what an investor looks for and

what to look for in an investor

A discussion of considerations from a pre-seed and seed
investor perspective
September 14 and October 14, 2004
Teri F. Willey, Managing Partner
ARCH Development Partners
tfw@archdp.com

Structure how a fund works

The Fund

The Partnership

Fund raises money from institutional investors (LPs)

University endowments, pension funds, insurance companies, corporate

venture funds, wealthy individuals
Fund may range from $30M - 400M, $1-$10M per LP
Fund lasts 10 years. First 3-4 years initial investments, then follow-on
investments and exits.
Multiple Funds may be managed concurrently
20% carry. (For a $100M fund, all gains over $100M get split 80/20 with
investors/fund managers)

The Management Company

2-3% fees per year. (2% fee on $100M is $2M year)

Return - % returns based on age of fund for

period ending 2003 (www.nvca.org)
60
50
40
30
20
10
0
-10
-20
-30

3 yr
5 yr
10 yr

Returns - by Stage of Business

Seed stage
250K-$1M
developing product

IRR 70+%

Need 10X in 5
years

Venture Series A
Revenue - paying
Customers

$1- $3M

IRR 50%

Need 5 X in 34 years

Venture Series B $3- 10M

Sales Expansion

IRR 40%

Need 3X in 2-3
years

Late stage
mature business

IRR 25%

Need 1.25X in
12 mos

$15-50M

BackgroundARCH Development Partners

Currently $28 million under management
LPs:

Universities, Foundations, Banks, Corporations, and Hospitals

Strategy:
Strategically

partner with communities to create start-ups

Current partners: Kalamazoo, Peoria, Lafayette, Cincinnati, St. Louis
Make pre-seed investments ($50,000 to $1,000,000)
Syndicate deals with other early-stage investors, e.g. angels
Structure deals for optimal early exits

Primary Deal Sources: University and Corporate spin-outs

Investments: Biotechnology, Information Technology
Geographic Focus: Upper Midwest: IL, IN, MI, OH. MO
General Partners: Experienced investors and entrepreneurs

ARCH LPs include

Banks:

National City Bank of the

Midwest
Silicon Valley Bank

Universities:

Purdue Research Foundation

University of Illinois
University of Chicago
University of Cincinnati

Corporations

Caterpillar
ADM

Hospitals

Methodist
Borgess
Bronson

Foundations

The Dow Foundation

The Kalamazoo Community
Foundation

Stage of investments
Focus

Pre-Seed

Description
Team

$ Needed
Keys to
Success

IP/Technology

Seed

Product-indevelopment

Technologist /
founder/business Plus first senior
mgmt team
development
member
<$500K
$250K to $1M
Identifying
Finding
technology via
development
relationships
Determining
partners
Developing
commercial
business strategy
viability
Recruiting BOD
Accessing
rights/Recruiting & SAB
CEO

Early Stage

Mid-Stage

Product at beta
clients

Full customer
pipeline

Senior mgmt
team formation

Senior mgmt
team in place

$1M to $5M

$2M to $20M

Growing the
Managing
sales pipeline
growth
BOD and SAB in Becoming
place
profitable
Identifying exits

Exit

Business
Expansion

Public Markets

The ARCH Model

Apply Time-tested Traditional VC Disciplines to:

Identify Platform Technologies

Create Patent Strategy
Recruit the CEO
Identify and Quantify the Market
Create the Business Model
Recruit BOD and SAB
Raise $$$
Manage to Milestones

Accelerating New Business Growth

Inception
Managing
Licensor
relationship
Technology due
diligence
Business plan
creation
Patent and IP
protection
Finding and
closing initial
financing
Consultation/
liaison on
university policy

Groundwork

Interim management

Talent

Toward
independence

Incorporation
Office space
Payroll and
benefits
Accounting
IT and telephone
Advisory board
and BOD

Marketing/PR
Financial model
and pricing
Business
development
Operations
processes
Product
development

Recruiting and
hiring
Organizational
structure
Compensation
planning
Staffing models
Culture
building

Product
commercialization
Customers
Revenue
Space to grow
Next round
funding
Updated Advisory
board
and BOD

Squeeze

At the early stages it is about squeezing out enough risk so

traditional corporate partners and investors can participate.
We think about how you can facilitate:

hitting the most critical milestone's)

in the least amount of time
with the least amount of money

light initial capitalization

management compensated w/stock
use non-dilutive funds
outsource
exit strategy flexibility

What we like to see - TYPE

Science/innovation based company.

