Getting Funded

This is a presentation created by Joe Medved a digital media VC with SoftBank Capital. You can read more from him on his blog: JoeVC

I have helped a number of our portfolio companies at SoftBank Capital build financial models over the years. This presentation walks through the construction of a general business model for early stage companies, with a focus on core revenue and expense drivers.

Want to learn more about turning your business idea into a fundable business model? Join us for our breakfast roundtable on October 19: The Capital Network Breakfast Roundtable: Building a High Growth Business for Angel and Venture Capital at the Foley Hoag Emerging Enterprise Center

This post was originally post by Timothy Bernard Jones on buzzient.com, on August 9 and has been posted with his permission. You can view the original post here

With the public equity markets in turmoil, one of the drumbeats I’m hearing is how private companies either:

A. Need to file and do an IPO as quickly as possible (for later stage companies)

or,

B. Need to raise as much VC as possible and stockpile it away while keeping the burn low(a la the Sequoia ventures presentation from a couple of years ago) until they can go public

What’s lost in this discussion is the critical question “Why go public?”.

So many startups and founders seem to be focused on getting an IPO, without asking themselves whether they really want to manage a public company. Especially right now. So few people realize that because of SEC Rule 144, insiders (save a few, but that’s another issue) don’t get to sell for 180 days. In that first six months, everyone in the company adds a stock widget to their desktop, and much productivity is lost daydreaming about the end of the lockup period.

In the interim, all sorts of crazy market and world events could take place that would hammer the stock lower and lower. Looking at the news over the last few days, I can’t help but think that insiders at a variety of recently public companies are banging their heads against the wall in angst.

Look at the Nasdaq right now. There are number of companies with cash flow machines as businesses that are getting pounded by the public markets. In times like these, being public exposes the company to the vagaries of the market and the volatility therein.

I think any founder really thinking about the long term has to consider staying private, and building a valuable company outside of the mood swings of the public market. Liquidity can be achieved in a variety of ways, from shadow stock to secondary sales, all without having to be publicly traded.

By thinking of staying private, founders can focus on really building solutions that help customers and a culture that inspires employees. I’m oft reminded of one of the best software companies around where this principle is manifest: SAS, the analytics giant in NC. #188 on the Forbes list of largest private companies, SAS has built a $2B+ revenue company without having to deal with Wall Street. The founder Dr. Jim Goodnight, pioneered many of the principles of building a totally supportive work environment; SAS provided on-site child care and other services long before most valley companies even dreamt of doing so.

Back in the 70′s (A decade we’re going to look more carefully at with this global financial/demand crisis), plenty of great companies stayed private and built value. Only when the go-go equity culture of the 80′s/90′s took hold did we see this crazy sense of urgency to go public. I’ve had the opportunity to be a part of two companies that have gone public; in both cases the IPO date was a bit anticlimactic. You STILL have to build a business.

So, looking at the tale of the tape, I can only think that like the 70′s, staying private is about to come back in fashion. Hopefully it’ll end there, and we won’t see polyester shirts, pleather, or bell bottoms again…;o)

Entrepreneurs who have successfully launched and grown their venture will inevitably have to start preparing for an exit. At last week’s panel on Financing Growth and Exits, The Capital Network (TCN) brought in an expert panel consisting of a successful entrepreneur, an investor, an investment banker and a lawyer to provide participants with a complete overview of the exit process. Here are some highlights of the Breakfast Roundtable on June 29:

Exit experiences become a complex but exciting process of “letting go” for entrepreneurs. Dr. Murat Kalayoglu, Founder and Chief Science Officer of HealthHonors, successfully took his idea from start-up to a successful exit in just 3.5 years. His advice was:

• Take the time to prepare the business, (as well as your mental state) for an exit.
• Leverage existing data to find new customers as well as reducing the cost of delivering incentives to customers for a speedy exit.
• A successful growth and exit can only be achieved by giving up some control and letting others help you succeed

Tim McMahon, Managing Director of Covington Associates, discussed the keys to executing a successful deal. His key points to ensure a successful exit were:

