Raising Capital in 2010 or Beg, Borrow and Steal 403 @ the School of Hard Knocks also called Why I hate the word “fundi

1. Raising Capital in 2010orBeg, Borrow and Steal 403@ the School of Hard Knocksalso called Why I hate the word “funding”

2. Getting the Terminology Right • “Funding” is what research a project consumes • It is a matter of academic curiosity • “Capital” is what entrepreneurs need and create • It is a matter of business and wealth creation • “Cash” is what keeps the enterprise alive • It is a matter of life and death

3. Getting the Thinking Right • “Debt” is not the same as “Equity” • “Expenses” are not the same as “Cash Flow” • A key programming language: “Accounting”

4. What’s up with Venture Capital? The V in VC = Vanishing

5. Getting To Angels • It’s about “Math” not “Prayers” • The technical term is “Win-some, Lose some” • “Rule of 2-6-2”: Out of every 10 investments • 2 die completely • 6 are the undead... Zombies... Cash never exits • 2 generate all of our returns • Every entrepreneur thinks they are in the right 2

6. Angels: Time Value of Money Investors have CHOICES about where to put their money Assuming average Time to Exit of 5 years, what are our alternatives? Portfolio MultipleEquivalent Investment Strategy 1x = (1+0%)5 Hoard Cash 1.5x =(1+8%) 5 Secured Debt 2.0x =(1+15%)5 Unsecured Debt 3.0x =(1+25%)5 Pay day loans 4.5x =(1+35%) 5 Other Startups Like You

7. The Basic Math 4.5X 22.5 X Our Expectations = 4.5X 35% Per Year Rate of Return Your Promise = 22.5 X 1.0X Dead Zombies 1X Live Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

8. Entrepreneur Math Average angel deal looking at 20 X exit, so... • IF • I want to keep control of my company (66%) • THEN • 33% of my company needs to be worth > 20X the investment • So 100% needs to be worth > 60X the investment!! • 80% of companies bought by Google were purchased for less than 100 M$ Angels will do this math, even if you don’t Corollary: Why are you better than average?

9. To Close an Angel • Show that our risk is lower than typical • Better than 20% chance of being in the right 20% • (we won’t believe you, but you get extra points for trying) • Or at least demonstrate that you are keenly aware of risks • Explain how their exit will be much sooner • Shrink that exponential function, exponentially • Prove that you understand basic business • Demonstrate a focus on making money for them • Demonstrate knowledge that business is about choices • Connect the dots from cool technology to wealth creation A good business opportunity will attract investors

10. Friends and Family Aren’t Like That • They want you to succeed more than they want to make money • Or maybe they just aren’t any good at math Really, they are buying into YOU... Corollary: If they won’t, who will?

11. YOU: the most important investor • “Skin in the Game”... yours first • If you don’t believe, then I won’t either • “Appetite for Risk”... if you don’t have the stomach, don’t sit at the table • “Risk” and “Reward” enjoy a Karmic balance

12. Banks • Banks only provide you cash for the capital you already have • They convert “Assets” to “Cash Flow” and vice versa • They don’t share your passion or care about your ideals • Banks *ONLY* care about the math Banks are NOT sources of capital

13. Financing • Easiest: Product with Gross Margin of 80% • Customer pays 20% in advance • This is the basis for “just pay S&H” (includes product cost) • Purchase Order Financing, or “factoring” in lingua banka • Unconditional Purchase order is financeable on *THEIR* credit rating • Conditional purchase order is financeable on YOUR ability to convince your investors you can meet the conditions • Services business can be SRED financed • Especially if US sourced revenue

14. EDC: Export Development Canada • “Export Express Credit” • $50,000 unsecured loan, repayable over 2 years • “Export Guarantee” • Provide guarantees to your bank (so your bank will give you more credit) • “Supplier Financing” • Purchase your foreign receivables

15. Government • It takes work... But in most cases you don’t have to pay it back • SR&ED Tax Credits • IRAP • OCE • Regional Development Incentives

16. SR&ED & OITC • Know this program inside and out • Simplistic: ~ 40% of 160% of eligible expenditures • There are lots of rules, but they are clear and easy to follow • You need to actually make the expenditures • You must maintain appropriate records, evidence • Expect to be audited – better safe than sorry • Note: expenditures and cash flow are not the same thing

17. IRAP • Most useful program is “Contribution” agreement • IRAP pays for R&D Salaries (about 60% of project) • Company pays for overheads (about 40%) • You pay your costs, IRAP reimburses a portion, about 60 days AFTER you spend it and send in proof • BUT, it can be difficult for many entrepreneurs • It is a finite resource, heavily over-subscribed • Requires a disciplined business management approach • Need to learn how to speak IRAP • Great program, Fantastic people, Really trying to help • But they are over-worked • Also provide other useful programs • Market research, mentorship, academic-industrial partnering...

