ESSAM 2011 Startup Financing

1. ESSAM 2011Startup Financing Professor Stephen Lawrence Leeds School of Business University of Colorado at Boulder

2. Agenda • Sources of Funding • Bootstrapping • Debt • Government funding • Non-traditional • Equity funding • Deal structure & term sheets • Valuation

3. How much money do we need? • Review cash flow statements • Find periods with negative cash balances • Schedule cash infusion(s) to eliminate negative balances • Add safety cushion (~10-25%) • Develop funding strategy • Eg, staged funding “tranches”

4. Startup Financing Cycle Cash from operations! http://enwikipediaorg/wiki/Venture_capital

5. Sources of Funds • Bootstrapping • Debt • Government funding • Non-traditional • Equity funding

6. LONG- SHORT- TOTAL TERM TERM COUNTRY EQUITY DEBT DEBT DEBT United Kingdom 68.3% 31.7% N/A N/A United States 48.4% 51.6% 26.8% 24.8% Canada 47.5% 52.5% 30.2% 22.7% Germany 39.7% 60.3% 15.6% 44.7% France 38.8% 61.2% 23.5% 43.0% Japan 33.7% 66.3% 23.3% 43.0% Italy 23.5% 76.5% 24.2% 52.3% Source: Scott Besley and Eugene F. Brigham, 2005. Essentials of Managerial Finance, 13th Ed. Global Capital Structures (1995)

7. 1. Bootstrapping Start-up without much capital “Pick yourself up by your bootstraps”

8. 0 What is Bootstrapping? • “Launching ventures with modest personal funds” • Bhide • Using Other People’s Resources (OPR) • Timmons • Scrooge mode

9. 0 Bootstrapping Examples • Make vs. buy (do it yourself) • Hire temps/subcontractors vs. employees • Employee benefits • Modest office and location vs. prestige • Virtual offices • Used furniture and equipment vs. new • PR (public relations) vs. advertising

10. Sources for Internal Funds • Profits • Sale of assets and little-used assets • Working capital reduction • Extended or discounted payment terms – suppliers • Collecting bills (accounts receivable) more quickly • Short-term internal source of funds: • Reducing short-term assets: inventory, cash, and other working-capital items • Extended payment terms from suppliers

11. 0 Bootstrapping Benefits • Requires less capital • Lowers risk • Improves decision making • Enhances flexibility • Focus on profitability • Investors love it • Establishes culture A Bhide, Bootstrap Finance, HBR

12. 0 Greatest Source of Money? Cash from Sales!

13. 2 Debt

14. Sources of Debt Funding • Credit cards • Bank loans • Typically insist on a secured loans • Second mortgage on house or property • Use equipment & facilities to secure loan • Revolving lines of credit • Investment banks • Less “expensive” than equity • Disadvantage: Must be paid regularly

15. 3 Government Funding

16. Types of Government Assistance • Direct loans & subsidies • Research grants • Tax benefits • Invest tax reductions • Production tax reductions • Support for hiring new employees • Employee training / retraining • Et cetera, et cetera …

17. 4 Non-Traditional Funding

18. Nontraditional Funding Sources • Customers • Development • Prepay • Co-invest • Trade credit (vendor terms & conditions) • Leasing vs buying • Factoring receivables (loans against invoices) • Loans secured by inventory

19. 5 Equity Funding

20. Equity Funding • Most “expensive” form of financing! • Give up ownership (equity) • Private Placement • Friends, family, and fools • Well to-do investors • Angels • “Professional” investors working alone or in syndicates • Colorado Capital Alliance (wwwanglecapitalcom) • Venture Capitalists

21. 5A. Private Placement • Funding from private investors, also called angels (family or friends or wealthy individuals) • Types of investors • Investor can influence nature and direction of the business to some extent • May be involved in the business operation • Entrepreneur needs to consider degree of involvement • Private offerings • A formalized method for obtaining funds from private investors • Faster and less costly

22. Family and Friends • Likely to invest due to relationship with entrepreneur • Advantage: easy to obtain money; more patient than other investors • Disadvantage: direct input into operations of venture • A formal agreement must be written to include: • Amount of money involved • Terms of the money • Rights and responsibilities of the investor • What happens if the business fails • Entrepreneur must consider impact on personal relationship

23. 5B. Angels – Informal Risk Capital • Consists of a virtually invisible group of wealthy investors (business angels) • Often will form syndicates • Investments range between $10,000 to $2,000,000 • Provide funding, especially in start-up (first-stage) financing • Contains the largest pool of risk capital in the United States

24. 5C. Venture Capital • A professionally managed pool of equity capital • A long-term investment discipline, usually occurring over a five-year period • Found in the: • Creation of early-stage companies • Expansion and revitalization of existing businesses • Financing of leveraged buyouts of existing divisions of major corporations or privately owned businesses • Venture capitalist takes an equity participation in each of the investments

25. Venture Capital Criteria • VC Firm Objective • Generation of long-term capital appreciation through debt and equity investments • Criteria for committing to venture: • Strong management team • Product and/or market opportunity must be unique • Business opportunity must show significant capital appreciation

26. Valuation http://wwwguayacanorg

27. Company Valuation Factors • Economic outlook- general and industry • Comparative data • Book (net) value • Future earning capacity • Dividend-paying capacity • Assess goodwill/intangibles • Previous sale of stock • Market value of similar companies’ stock

28. Seed capital 80 to 100% Startup financing 50 to 70% First-stage financing 40 to 60% Second-stage financing 30 to 50% Bridge financing 20 to 35% Restart financing variable Equity Discount Rates

29. Factors Affecting Discount Rates Cash Flow Adjustment Total Discount Rate Risk of failurepremium Value ofVC advice Value Add Investmentnot liquid Liquidity Justifiable Discount Rate Marketsensitivity Systematic Risk Risk-freeinvestment Base Rate Seed Stage 1 Stage 2 Bridge IPO Sahlman, A Method for Valuing High-Risk, Long-Term Investments, teaching note, HBS 9-288-006

30. Team Assignment • How will you fund your venture? • About how much money will you need? • How big will your business become? • What are your long-term goals for your venture? • Hold and operate? • Go public? • Sell out? • Others?

31. ESSAM 2010Startup Financing Professor Stephen Lawrence Leeds School of Business University of Colorado at Boulder

32. EXTRA Slides

33. 0 Bootstrapping – Capital Benefits • Need less capital • Reduces financial exposure • Reduces equity dilution • Reduces risk • Obsolescence • Lower sunk costs • Investor's love it • Proves concept and management team • Reduces risk

34. 0 Bootstrapping – Flexibility Benefits • Fluctuating conditions and uncertainty • Difficulty in predicting what resources are needed • Make changes quickly • Permits strategic experiments • Cost of making a mistake is minimized • Mistakes less likely to be fatal • Inexperienced entrepreneurs can screw-up • Don’t have the pressure of high growth

35. 0 Bootstrapping – Problem Solving • Accelerates problem identification • Reveals hidden problems (Like zero inventory in JIT) • Forces management to solve them • Focus is on sales and profits • Price for profitability • Reduces costs • Lower fixed costs • Higher variable costs, but high Gross Profit Margin solves • Lower break-even point • Establishes a problem-solving culture