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EPS 7573A: Venture & Growth Capital: Theory & Practice

Rob Adler Adjunct Professor Babson College Fall 2011

Office: Luksic 005, ground floor of Luksic radler@babson.edu or adler@yahoo.com (preferred), mobile 617-821-3705

Class Meetings: Thursdays, from 6:30 pm to 9:15 pm beginning September 1st in Luksic 108.

Final Examination: Thursday, October 13 during our scheduled class time. Laptop computers are optional, but VERY STRONGLY ENCOURAGED. Please be prepared to either email your final exam from the classroom (which will show a save date/time) and/or submit your final examination on a disk.
Individual Office Hours: By appointment. Generally there will be time during the semester on Thursdays between 5:00 pm 6:00 pm and then after class and at other times by phone, again by appointment. Course Materials: Texts: New Venture Creation. Entrepreneurship for the 21st Century, Jeffry A. Timmons and Stephen Spinelli, Jr. (Irwin/McGraw-Hill, 8th edition) The Course Packet: Case Studies in the Course Packet: CCBN (HBS 9-898-146) Spectrum Equity (HBS 9-295-021) Kurt & John Bauer Securities Online, Inc. Notes, Articles, and Problem Sets Method for Valuing High Risk, Long Term Investments: The "Venture Capital Method", WA Sahlman, (HBS 9-288-006) Note on Free Cash Flow Valuation Models, WA Sahlman, (HBS 9-288-023) (Please note this is OPTIONAL reading material) Note of Financial Contracting: Deals, WA Sahlman (HBS 9-288-014) Note on Private Equity Partnership Agreements (HBS 9-294-084) Note on Valuations in Private Equity (HBS 9-297-050) The Venture Capital Method - Valuation Problem Set, WA Sahlman, (HBS 9-396-090) Angel Investing (HBS 9-800-273)

Case Studies found in New Venture Creation, Timmons, (8th edition): Lightwave Technology, Inc Course Themes & Issues: The course will consist of five central themes, with sub-topics as follows: 1. Venture Capital Investing: Competencies & Capabilities -Knowledge, skills, competencies & capabilities required -What do venture capital and private equity investors do? -Identifying, screening & evaluating investing opportunities -The role of the investor and the limited partner -Evaluating risk & reward 2. Deals & Deal Structuring -Theory & reality in the private capital markets -The role of incentives and deal structures: Gatekeepers v. Generals, Limiteds v. CEOs -Legal, accounting and SEC issues -Crafting and negotiating the term sheet -Syndicating -Closing 3. Valuing High-risk, Long-term Equity Investments -Methods & issues in valuation -Negotiating the deal -The troubled portfolio -Analytical tools and software 4. Creating & Realizing Value -Exit options, strategies & dilemmas -Managing & orchestrating the IPO and the private sale -Evaluating & selecting investment bankers -Suppliers v. users of capital: inherent conflicts -The role of the Board 5. The Private Equity Fund as an Enterprise -Trends & sources of capital -The fund-raising process and economics of the Business -Managing the fund as a business -Monitoring the portfolio & analytical tools -Managing critical stakeholders: gatekeepers, limited partners, generals, prior investors, advisors, management, and board relationships Surely, this is an ambitious agenda for a course that will meet just six times before your final! I have tried to get as much of these five themes into the schedule as is possible. We will therefore plan to 2

