Financing Start-ups Jeff Skinner, London Business School KCL 28 January 2014 © Jeff Skinner 2014

© Jeff Skinner 2014

Financing Start-upsJeff Skinner, London Business School

KCL 28 January 2014

© Jeff Skinner 2014

The ‘Journey’

• Hypothesis• Test• Business Plan• Resources (including cash)• Execute • Sales, value create• Scale• Sell

© Jeff Skinner 2014

Finance for what?

• You’ve done market research• Found out what takes you towards:

– Sales (channel, supplier, team) development– Next round of investment.

• Maybe:– Proof-of-Concept (Action, Market, Value,

Manufacture…)– Value chain (supplier, distributor) building– Internal capacity (team, infrastructure etc) building– Working Capital (time delay to payment)

© Jeff Skinner 2014

Product-focused development

Development spend £££

Risk

Value of ‘business’

© Jeff Skinner 2014

Value-focused Development

Milestones

Risk Value of ‘business £££

Development spend £

© Jeff Skinner 2014

What’s a milestone?• Product (corporate spending other people’s cash??):

– Something else has worked– One more brick in the wall (tick on PERT chart)

• Value (entrepreneur spending ‘own’ cash):– Something fundamental hasn’t gone wrong (or maybe it

did – glad we found out early)– A ‘concept’ proved– ‘Leap of faith’ justified– Flipped some ‘heads’ in a row.

© Jeff Skinner 2014

Extract from business plan…

“Raised $1.2M to: • Protect initial IP • Develop prototypes • Launch evaluation kit program • Develop early sales channels and secure JDA partners

Seeking $5M in new capital to: • Scale existing JDA efforts • Transition JDA partners to solution sales • Begin mass production of ForceTouch sensor solutions “

© Jeff Skinner 2014

Wasted finance...

We chose the wrong risk

We didn’t prove anything

Development funding

Risk

Value

© Jeff Skinner 2014

© Jeff Skinner 2014

Sources of Finance

• Own sweat, resources under your control• Friends, fools, family etc (‘3Fs’)• Bootstrap (retained earnings, cashflow)• Customers, suppliers (who share your success)• Grants, ‘soft money’• Banks• Crowdfunding (the ‘Market’)• Angel Investors• Venture Capital

© Jeff Skinner 2014

Own ‘sweat’, resources

• All you have at the outset!• Likely to be limited• But early stage (research) costs little.• Web-based business might not need a lot. • The most important thing is to make the most

important thing the most important thing.• Can retain 100% ownership & control. • Unlikely to be enough unless a consultancy.

© Jeff Skinner 2014

“Family, family & fools”

• Maybe good for a few £k.• Leveraging emotional & social capital • Position as education (no return needed)• Think what happens if all is lost. • Be honest, keep communicating progress.• Careful if equity (OK if loan or grant)

© Jeff Skinner 2014

Bootstrap

• Buy an apple, sell the apple, buy two apples…• Slow growth – which sometimes fine (especially if good margin/multiplier)• Not good if small Window of Opportunity• Consult and use cash to grow main business• ‘Soft’ to ‘Hard’ - consultancy as mkt rsch)?• Keep all equity, control.

© Jeff Skinner 2014

Customers, suppliers

• Your success means:– More business, profit for suppliers, distributors, service providers.– Services or goods that users want.

• Can mean:– Generous terms negotiated from suppliers:

• Long payment terms• Some up-front, balance when you sell

– Customers paying in advance (positive cash flow):• Up-front (pay now, receive later)• Subscriptions

• Rare – but great since no dilution.

© Jeff Skinner 2014

Grants, ‘soft’ money

• Various small sums:– Start-up loans (Government): £10k.– TSB (or even RCUK) grants– Business Plan Competitions– ‘Start-up Chile’– University PoC, free stuff– Accelerator (mostly for equity)

• Maintain Ownership & Control. • Small sums but can make all the difference!

