Funding Entrepreneurship & Small Business Management Frank Moyes Leeds School of Business University of Colorado Boulder, Colorado

Funding Today’s Agenda  Funding  Sources  Bank debt  Deal structure: David Kendal, attorney  Valuation

Funding Next Week  Term Sheet negotiation

Funding VC Required Return on Investment  Seed 20x  Start-Up 10x  Early Stage 8x  Second Stage 5x  Third Stage 4x  Bridge 3x Return DCF Cash on Cash  80%  60%  50%  40%  30%  25% Bygraves & Zacharakis

Funding What do Investors Look For?  Management team  Experience  Expertise in industry  Passion  Commitment of CEO  Market potential: size & growth  Stage of development  Scalable product or service  Proprietary  Profitability  Acceptable valuation - return

Funding What Methods Are Used To Value Entrepreneurial Ventures?  VC method (see Bygraves & Zacharakis)  Financial projections  Market comps for similar companies  Multiple of earnings  Multiple of sales  Investor ROI  Usually not a cash flow stream  Pre-money & post money  Tangible book value  P/E ratio  Discounted cash flow is not a good method for valuing early stage companies!

Funding How Are Going to Fund Your New Venture?  Personal Resources  Friends & family  Debt  Equity  Grants  Non-traditional

Funding Personal Resources  Sources  Savings  Mortgage on house  Credit cards  Skin in the game – best indicator of commitment  Advantages  Prove the concept  Establishes value before go to outside investors  Disadvantages  Pressures on family

Funding Friends & Family  Easy negotiation  Should have a formal agreement  Advantages  Maintain control  Disadvantages  Unsophisticated investors  Different kind of obligation  Turn a good friend to an enemy?

Funding Equity  Sources  F & F  Angels  Private Placement  Venture Capital  Corporate venture subsidiaries  IPO (Initial Public Offering)  Advantage  Permanent capital  Disadvantages  Give up piece of company (dilution)  Responsibilities to investor  Exit for investor – achieve a return

Funding Angels  Sophisticated investor who invests in early stage companies  250,000 + angels in US  Invest $5 bill - $10 Bil, 20K – 30K companies annually  Typical investment = $25K - $250K  High net worth individuals  Usually wants to invest in industry where has experience  Accessing Angels  Not in the Yellow Pages  Networking  ACE-net.org

Funding Angels (cont’d)  Advantages  Early stage resource  Value-added money : network, advice, commitment  Disadvantages  No follow-on funds  Give-up equity  Over-control from angel

Funding Private Placement  Private offering to a focused group of investors  Accredited investors  SEC & Blue Sky Laws apply  If less than $1 million, then any number of small investors  Sam Adams  Advantages  Quicker & less expensive than IPO  SEC regulations are not as onerous  Disadvantages  Give up equity  Lack of advice / mentoring  Can be complicated, expensive & take a lot of time  Minority investors

Funding IPO  Public offering to buy ownership in an organization  Advantages  Obtain cash for opportunities that would otherwise be unaffordable  More capital with less stock dilution  To achieve liquidity for owners and investors  Disadvantages  Costly and time consuming  Change of leadership focus

Funding Grants  State, regional and municipal development agencies  CapCo  Federal  SBIR (Small Business Innovation Research)  CREDA (Cooperative Research & Development Agreement)  Research – university & corps.  Foundations  freemoney.com  Advantage: no equity or debt  Disadvantage:  Red tape and strings  Grant mentality

Funding Non-traditional Funding Sources  Customers  Suppliers  Joint ventures and strategic partners  Leasing of equipment  Broker/Promoters  Microloans – banks & non-profits <$25,000  Incubators  Equity for professional services

Funding Government  SBIC’s – a “government VC”  450 in the US  Backed by the SBA  $13 bill since 1958  Small Business Development Centers – state and local organizations finance job creation

Funding Debt  Banks  SBA  Credit unions, S & L’s  Factoring receivables & inventory  Commercial Finance companies  Mezzanine  Sits on balance sheet between debt and equity  Debt, but doesn't have to be repaid right away  Equity, warrants  Guido

Funding Debt  Advantages  No dilution  Disadvantages  Very difficult to obtain in early stages  Must pay back  Interest expense  Personal guarantee  Lack of value-add money

Funding Borrowing from Banks  Types of loans  How banks look at borrowers?  How do you approach a bank?  Personality of a bank  SBA Loans

Funding Types of Bank Loans  Short term loans  One time  Line of credit  Term loans  Monthly installments  Balloon  Secured and unsecured

Funding How Banks Look at Borrowers?  Attitude toward risk  4 C’s: credit history, character, capacity, collateral  How are you going to repay it?  Not: “If I default, there are assets to cover it.”  Banks don’t like work-out situations  Cash flow loans  Realizable assets  Accounts Receivable  Inventory  Personal guarantees

Funding How Do You Approach a Bank?  Establish a good credit history  Borrow when you don’t need it  Business Plan  Costs & fees  Loan processing fee  Interest rates  Services provided

Funding Personality of a Bank  Banks have different policies  Big company or small company  Aggressive or cautious  New companies or established  How important are relationships?  Shop around – new customers seem to get better deals than existing  Keep them informed of how your business is doing – no surprises

Funding Small Business Administration (SBA) Loans  Loan made by a bank, but guaranteed by the feds  Criteria for receiving a SBA loan similar to bank loan, but will take a greater risk  Fees  Interest rates

Funding Factors Affecting Discount Rates Total Discount Rate Base Rate Systematic Risk Liquidity Value Added 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 adjustment Value of VC advice Investment not liquid