Financing High Growth Companies

Fi i Hi h G thFinancing High Growth
CompaniesCompanies

VC – The Canadian Landscape
• In Canada, venture capital investors manage approximately C$21 billion of capital.
During 2004, $1.69B in new or follow-on CDN capital was invested in 545 companies.g , $ p p
• Within the technology sector:
– Communications and networking had the largest year-over-year growth, attracting
$350M in 2004, up 53% from $228M in 2003$350M in 2004, up 53% from $228M in 2003
– Software attracted investments of $234M and semiconductors $164M
– Electronics and computer hardware declined from $123M in 2003 to $80M in 2004
1400
180
200
800
1000
1200
ed(CADmillions)
100
120
140
160
180
fFinancings
200
400
600
Amountinveste
20
40
60
80
100
Numberof
0
Q12000
Q22000
Q32000
Q42000
Q12001
Q22001
Q32001
Q42001
Q12002
Q22002
Q32002
Q42002
Q12003
Q22003
Q32003
Q42003
Q12004
Q22004
Q32004
Q42004
0
Dollars Invested Number of Financings
4
Source: XYZ Research, Canadian Venture Capital Association, and MacDonald & Associates.
Dollars Invested Number of Financings
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The Financing DecisionThe Financing Decision
7

Three Phase Approach
• The financing process is typically organized into the following three phase approach:
Assess Situation
Contact Potential Negotiate and
Planning Phase Marketing Phase Transaction Phase
Assess Situation
Sources of Financing
g
Structure Financing
Assess Financing
Solicit Proposals
Manage Due Diligenceg
Requirements
Solicit Proposals
g g
Process
Develop a Financing
Create and Maintain a
C titi Biddi
Close Transactionp g
Memorandum
Competitive Bidding
Process
and Obtain Funding
90 days Typical Time Frame 120 days
10

Business Life Cycle
Establishment Phase Growth Phase
Company
Phase
Product concept
Exploration of
ideas
Company concept
Formation of
company
Development of
product
Introduction to
market
First sales success
Expansion of
marketing
outlets and
distribution
h lCompany concept
Market analysis
p
Preparation for
production
Detailed marketing
concept
channels
Improvement of
production and
marketing systems /
exploitation of
Profit
exploitation of
market potential,
entry into new
market areas
Loss
Investment
Phase Seed financing Development Start-up financing Expansion Mature financing
financing financing
Sources of
Financing
Owners
Angels
Family
Government
Suppliers
Strategic partners
Banks, ABLs
Lessors
Customers
Banks, ABLs
Subordinated
lenders
Banks, ABLs
Subordinated
lendersFamily
Friends
Strategic partners
Early-stage equity
funds
Early-stage
subordinated lender
Customers
Venture capital Private and public
equity markets
Securitizations
13

Review of AlternativesReview of Alternatives
16

Angels: Finding Angels
• Some notable Angels in Ontario include:
• Toronto: Active Angels
• Ottawa: Purple Angel, Band of Scoundrels, Axis Capital and Katsura
• There are several indirect routes to finding Angels such as:• There are several indirect routes to finding Angels, such as:
• Local Angel Matching Organizations
– Toronto Angel Group (TAG): www.tvg.org
– National Angel Organization (NAO): www.angelinvestor.ca
– Canadian Angel Investment Network: www.angelinvestmentnetwork.ca
– Cleantech Venture Network: www.cleantechventure.com
• Business Associations (local Boards of Trade, Chambers of Commerce)
– Toronto Board of Trade: www.bot.com
– Other business owners, usually members of business associations, may have workedOther business owners, usually members of business associations, may have worked
with angels. These individuals can help plug you into the network
• Local business owners
– Meet with as many local business owners as possible because:Meet with as many local business owners as possible because:
– Many angels are successful business owners, and
– It is likely that angels have invested in many of these enterprises
– In time these owners may be willing to refer you to the investors whom they know
19
In time, these owners may be willing to refer you to the investors whom they know
• Angels frequently syndicate; therefore, finding one Angel typically provides several leads

