VENTURE CAPITAL 101

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OUTLINE

1- Introduction & History

2- Investment Stages

3- Deal Structure

4- Portfolio & Returns Model

5- Fund Structure & Fees

6- Dealflow & Investment DD Procedure

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 1- Introduction & History

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DEFINITION

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THE HISTORY OF VENTURE CAPITAL

Venture capital was created in the 1960’s in Silicon Valley, and was

responsible for launching world-changing companies such as:

VC firms that funded these companies include Sequoia and Kleiner Perkins.

For the story of how VC was created, watch the documentary “Something
Ventured”, available online.

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HOW BIG ARE THE COMPANIES THAT VCs FUND

COMPANY VALUATIONS

At the low end, VC firms will co-invest with angel

investors. At the high end, VC firms often work
with PE firms.
FRIENDS & FAMILY VC firms typically fund companies that have
between $3m to $200m in enterprise value.

ANGEL

VENTURE CAPITAL $3,000,000 - $200,000,000

PUBLIC/PE $50,000,000 - $10,000,000,000+

$ MILLIONS 0 50 100 150 200 250

Some companies consider going public as they reach

higher valuations, although most high-tech firms are
staying private longer because of the abundance of
private equity, and volatility of the public markets.

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 2- Investment Stages

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CAPITAL RAISE AND TRACTION METRICS

STAGE IDEATION PRE-SEED SEED SERIES A SERIES B SERIES C+ IPO

CAPITAL
RAISE
<$250K $250K - $1M $1M - $3M $4M - $10M $10M - $25M $25+

Friends & family, Growth VCs, Private

INVESTORS Self funded, loans VCs, Angels Institutional VCs Institutional VCs
Angels, VCs Equity

Initial concept, Initial prototype, beta Strong usage from PMF, strong customer Expansion of product Market leading
identification of customers in target early customers, POCs growth & management lines, proven channels tech/platform,
customers and market segments, MRR $0- convert to customers. team. ARR $2m+, 3x Y/Y to scale customer customer trust.
TRACTION
opportunity. 25k MRR $25k-100k growth. acquisition. Predictable,
ARR $6m+, 3x Y/Y profitable. ARR
$15m+, 2 Y/Y

MRR: Monthly Recurring Revenue ARR: Annual Run Rate PMF: Product Market Fit

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OVERVIEW OF ACTIVE FUND IN THE CANADIAN VC SECTOR

NOVACAP

PANACHE

Source: BDC Canada’s Venture Capital Landscape

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CAPITALIZATION AND DILUTION
VC firms typically seek to gain 15% - 30% in each round of investment.

VC firms will often syndicate deals with other firms and investors, seeking to diversify the capitalization table.

VC firms have allocated reserves to invest in subsequent rounds, as the company gains traction and reduces risk.

Pricing is technology investments is typically expressed in terms of pre-money valuation, and never price-per-share.

From the entrepreneur’s point of view, they can raise three successive rounds at 25% dilution before investors own the majority of the company.

PRE-MONEY VALUATION $3,000,000

INVESTMENT $1,000,000
POST-MONEY VALUATION $4,000,000

In this example, investors have purchased 25% of the company’s shares.

Round Pre-money valuation Round size Post-money Round dilution Entrepreneur

valuation ownership

1 750,000.00 250,000.00 1,000,000.00 25% 75%

2 3,000,000.00 1,000,000.00 4,000,000.00 25% 56%

3 12,000,000.00 4,000,000.00 16,000,000.00 25% 42%

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UNICORN TIMELINE EXAMPLE-TWILIO

SEED A B C D E IPO

$1M $3.7M $12M $17M $70M $130M $2.51B

RAISED RAISED RAISED RAISED RAISED RAISED VALUATION

Approximately 7 years from seed investment to IPO

INITIAL INVESTMENT PERIOD FOLLOW-ON INVESTMENTS HARVESTING

0 1 2 3 4 5 6 7 8 9 10

Life of fund: 10 years

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UNICORN TIMELINE EXAMPLE-TWILIO

TRIPLE, TRIPLE, DOUBLE, DOUBLE, DOUBLE

§ Annualized revenue growth of 3x, 3x, 2x, 2x, 2x over 5 years (T2D3).

