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Funding Options Deep Dive - Equity Options


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Funding Options Deep Dive - Eq

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Funding Options Deep Dive - Equity Options

  1. 1. Funding Options for High Growth Companies September 5, 2012
  2. 2. Today’s  Experts  •  Jeremy  Halpern     –  Partner,  Nu8er  McClennen  &  Fish  LLP   –  Director,  MassVentures     –  Director,  The  Capital  Network   –  Angel  Investor   –  Former  entrepreneur   –  Geek  •  Ben  Li8auer     –  Member,  Launchpad  Ventures   –  Advisory  Board,  The  Capital  Network   –  Member,  Walnut  Ventures   –  Member,  Boston  Harbor  Angels   –  Director,  Lots  of  Startups   –  Former  Entrepreneur   –  Geek   2  
  3. 3. Funding  the  Company   Jeremy  Halpern  Nu8er  McClennen  &  Fish  LLP   @startupboston   Ben  Li8auer   @li8web  
  4. 4. Funding  the  Company   Assuming  you  plan  to  be     a  “high  growth”  company…  What  are  your  funding  opXons?  
  5. 5. Entrepreneurship  comes  in  many  types       HIGH   EXTREME   SOCIAL  VENTURE   NORMAL  GROWTH   GROWTH   HIGH  GROWTH   COMPANY   COMPANY   COMPANY   COMPANY   •  Goal is to fulfill •  Includes all •  Company can •  Growth profile a social need service grow fast (on-line) ultra-scalable •  Has mission businesses or has a scalable system •  Team focus is exit orientation •  Exploiting a local market need •  Team often •  Revenue $40M+ •  Team needs to motivated by exit support with lots of room •  Team has ‘great for growth (5 yr.) mission jobs’ •  $10m revenue in 5 yrs & market •  Based on $20M+ •  Growth profile •  Growth by adding size allows often one investment resource at a resources one by significant time one additional growth •  Exit targeted to •  Exit will be based •  Capital efficient IPO or by ‘large’ •  Exit …much total investment M&A event harder to find on value of cash flow (mature biz.) $2-4M fit •  Exit by M&A 5
  6. 6. Close  Up:  Extreme  High  Growth  vs  High   Growth   M&A or IPO Later VC Capital Needs Rounds High Formal Risk Venture Capital M&A Angels or Accelerators Angel Group or Micro-cap (or Micro-cap) funds Angels or Syndication Friends, Family & Accelerators or Micro-cap Founders Busines Low funds Friends, s Angels Risk Extreme Family & High Founders Time Growth HighCrystallize Demonstrate Market Entry Early Scaling Sustained Growth 6   Ideas Product Growth Growth
  7. 7. High  Growth  Company  •  CharacterisXcs   DisrupXve  InnovaXon  with  Strong  value  proposiXon   –  CorrelaXon  between  Large  Unmet  Need  :  SoluXon  •  High  Margin  Product  (RaXo  of  Revenue  :  COGS)     –  SomeXmes  Massive  Volume  Products  where  innovaXon  is  incremental  •  High  Rate  of  Revenue  Growth  over  sustained  period    •  Scalable  (Fixed  cost  is  a  low  percent  of  Revenue)    •  No  major  barriers  to  conXnued  growth  (ex.  blocking  IP;  geography;   regulatory)    •  Repeatable  sales  and  distribuXon  model  with  many  credit  worthy   customers    •  Large  Total  Addressable  Market  (TAM)    •  Defensible  innovaXon  able  to  withstand  compeXXon  and  changing   condiXons    •  [Capital  efficient]   7  
  8. 8. Capital  Source  View   HIGH   EXTREME   NON  PROFIT   SOCIAL  VENTURE   NORMAL  GROWTH   GROWTH   COMPANY   COMPANY   HIGH  GROWTH   ORGANIZATION   (COMPANY)   (COMPANY)   Risk / Return Return  on  Debt   Return  on  Equity  Impact  /  Tax  Write  off   Income   High  Return   Debt- Equity – Charity  $$   Pay it back Ownership stake Fixed Amounts % of Future Value 8  
