Lead to Win Financing the Business July 30, 2009 Morning Chuck Colford, CEO – Congruance IT, Inc. Ken Charbonneau, CA, CPA - KPMG

Module Objectives You will know about: Types of instruments for financing Sources of money Money raising process Pitching to investors Deal parameters Bootstrapping Key Financing Principles You will be able to: Plan to finance your business Understand dilution of ownership and control Anticipate and appeal to investor needs Know key benefits and pitfalls of various approaches Better understand and manage your downside risks Improve your prospects for closing good financing deals What Where Who How When

You will know about:

Types of instruments for financing

Sources of money

Money raising process

Pitching to investors

Deal parameters

Bootstrapping

Key Financing Principles

You will be able to:

Plan to finance your business

Understand dilution of ownership and control

Anticipate and appeal to investor needs

Know key benefits and pitfalls of various approaches

Better understand and manage your downside risks

Improve your prospects for closing good financing deals

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

Financing Sources Founders, Family, Friends Angel or Private Investors Commercial Banks Investment Banks & Boutiques Governments Venture Capital Firms (US, CDN, Intl) Public Markets Customers

Founders, Family, Friends

Angel or Private Investors

Commercial Banks

Investment Banks & Boutiques

Governments

Venture Capital Firms (US, CDN, Intl)

Public Markets

Customers

Financing “Surrogates” – The Usual Suspects Factoring Boutiques Payday advance for businesses Cash now in exchange for discounted receivables Agents, Underwriters Facilitators who will “help” you raise money – in exchange for… Influence peddlers Look like agents, but may just waste your time Some may damage your credibility and impair you Criminals Looking for creative ways to launder money May destroy your credibility and reputation Be careful – Not everyone is what they appear to be

Factoring Boutiques

Payday advance for businesses

Cash now in exchange for discounted receivables

Agents, Underwriters

Facilitators who will “help” you raise money – in exchange for…

Influence peddlers

Look like agents, but may just waste your time

Some may damage your credibility and impair you

Criminals

Looking for creative ways to launder money

May destroy your credibility and reputation

Financing – Core Principle ALL money comes with strings attached – Know what they are! Know who they obligate you to Know your downside (protect if possible) Understand what you are getting into

ALL money comes with strings attached – Know what they are!

Know who they obligate you to

Know your downside (protect if possible)

Understand what you are getting into

Source: Founders , Family, Friends Pitfalls Cash may be limited There is a difference between losing your shirt vs. all your shirts plus the closet they hang in. Consider impact if… (divorce of a spouse, founder fails to pull weight, or leaves…) Easy to protect downside (Shareholders agreement) Core group Value of commitment often greater than money Instruments: Equity or Loans For better or worse… Chose wisely Benefits: Already known (usually) Aligned interests Skin in the game Significant support given Relatively simple terms Easy closing Don’t forget - Spouses have skin in the game too

Pitfalls

Cash may be limited

There is a difference between losing your shirt vs. all your shirts plus the closet they hang in.

Consider impact if… (divorce of a spouse, founder fails to pull weight, or leaves…)

Easy to protect downside (Shareholders agreement)

Benefits:

Already known (usually)

Aligned interests

Skin in the game

Significant support given

Relatively simple terms

Easy closing

Source: Founders, Family, Friends Pitfalls Funds may be limited, but possibly sufficient Consider their exit – when will they need their money back Hard to protect downside Possible severe long term consequences If the company fails or you lose control – they may be hard to face May cost you family & friends Easiest to find Instruments: Equity or Loans May not be the easiest to live with Benefits: Already known – no hunt Relationship to leverage Aligns with your interests Not cross purpose Simple deal terms Easy closing Consider impact of subsequent financings on them

Pitfalls

Funds may be limited, but possibly sufficient

Consider their exit – when will they need their money back

Hard to protect downside

Possible severe long term consequences

If the company fails or you lose control – they may be hard to face

May cost you family & friends

Benefits:

Already known – no hunt

Relationship to leverage

Aligns with your interests

Not cross purpose

Simple deal terms

Easy closing

Source: Angel or Private Investors Pitfalls Finite cash - may be insufficient If you need many – harder to herd eagles Activist investors – some may not be compatible Endangered species – many ravaged by VCs Likely will NOT participate in deals with downstream VC plans Lookout for surrogates (big talkers) Hard to find Instruments: Equity or Loans Angels deserve their name – If you go this route protect them downstream Benefits: Opportunistic – may be just the right sized deal Can help with heavy lifting – in the business and further financing Similar backgrounds – usually they are successful entrepreneurs Sources of support and counsel – not just money Their experience & insight can be BIG help

Pitfalls

Finite cash - may be insufficient

If you need many – harder to herd eagles

Activist investors – some may not be compatible

Endangered species – many ravaged by VCs

Likely will NOT participate in deals with downstream VC plans

Lookout for surrogates (big talkers)

