Healthcare Fundraising 101


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Are you thinking about what you need to fund your company? Where do you start? Funding is not “one size fits all”. Every company has to approach their pathway to funding with a unique approach. Join our fundraising experts for an in-depth discussion of what options you have for funding and how to decide which paths are right for you and your company. We’ll have a specific focus on life science focused companies and technologies and the funding choices available for them.

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Healthcare Fundraising 101

  1. 1. Funding  Op*ons  for  Life  Science  Companies   May 6, 2014
  2. 2. The  Panel   Jeremy  Halpern    Partner,  Nu@er  McClennen  &  Fish    @startupboston   Yumin  Choi    Partner,  HLM  Venture  Partners    @yuminvc   Paul  Hartung     President  and  CEO,  Cognotpix,  Inc   PHartung@cognop*  
  3. 3. Funding  the  Company   Assuming  you  plan  to  be     a  “high  growth”  company…     What  are  your  funding  op*ons?    
  4. 4. Entrepreneurship  comes  in  many  types       4 NORMAL  GROWTH   COMPANY   HIGH   GROWTH   COMPANY   EXTREME   HIGH  GROWTH   COMPANY   SOCIAL  VENTURE   COMPANY   •  Includes all service businesses •  Exploiting a local market need •  Team has ‘great jobs’ •  Growth by adding resources one by one •  Exit will be based on value of cash flow (mature biz.) •  Growth profile ultra-scalable •  Team focus is exit •  Revenue $40M+ with lots of room for growth (5 yr.) •  Based on $20M+ investment •  Exit targeted to IPO or by ‘large’ M&A event •  Goal is to fulfill a social need •  Has mission orientation •  Team needs to support mission •  Growth profile often one resource at a time •  Exit …much harder to find fit •  Company can grow fast (on-line) or has a scalable system •  Team often motivated by exit •  $10m revenue in 5 yrs & market size allows significant additional growth •  Capital efficient total investment $2-4M •  Exit by M&A
  5. 5. Close  Up:  Extreme  High  Growth  vs  High   Growth     5   Capital Needs Time High Risk Low Risk Formal Venture Capital M&A or IPO Crystallize Ideas Demonstrate Product Early Scaling Growth Sustained Growth Angel Group (or Micro-cap) Syndication Angels or Accelerators or Micro-cap funds Angels or Accelerators or Micro-cap fundsBusines s Angels Market Entry M&A Later VC Rounds Extreme High Growth High Growth Friends, Family & Founders Friends, Family & Founders
  6. 6. High  Growth  Company  Characteris*cs   •  Disrup*ve  Innova*on  with  Strong  value  proposi*on   –  Correla*on  between  Large  Unmet  Need  :  Solu*on   •  High  Margin  Product  (Ra*o  of  Revenue  :  COGS)     –  Some*mes  Massive  Volume  Products  where  innova*on  is  incremental   •  High  Rate  of  Revenue  Growth  over  sustained  period     •  Scalable  (Fixed  cost  is  a  low  percent  of  Revenue)     •  No  major  barriers  to  con*nued  growth  (ex.  blocking  IP;  geography;   regulatory)     •  Repeatable  sales  and  distribu*on  model  with  many  credit  worthy   customers     •  Large  Total  Addressable  Market  (TAM)     •  Defensible  innova*on  able  to  withstand  compe**on  and  changing   condi*ons     •  [Capital  efficient]   6  
  7. 7. Return  on  Equity  Return  on  Debt   Income   High  Return   NON  PROFIT   ORGANIZATION   Capital  Source  View   7   Debt- Pay it back Fixed Amounts Equity – Ownership stake % of Future Value Charity  $$   Impact  /  Tax  Write  off   NORMAL  GROWTH   COMPANY   HIGH   GROWTH   (COMPANY)   EXTREME   HIGH  GROWTH   (COMPANY)   Risk / Return SOCIAL  VENTURE   COMPANY  
  8. 8. Match  Funding  Sources   8   NORMAL  GROWTH   COMPANY   HIGH   GROWTH   COMPANY   EXTREME   HIGH  GROWTH   COMPANY   SOCIAL  VENTURE   COMPANY   •  Friends family, founders •  Debt Bank and other •  (Future) Crowd funding (portal style) Early on •  Accelerators •  Individual Angels •  Micro Cap VCs •  Seed from VC Later stages •  Venture Funds •  Strategic VCs •  Angel Syndication •  Friends family, founders •  Charity$$ •  Crowds (Kick- starter) •  Impact Angels •  (Future) Crowd funding (portal style) •  Angels •  Angel Groups •  Angel Group Syndication •  Angel List •  Micro-cap Funds •  (Future) Crowd funding (portal style) •  Increasingly Strategic Corporate VCs
