareholder approval

• Regulatory filings

• Closing

• Post-closing filings

73

Terms and Conditions:

What do they mean for you?

• Escrow

• Earn-outs

• Recaps, management holdbacks

• Tax considerations

• Representations and warranties

• Indemnification

• Termination conditions

• Closing conditions74

Considerations

• Federal Securities Laws

• Antitrust Laws

• State Corporate Law

– Fiduciary duty

• State Contract Law

• Tax

• International

75

Fiduciary Duty

• Duty of Care

• Duty of Loyalty

• Duty of Good Faith

• Business Judgment Rule

• “Entire Fairness”

76

The M&A Process

Close

Plan Shop Bids Term sheet Diligence

77

Other Resources

79

80

81

Presidential Summit on

Entrepreneurship

Representatives from 50 countries, five continents

http://www.youtube.com/watch?v=uhLpFtpfeWY

84http://info.kpmg.us/ma-survey/index.html

85

http://www1.american.edu/academic.depts/ksb/finance_realestate/rhauswald/fin673/673mat/KPMG%20M&A%20Survey%202001.pdf

“83% Of Mergers Fail”

86https://tobyelwin.com/mergers-acquisitions-project-failure/

Personal Partnership: Marriage

87New York Times: 12/02/2014 – Claire Miller: http://www.nytimes.com/2014/12/02/upshot/

Business Partnerships: 80% fail

88http://www.forbes.com/sites/amandaneville/2013/03/01/why-partnership-is-harder-than-marriage/

Entrepreneurs 3/01/2013

Why Partnership Is Harder Than Marriage

“But the truth is that partnership is far more difficult to

maintain than marriage. In fact, whereas 50% of marriages

end in divorce, the number is closer to 80% for business

partnerships. And it’s exponentially more difficult if you

happen to have more than one partner.”

89

Key deal terms

90

91