Financing Growth

Alex F. DeNoble, Ph.D.San Diego State University

MEET U.S. Program

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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

Entrepreneur/Innovator Builder/Driver Corporate Fighter

Seed/DevelopmentPhase

GrowthPhase

MaturePhase

SALES

TIME

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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 B Growth:•Referencable customers•Company infrastructure•Strategic alliances•Strategic investors

Series A:•Technology validation•Further Market Validation•Assembling the team

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 Fund

Pension funds

Insurance cos

Individuals

Corporations

Portfolio Cos.

$

$

$

$

$

$

$

$

$

Venture Capital Funds FlowVenture Capital Funds Flow

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Venture

Capital Fund

Pension funds

Insurance cos

Individuals

Corporations

Portfolio Cos.

Harvesting the Venture FundHarvesting the Venture 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

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

requirements• Valuation

Source: Brian Dovey, Partner, Domain Associates

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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 StrategySome 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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Source: Guy Kawasaki

The Top Ten Lies of Entrepreneurs

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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