  9. 9. Non-­‐Equity  Sources   •  Accelerators  (some)   •  Kickstarter  type  dona5ons   •  Pre-­‐orders  from  end-­‐customers   •  Credit  from  vendors   •  Strategic  VCs   •  Strategic  NREs   •  Distribu5on  Contracts     Common  Theme:    Providing  early  cash  in  exchange  for  a  beHer   commercial  opportunity       9  
  10. 10. Equity  Sources   •  Accelerators  (some)   •  Friends  &  Family     Common  Theme:  Suppor5ng  success  of  the  entrepreneur;  business  terms  vary   •  Portal  Funding   •  Early  Angels   •  Super  Angels   •  Angel  Groups   •  Micro  VC   •  Tradi5onal  VC  (1st  Round)     Common  Theme:  All  are  looking  for   –  sale  (or  IPO)  of  the  Company  at  4-­‐10  x  original  investment   –  Capital  gains  treatment  on  all  sale  proceeds   –  Preferen5al  treatment  on  subop5mal  exit  versus  the  founders   10  
  11. 11. Sources  of  Equity  Capital    Must  have  exits  for  equity  model  to  work!!   –  2011  US  IPOs  -­‐  $36B   –  2011  US  M&A  -­‐  $57B     –  2011  US  Private  Equity  -­‐$35B   •  Exit  sources  extremely  variable  …  health  of  economy   •  All  exits:  indica*ve  of  future  cash  flow  or  market  control       Idea  Stage     • Friends     family,   founders   • Grants   • Crowds   (Kick-­‐   starter)   Demonstrate   Product  &   Market  Interest     • Accelerators   • Individual  Angels   • Angel  Groups   • Accelerators   • Micro  Cap  VCs     Market  Entry  &   Early  Growth   •   Crowdfunding   (portal  style)   •   Angel  Groups   •   Angel  Group   SyndicaSon   •   Angel  List   •   Micro-­‐cap  Funds       Early  Scaling   Growth   •  Most  Venture   Funds   •  Angel   SyndicaSon       Repeatable   Growth   • Most  Venture   Funds   • Strategic  VCs   • Angel   SyndicaSon   • Private  Equity      
  12. 12. High  Growth  Capital  by  Stage   &Amount   12   Venture Stage Investment Size Friends & Family Vendors Angels Traditional VC Angel Groups Corporate Venturing Grants Customers Crowdfunding Portal Funding AngelList Micro VC Equipment Financing Founder
  13. 13. Capital  Sources:  Size  &  Cost   Investment Size Investment “Cost” Traditional VC Micro VC Equipment Financing Angel GroupsAngels AngelList Corporate / Strategic Venture Customers Portal Funding Vendors Founder Friends & Family Crowdfunding Grants Venture DebtBank Loans Personal Loans Private Equity
  14. 14. So  What  is  Equity  Anyway?   •  Stock  =  right  to  residual  economic  interests  upon  sale/liquida*on  +   stockholder  vo*ng  rights  (usually  limited  to  Board  of  Directors  and  Sale  of   the  Company)   •  Preferred  Stock  =  right  to  be  paid  before  Common  Stock  Par*cipa*ng  =   original  investment  PLUS  a  pro  rata  share  of  remainder  Non-­‐Par*cipa*ng   =  original  investment  OR  a  pro  rata  share   •  Common  Stock  =  whatever  is  let  ater  all  other  creditors  and  preferred   stockholders  are  paid   •  Dividend  =  a  right  to  an  addi*onal  amount  upon  liquida*on  measured  as  a   func*on  of  *me  x  percentage  of  original  investment  .  Ex.  6.0%  per  annum   •  OpSons  /  Warrants  =  Contracts  allowing  holder  to  purchase  an  amount  of   stock  in  the  future  at  a  pre-­‐determined  price   •  Control  Rights  =  Statutory  and  Contractual   14  
  15. 15. Equity  Type  Comparisons   15   Solo  Angel   Super  Angel   Angel  Group   MicroVC   VC   Valua*ons   High  rela*ve  to   stage   High  rela*ve  to   stage   Low  rela*ve  to   stage   Low  rela*ve  to   stage   Medium   Type  -­‐  Likely   (less  likely)   Common   (Warrants)   Conv  Note   (Preferred)   Preferred   (Conv  Note)   Preferred   (Conv  Note)   Preferred   Board  Seat   Maybe   1  or  none   1-­‐2  of  5  +/-­‐   Observer   1  of  5  +/-­‐   Observer   1-­‐2  of  5  +/-­‐   Observer   Audited   Financials   No   No   No  (reviewed)   Yes   Yes   Nega*ve   Covenants   No   Some*mes   Yes   Yes   Yes   Preemp*ve   Rights   No   Some*mes   Yes   Yes   Yes   Ver*cal   Exper*se   Some*mes   Rarely   Some   Usually   Always  
  16. 16. Equity  Type  Comparisons   16   Solo  Angel   Super  Angel   Angel  Group   MicroVC   VC   Exit  Horizon   (from  $  in)   7  years   5  years   4  years   5  -­‐7  years   4-­‐5  years   Exit  Range   $20m+   $40m+   $50m+   $100m+   $250m+  
