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
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
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?
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
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
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
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
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
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
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
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
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
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
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)
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
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
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
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
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
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?
Dragonfly Should the Thompsons file for bankruptcy?