Funding Hurdles For Small Tech Firms

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Funding Hurdles For Small Tech Firms

• April 13 week 11 Management 519

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Outline

• Funding is important
• A great number Hurdles to funding
• Think of venture funding as a process
• Knowing Who and When to Ask
• Have a funding strategy
• Be willing to alter focus

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Financing the Firm

• Every business startup needs financing
• Especially High Tech
• It is not a one time event but rather a process
• The most important continuous process
• Yet few high tech entrepreneurs have a sharp
  understanding of it
• When, Why, How much, What flavor
• Great Mythology Around High tech

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The Importance of Financing

• Financing needs driven by Cash Flow,
• Revenues and Profits
• Cash Flow is king
• 5 minute elevator speech
• Business Plan and Business Planning Process

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Background

• Do VC funded startups have better success rates
• Means explain well
• Means and end game
• High tech needs creativity
• The ability to chose, court and obtain financing
  is critical to the long-term survival and growth
  of High Tech enterprises

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Types of Financing Options Language of fund
acquisitionSources
Process

• bridge loans,
• non-diluteable equity,
• customer financing,
• sweat equity,
• VC funding
• Angel financing the other professional equity
  options

• pre-seed,
• seed,
• startup,
• Mezzanine,
• first round
• Series A funding
• Placement
• Squash down

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Hurdles to Funding

• Risk Issues
• Infrastructure Issues
• Uniquely Attractive solution to a Problem
• Value Chain Positioning
• Funding Cycle
• Management Team
• Valuation
• Partnerships and Market channels
• Understanding funding sources and Process

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The Funding Cycle

• The Sources
• The process of Obtaining Funds
• The Language
• The strategy

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The Process

• Know the Funding Sources
• Know their proclivities
• Accurately know When they fund
• Understand the Process / Have a Strategy

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Process Stages of Funding

• Pre seed
• Seed
• Startup
• Series A
• Series B

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Sources of Funds

• Equity Investment Vehicles
• Angels
• VC
• Strategic Partners
• 3 Fs
• Non-diluteable Equity
• Debt
• Customer

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Know Their Tendencies

• All Differ on Risk Reward Profile
• Some willing to accept partial solutions
• Depending on the stage of financing differing
  equity instruments dominate
• Lets Look at the sources

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Customer Financing

• Many High Tech Startups do not think to seek
  out their customers for pre-seed, seed and
  startup financing
• The use of the High Tech firms product or
  service is critical or strategically important to
  the customer.
• Few other sources for the product or service are
  available.
• The relationship between the firms is solid.
• The reputation of the High Tech Founding team is
  excellent.

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Non Diluteable Equity funding

• The most famous form of non-diluteable equity
  funding sources for small firms in the United
  States is provided by the now more than 20 year
  old SBIR (Small Business Innovative Research)
  program
• Well over 2 Billion
• MTV Money for Nothing
• Order Fast track funds for DOD SBIR provide the
  High tech Startup now up to more than 1M

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Debt Instruments

• Traditional
• Houses, Cars etc
• Semi Traditional
• Equipment, SBA Loans, Lines of Credit, factoring
• New
• Credit cards

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External sources of Funding

• 3 Fs
• Angels
• VCs
• Strategic Partners

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3 Fs

• Friends, Founders and family members (Fools)
• Many firms find that this is perhaps the highest
  priced form of High tech firm equity funding
• If not in monetary terms then certainly along
  family and social ones
• Typical funding limit 150,000

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Strategic Partnerships

• Not New
• Choices associated with this form of financing
  have lead both to highly positive outcomes for
  High Tech Startups and much less desired ones
• The choice to obtain this type of funding has
  serious consequences on exit strategies,
  alternative forms of further financing and firm
  strategic direction
• Largest amount of external equity funding year in
  and year out

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Venture Capital

• 18.2 billion in 2003, with only 2 of those
  dollars spent in seed or early-stage investments
• Placement was 6.7 million derived from only
  2,715 deals
• The vast majority of VC funded firms have product
  sales as well as a need for in excess of 1
  million in equity

