IGNITE 2008 How Investors Value Technology Companies Art

IGNITE 2008 “How Investors Value Technology Companies” Art, Science, Maths and Realities What Entrepreneurs Need to Know Professor Alan Barrell and Peter Phillips

Agenda – Welcome to the Real World • Valuation – when and why is it important ? • Thinking about INVESTORS – they have the ££££/$$$$ • Deciding on best sources of Finance • The Background – Economics, Markets and Values • Case Based discussions – the art of the possible • Valuation calculations and methods – where do they fit ? • Special problems of Emerging Technologies • Valuing the Future…. Crystal Balls vs PCs Slide 2

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Stay Cool! Dilbert - Scott Adams Slide 4

Stay Cool! Dilbert - Scott Adams Slide 5

Stay Cool! Dilbert - Scott Adams Slide 6

Valuation – how and why? • To indicate value to potential investors • What is a company worth? - What someone will pay for it • What is this determined by? - Other investment choices (there are usually MANY !) Slide 7

A Search for Fair Value – see any Science here? Issue date Value at issue 1 Year On Bookham April 2000 £ 1. 2 billion £ 231 million Lastminute. Com. March 2000 £ 571 million £ 54 million Orchestream June 2000 £ 212 million £ 52 million Just 2 clicks Feb 2000 £---- Slide 8 £ 130 million

The Changing Horizon – World Economics affects Company Valuations Organisations Environment Issues Technology The death of deference Globalisation New employment patterns Slide 9

The Changing Face of Globalisation – Realities for Europe, US and The World • Two fifths of the Worlds people live in the two fastest growing large economies – China and India – FACT • Education, Wealth Creation and New Knowledge are at the heart of Economic Planning in Asia • Growth in Asia is far ahead of Europe. • The desire to LEAD is strong in Asia • CASH is in place in the Asian economies – as well as brainpower. • Growth of FDI and VC. Slide 10

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Some Economic Indicators – How are key Countries doing? How does it affect investing? GDP % Change Trade Balance US $ Bn Foreign Reserves US $ Bn China + 9. 5 + 8. 9 +60 1. 65 Trillion And growing! India + 8. 6 + 8. 0 - 25 130 Britain + 2. 9 + 0. 1 - 49 Euro Area + 2. 1 + 1. 0 + 86 USA • • • Ind. Prod. % + 3. 9 + 3. 5 - 679 Can the trend continue? China’s $s growing at 200 billions a quarter! Inward and outbound investing – trends Sovereign Wealth Funds Chinese and Indian VC investing Chinese and Indian Angel Investors are growing in number and getting organised Slide 12

The Phenomenon of Ancient China – Creativity and Inventiveness – some of the Inventions – many NOT financed or exploited – little return for inventors… • • • • • • The first lamps Magnetic Compass The Camera Gunpowder Paper for writing Printing Iron and Steel Smelting Copper and Bronze ware Oil Drilling and Production Coal Mining Pottery and Porcelain Wine making and tea culture Early Astronomy Sericulture – gave us Silk Seismography Traditional Medicine and Anaesthetics Acupunture Vaccination against Smallpox The Hot Air Balloon The Soushi Calendar Decimal and Binary Mathematics Slide 13

When a market “BOOMS” - Venture Capital Investments in E-Commerce (U. S. A. ) “When Greed overcame Fear” $5, 000 $4, 000 $3, 000 Netscape IPO 3 rd largest in Nasdaq History $2, 000 Amazon. com IPO $1, 000 $0 Slide 14 Source: Venture Economics Total Invested ($ million) $6, 000

Venture Capital Funds with Regional Associations – at the height of a “boom” Prime Technology Ventures Siemens VC FNI Venture Capital Alta Amadeus Berkeley ICT CRIL ET Capital Pall Mall Ventures Create Ventures Generics Life Sciences Prelude Cambridge Avlar Gateway TTP Ventures Abingworth 3 i Merlin More than £ 3. 0 million Less than £ 1. 0 million INVESTMENT SIZE - Cambridge Region only - UK and Europe Cambridge Venture Capital Scene – Estimated total value of funds: in excess of £ 1. 5 billions Slide 15

