Information for Participating in Venture Capital Fair

Situation

Procedures Venture Capitalists and Participants Should Know

Guidelines for Venture Capital Investors during Team Negotiations

What to Look for in a Team

Ideas for Discussion

Situation

Several teams entered the microcomputer business one year ago (4 quarters or decision periods). They have surveyed the market, conducted a market opportunity analysis, opened a factory, designed brands, opened sales offices, hired sales people, developed advertising campaigns, and engaged in test marketing for the past two quarters. They have been restrained from investing in research and development and taking out loans.

Recently, the teams have been preparing a business plan and pro forma financial statements. They must have detailed plans for the next year (4 quarters) and tentative plans for the third year in business.

The simulation is structured so that the teams will require venture capital to invest in R&D, new sales offices, and plant capacity. They can ask for up to 5,000,000 in either common or preferred stock or some combination of the two. They will receive this money in Quarter 5.

At this point in time, the teams are planning to present their business plan to you as a venture capitalist and request equity financing. (Even if they do not ask for money, you are on their board of directors and have the right to review the business plan.) The format we will use is a venture capital fair. Each team will make a

12-minute presentation. After you have seen all teams, you will decide which teams interest you. You will then make an appointment to review the business plan and negotiate your equity investment. You will be free to negotiate any deal you wish without consultation with the other investors.

Background details you should know:

The initial capitalization was 4,000,000 which was invested by the executive team in 1,000,000 increments over the 4 quarters of the first year.
Fifteen thousand shares of common stock have been authorized.
Four thousand shares of common stock have been issued to the executive team in exchange for their 4,000,000 investment.
The initial value of the common stock was 1000 per share. The executive team currently owns 100% of the company.
At the end of the first year of business, the executive team will present a two-year business plan to you and other venture capitalists whom also serve as their Board of Directors.
The executives will make a pitch to you and the other venture capitalists for outside capital.
The financial request should include the kind of stock (common or preferred), number of shares of stock offered for sale, and the proposed stock price
You will want to negotiate the size of the investment, the kind of stock, number of shares to be purchased, and the stock price depending upon their (and your) assessment of team performance to date, the soundness of the business plan, and the firm's profit potential.
The maximum amount a firm can accept from the venture capital community is 5,000,000.
The bank has set up a line of credit to the executive team equal to one and one half times the firm's equity position in the previous quarter (i.e., loan capacity = 1.5 x (common stock + retained earnings in previous quarter)
The bank is highly risk adverse and will call in a loan (in part or whole) if a firm's debt capacity declines due to unusual or extended losses.
The bank is intolerant of poor financial management. If a firm ends a quarter with a negative cash position, the bank will contact Guido to obtain an emergency loan to cover the firm's checking account.
For each 1000 of emergency loan funds added to a team's checking account, Guido will take one share of stock in the firm.
Other financial institutions will also buy long-term notes for a premium interest rate over conventional bank loans (+2 interest points). The acceptable debt capacity is two times the firm's equity position in the previous quarter (i.e., loan capacity = 2 x (common stock + preferred stock + retained earnings) in previous quarter. Long-term debt is for a fixed period of time with little possibility of the financial institution calling in the note due to short-term swings in income.

Procedures Venture Capitalists and Participants Should Know

The team will make a presentation to the venture capital group.

The venture capital group is composed of independent venture capitalists. There are an equal number of venture capitalists and teams. However, this does not imply that the venture capitalists are assigned to a team or that each team will receive money from at least one venture capitalist.

Each team is given 12 minutes to present its business plan to the group of potential investors; and the objective is to let the venture capitalists see all teams before they sit down to negotiate an equity investment with any one of them.

At end of the presentations, the venture capital group will quickly evaluate the quality of the teams.

Each individual investor:

decides which teams he or she wants to negotiate with and the order (probably no more than three for detailed negotiations);
informs each team whether and where he or she wants to meet with them. (It is possible that a team may need to meet with two investors at the same time.);
meets with the team to ask questions and negotiate an equity position;
is free to negotiate an equity position in any team; and
is free to contact the other venture capitalists for consultation. (It is not necessary that the investors agree on a common stock price.)

By the end of the negotiating period, all transactions must be concluded. Each venture capitalist will have given his/her money to the teams selected for investment and each team will have received all of the money they have been able to obtain from venture capitalists.

The negotiation is concluded when the venture capitalist physically gives the cash (in play money) for the equity investment. Both parties will sign a contract for the exchange (The team will later provide a stock certificate with the agreed upon stock price, number of shares, and total investment)

The team can issue the stock once they have turned over the cash to the instructor, along with a copy of the stock agreements, which they have negotiated with the venture capitalists.

Fast Eddy Capital Fund is the investor of last resort in case a team is not able to find suitable investors. GVCF will make an open offer at a stock price 50 less than the lowest stock price on the market.

The team presentations will begin at 1:15 pm and conclude by 2:30 pm

The venture capitalists will have 15 minutes of quiet time to review the business plans and select the teams for further talks and negotiations.

