Financing a Startup

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  • It is always a pleasure to be here with Dr. McQueen and his great students. You are having a wonderful experience, difficult as it may seem, an experience that is as a result of your first and most correct business decision, to get a solid education. I understand that you are getting more than you bargained for as the business school is now considered a top 25 school. The students and faculty are to be congratulated for that.
  • My job today is to discuss Raising Money in Small Company Environments. ( 30-300 employees) I want you to know that we will just scratch the surface today. You need to know that the views expressed her are my own, developed over 20 years managing small to medium sized businesses. There is no one way to think about any of this. If there is a skill you can develop in business it is flexibility in thought and approach. No matter where we are in our careers, we must guard against falling in love with one technology or methodology or operating procedure. The world is changing rapidly and technologies and methodologies are changing with it. Like Broken Field Running. Every step may require a new decision.
  • In order for you to appreciate my message today, it will be helpful to know a little bit about me. I am a farm boy from Southern Idaho, married with five children, the youngest of which is a senior in HS, the oldest just graduated from Law School. Dr. McQueen has forgiven me for my past affiliations, giving me an opportunity to make up for it by talking with you today. But speaking of broken field running…. Most of my business life has been in the Boston area with a few years in San Diego before moving here to do a startup SW company in 1993. I have focused upon small to medium companies that are undervalued/undermanaged/Underfunded/troubled.
  • Speaking of the inability to raise money, if you are going to start a business, you will have to have money. You will usually need a lot more than you think. In fact my rule of thumb is that you should do your best thinking in determining the amount needed and then multiply by four, Dr. McQueen says five. Chuck M. Experience. This is very common and probably the most prevalent cause of business failure. Four Early Stage Deals: $7, $18, $10 and $20 so far. The last one needed about $3 mil more and could not get it and as a result will not be able to achieve its potential. A couple of years ago, the average cost of starting a successful SW company in Silicon Valley was $16 mil.
  • Read the bullet points on the slide. Most small to medium sized companies raise money from one or more of these sources.
  • Let’s talk about Venture Capital
  • The venture world has been turned upside down in the last three years. The amount of money invested is way down from its peak during Q1, 2000. Last quarter investments totaled about $4 bil compared to $29 bil in Q1 2000. Last quarter, and for the last four quarters we were back to Q4, 1997 levels.
  • What is going on? The late ’90s as you know was a period of, as Alan Greenspan complained, Irrational Exuberance. The economy was extraordinarily strong, producing tremendous wealth for individuals. Much of that wealth was channeled into VC, so much that VCs had trouble investing it wisely. Coupled with the expansion of Internet technologies, yet to be rationalized and understood, the stage was set for thousands of bad investments. Felda Hardymon, a very experienced VC with Bessemer told me that they were making deals in six weeks, half the time of their normal process, in order to keep up with the rapid expansion of must-have ideas and business plans. He was so excited that he suggested that I invest fully half my available funds in Dot Com funds. Eighteen months later, $1 mil invested in such funds would be worth about $100k. Hundreds of billions were lost, much of it by VCs. Read the ponts on the slide.
  • Venture Capitalists have a reputation to uphold. They are often referred to as Vulture Capitalists . Read the points on the slide. This reputation is well deserved, especially if things don’t go well at the company.
  • However, we need to cut them some slack. They perform a vital role in the economy. Read the slide points.
  • The scenario which I am about to describe is, to some degree, the basis for the bad rap we lay on the VC. Read the points on the slide
  • Read the points on the slide. If you think that this is unusual, you would be mistaken. But, when things go well, VCs can be an invaluable resource for management guidance, contacts and of course, more money.
  • Generally, you could raise money from VCs if you had the following: Credible Management team: Experience and knowledge in the field. A large Market: They must see a way to create $50-$100 mil in value. Requires a market consistent with that goal. In other words if you want to start a company making arrows or LDS oriented Christmas ornaments it is unlikely that you could achieve this kind of value and thus attract significant VC. A great idea with a great bus plan: You better have done your homework. Must have thought of every detail.
  • Read the points on the slide.
  • Read the points on the slide.