RAISE BIGGER & BIGGER ROUNDS

§ Round sizes increase at a similar rate to revenue growth.

§ Growth is more important than profitability.
§ Company is almost constantly raising.
§ Company seeks profitability once they have significant market share.

FOR INVESTORS

Top performers in the portfolio will see increasing valuations every 12 – 18 months, and prospects for liquidity within 7 – 9 years.

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 3- Deal Structure

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DEAL STRUCTURE

VC FIRMS TYPICALLY INVEST IN BOTH CONVERTIBLE DEBT AND EQUITY ROUNDS.

There are two basic flavours of convertible debt: SAFE (Simple Agreement for Future Equity – developed by YCombinator) and KISS (Keep It
Simple Stupid – developed by 500 Startups). Both are meant to deliver capital quickly with entrepreneur-friendly terms.

Typical terms
§ Valuation cap: a pre-determined maximum valuation at which the capital will convert.
§ Discount: the discounted valuation at which capital will convert if the maximum valuation is not reached. (typically 20%).
§ Minimum qualified financing: the minimum amount of capital that must be raised at the next equity round for the debt to convert.
(typically $1m).
§ MFN (Most Favoured Nation) clause.
§ Information rights.

Investors and entrepreneurs often use the standard SAFE and KISS templates and customize terms. VCs usually favor convertible
debt in the early stages of a technology venture, and opt for equity rounds in series A financings and later.

Typical terms
§ Liquidation preferences.
§ ROFR and drag –along rights.
§ Preference shares issuance and conversion rights.

For more information on deal structure, see Venture Deals by Brad Feld & Jason Mendelson.

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DEAL STRUCTURE

TYPICAL DUE DILIGENCE

§ Industry & marketing analysis: is there market support for a $1B valuation?
§ Competitive analysis: what are the unique value propositions?
§ Sentiment & trending: will investors fund the next round (3x more) in 12 – 18 months?
§ Founders: are they world class entrepreneurs/inventors/leaders?
§ Governance & reporting: are the right procedures in place?

THE VC’S JOB IS TO PUSH VENTURES TO THE NEXT STAGE

§ Refine and support entrepreneur’s $1B vision.
§ Provide coaching and advice on strategy, hiring, and go-to-market.
§ Facilitate introductions to next-stage VC firms, and next-level team members.

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DEAL LINGO

”THEY’RE RAISING $1M ON SAFE NOTE, $4M CAP, 20% DISCOUNT”

VCs typically assume valuation = valuation cap. Thus, the minimum equity at conversion will be at least 20%. ($5m post-
money valuation).

More equity will be assigned conversion if the company fails to close a qualified financing above the $4m valuation cap.

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 4- Portfolio & Returns Model

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EXPECTED RETURNS

“HUGE IF IT WORKS”
§ Mostly binary outcomes: company
creates world changing technology,
or goes to zero.

DOUBLING DOWN
§ After initial investment, funds
typically allocate follow-on
investments for 20-30% of their
companies. On average, only 4% of VC
. investments return 10x or more.

PORTFOLIO SIZE
• Assuming 4% of the fund will return
10x+, a minimum portfolio of 25
companies is required.

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500 STARTUPS HISTORICAL FUNDING FUNNEL (FUND I & FUND II)

As of June 30, 2016 (count: $M)

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PANACHE VENTURES RETURNS MODEL
We believe a large, diversified portfolio of early-stage investments reduces risk and maximizes potential returns relative to
“traditional” VC funds.

