Lecture 8 $$$$$ Raising Money $$$$$$ Debt and Equity for a New Company

Ken Pickar Lecture Feb 1, 2011

HW for today

• What is the value you provide your customers?

• How will you capture that value (Business Model)? Name at least 2.

• How will you price your product(s)?

• How will your value capture be sustainable for 5 years?

Thoughts

• Feb 24 Fast Pitch LA we go there instead of class?

• Midterm Feb 10 • Coaching • Steve Streit lunch this Thursday • Tech Coast Angels Feb 18th

February 24, 2011

3:00-3:45


 UCLA Anderson School of Management - Korn Hall 2:00-3:00Registration Getting Funded In Today's Market Venture Partners 
 
 Venture capital and angel investors will discuss the current funding environment for start up companies.Jim Andelman – Rincon William Quigley – Clearstone Venture Partners 
 Eric Manlunas – Frontera Group 
 Scott Sangster – President, Tech Coast Angels - Los Angeles

3:45-4:30

2011 Start Up Business Climate 
 TCA porfolio CEOs will discuss the early stage business climate in 2011. Companies include LaughStub, YouMail, HitFix, CosNet and Others.

4: 30-5:00 5:00-5:30

Break Fireside chat with Mike Jones, CEO,

5:30-7:00

Fast Pitch Competition 
 CEOs of 8-10 of Southern California’s most promising startups will have 90 seconds to pitch their companies to a panel of seasoned judges. Pitches will be evaluated for fundability and presentation quality. The winners will be invited to present at a Tech Coast Angels screening session and be considered for funding.




7:00-9:00

Light Dinner and Networking 
 Network with hundreds of investors, entrepreneurs and other industry experts over a light dinner, wine and assorted beverages. Meet Tech Coast Angels, other angel investors and venture capitalists.

Midterm

Next week, Thursday, February 10 Submit presentation 5 pages (pdf) and 10 minute presentation (pdf of PPT) Continue Market interviews!! You should have made significant progress by next week!

Contents 1.

Updated Market Analysis. (50%) Show references 1.

Who is your customer? How big is he? How fast is he growing? What intense pain is this customer experiencing? Be as precise as possible in identifying customer. 2.

How big is the market segment? How fast is it growing? Be as precise as possible 2. Business model (20%) How will you make money?

3. What was the biggest surprise(s) you encountered in your research so far (10%) 4. Key issues to be resolved for the Final (20%) e.g., untested hypotheses. List as many major uncertainties as you can and some thoughts on how you will address them.

What other product issues drive companies besides profits?

6

For a new company Some financial principles

Cash flow is typically a negative quantity Monthly Negative Cash Flow= Burn Rate Central riveting thought Cash in Bank/Burn Rate

=

number of months until you are out of business

For a new company Some financial principles

Cash flow is typically a negative quantity Monthly Negative Cash Flow= Born Rate Central riveting thought Cash in Bank/Burn Rate

=

number of months until you are out of business The horror! The horror!

+$

Initial investment

Cash Profile

Product takes off “Hockey stick” Cash Burn Second investment Start here Time (months)

•

For a new company Some financial principles

“Cash is King”

–

Think cheap

•

Need to lower burn rate?

–

No office space

–

Smallest team you can use

– – – – – – –

Outsourcing Ebay Buy/make??

Smaller protoypes Low inventory Lower salary Zero salary

For a new company Some financial principles

•

“Cash is

–

King” Think cheap

•

Need to lower burn rate?

– – – – – –

Lease rather than buy Sell stuff Fire people or hire less Keep your day job Barter for space, services Pay in stock

Questions

•

When do you raise new money?

•

Debt vs Equity

–

What’s the difference?

Founder’s financing concern for a new company

Keep Control Issues

•

Degree of Desperation

•

Need for advice, contacts and mentoring

•

Valuation

•

Reserve for the future Need $

Existential Questions

• What

is

your reason for going into business?

• Do you need outside financing?

