funding options for consumer products companies

Funding Options for High Growth Consumer Product Companies

September 6, 2012

Today’s Experts •  Jeremy Halpern

–  Partner, Nu8er McClennen & Fish LLP – Top 10 Boston Law Firm –  Director, MassVentures – Venture Capital Firm owned by the Commonwealth –  Adjunct Professor, TuLs University, Entrepreneurial Leadership –  Director, The Capital Network –  Angel Investor –  Former entrepreneur –  Geek

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Funding the Company

Assuming you plan to be a “high growth” consumer products company…

What are your funding opXons?

Entrepreneurship comes in many types

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NORMAL GROWTH COMPANY

HIGH GROWTH COMPANY

EXTREME HIGH GROWTH COMPANY

SOCIAL VENTURE COMPANY

•  Includes all service businesses

•  Exploiting a local market need

•  Team has ‘great jobs’

•  Growth by adding resources one by one

•  Exit will be based on value of cash flow (mature biz.)

•  Growth profile ultra-scalable •  Team focus is exit •  Revenue $40M+

with lots of room for growth (5 yr.) •  Based on $20M+

investment •  Exit targeted to

IPO or by ‘large’ M&A event

•  Goal is to fulfill a social need

•  Has mission orientation

•  Team needs to support mission

•  Growth profile often one resource at a time

•  Exit …much harder to find fit

•  Company can grow fast (on-line) or has a scalable system

•  Team often motivated by exit

•  $10m revenue in 5 yrs & market size allows significant additional growth

•  Capital efficient total investment$2-4M

•  Exit by M&A

Close Up: Extreme High Growth vs High Growth

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Capital Needs

Time

High Risk

Low Risk

Formal Venture Capital

M&A or IPO

Crystallize Ideas

Demonstrate Product

Early Scaling Growth

Sustained Growth

Angel Group (or Micro-‐cap) SyndicaNon

Angels or Accelerators or

Micro-‐cap funds Angels or

Accelerators or Micro-‐cap funds Business

Angels

Market Entry

M&A

Later VC Rounds

Extreme High Growth

High Growth

Friends, Family & Founders

Friends, Family & Founders

High Growth Company CharacterisXcs

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•  DisrupXve InnovaXon with Strong value proposiXon –  CorrelaXon between Large Unmet Need : SoluXon –  How do you define “need” for brand companies

•  High Margin Product (RaXo of Revenue : COGS) –  SomeXmes Massive Volume Products where innovaXon is incremental

•  High Rate of Revenue Growth over sustained period –  CauXon against fad products

•  Scalable (Fixed cost is a low percent of Revenue) –  Usually markeXng and distribuXon are the big spends

•  No major barriers to conXnued growth (ex. blocking IP; geography; regulatory) –  Access to distribuXon networks is oLen a concern

•  Repeatable sales and distribuXon model with many credit worthy customers –  Is this a direct or indirect model

High Growth Company CharacterisXcs

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•  Large Total Addressable Market (TAM) –  SegmentaXon and key understanding of target customers

•  Defensible innovaXon able to withstand compeXXon and changing condiXons –  Is this patent, trademark or “experience”/usability

•  Capital efficiency within the verXcal

Return on Equity Return on Debt Income High Return

NON PROFIT ORGANIZATION

Capital Source View

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Debt-‐ Pay it back Fixed Amounts

Equity – Ownership stake % of Future Value

Charity $$

Impact / Tax Write off


HIGH GROWTH

(COMPANY)

EXTREME HIGH GROWTH (COMPANY)

Risk / Return


Match Funding Sources

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HIGH GROWTH COMPANY

EXTREME HIGH GROWTH COMPANY


•  Friends family, founders

•  Debt Bank and other

•  (Future) Crowd funding (portal style)

Early on •  Accelerators •  Individual Angels •  Micro Cap VCs •  Seed from VC Later stages •  Venture Funds •  Strategic VCs •  Angel

Syndication

•  Friends family, founders

•  Charity$$ •  Crowds (Kick-

starter) •  Impact Angels •  (Future)

Crowd funding (portal style)

•  Angels •  Angel Groups •  Angel Group

Syndication •  Angel List •  Micro-cap Funds •  (Future) Crowd

funding (portal style)

•  Increasingly Strategic Corporate VCs

Non-‐Equity Sources

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•  Accelerators (some) •  Kickstarter type donaXons

•  Pre-‐orders from end-‐customers •  Credit from vendors •  Strategic VCs •  Strategic NREs •  DistribuXon Contracts Common Theme: Providing early cash in exchange for a be8er commercial opportunity

Case Studies

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•  Pre-‐orders from end-‐customers –  Company sold products online with a 14 day delivery window –  Company collected all cash up front via credit cards –  Company used cash to pay a net 30 vendor to produce goods –  ProducXon and delivery enabled within 10 days.