Approximate Gross Exit % of Companies that Yield

Return Multiple Number of Companies Potential Returns
Value Per Company Return Multiple at Exit
20-50x+ $1B+ 1.5% 1 $73,125,000
10-20x $500M 2.5% 2 $26,785,714
5-10x $50M 5.9% 6 $47,410,714
1-5x $10M 25.3% 25 $40,191,360
0-1x $0 64.8% 63 $0
Total Returns $187,512,789
Fund Gross Multiple 3.75X

LARGE PORTFOLIO - SELECTIVE DIVERSIFICATION THEORY Representing an approximate compounded net

IRR of 24.4% over the 10-year life of the fund
§ Fund Size: $50M
§ Total Invested Capital: $42M (incl. $2M recycled capital)
§ Number of Portfolio Companies: 97
§ Initial investment generally between $150,000 and $300,000 per company
§ Follow-on of about $500,000 in 20% to 25% of our best companies (~24 second checks)

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FUND ALLOCATION STRATEGY

INITIAL INVESTMENTS VS. FOLLOW-ONS

§ Fund managers allocate the fund to initial and follow-on investments, typically 50% to each.
§ The 50% for initial investments is placed into companies with the view that the best performing companies will get access to a larger
proportion of the follow-on allocation.
§ In Panache Ventures’ allocation model, approximately 97 companies split the initial investment allocation, while only 20 – 25% of those
companies will receive follow-on investments.
§ Funds are usually restricted from building concentrated portfolios – for instance, no more than a certain percentage of the fund
invested in one company

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VC FUNDS vs. TYPICAL ANGEL INVESTING

VC FUND THE “AVERAGE” ANGEL

Reviews hundreds to thousands of geographically diverse Reviews a handful of local investment opportunities.
DEALFLOW investment opportunities annually.

Typically large enough to withstand 50%+ failure rate. Usually <10 companies.
PORTFOLIO SIZE

STAGE Pre-seed and beyond. Ideation, pre-seed, seed.

Typically quarterly, with company status and valuation Varies, but typically lacks information rights.
REPORTING
updates. Annual audit.

Regular check-ins and coaching/strategic sessions. Typically passive.

GOVERNANCE

Investment strategy for number of investments and Varies, but typically no allocation for follow-ons.
ALLOCATION
allocation for follow-ons.

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 5- Fund Structure & Fees

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MANAGEMENT & SHAREHOLDERS

LEGAL STRUCTURE

§ The fund is a limited partnership specifically formed for investing money.

§ Limited Partners agree to fulfill capital commitment, and the LPA (Limited Partner Agreement) outlines the rules as to how investors are
paid back when gains are realized.
§ The LPA also governs the activities and the rules for the fund, and can/usually include: allowable/restricted investment types, key man
clauses, investment period, life of fund, valuation policies, and rules of conduct for General Partners.

PARTNERS

§ Limited Partners are investors in the fund. They have no control over the management of the fund, but have liquidation preference over
the GP.
§ General Partners are managers of the fund, and make all the investment decisions. General Partners are also expected to contribute to
the fund and become LPs as well.
§ GPs are governed by a LPAC (Limited Partner Advisory Committee), comprised of 3 – 5 of the top LPs in the fund.

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FEES AND INCENTIVES

TYPICALLY ‘’2 & 20’’

§ Management fees: 2% annually on committed capital

§ In Canada, VC funds usually pay a 7% annual preferred return, or ”hurdle rate” – effectively, borrowing these management fees at 7%
annual interest.
§ Carried interest: 20%
§ After original capital plus preferred return is paid to LPs, the remaining returns above that are split – 20% to the fund managers, and
80% to the limited partners.
§ Investment period/capital calls
§ Typically, a 10-year VC fund will actively invest in the first 3-5 years of the fund. LP capital is committed, and called as investments are
made.

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 5- Dealflow & Investment DD Procedure

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DEALFLOW

WE START WITH FOUR BASIC QUESTIONS FOR POTENTIAL INVESTMENTS

1. What is it?
2. How big can it be?
3. Is there founder magic?
4. What are the deal terms?

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WHAT IS IT?

WHAT IS THE BUSINESS?

§ Can they clearly state: “We make software/hardware that does some amazing function that solves a major problem for a valuable
customer segment.”

§ Do they have a clear view of the competitive landscape? What is their unique value proposition?

