financing your business

Financing Your Business

Presented by: David HesslerOctober 19 2006

ENT 422

Building the Team & Financing Your Business

Outline:– Hessler background/biases– Building the Team—”War Stories”– Financing Sources

• “F, F & F”• Grants and Debt• Seed Equity• Venture & Angel Capital


David Hessler:– Technology entrepreneur– $ from/to friends and family– Past guarantor of “serious” debt– Financed by Angels– Ran venture fund; Investment Banker– “Successful” Angel investor

• Closed many debt & equity deals– BUILT COMPANIES & BEEN ON

BOTH SIDES OF THE DEAL


Building Your Team– Do you agree with Baron &

Shane?• Similarity vs. Complementarity?

• No “one man band”

– Special caution to engineers


Building Your Team (more)

– Have a “pre-nup” (Vesting)– Think like a lawyer

– Someone has to be “top guy”


Building Your Team (more)

– Perceived Fairness• Always think “fair market value”

– Division of Responsibility-DELEGATE!


Why Financing?– Seems obvious, but not

necessarily– Integral part of the plan for

the business (and “Business Plan”)

– Varies by type of business


How much spending is necessary/desirable before cash flow breakeven?– Financing should be a MEANS

to an end, not an END in itself.


Sources of Growth Capital– Personal assets– Company balance sheet– Grants– Loans– Equity—Venture & Angel Capital


SOURCES OF GROWTH CAPITAL

Personal Assets:– There IS a level below which you cannot

start a company– “Need money to raise money”

• Staying power• Responsibilities/need for current income

– Part of this is short term salary expectations.


SOURCES OF GROWTH CAPITAL Trade debt – accounts payable

− Positive “float” can often be negotiated with vendors/customersA. Pre-paymentsB. Progress payments (Gov’t contracting)C. Extended payment terms from

suppliers In hopes of future business For equity (?)

D. Factoring



For technology start-ups, grants can be key

1. Small Business Innovation Research (SBIR)

2. Cooperative Research & Development Agreement (CRADA)

3. Local government (few)


SOURCES OF GROWTH CAPITAL Senior, secured debt− Usually commercial banks

− Common misperception:− – BANKS DON’T FINANCE LOSSES !

− Need multiple collateral sources− Assets: A/R – 80%,− Inventory – 20-60%,− Fixed assets – 50%

− Cash flow – debt service as small % of earnings/cash


SOURCES OF GROWTH CAPITAL Senior, secured debt (Cont’d)

– Additional collateral / common issue:− Personal guarantee

1. (Almost) always required2. Considered a show-of-faith by

borrower3. All 20% owners (?)4. “Joint and several”5. Important to equity investors as well6. Can be reduced over time


SOURCES OF GROWTH CAPITAL Senior, secured debt (continued)

• Many costs beside interest rate• Usually includes difficult covenants

Profitability Coverage ratio Prohibited borrowing Liquidity

UCC Filings SBA Loans



Junior secured debt;Unsecured (subordinated) debt;Convertible, subordinated debt;Convertible Preferred stockCommon Stock


BREAK


Equity Financing


Venture Capital: Part of the larger asset class of “private equity” Definition: Money provided by

professionals who invest alongside management in rapidly growing companies


– History 1920’s - DuPont Financing of GM 1930’s - Rockefellers Back Entrepreneurs 1946 - American Research & Development (ARD) 1950’s - Shockley transistor/Fairchild; Haloid/Xerox 1960’s - SBIC & Private Partnership Proliferation 1970-75- Industry shakeout 1978+ - “Boom” in Venture Capital

--20% capital gains tax rate --SEC Rule 144; S-18 -- ERISA Exemption

1980s – Growth of the “Mega fund” - Bigger Deals, Geographic concentration

1990s – Bigger Funds, Bigger Deals - Record Returns (1999 Vintage, 100%+ IRR)

2000+ - Serious Slowdown/Troubled Portfolios 2004-06 - Coming Back to “Normal” (?)


Stages of Venture Capital:– Seed: Business plan; market validation;

technical feasibility– Start-up: Prototype development; non-

revenue customers; company infrastructure

– First Stage: Initial Mfg.; revenue generation

– Second Stage: Shipping , but not profitable– Third Stage: Profitable, need expansion– Bridge Financing: Additional growth prior to

liquidity event


Common Myths:

– VCs want majority control

– Founders/owners get ‘fired’


“Venture Capital is not for most companies.”– Millions of privately-held businesses– 700,000 new businesses formed

annually– But only 3000-5000 venture financings

annually

Investors seek 10x return in 5 years- Very Rare


Equity Investment, therefore:

– Liquidity event is required– Requires size and growth– Means the investor behaves

like an owner


Valuation Example:Year Five Revenue: $100MYear Five Net Income: $ 10MFuture Value (15 P/E) $150MBPlan Investment Req’d $ 10M

VC Ownership: 67% (10X)If B. Plan investment required today is $5M, VC Ownership: 33%


Why not (institutional) Venture Capital?

Small deals cannot attract venture capital:

- Financial capital has grown faster than human capital

- VC requires intense management (Board seat)

- Each VC can only do five boards- With $300M fund, 10 principals,

each deal is $6M (Minimum)


• The good news:• The rise of angel investment:

• Institutional: $22.13B to 2239 companies

$9.9M/deal

• Angel: $20 B to 40,000 +/- companies

$500K/deal

Financing Your Business -Term Sheet Discussion

• The Term Sheet

1. “Shorthand” description of the terms of a proposed investment

2. Delays incurring legal costs until terms are agreed

• Can be more or less company or investor “friendly”


Terms included: Representations & Warranties Positive and negative

covenants Securities description

– - rights & responsibilities


Why required?

Investors will (usually) be minority investors

They do not control day-to-day actions Key management actions can “ruin” the

investment

The goal is not control of the company, it is protection of the investment!


Key Terms:– Series A Redeemable, Convertible,

Participating Preferred Stock-- Conditions of closing:

Business Plan Showing… Receipt of info requested… Declaration of capitalization Employment agreements (salary) Shareholder notes converted “Definitive docs…,” “…no material

change…”


Key Terms: Valuation – spells this out several

different ways • “Fully diluted…” (including provision for options)• Pre-money total• Per share price

Liquidation preference • A specified amount first, PLUS• Continue to participate with the Common• Series A Investors get to determine if a

sale/merger is a liquidation


Key Terms:Board of Directors

• Series A investors specify size of the Board and number of Series A members

• Audit and Compensation committees with independent directors

Dilution protection – full ratchet


Covenants: Need 2/3 majority of Investors to:

• Issue stock;• Sell or merge• Declare dividends;• Repurchase stock (except employee);• Amend By-Laws;• Create a subsidiary;

• Incur debt greater than $X;• Acquire or dispose of assets greater than $Y;• Incur capital expenditure greater than $Z


Conclusions:

Sounds difficult, but… There are reasons for the demands Need alignment of goals

and…. Everything is negotiable!


QUESTIONS/DISCUSSION

financing your business

Documents

businesswhy financing

businessventure capital

team morehave

business break

business planvaries

cash flow debt service

equity investors

future businessfor equity