Benefits:

Opportunistic – may be just the right sized deal

Can help with heavy lifting – in the business and further financing

Similar backgrounds – usually they are successful entrepreneurs

Sources of support and counsel – not just money

Example – Why protection is needed “ Concentration of Debt and Share Ownership: The majority of the Company’s long term debt as well as the issued and outstanding common shares of the Company are held, owned or controlled by funds, subsidiaries or parties associated with Vengrowth Asset Management Inc. and Wellington Financial LP. As a result of this significant position of influence over most elements of the Company’s overall capital structure, these parties have the ability to elect all of the Company’s directors and to determine the outcome of most corporate actions requiring lender and shareholder approval irrespective of how other shareholders of the Company may vote.” - Source: Google (Management’s Discussion & Analysis, Nexient Learning Inc., 2008) A common challenge

“ Concentration of Debt and Share Ownership:

The majority of the Company’s long term debt as well as the issued and outstanding common shares of the Company are held, owned or controlled by funds, subsidiaries or parties associated with Vengrowth Asset Management Inc. and Wellington Financial LP. As a result of this significant position of influence over most elements of the Company’s overall capital structure, these parties have the ability to elect all of the Company’s directors and to determine the outcome of most corporate actions requiring lender and shareholder approval irrespective of how other shareholders of the Company may vote.”

- Source: Google (Management’s Discussion & Analysis, Nexient Learning Inc., 2008)

Source: Commercial Banks Pitfalls Hard to get Risk averse - Need collateral to offset their risk Receivables Assets purchased Loans can be called in “ A banker is someone who will loan you money – when you no longer need it” – Anon Instruments: Debt Benefits: Easy to find Lots of cash Simple terms on deals Good lines of credit as your business ramps Your business builds credibility Money gets easier A good banker can provide valuable referrals

Pitfalls

Hard to get

Risk averse - Need collateral to offset their risk

Receivables

Assets purchased

Loans can be called in

Benefits:

Easy to find

Lots of cash

Simple terms on deals

Good lines of credit as your business ramps

Your business builds credibility

Money gets easier

Source: Financial Companies, Boutiques Pitfalls As specialists, they may be running the table terms may heavily favour their side May have high costs relative to the risk they assume Can prey on desperation Instruments: Debt, Equity or hybrids Factoring Preferential Debt (e.g. bridge loans) Benefits: Specialize in specific types of transactions well suited in certain circumstances Often complex Terms and Conditions Consider each on its own merit – with counsel

Pitfalls

As specialists, they may be running the table

terms may heavily favour their side

May have high costs

relative to the risk they assume

Can prey on desperation

Benefits:

Specialize in specific types of transactions

well suited in certain circumstances

Often complex Terms and Conditions

Source: Governments Pitfalls Each process takes time and has reporting demands May be at odds with normal business goals Look closely at strings A 50 cent dollar is still not free So many programs… Must manage the distractions and time demands on small team Instruments: Cash, Tax Credits, Low (or No) interest loans IRAP, SRED EDC, NSERC R&D, GOA (PEMD), CED-CFCD, CLD, … Benefits: Significant capital to deploy No dilution Limited obligation to repay grants Low cost of cash Everything from feasibility studies to commercialization & beyond may qualify Transparent Need to stay on target (Can’t chase everything) Hire help to manage processes as required.

Pitfalls

Each process takes time and has reporting demands

May be at odds with normal business goals

Look closely at strings

A 50 cent dollar is still not free

So many programs…

Must manage the distractions and time demands on small team

Benefits:

Significant capital to deploy

No dilution

Limited obligation to repay grants

Low cost of cash

Everything from feasibility studies to commercialization & beyond may qualify

Transparent

Source: Venture Capital Firms Pitfalls Want to exit, not own Huge demands on time Onerous Terms Tranches Poison follow-on deals Cram downs Tinkering (experience mismatch, favours) Burn & Churn - Founder rollover, high burn rates May panic prematurely They may also be in jeopardy Canadian, US, and Int’l have differences Instruments: Equity, Convertible Debt Benefits: Good ones can help you win - Go Big plays Some have vast capital reserves to deploy Can help you go IPO Can help you secure loans May have experience in the space Some have winning track records – that repeat All VCs are not equal - Is your Partner a partner?

Pitfalls

Want to exit, not own

Huge demands on time

Onerous Terms

Tranches

Poison follow-on deals

Cram downs

Tinkering (experience mismatch, favours)

Burn & Churn - Founder rollover, high burn rates

May panic prematurely

They may also be in jeopardy

Benefits:

Good ones can help you win - Go Big plays

Some have vast capital reserves to deploy

Can help you go IPO

Can help you secure loans

May have experience in the space

Some have winning track records – that repeat

Source: Equity Markets Pitfalls Too daunting for early stage companies Prospectus and underwriting are complex Reporting burden (SarbOx, et.al.) Harsh audit, compliance & legal costs Many players – many middle men to feed CPC can put you in a fishbowl with little cash Surrogates abound IPO, TSX, NASDAQ, OTC, Pink Sheets Capital Pool Company (CPC) - Reverse takeover transaction Benefits: Lots of cash out there Recipes are known Mismatched for early stage companies

Pitfalls

Too daunting for early stage companies

Prospectus and underwriting are complex

Reporting burden (SarbOx, et.al.)