  9. 9. Match  Funding  Sources   HIGH   EXTREME  SOCIAL  VENTURE   NORMAL  GROWTH   GROWTH   HIGH  GROWTH   COMPANY   COMPANY   COMPANY   COMPANY  •  Friends •  Friends family, •  Angels Early on family, founders •  Angel Groups •  Accelerators founders •  Debt Bank and •  Angel Group •  Individual Angels•  Charity$$ other Syndication •  Micro Cap VCs•  Crowds (Kick- •  (Future) Crowd •  Angel List •  Seed from VC starter) funding (portal style) •  Micro-cap Funds Later stages•  Impact Angels •  (Future) Crowd •  Venture Funds•  (Future) funding (portal Crowd funding •  Strategic VCs style) (portal style) •  Angel •  Increasingly Syndication Strategic Corporate VCs 9  
  10. 10. Non-­‐Equity  Sources  •  Accelerators  (some)  •  Kickstarter  type  donaXons  •  Pre-­‐orders  from  end-­‐customers  •  Credit  from  vendors  •  Strategic  VCs  •  Strategic  NREs  •  DistribuXon  Contracts  Common  Theme:    Providing  early  cash  in  exchange  for  a  be8er  commercial  opportunity     10  
  11. 11. Equity  Sources  •  Accelerators  (some)  •  Friends  &  Family  Common  Theme:  SupporXng  success  of  the  entrepreneur;  business  terms  vary  •  Portal  Funding  •  Early  Angels  •  Super  Angels  •  Angel  Groups  •  Micro  VC  •  TradiXonal  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   –  PreferenXal  treatment  on  subopXmal  exit  versus  the  founders   11  
  12. 12. 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:  indicaXve  of  future  cash  flow  or  market  control     Idea  Stage     Demonstrate   Market  Entry  &   Early  Scaling   Repeatable   • Friends     Product  &   Early  Growth   Growth   Growth   family,   Market  Interest     •   Crowdfunding   •  Most  Venture   • Most  Venture   founders   • Accelerators   • Individual  Angels   (portal  style)   Funds   Funds   • Grants   • Angel  Groups   •   Angel  Groups   •  Angel   • Strategic  VCs   • Crowds   • Accelerators   •   Angel  Group   SyndicaSon   • Angel   (Kick-­‐   • Micro  Cap  VCs   SyndicaSon   SyndicaSon   starter)   •   Angel  List   • Private  Equity     •   Micro-­‐cap  Funds  
  13. 13. High  Growth  Capital  by  Stage   &Amount   Traditional VC Micro VC Angel Groups AngelList Corporate VenturingInvestment Grants Equipment Financing Size Angels Portal Funding Customers Friends & Family Vendors Crowdfunding Founder Venture Stage 13  
  14. 14. Capital  Sources:  Size  &  Cost   Angels Angel Groups Traditional VC AngelList Private Equity Micro VC Corporate / Strategic Crowdfunding VentureInvestment Friends & Family Portal Funding “Cost” Founder Venture Bank Debt Loans Vendors Equipment Financing Personal Loans Customers Grants Investment Size
  15. 15. So  What  is  Equity  Anyway?  •  Stock  =  right  to  residual  economic  interests  upon  sale/liquidaXon  +   stockholder  voXng  rights  (usually  limited  to  Board  of  Directors  and  Sale  of   the  Company)  •  Preferred  Stock  =  right  to  be  paid  before  Common  Stock  ParXcipaXng  =   original  investment  PLUS  a  pro  rata  share  of  remainder  Non-­‐ParXcipaXng  =   original  investment  OR  a  pro  rata  share  •  Common  Stock  =  whatever  is  lev  aver  all  other  creditors  and  preferred   stockholders  are  paid  •  Dividend  =  a  right  to  an  addiXonal  amount  upon  liquidaXon  measured  as  a   funcXon  of  Xme  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   15  