Senior Debt – Overview
• Senior debt typically refers to a revolving line of credit and term debt.
• Senior debt financing is usually the lowest-cost financing because it has first priority on
cash flow and is secured by the borrower’s assets.
Secured by A/RRevolving
Line of
Credit
Secured by: First lien on the current and
long-term assets (typically
inventory and accounts
i bl ) t i d b
S i T D bt
Secured by Inventory
Credit receivable), constrained by
leverage ratios
Interest
rate:
Prime plus 0.75% - 1.5%
Junior Secured Debt
Senior Term Debt rate:
Term: Typically one year but up to
three
Subordinated Debt
Lender: Bank, ABL or finance company
22
Equity

Asset-Based Loans
• Asset-based loans are fully collateralized by the value of the Company’s assets and are
based on a formula that applies an advance rate to the assets of the Company in available
margining.
• Advance rates will vary depending on the type, age and quality of a company’s assets;
Typical advance rates are 85% of accounts receivables, 50% of inventory and 50% of net
property, plant and equipment.
Asset-Based LoansAsset-Based Loans
Advantages Disadvantages
Determining the amount to be borrowed is
l l h f d
Asset-Based loans typically require slightly
h hrelatively straightforward. higher interest rates.
The advance rate formulas provide a
mechanism for the available loan to grow
ith b i (B ilt i di i li )
Ongoing fees associated with the lender
monitoring the Company’s assets.
with your business (Built-in disciplines).
Less restrictive financial covenants.
Typically greater margining availability.
25
yp y g g g y

Traditional Bank Overview
• Credit statistics and leverage covenants for highly leveraged loans have steadily increased in the
past in the wake of an improving economic outlook, increased profitability and strong investor
demand.
• Although, most recently, debt multiples have flattened out and have started to contract a bit.
• Lenders have become a little more cautious and concerned over the general economic
environment, and the pressure that raw materials (oil, steel, etc.) has placed on the economy.
A D bt M lti l / Hi hl L d LAverage Debt Multiples / Highly Leveraged Loans
1.7x
1 2 1 5
5.0
6.0
5.3x*
4.5x
4.0x*
3 7 3 8x
4.0x
4.5x 4.3x
2.6x
3.0x
2.3x2.4x2.2x
2.9x
3.3x3.5x
1.2x
1.2x
1.5x 1.4x 1.7x
1.5x 1.7x
2.0
3.0
4.0 3.7x 3.8x
2.2x
0.0
1.0
98
99
00
01
02
03
04
04
199
199
200
200
200
200
1H'0
Aug'0
Bank Debt/EBITDA Total Debt/EBITDA
28
Source: Portfolio Management Data, * Represents rounding error

Collateral Summary
Type of Collateral Asset-Based Traditional Bankyp
Accounts receivable Up to 85% 65% - 85%
Inventory 65% (may differ for raw
materials WIP and finished
30%-60% (may differ for raw
materials WIP and finishedmaterials, WIP, and finished
goods)
materials, WIP, and finished
goods)
Machinery and
equipment
60%-90% of the orderly
liquidation value
40% - 90% of the orderly
liquidation valueequipment liquidation value liquidation value
Real estate 60+% of the appraised fair
market value
60+% of the appraised fair
market value
T d k 50% f h i d f dTrademarks 50% of the appraised forced
liquidation value
-
WIP – Work in process.
31

Term Loan Overview
• Typical financial covenants associated with a term loan are consistent with a line of credit
and may include:
– Leverage Ratio: Senior Debt / EBITDA
– Interest Coverage: EBITDA / Senior Interestg /
– Fixed Charge Coverage: (EBITDA - capex - cash taxes) / (cash interest + debt
amortization)
• The amortization period for senior term debt is typically four to seven years, with monthlyp yp y y , y
or quarterly payments required.
• While some lenders will allow the amortization schedule to vary according to a company's
cash flow ‘sculpted payments’ and/or allow bullet payments, these arrangements may
require a higher rate of interest.
• Some lenders will link a loan’s interest rate to a ‘pricing grid’, which reduces the interest
rate as the company becomes less leveraged/risky.
• A rule of thumb is that interest rates decline by 50 basis points for each 0.5x EBITDA
decline in total leverage.
34

