Chapter 18 Financing Start-up and Growth. Copyright © Houghton Mifflin Company18-2 Overview...
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Transcript of 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
Copyright © Houghton Mifflin Company 18-4
The Fundamental Truths About Raising Money
Copyright © Houghton Mifflin Company 18-5
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
Copyright © Houghton Mifflin Company 18-6
Upfront CostsFinancialsConsultant
CPA/AuditorI-Banker
Marketing CostsProspectus
LegalPrinting
Back-end CostsI-Banking
LegalBrokerage
Easily up to $200,000
2: Cost of Raising Capital
Copyright © Houghton Mifflin Company 18-7
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
Copyright © Houghton Mifflin Company 18-9
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
Copyright © Houghton Mifflin Company 18-10
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
Copyright © Houghton Mifflin Company 18-11
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
Copyright © Houghton Mifflin Company 18-12
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
Copyright © Houghton Mifflin Company 18-13
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
Copyright © Houghton Mifflin Company 18-14
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
Copyright © Houghton Mifflin Company 18-15
MORE on Angels
• Order of investment interest
– Manufacturing—industrial/commercial
– Manufacturing—consumer
– Energy/natural resources
– Services
– Retail/wholesale
Copyright © Houghton Mifflin Company 18-16
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
Copyright © Houghton Mifflin Company 18-17
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
Copyright © Houghton Mifflin Company 18-18
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
Copyright © Houghton Mifflin Company 18-19
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
Copyright © Houghton Mifflin Company 18-20
Private Placement
• Advantages
– Less costly, less time consuming than IPO
– Availability of standardized offering statements
– Don’t have to file with SEC
Copyright © Houghton Mifflin Company 18-21
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
Copyright © Houghton Mifflin Company 18-22
Debt Sources
• Commercial banks
• Commercial finance companies
• Small business administration
• State-funded venture capital
• Incubators
• Customers and suppliers
Copyright © Houghton Mifflin Company 18-23
Venture Capital
• Less than 1% of the 300K companies growing 20%+ per year are backed by VCs
Copyright © Houghton Mifflin Company 18-24
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
Copyright © Houghton Mifflin Company 18-25
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
Copyright © Houghton Mifflin Company 18-26
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
Copyright © Houghton Mifflin Company 18-27
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
Copyright © Houghton Mifflin Company 18-28
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
Copyright © Houghton Mifflin Company 18-29
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%
Copyright © Houghton Mifflin Company 18-30
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
Copyright © Houghton Mifflin Company 18-31
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?
Copyright © Houghton Mifflin Company 18-32
The Initial Public Offering (IPO)
The IPO Process
Copyright © Houghton Mifflin Company 18-34
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
Copyright © Houghton Mifflin Company 18-35
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
Copyright © Houghton Mifflin Company 18-36
Of 3,186 firms that went public in 1980s, only 58
percent still listed on one of three major exchanges
Copyright © Houghton Mifflin Company 18-37
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
Copyright © Houghton Mifflin Company 18-39
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
Copyright © Houghton Mifflin Company 18-40
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
Copyright © Houghton Mifflin Company 18-41
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
Copyright © Houghton Mifflin Company 18-42
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
Copyright © Houghton Mifflin Company 18-43
Take-Aways
• List what students took away from the discussion in real time