• Keep your exit strategy in mind - Company building is fundamentally about building long term monetary value
• Start raising your visibility by aggressive PR and building strong relationships with potential buyers
• Know both your tangible and intangible value drivers: revenue, profit, team, sales, expense, geography
• Articulate the story of your business and keep it consistent. What differentiates you from your competitors?
• Know your buyer universe: Market/Channel Partners, Vendors, Suppliers, Competitors, Indirect, Direct, Investors, Angels, Venture Capital, Private Equity
• Build strong relationships early and often: a successful partnership has two-way benefits at exit time
• Get organized – A successful exit takes time. Make sure your financials are in order and you have gathered the right advisors

Roger Walton, General Partner at Castille Ventures, spoke of the many paths a business can take from seed to expansion and growth, and finally to an exit. He advised:

• Any company that incurs revenues greater than $5 million and has proven its idea can grow should have begun exit preparation.
• A firm’s main motivations to acquire another company are to fulfill a strategic need, lower costs, lower risk, to increase growth or valuation potential, or to acquire a unique technology, intellectual property, or team.
• The keys to a successful growth in the eye of the investor are a large market, sustainable competitive edge, a scalable offering and business model, and a scalable team. Firms that take all of this into account should consider themselves in good standing to be acquired.

Panelist Paul Sweeney, a Corporate Partner with our sponsor Foley Hoag LLP, provided some key tips for entrepreneurs to consider when preparing for an exit. He advised:

• Founders should always remain in close contact with their lawyer and collect due diligence throughout the entire lifetime of the business.
• Don’t lose track of your equity holders: make sure your stock ledger and capitalization table are complete, correct and up-to-date
• Don’t ignore 409A problems: Granting options below fair market value can have a very ugly result
• Founders should limit unaccredited investors because unaccredited investors such as friends and family often impose a greater disclosure liability, are not as sophisticated as an accredited investor and require more disclosure.
• Pay close attention to key LOI terms, i.e., purchase price calculation, tax treatments of certain issues, identification of non-competes and employment agreements, indemnification limits
• Don’t give away “veto” rights unless absolutely necessary: Preferred Stock investors should be only non-founder player with right to block transaction
• Don’t freely grant Rights of First Refusal or Rights of First Offer

While founders, investors, lawyers, and acquirers all play a vastly different role in an exit, all are an essential part of the process. Learning what to expect from each party will help entrepreneur’s carry out the most successful exit.

A key theme mentioned by all panelists throughout the program, is the important of building strong relationships early. It is important to build relationships with customers and potential buyers early on to ensure a successful and competitive sale process later on.

About 80 entrepreneurs, early stage VCs and angel investors came to Nutter McClennen & Fish’s Seaport office last week for The Capital Network’s first Venture Fast Track Boot Camp. The theme of the interactive FastTrack was to give entrepreneurs an in-depth understanding of what it takes to raise early stage capital for a startup company.

In the audience were folks like Read McCarty, founder of Sandbox Medical (a provider of neonatal feeding solutions), Farnaz Bakhtari, Founder of TrainingPal (a SaaS based solution for the personal training and physical therapy markets), and Robin Coxe, founder of Close-Haul Communications (a developer of cellular over IP hotspots). Attendees included companies in the biotech, medical equipment, SaaS, cleantech, mobile, enterprise software, and other high growth fields.

In addition, fellow TCN Venture Coaching Graduates attended to share their success, such as Bettina Hein of Pixability and Joshua Herzig-Marx of Incentive Targeting. The group was joined by active Angels and VCs such as Jean Hammond of Launchpad and GoldenSeeds, David Beisel, of Venrock Capital, Jon Lim, of Polaris Ventures and the Polaris Dogpatch, Chris Sheehan, of Common Angels, and Elon Boms of Launch Capital.

The day started with keynote speaker Eric Paley, Managing Partner of Founder Collective, who discussed the current state of early-stage financing and the importance of leveraging the “network of trust”. Eric’s inspiring story focused on what to do when you are ready for financing, but it isn’t forthcoming. He illustrated the importance of building a strong Board and an active advisory group that were not just “window dressing.”

Some tidbits of advice gleamed from several of our sessions include:

On Creating a Business Model & Financing Plan moderated by George Simmons of Launchpad Venture Group & Yumin Choi of HLM Venture Partners:

• Lack of a consistent CEO is one of the biggest mistakes a start-up company makes. Founders should ask themselves honestly: Am I the right person to take my company from idea to exit?
• Would you rather be “rich” or be “king/queen”. Would I rather own 6% of a $100 million dollar company, or 100% of a lifestyle company?
• Fundable companies have large markets, create valuable solutions for critical customer problems, create barriers to entry for competitors, and have a well rounded “A” team.
• Most common mistake in looking at your financials? Entrepreneurs focusing only on top/bottom line. Learn to appreciate the value of gross margins, compare yours to your industry and know why your gross margin is higher/lower than others.
• Capital efficiency is critical to determining your financing needs.

