Lecture 10$$$$$ Raising Money $$$$$$

Debt and Equity for a New CompanyKen Pickar

Lecture Feb 16, 2011

Agenda

• HW presentation (Fluidica)• Pasadena Leadership Opportunity

– Trity Pourbahrami

• Lecture on Raising Money

HW for Feb 21 (revised!)

1. How will you sell your product? (Sales strategy) 20%

2. Why should you be successful using these avenue/avenues? 20%

3. What will be your funding source? 20%

4. Why they should invest in you? 20%5. Marketing research update 20 %

4

What other product issues drive companies besides profits?

For a new companySome financial principles

Cash flow is typically a negative quantity

Monthly Negative Cash Flow= Burn Rate

Central riveting thought

Cash in Bank/Burn Rate

= number of months until you are out of business

For a new companySome financial principles

Cash flow is typically a negative quantity

Monthly Negative Cash Flow= Born Rate

Central riveting thought

Cash in Bank/Burn Rate

= number of months until you are out of business

The horror! The horror!

Cash Profile

Time (months)

+$

Initial investment

Cash Burn Second investment

Product takes off“Hockey stick”

Start here

For a new companySome financial principles

• “Cash is King”– Think cheap

• Need to lower burn rate?– No office space - “virtual company”– Smallest team you can use– Buy/make??– Outsourcing of everything– Ebay– Smaller prototypes– Low inventory– Lower salary– Zero salary

For a new companySome financial principles

• “Cash is King”– Think cheap

• Need to lower burn rate?– Lease rather than buy– Sell stuff– Fire people or hire less– Keep your day job– Barter for space, services– Pay in stock

Questions

• When do you raise new money?• Debt vs Equity

– What’s the difference?

Founder’s financing concern for a new

company

Keep Control Need $

Issues

•Degree of Desperation

•Need for advice, contacts and mentoring

•Valuation

•Reserve for the future

Existential Questions

• What is your reason for going into business?

• Do you really need outside financing?• Are you a business with a potential

“liquidity event” or are you a “lifestyle business”?

• How important is control to you?• What is your minimum burn rate• How long until you are “cash flow neutral”?

Start-up Rule

CEO looks for financing all the time

Where can you get money?

Summary Categories of places to get money

1. Advance on Sales2. Debt3. Equity

Plus and Minus of Debt or Equity

Debt +• More control• No sharing of success• Fixed interest rate

(predictable)• Big motivator• Tax advantage

Debt –• Affects cash flow• Reduces profits• Have to pay good times or bad

Equity +• Easier To begin with • Helpful (?) partner• Motivator• Validates model

Equity -• Share upside• Loss of control

1. Operating funding• “Sweat” Equity • SBIRs (Small Business Innovation Research) • Research Contracts

– Feds– State– Corporate partner– Customer– Supplier

• Barter– Rent– Professional services– What else?

• Free services• Part-time consulting

2. Debt- Sources of Funds

• Short term loans Securing a succession of small loans can help you cover expenses while building revenues

• Personal Credit They're not just for car loans and home mortgages. Now credit unions are making business loans.

• Credit Cards

• Home Equity Assuming you have any

• Purchase orders as entry-level collateral

• SBA Loans

• Private Loan Guarantees Find an investor to guarantee your loan.

Debt (continued)

• Asset-Based Loans Use your assets—like accounts receivable and inventory—to help you land funding.

• Equipment Leasing .

• Inventory-based lines of credit

• Royalty FinancingGet advance against future sales.

Debt Sources

• Credit Unions• Community Development

organizations• Home Equity• Subordinated Debt• Warrants

3. Equity Sources• Self-Funded Corporation• Outside Capital Sources

– Seed (10-100K)• Friends, Family and Fools

– Angel (250K- 1M)– VC (2-10M)– Mezzanine (50M)– Liquidity event (500M- ? )

• IPO• Acquisition

How do you trade-off ownership for capitalization?

• Before funding, you owe 100% of the company • Assume you would like to raise money. How do you calculate who owns what after the money is raised?

Ownershipbefore

Ownershipafter

Pre-money 2M 100% 67%

AngelInvestment

1.0M 33%

Post Money 3.0M 100%

A round

Pre-money2M (how is this determined?)Angel invest 1M (Why this amount?)Total 3M (Valuation after A Round)Congratulations (?)

1. You have lost 1/3 of your company. 2. You have added strangers to your Board. 3. Well, at least you have majority ownership4. Your company is worth 3M of which your share is 2M. This is the best measure of a companies worth. What are others?

How to determine Pre money valuation

• Some Factors– IP protection– Market addressed (Validated?)– Management Team– Net present value of future profits– Return on investment – What else?

How to determine Pre money valuation

• Some Factors– IP protection– Market addressed (Validated?)– Management Team– Leadership– Net present value of future profits– Return on investment – What else?

Market for start-ups!

How much do I need?

• Usually more than you think– Time = money– Excessive optimism

• Market development• Hire people• Murphy’s Law• You don’t know what you don’t know

• Leverage all sources• Never stop• Allow 6 + months to raise money

I need more money to grow (or to survive)

B RoundPre-money10M (how is this determined?)VC invest 5M (Why this amount?)Total 15M (Valuation after B Round)Congratulations (?)

1. Your company is now worth 15M 2. You have added new strangers to your Board. 3. How much do you own?

Ownership after B round• You own (66%) (15M) (66%) = 6.7M• Angels own (33%) (15M) (66%) = 3.3M• VC owns (33%) 15M = 5M

Bad news: You’ve lost control! 66%X66% = .44Good news: Your investment is now “valued” at

6.7M (Up round. What is the alternative?)Bad News: This investment is illiquid, i.e. there is no

market to convert to cash (changing: there are markets now being established for pre-public companies)

Good News: You have funding to take you to the next level

And so it goes. . .

And so it goes. . .

• Until– RIP

And so it goes. . .

• Until – Walking wounded

And so it goes. . .

• Until – Life style company

And so it goes. . .

• Until– Acquisition

And so it goes. . .

• Until– IPO

Projections

• In Business Plan, need to project income and cash flow statements ~ 5 years

• We will discuss this in a future lecture

Conclusion

• Financing Decision determines what kind of company you will build