Harsh audit, compliance & legal costs

Many players – many middle men to feed

CPC can put you in a fishbowl with little cash

Surrogates abound

Benefits:

Lots of cash out there

Recipes are known

Source: Customers Pitfalls Pacing of growth less than equity financings Innovators Dilemma risk Hostage to established solution – vs disruptive solutions Getting off plan too far Scalability Services ramp slower than product Retention of IP ownership Instruments: Income (Invoices), Equity Bootstrapping Benefits: Pay as you go Validate business model Endorsements Retained earnings May pay dividends May be able to make strategic investments Referrals to more customers Yes Virginia – There is a Santa Clause May be ideal – If your solution can get early wins

Pitfalls

Pacing of growth less than equity financings

Innovators Dilemma risk

Hostage to established solution – vs disruptive solutions

Getting off plan too far

Scalability

Services ramp slower than product

Retention of IP ownership

Benefits:

Pay as you go

Validate business model

Endorsements

Retained earnings

May pay dividends

May be able to make strategic investments

Referrals to more customers

Yes Virginia – There is a Santa Clause

Source: Criminals Pitfalls Prey on your need Often very well disguised Easy to fall victim May irreparably damage the business and your reputation Downside protection: Trust “spider senses” Reverse due-diligence Quality legal counsel, solid paperwork You are judged by the company you keep. Benefits: Seemingly unlimited supply of money Unfortunately - it is NOT good money. Don’t be naïve – Don’t get burned

Pitfalls

Prey on your need

Often very well disguised

Easy to fall victim

May irreparably damage

the business and

your reputation

Downside protection:

Trust “spider senses”

Reverse due-diligence

Quality legal counsel, solid paperwork

Benefits:

Seemingly unlimited supply of money

Unfortunately - it is NOT good money.

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

Instruments for Financing Your Business Pure forms Equity (Common and Preferred Shares) Money raised by selling a portion of ownership Debt (Loans) Money raised by borrowing – obligation to repay Gifts (Grants, Incentives, Awards) Seemingly “free” money Income (Revenue, Investment) Sales, Investment Returns and Interest Hybrid forms Convertible debentures Factoring receivables or credits Any blend of the above… (Barter – In lieu of Cash) Raising Cash

Pure forms

Equity (Common and Preferred Shares)

Money raised by selling a portion of ownership

Debt (Loans)

Money raised by borrowing – obligation to repay

Gifts (Grants, Incentives, Awards)

Seemingly “free” money

Income (Revenue, Investment)

Sales, Investment Returns and Interest

Hybrid forms

Convertible debentures

Factoring receivables or credits

Any blend of the above…

(Barter – In lieu of Cash)

Equity - All equity is not equal Common Shares represent Proportional ownership of a company A residual claim to the earnings and assets of the company Entitlement of dividends Voting rights Preferred Shares represent Voting rights Proportional ownership of a company Priority claim on dissolution up to par value Priority claim to dividends at a fixed rate No voting rights unless otherwise specified VC’s typically vote preferred shares “on an as converted basis” A permanent form of financing Slide

Common Shares represent

Proportional ownership of a company

A residual claim to the earnings and assets of the company

Entitlement of dividends

Voting rights

Preferred Shares represent

Voting rights

Proportional ownership of a company

Priority claim on dissolution up to par value

Priority claim to dividends at a fixed rate

No voting rights unless otherwise specified

VC’s typically vote preferred shares “on an as converted basis”

Debt - comes in many shapes & forms Debentures Bond or promissory note to pay a fixed sum Not secured by a mortgage or a claim on a specific asset Supported by the general creditworthiness of the borrower Asset backed loans Secured by a mortgage or claim on a specific asset Capital and operating Leases Revolving credit bank loans An agreement to extend credit up to a predetermined maximum Unlike equity, repayment is required! Slide

Debentures

Bond or promissory note to pay a fixed sum

Not secured by a mortgage or a claim on a specific asset

Supported by the general creditworthiness of the borrower

Asset backed loans

Secured by a mortgage or claim on a specific asset

Capital and operating Leases

Revolving credit bank loans

An agreement to extend credit up to a predetermined maximum

Shares and debt are often convertible Preferred shares Risk reduction – priority claim Improved ROI – fixed dividend Vehicle for valuation ratchets Debentures Vehicle for bridge financing Dodges valuation considerations Converting shares and debt to common shares Slide

