Raising Capital to Fund Growth

Jeff Amerine, PMPTechnology Licensing Officer

Adjunct Instructor, EntrepreneurshipUniversity of Arkansas

Advisor, Innovate Arkansasjamerine@uark.edu

Introductions Financing Basics Where’s the Money? What’s Available in Arkansas? Financing Sources What Attracts the Money? Recap / Q&A

– BS, US Naval Academy 1984– MS, Operations Management – University of Arkansas– US Air Force Officer 1984-1990– System engineer, product manager, VP, CEO, CTO

• 18 years in telecom and software technology development• 7 startup ventures• 3 Fortune 500s

– U of A Technology Licensing Officer & Adjunct Instructor, Entrepreneurship

– Staff Advisor, Innovate Arkansas– Manager & Investor, Gravity Ventures Arkansas

University of Arkansas Technology Licensing Office◦ Access to 100+ technologies developed at the UA◦ Team of business and intellectual property professionals◦ Mission:

Commercialize world-class research to build a sustainable knowledge-based economy to benefit Arkansas and the world.

◦ http://www.uark.edu/ua/tlo/index.html

Innovation Center535 Research Center Blvd

Academic

BusinessLegal

◦Patents

◦Trademarks

◦Copyrights

◦Trade Secrets

TM

©

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What Does IA Do?

•Accelerate the technology commercialization process

•Facilitate partnerships between firms, universities and economic development organizations

•Prepare firms to obtain early-stage capital •Provide expert assistance in technology, business, organizational management and marketing

•Advise with legal and intellectual property matters

“I shall be telling this with a sigh Somewhere ages and ages hence: Two roads diverged in a wood, and I— I took the one less traveled by, And that has made all the

difference.”

The Road Not TakenBy: Robert Frost

$$

Time

Seed Early Growth Mature / Expansion

Adrenaline Junkies

Growth Leaders

Crank Turners

Revenues

Expenses

Passion and commitment: You have to be a true believer

Value proposition: Solves a real problem or meets a real need

The team: Onboard the bus and in the right seats

Competitive advantage: Better, faster, cheaper

Focus, focus, focus: Avoid trying to “boil the ocean”

Repeatable, scalable processes: Execution is key

Choose your customers well!

Remember accounting profits are great but cash is king!

How do I finance my startup??Equity???Debt???

Bootstrap???Other???

Equity finance = selling shares or membership units

Advantages: Does not impact cash flow, higher risk tolerance. Disadvantages: Loss of control; dilution of interest

Debt finance = taking a loan from a bank or individual

Advantages: Does not dilute ownership Disadvantages: Loan payments, personal guarantees, banks don’t lend money to startups without assets

Bootstrapping= working for free or using “FFF” money

Advantages: May not dilute ownership, friendly terms Disadvantages: Family issues, personal guarantees, not eating or having fun….

Friends Family Fools

Government: Grants, SBIR/STTR, Loans, Recovery Act

Advantages: Does not dilute ownership Disadvantages: Takes forever, political decision criteria, government rights and oversight

Angels VCs Strategic investors Debt Mezzanine Public markets Other

Mostly not here…but we are working on that point

Angel ◦ Fund for Arkansas’ Future

$6M angel fund Up to $500K investments

◦ Gravity Ventures Arkansas $>1M angel fund $50K-100K investments

Public Sector Seed Capital◦ Arkansas Science & Technology Authority (ASTA)

◦ Up to $50K-$300K in royalty/ debt financing◦ Arkansas Development Finance Authority (ADFA)

◦ Risk Capital Matching Fund - $100K - $750K

Mezzanine ◦ Diamond State I & II◦ Look for EBITDA positive growth stage companies

• Other Investment Incentives– Arkansas Economic Development Commission

• Equity investment state tax credits – 33.3% • Can be monetized and transferred

– ASTA• R&D state tax credits – 33%• Can be monetized and transferred

– Arkansas Capital Corporation• New Market Investment tax credits• SBA Loan Guarantees

Management Team, Management Team, Management Team

Intellectual Property that can be a barrier to entry Customer traction – can the company execute?