18. Regional Initiatives • OCRI • Strong and active entrepreneurship program • Sponsors Lead To Win • Various events • Referrals to Provincial programs (OCE, MARS...) • Grass Roots Initiatives • The Ottawa Network, DemoCamp, TeamCamp... The Good news: Opportunity Cost trending to  $0

19. Employees • Slavery was outlawed long ago, but... ... Sweat Equity is part of the package • Innovative “on spec” or “rev-share” deals • Directors, Executives and Officers are Special • But... Get appropriate legal advice

20. Suppliers • Take As Long As Possible to Pay • They often have more patience than you think • If you succeed, you’ll buy more • It’s in their interest that you survive • Cash is our most precious resource • Count cash in terms of Door-Open-Days

21. Customers • The only source of capital you don’t eventually have to pay back • Customers are the folks who pay you • Avoid Whiners (won’t pay) • Differentiate from Users (don’t pay) • If you can’t find at least one Customer willing to put it in writing, you have to wonder if any exist at all

22. Summary: Sources of Capital • Venture Capital • Angel Capital • Friends and Family • Banks • Government • Employees • Suppliers • Customers

23. Financial Engineering • A few illustrations in the art of the possible • Makes many simplifying assumptions • Get professional advice (legal, accounting) • Start with the typical Founder Scenario • Work for a year from your kitchen for no salary • 1 year later... What do you have?

24. A Tale of Two Founders A: Works for a year “for free” B: Personally Begs, Borrows or Steals $100,000 • Lends it to their company • Company uses this stash of cash to pay B a salary+benefits of $100,000 • Company pays source deductions of about $35,000 • (B takes home about $65,000 after tax, which gets returned to whence it came) • Company eventually receives SRED Tax Credit of $43,000 • (company repays B $43,000 of the $100,000 loan principal, which also goes back to whence it came) • When The Dust Settles, both A and B have 0 net cash, but • Founder B shows a $57,000 loan to the company (skin in the game!!) • which can be offset against future income, tax free even if the company fails • Founder B has EI, CPP benefits • Founder B isn’t “unemployed” to the rest of the world Your Mileage May Vary, Some Restrictions Apply

25. Three Founders, IRAP+SRED C: Approved for $100,000 IRAP program and begs, borrows or steals $100,000 • Lends it to their company (showing IRAP sufficient cash to execute the program) • Company pays salary+benefits of $100,000 • Company pays source deductions of about $35,000 • (C takes home about $65,000, which gets returned to whence it came) • Along the way, IRAP pays the company $60,000 • (company repays C $60K of the $100K oan, $35K goes to retire the loan, leaving $25K free cash) • Eventually receive SRED Tax Credit of about $16K (SRED is reduced by contributions etc.) • (company repays C another $16K of the loan principal, total $41K free cash) • When The Dust Settles, C has net $41K after-tax cash • (equivalent to 60K/year salary) • Founder C also holds a $24,000 loan to the company which can be offset against future income, tax free even if the company fails • Founder C has EI, CPP benefits • Founder C is employed at a better rate than flipping burgers • Again, Your Mileage May Vary, Some Restrictions Apply Put it All Together with an Angel Investment

26. IRAP & SRED & Angel & Bank D: Approved for $100K IRAP program, $30K Equity from Angel, $70K Personally Secured Bank Loan • Company starts with 100K in bank • Company pays salary+benefits of $100K • Company pays source deductions of about $35K • (D takes home about $65,000) • Along the way, IRAP pays the company $60,000 • (company repays bank $60,000 of the $70,000 loan) • Eventually receive SRED Tax Credit of about $16,000 (SRED is reduced by contributions etc.) • company repays bank remaining $10,000 of the loan principal • company has $6,000 left over, but it will also owe some interest • When The Dust Settles, D has taken home a good salary, AND • Angel investor gets $100K worth of work done for $30K investment • Company has established a good credit rating Add revenue, and even a break-even business is profitable