II. 2 Funding startups

1

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2

timeSweat equity Seed money Start-up Expansion

Entrepreneur, 3 F’s

Business Angel

CCF

Venture Capitalst

PrototypeProduct

introductionMarketing

Expansion

Sales

engineeringprototype

Concept

know how timeresearch

1st marketing plan

proof of concept

product dev.

business planproduction

prototype

1st personnel

start marketingmanagement teammarket studies

workingcapital

Productsupport

helpdesk

maintenance

product enhancements

regional

marketsegment

marketing plan

Source: Rudy Aernoudt (adapted BAN-V)

funding growth

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enfocus 1993-1997

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enfocus 1998-2003

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Enfocus 1993-2003

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artwork systems 1993-1996

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biot

ech

com

panybiotech and finance

CCF

Time

biotech valley of death: best case

scenario

‘regular’ company

valley of death

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Conclusions • Many companies require capital to fund their startup

• Size of the needs depends on many factors• Often related to the ‘business model’ of your project: Service company? Technology developer? Investment goods supplier? Component supplier? Economies of scale?

• What enabling technology? What end-user industry? Pace of change in industry?

• There are several potential sources for this funding• Your own resources• 3F’s: friends, family and fools• banks• partners• customers and suppliers• venture capital and business angels• Stock exchange (IPO)

• Each have their properties, pro’s and con’s

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2.1 Sources of funds: an overview

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Health City story• Sportopolis (now Health City): fitness center at university

• how to turn 50.000 euro into 2,5 million euro • 50.000 euro own capital• funding by brewery: 200.000 euro• public/private collaboration adds 1 million• and then loan by bank: double the amount = 1,25 million euro

• -> be pragmatic and opportunistic!

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Cash flow positive• = your operation funds itself -> generates profits

• -> No additional funds needed for day-to-day operations• May still require new capital for investments

• It is the ultimate objective of all enterprizes to be profitable • You can’t be a promising star forever!

• Very few companies managed to be cash flow positive from very early stage on

• Artwork Systems

• Don’t underestimate the amount of money that is tied in an organization

• Stock (voorrraad), unpaid customer invoices, monthly salaries...• = working capital needed to prefinance the operation

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Supplier and customer credit• Payment conditions have a substantial impact on funding needs of a company

• if suppliers and employees have to be paid before a company receives money from their customers the company must finance this upfront

• Customers that pay upfront generate money upfront!

• Long payment terms by suppliers generate a lot of room!

• Customers that don’t pay their invoices create big problems for a company

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Banks• Banks are limited by law in the risks they take

• They therefore always look for collateral (onderpand), which they can sell in case of failure of project

• This limits their use for high tech startups, where assets are intangible, or don’t have resell value

• software

• This is why Health City could access banks and Enfocus not

• Governement can intervene by being the guarantor for loans to startups (waarborgregeling, via PMV)

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Government• Governments may support certain activities by providing funding

• Research funds• Public(ly supported) Venture Capital Funds• Public-private collaboration• Ad-hoc subsidies

• For patents,...

• Always check subisidies

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Partners, alliances• In some case strategic alliances are major source of funds

• Ablynx: drug companies• Sportopolis: breweries

• Many alliances are based on simple logic:• Capital-rich established partner invests in startup, in exchange of substantial long-time revenue streams

• sales of drugs, beer

• Alliances can have vastly different ‘formats’• Investor• Customer• Supplier• Paying for exclusive access

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Risk capital

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Informal risk capital• Own resources and time

• Each entrepreneur invests his own time and often money• Belgium: 90% of startups use own capital of entrepreneur; often pays himself small or no wage in startup period

• Friends, family and fools• can be source of funds• be aware of disadavantages:

• risking personal relationships• inexperience of investors

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Venture Capital

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what it’s all about...

• Enfocus software 1998

• 1 million Euro in venture capital for 28% of company

• To fund expansions plans

• Shares sold for +/- double the amount one year later

-1.000.000

2.000.000

5.000.000

8.000.000

11.000.000

F 1999 F 2000 F 2001 F 2002 F 2003 F 2004

sales benefits

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Venture Capital

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• Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk, growth oriented companies.

• the companies usually have a novel technology or business model in high technology industries, such as biotechnology, IT, materials, etc.

