Attaining Equity Financing in the Silicon Valley

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Attaining Equity Financing in the Silicon Valley

• Professor Mark V. Cannice, Ph.D.
• Associate Professor of Entrepreneurship
• Executive Director, USF Entrepreneurship Program
• University of San Francisco
• cannice_at_usfca.edu
• www.EntrepreneurshipProgram.org

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Topics of Discussion

• Sources of Equity Financing
• Venture Capital Criteria for Financing
• Attaining Competitive Advantage
• Valuation of your Company
• Process of Finding Equity Funding

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Sources of Equity Financing

• FFFF
• Angel Investors
• Venture Capitalists
• Corporate Venture Division (e.g.
  Intel Capital)
• MA
• Public Markets (IPO)

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Venture Capital Criteria for Funding

• Characteristics of a fundable business
• Meets an important consumer or business need
• (it solves a problem)
• Competitive (Unfair) Advantage Sustainable
  Business Model
• Large market size with high growth rate
• Potential to gain 20 of market over time
• High durable margins (40 or better)

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Venture Capital Criteria (continued)

• A fundable business
• Recurring revenue
• High valuation multiples (specific industries)
• High return to investors (25 - 40/year)
• Is a good fit with the management teams desires
  and capabilities
• Clear exit mechanism and strategy

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Developing Sustainable Competitive Advantage

• Sustainable Competitive Advantage some aspect
  of your business (which is not easily copied)
  that allows you to enjoy greater market demand
  (greater market share and/or better pricing
  power) or lower costs than your competitors

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Sustainable Competitive Advantage

• Company resources that may lead to sustainable
  competitive advantage
• Intellectual property whose functionality cannot
  be easily replicated
• Brand
• Exclusive distribution network
• Exclusive supply sources

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Funding Timeline

• How much money do you need and when (time-line)?
• Seed capital - product development/test
  marketing?
• Series A or 1st round cover 1 year of cash needs
  - operations and investment
• Series B or 2nd round awarded if company met
  early objectives (proof of concept/customer
  acceptance) - used for marketing campaign and
  sales growth
• Series C or 3rd round awarded if sales growth
  meets expectations and profitability is achieved
  or expected use to accelerate growth
• Mezzanine (get ready to go public capital) -
  capital infusion to ensure company meets SEC
  requirements for public offering
• Initial Public Offering (IPO) - if Venture Firm
  can find investment banker to underwrite firm and
  current market environment is accepting

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Valuation Methods

• Valuation- determining what a company is worth
• This is critical so an appropriate deal can be
  struck between investors and entrepreneurs -
  (cash for equity in firm?)
• NPV
• Present value of expected future earnings or cash
  flows discounted by appropriate discount rate
  (investors ror).
• Example Determine forecast earnings or cash
  flows from pro forma income statements or cash
  flow statements and discount those earnings or
  cash flows by the investors required rate of
  return
• Forecast earnings year 1 (1 mil), year 2
  (0), year 3 1 million, year 4 5 million,
  year 5 10 million
• Investors ror 50
• NPV of company (1)/1.5 0/1.52 1/1.53
  5/1.54 10/1.55

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Valuation Methods

• P/E
• Value equals multiple of earnings at given point
  in time discount that value back to present
• Example year 5 earnings 10 million, industry
  P/E is 10 so value of company at end of year 5
  is 10 million x 10 100 million. Discount
  that amount to present day by investors ROR, -
  100 million/1.55

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Valuation

• Venture Capitalist way
• Ex. 1 million investment with 50 ror, 5 year
  holding period (FV 7.6 million), industry P/E
  of 15, year 5 after-tax profit of 1million
  (company value of 15 million).
• (7.6 FV of investment/15 million future total
  value of company) investor buys 51 of company
  today with 1million.
• Rule of thumb for emerging industries
• Pre-money 3 4 million

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After Valuation - then what?

• Agree upon valuation then negotiate with
  investors for needed funds and ownership
  dilution.
• Dependent greatly on current market demand for
  any new company as well as demand on your
  particular industry
• Valuation you determined from your calculations
  and negotiation is the pre-money valuation for
  your business. That is the value of your
  business before any further money is invested.

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Pre/post money

• Pre-money/post-money
• Pre-money valuation set at 5 million. Investor
  puts in 1 million. post-money valuation is
  6million. Investor has bought 1/6 of firm
  equity (16.7)

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Staged Financing/Dilution example

• 1st stage financing
• Valuation is 5million
• Investor puts in 1million
• 2nd stage financing
• Valuation is 10 million
• Investor puts in 5 million
• 3rd stage financing
• Valuation is 50 million
• Investor puts in 10 million
• IPO
• Valuation is 500 million
• Public invests 100 million

• 1st stage dilution is 16.7 (1/6) founders retain
  83.3 equity
• 2nd stage dilution is 33 (5/15) founders retain
  50 equity.
• 3rd stage dilution is 16.7 (10/60), founders
  retain 33.3
• IPO dilution is 16.7 (1/6), founders retain
  16.7 equity worth 100 million.

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Process to find equity funding

• Prepare an elevator pitch
• Talk to people (lots of people)
• Go to business and university events (business
  plan competitions)
• Referrals to investors

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Thank You!

• Questions?
• USF Silicon Valley Venture Capitalist Confidence
  Index Report (Bloomberg ticker symbol USFSVVCI)