Financing Your Business

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Financing Your Business
Presented by David Hessler March 28, 2009
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Financing Your Business

• Outline
• Why financing?
• Financing Sources
• Debt
• Equity-Venture Angel Capital
• Terminology
• Alternate structures
• Recent Trends and Outlook

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Financing Your Business

• Why Financing?
• Obvious? Not necessarily
• Integral part of the plan for the business (and
  Business Plan)
• Varies by type of business

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Financing Your Business

• How much spending is necessary/desirable before
  cash flow breakeven?
• Financing
• A MEANS to an end,
• not an END in itself.

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Financing Your Business

• Stages of Financing

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Financing Your Business

• Sources of Growth Capital
• Personal assets
• Friends and family
• Grants
• Loans
• Equity - Venture Angel Capital

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Financing Your Business

• SOURCES OF GROWTH CAPITAL
• Guerilla (bootstrap) Financing
• Down-n-dirty prototypes
• Market studies
• Pre-payments from customers
• Progress payments (Govt contracting)
• Extended payment terms from suppliers
• Factoring (of accounts receivable)
• Etc.

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Financing Your Business

• SOURCES OF GROWTH CAPITAL
• Senior, secured debt
• Usually commercial banks
• Common misperception
• BANKS DONT FINANCE LOSSES !
• Need multiple collateral sources (assets)
• A/R 80,
• Inventory 20-60,
• Fixed assets 50
• Cash flow debt service as small of
  earnings/cash
• PERSONAL GUARANTEES!

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Financing Your Business

• Equity Financing
• Overview
• Terminology
• Alternative Structures
• Recent trends/Outlook

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Financing Your Business

• History of US Venture Capital
• 1920s - DuPont Financing of GM
• 1930s - Rockefellers Back Entrepreneurs
• 1946 - American Research Development (ARD)
• 1950s - Shockley transistor/Fairchild
  Haloid/Xerox
• 1960s - SBIC Private Partnership Proliferation
• 1970-75- Industry shakeout
• 1978 - Boom in Venture Capital
• --20 capital gains tax rate
• --SEC Rule 144 S-18
• -- ERISA Exemption
• 1980s Growth of the Mega fund
• - Bigger Deals, Geographic concentration
• 1990s Bigger Funds, Bigger Deals
• - Record Returns (1999 Vintage, 100 IRR)
• 2000-03 - Serious Slowdown/Troubled
  Portfolios/Industry shakeout
• 2004-05 - Some return to normal. Continued
  move up market
• 2006-07 - Returns decline competition from
  Hedge Funds

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Financing Your Business

• Stages of Venture Capital
• Seed Business plan market validation
  technical feasibility
• Start-up Prototype development non-revenue
  customers company infrastructure
• First Stage Initial Mfg. revenue generation
• Second Stage Shipping , but not profitable
• Third Stage Profitable, need expansion
• Bridge Financing Additional growth prior to
  liquidity event

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Financing Your Business

• Stages of Financing

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Financing Your Business

• Venture Capital Returns ( per yr.)
• Fund Type 1 Yr 3 Yr 5 Yr 10 Yr 20 Yr
  Target
• Early/Seed VC 23.6 6.8 3.1 34.5 20.8 40-100
• Balanced VC 38.0 14.4 9.9 15.1 14.3 30-50
• Later Stage VC 41.4 10.5 8.4 8.3 13.8 25
• All Venture 32.3 10.4 6.7 17.9 16.4 20
• SP 500 10.8 10.7 13.1 4.9 8.1
• NASDAQ 14.2 12.2 17.9 4.8 9.4
• Source Thomson Venture Economics/National
  Venture Capital Association

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Financing Your Business
Mostly later stage 3,416 deals 25.5B
Early Stage Late
25.6B 51,000 deals Mostly early stage
864 Early Stage
312 Seed
Angel Investment source UNH CVR
VC Investment source NVCA/PWC/VE
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Financing Your Business