  • One of the most challenging aspects of choosing to work in a small company is the difficulty of assessing risk. If people could accurately assess the risk, I am convinced that nobody would do it, any more than you would try to cross I15 at rush hour. There you can assess the risk. There is business risk, technology risks, political risks and career risks. VCs are in the business of taking large risks but they go to extraordinary lengths to reduce the risks they face. Control position: It is always understood that they may need to throw some or all of the mng team out at some point along the way. CGX 13 VPs, I was the 4 th president at the last company. Founders and VPs gone. Seasoned Mngt: If you want to start a business in a market you know nothing about, they will probably not work with you. Read last two points
  • Describe Sandlot Cap Table, preferred stock and LP and its affect on employees ownership. Veto Power: Sun Dog sold one day out of the blue. Get in your face: 27 year old, fresh out of B school
  • Read the points of the slide. Professional money managers try very hard to diversify their investment risks. A properly balanced portfolio must include investments on the risky end of the scale. For this reason, even large conservative portfolios such as pension funds, insurance contingency funds will invest with VCs. (Utah Pension Funds) The top VC funds will also often actually funnel excess dollars into other VC funds as a means to both put the money to work and to diversify the risk.
  • There are about 600 VC firms in the US located in every state. They range from two guys and a dog to a hundred or more employees. Sometimes they are categorized by their industry, geographic and round / class preference. For example my friend Neil Ryan of Oxford Biosciences invest exclusively in Biomedical companies because he knows most about that industry and the products. The guys at Innocal of Orange County do not like to do deals in Utah because they like to take an active role and don’t want to have to travel to do it. Bessemer Venture Partners usually do later stage deals because they want others to take those initially, very dangerous seed rounds. Larger VC firms may accept deals in all categories.
  • Are there any questions?
  • Read the points on the slide. Diversifying own portfolios: They want to take advantage of the potential of high risk/high reward opportunities. They perform a useful role, investing in seed situations which are less and less attractive to major VCs.
  • Read the points of the slide Less sophisticated evaluation: Sabin / Young Bros Move quickly: Bill Pope decision.
  • Read the points of the slide Smaller amounts of money: Implication is that you wind up with more investors to deal with . This can be time consuming and causes problems later when it is time to merg, sell or pursue changes in the business plan. May be some legal problems selling stock to “unqualified” investors. Less staying power means that when you need money later they may or may not be able to provide it.
  • The last source we will talk about and the one that I feel is the most advantageous to the small company is Strategic partners.
  • Read the points on the slide. For Example: Andy Evans: Sun Dog. $3.4 vs $78 to combine with Andy’s products. Let me give you several examples from ViewSoft, a SW an Internet applications deployment company we sold to Citrix Systems in 1999. Getz Brothers, Tandem Computers, ETF, Citrix
  • Read the points on the slide Cost of Money lower: You save more of the ownership for yourself. They don’t care about the valuation as much as they do their own products or plan. Sometimes this creates strange bedfellows. You are aware that MS has invested hundreds of millions of dollars in Apple Computer. Why would they do that? Other Benefits-Read Slide
  • Are there any questions about strategic partners?
  • Who here considers himself or herself an entrepreneur? Read the points on the slide. Assemble good Mngt Team: Look for those who have been trained in professional environments. Spend five to seven years at an organization that will teach you about marketing, finance or development. Then go do your thing. Pursue a good idea: Do your homework. Be persistent: Kyle Love, ViewSoft should have gone out of business several times.
  • Once again, I am pleased to have been here this morning. Thank you for your questions and attention. May I close with this thought: Because of the uncertain nature of entrepreneurism and working with small companies, don’t neglect to get all the education you can get while you can. Starting your own company or getting in on the ground floor is not a substitute for a good formal education, even if you believe that you will make a million dollars. If you continue to grow in your profession, that MBA on your resume will be significant over and over again your whole life. Thank you.

