Financing the firm Dr. Steven Walsh

Outline Every firm needs it What is happening today Some Nomenclature 5 steps in firm development as seen by a financier Types of funding and average placements Nightmare examples Valuation

Financing the Firm Every business startup needs financing –Especially High Tech The most important continuous process Yet Few high tech entrepreneurs have a sharp understanding When, Why, How much, What flavor Mythology Around High tech

The Importance of Financing The Importance of Financing Financing needs driven by Cash Flow, –Revenues and Profits Cash Flow is king 5 minute elevator speech Business Plan and Business Planning Process

Background Do VC funded startups have better success rates –No on survivability –Yes for super success High tech needs creativity The ability to choose, court and obtain financing is critical to the long-term survival and growth of “High Tech” enterprises

Types of Financing Options “Language of fund acquisition” Sources Process bridge loans”, “non-dilutable” equity, “customer” financing, “sweat equity”, VC funding “Angel” financing the other professional equity options pre-seed”, “seed”, “startup”, “Mezzanine”, “first round” “Series A” funding Placement “Squash down”

High Tech Funding Today Funding Stream Vs. Single Placement –Every funding choice makes your next funding simpler or harder Firms today must have a proactive rather than reactive equity strategy One Process Pre-seed – Seed – Startup – Early Venture –Late stage venture Sources

Pre -Seed Pre Seed financing is a small amount of funds required by the nascent entrepreneurs in order to define their value proposition, convince themselves of the viability of the concept and initiate activity Primarily funded by self – funded or provided by the three F’s; Friends, Family and Founders. $150,000

Seed financing a relatively small amount of capital provided to an inventor or entrepreneur to prove a concept and to qualify for start-up capital. This may involve product development and market research as well as building a management team and developing a business plan, if the initial steps are successful

Pre seed and seed in the US Primarily funded by self or SBIR Over $2 billion in SBIR funding

Start-up financing “is provided to companies completing product development and initial marketing. Companies may be in the process of organizing, or they may already be in business for one year or less, but have not sold their product commercially. Usually such firms will have made market studies, assembled the key management, developed a business plan and are ready to do business.”

Seed and Startup Sources Either self financed, funded by individual Angel investors, customer financed or provided by non-dilutable equity sources. firms in these stage are High Tech startups with no sales, and which are in general eschewed by the Venture Capital community. Funding required is often less than $500,000.

Early- or first-stage financing Provided to companies that have expended their initial capital (often in developing and market testing a prototype) and require funds to initiate full-scale manufacturing and sales Traditionally been funded by Venture capitalists but is increasingly being addressed by angel networks and large firms interested in strategic partnerships The typical placements are under $2,500,000

Late Stage - Expansion financing Subsequent investment rounds typically financing company product and/or market expansion, or keeping the company financially healthy shortly before a liquidity event such as an initial public offering (IPO) or acquisition has traditionally been funded by Venture capitalists but is increasingly being provided by large firms seeking strategic partnerships Typical placements in this stage are under $5,000,000.

Sources Depending on the stage of financing differing equity instruments dominate –Equity Investment\ Angels Dominate early stage VC and Strategic Partners Later stages Self Financed –Government Non-dilutable Equity Pre-seed and seed

Self Financed 3 F’s Debt Non dilutable Equity (SBIR) Customers

Customer financing Many “High Tech Startups” do not think to seek out their customers for pre-seed, seed and startup financing – The use of the High Tech firm’s product or service is critical or strategically important to the customer. – Few other sources for the product or service are available. – The relationship between the firms is solid. – The reputation of the High Tech Founding team is excellent.

“Non – Dilute-able” Equity funding The most famous form of non-dilutable equity funding sources for small firms in the United States is provided by the now more than 20 year old SBIR (Small Business Innovative Research) program Well over $2 Billion –MTV “Money for Nothing” –Order Fast track funds for DOD SBIR provide the High tech Startup up to $850,000

Debt Instruments Traditional –Houses, Cars etc Semi Traditional –Equipment, SBA Loans, Lines of Credit, factoring New –Credit cards

External sources of Funding 3 F’s Angels VC’s Strategic Partners

3 F’s Friends, Founders and family members (Fools) –Many firms find that perhaps the highest priced form of High tech firm equity funding is the three F’s if not in monetary terms then certainly along family and social ones.

3F Night mare First, remembering that financing the firm is a series of decisions rather than just one instance too many other financing sources view the overuse of friends, family and founders as presenting problems in attracting investment later. One firm that we are consulting too presently has over 100 owners and is still in the pre-seed stage of funding

Strategic Partnerships Not New Choices associated with this form of financing have lead both to highly positive outcomes for “High Tech Startups” and much less desired ones The choice to obtain this type of funding has serious consequences on exit strategies, alternative forms of further financing and firm strategic direction Largest amount of external equity funding year in and year out

Strategic Partners Valuation Firms with a strategic need for you and your technology often value your technology product paradigm highly Good or Bad? In the best of all cases you have a strategic partner that if you perform will provide the exit strategy for your “High Tech” startup.

Good or Bad In the worst of all cases your strategic partner was actually practicing “gate keeping” during your acquisition, has lost interest, market share or simply has embraced other and to them more interesting projects.

How should one go about developing a Strategic Partner?” Like amorous Porcupines? –No Shotgun Weddings –Proactive Selection

Partner Selection Process

Angels $18.1 billion derived from 42,000 deals in 2003 Angels often fund enterprises in a group and they rarely invest more than $50,000 individually in any one enterprise They tend to fund companies in industries that they are very familiar. Paul Atherton NanoVentures Ltd as an example –Provide Mentoring

Angel Founder Jim Von Ehr

VC $18.2 billion in 2003, with only 2% of those dollars spent in seed or early-stage investments Placement was $6.7 million derived from only 2,715 deals The vast majority of VC funded firms have product sales as well as a need for in excess of $1 million in equity

VC VC usually have a timeline to acquire from 1/3 to ½ of a firm, and have strong board of director positions and strong firm control. They wish to obtain again a 20 to 40 times investment back in three to seven years. They will demand a clear exit strategy, and focus on the efforts of the firm on “hitting the home run.” The firm is weighted toward a short tem rather than sustainable firm strategy. Often VC firms require continuous monitoring systems

Valuation How much is the firm worth? –It Depends –Reverse valuation –Sales and Profit Multiples –NPV –Risk Discounts –P/E ratios and market share analysis

Reverse valuation The Dominant form –It is a commonly used method by Angels and VC’s alike to determine if they will provide funding to a potential firm, the timing of investments in your firm and the percentage ownership that they would need to receive from a firm for a given investment or placement in your firm. An Angel or VC will not usually invest in a firm where they cannot receive a potential 20 to 40 times their investment returned in three to seven years

Example An example: A firm needs $10 million dollars to meet their strategic demands The equity providing firm wants to own no more than 1/3 of the firm The VC requires 20 x Return in the fifth year. 20 x return on $10 million is $200 million The value of the firm must reach with all the discounts would be $600 million and have an exit strategy that is believable to that firm with an acceptable level of risk.

Sales and profit multiples Oldest Bromide a multiple of single years sales often the number that is used is –one times gross sales (revenues) or –a multiple of this years profits