•  Strategic NREs –  Strategic partner sold large devices; one key customer complaint was

throughput on the machine –  Company was producing a consumable product that would work on mulXple

machines –  Company received $600k+ of NRE cash in exchange for a 1 year lead on its

compeXtors –  Company believed that reduced buying pool only limited revenue in yr. 1 by

20%

Day 1: Collect Cash – IniXate Order

Day 10: Order Ships

Day 40: Vendor Paid

Equity Sources

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•  Accelerators (some) •  Friends & Family

Common Theme: SupporXng success of the entrepreneur; business terms vary

•  Portal Funding •  Early Angels •  Super Angels •  Angel Groups •  Micro VC •  TradiXonal VC (1st Round) •  Private equity for later stage

Common Theme: All are looking for –  sale (or IPO) of the Company at 4-‐10 x original investment –  Capital gains treatment on all sale proceeds –  PreferenXal treatment on subopXmal exit versus the founders

Specialized Equity Sources

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•  Angel groups –  CircleUp –  Investors Circle (Sustainable products)

•  Private Equity –  TSG Consumer Partners –  Baird

•  Inventory or Component Financing

•  Vendor Financing –  manufacturing partners (credit +/-‐ Cash for long term lock) –  prototyping vendors –  TesXng and design vendors

•  Royalty Financing

High Growth Capital by Stage &Amount

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Venture Stage

Investment Size

Friends & Family

Vendors

Angels

TradiXonal VC

Angel Groups

Corporate Venturing

Grants

Customers

Crowdfunding

Portal Funding

AngelList

Micro VC

Equipment Financing

Founder

Private Equity

Capital Sources: Size & Cost

Investment Size

Investment “Cost”

TradiXonal VC

Micro VC

Equipment Financing

Angel Groups Angels

AngelList

Corporate / Strategic Venture

Customers

Portal Funding

Vendors

Founder Friends & Family

Crowdfunding

Grants

Venture Debt Bank

Loans

Personal Loans

Private Equity

So What is Equity Anyway?

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•  Stock = right to residual economic interests upon sale/liquidaXon + stockholder voXng rights (usually limited to Board of Directors and Sale of the Company)

•  Preferred Stock = right to be paid before Common Stock ParXcipaXng = original investment PLUS a pro rata share of remainder Non-‐ParXcipaXng = original investment OR a pro rata share

•  Common Stock = whatever is leL aLer all other creditors and preferred stockholders are paid

•  Dividend = a right to an addiXonal amount upon liquidaXon measured as a funcXon of Xme x percentage of original investment . Ex. 6.0% per annum

•  OpNons / Warrants = Contracts allowing holder to purchase an amount of stock in the future at a pre-‐determined price

•  Control Rights = Statutory and Contractual

Equity Type Comparisons

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Solo Angel Super Angel Angel Group MicroVC VC

ValuaXons High relaXve to stage

High relaXve to stage

Low relaXve to stage

Low relaXve to stage

Medium

Type -‐ Likely (less likely)

Common (Warrants)

Conv Note (Preferred)

Preferred (Conv Note)

Preferred (Conv Note)

Preferred

Board Seat Maybe 1 or none 1-‐2 of 5 +/-‐ Observer

1 of 5 +/-‐ Observer

1-‐2 of 5 +/-‐ Observer

Audited Financials

No No No (reviewed) Yes Yes

NegaXve Covenants

No SomeXmes Yes Yes Yes

PreempXve Rights

No SomeXmes Yes Yes Yes

VerXcal ExperXse

SomeXmes Rarely Some Usually Always

Equity Type Comparisons

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Solo Angel Super Angel Angel Group MicroVC VC

Exit Horizon (from $ in)

