1. On Bootstrapping MGT 709 New Venture Creation

2. Agenda  Note on Attracting Stakeholders  Adams  Bankruptcy  NanoGene  Dragonfly

3. Adams On Bootstrapping  Raise the right amount of capital at the right stage of development  Market risk is higher than technical risk (in IT at least)  The risk you will launch a product and point it in the wrong direction  Higher risk means less likely to get cash  Get the right product to the right market with a reasonable amount of money

4. Why raising too much money is a problem?  Company becomes output-oriented not execution oriented  Temptation to spend, spend, spend  My experience at Fastpac  Only tangible progress towards proving the business model counts  Ownership becomes diluted  High risk means low valuation  Employees not as motivated  Second round investors less interested

5. Alternative  Value inflection points = execution milestones  Raise new finance only after you pass a milestone  Raise only what you need to get to the next milestone  Building infrastructure is never validating the market  Get infrastructure done as quickly as possible – use pre- arranged deals or outsource  How long would it take you to find some reputable and economical people to do tax, banking, payroll, and legal services in Las Vegas?

6. The Big Two  #1 Market validation  See earlier lecture  #2 Develop a profitable business model  Is demand sufficient to generate profits?  Focus and speed help here  Both these are “must-dos” to raise seed capital

7. Other Milestones  Recruit senior executives and key advisors  People willing to bet their reputations and careers on the opportunity  Hire quality managers and individual contributors  Predict up front who you will need to hire and when – quarter by quarter  The team is what enables you to execute  Product evolution:  prototype and develop the product  Sign on brand name customers – ultimate validation  Establish partnerships  Line up investors  Lead, strategic, other

8. Some Big Rules  Big rule #1: NEVER RUN OUT OF CASH  things will cost more than you think  Big Rule #2: Everything will take TWICE as long as you think  Concept of the Virtuous Circle

9. Attracting Stakeholders  All stakeholders take a risk in supporting a new venture  Investors, employees, suppliers, customers  Need additional inducements or may not participate at all  Risk depends on the irreversibility of the investment  Specific investments are more risky, sunk costs  Make fungible investments

10. Reduce asset specificity  Reusable, off the shelf inputs  Reduces supplier risk  Reduces employee training risk  Reduces customer investment in learning, search, and adaptation  Problem is that these inputs can be easily imitated and therefore not source of CA  Make specific investments in area of greatest payoff  Undertake phased development

11. Avoid the risk averse  Select stakeholders who are the most willing to and capable of bearing risk  Diversified portfolios  Investors, suppliers, buyers  Seek those most experienced with bearing risk  Investors, employees, suppliers, buyers  “Bell cows” – visionaries whose participation raises the comfort level of others  Those with excess capacity  Employees, suppliers, distributors, investors  Cultivate risk seekers  Employees, investors, customers

12. Convincing Stakeholders  Attributes  Enthusiasm, belief in product, reliability, perseverance  Phelan and Alder study  Ham and Egging  Everyone else is on board or almost on board  Ask for small increments of commitment and leverage that to the next stakeholder  Basic sales skills  Develop a decision schedule, know what you need, anticipate objections, handle advisors, follow up

13. Bankruptcy  The result of running out of cash to meet legal obligations!  Chapter 7 – basic liquidation  Chapter 11 – reorganization  Chapter 13 – personal debt adjustment  Personal and business causes  Voluntary or involuntary  No need to be insolvent – projected insolvency  Chapter 11 good for dealing with potential tort liability

14. Filing for Bankruptcy  Voluntary - Pay the filing fee at the local US district court  Involuntary  Three or more creditors whose claims exceed $x OR one or more creditors if <12 creditors  No need to demonstrate inability to pay just inability to pay on time  Sanctions for frivolous applications  Involuntary petitions are rare

15. Chapter 7  Debtor’s duties  File a list of creditors, assets and liabilities  Surrender non-exempt property and records  Appear at hearings, attend meetings, cooperate  Duties of trustee:  Trustee initially interim then elected  Must expeditiously reduce non-exempt assets to cash  Examine the validity of all claims  Provide reports  Exemptions:  Interest in a residence (homestead exemption)  A motor vehicle, some furnishings, jewelry, tools, life insurance, health aids, pensions and benefits, criminal compensation

16. Priority  Secured creditors  Priority claimants  Wages, trustee expenses,  General unsecured creditors  Discharge from all debts then occurs  Excludes child support, alimony, certain taxes, student loans, criminal damages  Only once every 8 years (under new law)  A creditor cannot enforce a discharged debt (except secured debts)

17. Chapter 11  Retain assets but pay some portion of future income to creditors  More value as a going concern than liquidated  Voluntary or involuntary  Court appoints committee of unsecured creditors (usually seven largest) to act as board  Fiduciary duty to other creditors  Owner normally continues to run business but trustee may be appointed  The plan  Owner has 120 days to file a plan, 60 further days to negotiate  Any creditor may file a plan after this “exclusivity” period  Plan must show how classes of creditors will be treated  Court must approve plan but must be “fair and equitable”  Dissenting creditors must also be protected

18. Chapter 13  Chapter 11 for individuals  Not means tested (like Chapter 7 under new rules)  Can wipe out some taxes and tort claims  Five year repayment plan  Discharge after plan followed  Plan must be approved by court  Every 2 years (4 years after Chapter 7 or 11)  Can’t have wages garnished or law suits for plan period

19. Negotiations  Different classes will have different interests  Different classes of creditors may exchange quicker resolution for less money  Debtor tools  Opportunity cost of ceasing operation on productive assets (e.g. finding a new tenant)  Cost of litigation  Continued operation more lucrative than liquidation  Creditor tools  Risk of criminal action, personal guarantees, right to file a plan after exclusivity period, alternatives to debtor’s scenarios

20. Ways to avoid involuntary bankruptcy  Have more than 12 creditors  Have no 3 creditors’ claims exceed $x  Maximize exempt assets  Avoid fraudulent conveyance  Trustees can recover preferential payments to certain creditors (normally those within 90 days of filing, or one year to insiders)  “Ordinary course of business” payments are exempt

21. Recent changes to bankruptcy law (Oct, 2005)  A means test for chapter 7 eligibility based on the debtor’s income versus the state median income  Mandatory credit counseling  Mandatory debtor education  Cash advances and luxury purchases are non- dischargeable  New homestead exemption rules  no moving to a homestead state, $125K equity cap  A new rule requiring consumers filing chapter 7 to wait eight years instead of six to file again  Dismissal of petitions for failure to provide a certificate of credit counseling  Increased reporting requirements for payments from employers for 60 days before the bankruptcy filing and a statement of monthly net income

22. NanoGene  How should the company determine compensation and equity?  Should they hire Paige Miller  for what equity/compensation?  What should the new company culture be?

23. Dragonfly  Should the Thompsons file for bankruptcy?