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Knowing Your Funding Source - Presented by Jeevan Padiyar and Eric Baum

  1. K N O W I N G Y O U R F U N D I N G S O U R C E U N D E R S T A N D I N G Y O U R I N V E S T O R F A C I L I T A T E D B Y : E R I C B A U M – S O L I D E A J E E V A N P A D I Y A R – T H E C O N N E C T O R S G R O U P G U E S T S P E A K E R : J O E D A N I E L S – F U L B R I G H T & J A W O R S K I Course 2
  2. Agenda 2 ◊ Introduction ◊ Key Providers of Venture Capital ◊ The Financing Lifecycle ◊ Understanding Investor Types And Requirements ◊ Planning for Funding ◊ Managing Investor Relations ◊ Ticking Time Bombs of a Term Sheet – Guest Speaker
  3. Putting the Pieces Together 3 *How to stand out in the eyes of an Angel* *How to speak the language and get what you want* *Getting into the head of an investor* *How to transform your idea into a reality* *How to assemble and benefit from a team of high-powered experts* *Finding funding in hard to reach places* *How to have your cake and share it too* 1 3
  4. Introducing the Players 4 FFF Angel Venture Capital (VC) Strategic Partner “Friends, Family, and Fools” who provide individual contributions for seed funding Fills the gap in financing between FFF and venture capital; high net worth individuals where investment can range from a few thousand dollars to a million dollars Type of private equity capital provided to early-stage, high-potential growth companies; usually do not consider investments under $1-2 million Companies that make investments for strategic benefit or alignment; in some instances, subsidiaries of large corporations that are established to make venture capital investments (Corporate VCs) Bank Cheaper source of capital than angel investors, but usually not available for early-stage ventures
  5. The Financing Life Cycle 5 Revenue Time FFF, Angels Seed Capital: Low level financing needed to prove a new idea, design prototype, etc 1st Round: Early sales, marketing, & manufacturing funds 2nd Round: Working capital for companies with sales growth, but have usually not reach break even 3rd Round: Typically for market expansion, acquisition, product dev, etc. Mezzanine: Intended to finance the “going public” process IPO Early Stage Later Stage (Expansion) Angels, VCs VCs, Strategic Partners, Acquisitions / Mergers Valley of Death Break Even
  6. Getting Up Close and Personal 6 FFF “Love Money” Angel “Dumb Money” VC “Blood Money” Strategic Partner Investment Considerations Personal / Relationship-Driven Emotion over Numbers Technical over Emotion Strategic Fit / Portfolio Value Valuation Determination Art Art & Science Mostly Science Revenue Multiple Level of Funding Generally < $500K for the round Generally $25K - $250K; usually < $1M for the round Generally $1M – $5M; can be greater Generally > $5M; varies Funding Source Own Money Own Money Others’ money (LPs) Company’s’ money Time to Close Quickly Few Weeks / Months Longer Process Longest Process Term Sheet Driven By Entrepreneur Entrepreneur usually determines offering round terms, but super angels may play more active role VCs dictate terms and prepare term sheet (generally take 30-40% of ownership) Terms negotiated between company and strategic partner Interesting Stats: • Angel investment accounts in total for almost as much money invested annually as all venture capital funds combined, but into more than ten times as many companies ($26 billion vs. $30.69 billion in the US in 2007, into 57,000 companies vs. 3,918 companies). • Of the US companies that received angel funding in 2007, the average capital raised was about $450,000.
