Financing Growth

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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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Sources of Capital by Stage of Development
Seed Stage Self-funded Family, friends, fools (3fs) Government grants Series B Growth Angel syndicates VCs Strategic Partners
Series A Angel Investors Angel Syndicates Some early-stage VCs Rapid-Growth VCs 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

• Growth Phase
• Building an organization
• Infrastructure
• Policies
• Procedures
• Managing people
• Recruit
• Train
• Retain
• Managing Customers Markets
• Raising Capital

• Seed / Development Phase
• Defining, refining and testing products
  markets
• Gaining credibility
• Customers
• Suppliers
• Investors
• Attracting critical talent
• Establishing logistics distribution channels

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Types of Equity Capital

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

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Venture Capital Funds Flow
Portfolio Cos.
Pension funds


Insurance cos


Venture Capital Fund

Individuals




Corporations
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Harvesting the Venture Fund
Portfolio Cos.
Pension funds
Insurance cos
Venture Capital Fund
Individuals
Corporations
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

• Founders 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

• Companys 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

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

• Art
• Management
• Investors
• Location
• The Story
• The Deal

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 doesnt 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?
• Dont 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 Ive 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 Bezoss 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 dont 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
• Youre 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
• Were 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