chapter 18 financing start-up and growth. copyright © houghton mifflin company18-2 overview...

Chapter 18

Financing Start-up and Growth

Copyright © Houghton Mifflin Company 18-2

Overview

• Starting with a plan

• Financing start-ups

• Financing growth

• Valuing the business

Risk Points and Associated Funding

Preparation for Start-UpSeed Capital

Friends and FamilyPrivate Investors

SBIR/STTR

Preparation for Start-UpSeed Capital

Friends and FamilyPrivate Investors

SBIR/STTR

Early Stage FundingPrivate Investors

Some Venture CapitalStrategic Partners

Early Stage FundingPrivate Investors

Some Venture CapitalStrategic Partners

Late Stage FundingVenture CapitalPublic Equity

Strategic Partners

Late Stage FundingVenture CapitalPublic Equity

Strategic Partners

Revenues

Manufacturing Risk

Manufacturing Risk

Development Risk

Development Risk

First Customer

First Customer

Marketing Risk

Marketing Risk

Management Risk

Management Risk Initial

Public Offering

Year 1 Year 2 Year 3


The Fundamental Truths About Raising Money


1: Raising Capital

• Takes twice as long as projected

• Investors identified may not work out

• Second-round may request buyout

• Significant costs to raising capital


Upfront CostsFinancialsConsultant

CPA/AuditorI-Banker

Marketing CostsProspectus

LegalPrinting

Back-end CostsI-Banking

LegalBrokerage

Easily up to $200,000

2: Cost of Raising Capital


3: Can You Impress Investors?

• Defensible competitive advantage?– Patented technology– Cycle time– Marketing, advertising, and sales force– Low cost manufacturing

• Customers?

• Experience?

• Growing market?

• Who are your friends?

Understanding the Funding Stages


Start with a Financing Strategy

• Look for smart money (who invests is more important than terms)

• Buy top management with first $$$

• Get moving fast, early prototype with customer feedback

• Focus on one investor and get an intro

• Don’t marry your first date

• Go for the best deal, not the biggest


Financing the Start-up

• Entrepreneur resources– Savings, credit cards, mortgages, stock

market accounts, friends and family

• Bootstrap– Hire as few employees as possible– Lease or share everything– Use other people’s money


Stage One: Bootstrapping in an Incubator

• Average incubee’s sales increased

• > 400% from time entered to time exited

• > Average annual growth in sales was $239,535

• 87% of grads still in business

– Only 20% of new start-ups


Do Incubators Meet Needs?

• Higher order needs need to be met– Human network, access to expertise and

capital, partnerships, professional resources, product design, first 100 customers

• Some negatives– Perception of being babied– Artificial buffer– Equity stake by incubator


Stage One: Private Investor “Angel” Profile

• Educated white males—40s/50s

• Net worth over $750k

• Used to be entrepreneurs

• First stage financing and young firms

• Invest near home—involved

• One to two deals a year

• Invest between $10,000 and $500,000


More on Angels

• 3 to 10 year time frame for ROI

• 5–10 times their investment, function of risk

• Find deals through referrals from business associates

• Make decisions more quickly

• Requirements for due diligence may be lower


MORE on Angels

• Order of investment interest

– Manufacturing—industrial/commercial

– Manufacturing—consumer

– Energy/natural resources

– Services

– Retail/wholesale


An Unlikely Angel Investment

• A “me too” type of product

• No intellectual property

• Business location more than 100 miles away

• Mature or fading industry

• Return on investment less than 15 percent

• Not enough market research with customer

• Weak competitive analysis


An Unlikely Angel Investment (cont.)

• A poorly defined vision for the company

• No management team, a solo entrepreneur

• Weak management team with no experience

• Exit time more than 7 years away

• Unfamiliar business or industry

• Minority position with no voting rights

• Too many co-investors


What Winning Angels Do

• Consider the source carefully

• Focus on the model, not the plan

• Emphasize the entrepreneur and the team

• Seek a scalable business

• Look for the exit

• Identify the unfair advantage

• Focus on deals where they know something


Stage One/Two:Private Placement

• Raising capital from private investors– Securities:

common/preferred stock, notes, bonds, debentures, limited partnership shares, etc.