• The venture capital fund receives equity (aandelen) in exchange for the monies invested in the company

• The typical venture capital investment occurs after the seed funding round as growth funding round (also referred to as Series A round)

• The VC generates a return by selling the shares it owns in an IPO (initial public offering, beursgang) or trade sale of the company.

• Venture capital is a subset of private equity. Therefore, all venture capital is private equity, but not all private equity is venture capital.

• Based on Wikipedia

• Risk sharing investment money

• With limited investment time horizon

• Supplied by professional investors

• In growth oriented companies

• In form of shares of company

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Not for everybody...

• START database• Flemish enterprises (vennootschappen) • between one and two years old• employing 50 or less people• representative population of 637 enterprises was selected and queried.

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some statistics

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impact of venture capital

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Venture Capital as % of GDP

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Relevance for US economy

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Companies Founded With Venture Capital

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VC-backed job creation

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VC and creative destruction

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Venture Capital in Belgium 2005

• source: EVCA, Pricewaterhousecooper and Thomson Venture Economics

• compared to 5.700 million Euro in Silicon Valley in 2005

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2008, 2009 in the US• US Venture capitalists invested

• $28.3 billion in 3,808 deals in 2008 (+/- average for 2002-2009)• $17.7 billion in 2,795 deals in 2009. (-37,5% in one year)• Silicon Valley attracted 40 percent of total US venture capital dollars and 31 percent of total US deals.

• New England was a distant second at 12 percent of total US funding and deals.

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US Venture Capital per sector Q3 2010• Total invested Q3 2010: $5,2 billion in 716 deals

• The Software industry • $1.0 billion going into 190 deals.

• The Biotechnology industry • $944 million going into 108 deals.

• Internet-specific companies • $661 million going into 154 deals

• a company with a business model that is fundamentally dependent on the Internet, (overlaps a/o with software industry)

• The Clean Technology sector• alternative energy, pollution and recycling, power supplies and conservation

• $625 million and 58 deals • saw a 59 percent decrease in dollars and 26 percent in deals compared to the second quarter

• Medical Devices and Equipment

• $573 million going into 82 deals.

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Sources of European VC funds

• Belgium 2002• banken (55,1%)• particulieren (27,5%)• publieke sector (7,2%)• privé ondernemingen (6,7%)• universiteiten (3,5%)

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The Venture Capitalist

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the financial logic of a VC

quality of investment bad alive ok good super total

amount invested 200 400 200 100 100 1000

Multiple after 5 years 0 x1 x5 x10 x20

Cash from trade sale 0 400 1000 1000 2000 4400

Revenue -200 0 800 900 1900 3400

• (Peter Camps)

• VC’s look for companies that have the potential to score really big, to compensate for the total failures

• sometimes it feels like VC’s want to be lied to. • I’ve never over-promised, I’ve always presented what I believed was realistic – or even

conservative.• but it’s important to show the long-term upside potential, • so you end up with a two-pronged business plan

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Different VC leagues Friends, Family and Fools (3F’s)

– Pre-seed financing– Smal(ler) amounts, single investment

Business Angel (BA)– Seed/ start-up financing– Relatively small amounts, limited investments– Active monitoring and assistance

Venture Capitalist (VC)– Seed/ start-up/ expansion financing– Bigger amounts, larger portfolio of investments– Also ‘hands on’ financing, but due to portfolio size, less than BA

Private Equity (PE)– Turnaround financing, leveraged buyouts– Large scale projects (consolidation of industry players,...)– Very big amounts– Little hands-on, but mainly financial architects– Often commitment to firm limited in time (exit)– Examples: Health City

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Business Angels• Business angels are (ex-) entrepreneurs who invest in high potential startup companies

• Average investment between 25.000 and 250.000 euro

• Besides financial support they provide guidance of entrepreneur, using their own expertise

• Business Angels often have an extensive network of contacts and can give the companies a substantial credibility boosts towards customers, suppliers, banks...

• Many Countries have Business Angels Networks

• In Belgium• www.banvlaanderen.be• www.beangels.eu

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The Venture Capitalist...

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The largest US VC’s...