All transactions must be completed by 4:30

The only denomination we have is 100,000 bills. If change is needed, use IOUs.

Guidelines for Venture Capital Investors during Team Negotiations

I would suggest spending 10 to 20 minutes asking about the plan, the competition, the market, and the cash flow. Then spend whatever amount of time you want negotiating a stock investment. It might be wise to wait on the negotiations until after you have visited the other firms on your short list.

You do not need to conclude the terms of the agreement during the first meeting. You can ask the team to return later for final negotiations. For example, you might want to wait until you have negotiated with one or two teams before you finalize your position.

You will receive 4,000,000/3,200,000 in cash (40 one hundred-thousand bills) before the presentations begin.

This is all the money you will have to invest. You are free to invest it all in one firm or divide it among a combination of firms. I would prefer that you diversify your investments and invest in more than one firm. I suggest being easy with investments up to 1,500,000 in total and stingy investing beyond that. Make the last 500,000 to 1,000,000 tougher to get.

As you negotiate your equity investment, think about a stock price between 700 and 1200 per share, depending upon the risk you perceive. This risk will depend in part upon how well they have done in the past and how well you think they will do in the future (a good assessment of the market and a good plan).

You are free to set any schedule you want for in-depth negotiations. It is not a bad idea to keep to a 20 to 30 minute schedule, but you can go longer or shorter if you wish.

Usually, a venture capitalist is not interested in dividends as a way to make money. More likely, he or she would like to see the company go public or be bought by a large company and make tons of money by the appreciation of the stock. Not many participants know this.

You are free to conduct your negotiations wherever and whenever you wish.

Guido is the investor of last resort, so all teams will have access to money.

What to Look for in a Team

Here are a few things to look for as you review each team and assess the risk of investment:

You should look for a detailed business plan through quarter 8 (they are in quarter 5) and a tentative plan through quarter 12. They should also have cash flow projections and pro forma income statements and balance sheets through quarter 8 (firm). Some teams may not have a good cash flow complete. If this is the case, focus on the overall strategy and the tactical plan.

You should look for correspondence between the details of the business plan (i.e., advertising expenditures or sales force) and disbursements in the cash flow. One thing to watch out for is growth of sales without a corresponding increase in marketing effort. There is a cause and effect relationship between their decisions (increase advertising, introduce new technology, expand sales offices) and demand. If sales are increasing without a corresponding increase in things, which generate the demand, they are dreaming.

Encourage the team to grow the marketing side of the business (new brands with R&D, sales offices, salespeople, advertising) in order to drive the demand they want.

The executive teams should know their market. They should know which segments are the best served, which geographic markets are the largest by segment and what it will take in new product technology to capture their target markets. They should have also figured out what their competition is likely to do and have developed a plan, which takes advantage of their weaknesses and protects them against the competitors' strengths.

Good market performance requires a good team and team work. Real venture capitalists often say they would rather invest in a class A team with a class B plan than a class A plan and a class B team. Look to see how well the team works together.

It is OK to set conditions for the investment such as spending it only on R&D, plant capacity, or inventory. You may also want to set hurdles for them such as not expanding into three segments until they achieve positive retained earnings and/or a certain market share. (There will be a tendency to try to do too much and they will generally underestimate their cash flow requirements.)

Ideas for Discussion

The teams are probably better prepared to discuss their market opportunity analysis and the tactical decisions of their strategic plan than they are the justification for their pro forma financial statements.

During your one-on-one discussions, I would spend more time on these dimensions than the financials, perhaps 2 to 1.

Here are some ideas for discussion:

Why did you pick these target markets? Geographic markets? What is their market potential?

What did you learn from your test marketing? How did you adjust your initial strategy based upon what you learned?

Convince me that this is a good plan.

What does your target market want and how will you deliver it to them?

Brands (How did you decide what to build into a brand and which R&D features to develop? What needs are you serving? Did you consider how these designs would affect your production operations?)

Prices (What will the market bear? How sensitive is the market to price differences?)

Service (How important is service and how much will you provide?)

How will you promote your brands?

What is your sales force plan?

What is your advertising plan?

What is the balance between sales and advertising? Which is more important?

When you launch your new brands, how will your strategy change?

How much profit are we making or will we make on these brands? (You might ask if they have done an ABC analysis. Some will have and some will not have.)

What are your plans for the factory?

How are you scheduling your investments in production capacity to coincide with your market development plans?

What is your capacity utilization? What is your strategy for maximizing it?

What do you plan to do to improve factory operations? Will any of these expenditures help you to better serve the customer?

Who are the competitors that worry you the most? Why is that?

What do you think they will do in the next year of business? What investments will they make? What are you doing to combat their strategy? How does this plan reflect what you think they will do?

Are there any weak competitors that you can attack? How would you do that?

How are all of these decisions affecting your cash flow needs?

I am sure you can easily pick up from here.

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