Physical proximity to the investors Other interested investors – nobody wants to be first Entrepreneur skin in the game

Realistic valuation – this depends a lot on where you sit

Angels◦ Typically high net worth individuals◦ Look to do very early stage seed investments◦ Often bring relevant domain knowledge◦ Occasionally form “Angel Funds”◦ This group can some times be broadened to

include “friends, fools, and family”◦ Examples: Fund for Arkansas’ Future

• VC Firms grew out of Silicon Valley in the 1950s• Largest concentration around R&D Universities• Desired returns: Typically a minimum of 10X• Examples: Kleiner-Perkins, Sevin-Rosen, NMP

• Investment Preferences: – Proven management team– Intellectual property that creates high barriers– Customer traction

Venture Fund LLP

Limited PartnersVenture Investments

•Public Institutions•Individuals•Private Equity Firms•Mutual Funds

Successful VC funds:◦ Out of ten investments made after 3-5 years:

One big home run – at least 10X or more return Four marginal survivors Three on life support Two total failures

“1 home run (10x) out of ten investments” ……Chrysalis VC Fund

Historical Returns – High teens to >30%

1-2 Winners10X Returns

Due Diligence on 20 Investments

Receive 1000s of Business Plans

Read 1000s of Executive Summaries

Invite 100s of Companies to Present

Invest in

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Returns by Asset Class

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

Yr. 1 Yr. 3 Yr. 5 Yr. 10 Yr. 20

Early/Seed VC

Balanched VC

Later Stage VC

All Venture

NASDAQ

S&P 500

Industry Preference Stage Preference Investment Size Parameters Geographic Preference Risk Balancing and Age of Fund Fund Experience and Expertise Due Diligence

Based on VC perceived risk, usually not the risk the entrepreneur sees

Four main risk categories:◦ Product/Technology risk◦ Market risk◦ Execution/Management risk◦ Financing Risk

No “standard” way to determine valuation!!

Examples: ◦ Net Present Value of Discounted Cash Flows◦ Multiple of Annual Revenues◦ Multiple of Net Income◦ Multiple of Subscribers◦ Valuation by Comparison◦ Use of Valuation Tools – www.equitynet.com

Recommendation: ◦ Look at the comparable companies in your space

◦ Set your valuation within the range of the comps

◦ Be conservative

Pre-revenue startups seldom have valuations greater than $1M-2M even with great IP and management

Term Sheet – a proposal to invest Not binding Outlines the deal points Investment contingent on negotiation and

due diligence

Key Points◦ Pre-money valuation◦ Post-money valuation

Pre-money valuation = $4M Investment = $1M Post-money valuation = $5M

VC ownership = $1M / $5M = 20%

VCs typical want preferred stock

Typical VC deal needs an exit in 5-7 years Want a 10X return minimum Play for capital appreciation

◦ Example: $1M today = $10M @ Exit

◦ VC Protections = Preferred Stock, Ratchets, Anti-dilution

◦ VC Ownership will “Ratchet-up” if company misses milestones

Key Points to Negotiate

◦ Board of Directors

◦ Vesting & Acceleration

◦ Option Pool & Acceleration

◦ Preferred Stock

◦ Anti-Dilution Protection

Comprehensive review of everything◦ Management references◦ Market size & need◦ Sales Pipeline & Customers◦ Strategic relationships◦ Financials◦ Intellectual property◦ Legal issues

Grueling process that will find the BS! Can last 30-90 days

Entrepreneurs’ Disease: 100% X 0 = 0

Unrealistic valuations

Lack of preparation for having a VC “help” run your company

Excellent management that has a track record

Intellectual Property or Subject Matter Expertise that creates a competitive barrier

Solves big problems in big markets - $1B++

Customer traction – i.e. somebody will buy your widget

Entrepreneur “skin in the game”

Skype◦ VOIP service provider◦ Revenues based on “eyeballs”, advertising or some such◦ No cost for PC-to-PC calls◦ Initial VC investors:

Draper –Richards: Bill Draper and Howard Hartenbaum - $250,000 initial investment

◦ Sells to eBay in 2006 for $2.1B

◦ Initial VCs make 1300X return on their initial investment

Irrational Exuberance?? Possibly, but some big hits still happen – RARELY.