Preferred shares

Risk reduction – priority claim

Improved ROI – fixed dividend

Vehicle for valuation ratchets

Debentures

Vehicle for bridge financing

Dodges valuation considerations

Other equity vehicles Options & Warrants Convey the right to buy common shares at a specified price on or until a specified date Can be used to Incent employees and management Provide “Sweeteners” to investors Dilute founders Equity may not be permanent when it is Redeemable Can be repurchased and cancelled for cash or other consideration at the option of the issuer (i.e. the company) Retractable Can be tendered for repayment and cancellation at the option of the investor Options & warrants - a right but not an obligation Equity may not be permanent and look like debt Slide

Options & Warrants

Convey the right to buy common shares at a specified price on or until a specified date

Can be used to

Incent employees and management

Provide “Sweeteners” to investors

Dilute founders

Equity may not be permanent when it is

Redeemable

Can be repurchased and cancelled for cash or other consideration at the option of the issuer (i.e. the company)

Retractable

Can be tendered for repayment and cancellation at the option of the investor

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

Process is Important – Prepare & Plan Before you try to raise money: Founders need to align on approach Corporate structure matches the approach above Phases are distinct and may be financed differently How much money do you need? Now? Later on? Need a Business Plan summary Need a Financing Plan Create a Pitch (elevator speech + presentation) Iterate as you learn Sort out how to divide and conquer the work Warning: Failure to properly address steps 1 & 2 above can be severely debilitating, or even fatal Yet it is often overlooked… One size does not fit all - Figure out what fits your business. Don’t misfire – Usually get only 1 chance per prospect.

Before you try to raise money:

Founders need to align on approach

Corporate structure matches the approach above

Phases are distinct and may be financed differently

How much money do you need? Now? Later on?

Need a Business Plan summary

Need a Financing Plan

Create a Pitch (elevator speech + presentation)

Iterate as you learn

Sort out how to divide and conquer the work

Warning:

Failure to properly address steps 1 & 2 above can be severely debilitating, or even fatal

Yet it is often overlooked…

Your Corporate Structure is Important Enables how you inject money into business Enables how money (and profits) get paid out Enables who controls the business Voting rights Board seats “The CEO serves at the pleasure of the Board” Captures and discloses any special rights Determines how boundary conditions will be resolved Disputes Departures Changes of control Getting money out Calling the shots

Enables how you inject money into business

Enables how money (and profits) get paid out

Enables who controls the business

Voting rights

Board seats

“The CEO serves at the pleasure of the Board”

Captures and discloses any special rights

Determines how boundary conditions will be resolved

Disputes

Departures

Changes of control

Corporate Structure - Examples Taking the VC Route CCPC Federal + US subsidiary (Delaware) Enables Cdn VC to invest Allows US VC to invest later and flip parent Careful – VCs will want control as early as possible Board will be more complex – multiple interests Taking a bootstrapping route Can start with sole proprietorship early and flip Incorporate federally or provincially Different classes of shares for different players e.g. Founders, Spouses, Family Trusts Enables good use of dividend tax advantages and income splitting Small board (even sole Director) OK One size does not fit all

Taking the VC Route

CCPC Federal + US subsidiary (Delaware)

Enables Cdn VC to invest

Allows US VC to invest later and flip parent

Careful – VCs will want control as early as possible

Board will be more complex – multiple interests

Taking a bootstrapping route

Can start with sole proprietorship early and flip

Incorporate federally or provincially

Different classes of shares for different players

e.g. Founders, Spouses, Family Trusts

Enables good use of dividend tax advantages and income splitting

Small board (even sole Director) OK

Process is Important – “The Deal” After you have planned execute the financing plan Raise Money: Make connections Work the pipeline Ask for money Discuss the deal terms Due diligence (Reverse due diligence) Paper the agreement – Ts and Cs Closing Deposit the proceeds Celebrate Repeat as required $$$ Leads $

After you have planned

execute the financing plan

Raise Money:

Make connections

Work the pipeline

Ask for money

Discuss the deal terms

Due diligence (Reverse due diligence)

Paper the agreement – Ts and Cs

Closing

Deposit the proceeds

Celebrate

Your First Financing Founders inject capital Who will be the founders Maybe only $10 Pure equity – can be various classes Founders agreement Incorporation Shareholders register and Cap Table Open bank account Your first bank deposit Celebrate Get off to a good start Many founders forget this round – and it haunts them later! Recall the process: Make connections Work the pipeline Ask for money Discuss the deal terms Due diligence (Reverse due diligence) Paper the agreement – Ts and Cs Closing Deposit the proceeds Celebrate What Ts & Cs to consider?

