Lecture 8$$$$$ Raising Money $$$$$$

Debt and Equity for a New CompanyKen Pickar

Lecture Feb 1, 2011

HW for today

• What is the value you provide your customers?

• How will you capture that value (Business Model)? Name at least 2.

• How will you price your product(s)?• How will your value capture be

sustainable for 5 years?

Thoughts

• Feb 24 Fast Pitch LA we go there instead of class?

• Midterm Feb 10• Coaching• Steve Streit lunch this Thursday• Tech Coast Angels Feb 18th

February 24, 2011UCLA Anderson School of Management - Korn Hall2:00-3:00 Registration3:00-3:45 Getting Funded In Today's MarketVenture capital and angel investors will discuss the current funding environment for start up companies.Jim Andelman – Rincon Venture PartnersWilliam Quigley – Clearstone Venture PartnersEric Manlunas – Frontera GroupScott Sangster – President, Tech Coast Angels - Los Angeles3:45-4:30 2011 Start Up Business ClimateTCA porfolio CEOs will discuss the early stage business climate in 2011.  Companies include LaughStub, YouMail, HitFix, CosNet and Others.4:30-5:00 Break5:00-5:30 Fireside chat with Mike Jones, CEO, 5:30-7:00 Fast Pitch CompetitionCEOs of 8-10 of Southern California’s most promising startups will have 90 seconds to pitch their companies to a panel of seasoned judges. Pitches will be evaluated for fundability and presentation quality. The winners will be invited to present at a Tech Coast Angels screening session and be considered for funding.7:00-9:00 Light Dinner and NetworkingNetwork with hundreds of investors, entrepreneurs and other industry experts over a light dinner, wine and assorted beverages. Meet Tech Coast Angels, other angel investors and venture capitalists. 

MidtermNext week, Thursday, February 10Submit presentation 5 pages (pdf) and 10 minute presentation (pdf

of PPT) Continue Market interviews!! You should have made significant

progress by next week!

Contents1. Updated Market Analysis. (50%) Show references

1. Who is your customer? How big is he? How fast is he growing? What intense pain is this customer experiencing? Be as precise as possible in identifying customer.

2. How big is the market segment? How fast is it growing? Be as precise as possible

2. Business model (20%) How will you make money?3. What was the biggest surprise(s) you encountered in your

research so far (10%)4. Key issues to be resolved for the Final (20%) e.g., untested

hypotheses. List as many major uncertainties as you can and some thoughts on how you will address them.

6

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– Smallest team you can use– Outsourcing– Ebay– Buy/make??– Smaller protoypes– 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 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. Need Operating funding prior to product sales

2. 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• SBIRs (Small Business Innovation Research) • Research Contracts

– Feds– State– Corporate partner– Customer– Supplier

• Barter– Rent– Professional services– What else?

• “Sweat” Equity • 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– 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

– 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%) (10M) (66%) = 44%• Angels own (33%) (10M) (66%) =

22%• VC owns (33%) 15M = 33%

Bad news: You’ve lost control!Good news: Your investment is now

(44%)(15M) =6.6M (Up round. What is the alternative?)

Bad News: This investment is illiquid, i.e. there is no market to convert to cash

And so it goes. . .

• Until– Walking wounded– RIP– Life style company– Acquisition– 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