Financing Growth

Alex F. DeNoble, Ph.D.

San Diego State University MEET U.S. Program

The Fund-raising Challenge:

Raising funds is like a chess match. The entrepreneur must constantly think ahead to the next fundable milestone. This challenge raises 2 fundamental questions:

• •

What does my company have to look like at the next fundable milestone?

What must I do to get the company ready for the next fundable milestone?

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Growth of a Firm

• Firms evolve through lifecycle stages • Each stage is characterized by: – New strategic challenges and issues – Evolving managerial skill requirements – Changing levels & types of risks – Changing financial requirements

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COMPANY PHASES SALES

Seed/Development Phase Growth Phase Mature Phase

Entrepreneur/Innovator Builder/Driver TIME Corporate Fighter MEET U.S.

Sources of Capital by Stage of Development Seed Stage: Self-funded Family, friends, fools (3f’s) Government grants Series B: Growth: Angel syndicates VC’s Strategic Partners Series A: Angel Investors Angel Syndicates Some early stage VC’s Rapid-Growth: VC’s Strategic Partners IPO Corporate Buy-outs

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Value Drivers by Stage of Development Seed Stage: •Proof of concept •Initial market validation Series A: •Technology validation •Further Market Validation •Assembling the team Series B Growth: •Referencable customers •Company infrastructure •Strategic alliances •Strategic investors Rapid Growth: •Sales Growth •Profitability

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Challenges of a Growing Firm

Seed / Development Phase • Defining, refining and testing products & markets • Gaining credibility – Customers – Suppliers – Investors • Attracting critical talent • Establishing logistics & distribution channels Growth Phase • Building an organization – Infrastructure – Policies – Procedures • Managing people – Recruit – Train – Retain • Managing Customers & Markets • Raising Capital

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Types of Equity Capital

• Savings and other personal assets • Friends, family and fools (the 3 F’s) • Angel Investors • Angel Syndicates • Venture Capital Firms • Strategic Corporate Partners • The Public Markets • Corporate Buyout

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Venture Capital Funds Flow

Pension funds Insurance cos Individual s Corporation s $ $ $ $ Ventur e Capital Fund $ $ $ $ $

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Portfolio Cos .

Harvesting the Venture Fund

Portfolio Cos .

Pension funds Insurance cos Individuals Corporations Ventur e Capital Fund Return on Investment

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Deal Structure Issues:

Objectives of Equity Investors • Maximum Return (IRR; Xreturn) • Large Equity participation • Liquidity • IPO • Merger or Trade Sale • Put back to the Company • Hedge Risk

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How Equity Investors Hedge Risks

• Financial instruments • Control • Keep founders and motivate them • Avoid litigation • Voice in management • Control over major events • Protect proprietary information • Preemptive & first refusal rights • Antidilution provisions • Covenants (negative & affirmative)

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Deal Structure Issues:

Founder’s Objectives • Keep as much equity as possible • Minimize dilution • Keep control of operations • Incentives for founders & key employees • Quality investors with deep pockets • Keep restrictions to a minimum • Force conversion of preferred to common as soon as possible

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Deal Structure Issues:

Company’s Needs • Minimum funds to get to next milestone • Balance Sheet Considerations • Debt vs equity • Simple capital structure • Availability of conventional financing • Cash flow & income statement considerations • Future Needs • Current Investors vs future investors • Other sources of cash

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Art vs. Science of Equity Investing

Art • Management • Investors • Location • The Story • The Deal Source: Brian Dovey, Partner, Domain Associates

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Science • Market • Competition • Technology • Proprietary position • Financial requirements • Valuation

Science: Market

• Size/Unmet Need • Customer requirements • Customer loyalty • Sales cycle • Price sensitivity Source: Brian Dovey, Partner, Domain Associates

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Science: Competition

• Who else is out there?

• What is their edge?

• What is your unfair advantage?

• How long can you sustain this unfair advantage? Source: Brian Dovey, Partner, Domain Associates

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Science: Technology

• What do other experts think about the business?

