Wednesday, September 17, 2008

Discussion with Megan Clark of UT about CTAN Funding Process

Megan Clark of UT’s MBA program focuses on entrepreneurship and helps a Bolivian incubator start up their angel network.

What is the UT program called?

Basically it is a program called Ford Fellows, which is an LBJ/MBA program. It includes a two-week research project during the summer. I got paired up with an incubator in Bolivia and they just set up the country’s first angel network. So what they want to do is benchmark against US angel networks to see what best practices have come out, how deals work here, and so forth. They not only need to set up the network to be functional and sustainable, but also need to educate investors about how angel networks work.

Sure, so how do they do it down there?

They have the typical early stage friends and family financing, and past that the only thing available is debt, but very few of these early-stage companies can do that.
You know, it’s a Third World country, so there aren’t any venture capital firms or investor networks. Plus the country is moving toward a more socialist system. The president is nationalizing a lot of their most profitable industries like natural gas. So that creates an additional level of risk and uncertainty.

What kind of deals do they normally do?

They seem to be doing a lot of technology startups related to the country’s major industries. But I haven’t seen their portfolio so I don’t know what else they are doing. You can read more about them on their website , though they don’t have an English section yet. I do know that they’ve just finished their first angel forum. 4 projects were selected to present from among 70 applicants. And three of those got financed through the event.

So how long have you been with Central Texas?

We’ve been in business for 2 years now. We focus on a diverse set of deals including software, consumer products, wireless, healthcare, IT, and other things such as gaming and films. We look for deals that are raising two million dollars or less, have a complete or near-complete product, and based here in Texas. We look at 30 deals at a time and choose 4 to present to the group.

Is this every month?

Well every other month, we have about 6 rounds of dealflow per year. A screening meeting and a presentation meeting and we don’t do too much in the summer so we did 4 rounds in the spring and will do 2 in the fall. It’s a member-led group and everyone decides what they want to write a check for.

So it’s not like a true fund that everybody pools in to.

That’s right. It’s a network group. But it’s not that different from the family and friends in whom everybody writes a check for the amount they want. I believe we’re more rigorous on due diligence, than family and friends might choose to be. We’re seeing a lot of deals since many businesses have downshifted from 5-10 million dollars raise in the 1990s to a $500,000 raise today.

Why is that?

Several factors such as off shoring, outsourcing, and better business services that are available today.

So what questions do you have for me today?

First thing they are looking for is what the network rules are? I saw that you’re a non-profit corporation.

That’s right, it’s a Texas non-profit.

I saw on your website, something through the membership page, there are rules of membership and conduct and a membership agreement. Generally what do your members agree to?

Everyone is responsible for their own due diligence. Also if you have any interests other than investing such as performing consulting work or contract work you make that known to the other members.

Do your members pay to be in the group?

That’s right. There are annual dues of $1500/person/year.

And do the VCs pay more?

Commercial membership is $3000.00 per member and they get 2 chairs in each meeting.

Can you walk me through the process from _ an application to actual investment?

Well it begins with the application on the website. We use a package called Angelsoft that all members have access to. So when we have our screening meeting we take the list of deals that are available and we send it to the members and they each sign up to lead the discussion on a deal. The members come together and we go around the table and discuss each deal and at the end we each get 4 votes. The top 4 vote winners go to the presentation meeting a few weeks later.

How many people are there in the screening meeting?

Typically about half the group comes to the screening meeting. We review 20-25 deals in the meeting. But the idea is if a deal some votes it can go to the next screening gets meeting. If it doesn’t get any votes then it’s declined out at that point. So some deals go from time to time because we only accept 4 in and if we get more than 4 good deals at a time – sometimes you get 6 or 8 good deals – it takes a couple of rounds before they get in.

So no one does pre-screening of the deals?

I do that. Our three basic criteria to consider a deal are– based in Texas, complete or near-complete product, and two million dollars raise or less.

How does it work if they are voted into a presentation meeting?

They each get to pitch for ten minutes with a five minute Q&A session. They get a table on the back of the room for their demo or brochures. There’s a networking time at the beginning and the end of the meeting. We’ve place signup sheets on the table and everybody signs up for the deals they are interested in and the following week I call a meeting at their office for 2 hours and we go back through their slides and ask lots of questions.

What are you looking at in that first selection at the first meeting?

It’s a one-pager. We have a form that they basically paste in their executive summary. If it goes to the follow up meeting then the angels go on the website and start reading the business plan in advance. So as you go further down the path people are going to be spending more and more time with it.
And then after they see it at the follow-up meeting how do they handle due diligence?

