Presentation on theme: "Financing Your Business Presented by: David Hessler October 17, 2006 GBA 491."— Presentation transcript:
Financing Your Business Presented by: David Hessler October 17, 2006 GBA 491
Financing Your Business Outline: –Background –Hessler background/biases –Sources F, F & F Grants and Debt Seed Equity Venture Capital –Questions?
Financing Your Business Why Financing? –Seems obvious, but not necessarily –Integral part of the plan for the business (and Business Plan) –Varies by type of business
Financing Your Business How much spending is necessary/desirable before cash flow breakeven? –Financing should be a MEANS to an end, not an END in itself.
Financing Your Business David Hessler: –Technology entrepreneur –$ from/to friends and family –Past guarantor of serious debt –Financed by Angels –Ran venture fund; successful Angel investor Closed many debt & equity deals –BEEN ON BOTH SIDES OF THE DEAL
Financing Your Business Sources of Growth Capital –Personal assets –Company balance sheet –Grants –Loans –Equity –Strategic Alliances/Licensing
Financing Your Business SOURCES OF GROWTH CAPITAL Personal Assets: –There IS a level below which you cannot start a company –Need money to raise money Staying power Responsibilities/need for current income –Part of this is short term salary expectations.
Financing Your Business SOURCES OF GROWTH CAPITAL Trade debt – accounts payable Positive float can often be negotiated with vendors/customers A. Pre-payments B. Progress payments (Govt contracting) C. Extended payment terms from suppliers In hopes of future business For equity (?) D. Factoring
Financing Your Business SOURCES OF GROWTH CAPITAL For technology start-ups, grants can be key 1.Small Business Innovation Research (SBIR) 2.Cooperative Research & Development Agreement (CRADA) 3.Local government (few)
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
Financing Your Business SOURCES OF GROWTH CAPITAL Senior, secured debt (Contd) –Additional collateral / common issue: Personal guarantee 1.(Almost) always required 2.Considered a show-of-faith by borrower 3.All 20% owners (?) 4.Joint and several 5.Important to equity investors as well 6.Can be reduced over time
Financing Your Business SOURCES OF GROWTH CAPITAL Senior, secured debt (continued) Many costs beside interest rate Usually includes difficult covenants Profitability Coverage ratio Prohibited borrowing Liquidity UCC Filings SBA Loans
Financing Your Business SOURCES OF GROWTH CAPITAL Junior secured debt Sometimes used when collateral can be segregated Used for unique asset Vendor financing Inter-creditor agreements
Financing Your Business SOURCES OF GROWTH CAPITAL Unsecured (subordinated) debt Varies widely in terms, prices covenants, etc. A. Used when bank rules cannot be met B. Almost always more expensive C. May include an equity kicker D. Different personality 1.Gunslinger 2.Dealmaker 3.Tough E. Inter-creditor (?) F. May trigger bank covenants
Financing Your Business SOURCES OF GROWTH CAPITAL Convertible, subordinated debt Varies widely in terms, prices & covenants A. Often really an equity investment, but with extra protection (liquidation preference) for the investor B. Key features 1. Term 2. Interest – rate, timing 3. Conversion price (to what Security?) 4. With, without detachable equity feature C. Terms are (usually) part of the Security
Financing Your Business SOURCES OF GROWTH CAPITAL Convertible Preferred stock Senior rights in liquidation, AND… A. Security of choice for VCs B. Always convertible to Common (VC version) C. Allows for numerous special terms D. Can be issued in multiple classes (A round, B round, etc.) Common stock Typically held by founders, friends-and-family, etc.
Financing Your Business Venture Capital: Part of the larger asset class of private equity Definition: Money provided by professionals who invest alongside management in rapidly growing companies
Financing Your Business –History 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+ - Serious Slowdown/Troubled Portfolios 2004-06 - Coming Back to Normal (?)
