Keys to Financing the New Venture

1. Keys to Financing the New Venture Alec Johnson, Ph.D. University of St. Thomas

2. The Problem • “Small business management is cash flow management.” Dr. Robert Pricer, Weinert Applied Ventures Program, Unviersity of Wisconsin • “Cash is King.” Dave Stassen, Partner, St. Paul Venture Capital • “You’re not an entrepreneur until you’ve written payroll checks on Friday and spent the weekend collecting the cash to cover them.” Keith Streckenbach, founder and CEO of PharmacyOneSouce.com

3. Entrepreneurial Finance vs. Corporate Finance • Differences from Corporate Finance • Diversification and Value • Involvement of Investors • Harvesting

4. The Problem - Objectives Entrepreneur Investor Minimize Cost Maximize Return Maintain Control Maximize Ownership Minimize Involvement Minimize Risk

5. The Problem - Management • What is the Ultimate Task of an Entrepreneur? • Job #1 is Risk Management • Largest risk is Financial and question becomes “How?”

6. The Problem - Structure • Type, i.e. Do I use debt, equity or some combination. • Timing, i.e. When do I need it? • Amount, i.e. How much do I need?

7. Debt Represents a fixed cost Represents more risk Cheapest type of outside financing Equity No interest payment No obligation to repay Most Expensive type of financing Type – Two General Classes

8. Sources of Debt Financing • Friends and Family • Banks • Leasing • Factoring

9. Bank Financing • Commercial banks are the largest source of external capital for growing firms. • Problems: • Lack of collateral • Lack of earnings history

10. Leasing • Often used technique to acquiring assets without having to purchase them. • Two types of Leases: • Operating Lease • Capital Lease

11. Factoring • Factors buy company’s accounts receivables at a discount. • Recall R&R case. • Gets cash to company quickly, but must have cost of factor available in profit margin.

12. Equity • When to use equity? • Every company has some form of equity. • Founders raise equity when: • there is no collateral to secure debt • insufficient cash flow to secure debt • required growth capital more than banks can provide.

13. Types of Equity Instruments • Typically used in small business placements: • Common Stock • Preferred Stock

14. Types of Equity Instruments • Common Stock Characteristics: • Most common form of issuance • Last in liquidation = ? • Represents Entire ownership of firm.

15. Types of Equity Instruments • Preferred Stock Characteristics: • Pays dividends • Preference in liquidation

16. Types of Equity Instruments • Preferred Stock Characteristics: • Looks a lot like Debt! • Used by Venture Capitalists to gain position in liquidity event while minimizing risk.

17. Types of Equity Investors • Angel Investors • Venture Capitalists

18. Types of Equity Investors: Angels • Typical Angel Investor • Private individual (not an institutional fund) • Age: 47 –54 years • Gender: Male • Net Worth: $1,000,000 +

19. Types of Equity Investors: Angels • Typical Angel Investor • Education: Bachelors or greater • Average Investment: $59,000 • Preferred Stage: Start-up (56%) and infant or young (24%)

20. Types of Equity Investors: Angels • Typical Angel Investor • Required Rate of Return: 15% - 45% • Length of Investment 3 – 10 years • “Patient Money”

21. Types of Equity Investors: Venture Capital • Typical Venture Capital Firms • Institutional Firm • Raises money from various sources, including Angels • Creates “pool” of capital, a fund. • Develops portfolio of firms under management

22. Types of Equity Investors: Venture Capital • Typical Venture Capital Firms • Average Investment: $1 M to $50 M per investment. • Industries: High Growth, early or later stages • Services Provided: None to direct management decision making and board control. • Required Rate of Return: 10X in 3-5 years. • Typically invest using Preferred Stock

23. Venture Capital Investments, Q2 2001 2.2% of Venture Capital invested in Midwest!

24. Timing – Sources of New Venture Financing* *Adapted from: Smith and Smith, Entrepreneurial Finance, 2000

25. Timing - Cash Needs • Goal is to manage risk to business and to investor. • Minimize risk by staging investments • Establish stages by developing solid business plan and financial projections!

26. Case Study – Ascend Medical • Facts: • Development stage Medical Device company. • Prototype of catheter for stroke victims nearly complete. • Market need unclear. • FDA process is three years and $30M in expense • No guarantee of approval.