We do share the due diligence but each member is responsible for their own. The idea is if there is a term sheet on the table and there is money _ then you go into due diligence. If not, then we negotiate the terms sheet at a high-level. Quite often it turns out to be an iterative thing – do some due diligence and find out how that changes the terms, go negotiate and do more due diligence.

I see and then all the angels agree to the same term sheet?

Yes that’s the key that we’re all on the same term sheet and that is one challenge. We have to do it. We have to negotiate as a group not individually; you can't have five different negotiations going on, you have to have one negotiation going on. And that’s what we do is try to get everybody to a common offer.

Do you have a standard terms sheet.

Yes when we vote the deals into the presentation room we send them a blank terms sheet so they can educate themselves on the key beforehand and understand what are the trade-offs are. Then when the negotiations occur they are ready.

How did come up with that terms sheet?

Over time we just started seeing the same things over and over again. Also the character of the group determined that we wanted equity not convertible debt. The members want liquidation preferences. So over time we started seeing the same things over and over again and it was finally codified into a term sheet. If people don’t have anything it helps to give us a starting point as opposed to starting with a blank sheet of paper, which is very hard of course.

How do you handle valuations?

It’s a negotiation of course, but if the entrepreneur has the product ready to go to market and the team is in place and the IP is strong, then they get a better valuation. If somebody does not have a product ready to go to market, the chances are someone else does and that’s kind of a filter.

What is they already have a terms sheet?

Well if they already have a term sheet negotiated, and quite often they do, then it’s easier for the members to jump on board.

I’m still wondering about the full term sheet and how it works. Why would you want equity over convertible debt?

With convertible debt the idea is you sign an agreement now and they will convert at a future time when an equity raise is done. And in theory as the company goes down the road it gets more value so it sets a better price in the future than today. That’s the theory. In some cases there was no equity raise and then the valuation gets set arbitrarily. So that’s why the members like equity because valuation is set now and you know what it’s going to be.

And what happens after the angels make their investment?

The angels make the investment and then follow the progress of the company. The entrepreneur should be keeping the investors up-to-date with a monthly or quarterly statement. In some cases we negotiate it up front so that every quarter you’re going to be sending the financials and a summary of what is happening to the investors.

So where did people go to find out about the group?

They can go to our seminars which we run with the ATI and get general information about the funding process.

Best regards,
Hall T.

Monday, September 15, 2008

Alan Pita, President of Logic Refinery, Inc. Talks about System Verification

What is the problem Logic Refinery is trying to solve?

More than 50% of system-on-a-chip (SoC) designs come back from their
first tape-out event with hardware that simply doesn't work well enough to ship. The multimillion-dollar engineering costs associated with doing another tape-out (called a "re-spin") are typically dwarfed by the cost of lost time-to-market.

How are you solving that?

The common approach to verification is to write a software program called a "testbench" to verify virtual models of the chip using software simulation, and sometimes hardware emulation. This approach worked very well for simpler designs. The industry has discovered that it simply doesn't give verification teams enough leverage to verify the more complex SoC designs in a reasonable time.

Our product is a software program we have named the "Strategen Verification Engine". It's the first tool designed to fully solve the system verification problem, and it's vastly more effective than the testbench-only approach. Applying Strategen to their verification plan accelerates and enables the whole system verification effort, allowing all of the critical bugs to be found and fixed before the
first tape-out.

How will your customers estimate the value of our product?

Applying Strategen does have a substantial productivity benefit; however, the real value of Strategen is not merely a function of team acceleration. For the management of SoC design firms, verification is seen as a risk management game. The industry is at a crisis point because they simply can't make the risk of failed SoC tape-outs go away with staffing, schedule, and existing tools. The approach behind Strategen has the ability to close this business risk for management, enabling them to plan for "first silicon success".

Who are you targeting to buy the system?

Firms that are doing system-on-a-chip design, especially the more complex SoC designs with hundreds of IP blocks. There are hundreds of these firms, with thousands of tape-out events every year.

Do you have any customers so far?

We are presently scheduling demos and initiating Alpha testing at customer sites. We'd like to convert some of these Alpha sites into paying customers over the next 6 months or so.

How much will you need to get the company up and running?

Our advisors estimate between four and eight million dollars will be needed in several funding rounds to take us all the way to exit. We’ll start with a first round of about $1.5M USD to get the product and associated business processes prepared for a full-on sales and marketing effort and get the first few paying customers signed up.

What is your beachhead market –say the first 20 customers you’ll go

Basically there are 195 ARM licensees. These are our ideal customers. Again, the verification problem is something that all of our customers recognize and they can't spend enough money to solve it.

Best regards,
Hall T.