© Jeff Skinner 2014

“Businesses can apply for both the CSR Awards and the Transformational Finance Awards, while social ventures should get their applications for the ‘Big Venture Challenge’ by Feb 10th

… Sarasin & Bridges have announced a £30m Social Investment Fund while the UK’s first Local Impact Fund’ has been launched in Liverpool”

‘ClearlySo’ Newsletter (27Jan2014)

© Jeff Skinner 2014

Banks

• Hardly ever for ‘high risk’ • Usually secured debt.• You have few assets as security.• Can securitise:

– fixed assets (marketable machinery etc)– working capital & invoices.

• Low risk, lowish interest• Short term (can be called in) • Really not for start-ups

© Jeff Skinner 2014

Crowdfunding

• New entrant – P2P finance - on the rise.• Currently illegal to offer shares to the public* • But can give sample, information for donation• Some services (e.g. CrowdBnk) can fix equity.• Think of this as a fundraising campaign • Research Kickstarter etc to see what works

* Except ‘High Net Worth’ Individuals

© Jeff Skinner 2014

Angel investors• ~£20k - £200k – • Often first serious money• ‘High Net Worth’ individuals• Bring expertise as well as money. • Gather & ‘syndicate’ in Clubs, accelerators • See: https://angel.co (Angellist)• Angel Co-investment Funds - See:http

://www.capitalforenterprise.gov.uk/bacf• Massive Govt Incentives – SEIS up to £150k.• Take risk (thus equity & control).

© Jeff Skinner 2014

Venture Capital

• Tend to specialise.• Most ‘famous’ - but back very few.• Seek x10 returns to compensate for ‘lemons’. • From £500k to £5M first round.• Looking for high growth – best for businesses:

– Ready to ‘scale’ – Needing lots of R&D - then going global (Pharma)

• Court but unlikely to be ‘VC-ready’ for years.

© Jeff Skinner 2014

Other things bought for equity

• Idea itself?• Individual (Sweat Equity)• Team (ability to execute). • Intellectual Property (brand, data, patents…)• Assets (property, facilities)• Cash• Contracts?• ‘Goodwill’ (relationships, sticky customers,

subscriptions

© Jeff Skinner 2014

Types of cash investment

• Pure debt:– Secured– Pay back with interest– Very limited upside and downside

• Pure equity (ordinary shares)– Unsecured– Share of eventual profits/sale– Share fully in upside and downside

© Jeff Skinner 2014

Variants on Debt/Equity

• Preferred Shares• Liquidation Preference• Convertible loan• Anti-Dilution• Ratchets• Warranties• Preferential right to invest in future rounds • Option pool

© Jeff Skinner 2014

Controlling Interests

• Standard Shareholder rights• Nominee Directors• Veto Rights• Vesting (with Good & Bad Leaver provisions)• Tag & Drag Along Rights

© Jeff Skinner 2014

Gen up

• These terms are the language of investment.• Not difficult to understand. • Read some Agreements:

http://www.bvca.co.uk/ResearchPublications/StandardIndustryDocuments/Modeldocumentsforearlystageinvestments.aspx

• Read the book (terms & process explained): http://www.simonacland.com/venturecapital/angelsdragonsandvultures.htm

• Things that can go wrong – read for example:http://www.seedcamp.com/resources/investment-are-you-in-danger-of-raising-a-toxic-investment-round

• Always understand everything – seek worked examples (‘if…then’).

© Jeff Skinner 2014

© Jeff Skinner 2014

(Pre-Money) Valuation of Business

• Valuation hard if complex (debt/equity) instruments used.

• But if pure equity (share of business) then:– DCF (risk-adjusted future revenue)– Benchmark, ‘market’ (what others got)– What VC needs now to get 10X at exit.– Whatever you/they can negotiate.– Price that leaves you with just enough incentive.

• Remember that investor has another bite of cherry but you may not.

© Jeff Skinner 2014

Conclusions

• You’re in two markets: product and money• Investor is a customer: buy money with equity• Research market before ‘selling’:

– Why wouldn’t you (& people like you) invest?– What do you (& other investors) value?

• Start conversations now:– Build awareness, relationship, reputation– Seek advice

© Jeff Skinner 2014

Heterogeneous investors

• Investors ‘segment’ just like other customers• Different preferences when it comes to:

– Available resources (cash)– Degree of involvement– Risk & reward appetite– Pressures (e.g. exit, IRR)– Languages– Knowledge, sophistication.

© Jeff Skinner 2014

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