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VC

• VC usually have a timeline to acquire from 1/3 to
  ½ of a firm, and have strong board of director
  positions and strong firm control.
• They wish to obtain again a 20 to 40 times
  investment back in three to seven years.
• They will demand a clear exit strategy, and
  focus on the efforts of the firm on hitting the
  home run.
• The firm is weighted toward a short tem rather
  than sustainable firm strategy.
• Often VC firms require continuous monitoring
  systems

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Angels

• 18.1 billion derived from 42,000 deals in 2003
• Angels often fund enterprises in a group and they
  rarely invest more than 50,000 individually in
  any one enterprise
• They tend to fund companies in industries that
  they are very familiar.
• Paul Atherton NanoVentures Ltd as an example
• Provide Mentoring

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Funding in Stages
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Pre -Seed

• Pre Seed financing is a small amount of funds
  required by the nascent entrepreneurs in order to
  define their value proposition, convince
  themselves of the viability of the concept and
  initiate activity
• primarily self funded or provided by the three
  Fs Friends, Family and Founders.
• 150,000

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Seed Financing

• Usually a relatively small amount of capital
  provided to an inventor or entrepreneur to prove
  a concept and to qualify for start-up capital
• This may involve product development and market
  research as well as building a management team
  and developing a business plan, if the initial
  steps are successful

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Start-up Financing

• Used to complete product development and initial
  marketing.
• Companies are organizing or been in business for
  less than 1 year
• They have not sold their product commercially.
• Usually such firms will have made market studies,
  assembled the key management, developed a
  business plan and are ready to do business.

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Seed and Startup Sources

• Either self financed, funded by individual Angel
  investors, customer financed or provided by
  non-diluteable equity sources
• firms in these stage are not highly embraced by
  the Venture Capital community.
• Angels Dominate
• Funding required is often less than 500,000.

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Early- or First-stage Financing

• Provided to companies that have expended their
  initial capital (often in developing and market
  testing a prototype) and require funds to
  initiate full-scale manufacturing and sales
• Traditionally been funded by Venture capitalists
  but is increasingly being addressed by angel
  networks and large firms interested in strategic
  partnerships
• The typical placements are under 2,500,000

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Late Stage - Expansion financing

• Subsequent investment rounds typically financing
  company product and/or market expansion, or
  keeping the company financially healthy shortly
  before a liquidity event such as an initial
  public offering (IPO) or acquisition
• has traditionally been funded by Venture
  capitalists but is increasingly being provided by
  large firms seeking strategic partnerships
• Typical placements in this stage are under
  5,000,000.

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Attractiveness

• Hype Pros Cons
• Solutions more than technology
• Management Team and Technology Team

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Knowing What type of Funding to Attract and When

• Who should you go after and when
• Your time resources are not infinite
• You have to move

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Have a Funding Strategy

• The flavvor of money you initially get can
  actually decrease your ooverall funding chances

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Attracting High Tech Funding Today

• Funding Stream Vs. Single Placement
• Firms today must have a proactive rather than
  reactive equity strategy
• One Process
• Pre-seed Seed Startup Early Venture Late
  stage venture
• Sources

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Good or Bad

• In the worst of all cases your strategic partner
  was actually practicing gate keeping during
  your acquisition, has lost interest, market share
  or simply has embraced other and to them more
  interesting projects.

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How should one go about developing a Strategic
Partner?

• Like amorous Porcupines?
• No Shotgun Weddings
• Proactive Selection

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Partner Selection Process
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Angels

• 18.1 billion derived from 42,000 deals in 2003
• Angels often fund enterprises in a group and they
  rarely invest more than 50,000 individually in
  any one enterprise
• They tend to fund companies in industries that
  they are very familiar.
• Paul Atherton NanoVentures Ltd as an example
• Provide Mentoring

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Angel Founder

• Jim Von Ehr

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VC

• 18.2 billion in 2003, with only 2 of those
  dollars spent in seed or early-stage investments
• Placement was 6.7 million derived from only
  2,715 deals
• The vast majority of VC funded firms have product
  sales as well as a need for in excess of 1
  million in equity

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VC

• VC usually have a timeline to acquire from 1/3 to
  ½ of a firm, and have strong board of director
  positions and strong firm control.
• They wish to obtain again a 20 to 40 times
  investment back in three to seven years.
• They will demand a clear exit strategy, and
  focus on the efforts of the firm on hitting the
  home run.
• The firm is weighted toward a short tem rather
  than sustainable firm strategy.
• Often VC firms require continuous monitoring
  systems

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How should one go about developing a Strategic
Partner?