But…. Boom can lead to BUST- valuation implications? “Return of Fear…. ” “Down Rounds”. . Discuss…. Peak of Irrational Expectations E-tailers shakeout begins Christmas 1999 Investor disillusionment IPO Fever Late Business disappointment Christmas 1998 Investors Robust e-businesses survive & thrive Amazon. com Early investors Netscape WWW Invented Pioneer investors R&D 1990 Marketing 1995 2000 Slide 16 Rational Expectations Internet in every business Profitability Cash Flow 2005 2010 Bygrave; Gartner. Group, 11/99

US Angels – The REAL early stage funders ! • In 2000 US business Angels invested more than $200 billions in early stage companies • This was much more than the so called “venture capital industry” which did not reach investment levels that year of $150 billions. • In the difficult year of 2002 – when VCS “sat on hands” – Cambridge Angels kept the early stage and emerging business sector alive and well • Cambridge Angels are adopting the US success model and working more closely together. Slide 17

The Competitive Threat “Today’s Peacock is tomorrow’s feather duster” – There is ALWAYS competition…. Slide 18

Sources of Competitiveness Information Learning Risk Creativity Reputation Speed Values Cost Slide 19

Valuations and Technology Development – “Survival of the Fastest…” 1971 All international phone calls 1975 All airline passengers 1984 All mobile phones 1992 All emails 1998 Source: Analysys, World Bank and ITU Slide 20 All SMS

Three Converging Revolutions Three Pervasive Technology Platforms BIO TECH Pharmaceuticals Diagnostics Research/Info Tools Industrial INFO TECH Hardware Software Communications Genomics Bioinformatics Proteomics Bioelectronics Microfluidics Nanobiotechnology Drug Delivery Biosensors Biochips Nanodevices Nanosensors Nanoelectronics NANO TECH Electrical Structural Biomedical Energy & Environment Slide 21

Characteristics of high technology regions. Catalysts for Growth – Centres of Investment – is the environment where most of us are? . . • • • Universities and centres of academic excellence Exploitable, converging Technologies Entrepreneurs with marketable ideas and products • Business angels and established seed funds • Sources of early stage venture capital • Core of successful large companies • Quality management teams and talent • Supportive infrastructure • Affordable space for growing businesses • Access to capital markets • Attractive living environment and accommodation source : - Gibbons - Stanford University 1998 Slide 22

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The emergence of high-technology clusters in Greater Cambridge 50, 000 Slide 24

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Overlapping Technologies support Overlapping Business Clusters HEALTH Medical services Bio-informatics Telecoms Medical devices and scientific instruments INFORMATION and COMMUNICATIONS TECHNOLOGY Networking Computing Bio-pharmaceuticals University/ Research Institutes Wireless Inkjet printing Medical research Technology Consulting Publishing Basic Research KNOWLEDGE CREATION Education Slide 26 Sound & vision

“Show Me The Money!” • • Basics – Investment Readiness How organised are we ? Company structure ? Management Team? Intellectual Property? Vision, Purpose, Plans and Positioning Ideas? Advisors ? “Greyhairs and Wisdom” ? Basics – eg Accounts and Controls ? • “Rumsfeld Questions” – “What we DON’T know? ” Slide 27

Sources Of Business Finance “Our Money” B A Family and Friends N K Risk Business Angels Seed Funds Early Stage VC Expansion Capital Pre-IPO Maturity Slide 28 F I N A N C E ? ?

Converging Interests and Influences Innovating in the Overlap and Adding Value – working together – across functions as well as across borders – public funds are available EDUCATION & RESEARCH including Universities INDUSTRY & BUSINESS GOVERNMENT National & Local Slide 29

Stages Of Investment (1) 1. Seed Developing IPR, unlikely to have full time employees, and may well have no business premises. Working on “proof of principle” 2. Start up Companies in the process of being set up, with limited trading. Involved in product development and initial marketing 3. Early stage Companies that have completed the “proof of principle”, own some IPR, have a management team substantially in place, requiring funds for manufacturing and/or licensing, and sales Slide 30

Stages Of Investment (2) 4. Expansion Established companies, with a full management team and generating sales, and require further finance to break into new markets. The definition “Expansion” often creates confusion 5. Pre IPO Final round prior to a listing on a recognised Stock Exchange. Can be referred to as “Expansion” funding 6. Later stage Many variants – M and A, MBO, MBI etc. Slide 31