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
Financing Your Business Venture Economics (Example): –$300M Fund Raised from: Pension Funds Endowments Foundations Corporations Individuals
Financing Your Business Venture Economics (Example): –Managed by ten principals –Annual Fee: 2.5%, ($7.5 Million/yr.) Pays office staff, travel, principal salaries, etc. –Returns: 5X growth over 5 yrs: - $300M becomes $1.5 B (35-40%) - Gain: $1.2 B - VC Team gets 20% $240M (split 10 ways)
Financing Your Business Common Myths: –VCs want majority control –Founders/owners get fired
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
Financing Your Business Equity Investment, therefore: – Liquidity event is required – Requires size and growth –Means the investor behaves like an owner
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) If B. Plan investment required today is $5M, VC Ownership: 33%
Financing Your Business Why not (institutional) Venture Capital? Small deals cannot attract venture capital: - Financial capital has grown faster than human capital - VC requires intense management (Board seat) - Each VC can only do five boards - With $300M fund, 10 principals, each deal is $6M (Minimum)
Financing Your Business The good news: The rise of angel investment: Institutional: $22.13B to 2239 companies $9.9M/deal Angel: $20 B to 40,000 +/- companies $500K/deal
Financing Your Business -Term Sheet Discussion The Term Sheet 1.Shorthand description of the terms of a proposed investment 2.Delays incurring legal costs until terms are agreed Can be more or less company or investor friendly
Financing Your Business -Term Sheet Discussion Terms included: Representations & Warranties Positive and negative covenants Securities description –- rights & responsibilities
Financing Your Business - Term Sheet Discussion The mechanics: Three page cover letter Four page security description
Financing Your Business - Term Sheet Discussion Why required? Investors will (usually) be minority investors They do not control day-to-day actions Key management actions can ruin the investment The goal is not control of the company, it is protection of the investment!
Financing Your Business -Term Sheet Discussion Key Terms: Series A Redeemable, Convertible, Participating Preferred Stock How many shares; how many $$ Investors: individually or via a single purpose legal entity
Financing Your Business -Term Sheet Discussion Key Terms: Conditions of closing: Business Plan Showing… Receipt of info requested… Declaration of capitalization Employment agreements (salary) Shareholder notes converted Definitive docs…, …no material change…
Financing Your Business -Term Sheet Discussion Key Terms: Company pays closing costs (no cap) Exclusivity/no shop 30 days (??) Must terminate other deal discussions Must disclose other offers to us Company representations No breach of any other contract No brokers fees
Financing Your Business -Term Sheet Discussion Key Terms: Valuation – spells this out several different ways Fully diluted… (including provision for options) Pre-money total Per share price Dividends – provision for: None Cumulative/Non-Cumulative Accrued or cash
Financing Your Business -Term Sheet Discussion Key Terms: Liquidation preference A specified amount first, PLUS Continue to participate with the Common Series A Investors get to determine if a sale/merger is a liquidation Mandatory conversion (to Common) 2/3 majority want it IPO of at least $XXX
Financing Your Business -Term Sheet Discussion Key Terms: Redemption at Investor option Specified return After five years With payment terms Voting Rights On an as-converted basis, except As a class on matters of corporate control
Financing Your Business -Term Sheet Discussion Key Terms: Board of Directors Series A investors specify size of the Board and number of Series A members Audit and Compensation committees with independent directors Dilution protection – full ratchet
Financing Your Business -Term Sheet Discussion Key Terms : Information rights Financial statements Annual audited; monthly and quarterly unaudited Annual operating plan 30 days before fiscal year Standard inspection and visitation rights Two Demand Registration rights after IPO and unlimited Piggyback Registration rights Pre-emptive rights (to hold % ownership constant)
Financing Your Business -Term Sheet Discussion Covenants: Need 2/3 majority of Investors to: Issue stock; Declare dividends; Repurchase stock (except employee); Incur debt greater than $X; Acquire or dispose of assets greater than $Y; Incur capital expenditure greater than $Z Sell or merge
Financing Your Business -Term Sheet Discussion Key Terms (2/3 Majority): Transact with related parties; Amend By-Laws; Create a subsidiary; Change the business or enter a new business Key Man Life insurance on….
Financing Your Business -Term Sheet Discussion Conclusions: Sounds difficult, but… There are reasons for the demands Need alignment of goals and…. Everything is negotiable!