• Like amorous Porcupines?
• No Shotgun Weddings
• Proactive Selection

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Partner Selection Process
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3F Night mare

• First, remembering that financing the firm is a
  series of decisions rather than just one instance
  too many other financing sources view the overuse
  of friends, family and founders as presenting
  problems in attracting investment later. One firm
  that we are consulting too presently has over 100
  owners and is still in the pre-seed stage of
  funding

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Strategic Partners Valuation

• firms with a strategic need for you and your
  technology often value your technology product
  paradigm highly
• Good or Bad?
• In the best of all cases you have a strategic
  partner that if you perform will provide the exit
  strategy for your High Tech startup.

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Good or Bad

• In the worst of all cases your strategic partner
  was actually practicing gate keeping during
  your acquisition, has lost interest, market share
  or simply has embraced other and to them more
  interesting projects.

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Valuation

• How much is the firm worth?
• It Depends
• Reverse valuation
• Sales and Profit Multiples
• NPV
• Risk Disacounts
• P/E ratios and market share analysis

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Forming a Team

• Every business startup needs additional people
  especially
• venture capitalist state that the founding team
  is one of the most important factors that
  determine the value of an enterprise
• that A strategies come from A teams

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Reverse valuation

• The Dominant form
• It is a commonly used method by Angels and VCs
  alike to determine if they will provide funding
  to a potential firm, the timing of investments in
  your firm and the percentage ownership that they
  would need to receive from a firm for a given
  investment or placement in your firm.
• An Angel or VC will not usually invest in a firm
  where they cannot receive a potential 20 to 40
  times their investment returned in three to seven
  years

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Example

• An example
• A firm needs 10 million dollars to meet their
  strategic demands
• The equity providing firm wants to own no more
  than 1/3 of the firm
• The VC requires 20 x Return in the fifth year.
• 20 x return on 10 million is 200 million
• The value of the firm must reach with all the
  discounts would be 600 million and have an exit
  strategy that is believable to that firm with an
  acceptable level of risk.

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Sales and profit multiples

• Oldest Bromide
• a multiple of single years sales often the number
  that is used is
• one times gross sales (revenues) or
• a multiple of this years profits

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Born Global Product Charateristics

• Finish, Internationalism
• SMEs
• IT and
• Product features and national acceptance
• Degree of adaptation vs. Standardization
• Stand alone or components
• Value chain Position and market entry
• Tailored/modified vs. standard products and
  international

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Why a team

• First, entrepreneurial research has shown us that
  start-ups with members with previous
  entrepreneurial experience whether they had been
  previously successful or not form teams that have
  a better survival rate.
• Companies that are started by teams show a higher
  success rate (2 to 1)
• High tech cost to develop is very high

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Why Team

• The first thing to understand is that
  commercialization of new technologies, unlike
  inventing, is a group effort
• The skills required for commercialization are not
  often found in one person no matter how well s/he
  multi-tasks
• Technology is not the only hard part of a high
  tech startup

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Team Members

• An expert in the technology who can carry out
  additional research as required to develop a
  saleable product (remember the second first
  product experiences).
• An expert in sales and marketing to those firms
  in your target industry, i.e. where the product
  will be sold.
• An expert in finance, budgeting, and financial
  control.
• An expert in manufacturing of products of similar
  type not necessarily your specific technology
  -- but technologies that are as complex and use
  similar materials.
• Other experts as may be required to produce your
  product.

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Tasks

• Proper selection is vital
• a business rather than just an idea needs much
  more than technology to thrive
• New firm management teams rarely change during
  the first 6 years

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Micro / Nano?