Prefer university or corporate owned intellectual
property as the basis for the spin out (vs independent
inventor).
Biomedical, biotechnology, pharmaceutical,
bioinformatics, information technology, wireless,
internet infrastructure.

What we like to see - STAGE

Pre-business plan and management team is fine.

We prefer to act as founders at this stage, assist with
company formation and management and board
recruitment and the acquiring the necessary
intellectual property rights.

What we like to see - $ REQ

50k to 1 million needed for the purpose of squeezing

risk out of the venture and positioning it for further
investment or revenue generation.
20-50 million total to get to exit.
Realistic expectations regarding valuation, that is
what the investment buys in ownership and control

What we like to see - MARKET

The product(s) the company is proposing to develop should

have a market of 200 million or more (that is the companys
sales are expected to be 200 million or more annually in a
reasonable time after product launch)
Understanding of the commercialization strategy and
competitive advantage.

Clear and realistic idea of who and what the competition is and how
the idea will reach the market in the form of a product.
Know where the pain is that this product addresses and where a the
incentives are to adopt the new product (the value proposition).

What we like to see - IP

The proposed product should be based on an

appropriate proprietary position, preferably a strong
patent position or the real potential for one.
This includes understanding freedom to operate
issues and determining that they are clearly
addressed or reasonably manageable.

What we like to see - MGMT

If there are there already or if we need to recruit

them:

Product development experience and operating experience

(fund raising a plus).
Reasonable compensation expectations.
Chemistry with the founding scientists/innovators.
Early stage company experience
Network

What we like to see - EXIT

The company or proposed company should be one

poised for an acquisition exit or in some cases an
IPO exit.
Pre-seed and seed stage investors like ARCH may
lean toward an acquisition exit as it is consistent
with our model (and the only choice when the
window is closed) and hence towards deals in
industries in which mergers and acquisitions (M&A)
is the favored transaction.

Risk

As we evaluate each of the foregoing we are

considering the main types of risk, if they are
manageable and if so how they will be managed:

IP
Market
Technical
Financing
Management

Return

How

many shares are we going to own at exit.

much do we invest to get there.
much to others invest to get there.
long will it take us to get there.
much will they be worth at exit.

Addressing dilution for the investors

aka: anti-dilution

Price protectionsif stock is sold, at a price less what the

investor with anti-dilution protection paid for it, the lower
price is applied to the conversion formula

Full-ratchet
Weighted average

Preemptive rightsthe right of the investor to acquire new

securities issued by the company to the extent necessary to
maintain its percentage interest on an as converted basis)

Warrant coverage

Addressing dilution warrants ( A security that permits its

owner to purchase a specific number of shares of stock at a predetermined price )

Another way investors may manage dilution

Used with or without interest on convertible bridge
loans
As a condition of investment
A way to have a little more at upside
Contract

Decisions other

Protective provisions

may provide significant control of the investors even if

they do not own a majority of the company.
Outlines which decisions require approval of the investors
(which class of investors, percent, etc.)

Voting of the option pool

Investment terms may provide for voting of the option

pool

Finally - liquidation preferences

In the event of liquidation, holders of preferred stock typically have a

priority claim to the assets of the corporation. For example:
In the event of any liquidation or winding up of the Company, the holders
of the Series A Preferred shall be entitled to receive in preference to the
holders of the Common Stock a per share amount equal to the Original
Purchase Price plus any unpaid dividends (the Liquidation Preference).
After the payment of the Liquidation Preference to the holders of the
Series A Preferred, the remaining assets shall be distributed ratably to the
holders of the Common Stock and the Series A Preferred on a common
equivalent basis. A merger, acquisition, sale of voting control or sale of
all or substantially all of the assets of the Company in which the
shareholders of the Company do not own a majority of the outstanding
shares of the surviving corporation shall be deemed to be a liquidation.

OPEN CHANNEL
SOFTWARE