ESSAM 2011 Startup Financing Professor Stephen Lawrence Leeds School of Business University of Colorado at Boulder

Agenda Sources of Funding 1.Bootstrapping 2.Debt 3.Government funding 4.Non-traditional 5.Equity funding Deal structure & term sheets Valuation

How much money do we need? Review cash flow statements Find periods with negative cash balances Schedule cash infusion(s) to eliminate negative balances Add safety cushion (~10-25%) Develop funding strategy  Eg, staged funding “tranches”

Startup Financing Cycle Cash from operations!

Sources of Funds 1.Bootstrapping 2.Debt 3.Government funding 4.Non-traditional 5.Equity funding

6 Global Capital Structures (1995) LONG- SHORT- TOTAL TERM TERM COUNTRY EQUITY DEBT DEBT DEBT United Kingdom 68.3% 31.7% N/A N/A United States 48.4% 51.6% 26.8% 24.8% Canada 47.5% 52.5% 30.2% 22.7% Germany 39.7% 60.3% 15.6% 44.7% France 38.8% 61.2% 23.5% 43.0% Japan 33.7% 66.3% 23.3% 43.0% Italy 23.5% 76.5% 24.2% 52.3% Source: Scott Besley and Eugene F. Brigham, Essentials of Managerial Finance, 13 th Ed.

1. Bootstrapping Start-up without much capital “Pick yourself up by your bootstraps”

What is Bootstrapping? “Launching ventures with modest personal funds”  Bhide Using Other People’s Resources (OPR)  Timmons Scrooge mode

Bootstrapping Examples Make vs. buy (do it yourself) Hire temps/subcontractors vs. employees  Employee benefits Modest office and location vs. prestige  Virtual offices Used furniture and equipment vs. new PR (public relations) vs. advertising

Sources for Internal Funds Profits Sale of assets and little-used assets Working capital reduction Extended or discounted payment terms – suppliers Collecting bills (accounts receivable) more quickly Short-term internal source of funds:  Reducing short-term assets: inventory, cash, and other working-capital items  Extended payment terms from suppliers

Bootstrapping Benefits Requires less capital Lowers risk Improves decision making Enhances flexibility Focus on profitability Investors love it Establishes culture A Bhide, Bootstrap Finance, HBR

Greatest Source of Money?

2 Debt

Sources of Debt Funding Credit cards Bank loans  Typically insist on a secured loans  Second mortgage on house or property  Use equipment & facilities to secure loan  Revolving lines of credit Investment banks Less “expensive” than equity Disadvantage: Must be paid regularly

3 Government Funding

Types of Government Assistance Direct loans & subsidies Research grants Tax benefits  Invest tax reductions  Production tax reductions Support for hiring new employees Employee training / retraining Et cetera, et cetera …

4 Non-Traditional Funding

Nontraditional Funding Sources Customers  Development  Prepay  Co-invest Trade credit (vendor terms & conditions) Leasing vs buying Factoring receivables (loans against invoices) Loans secured by inventory

5 Equity Funding

Equity Funding Most “expensive” form of financing!  Give up ownership (equity) A.Private Placement  Friends, family, and fools  Well to-do investors B.Angels  “Professional” investors working alone or in syndicates  Colorado Capital Alliance (wwwanglecapitalcom) C.Venture Capitalists

5A. Private Placement Funding from private investors, also called angels (family or friends or wealthy individuals) Types of investors  Investor can influence nature and direction of the business to some extent  May be involved in the business operation  Entrepreneur needs to consider degree of involvement Private offerings  A formalized method for obtaining funds from private investors  Faster and less costly

Family and Friends Likely to invest due to relationship with entrepreneur  Advantage: easy to obtain money; more patient than other investors  Disadvantage: direct input into operations of venture A formal agreement must be written to include:  Amount of money involved  Terms of the money  Rights and responsibilities of the investor  What happens if the business fails Entrepreneur must consider impact on personal relationship

5B. Angels – Informal Risk Capital Consists of a virtually invisible group of wealthy investors (business angels) Often will form syndicates Investments range between $10,000 to $2,000,000 Provide funding, especially in start-up (first- stage) financing Contains the largest pool of risk capital in the United States

5C. Venture Capital A professionally managed pool of equity capital A long-term investment discipline, usually occurring over a five-year period Found in the:  Creation of early-stage companies  Expansion and revitalization of existing businesses  Financing of leveraged buyouts of existing divisions of major corporations or privately owned businesses Venture capitalist takes an equity participation in each of the investments

Venture Capital Criteria VC Firm Objective  Generation of long-term capital appreciation through debt and equity investments Criteria for committing to venture:  Strong management team  Product and/or market opportunity must be unique  Business opportunity must show significant capital appreciation

Valuation

Company Valuation Factors Economic outlook- general and industry Comparative data Book (net) value Future earning capacity Dividend-paying capacity Assess goodwill/intangibles Previous sale of stock Market value of similar companies’ stock

Equity Discount Rates Seed capital  80 to 100% Startup financing  50 to 70% First-stage financing  40 to 60% Second-stage financing  30 to 50% Bridge financing  20 to 35% Restart financing  variable

Factors Affecting Discount Rates Total Discount Rate Base Rate Systematic Risk Liquidity Value Add Cash Flow Adjustment Seed Stage 1 Stage 2 Bridge IPO Justifiable Discount Rate Sahlman, A Method for Valuing High-Risk, Long-Term Investments, teaching note, HBS Risk-free investment Market sensitivity Risk of failure premium Value of VC advice Investment not liquid

Team Assignment How will you fund your venture? About how much money will you need? How big will your business become? What are your long-term goals for your venture?  Hold and operate?  Go public?  Sell out?  Others?

ESSAM 2010 Startup Financing Professor Stephen Lawrence Leeds School of Business University of Colorado at Boulder

EXTRA SLIDES

Bootstrapping – Capital Benefits Need less capital  Reduces financial exposure  Reduces equity dilution Reduces risk  Obsolescence  Lower sunk costs Investor's love it  Proves concept and management team  Reduces risk

Bootstrapping – Flexibility Benefits Fluctuating conditions and uncertainty Difficulty in predicting what resources are needed Make changes quickly Permits strategic experiments Cost of making a mistake is minimized  Mistakes less likely to be fatal  Inexperienced entrepreneurs can screw-up  Don’t have the pressure of high growth

Bootstrapping – Problem Solving Accelerates problem identification  Reveals hidden problems (Like zero inventory in JIT)  Forces management to solve them Focus is on sales and profits  Price for profitability  Reduces costs Lower fixed costs Higher variable costs, but high Gross Profit Margin solves Lower break-even point Establishes a problem-solving culture