“Show Me The Money” – It’s more than “valuation” • • • Understanding the “Money Supply Chain” Research and Help – and where to find it What’s Best for Our Business ? “Money on its own may not bring the Value you need” Friends, Banks, “Angels”, VCs et al. Grants – including DTI R & D Grants Resourcefulness, Resilience and Recovery” Learning from encounters with investors Attention to detail – “nitty gritty” Slide 32

The Early Stage Business Balance – what do investors look for and see? When “valuing” ? Inspired Leadership Creativity Vision Management Enthusiasm Research & Analysis Bullshit Courage Caution Optimism Process Market Knowledge Financial Control The role of Chairman and NXDs Slide 33

Sources Of Business Finance The Venture Capital Jungle – where Valuations are a “specialty” 1) 2) 3) 4) 5) 6) 7) 8) The “Bibles” – BVCA and EVCA Handbooks and Websites VCs can be small, large, regional, national, international, privately held or publicly quoted. UCFs growing in number. RDA and Govt supported VCs are emerging to fund up to £ 250 K or £ 500 K VCs can be “general” or industry focussed All VCs have clear investment criteria. VCs are firmly regulated by the FSA, or other National Regulatory bodies. Some are regulated in the Channel Islands. Corporates make direct investments AND some have free standing VC operations. Slide 34

Engaging The Funders • Preparing the case - how to start -”Do we need help ? ” Intermediaries-Corporate Finance. • Is the Business Model Clear? • Keep Business Plans Simple! • Targeting funders - Investors have specific criteria • ? Angels, Banks, Seed Fund, Corporates or VCs – or a “mix” • Matching agendas • Sponsors for spin-outs • Organisations and people - the forward plan Slide 35

One Fund’s Investment Criteria Cambridge Gateway Fund • • • Innovative core technology Protected/protectable I. P. Sectors - I. T. , Telecomms, Life Sciences Beyond proof of concept - not seed, not start-up Management team, Business Model and Plan in place • Potential to exploit global markets • Ready for “roll out” Slide 36

Due Diligence is a two way thing: it will affect valuation get it RIGHT ! • Investors due diligence agenda: – Technology and I. P. – Market - is it really there? – People - can they do it? – Exit options and drive • Due Diligence on Investors: – Investment criteria – Track record – People, relationships, references – Clarity of expectations – Available finance - including “follow on” – Willingness to syndicate and to participate Slide 37

Exploring the Spirit of Adventure and Discovery – and on to Entrepreneurs • An early case of an “Angel Investment” • Adversity and achievement – rewards for persistence • Investors look for “special people” • Inspiration and Passion show in different ways • Investors invest in…People mostly • Knowing the Investor mindset Slide 38

A “Brainpower Hero” Slide 41

Einstein on IMAGINATION…. “Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world” Albert Einstein 1879 - 1955 Slide 42

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Why MINDSET matters – what’s an Entrepreneur ? “You look at things and ask - why? but I dream of things that never were and ask why not? ” George Bernard Shaw Slide 44

Schumpeter (1911) on Entrepreneurs “Entrepreneurs blow gales of creative destruction. ” Role of the entrepreneur in transforming economies by developing: · New products · New methods of production · New ways of organizing · Untapped raw materials · Enhanced competitive performance Josef Schumpeter Vienna 1911 Slide 45

Is there RISK involved? . . Oh dear…. How do we manage risk ? . . Slide 46

As an Investor - Would you invest in this team ? Slide 47

If you or I had done so in 1978 – we wouldn’t be working here now ! Microsoft Corporation, 1978 Slide 48

Time for a final little story, about a bright little boy…. Slide 49

Who became a brilliant young man…. Slide 50

Inventor and champion of Intellectual Property Rights……. . Slide 51

NOT just the inventor of the Electric Light…. . Thomas Edison – he built an Empire on Intellectual Property – “Capturing Imagination and creating / adding value” Slide 52

Let’s look at some Realities – Cases we have known • Contrasting financing means and valuation – Ink Jet Printing • Technology, Passion and Energy don’t always prove sufficient – Active RF • A Funding Fable – “Valuation Obsession” almost killed the company Slide 53