Guy Kawasaki interviews:◦ Mike Moritz, Sequoia Capital and Paul Graham, Y

Combinator◦ http://www.building43.com/videos/2009/08/07/

fireside-chat-money-and-passion/

• Existing Fortune 500 firms• Look to invest in technologies that can benefit

their business portfolio• Open to “Extrapreneurship” i.e. spin-outs• Create their own venture funds• Examples: GE, IBM, Intel, Honda, NEC, Chevron

• Upside: Can bring tremendous market access• Downside: Very slow moving typically

Honda Strategic Venturing (HSV)

Strategic venture investment arm of the global Honda R&D organization.

• Window to Global Innovation : Create new value jointly by bridging the outside

entrepreneurs and our internal R&D through venture investing• Spinout of Internal R&D projects : Develop new businesses via technology

carve-outs which find a better commercial fit outside of Honda • Entrepreneurship at Honda R&D : Enhance Honda’s innovation spirit by

harnessing entrepreneurship in the global venture community

Drive Innovation

Alternative Energy• Fuel cell, hydrogen reformer • Battery, Bio-fuel, Solar energy• Energy harvesting

Robotics

Communication for Mobility

• Sensors, Gyros, Radar• Actuators, Motors• Image processing, voice recognition

• Wireless Communication• In-vehicle network• Human machine interface

Advanced Materials• High performance materials: coating, fabric,

rubber, structure, nano• Functional materials: catalysts, membranes,

electrodes

High Interest Technologies

Target: ◦ Game-changing technologies ◦ Technologies that can contribute to Honda’s R&D road map

Primary Interest: Mutual Strategic Value◦ We offer:

Funding Joint development with Honda R&D Product / Market knowledge

◦ We seek: Board observer rights Strategic commercial rights

Investment Size: ◦ Seed-to early-stage:

HSV Fund (Honda’s technology venture fund w/ partner Atrium)◦ Mid-to late-stage:

Honda Motors direct investment

Some venture firms focus on debt◦ Gives first preference on assets◦ Can be convertible to equity◦ Avoids/limits shareholder dilution…◦ But it has to be paid every month

◦ Examples: Western Tech Investments, Silicon Valley Bank, Commercial banks/SBA loans

Growth financing to get to liquidity event

Targeted at profitable companies that need to scale

Last stage financing before M&A activity or IPO -

Typically $10M-$100M or more in financing

Can be debt/equity and is typically a syndicate of private equity funds

Forget about it…. Post 2001 - virtually unavailable

Sarbanes-Oxley (SOX) requirements have a further stifling impact

Not a good exit or liquidity strategy for US-based tech startups at this point

Some rare exceptions still arise…

US Government◦ SBIR/STTR funding can be a great source of seed,

pre-seed funding

◦ Universities know how to get this funding

◦ No dilution, no equity, and no debt

◦ Some Incubators use this to get companies rolling: Virtual Incubation Company (VIC)

◦ Process can be slow and involved

$$

Time

Seed Early Growth Mature / Expansion

Angels

VCs

Strategic InvestorsDebt Investors

Revenues

Revenues

Expenses

Mezzanine

Bootstrap – self financing

SBIR/STTR

UniversityR&D

TechnologyEngine

Entrepreneurial

Culture

AvailableVentureFinance

UniversityR&D

TechnologyEngine

EntrepreneurialCulture

AvailableVentureFinance

The Road Less Traveled – new ventures are critical to our economic health and success!

The team, the plan, and a good finance strategy are key

A “startup culture” has to be nurtured

Arkansas is taking steps to create the right environment

Raising Capital to Fund Growth

Jeff Amerine, PMPTechnology Licensing Officer

Adjunct Instructor, EntrepreneurshipUniversity of Arkansas

Advisor, Innovate Arkansasjamerine@uark.edu

“Techpreneurship Blog”http://blog.innovatearkansas.org