Founders inject capital

Who will be the founders

Maybe only $10

Pure equity – can be various classes

Founders agreement

Incorporation

Shareholders register and Cap Table

Open bank account

Your first bank deposit

Celebrate

Recall the process:

Make connections

Work the pipeline

Ask for money

Discuss the deal terms

Due diligence (Reverse due diligence)

Paper the agreement – Ts and Cs

Closing

Deposit the proceeds

Celebrate

Financing – Core Principle Good paper is like a good parachute – It may not let you down gently, but it improves survival odds. Goal: To clearly agree on “what we all agree on” Easier when everything is friendly and not stressed Everyone understands their rights and obligations Know up front what happens in the event of… Death, Divorce, Failure of commitment, Change of control, Resignations and Terminations Actually lowers stress when the rules are known Saves money on lawyers to sort it out later reduces distractions at the “worst possible times”

Good paper is like a good parachute – It may not let you down gently, but it improves survival odds.

Goal: To clearly agree on “what we all agree on”

Easier when everything is friendly and not stressed

Everyone understands their rights and obligations

Know up front what happens in the event of…

Death, Divorce, Failure of commitment, Change of control, Resignations and Terminations

Actually lowers stress when the rules are known

Saves money on lawyers to sort it out later

reduces distractions at the “worst possible times”

Financing - Exercise How far along are you? Show of hands Poll the room 30 minutes - Breakout into groups of 8 or less Handouts – Typical Ts & Cs for founders Appoint a scribe Discuss items – Are some more relevant? Why? 20 minutes – Return & Share Key findings from each group Class discussion Review some typical shareholder agreement terms Group discussion

How far along are you?

Show of hands

Poll the room

30 minutes - Breakout into groups of 8 or less

Handouts – Typical Ts & Cs for founders

Appoint a scribe

Discuss items – Are some more relevant? Why?

20 minutes – Return & Share

Key findings from each group

Class discussion

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

Network to find investors Referrals Not Cold-calling Consider: Who is active in your space Who can open doors Who can assist with execution of the plan Manage money hunt just like sales It is a pipeline Many leads will not pan out Allocate resources as probability increases Requires tracking and follow-up Ask for the money Slide "Referrer Trust Index” Syndicate Lead Portfolio Companies Business Associates Friends

Referrals

Not Cold-calling

Consider:

Who is active in your space

Who can open doors

Who can assist with execution of the plan

Manage money hunt just like sales

It is a pipeline

Many leads will not pan out

Allocate resources as probability increases

Requires tracking and follow-up

Ask for the money

Develop a Simple Pitch – Sample Outline Build interest in first 10 minutes or risk getting cut off. Experience shows 12 charts is about max! 7-8 slides = 15-20 mins. 12 charts = 25-30 mins. You don’t need to tell them everything on first date. Secure interest for a follow-on meeting. Slide Introduce yourselves – and show depth of team The Team What you are asking for; Use of Proceeds, Exit strategy. The Close Previous deals; Valuation; Ownership (as relevant) Current Structure 1 st year monthly, 5 year projection, cash management Financial Plan Key achievements and future milestones Progress to Date Incumbent & emerging players; How you differentiate Competitive Position Sales cycle, Value chain, channels or partners Go to Market Pricing, margins, COGS, sensitivity Business Model Your technology or other unfair advantage Your IP How you solve the customer’s pain? Your Solution Size and growth of market; window of opportunity The Market Who are they? What is their challenge? Customer’s Pain

A real deal begins with a Term Sheet The “Show Me Yours And I’ll Show You Mine” stage Asking for a Term Sheet vs. presenting one Deal litmus for both sides Identifies key deal terms on a broad basis Allocates risk Allocates rewards Allocates control Establishes valuation expectations Don’t accept it on the spot You need to understand it, negotiate, possibly say no Slide

The “Show Me Yours And I’ll Show You Mine” stage

Asking for a Term Sheet vs. presenting one

Deal litmus for both sides

Identifies key deal terms on a broad basis

Allocates risk

Allocates rewards

Allocates control

Establishes valuation expectations

Don’t accept it on the spot

You need to understand it, negotiate, possibly say no

Negotiation is a process of allocating risk & return – On both sides Founders’ incentives Valuing the company Control decision making Investor downside protection DEAL TERMS Slide

All deal terms must be considered Provisions to align founder’s incentives: Performance and forfeiture provisions Stock options/grants Vesting schedules Provisions to control decision making (veto rights): Board rights Super-majority rights Addition of management team Terms of employment contract (e.g. buyback provisions, non-compete clauses etc.) Slide Provisions to protect investor financial downside: Staging capital infusions (tranches) Anti-dilution provisions Liquidation preferences Put rights Automatic conversion Piggyback rights Demand rights Other Provisions Valuation Who bears legal costs Timeframes Corporate Structure Changes

Provisions to align founder’s incentives:

Performance and forfeiture provisions

Stock options/grants

Vesting schedules

Provisions to control decision making (veto rights):

Board rights

Super-majority rights

Addition of management team

Terms of employment contract (e.g. buyback provisions, non-compete clauses etc.)