cover a lot of territory during each class session. This will require a lot of preparation on both our parts, as well as the best case-discussion skills that you have accumulated during the MBA program. BEFORE THE COURSE ACTUALLY STARTS: It is very important to get a head start and mastery of the technical notes at the beginning of your course packet, ideally BEFORE OUR FIRST CLASS SESSION, ESPECIALLY IF YOUR FINANCE COMPETENCY IS MODERATE TO WEAK. Our capacity to advance our discussions in class and to enrich the level of insight will rise proportionately to our fluency with the concepts and technical aspects of these notes. We will not have time in class to discuss every single technical issue, so it is very important to get to these notes early, and to get whatever outside help you may personally need to master these, if any of this finance is not familiar to you. Learning Objectives: 1. To acquire knowledge, competencies and skills in raising, investing and harvesting venture and private equity capital. 2. To develop a capacity for selecting and evaluating venture and private equity capital as a user (CEO or general partner) or supplier (limited partner) of capital. 3. To examine the theory and realities of the private equity markets. 4. To gain knowledge and capacities for managing risk/reward in the venture capital and private equity markets. This is a complex and uncharted territory. My aim is to teach you as future entrepreneurial leaders to use a financial perspective on the entrepreneurial process and entrepreneurial finance issues, though I will argue that finance is the least important part of the value creation and enhancement process. My expectation is that you will enhance your capacity to envision, anticipate, and orchestrate this process and thereby influence positively one's odds for success, and minimize the odds of blunder. I also hope to teach effective entrepreneurial practice from the perspective of users and suppliers of capital, so you can gain a keener appreciation of the role of financial analytics, and, more importantly, the art of recognizing and seizing the moment to actually make a deal happen. Hopefully, you will also come to recognize and appreciate that the numbers and analytics are vital, but serve as gateways and points of departure for exploring the more important and often more subtle issues, tactics and strategies. Underlying the course is the central concept and model of the entrepreneurial process from New Venture Creation. The central capabilities embedded in this framework include opportunity recognition, creation and pursuit; leadership and team building; resources marshaling and bootstrapping; the uncertain and dynamic context; and notion of Fit. (A close review of Chapters 3&5 is essential to understanding these concepts.) We will build on this model and the technical notes to examine ways entrepreneurs and investors identify opportunities, create and muster the necessary resources, finance and eventually harvest, growth ventures. Our focus is the financing and development of high potential ventures e.g. multi-million plus revenue potential. I have found over the years that it is often riskier, more painful personally and considerably less rewarding to think too small. We will examine a number of issues inherent in the value creation and realization process, including:

1. What constitutes an attractive venture opportunity for venture capitalists, and what is the difference between just another idea and a good business opportunity? How do opportunities evolve over time? What and when is an opportunity a descendent of financial considerations? 2. How should the capital resource be marshaled: how much money is needed to start, acquire or expand the business; how, when, and what kind of financing should be developed to seize the opportunity? Who should, and should not, invest, and why? 3. What people should be attracted to the team (i.e., how should the people resource be leveraged)? 4. What do venture capitalists do and what roles do they perform to create or add value, achieve a positive cash flow, and to develop harvest options? 5. How do successful investors and entrepreneurs marshal the necessary financial and non-financial resources inside and outside the firm to seize and execute opportunities, and what pitfalls do they manage to avoid, and how? What deals should be struck with each of these resource suppliers? Who are the contacts and networks entrepreneurs need to access and to develop? 6. What do entrepreneurs need to know about the fund-raising process and the capital markets? What sources of risk, growth and venture capital financing (equity, debt and other innovative means) are available for entrepreneurs, and how is appropriate financing negotiated and obtained? 7. What criteria do venture capital and private equity investors utilize to screen and evaluate fund raising proposals, and how is this done? 8. What are the legal and contractual issues involved in raising outside risk capital? What inherent conflicts exist between users (entrepreneurs) and suppliers (investors) of capital? 9. How are deals structured, valued, and orchestrated whether they are for start-ups, expansion, LBOs and MBOs, IPOs, troubled companies, or the purchase of existing ventures? What are the critical issues, consequences and payoffs of different financial strategies and deal structures? 10. What are the future consequences of decisions made by investors and entrepreneurs at each point in time? What options are precluded or preserved? What new options may emerge? What are some of the nastier pitfalls, minefields, and hazards one needs to anticipate, prepare for and respond to? 11. What decisions can be made to increase the reward to risk ratio at each stage of a companys development? How do entrepreneurs and investors change the odds and thereby reduce or shift the risk? 12. How and when should opportunities be harvested from a personal, stakeholder, corporate and investor perspective? 13. What are the important factors outside the control of management? And investors? How are these factors likely to change over time and how can both make sensible decisions in the light of these probable changes? 14. In each of these issues how critical and sensitive is the current context and timing? 4