Summary of Terms
• The following is a summary of select senior debt attributes:
Line of Credit
(Bank and ABL) Senior Term Loan Junior Secured
Use Working capital Working capital growth Growth capitalUse Working capital Working capital, growth
capital
Growth capital
Security First lien (current assets) Second lien (fixed assets) Second lien (fixed assets)
Ranking First charge Second charge Third chargeRanking First charge Second charge Third charge
Covenants Debt/EBITDA, Fixed
Charge, Tangible Net
Worth (TNW)
Debt/EBITDA, Fixed
Charge, Interest
Coverage, TNW
Debt/EBITDA, Fixed
Charge, Interest
Coverage, TNW
Term Revolving, typically
annual renewal required
Typically 4-7 years but
up to 10 years
Up to 10 years, with cash
flow sweep provision
Coupon Cash pay – floating Cash pay – floating/fixed Cash pay – floating/fixed
All-in Rate Prime + 75 BPS Prime + >100 BPS Prime + >600 BPS
Warrants None Occasionally Occasionally
Prepayment Minimal Depending on agreement Depending on agreementPrepayment
Penalties
Minimal Depending on agreement
this may be expensive
Depending on agreement
this may be expensive
Capital Providers Banks, Non-Banks,
Institutions
Banks, Non-Banks,
Institutions
Non-Banks, Institutions
37
Liquidity High Medium Low

Sub-Debt – Overview
• Competition in the Canadian market is currently robust and being driven by:
– The emergence of a variety of new specialty funds stemming from the requirement of
Labour Sponsored funds to meet pacing requirements
– Existing funds are actively raising new capital (recently TD Capital raised $500 million)
– Given the return profile of LBOs and a lack of quality deals, M&A activity is driving
pricing to very competitive levels
40

Sub-Debt – Considerations
When Why Advantages Disadvantagesy g g
Stable cash flow Maxed out on senior
debt capacity
Repayment terms
can be structured
around cash flows
Expensive form of
financing, high
interest rate
Growth prospects Medium-term needs Transaction costs are
generally lower than
for equity issues
Places additional
burden on cash flow
Substantial operating
history
Debt terms can be
tailored
Strong management Can be structured asStrong management
team
Can be structured as
quasi-equity
Non-cyclical, low to
medium-technology
Partner – not a
lendermedium technology
businesses
lender
(general alignment
of interests)
43

Equity Financing
• Equity is the most expensive form of financing and is a company’s bottom layer of
financing.
Secured by: Unsecured
IRR: 30% - 40% compounded
Secured by A/R
IRR: 30% - 40% compounded
annually
Term: Generally 3 – 7 years
d l
Secured by Inventory
Lender: Management, employees,
outside investors
Equity incurs the highest risk and expects returns
th t t ith th t i k
Senior Term Debt
that commensurate with that risk
Subordinated Debt
Junior Secured Debt
Equity
46

Private Equity – Options
Private Equity
Venture Capital BuyoutVenture Capital Buyout
Angel/
seed
Startup
First
stage
Second
stage
Third
stage
Bridge
Growth
capital
Turn-
around
MBOs
Early stage Expansion / Later stage
seed stage stage stage capital around
Prove a
concept –
business plan
stage
No sales but
operating –
product
development
and initial
Revenues, no
profit – focus
on sales and
manufacturing
Revenues, no
profit – initial
expansion
Break-even
profits –
major growth
Usually the
final round of
financing
before going
public within
Equity and/or
mezzanine
invested to
enable a
management
Equity and/or
mezzanine
invested in
existing
business that
Equity and/or
mezzanine
capital to
fund growth
in anand initial
marketing
public within
6-12 months
management
team to
acquire a
product line
or business
business that
experienced
difficulties,
with a view to
re-establish
prosperity
in an
established
business via
internal
expansion or
acquisition
Source: Canadian Venture Capital AssociationSource: Canadian Venture Capital Association
49