Provisions to protect investor financial downside:

Staging capital infusions (tranches)

Anti-dilution provisions

Liquidation preferences

Put rights

Automatic conversion

Piggyback rights

Demand rights

Other Provisions

Valuation

Who bears legal costs

Timeframes

Corporate Structure Changes

Valuation Striking a valuation (or share price): Is much easier before you get too far in Founders by in cheap …but pay for it with sweat & risk By proxy Whatever is a reasonable value for a similar company in a similar business at a similar stage By negotiation Discounted cash flows, Milestones achieved Whatever you can agree on with an investor By 3 rd party Valuation assessment can be expensive Put off until later Convertible debenture – flip to equity later on Building value raises the price – Job #1 Unless you get crammed down Or fail to execute

Striking a valuation (or share price):

Is much easier before you get too far in

Founders by in cheap

…but pay for it with sweat & risk

By proxy

Whatever is a reasonable value for a similar company in a similar business at a similar stage

By negotiation

Discounted cash flows, Milestones achieved

Whatever you can agree on with an investor

By 3 rd party

Valuation assessment can be expensive

Put off until later

Convertible debenture – flip to equity later on

Valuation – Core Principle In Julius Caesar’s Rome, "the fire department" was a group of slaves, carrying around advanced (at that time) pumps. Roman fires tended to be very violent and widespread, so the slaves were naturally slow to respond, thereby enhancing their own safety. As a result, there was a lack of effective firefighting. One clever businessman, Marcus Licinius Crassus, created a private fire department. He and his slaves would go to a burning house and if he believed the building was worth saving, he would attempt to buy it from the distraught owner at a huge discount. As the building continued to burn, he would offer less and less money. As soon as the owner relented to sell to Crassus, his slaves would put out the fire, subsequently repairing and reselling the property. Crassus made a fortune with this approach, which has been adapted with success to the present day. Marcus L. Crassus – The first VC? Valuations are higher when you are not desperate.

In Julius Caesar’s Rome, "the fire department" was a group of slaves, carrying around advanced (at that time) pumps. Roman fires tended to be very violent and widespread, so the slaves were naturally slow to respond, thereby enhancing their own safety. As a result, there was a lack of effective firefighting.

One clever businessman, Marcus Licinius Crassus, created a private fire department. He and his slaves would go to a burning house and if he believed the building was worth saving, he would attempt to buy it from the distraught owner at a huge discount. As the building continued to burn, he would offer less and less money. As soon as the owner relented to sell to Crassus, his slaves would put out the fire, subsequently repairing and reselling the property.

Crassus made a fortune with this approach, which has been adapted with success to the present day.

Be prepared for due diligence Fact checking and so much more Due diligence begins with the first meeting & never ends Reverse Due Diligence – Check out your investors – talk to some of their other investees Rep’s and Warrantee's may be required – Use good counsel Tips Be prepared with documents and references Don’t burn out your references – Wait until you are well along with an investor Push the process, don’t be pulled Remember buyer behaviour – Cognitive dissonance Don’t lose credibility – it’s better to tell them than for them to find out Slide

Fact checking and so much more

Due diligence begins with the first meeting & never ends

Reverse Due Diligence – Check out your investors – talk to some of their other investees

Rep’s and Warrantee's may be required – Use good counsel

Tips

Be prepared with documents and references

Don’t burn out your references – Wait until you are well along with an investor

Push the process, don’t be pulled

Remember buyer behaviour – Cognitive dissonance

Don’t lose credibility – it’s better to tell them than for them to find out

Closing Term Sheet forms basis of definitive agreements: Subscription Agreement Shareholders Agreement Management Contracts Term Sheet may have evolved/devolved Tips Ensure professional advisors understand the process Proactively manage the process until the end Slide

Term Sheet forms basis of definitive agreements:

Subscription Agreement

Shareholders Agreement

Management Contracts

Term Sheet may have evolved/devolved

Tips

Ensure professional advisors understand the process

Proactively manage the process until the end

Financing – Core Principle A deal is not done until the money transfers! Many things can go wrong – some big, some small. They can go wrong at any time – including at the last moment. Wait for the cash to hit the bank before considering the deal done.

A deal is not done until the money transfers!

Many things can go wrong – some big, some small.

They can go wrong at any time – including at the last moment.

Wait for the cash to hit the bank before considering the deal done.