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Members Belgian Venture Capital Association• 3D Participaties3iAllegro Investment FundARKimedes FondsBecap PE Asset Managers & AdvisorsBMI-SBIBNP Paribas FortisCapricorn Venture PartnersCreafund ManagementCapital-EFin.CoGemma FrisiusFonds

Gilde Buy-Out PartnersGimvHunza ManagementIndufinInframanINGInvestsudKBC Private EquityLRMNivelinvestNPM CapitalOcas VenturesPMVPE GroupQat InvestmentsQuest for GrowthRiverside

Sofindev ManagementSofinimSopartecSowalfinSRIB/GIMBSRIWStonefundSynapsis AssociatesTheodorusTrustCapital PartnersVendis CapitalVesalius BiocapitalWaterland Private Equity

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Corporate Venture Capital

Nokia growth partners is a diversified institutional investment management firm headquartered in Menlo Park, Ca. It is fully funded by Nokia with US$ 200m under management.

Nokia growth partners invests globally directly into growth stage technology companies as a venture capital fund.

Nokia growth partners is funded by Nokia to provide superior returns and investments into companies, firms and people that are changing the face of mobility, communications and the internet.

with an overall strategy to enable innovation, intel capital seeks out and invests in promising technology companies worldwide. we focus on technologies that help to develop industry standard solutions, drive global internet growth, facilitate new usage models, and advance the computing and communications platforms.

as part of Intel corporation, Intel capital calls on some of its best and brightest to evaluate prospective investments, offer business and technology guidance...

we are among the largest venture capital entities in the world with offices in established and emerging markets around the world. since 1991, Intel capital has invested more than us$6 billion in nearly 1,000 companies in more than 40 countries. in 2006, Intel capital invested about US$ 1.07 billion in 163 deals.

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US corporate VC as % of total US VC

National Venture Capital Association, PricewaterhouseCoopers Private Equity & Venture Capital Practice August 30, 2007

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Some terms Funding stages

Pre-seed– Mostly just an idea about the

business concept– No product yet– Technological uncertainty

Seed – Business concept is fine-tuned– Proof of concept delivered– Prototype might be delivered as

well Early stage/ start-up

– Proof of product– Company starts up, makes first real

marketing expenses Growth/ expansion

– Proof of market– Company expans and turns break-

even

– Investment rounds• VC’s do not invest all the money required to get to profitability in one go

• Often the ‘necessary’ funds are provided to achieve certain milestones

• Round A, Round B...

• Lead investors and others• Often one investor does the work: due dilligence,...

• Often (a) new investor(s) join in the following rounds, and they become lead investor

–

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E-ink investment rounds

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what you need to understand about VC’s• Peter Camps

• VC’s are also looking for ROI on their own time • in general, a vc spends a relatively fixed amount of time on each company they actually invest in

• this means that, depending on the VC’s internal structure, the VC needs each investment to be for a certain minimal amount

• that’s one reason why sometimes it seems easier to get $2m than $1m, provided you can come up with a meaningful way to spend 2m.

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Venture Capital• Not destined for average starter...

• <1.5% of all Belgian startups use VCs or Business Angels

• Growth intention and potential is a necessary condition• Often linked to innovative/technology• But not necessarily, in both directions!• 30-50% of all ‘innovative startups’ in Flanders use VC in some stage of its life

• Fewer do so from startup

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How VCs decide...• Most VC’s focus on a certain subset

• such as• industry sector (biotech, IT, energy,

materials...)• investment size• stage of investment (early stage capital, ..)• geographical focus

• this functions as a filter for VC’s• It enables them to provide ‘smart money’:

allows them to leverage their expertise and networks within a certain domain

• Two schools of thought: – ‘ I invest in people first and foremost.

Smart people will find great opportunities and I will never know the sectors or technologies as well as smart people.’

– ‘I don’t care about people, I care about markets. I look for big painful problems that customers have. If management doesn’t work out, I can always fix management.’

• Typical Venture Capitalist profiles• technology investors

• focus on uniqueness and protection of product and technology, then on close personal contact with entrepreneur

• investment manager has technical expertise, sometimes ex-entrepreneurs

• often governement funded, local focus• people investors

• leadership, team, then financial• mainly private investors, both early stage and

follow up investments• non technological as well as techological

• financial investors• 30% of sample• financial return from BP is essential, then

team• Often funds related to banks

• Other considerations• Fund duration• Portfolio balancing• Recent experiences• Personal preferences: distance,...