Contrasting Case Studies – same business sector – similar companies – similar valuations. Equity finance is not the ONLY way – but valuation counts any way Domino Willett § Venture Capital § Organic growth & bank borrowing § IPO – LSE 43 X oversubscribed § No equity investments § Growth financed by rights issues § No public offerings § Significant acquisitions to buy new technology (e. g. laser coders) § New technology “developed within” – at controlled costs (e. g. laser coders) § Always profitable § Half yearly reporting § 1, 500 shareholders § No public reporting other than annual accounts § Regular dividends § No Dividends for first 10 years § Shareholder driven – business ratios and “bottom line” focus § Growth and ambition driven § Owners’ re-investment policy minimise reported bottom line and taxes § Founder realised £ 21 millions § Founder realised £ 60 millions – cash. Slide 54

“Pilgrim’s Progress” – A true story… Slide 55

Pilgrim’s History • Born Cambridge 1967 • Educated London & Cambridge Slide 56 • BSc Computer Engineering • Early work Cambridge & Oxford

Pilgrim’s History Then… • To Silicon Valley • Euphonix Inc – Palo Alto • Atari Corporation – Sunnyvale • Chromatic Research Inc – Sunnyvale Slide 57

Pilgrim’s Experience • • Project Management Real Time Systems ASIC Design Systems Architecture Digital Multimedia User Interface Design Technical Leadership Slide 58

Pilgrim’s Company in UK – active. RF Ltd • • • Back to Cambridge in 1997 Passion to start own company Bitten by the Entrepreneurial bug! A “One man band” … or more correctly – “One man & his dog” Slide 59

Tagging Crumpet Slide 60

Tagging Crumpet • Dog collars to security systems Slide 61

The original concept (Jan 1999) Slide 62

Early Chronology – Post Dog Collar! • October 1998 – Incorporation • October 1998 - February 1999 – “One man & his dog” • Angels to the Rescue! Slide 63

Commercial micro-location Slide 64

Power Evolution at active RF – valuation implications Share class Preferred Ordinary Options VC’s board CEO Founder board Passive Shareholders Angels Employees Slide 65 Angels Founder

Factions in Conflicts of Interest – value and control diminish…. Angels The Com pan Ordinary Shareholders y Founder Employees Slide 66 VC CEO Chairman and Board

active. RF Limited – slippery slope • • Dog collars to security systems The leap from Lab to Industry Cultural success Technical failure What happened to the revenues? Management evolution and the CEO Valuation from zero to £ 250 K to £ 5. 5 m to £ 250 K to zero. Slide 67

Adventure vs. Slide 68 Venture

antenova Limited – how it started – Pilgrim again…. • IP acquired and brought to Cambridge £ 120 k Angels, Family & Friends Slide 69

Case Study: Antenova – a funding fable • Disruptive technology which could change the world – from University collaboration • Outstanding management – technical and operations • Inexperienced in fundraising • Valuation obsession • Where has all the money gone? • Salvation, adequate funding and continued progress Slide 70

Thinking Of Angels! – we keep referring to them ! Slide 71

Some Angel Groups Active in Cambridge • Cambridge Angels - Serial Entrepreneurs, Cambridge locations • Cambridge Capital Group – geographically more spread – Cambridge centric investors • I. Q. Capital – was Great Eastern Investment Forum • Glen House Capital Strategies Ltd • Sophia Business Angels Slide 72

Connections • www. cambridgeangels. net • www. cambridgecapitalgroup. co. uk • www. iqcapital. co. uk • www. glenhouse. uk. com • www. sophiabusinessangels. fr Slide 73

Financing Tomorrow’s Businesses – Optimizing your value • • • Technical Expertise Marketing Expertise What else you get from Contacts Decision Making skills Business Angels…. Presentation skills Dealmaking skills Money-raising skills Other Financial skills Possible exit routes and practical help with exit Slide 74 7

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If at first you don’t succeed…. try again…. but learn from the mistakes! Slide 77

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Inspiration SHOWS – investors have emotions! “Excellence can be achieved, if we: Care more than others think is wise, Risk more than others think is safe, Dream more than others think is practical, Expect more than others think is possible. ” Deborah Johnson-Ross Slide 79

VALUATION is a major topic – serious study needed ! For more information…… www. alanbarrell. com alan@alanbarrell. com