7 years 5 years 4 years 5 -‐7 years 4-‐5 years

Exit Range $20m+ $40m+ $50m+ $100m+ $250m+

Structure of an Equity Deal

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•  Company and Investors agree on a “pre-‐money valuaXon” (PM) which leads to a price per share

•  Investors put in $X •  Investors then own: X / (X + PM) of the company

Example: PM = $1M X = $0.5M Investors own 0.5/1.5 = 33% Remember: New issuance NOT transfer

Understand the Funding Path

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•  We’re talking about 1st funding here •  What is the probable complete funding picture? – This is only funding – Another small round then probable small exit – Big money needed before exit

•  Each funding event should occur at an “inflecXon point” – Hopefully at a point where risk is removed –  Increased PM = so-‐called “up round”

Understand the Funding Path, cont.

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•  What if things aren’t going so well? – Flat or decreased PM = so-‐called “down round”

•  More money coming in without increased PM means everyone gets diluted, but…

•  Depending on anX-‐diluXon provision entrepreneur may carry more burden than the investors

What about ConverXble Debt?

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•  Many seed-‐stage companies use an instrument called ConverXble Debt. Huh?

•  ConverXble debt is not tradiXonal bank debt •  Converts exist for two major reasons –  Investors and Entrepreneurs find it hard to agree on a PM valuaXon

– SomeXmes quicker and cheaper to document than equity deals (but not really)

ConverXble Debt provides OpXonality

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•  ConverNble Debt = unsecured debt obligaXon of the Company that may be converted into equity of the Company.

•  Conversion Trigger = Qualified Financing usually at some

minimum amount of funds (ex. $500,000)

•  If Notes stays as Debt = Get back principal and interest ahead of other equity (behind other creditors typically)

•  If Notes Convert = Convert amount of debt and interest into equity at the valuaXon in the next round

•  aLer applicaXon of a Discount (oLen 5 – 20%) •  subject to a maximum valuaXon amount (the “Cap”)

Basic Structure of ConverXble Debt

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•  Investor loans $ to Company an5cipa5ng another round of funding •  Investment accrues small interest •  When the funding occurs, investment + interest convert to equity,

usually at a discount (5-‐20% typically)

Example: •  Investors loan $200K to Company •  20% discount •  As of conversion, interest of $10k has accrued •  Next Round PM = $2m •  Conversion Amount = 1/(1 -‐ 0.2)* $210k = $262,500 At Conversion, Noteholders receive 262.5K / (PM + 262.5K + New Money)

ConverXble Debt – ComplicaXons!

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•  What if only a li8le money comes in? •  When does the debt convert? •  What happens if PM of next round is huge? •  Does the investor have any say in things? •  What if there is an equity investment that doesn’t trigger conversion?

•  What happens if it never converts? •  What happens if Company gets bought?

ConverXble Debt – SoluXons?

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•  Caps and Floors – May defeat purpose with signaling

•  Default conversion price and security at maturity •  Open round, minimum close •  Quick sale preferences (ex. 2x) •  Governance provisions •  Careful a8enXon to conversion condiXons

ConverXble Debt – Worse than Equity?

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•  MulXple liquidaXon preference (circa 2008) –  Ex. $500k of Notes with cap at $2m PM –  Next Round at $6m PM –  Issue Noteholders 3x number of shares –  3x shares equals 3x liquidaXon preference!!

•  Without a floor, effecXvely Full Ratchet AnX-‐diluXon

•  Preference Overhang –  In prior example Noteholders bought $262,500 of preference for $200,000.

–  All other Series A Holders bought 1:1 preference

•  Not Just a Price Adjustment

www.TheCapitalNetwork.org

Upcoming Programs

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Sep 18 Financial ProjecXons for PresentaXons

Oct 16 Building a High Growth Business for Angel and Venture Capital

Oct 24 Structuring Founder RelaXonships: Stockholder Agreements & Choice of EnXty

Nov 5 Mobile Fast Track

Leveraging The Crowd

Crowdfunding v. CrowdinvesXng

Perks Debt/Equity Financing

Crowdfunding is a phenomenon

530 854

1,470

2,806

2009 2010 2011 2012(est.)