Transcript

  • 1. Raising Money in Small Companies November 11, 2004 Dale H. Munk
  • 2. Raising Money in Small Companies November 11, 2004 One Man’s View
  • 3. Background
    • -Farmer from Southern Idaho
    • -Married, Five Children
    • -MBA from the Other School in Utah
    • -Business Locations Boston, San Diego and Provo
    • -Focused on Small to Medium Sized Companies / Troubled
  • 4. Money
    • -Almost All Businesses Need It
    • -You Need Much More than You Think
    • -Bad Things Happen if You Can’t Get It
    • -Survive or Capitalize on Opportunities
  • 5. Three Primary Sources of Financing
    • - Venture Capitalists
    • -Angel Investors
    • -Strategic Partners
  • 6. Three Primary Sources of Financing
    • -Venture Capitalists
    • -Angel Investors
    • -Strategic Partners
  • 7. Dramatic Upheaval
    • -First Quarter, ’00 the Zeneth-$29 Bil
    • -Last Quarter-$5.9 Bil
    • -Last Quarter at-Q4, 1998 Levels
  • 8. Dramatic Upheaval
    • -In Q1 2000, Invest in Any Crazy Idea
    • -Today, Better Have a Great Plan
    • -Startup Investments are Sparce
    • -Old Deals are on Life Support
  • 9. Vulture Capital
    • -Waiting to Pick the Bones
    • -Greed and Fear-Mostly Greed
    • -Demand 50%-70% of the Company
    • -Ruthless with Management
  • 10. A Kinder, Gentler View
    • -Providing Fuel for Ideas
    • -Facilitate the Advancement of Technology
    • -Take Big Risks / Should Get Big Rewards
  • 11. Vulture Capital Scenario Local Current Example
    • -Three Founders Raied $2 Mil from Friends and Family
    • -Worked Like Dogs for Eight Years
    • -Suffered
    • -Went to VCs for Rescue
  • 12. Vulture Capital Scenario Local Current Example
    • -Took 60%, 25% and 25% in Three rounds
    • -Founders Now Hold 1.2% But are at the Bottom of the Waterfall. Will Get Nothing
    • -Lost Their Jobs to Boot
  • 13. Qualify for Venture Capital If You Have
    • -A Credible Management Team
    • -A Large Market
    • -A Great Idea With a Great Bus Plan
    • -A Credible Exit Strategy
  • 14. Qualify for Venture Capital If You Have
    • -Ability to Provide 5-10 X Investment
    • -Over 3-5 Years
    • -Implying Ability to Create $50-100 Mil Valuation
  • 15. How They Think?
    • -Philosophy of 3 of 10 is Good Enough
    • -A Few Losers, A Few Winners, A few Marginal
    • -Parametric Technologies
    • -It is About Managing Risk
  • 16. Managing Risk
    • -Take Controlling Position (50%-70%)
    • -Invest in Seasoned Management
    • -Conduct Extensive Due Diligence
    • -Invest Small Amounts in Many Deals
  • 17. Managing Risk
    • -Insist on Preferred Stock, Liquidation Preferences, Anti-Dilution Provisions and Dividends
    • -Require Board Seats
    • -Seek Veto Power on Major Decisions
    • -Get in Your face
  • 18. Where Do They Get Their Money?
    • -Wealthy Individuals
    • -Insurance Companies
    • -Pension Funds
    • -Other VC Funds
  • 19. Venture Capital
    • -About 700 (1300) in the US
    • -Industry Preference
    • -Geographic Preference
    • -Round / Class Preference
  • 20. Venture Capital
    • Questions?
  • 21. Three Primary Sources of Financing
    • -Venture Capitalists
    • -Angel Investors
    • -Strategic Partners
  • 22. Angels
    • -Wealthy Individuals
    • -Diversifying Their Own Portfolios
    • -Usually Not Part of Organized Group
  • 23. Angels
    • -More Hands Off than VCs
    • -Less Sophisticated Risk Evaluation
    • -Move More Quickly
    • -Easier to Control
  • 24. Angels
    • -Pay Higher Price
    • -Willing to Do Seed
    • -Invest Smaller Amounts
    • -Less Staying Power
  • 25. Angels
    • Questions?
  • 26. Three Primary Sources of Financing
    • -Venture Capitalists
    • -Angel Investors
    • -Strategic Partners
  • 27. Strategic Partners
    • -Investments Leverage Their Own Business Initiatives
    • -ROI Not Measured by Money on Money
  • 28. Strategic Partners
    • -Cost of the Money is Lowest
    • -Other Benefits: Validation, Testing, Marketing Help, Rollout
    • -In Your Face for All the Right Reasons
  • 29. Strategic Partners
    • Questions?
  • 30. Keys to Raising Money
    • -Assemble a Good Management Team
    • -Pursue a Good Idea / Test, Validate, Study it Out
    • -Quadruple Best Cash Needs Estimates
    • -Be Persistent-Hang In There
  • 31. Raising Money in Small Companies March 2, 2004 Questions