• Venture Capital is not for most companies.
• Millions of privately-held businesses
• 700,000 new businesses formed annually
• But only 3000-5000 venture financings annually
• Investors seek 10x return in 5 years
• - Very Rare

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Financing Your Business

• Equity Investment, therefore
• Liquidity event is required
• Requires size and growth
• Means the investor behaves like an owner (whose
  goal is to build/sell the company)

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Financing Your Business

• Common Myths
• VCs want majority control
• ownership is determined by valuation
• Other investment terms give control

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Financing Your Business

• Valuation Example
• Year Five Revenue 100M
• Year Five Net Income 10M
• Future Value (15 P/E) 150M
• BPlan Investment Reqd 10M
• VC Ownership 67 (10X)
• Note If Bus. Plan investment required today is
  5M (instead of 10MM),
• -VC Ownership 33

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Financing Your Business

• More on Valuation
• Pre-money/post money
• Investor agrees to invest 250K, but asks for 25
  of the company
• What is the valuation?

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Financing Your Business

• More on Valuation
• Pre-money/post money
• Investor agrees to invest 250K, but asks for 25
  of the company
• What is the valuation?
• Answer 750K (pre-money)

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Financing Your Business

• More on Valuation
• Pre-money/post money
• You value your company at 3MM, and you are
  seeking 1MM investment
• What will the investor(s) own?

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Financing Your Business

• More on Valuation
• Pre-money/post money
• You value your company at 3MM, and you are
  seeking 1MM investment
• What will the investor(s) own?
• Answer 25 (1MM out of 4MM post money)

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Financing Your Business

• Alternative deal structures for Early Stage
  Equity Deals
• Common Stock
• Preferred Stock
• More/less company friendly
• Convertible debt
• --All get described in Term Sheet, then finalized
  in legal documents at Closing.

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Financing Your Business -Term Sheet Discussion

• Terms included
• Representations Warranties
• Positive and negative covenants
• Securities description
• rights responsibilities

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Financing Your Business

• Common stock
• The simplest
• Investors Founders all on the same basis
• Most company favorable
• Little/no protection for the investors
• Votes proportional to shares
• Passive investors
• Proportional treatment in bankruptcy
• Requires agreement on Valuation

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Financing Your Business

• Preferred stock
• Typical of VCs
• Gets first liquidation preference
• Allows for varying degrees of
• Protection
• Control
• Can be several layers Series A, Series B,
• Each with increasing preferences
• Requires agreement on Valuation

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Financing Your Business

• Example Preferred Stock Covenants
• Need 2/3 majority of Investors to
• Issue stock
• Sell or merge
• Declare dividends
• Repurchase stock (except employee)
• Amend By-Laws
• Create a subsidiary
• Incur debt greater than X
• Acquire or dispose of assets greater than Y
• Incur capital expenditure greater than Z

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Financing Your Business

• Convertible debt
• Common for angels
• Technically debt, but intended to become equity
• Delays decision on valuation
• Converts at a discount to future investment
• What if no future investment?

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Financing Your Business

• Recent Trends and Outlook
• VCs shutting down
• Sequoia Venture Fund Sept. 08 presentation
• Preserve capital for existing companies
• No MA exits
• No IPOs
• Their investors (pension funds, etc.) have lost
  big money

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Financing Your Business

• Recent Trends and Outlook
• Angel Investors Not clear
• Likely to be down nationally
• Portfolios got hurt
• Less play money
• Also, Angels have new high risk/high return
  choices
• In the public stock market
• In real estate

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Financing Your Business

• Bottom Line
• Understand the different funding sources.
• Understand where your company is.
• Understand your investors and the implications of
  an equity deal before you start the process.
• Remember that you will all be partners when the
  deal is done.
• The term sheet process is a good free look.
• Involve your advisors early.

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Financing Your Business

• QUESTIONS/DISCUSSION
• David V. Hessler
• David.Hessler_at_htr.org
• 585-214-2445