• Reg D– Sophisticated investors– Blue Sky laws


Private Placement

• Advantages

– Less costly, less time consuming than IPO

– Availability of standardized offering statements

– Don’t have to file with SEC


Alternative Sources

• Strategic alliances– R&D limited partnership– Joint venture

• Small Business Investment Company (SBIC)

• SBIR Grants– Phase I: develop concept and test feasibility– Phase II: pursue the innovation and develop

the product– Phase III: commercialize the technology


Debt Sources

• Commercial banks

• Commercial finance companies

• Small business administration

• State-funded venture capital

• Incubators

• Customers and suppliers


Venture Capital

• Less than 1% of the 300K companies growing 20%+ per year are backed by VCs


Venture Capital Terms:Basic Principles

• VC gets money back first

• Participation in upside

• Control over fundamental events

• Creation of path to liquidity

• Preferred stock is the investment security of choice


Capital Structure

• Investment deal has

– Amount of money to be invested

– Timing and use of investment moneys

– Return on investment to investors

– Level of risk involved

• Preferred stock or debentures


Rules for Dealing with VCs

• Know your enemy

• Don’t shop the business plan

• Approach through a referral

• Write a killer executive summary

• Check out the terms sheet carefully

• Be patient

• Be prepared for a staged investment


What VCs Relate to

• Location can matter

• Growth track: bigger is better

• 10X investment in 5 years

• 25–50% per year

• PE = 15:1 or more


What VCs Relate to (cont.)

• Planned exit—make it short

• New paradigm, lead products

• Number of co-investors

• Bridge financing to position for an IPO

• Board seats


Ownership

• Stage 1: give up 30% + for every $1M

• Stages 2–3: give up 8–15% per $1M

• Stages 4,5,6: give up 5–6%


Your Due Diligence on the VC

• Identify your dream teams

• Don’t accept a term sheet before due diligence. Stay in control

• Request 5 references from each VC


Your Due Diligence on the VC (cont.)

• Interview references– Why did you choose this firm?

– How effective have they been in securing deals and partnerships?

– How effective have they been in recruiting board members?

– How have they helped your company increase its valuation?

– On a scale of 1–5, how would you rate the contact partner?


The Initial Public Offering (IPO)

The IPO Process


Advantages of Going Public

• Source of interest-free growth capital

• More prestige and clout

• Easier to form alliances and negotiate deals

• Public stock used to attract employees and reward existing employees


Disadvantages of Going Public

• Expensive process: $300,000+

• Time-consuming

• Company information is public

• CEO responsible to shareholders

• Entrepreneur may not control stock

• Pressure to perform in the short term

• SEC reporting requirements


Of 3,186 firms that went public in 1980s, only 58

percent still listed on one of three major exchanges


The stock of only one third of these firms was

selling above issue price

Development

Seed & Early Stage Growth & Harvest

R&D Break-evenProfitable, Needs

Expansion Capital

Buyout, Merger, IPO

Direct OfferingsWarrants

Common Stock

Common Stock Common Stock

First Customer

MultipleCustomers

Multiple Products

May 2002 Nov 2002 June 2003 Sept 2005

NotesBonds

DebenturesCommon StockPreferred StockDirect Offerings

Sept 2003

Direct OfferingsWarrants

NotesCommon StockPreferred Stock

Debentures

Major Financing Instrumentsat Different Milestones


Valuing the Business

• Fair market value: willing seller and buyer

• Intrinsic value: interpreting balance sheet and income statements

• Investment value: worth to an investor

• Going concern value: current financial status

• Liquidation value: amount recover from sale of assets

• Book value: accounting measure that is the difference between total assets and total liability


Valuation Methods

• Multiple of earnings– Market price of common stock/earnings

per share

• Discounted Cash Flow Analysis– How much an investor would pay today to

have a cash flow stream of X dollars for X number of years into the future


Other Factors in Valuation

• The assumptions used to estimate value

• The degree of legitimate control the owner has in the business

• Intangibles like a loyal customer list and intellectual property

• The bottom line: Negotiation determines the value


Summary

• Plan financing stages carefully

• Use friendly money first

• Stick with private placement as long as possible

• Do YOUR due diligence

• Get references

• Be proactive


Take-Aways

• List what students took away from the discussion in real time

chapter 18 financing start-up and growth. copyright © houghton mifflin company18-2 overview...

Documents

capital slide

growth slide

business slide

incubator slide

lower slide

biggest slide

peoples money slide

stage financing