• How many technical things must go right for it to be a success?

• Is it breakthrough or incremental? Source: Brian Dovey, Partner, Domain Associates

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Science: Proprietary Position

• What is patentable and is it worth patenting?

• Are you free to practice your art?

• Can you block others?

• What should stay a trade secret?

• Is there a cohesive strategy to move the product to market?

Source: Brian Dovey, Partner, Domain Associates

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Science: Financial Requirements

• How much money is needed to reach the next financeable milestone?

• Do you believe them?

• What happens when that doesn’t happen?

Source: Brian Dovey, Partner, Domain Associates

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Science: Valuation

• Who are you selling to?

• What might they be willing to pay?

• Run some numbers as a reality check • What type of return will justify the risk?

Source: Brian Dovey, Partner, Domain Associates

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Art: Management

• Do they have the right people?

• Can they recruit the right people?

• Can you work with them?

• Are they bureaucrats?

• How do they work up and down the organization?

• Can they tell the right story to the right audience?

• Is the chemistry right?

Source: Brian Dovey, Partner, Domain Associates

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Art: Investors

• How much is the corporation willing to risk?

• Are other investors interested in the deal?

• Are there investors from previous rounds still investing?

• Do the investors have experience in this industry?

Source: Adapted from Brian Dovey, Partner, Domain Associates

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Art: Location

• Will it be easy to recruit senior management to your location?

• Will it be easy to recruit new employees when you need them?

• Are there potential acquirers around?

Source: Brian Dovey, Partner, Domain Associates

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Art: The Story

• Is it compelling?

• Is it understandable?

• Is it differentiable?

• Can it be told in 15 minutes or less?

Source: Brian Dovey, Partner, Domain Associates

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Art: The Deal

• How do you and others value the company?

• Is it destined to be public or acquired?

• Do you syndicate? With whom?

• Who are you competing with for the deal?

• Don’t forget the management pool • Is a “staged financing” appropriate?

Source: Brian Dovey, Partner, Domain Associates

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Value-Added Benefits of VCs

• Obtaining additional equity financing • Recruiting and selecting additional member of the management team • Interfacing with other investors • Monitoring financial performance • Serve as a sounding board to team • Monitor operating performance • Formulating business strategy Source: Ehrlich, De Noble, Moore & Weaver, 1994

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Exit Strategy

Some options include: • Going public • Selling the business • A stock buy-back at the going rate • Leveraged buy-out • Second round of investment Source: Ehrlich, De Noble, Moore & Weaver, 1994

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The Top Ten Lies of Entrepreneurs

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

# 10 Entrepreneur “Our Projections are conservative” Investor “Multiply this forecast by .1 and add five years”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#9

Entrepreneur “IDC (or Jupiter or Yankee Group or Gartner Group) forecasts that our market will be $50 billion by 2003” Investor “This is the fifth $50 billion market I’ve heard about today”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#8

Entrepreneur “Amazon will sign our deal next week” Investor “Call me when you get Bezos’s signature”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#7

Entrepreneur “Key Employees are set to join us as soon as we get funded” Investor “Give me their phone numbers so I can verify this story”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#6

Entrepreneur “We have no competition” Investor “Either there is no market or you don’t know how to use a search engine”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#5

Entrepreneur “We need you to sign a non disclosure agreement” Investor “You’re clueless: no one signs a nondisclosure agreement”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#4

Entrepreneur “Cisco (or Oracle or HP or Sun) is too slow to be a threat” Investor “If arrogance were venture capital, your deal would be oversubscribed”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#3

Entrepreneur “We’re glad the bubble has burst” Investor “We are too, because your valuation

just

dropped 50%”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#2

Entrepreneur “Our patents make our business defensible” Investor “Hire more engineers, not patent attorneys”

Source: Guy Kawasaki

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Top Ten Lies of Entrepreneurs

#1

Entrepreneur “All we have to do is get 1% of the market” Investor “I want to fund a company that will get 99% of the market”

Source: Guy Kawasaki

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Thank You

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