  16. 16. Equity  Type  Comparisons   Solo  Angel   Super  Angel   Angel  Group   MicroVC   VC  ValuaXons   High  relaXve  to   High  relaXve  to   Low  relaXve  to   Low  relaXve  to   Medium   stage   stage   stage   stage  Type  -­‐  Likely   Common   Conv  Note   Preferred   Preferred   Preferred  (less  likely)   (Warrants)   (Preferred)   (Conv  Note)   (Conv  Note)  Board  Seat   Maybe   1  or  none   1-­‐2  of  5  +/-­‐   1  of  5  +/-­‐   1-­‐2  of  5  +/-­‐   Observer   Observer   Observer  Audited   No   No   No  (reviewed)   Yes   Yes  Financials  NegaXve   No   SomeXmes   Yes   Yes   Yes  Covenants  PreempXve   No   SomeXmes   Yes   Yes   Yes  Rights  VerXcal   SomeXmes   Rarely   Some   Usually   Always  ExperXse   16  
  17. 17. Equity  Type  Comparisons   Solo  Angel   Super  Angel   Angel  Group   MicroVC   VC  Exit  Horizon   7  years   5  years   4  years   5  -­‐7  years   4-­‐5  years  (from  $  in)  Exit  Range   $20m+   $40m+   $50m+   $100m+   $250m+   17  
  18. 18. Structure  of  an  Equity  Deal  •  Company  and  Investors  agree  on  a  “pre-­‐money   valuaXon”  (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   18  
  19. 19. 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  “inflecXon   point”   –  Hopefully  at  a  point  where  risk  is  removed   –  Increased  PM  =  so-­‐called  “up  round”   19  
  20. 20. 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  anX-­‐diluXon  provision   entrepreneur  may  carry  more  burden  than  the   investors   20  
  21. 21. What  about  ConverXble  Debt?  •  Many  seed-­‐stage  companies  use  an  instrument   called  ConverXble  Debt.  Huh?  •  ConverXble  debt  is  not  tradiXonal  bank  debt  •  Converts  exist  for  two  major  reasons   –  Investors  and  Entrepreneurs  find  it  hard  to  agree  on  a   PM  valuaXon   –  SomeXmes  quicker  and  cheaper  to  document  than   equity  deals  (but  not  really)   21  
  22. 22. ConverXble  Debt  provides  •  OpXonality   of  the  Company   ConverSble  Debt  =  unsecured  debt  obligaXon   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  valuaXon  in  the  next  round   •    aver  applicaXon  of  a  Discount  (oven  5  –  20%)   •    subject  to  a  maximum  valuaXon  amount  (the  “Cap”)   22  
  23. 23. Basic  Structure  of  ConverXble  Debt  •  Investor  loans  $  to  Company  an#cipa#ng  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)   23  
  24. 24. ConverXble  Debt  –  ComplicaXons!  •  What  if  only  a  li8le  money  comes  in?  •  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?   24  
  25. 25. ConverXble  Debt  –  SoluXons?  •  Caps  and  Floors   –  May  defeat  purpose  with  signaling  •  Default  conversion  price  and  security  at  maturity  •  Open  round,  minimum  close  •  Quick  sale  preferences  (ex.  2x)  •  Governance  provisions  •  Careful  a8enXon  to  conversion  condiXons   25  
  26. 26. ConverXble  Debt  –  Worse  than  •  Equity?   2008)   MulXple  liquidaXon  preference  (circa   –  Ex.  $500k  of  Notes  with  cap  at  $2m  PM   –  Next  Round  at  $6m  PM   –  Issue  Noteholders  3x  number  of  shares   –  3x  shares  equals  3x  liquidaXon  preference!!  •  Without  a  floor,  effecXvely  Full  Ratchet  AnX-­‐diluXon  •  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   26  
  27. 27.  
  28. 28. Upcoming  Programs  Sep  13   Funding  OpXons  Deep  Dive:     Consumer  Products  Companies  Sep  18   Financial  ProjecXons  for  PresentaXons  Oct  16   Building  a  High  Growth  Business  for  Angel  and   Venture  Capital  Oct  24   Structuring  Founder  RelaXonships:     Stockholder  Agreements  &  Choice  of  EnXty  Nov  5   Mobile  Fast  Track   28