• Micro / Nano based businesses need knowledge
  specialists from their inception.
• The nature of Micro and Nano technology business
  are solution formed at the interface of multiple
  disciplines.

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Proper Selection

• Survival, success and growth
• The Pros and Problems of accepting the first
  choice
• People lament choice
• The power of the 2nd enterprise

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Consequences

• The choices involved in forming a founding team
  are made even more important due to the long term
  consequences of these decisions
• do not make the common mistake of limiting the
  choice of founding team members to your own
  personal network

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Factors and Characteristics

• First among the proper characteristics of your
  selected team members is that each of them has
  the same enthusiasm and belief in your technology
  as you have. They must be as convinced as you
  are that the technology will soon be a major
  factor in creating market success and profits

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Factors and Characteristics

• There should be an experienced chief executive
  officer (CEO) to oversee the business. This is
  rarely the technologist who is most often Chief
  technology Officer (CTO). If you as a
  technologist chose to be the CEO, keep in mind
  that if you later seek outside financing, you
  should have had a history of accomplishment
  either in a similar position prior to this
  business or demonstrable evidence of skill and
  experience in this start-up that will assure
  investors of your capabilities

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Factors and Characteristics

• Third, you need to make a list of the important
  knowledge and skills your team needs to augment
  your own. For example business owners typically
  think in terms of management functions such as
  finance and control, research and development,
  engineering and design, production, marketing and
  customer service. This is a logical way to sort
  out the businesses skill and knowledge needs.

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Factors and Characteristics

• There is no formula that dictates how the above
  functions should be filled. You can combine or
  separate functions as suits the people that make
  up your team.
• Look for multiples

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How to choose the right people?

• Can you evaluate People?
• Could you trust these people after a few
  important interactions?
• Were you correct in your judgment of them as
  people or were you disappointed when they failed
  to honor your trust in them?
• Seeing past the credentials

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Selection

• Selection requires that you look past
  congeniality, credentials, and personal
  attractiveness and focus on past accomplishments
  of each candidate
• perhaps you need to add a good people evaluator
  as your first team member
• hire a professional personnel manager

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What Kind of People

• A Scorpion is a scorpion is a scorpion
• Ask the Frogg

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What Kind of People

• First, there are those who claim that you should
  select individuals who are much like you.
• they are the extension of you
• If you are an extrovert, you cannot hire someone
  who is introverted, negative and hates people.
  This does not work.

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What Kind of People

• The other philosophy is that your team members
  have to possess the skills that you do not have.
• Keep outlook in mind

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COMPENSATING TEAM MEMBERS

• No Money Honey
• Given the past and current reluctance of venture
  capitalists and/or angel investors to invest in
  early stage startup high-tech businesses, is not
  likely that you will have a big fund of venture
  capital at startup.
• Ownership

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Establish a fair formula

• for the distribution of shares of stock among the
  team members
• Fair does not mean equal
• Valuation is negotiable among the team members
  and any value that is agreeable to all is
  appropriate and fair. When valuing the shares,
  pay no attention to the stocks par value

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Distribution

• To allow the team to avoid paying tax on their
  stock, high tech startups frequently distribute
  stock options instead of stock
• The problem with options is they confer no voting
  rights on the holder. And team members usually
  want to have the right to vote in shareholder
  meetings
• Plan on issuing the shares over a period of three
  to five years with so many for each year the team
  member remains employed in the firm

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Flexibility

• . It is possible to adjust the number of
  authorized shares rather easily if 2/3 of the
  shares are closely held by you, the founding team
  members and one or two outside investors
• Establishing a market for your corporations
  shares, either through an IPO or an acquisition,
  will allow those with itchy feet to take their
  cash and move on. (IPO or Buyout)

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MAINTAINING CONTROL

• 51
• Closely held ( founding team)
• A few shareholders have over 50
• Differing Stock
• resticted etc

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Tech abend Team formation

• Make sure they understand the innovation cycle

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Board

• Board as founding team
• Non-Team members
• Use of an Informal board
• Monthly scheduled meetings
• Number of options for work as a board