  7. Finding the Right Fit 7 FFF Angel VC Strategic Partner • Easy to find • More lenient due diligence / required documentation • Immediate source of funds • More emphasis on personal relationship / credibility • Limited oversight • Can fill investment gap between FFF and VC • Moderate due diligence requirements • Often more flexible / lenient terms • More permissive investors • Can provide valuable management advice and contacts • Shorter process to close funds • Can provide large sums of financing (i.e., >$1M) • Extensive network of contacts and alliances • Provide strategic, financial, and operational advice • Can help identify and facilitate acquisition / IPOs • Makes it easier to secure further funding • Ability to access / leverage new capabilities and resources • Established assets • Shared risk • Name brand recognition and credibility • Potentially built-in customer base • Difficult to raise larger sums of money • Mixes business and personal life • May not be as well connected or value- adding as other types • May not be accredited investors • Harder to find; meet through referrals, conferences, etc. • Limited capital capacity • No national reputation to leverage • Less follow-on money compared to institutional sources • Can be a long and complex process to secure a deal • Dictate harder terms and pricing • Usually want greater ownership stake or control of business; likely to want to influence strategic direction • Sacrifice of some control and flexibility (e.g. exclusivity) • Business strategy / direction may have to change to align with partner • Success depends on ability to develop and manage relationship AdvantagesDisadvantages
  8. Managing Expectations 8 Risks Calculated Risks FFF Angel VC Strategic Partner Round Invested (Typically) Pre-Seed Seed Round 1 and after Round 2-3 Relative Investment Risk Highest Lowest Pre-Money Valuation <$1M $1M - $3M >$5M >$10M Typical Return Expectation Varies greatly based on structure (e.g., equity vs. debt); equity can typically yield greater than 25X 20X+ 15-20X+ 4-6X
  9. What it Takes to Get to the Table 9 FFF Angel VC Strategic Partner Business Concept Executive Summary High Level Business Model Realistic Exit Strategy Cap Table & Offering Docs Detailed Business Plan Prior Capital Investment Management Team vs. Entrepreneur Board Seat Prototype Established Path to Monetization Established Product with Traction History of Sales Growth TypicalRequirements As you move across the spectrum of investor type, there are increasing requirements placed on entrepreneurs to secure funding.
  10. It’s a Balancing Act 10 CostofCapital Funding Round Earlier funding rounds are more expensive than later rounds; cost of capital decreases as company matures A If You Raise Too Much • Start-up tend to overspend when they have extra cash • Leads to complacency / inefficiency • Increased dilution for entrepreneur and investors BIf You Raise Too Little • Management attention continually focuses on funding instead of the business • Risk of future down rounds if capital needs become critical • Could run out of cash “When in doubt, take a little more”
  11. Getting It Right 11 1 When financing, don’t think about just the current round. What will your capital needs be over the next 3-5 years? What capital do you require if you hit your milestones and sales targets? What capital would you need / want if you didn’t hit the targets expected? How does each setback or milestone achieved affect your financing roadmap? Planning funding rounds is not a series of one-off activities - successful entrepreneurs develop a 3-5 year funding plan or roadmap to avoid major pitfalls. 2 Look out for the warning signs! Have you thought about the upfront inventory cost if you start growing quickly? Have you modeled scaling up for success (people, system, office space, operations)? Do you have adequate operating cash flow to cover AR cycles? If the macro environment or your business softens more than expected, do you have enough contingency built in? It’s OK to be wrong, but need to make a good faith effort to not mislead investors.
  12. 12 1 Make a commitment to connecting with investors and keeping them in the loop • Publish at least a quarterly status report highlight key accomplishments, upcoming milestones, funding status, issues / challenges, financial metrics • Conduct a quarterly investor conference call to discuss key events and Q/A • Forward relevant industry articles, press, etc. • Be accessible and responsive to questions (during good times and bad) Your investors can be your champion or cheerleader – enable them to help you, not hinder. 2 Communicate your unique selling proposition – the “investable idea” • Have meaningful and credible investment messages that sell benefits, not just features • Remind investors why they should put money in your idea vs. all the other options out there 3 Remember it is not about “stock promotion” - investor confidence is hard won, but easily lost • Don’t over-promise and under-deliver • Manage expectations appropriately BUT Managing the Investor Relationship
  13. Managing the Investor Relationship 13 5 Focus on building your reputation and credibility • What investors think of you – whether they believe in you and will give you the benefit of the doubt – can be critical to managing adverse situations • CGE&Y study found that intangible assets such as brand and reputation affects up to 35% of a company’s valuation 4 Do your investor research • Understand what your investors care about and their different goals, styles, and preferences • Understand the gap between perception and reality – what investors really think about you vs. what you believe they think about you • Know the market sentiment on key issues affecting valuation Investors can be fickle! Long-term success depends on addressing investor concerns and building confidence in your company. REMEMBER: 6 Know how to protect yourself • Beware of repurchase rights • Using right of first refusal can be a strategic asset
  14. “Term Sheet Ticking Time Bombs” Guest Speaker: Joe Daniels Fulbright & Jaworski 14 Avoiding Legal Pitfalls
  15. T H A N K Y O U 15 Questions