27. Case Study – Ascend Medical • Analysis – Type? • Debt is not an option. • Angels to get the product through prototype development, further market study, conduct focus groups with doctors. $500,000. • Venture Capital to take it through FDA process and initial market launch. $45M

28. Case Study – Sporto • Facts: • Start up phase winter apparel company • One season’s sales under it belt • Moderate growth plans • Required funds: $1.5 M • Needs immediate funds of $100,000 to expand sales organization and $1.4 M to expand product line and related marketing expenses over the next 18-24 months

29. Case Study – Sporto • Analysis – Type? • Venture Capital not an option – growth too slow • All debt not an option – unless financials can demonstrate adequate cash flow and plenty of collateral available. • Private equity with debt mix is viable option • Factoring after sales grow, leasing office equipment • Alternative?

30. Case Study – Sporto • Analysis – Timing? • Could split rounds up, reduce overall cost of capital. • Rounds are close enough that it might make sense to raise all at one time. • Unless founder gets lucky? Example

31. The Big Picture – Business Plan Competitor Analysis Functional Plans Environmental Trends Business Plan Pro formas Customer Analysis Financing Evaluation-CMOPs

32. Business Plans • What is a business plan? • Something you produce because the bank expects it? • Something you produce because every says you should? • ?

33. Business Plans – Make Your Argument • Argument contains some consistent themes • What is the product or service? • Who is MOST likely to buy it? • How much are they willing to pay for it? • How many of “THEM” are there?

34. Business Plans – Make Your Argument • Argument contains some consistent themes • Who is MOST likely to buy it? • Where and How will they purchase the product? • How will I let them know about it? • Does my team have the ability to execute the plan?

35. “Everything should be made as simple as possible, but not more so.” Albert Einstein

36. A Sales Document to Raise Capital A Road Map to Developing a Successful Organization-Do we have a product the market wants and do we have an organization that can see it to market? The Plan makes an argument for why the business will be successful!!!!! Business Plan-The Purpose

37. Executive Summary Company History Major Products/Services Marketplace Competition Marketing Plan Operations-Manufacturing Management Team Risks Financial Analysis Business Plan Outline

38. Company Description • What business are you in? • What are your: • products or services? • customers? • applications? (Different uses and needs satisfied • What is your distinctive competence? • What is your competitive advantage? • What is your Mission Statement

39. Sustainable Competitive Advantage • Versus Distinctive Competence Ask the question “What do we have that can’t be replicated by our competitors?” vs. “What are we good at?”

40. Mission Statement • What do we do? • How do we do it? • Who do we do it for? Example: Brew – On - Premise

41. Market Analysis & Marketing • Industry description and outlook • Target markets (segments) • Competition • Reaction from prospective customers • Marketing activities (strategy/pricing) • Selling activities • The Key is your Feasibility Study

42. Example 1: Brew on Premise

43. Example 1 - Brew on Premise • Counties are comparable • 15 batches per day in Boulder • Ratio of target population 1.6:1 • Expected revenues for Badgerland to reach 24 batches per day after 2 years of operation.

44. Example 2 – Ascend Medical • Different approach to argument • Focus isn’t one likely demographic • Focus is on treatable number of cases

45. Example 2 – Ascend Medical • Process: • Population growth through 2010 (Source: US Census) • “Target” population not important. All medical research data based on incidence in US population. • Medical data implies number of treatable cases by type of stroke.

46. Example 2 – Ascend Medical • Process: • Once number of treatable cases established by type of stroke, can then establish type of treatments received. • Those requiring clot removal (vs. stenting, etc.) are established as likely candidates for this procedure. • 356,000 treatable cases today, growing to 560,000 in 2010.

47. Management and Ownership • Key management positions • Background of personnel • Board of Directors • Ownership • Starting a business is about building a successful organization and working in a “team.” • Does your team cover all the necessary roles or have you developed a plan to cover areas that are weak?

48. Management Software, Medical Device, etc. Franchise Granite Gear Low Moderate High Level of Sophistication

49. Software, Medical Device, etc. Franchise Granite Gear none moderate high Product Development Level of Complexity

50. Software, Medical Device, etc. Franchise Granite Gear short moderate high Time To Market