Investment Landscape and Ecosystem Canadian VC poorest performing asset class 10 Year returns of entire asset class 2%, since inception 0% Underperformed index: 9.8% for Canadian small cap index; US VC rate of return is 18.3% over the 10 year period. Survivorship bias actually shows performance is actually worse; 13 of 20 LSVCC funds no longer active (1998-2007) Labour sponsored funds raised $907M in 2006, but fell to $532 by 2008 Cram Down VC financings have crushed angels Many private investors will not invest in startups That need follow-on VC Fear of technology companies (since VC is typically needed) Ecosystem now has a gap – VCs need companies matured to a stage that angels funded Cdn VC fund raising down US VCs much more viable Technology Development & Demonstration Product Commercialization & Market Entry Market Development & Sales Volume Ramp Founders Banks, Markets VCs Angels $ $$ $$$

Canadian VC poorest performing asset class

10 Year returns of entire asset class 2%, since inception 0%

Underperformed index: 9.8% for Canadian small cap index;

US VC rate of return is 18.3% over the 10 year period.

Survivorship bias actually shows performance is actually worse; 13 of 20 LSVCC funds no longer active (1998-2007)

Labour sponsored funds raised $907M in 2006, but fell to $532 by 2008

Cram Down VC financings have crushed angels

Many private investors will not invest in startups

That need follow-on VC

Fear of technology companies (since VC is typically needed)

Canadian Labour Sponsored VC Performance Source: 2008-02-16 Globe & Mail – “The ugly truth about Labour Sponsored Funds” Slide

Venture Capital in Ottawa $1.26 Billion in 2000 down to $130 Million last year Investment bias - mainly to follow on rounds Ottawa’s investment falloff worse than national results If you need VC – You should plan to look south for it Slide

$1.26 Billion in 2000 down to $130 Million last year

Investment bias - mainly to follow on rounds

Ottawa’s investment falloff worse than national results

If you need VC – You should plan to look south for it

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

What do these companies have in common? Slide

Bootstrap…the definition A strap that is looped and sewn to a boot for pulling it on A means of financing a company through the creative acquisition and use of resources without raising cash from independent investors A process that is self-initiating and self-sustaining Slide

A strap that is looped and sewn to a boot for pulling it on

A means of financing a company through the creative acquisition and use of resources without raising cash from independent investors

A process that is self-initiating and self-sustaining

Bootstrap versus Big Money Slide

Advantages It forces you to concentrate on selling to bring cash into the business Lessens the need for cash, minimizes expenses Avoid the problems of raising too much money Founders retain greater authority, control and flexibility Equity is expensive especially at startup Positions the company for external financing in the future Slide

It forces you to concentrate on selling to bring cash into the business

Lessens the need for cash, minimizes expenses

Avoid the problems of raising too much money

Founders retain greater authority, control and flexibility

Equity is expensive especially at startup

Positions the company for external financing in the future

Disadvantages May not generate enough cash to grow at the desired rate Limits potential sales, market share and overall competitive position Provides insufficient support for high growth and capital intensive businesses Slide

May not generate enough cash to grow at the desired rate

Limits potential sales, market share and overall competitive position

Provides insufficient support for high growth and capital intensive businesses

Strategies for success Get operational quickly Go find a customer Forget about the crack team Keep growth in check Focus on cash Form alliances Slide

Get operational quickly

Go find a customer

Forget about the crack team

Keep growth in check

Focus on cash

Form alliances

Get operational quickly Get up and running rather than waiting for the home run Look for cash generating products or services, i.e. sell your brain! Take on opportunities that might not be part of the “strategic plan” A business that is making money builds credibility Slide

Get up and running rather than waiting for the home run

Look for cash generating products or services, i.e. sell your brain!

Take on opportunities that might not be part of the “strategic plan”

A business that is making money builds credibility

Go find a customer Reach out to customers from day one Get out and sell before the product is ready Use personal passion and salesmanship to substitute for big marketing budgets Offer products with tangible advantages over competitors Slide

Reach out to customers from day one

Get out and sell before the product is ready

Use personal passion and salesmanship to substitute for big marketing budgets

Offer products with tangible advantages over competitors

Forget about the crack team Reliance on inexperienced people is common To learn faster, ask for help Learn from mistakes Slide

Reliance on inexperienced people is common

To learn faster, ask for help

Learn from mistakes

Keep growth in check Expand at a rate that you can control Manage within your financial means Facilitates development of management skills under less pressure First-mover advantages are often short-lived Keep your finger on the pulse of performance Slide

Expand at a rate that you can control

Manage within your financial means

Facilitates development of management skills under less pressure

First-mover advantages are often short-lived

Keep your finger on the pulse of performance

Focus on cash Cash is king – not profits, market share or other metrics Create healthy margins from day one Say no to loss making strategies to build market share or a customer base Understand cash flow – cash position, monthly burn, timeline $ Slide

Cash is king – not profits, market share or other metrics

Create healthy margins from day one

Say no to loss making strategies to build market share or a customer base

Understand cash flow – cash position, monthly burn, timeline

Form alliances for Market penetration Sales/marketing channels Product credibility Joint bidding on projects Accelerate time to market Geographic expansion Business experience Enhance company status Slide