U.S. Fund Activity in Canada
• In the first half of 2004, a total of 57 early-stage Canadian software companies raised $53
million in new or follow-on venture financing from all sources.
• Of this amount, 5 companies raised $18 million from US venture capital firms.
• Capital invested in early stage software companies by US VCs has risen dramatically thisCap a es ed ea y s age so a e co pa es by US Cs as se d a a ca y s
year, and is set to eclipse 2003 and 2002 levels of $61 million and $10.6 million.
• U.S. VCs are increasingly stepping in to fill the funding gap for early stage software
companies, especially during series B and C rounds.p , p y g
• U.S. VCs typically co-invest with Canadian-based firms that are intimately familiar with the
market and the contemplated company, possibly through an earlier round of financing.
Date Source: Macdonald & Associates Ltd
The US venture capital is an appealing option for early stage Canadian software
52
The US venture capital is an appealing option for early stage Canadian software
companies seeking to raise follow-on capital in excess of $10 million.

Buyout Capital – Current Market Overview
• XYZ is an active participant in the Canadian Venture Capital community, maintaining a
board seat with the Canadian Venture Capital Association (CVCA) and conducting joint
research on the state of the Canadian private equity market.
• XYZ co-authors the quarterly Venture Capital Confidence Survey with the CVCA. The most
recent survey (Quarter 2, 2004) noted the following about the Canadian Market:
– Focus on growth capital opportunities in the manufacturing, computer software and
communications sectors;
– Mergers and acquisitions continue to be the preferred exit strategy;
– Competition for new investment opportunities are growing;
– 17% of survey respondents are currently looking at deals in the software industry
(second only to manufacturing);
– Over the next six months, the following is expected:
– the average entry EBITDA multiples on transactions are expected to be 5.2x;
– the average entry Revenue multiples on transactions are expected to be 1.6x;
– Debt to EBITDA multiples are expected to be 3.2x;
XYZ believes that the current environment
55
presents an excellent opportunity for qualified companies.

Buyout Capital – Considerations
Advantages Disadvantagesg g
•Long-term source of capital; minimizes
repayment risk.
•Reconciling the interests and objectives of
management versus those of equity
holders (owners).( )
•Equity investors are more willing to finance
future growth opportunities.
•Issuance cost of 4% to 6%.
•Positive impact on cash flow as there is no •Valuation of the business•Positive impact on cash flow as there is no
interest or amortization.
•Valuation of the business.
•Significant upside returns are required
(30% +)(30% +).
•Most expensive form of capital once
dilution is taken into consideration.
58

Private Equity – Select Providers
• The following lists all significant Canadian private equity providers:
Banks Institutions Gov’t Corporate Tech VCs
VCs and Labour
Sponsored Large CDN Funds
• Bank of Montreal
Capital Corp
• Manulife Capital •BDC Canadian Based • VenGrowth • OMERS / Borealis
Private EquityCapital Corp.
(BMOCC)
• CIBC Capital
Partners
• HSBC Capital
• OMERS
• Ontario Teachers’
Pension Plan
Board
CDP
•EDC
•FCC
• BCE Capital
• Bell Mobility
• Shaw Ventures
• TELUS Ventures
• GrowthWorks
• Priveq Capital
• Covington
Capital
Private Equity
• ONEX/ONCAP
• EdgeStone Capital
• Kilmer Capital
HSBC Capital
• RoyNat Capital
• Scotia Merchant
Capital Corp.
• TD Capital
• CDP
International
• Intel Capital
• GE Equity
• JL Albright
• Jefferson
Partners
• Skypoint
• Torquest Capital
• Macquarie Bank
• CAI
• Clairvest• TD Capital • GE Equity
• Motorola Ventures
• Lucent Venture
Partners
T V t
• TechnoCap
• Ventures West
• FSTQ
Clairvest
• McKenna Gale
• Richardson Financial
Group
• Callisto Capital• Tyco Ventures
• Alcatel Ventures
• Corning Innovation
Ventures
• Callisto Capital
• For a more comprehensive view, go to the web-site of the Canadian Venture Capital and
Private Equity Association (www.cvca.ca)
61

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