Global Crowdfunding Market USD Millions

North American non-‐equity crowd-‐funding: $837 million

63% CAGR

Perk Crowdfunding

•  DonaXons or pre-‐product sales

•  Low cost way to test the market

•  Create buzz about your product

•  Event focused not company focused

•  More selecXve

•  Larger community

•  More restricXons

Kickstarter v. Indiegogo

•  Open pla{orm

•  Smaller community

•  Fewer restricXons

Crowd InvesXng

•  Enabled by the JOBS Act

•  Debt or equity investment

•  Company focused not event focused

•  Long term investor involvement

Crowd investors add daily value

Crowd investors add everyday operaXonal value. Crowd investors help with: •  A/B tesXng •  Social media markeXng •  RecruiXng •  Market research •  Customer acquisiXon

Why Seek Crowd investment?

•  Structured to compliment Angel and VC •  Access hundreds of investor advocates

•  Efficiently acXvate and manage investors

QuesXons?

Mike Norman

[email protected]

Debt Alternatives to VC Financing Dan Allred

Silicon Valley Bank (617) 796-6904 [email protected]

Twitter: @dgallred http://danallred.tumblr.com

Funding sources: the lines are blurring

TradiXonal VC Funds

Seed Funds

Super Angels

Angels

Debt vs. Equity

Debt •  Lower risk: first money to

be paid back •  RelaXvely inexpensive •  First lien on company assets •  NegaXve covenants

Equity •  Higher risk: lives & dies with

the company •  Very expensive •  Unsecured (typically) •  BOD governance

Primary uses of debt

•  Financing assets – Working capital – Fixed assets

•  Financing growth – Growth capital – “Venture debt”

•  Special situaXons – Bridge loans – Financing “near” assets

Think like a lender

The tradiXonal credit model – Primary source of repayment: cash-‐flow

•  QuesXon: what is the probability that cash-‐flow will be sufficient to support operaXons and repay the loan?

– Secondary source of repayment: collateral value •  QuesXon: what is the probability that the liquidaXon value of the assets would be sufficient to repay the loan should the cash-‐flow prove insufficient?

Think like a “venture lender”

A twist on the tradiXonal credit model – Primary source of repayment: cash-‐flow from future equity •  QuesXon: what is the probability that the investors will provide addiXonal equity sufficient to support operaXons and repay the loan?

– Secondary source of repayment: enterprise value •  QuesXon: what is the probability that the enterprise value (IP, customer base, licenses, etc.) is sufficient to repay the loan should the venture support prove insufficient?

Think like a working capital lender

Another twist on the tradiXonal credit model –  Primary: cash-‐flow within the working capital cycle

•  QuesXon: what is the probability that the accounts receivable are collectable in a Xmeframe sufficient to revolve the loan?

–  Secondary: collateral value of working capital assets •  QuesXon: what is the probability that the Bank could collect the accounts receivable and liquidate the other working capital assets aLer the Company ceases operaXons?

Working capital lines of credit

•  Uses of capital –  Financing working capital assets such as A/R and inventory –  SomeXmes includes a porXon available to finance POs

•  Security –  First priority lien on all business assets –  Typically a negaXve pledge on IP

•  Structure –  Revolving line of credit with formula borrowing base (i.e. 80% of A/R) –  Financial covenants to measure liquidity (i.e. balance sheet covenant)

& performance to plan (i.e. income statement covenant) –  Standard negaXve covenants (similar to prior slide)

•  Pricing –  Prime based interest rates ranging from Prime to mid double digits

based on liquidity levels –  Commitment fee ~0.5-‐1.0% and perhaps unused line fees as well –  Warrants may be included if there is an element of “venture risk”

Recurring revenue lines of credit

•  Uses of capital –  MoneXze value associated with recurring revenue –  Support sales, markeXng & product development as MRR grows

•  Security –  First priority lien on all business assets –  Typically a negaXve pledge on IP

•  Structure –  Revolving line of credit with formula borrowing base (i.e. 1-‐3x MRR) –  Financial covenants to measure liquidity & performance to plan

(similar to prior slide) –  Standard negaXve covenants (similar to prior slide)

•  Pricing –  Prime based interest rates ranging from Prime to mid double digits

based on liquidity levels –  Commitment fee ~0.5-‐1.0% and perhaps unused line fees as well –  Warrants may be included if there is an element of “venture risk”

QuesXons?

Dan Allred Silicon Valley Bank (617) 796-‐6904 [email protected] Twi8er: @dgallred

h8p://danallred.tumblr.com