• Are you a business with a potential “liquidity event” or are you a “lifestyle business”? • How important is control to you?

• What is your minimum burn rate • How long until you are “cash flow neutral”?

Start-up Rule CEO looks for financing all the time

Where can you get money?

Summary Categories of places to get money

1. Need Operating funding prior to product sales 2. Debt 3. Equity

Plus and Minus of Debt or Equity

Debt + • More control • No sharing of success • Fixed interest rate (predictable) • Big motivator • Tax advantage Debt – • Affects cash flow • Reduces profits • Have to pay good times or bad Equity + • Easier To begin with • Helpful (?) partner • Motivator • Validates model Equity • Share upside • Loss of control

• • • • • •

1. Operating funding

SBIRs (Small Business Innovation Research) Research Contracts

–

Feds

– –

State Corporate partner

– –

Customer Supplier Barter

–

Rent

– –

Professional services What else? “Sweat” Equity Free services Part-time consulting

2. Debt- Sources of Funds

•

Short term loans

Securing a succession of small loans can help you cover expenses while building revenues •

Personal Credit

They're not just for car loans and home mortgages. Now credit unions are making business loans.

• Credit Cards •

Home Equity

Assuming you have any • P

urchase orders as entry-level collateral

• SBA Loans •

Private Loan Guarantees

Find an investor to guarantee your loan.

Debt (continued)

•

Asset-Based Loans Use your assets—like accounts receivable and inventory—to help you land funding.

• •

.

Equipment Leasing Inventory-based lines of credit

•

Royalty Financing Get advance against future sales.

Debt Sources

• Credit Unions • Community Development organizations • Home Equity • Subordinated Debt • Warrants

3. Equity Sources

• Self Funded Corporation • Outside Capital Sources – Seed (10-100K) •Friends, Family and Fools – Angel (250K- 1M) – VC (2-10M) – Mezzanine (50M) – Liquidity event (500M- ? ) •

IPO

•

Acquisition

How do you trade-off ownership for capitalization?

• •

Before funding, you owe 100% of the company Assume you would like to raise money. How do you calculate who owns what after the money is raised?

Pre-money 2M Ownership before 100% Ownership after 67% 33% Angel Investment Post Money 1.0M

3.0M

100%

A round

Pre-money 2M (how is this determined?) Angel invest 1M (Why this amount?) Total 3M (Valuation after A Round) Congratulations (?) 1. You have lost 1/3 of your company. 2. You have added strangers to your Board. 3. Well, at least you have majority ownership 4. Your company is worth 3M of which your share is 2M. This is the best measure of a companies worth. What are others?

How to determine Pre money valuation

• Some Factors – IP protection – Market addressed (Validated?) – Management Team – Net present value of future profits – Return on investment – What else?

How to determine Pre money valuation

• Some Factors – IP protection – Market addressed (Validated?) – Management Team – Net present value of future profits – Return on investment – What else?

Market for start-ups!

How much do I need?

• Usually more than you think – Time=money – Excessive optimism •Market development •Hire people •Murphy’s Law – Leverage all sources – Never stop – Allow 6 + months to raise money

I need more money to grow (or to survive) B Round Pre-money 10M (how is this determined?) VC invest 5M (Why this amount?) Total 15M (Valuation after B Round) Congratulations (?) 1. Your company is now worth 15m 2. You have added new strangers to your Board. 3. How much do you own?

Ownership after B round

• • •

You own (66%) (10M) (66%) Angels own (33%) (10M) (66%) VC owns (33%) 15M = 44% = 33% = 22% Bad news: You’ve lost control!

Good news: Your investment is now (44%)(15M) =6.6M (Up round. What is the alternative?) Bad News: This investment is illiquid, i.e. there is no market to convert to cash

And so it goes. . .

• Until – Walking wounded – RIP – Life style company – Acquisition – IPO

Projections

• In Business Plan, need to project income and cash flow statements ~ 5 years • We will discuss this in a future lecture

Conclusion

• Financing Decision determines what kind of company you will build