Entrepreneurship Canadian Edition William D Entrepreneurship Canadian Edition William D. Bygrave, Andrew Zacharakis, Sean Wise

RAISING MONEY FOR STARTING AND GROWING BUSINESSES Chapter 11

Learning Objectives Bootstrapping New Ventures Learning Objective 11.1 Explain how entrepreneurs may bootstrap a new venture. Valuation Learning Objective 11.2 Describe the methods of valuing a company. Financing a New Venture Learning Objective 11.3 Describe ways to finance a new venture. Harvesting Investments Learning Objective 11.4 Describe how investors can harvest or recoup their investment in a venture.

Today’s Key Concepts Progression of finance Subjective nature of valuation Calculating valuation Six things investors look for Spectrum of finance The venture capital cycle Three ways to harvest an investment IPO vs. M&A vs. buyback Inflection points 10 magic slides

Progression of Raising Money Turning to friends & family Approaching business angels Raising VC funding Going public Being acquired

How Much To Raise? Each round of investment will dilute you 20-40% Ask for enough capital to get you to the next inflection point (e.g. finding MVP, first sales, scaling up, break even, etc.)

Inflection Points Obtaining IP rights First pilot Multiple pilots Getting your first paying customer Standardizing your offering Having enough cash flow to start paying yourself When your recurring revenue equals your monthly fixed expenses Entering a new territory with current product Entering a new product into a the current territory

The Investor Slidedeck The same list that appears in the business plan, the lean startup canvas and the business model canvas

The 10/20/30 Rule Guy Kawasaki 10/20/30 Rule of Presentations: 10 slides 20 minutes 30 point font

What Investors Listen For: Reasons to say ‘no’ Anything that shows this isn’t a good investment, e.g., Unsophisticated founders Unrealistic objectives Lack of traction

Value Is in The Eye of the Beholder ROLEX: Gentleman’s stainless steel Rolex Oyster Perpetual Datejust Chronometer bracelet watch, circa 1987 Limited Edition Worn by Michael Douglas for his role in the movie Wall Street

Valuation is Art not Science Depends on: Company factors Investor factors Market Factors Is subjective not objective Is not the key to investment (the other terms matter too!)

Basic Ways of Evaluating a Business Earning-capitalization valuation Present value of future cash flows Market-comparable valuation Asset-based valuation Valuation is not an exact science. Each of the above methods may get to vastly different monetary values of a company.

Valuation? PostMV = PreMV + Cash Invested Investor Equity = Cash Invested / PostMV Founder Equity = PreMV / PostMV But how do you set PreMV? Value is in the eye of the buyer (not seller) Always ask: We need $X, to hire Y and do Z, which will result in an increase of A and a doubling of B over the next 1X months

Valuation in Action John offers the Dragons 10% of his Startup but wants $250,000. How much is it worth (according to John) before an investment? Dragon 1 wants to invest $100,000 into John’s Startup, but she wants 20%. If the founders agree, what will their PostMV be? Dragon 2 offers John $250,000 on a $2 million PostMV, is that a better deal?

Income-Based Valuation Methods Earnings Capitalization Method: Company value = Net Income/ Capitalization Rate Present Value of Future Cash Flows: PV = PV of the future free CF + the residual (terminal) value of the firm Market-comparable Valuation (Multiple of earnings): Total Equity Valuation = NI x P/E

Asset-Based Valuation Methods Fair market value of assets Liquidation Value Adjusted book value Replacement value

Reduced-rate services External Financing External Financing Vendor financing Reduced rent Customer financing Leased equipment Federal programs Reduced-rate services

Finding Business Angels Formal angel groups Pros: Easy to find Cons: May charge for the privilege to present or submit a business plan; Limited number (several thousand) 2. Individual angels Pros: Several hundred thousand available Cons: Hard to find and approach; must identify prospects and present

Types of Business Angels Entrepreneurial Angels May be valuable advisors Corporate Angels May take over or ruin company Professional Angels Silent partners Enthusiast Angels Passive investors Micromanagement Angels Intervene in the business

Top 6 Investment Factors For VCs Management team Target market Product/ service Competitive positioning Financial return Business plan VCs may help you hire a Team Fragmented, accessible, and growing Competently written business plan 7X return in 5 years Better and protected Open distribution channels

Why All VC Investments Must Be Stars On Day One? Venture capitalist’s job is to generate returns for their investors Use a Portfolio Approach So the best must make up for the worse Outcomes ROI Percentage of Portfolio Stars 5-10 x 10-15% Zombies 1-2 x 50% Dogs 35-40%

VC The VC Firm Cycle Raise Fund Harvest Vest Fund Returns Grow Ventures Harvest Returns

How to Assess a VC Value added Patience Board of directors Availability Deep Pockets Added Value Value added Patience Deep pockets Accessibility Board of directors

Harvesting (Exiting) Investments Initial Public Offering (IPO) An acquisition A buyback of the investor’s stock Very Unlikely

Ideal Candidates for Venture Capital Founder has significant management and entrepreneurial experience with demonstrated ability to manage a rapidly growing company in a fast-paced industry segment. There are no dominant competitors. The company has satisfied customers. The company projects sales of $50 million in five years. Founders is recognized as a star in the industry Vice The gross income margin is expected to be better than 60%, with a net income margin better than 10%. Members of the top management team have worked together before. The amount of capital needed in total is between $5 million and $10 million. The product/service is 10x better than those of its competitors. The company has the potential to go public in five years. Intellectual capital such as patents and copyrights is protected. Potential return of 7x or higher. The market segment is fragmented, growing rapidly, and expected to be big. IRR of 60% or higher.

Upsides Downsides Pros and Cons of an IPO Financing High expenses Follow-on financing Public fishbowl Realizing prior investments Short-term horizon Prestige and visibility Post-IPO compliance costs Compensation for employees Management’s time Acquiring other companies Takeover target Employee disenchantment

Advantages/Disadvantages of an Acquisition (part 1) Founder & CEO Selling a “baby” can be traumatic Management Executives can stay focused on growing the company Company The buyer usually has deep pockets Investors Investors easily exit their investment

Advantages/Disadvantages of an Acquisition (part 2) Converting Stock Entrepreneur & employees get cash right away Employment Agreement Key employees may need to sign a non-compete Culture Could be a clash of cultures Costs Expenses are lower than an IPO

Case: Red Flag Deals Compare Derek’s two options, raising external funding or exit and sell: What were the key points to consider? How would you decide which option to take? If you were in Derek’s position, would you have taken venture capital? Why? Why not? If you were in Derek’s position, would you have made the decision to sell, knowing that there was potential to grow with third party assistance? Post sale, would you have stayed on with Yellow Pages Group to continue working on Red Flag Deals?

Recap Sophisticated investment money requires a future harvest time (return on investment) Harvest can be acquisitions or public offerings Investors want to know entrepreneur will remain on with the company after harvest You can only raise the next round after hitting the milestones set out in the last raise You can only raise enroute to an inflection point

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