On Raising Money from Friends & Families, Angels & VCs led by Jean Hammond, of Hub Angels, Launchpad Venture Group, and Golden Seeds, Carl Stjernfeldt of Castile Ventures, Joshua Herzig-Marx of Incentive Targeting, and Alex Golvsky of Nutter McClennen & Fish:

• When pitching your idea to an investor, even if the investor is not a good fit, ask if you can pitch to get advice.
• When going to friends and family for money, always write it down.
• When looking for angel group funding, find an internal champion.
• Always perform due diligence on your investor to see if they are good match — by stage, size, return profile, exit timing, interests and strategy.
• Some companies are a better fit than others for a particular type of capital. Figure out if you are a best fit with venture capital, angel capital, strategic capital, debt capital or bootstrap financing.
• Consider who an investor’s competitors are — because you may not be able to get funding from their competitors later.

On Dilution & Founder Equity Issues, led by Jeremy Halpern, of Evolution Advisors:

• Entrepreneurs should model the dilution impact of early stage investment – and understand exactly how this will affect the ultimate distribution of proceeds from a downstream sale of the company.
• The last investor is the most senior investor, which means last money in, is first money out.
• Participating preferred stock makes a deal significantly more investor friendly.
  If you pair strong valuations with strong anti-dilution measures, subsequent downround financings can radically diminish a founder’s equity value.
• Founders will typically take 100% of the dilution impact from an option pool that is adopted as part of the financing. If you are raising 12 months worth of cash, the option pool will need to cover the Company’s compensation needs for such 12 month period. This is just a fancy way of decreasing the pre-money valuation.

On Pitching the Plan led by Jeremy Halpern, of Evolution Advisors, Yumin Choi of HLM Venture Partners, and Jeffrey Arnold of Boston Harbor Angels and Mass Med Angels:

• When pitching investors, first appeal to their greed, then address their fears, then make sure they think you are a good use of their time.
• Successfully raising capital starts and stops with establishing your credibility – are you honest about the opportunity, risks and problems, and do you appropriately blend passion, humility and confidence.
• Investors invest in people because businesses don’t make things happen, people do.
• Focus on the value proposition and the market – not the technology
• If you can’t present your opportunity, solution, market, value proposition, competitive advantage, business model and team in less than 15 slides – you don’t know your business.
• Powerpoint slides are not the presentation – they are illustration – YOU are the presentation

On Angel & Venture Term Sheets and Negotiation/Valuation led by Bob Creeden, of Partners Innovation Fund, Jean Hammond,of Hub Angels, Launchpad Venture Group, and Golden Seeds, Jon Lim, of Polaris Ventures, Jeffrey Arnold of Boston Harbor Angels and Mass Med Angels, and Michelle Basil, of Nutter McClennen & Fish:

• It is important to pick your battles, not all terms are worth arguing over. Find the and focus on the key terms that are important to you.
• Understand how participation or multiple liquidation preferences change the economics of the deal
• Control over the board and the timing of selling the company is a critical issue
• Covenants and other rights of the Preferred investors can mean that even a minority investment will exercise significant control over the operation of the business
• Will you require the investors to pay-to-play – to support the company in subsequent financings or lose their preferred status and rights
• Valuations are driven by stage, leverage, the venture’s underlying competitive advantage and the ability to drive revenue
• Traditional valuation methodologies do not work for high risk, early stage companies — investors are trying to understand what their percentage of ultimate sale proceeds will be – and whether that is a good return on their investment.

Participants found the sessions very helpful, unlike any other all-day program with concrete takeaway material, a Mentor lunch session and a chance to meet with a high quality group of similar entrepreneurs. Tim Noetzel, founder of Pintley.com (an online community for the craft and micro beer industries), called it, “the most helpful and comprehensive program on early stage fundraising I ever attended.”

Let us know your thoughts on some of the above topics. We’d love to hear from you!