  17. 17. Structure  of  an  Equity  Deal   •  Company  and  Investors  agree  on  a  “pre-­‐money   valua*on”  (PM)  which  leads  to  a  price  per  share   •  Investors  put  in  $X   •  Investors  then  own:  X  /  (X  +  PM)  of  the  company   Example:   PM  =  $1M   X  =  $0.5M   Investors  own  0.5/1.5  =  33%     Remember:  New  issuance  NOT  transfer   17  
  18. 18. Understand  the  Funding  Path   •  We’re  talking  about  1st  funding  here   •  What  is  the  probable  complete  funding  picture?   – This  is  only  funding   – Another  small  round  then  probable  small  exit   – Big  money  needed  before  exit   •  Each  funding  event  should  occur  at  an  “inflec5on   point”   – Hopefully  at  a  point  where  risk  is  removed   – Increased  PM  =  so-­‐called  “up  round”   18  
  19. 19. Understand  the  Funding  Path,  cont.   •  What  if  things  aren’t  going  so  well?   – Flat  or  decreased  PM  =  so-­‐called  “down  round”   •  More  money  coming  in  without  increased  PM   means  everyone  gets  diluted,  but…   •  Depending  on  anS-­‐diluSon  provision   entrepreneur  may  carry  more  burden  than  the   investors   19  
  20. 20. What  about  Conver*ble  Debt?   •  Many  seed-­‐stage  companies  use  an  instrument   called  Conver5ble  Debt.  Huh?   •  Conver5ble  debt  is  not  tradi5onal  bank  debt   •  Converts  exist  for  two  major  reasons   – Investors  and  Entrepreneurs  find  it  hard  to  agree  on   a  PM  valua5on   – Some5mes  quicker  and  cheaper  to  document  than   equity  deals  (but  not  really)     20  
  21. 21. Conver*ble  Debt  provides  Op*onality   •  ConverSble  Debt  =  unsecured  debt  obliga*on  of  the  Company   that  may  be  converted  into  equity  of  the  Company.       •  Conversion  Trigger  =  Qualified  Financing  usually  at  some   minimum  amount  of  funds  (ex.  $500,000)   •  If  Notes  stays  as  Debt  =  Get  back  principal  and  interest  ahead   of  other  equity  (behind  other  creditors  typically)   •  If  Notes  Convert    =  Convert  amount  of  debt  and  interest  into   equity  at  the  valua*on  in  the  next  round   •    ater  applica*on  of  a  Discount  (oten  5  –  20%)   •    subject  to  a  maximum  valua*on  amount  (the  “Cap”)     21  
  22. 22. Basic  Structure  of  Conver*ble  Debt   •  Investor  loans  $  to  Company  an5cipa5ng  another  round  of  funding   •  Investment  accrues  small  interest     •  When  the  funding  occurs,  investment  +  interest  convert  to  equity,   usually  at  a  discount  (5-­‐20%  typically)     Example:   •  Investors  loan  $200K  to  Company     •  20%  discount   •  As  of  conversion,  interest  of  $10k  has  accrued   •  Next  Round  PM  =  $2m   •  Conversion  Amount  =  1/(1  -­‐  0.2)*  $210k    =  $262,500     At  Conversion,  Noteholders  receive  262.5K  /  (PM  +  262.5K  +  New  Money)   22  
  23. 23. Conver*ble  Debt  –  Complica*ons!   •  When  does  the  debt  convert?   •  What  happens  if  PM  of  next  round  is  huge?   •  Does  the  investor  have  any  say  in  things?   •  What  if  there  is  an  equity  investment  that   doesn’t  trigger  conversion?   •  What  happens  if  it  never  converts?   •  What  happens  if  Company  gets  bought?   23  
  24. 24. Conver*ble  Debt  –  Solu*ons?   •  Caps  and  Floors   – May  defeat  purpose  with  signaling   •  Default  conversion  price  and  security  at   maturity   •  Quick  sale  preferences  (ex.  2x)   •  Governance  provisions   •  Careful  agenSon  to  conversion  condiSons   24  
  25. 25. Conver*ble  Debt  –  Worse  than  Equity?   •  MulSple  liquidaSon  preference  (circa  2008)   –  Ex.  $500k  of  Notes  with  cap  at  $2m  PM   –  Next  Round  at  $6m  PM   –  Issue  Noteholders  3x  number  of  shares   –  3x  shares  equals  3x  liquidaSon  preference!!   •  Without  a  floor,  effecSvely  Full  Ratchet  AnS-­‐diluSon   •  Preference  Overhang   –  In  prior  example  Noteholders  bought  $262,500  of  preference  for   $200,000.       –  All  other  Series  A  Holders  bought  1:1  preference   •  Not  Just  a  Price  Adjustment   25  
  26. 26.