Financing the firm

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					Financing the firm
   Dr. Steven Walsh
• Every firm needs it
• What is happening today
• Some Nomenclature
• 5 steps in firm development as seen by a
• Types of funding and average placements
• Nightmare examples
• Valuation
         Financing the Firm
• Every business startup needs financing
  – Especially High Tech
• The most important continuous process
• Yet Few high tech entrepreneurs have a
  sharp understanding
• When, Why, How much, What flavor
• Mythology Around High tech
 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
• Do VC funded startups have better
  success rates
  – No on survivability
  – Yes for super success
• High tech needs creativity
• The ability to choose, court and obtain
  financing is critical to the long-term
  survival and growth of “High Tech”
       Types of Financing Options
       “Language of fund acquisition”
     Sources                 Process
•   bridge loans”,            •   pre-seed”,
•   “non-dilutable” equity,   •   “seed”,
•   “customer” financing,     •   “startup”,
•   “sweat equity”,           •   “Mezzanine”,
•   VC funding                •   “first round”
•   “Angel” financing the     •   “Series A” funding
    other professional        •   Placement
    equity options            •   “Squash down”
   High Tech Funding Today
• Funding Stream Vs. Single Placement
  – Every funding choice makes your next funding
    simpler or harder
• Firms today must have a proactive rather
  than reactive equity strategy
• One Process
• Pre-seed – Seed – Startup – Early
  Venture –Late stage venture
• Sources
                 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 funded by self – funded or provided
  by the three F’s; Friends, Family and

• $150,000
            Seed financing
• 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
  Pre seed and seed in the US
• Primarily funded by self or SBIR
• Over $2 billion in SBIR funding
         Start-up financing
• “is provided to companies completing
  product development and initial marketing.
  Companies may be in the process of
  organizing, or they may already be in
  business for one year or less, but 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.”
    Seed and Startup Sources
• Either self financed, funded by individual
  Angel investors, customer financed or
  provided by non-dilutable equity sources .
• firms in these stage are High Tech
  startups with no sales, and which are in
  general eschewed by the Venture Capital
• Funding required is often less than
  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
      Late Stage - Expansion
• 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
• Depending on the stage of financing
  differing equity instruments dominate
  – Equity Investment\
     • Angels Dominate early stage
     • VC and Strategic Partners Later stages
     • Self Financed
  – Government Non-dilutable Equity
     • Pre-seed and seed
              Self Financed
•   3 F’s
•   Debt
•   Non dilutable Equity (SBIR)
•   Customers
           Customer financing

• Many “High Tech Startups” do not think to seek out
  their customers for pre-seed, seed and startup
  – The use of the High Tech firm’s 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
    “Non – Dilute-able” Equity

• The most famous form of non-dilutable 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 up to $850,000
          Debt Instruments
• Traditional
  – Houses, Cars etc
• Semi Traditional
  – Equipment, SBA Loans, Lines of Credit,
• New
  – Credit cards
    External sources of Funding
•   3 F’s
•   Angels
•   VC’s
•   Strategic Partners
                    3 F’s
• Friends, Founders and family members
  – Many firms find that perhaps the highest
    priced form of High tech firm equity
    funding is the three F’s if not in monetary
    terms then certainly along family and
    social ones.
             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
        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
• 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
     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.
                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.
    How should one go about
 developing a Strategic Partner?”
• Like amorous Porcupines?
  – No Shotgun Weddings
  – Proactive Selection
Partner Selection Process
• $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
          Angel Founder
• Jim Von Ehr
• $18.2 billion in 2003, with only 2% of those
  dollars spent in seed or early-stage
• 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
• 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
• How much is the firm worth?
  – It Depends
  – Reverse valuation
  – Sales and Profit Multiples
  – NPV
  – Risk Discounts
  – P/E ratios and market share analysis
            Reverse valuation

• The Dominant form
  – It is a commonly used method by Angels and VC’s
    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

• 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.
    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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