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
“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
 Entrepreneurial Finance vs.
Corporate Finance
Differences from Corporate Finance
– Diversification and Value
– Involvement of Investors
– Harvesting
 The Problem - Objectives

Entrepreneur Investor
Minimize Cost Maximize Return

Maintain Control Maximize

Ownership
Minimize Minimize Risk
Involvement
 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 Equity
– Represents a fixed cost – No interest payment
– Represents more risk – No obligation to repay
– Cheapest type of outside – Most Expensive type of
financing 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 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.
 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

15 Dollars
10 Share

0
Communications Consumer and Biopharm Semiconductors Med Sftwr Retailers Consumer &
and Networking Business Bus.
Services

2.2% of Venture Capital invested in Midwest!

 Timing – Sources of New Venture
Financing*

Development Start-Up Early Rapid Growth Exit

Growth
Entrepreneur/
Friends/Family
Angels/Partner
Banks/Lessors
Venture Capital
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 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
 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

Environmental Business Plan

Trends Pro formas

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 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 Outline

Executive Summary Marketing Plan

Company History Operations-
Major Products/Services Manufacturing
Marketplace Management Team
Competition 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

can’t 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 (% Median Income Median Rent (upper

age 24-55) quartile)

Boulder County, 225,339 (52%) $35,322 $449 ($585)

Colorado

Dane County, 367,085 (54%) $32,703 $423 ($527)

Wisconsin
 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 isn’t 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

Software, Medical
Franchise Granite Gear Device, etc.

Low Moderate High

Level of Sophistication
 Product Development

Software, Medical
Franchise Granite Gear Device, etc.

none moderate high

Level of Complexity
 Time To Market

Software, Medical
Franchise Granite Gear Device, etc.

short moderate high

 Time to Profitability

Software, Medical
Franchise Granite Gear Device, etc.

Short < 6 Moderate 9 to 18 High >24

months months months
 Market Risk

Software, Medical
Franchise Granite Gear Device, etc.

High Moderate Low

Product Acceptance
 Capitalization

Software, Medical
Franchise Granite Gear Device, etc.

Low < $50,000 Moderate High > $2M

$500K to $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

Environmental Business Plan

Trends Proformas

Customer Analysis Financing

Evaluation-CMOPs