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HOW BIG CAN IT BE

DOES THE BUSINESS HAVE BILLION-DOLLAR POTENTIAL?

§ What is the Total Addressable Market (TAM) size?

§ What are the trends in this sector?
§ Is this sector/segment ripe for disruption?
§ Do the founders have a vision of what the world will look like in 10 years, and how their products/services fit in that world?

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IS THERE FOUNDER MAGIC

THE FOUNDERS

§ Do they have a world-changing mission/vision?

§ Have they impressed you with their knowledge, drive, achievements, effectiveness and leadership skills vs. other founders you’ve
invested in?
§ What are the founders uniquely qualified to do?
§ Is there founder/product fit?

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WHAT ARE THE DEAL TERMS

§ Are they raising enough money for 12 – 18 months of runway?

§ What will they achieve in those 12 – 18 months?

§ Are these achievements impressive enough to raise the next round?

§ Will we see a 3x increase in valuation at the next round if the company hits its goals?

§ Are the other investors in the round people/funds you respect and want to work closely with?

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DUE DILIGENCE

ADDITIONAL DUE DILIGENCE CHECKLIST ITEMS

§ Business model review, market size, competitive review.

§ Go-to-market plan, sales pipeline, customer validation.
§ Technology/product review, differentiation.
§ Team biographies and background checks, personnel plans.
§ Operations review, traction metrics.
§ Budget, use of proceeds.
§ Risk Analysis.
§ Legal review – contracts, minute book, corporate structure, current shareholders.
§ Transaction details – round size, co-investors, terms, returns model.

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SUCCES FACTORS

WHAT MATTERS MOST FOR

BUSINESS SUCCESS
Bill Gross of Idealab, started over 125
companies TED2015 talk

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SUCCESS FACTORS

WHAT MATTERS MOST FOR BUSINESS SUCCESS

5 factors were taken into account for Bill’s study

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SUCCESS FACTORS

WHAT MATTERS MOST FOR BUSINESS SUCCESS

Timing was the most important factor.

Example: Idealab launched a video content business before broadband was widely available, and before codec software was readily available. Youtube launched as
this problem was being solved

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CURRENT ON-TREND THEMES IN VENTURE CAPITAL

FINTECH
Shape the future of finance with open/API banking and new digital experiences

ARTIFICIAL INTELLIGENCE
Enable automation and optimization in all industries, using ML and deep learning, computer vision, and natural language processing

DIGITAL HEALTH
Empower people and organizations to live better lives

ENTERPRISE SOFTWARE
Focus on industry verticals at the edge of software driven transformation

BLOCKCHAIN
Disrupt centralized platforms

WOMEN IN TECH
Seeking better financial outcomes through gender equality

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SUMMARY

§ Venture Capital started in the 1960’s, and is responsible for the success of revolutionary companies such as Apple, Genentech, Cisco, and
Intel.

§ Venture Capital today helps fund startups with similar goals: to change the world.

§ VCs typically invest in companies between $3m - $200m in valuation, with the goal of reaching a $1B+ valuation.

§ Venture investing in any one venture is risky; venture funds diversify the risk by building portfolios of startup companies.

§ Results are almost binary: because only 4% of investments produce 10X+ returns, VCs invest with a ”huge if it works” philosophy.

§ The role of a VC is to help a company reach the next stage of funding. During the first 5 years of a superstar company, revenues will triple,
triple, double, double, double – year on year growth.

§ 50% of a VC fund is allocated to initial investments, and 50% for follow-ons, to double-down on the winners.

§ VCs will screen thousands of companies, and will typically ask 4 questions in deal screening: 1) What is it? 2) How big can it be? 3) Is there
founder magic? 4) What are the deal terms?

§ Entrepreneurial success: one study shows that timing is the most important factor.

§ Current on-trend themes in VC: fintech, AI, digital health, enterprise software, blockchain, women in tech.

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 Contact info

Patrick Lor – [email protected]

David Dufresne – [email protected]
Mike Cegelski – [email protected]
Prashant Matta – [email protected]
Nicolas Jacques-Bouchard – [email protected]

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