15. What are some of the personal and career options and opportunities that may fit with your goals and dreams? How can these become reality? Grading: I very much appreciate that you are all mature adults; face many demands of school, jobs, families, field studies or independent projects, and recruiting; and are here to get as much out of the course as is possible. First, your presence and active participation to in-class learning is vital if we care to have a lively and useful course. This means being well prepared, contributing -- not an occasional chip shot -- and being ready to disagree with others, develop your own position, and engaging others in lively discussion, rather than just me. It is very important to have class discussions relate to what has been said previously and to build upon the valuable thought of those who have spoken. To encourage the highest quality of preparation and participation so we can all win, I will continually ask for cold call openers and during class. Thats what the case method is all about. The overall effectiveness of your participation will constitute half your final grade. The other half of your final grade will be based on the final exam. My expectation is that each of you will contribute significantly to the class. Ask me for feedback any time you would like. Second, there is an absolute level and amount of work you accomplish, both in your discussion and analysis of cases for class, and the final exam. There is no substitute for accomplishing a lot of high quality work. I encourage effort and reward results. Third, I will place a good deal of weight on relative progress and improvement over the term, without penalizing in any way a select few who may start out and sustain an outstanding effort. When I recognize growth and learning due to your strong personal effort, I reward it. Decision Time As the term progresses you will be immersed in some fun, at times easy, at times difficult, at times stressful, personal career decisions. If you would like to discuss your deliberations or dilemmas with me Im happy to do so. At your convenience and option, please make an appointment (it will be a face-to-face appointment or a telephone appointment).


Please note the preparation needed PRIOR to our first class session!
Date September 1 Thursday #1 Topic & Assignment Introduction to Venture & Growth Capital Course and Venture Capital Industry Overview Readings: NVC8e Ch. 1 & 3 Case: Kurt and John Bauer Assignment: Read the case and formulate answers to the following: 1. Evaluate the opportunities facing the Bauers in 1994. 2. What fund raising strategy would you recommend? Who will and will not invest and why? 3. How would you value a start-up Internet company? 1. What entrepreneurial opportunities existed via the Internet and what are the implications? 2. What should the professor say? What should they do? Blackboard: Please submit answers to the questions posted on our BLACKBOARD site no later than midnight on Wednesday, 8/31. September 8 Thursday #2 Venture Capital Investing-Theory & Reality Readings: NVC8e Ch. 5 Angel Investing (HBS 9-800-273) Note on Valuations in Private Equity (HBS 9-297-050)* Case: Securities Online, Inc. Assignment: Read the case and formulate answers to the following questions. 1. What has changed at SOI in just a year? Why? 2. How has value been created? 3. Would you invest in SOI? Blackboard: Please submit answers to the questions posted on our BLACKBOARD site no later than noon on Thursday, 9/8. September 15 Thursday #3 The Business of Venture Capital Readings: Note on Private Equity Partnership Agreements (HBS 9-294-084)* Case: Spectrum Equity Assignment: Read the case and formulate answers to the following questions. 1. Evaluate the opportunity facing Applegate and Collatos.

2. What are the economics of a venture capital partnership? How do VCs make money? 3. When should a new partnership raise capital? 4. Why is succession so difficult in the VC industry? 5. Who should be a venture capitalist? Blackboard: Please submit answers to the questions posted on our BLACKBOARD site no later than noon on Thursday, 9/15. September 22 Thursday #4 Deals and Deal Structuring Readings: Venture Capital Method: Valuation Problem Set (HBS 9-396-090) A Method for Valuing a High-Risk, Long Term Investments (HBS 9288-006) Note on Financial Contracting: Deals (HBS 9-288-014) Deal Structure and Deal Terms (HBS 9-086-805) NVC8e Ch. 13 & 14 Assignment: Complete Valuation Problem Set. Please submit answers to the Valuation Problem Set via email to me (radler@babson.edu or adler@yahoo.com ) no later than noon on Thursday, 9/22 September 29 #5 Thursday Creating and Realizing Long Term Value Readings: NVC8e Ch. 15 Case: Lightwave Technology, Inc. NVC8e 502-509 Assignment: 1. Evaluate the progress of the company. 2. Evaluate the proposed financing? 3. As a private equity investor, would you invest and why? 4. What should he do? Blackboard: Please submit answers to the questions posted on our BLACKBOARD site no later than noon on Thursday, 9/29.

October 6 Thursday


Crafting Exit Strategies Case: CCBN plus in-class handout Assignment: 1. Evaluate the opportunity described in the CCBN business plan. 7

2. As an investor, what kind of due diligence would you do prior to making an investment? 3. What kind of valuation range would you consider reasonable as investors in this business? 4. If you were Parker/Adler who would you go to in raising this initial round of capital? 5. What are several of the keys to this venture's success?

Blackboard: Please submit answers to the questions posted on our BLACKBOARD site no later than noon on Thursday, 10/6. Course Wrap-up October 13 Thursday #7 FINAL EXAMINATION The final will be during our normally scheduled class time and in our regular classroom. Use of Laptop Computers Strongly Encouraged!!