Keys to Financing the New Venture

Alec Johnson, Ph.D. University of St. Thomas

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 Youre not an entrepreneur until youve written payroll checks on Friday and spent the weekend collecting the cash to cover them. Keith Streckenbach, founder and CEO of
PharmacyOneSouce.com

Entrepreneurial Finance vs. Corporate Finance

Differences from Corporate Finance
Diversification and Value Involvement of Investors Harvesting

The Problem - Objectives

Entrepreneur
Minimize Cost Maintain Control Minimize Involvement

Investor
Maximize Return Maximize Ownership Minimize Risk

The Problem - Management

What is the Ultimate Task of an Entrepreneur?

Job #1 is Risk Management

Largest risk is Financial and question becomes How?

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?

Type Two General Classes

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

Sources of Debt Financing

Friends and Family Banks Leasing Factoring

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

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

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

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.

Types of Equity Instruments

Typically used in small business placements:
Common Stock Preferred Stock

Types of Equity Instruments

Common Stock Characteristics:
Most common form of issuance Last in liquidation = ? Represents Entire ownership of firm.

Types of Equity Instruments

Preferred Stock Characteristics:
Pays dividends Preference in liquidation

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.

Types of Equity Investors

Angel Investors Venture Capitalists

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 +

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%)

Types of Equity Investors: Angels

Typical Angel Investor
Required Rate of Return: 15% - 45% Length of Investment 3 10 years Patient Money

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

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

Venture Capital Investments, Q2 2001

30 25 20 1 5 1 0 5 0
Cm u ic tio s o mn a n a dNtw rkin n e o g Cn u e a d o s mr n Bs e s u in s Srv e e ic s B pa io h rm Sm o d c rs e ic n u to MdS r e ftw Rta rs e ile Cn u e & o s mr Bs u.

D lla o rs Sa h re

2.2% of Venture Capital invested in Midwest!

Timing Sources of New Venture Financing*

Development Entrepreneur/ Friends/Family Angels/Partner Banks/Lessors Venture Capital Start-Up Early Growth Rapid Growth Exit

IPO

*Adapted from: Smith and Smith, Entrepreneurial Finance, 2000

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!

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.

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

Case Study Sporto

Facts:
Start up phase winter apparel company One seasons 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

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?

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

The Big Picture Business Plan

Competitor Analysis Functional Plans Business Plan Pro formas

Environmental Trends

Customer Analysis

Financing
Evaluation-CMOPs

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

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?

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?

Everything should be made as simple as possible, but not more so.

Albert Einstein

Business Plan-The Purpose

A Sales Document to Raise Capital A Road Map to Developing a Successful OrganizationDo 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 Outline

Executive Summary Company History Major Products/Services Marketplace Competition Marketing Plan OperationsManufacturing Management Team Risks Financial Analysis

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

Sustainable Competitive Advantage

Versus Distinctive Competence
Ask the question What do we have that cant be replicated by our competitors? vs. What are we good at?

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

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

Example 1: Brew on Premise

Total Population (% age 24-55) Boulder County, Colorado Dane County, Wisconsin 225,339 (52%) Median Income Median Rent (upper quartile) $449 ($585)

$35,322

367,085 (54%)

$32,703

$423 ($527)

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.

Example 2 Ascend Medical

Different approach to argument Focus isnt one likely demographic Focus is on treatable number of cases

Example 2 Ascend Medical

Process:
1. Population growth through 2010 (Source: US Census) 2. Target population not important. All medical research data based on incidence in US population. 3. Medical data implies number of treatable cases by type of stroke.

Example 2 Ascend Medical

Process:
1. Once number of treatable cases established by type of stroke, can then establish type of treatments received. 2. Those requiring clot removal (vs. stenting, etc.) are established as likely candidates for this procedure. 3. 356,000 treatable cases today, growing to 560,000 in 2010.

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?

Management

Franchise

Granite Gear

Software, Medical Device, etc.

Low

Moderate

High

Level of Sophistication

Product Development

Franchise

Granite Gear

Software, Medical Device, etc.

none

moderate

high

Level of Complexity

Time To Market

Franchise

Granite Gear

Software, Medical Device, etc.

short

moderate

high

Time to Profitability

Franchise

Granite Gear

Software, Medical Device, etc.

Short < 6 months

Moderate 9 to 18 months

High >24 months

Market Risk

Franchise

Granite Gear

Software, Medical Device, etc.

High

Moderate

Low

Product Acceptance

Capitalization

Franchise

Granite Gear

Software, Medical Device, etc.

Low < $50,000

Moderate $500K to $2M

High > $2M

Risks
Competitive Risks Technological Risks Organizational Risks Main Point: Identify them and develop a plan to deal with them if and when they arise.

Funds Required and Their Uses

How much money do you require now? How much will you require over the next five years? How will the funds be used?

Funds Required and Their Uses

Debt/Equity mix What terms do you ask? (Let the commercial money market help you select winners) Do you plan to harvest? Be explicit about the deal you offer

Financial Data
Historical financial statements and projections for the next five years Key assumptions

Appendices
Resumes Pictures of products Sales literature Supporting published market studies or trade journal articles Patents

The Big Picture

Competitor Analysis Functional Plans Business Plan Proformas

Environmental Trends

Customer Analysis

Financing
Evaluation-CMOPs