Market penetration

Sales/marketing channels

Product credibility

Joint bidding on projects

Accelerate time to market

Geographic expansion

Business experience

Enhance company status

Bootstrapping methods have various levels of value potential and application Customers: Ask customers to prepay fees or provide advances Get customers to fund customization work (and let you own the IP) Deliver invoices with the goods, pay attention to collections Don’t do business with dead beats and dreamers Market with no money – website, biz cards, tradeshows, cold calls Slide

Customers:

Ask customers to prepay fees or provide advances

Get customers to fund customization work (and let you own the IP)

Deliver invoices with the goods, pay attention to collections

Don’t do business with dead beats and dreamers

Market with no money – website, biz cards, tradeshows, cold calls

Bootstrapping methods have various levels of value potential and application Suppliers: Ask for credit Deal with service providers for low rates Make use of below market rent space Barter your products or services Don’t abuse them Slide

Suppliers:

Ask for credit

Deal with service providers for low rates

Make use of below market rent space

Barter your products or services

Don’t abuse them

Bootstrapping methods have various levels of value potential and application Your team: Forgo, reduce or delay compensation (sweat equity) Employ relatives and friends at below market salaries Look for volunteers and co-op students Hire part-time networks not full-time staff Pay with stock or stock options Work from home Slide

Your team:

Forgo, reduce or delay compensation (sweat equity)

Employ relatives and friends at below market salaries

Look for volunteers and co-op students

Hire part-time networks not full-time staff

Pay with stock or stock options

Work from home

Bootstrapping methods have various levels of value potential and application You: Use personal savings, credit cards and loans Forgo, reduce or delay compensation (sweat equity) Work from home Develop product at night and weekends while working elsewhere Wear lots of hats Slide

You:

Use personal savings, credit cards and loans

Forgo, reduce or delay compensation (sweat equity)

Work from home

Develop product at night and weekends while working elsewhere

Wear lots of hats

Financing – Core Principle “ Every dollar you save is one less you need to raise” Actually it is often > $1 per dollar saved All money does not have equal cost Valuation changes and dilution multiplies the impact of early savings Seems obvious, but routinely not practiced. Especially by so called “Smart money” Truly Smart money – avoids being wasted. Avoid burning cash unnecessarily

“ Every dollar you save is one less you need to raise”

Actually it is often > $1 per dollar saved

All money does not have equal cost

Valuation changes and dilution multiplies the impact of early savings

Seems obvious, but routinely not practiced.

Especially by so called “Smart money”

Truly Smart money – avoids being wasted.

Cash Conserving Tips Be Thrifty Compensate with Stock/Options Use Co-op Students Services in kind Say NO to company credit cards Use payroll provider Share premises with others Priceline.com Receivables Invoice when product is delivered Add late payment penalties Factoring Payables Negotiate extended payment to suppliers Make prompt payment only when meaningful discounts apply Capital Expenditures Borrow from another business Buy used equipment Consider leasing capital equipment Capital Structure Convert debt into equity Shop around to minimize cost of debt Leverage Government Programs Elect to file GST monthly Take full advantage of Investment Tax Credits (ITCs) Exploit government hiring support initiatives Build positive banking relationship You may need a friend if the cash gets tight Slide

Be Thrifty

Compensate with Stock/Options

Use Co-op Students

Services in kind

Say NO to company credit cards

Use payroll provider

Share premises with others

Priceline.com

Receivables

Invoice when product is delivered

Add late payment penalties

Factoring

Payables

Negotiate extended payment to suppliers

Make prompt payment only when meaningful discounts apply

Capital Expenditures

Borrow from another business

Buy used equipment

Consider leasing capital equipment

Capital Structure

Convert debt into equity

Shop around to minimize cost of debt

Leverage Government Programs

Elect to file GST monthly

Take full advantage of Investment Tax Credits (ITCs)

Exploit government hiring support initiatives

Build positive banking relationship

You may need a friend if the cash gets tight

Agenda Financing sources Instruments for financing Equity financing process Your first equity transaction Exercise External Investors Bootstrapping Wrap Up

Financing sources

Instruments for financing

Equity financing process

Your first equity transaction

Exercise

External Investors

Bootstrapping

Wrap Up

Wrap We have scratched the surface You will learn as you go if you pay attention Don’t be intimidated Lots of people less skilled have succeeded Perseverance is the key ingredient You are in select group – 2002 class beat the odds Don’t let your assumptions go unchecked Get help when you need it Help each other Call on us The rules of the game continue to evolve We are all still learning Good luck – And Thank-you

We have scratched the surface

You will learn as you go if you pay attention

Don’t be intimidated

Lots of people less skilled have succeeded

Perseverance is the key ingredient

You are in select group – 2002 class beat the odds

Don’t let your assumptions go unchecked

Get help when you need it

Help each other

Call on us

The rules of the game continue to evolve

We are all still learning