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belgian vc selection criteria

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What Khosla Ventures looks for in seed stage investments

• Overall • a crazy idea that may have a

significantly non-zero chance of working.

• the key technology risks of your approach need to be identified.

• The economic and market benefits if it is successful need to be identified

• Planning for risk elimination at the lowest possible cost is the key variable we look for.

• Your seed plan should validate your hunches about the market and help you decide what market segment you want to enter.

• problem overview• What is the problem you are trying to solve?

•your unfair advantage• Do you have a scientific

breakthrough or IP, a business-model innovation, or a unique partnership?

• Address the innovation in significant detail—think science and engineering, not marketing.

• Why is now the right time? • What has been proven and how far is this from a commercial scale?

• What risks remain to be proven? • What are the three major things

that could go wrong? • How long will it take to experimentally validate the technology viability?

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What Khosla Ventures looks for in seed stage investments

• milestones / financials• What are the technical milestones that this financing will achieve?

• What are your future milestones, and how much capital will you need to achieve these milestones?

• What is your total and operating cash burn (the amount you're spending) per month

• your team• Who are you, and why are you

qualified to lead this opportunity? What skill sets do you bring to this problem? What technical skills will your team need to add? Do you envision yourself as the long-term CEO or in another role? Address why you are uniquely qualified to solve this problem. People key to your innovation matter to us.

• market / competition• Do you have a good understanding of the competitive landscape?

• Are you comparing your company against the technology competition in areas that matter to the end customer? Are you comparing your future product to your competitor's current product or to their future product?

• Is your innovation addressing a need in a large enough market ($1B plus)?

• How significant a step forward is represented by the technology or innovation? What impact will it have on the competition?

• Why can't your plan be replicated tomorrow by a competitor? Why have other players in the field missed out on the technology?

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Seed fund - what doesn't matter• "We project $XXXM in revenue in 2019."• Your five-year marketing financials and

revenue projections are a shot in the dark. • All forecasts are wrong (including

ours); focus on the burn rate and your path toward achieving the milestones, instead of false precision at this stage.

• "We expect to grow from 50M to 150M users in XXX."• We're more interested in how you

acquire your initial customers, and how you keep them. Plans often fail to explain how the founders will bootstrap themselves in the start-up mode. How will you get that large customer base in the first few months or quarters? Details matter more than gross, unsupported assumptions. If you have indicators of solutions to this bootstrap risk, that is important for us.

• "I have the next Facebook / Google / Twitter."• If your business plan is built on copying

what existing companies are already doing, you are unlikely to succeed. Instead, explain to us why you are the first XYZ. A better Facebook or social network will receive substantial skepticism; but again, we have occasionally climbed past this skepticism. We will keep an open mind, but another "me too," slightly-better-features plan is seldom our cup of tea.

• "I have a complete business plan; I just need funds to make it happen."• Unfortunately, experience has led us to

disagree. If you are looking solely for funds as opposed to help building a business, we are probably not your best option. It is important to us to understand what help you need and how open you are to this help.

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Elements of Sustainable Companies according to Sequoia Capital

• Start-ups with these characteristics have the best chance of becoming enduring companies. We like to partner with start-ups that have:

• Clarity of Purpose• Summarize the company's business on the back

of a business card.

• Large Markets• Address existing markets poised for rapid

growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop.

• Rich Customers• Target customers who will move fast and pay a

premium for a unique offering.

• Focus• Customers will only buy a simple product with a

singular value proposition.

• Pain Killers• Pick the one thing that is of burning importance

to the customer then delight them with a compelling solution.

• Think Differently• Constantly challenge conventional wisdom. Take

the contrarian route. Create novel solutions. Outwit the competition.

• Team DNA• A company’s DNA is set in the first 90 days. All

team members are the smartest or most clever in their domain. "A" level founders attract an "A" level team.

• Agility• Stealth and speed will usually help beat-out

large companies.

• Frugality• Focus spending on what's critical. Spend only on

the priorities and maximize profitability.

• Inferno• Start with only a little money. It forces discipline

and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower.

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Financial expectations of VC’s

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Duration of VC investment• VC’s are want their money back out of your company within a reasonable time frame

• depending on the VC (a/o the duration of his fund) this can be 2-7 years

• before they even consider the investment, they want to understand the “exit” possibilities

• so VC’s want to know the current shareholders attitude towards an exit

• your business plan should explore exit opportunities

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Some things VCs understand

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• The future is unknown

• All projects are risky, not all will succeed

• -> as many projects will fail completely, and some others will never achieve the grand hopes that were expected, everything relies on the few projects that make it big

• -> the theoretical potential of all VC projects must be very high for VCs to be interested:

• seed stage: +/- 50% IRR• later stage: +/- 35%

• http://ventureahead.com/VC_survey_results/VC_Practices_Survey/IRR/irr.htm

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valuation

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valuation: why? business valuation: to

determine the fair market value of an owner’s interest in a business

reasons for business valuation– external

investors need to find out wether or not they should participate in a company

entrepreneurs need to know what share they are willing to sell in exchange for the additional money

– internal capital allocation investment decisions M&A during licence negotiations

• By definition uncertain value:• High risk, long time horizon, market

conditions...

• Valuation calculations• return expected by VC• expected profits of company in # years

• validity of prediction• value of the company, based on its

profits, on P/E ratio• Market value

• Much depends on • situation of market and economy• negotiation position• “there is no gold standard when it comes

to valuation: it is and will remain a subjective task. Consequently, a company can have as many values as there are people doing the valuation.” (Frei & Leleux, 2004)

•

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valuation techniquesdiscounted cash flow valuation (DCF)

– NPV– IRR– Risk Adjusted NPV

relative valuation/comparables real option valuationadded value

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Due diligence

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Due Diligence• In the course of the process an in-depth study of your project will be performed

• Due diligence is the process by which confidential legal and financial information is exchanged, reviewed and appraised by the parties to a merger or substantial asset transfer.

• The essence is an effort to make everyone as aware as can be of any liabilities the other party may bring to the transaction.

• The desire is to create a "no surprises" situation.

• The potential investor generally uses in-house resources or hires a consulting firm

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term sheets

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Term sheet• Document in which the conditions under which the VC invests in the company is defined

• Is translated in final contract between actors: shareholder agreement, side letters

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Some things to watch out for...• watch closely for clauses that undermine

your control over the company• vc’s often agree invest large sums of money in

a startup company in return for a relatively small percentage of the shares

• it is therefore reasonable that the vc expects certain additional control rights, over and above the rights automatically attached to the percentage of shares they own

• make sure you feel comfortable with these additional control rules, especially since all of this stuff is in fairly inaccessible legalize.

• watch closely for clauses that define procedures or restrictions for selling shares

• vc’s will demand certain limitations on selling shares. for example, they’ll want a “sell along” clause, to ensure that you don’t sell your 80% percent of the company to some bozo, leaving the vc’s with basically worthless shares.

• make sure you feel comfortable with these rules, and try to make them as symmetric as possible (e.g. providing other minority shareholders with the same rights as the vc’s).

• watch closely for non-compete and commitment clauses

• the vc will want to guarantee that the key company staff remains committed to the company for a certain period of time after the investment; a reasonable request

• make sure you understand the implications of these extra “ties” to the company, and minimize the period

• don’t run out of money before you get new funding

• don’t wait too long to start the process• don’t ramp up your expenses until you have

new funding secured• it is much easier to get money when you don’t

need it (yet)• people appreciate the fact that you have planned

ahead

• never sign a personal guarantee, unless that’s exactly what you want

• (Peter Camps)

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What does this mean?

• In case of sale of company VCs are the first to receive their money back, increased by 20% per year

• Then other shareholders ‘catch up’

• Additional monies are distributed pro-rata

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And this?

• If the VCs find a buyer for their shares at a price at least 3 times the price they paid, then all other shareholders must sell their shares at the same conditions

• If not they must buy over the VCs share at the established price

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• Tot hier

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after you get the funding• Peter Camps

• be prepared for a different mode of operation• the control rules and a formal board of directors require quite some time preparing for and running meetings

• updating business plans, preparing investment requests, building argumentation pro/con potential business strategies, etc

• this is not all bad, since it forces you into a professional, structured mode of operation.

• but it does take time and effort• it can be very frustrating to explain your business to someone who doesn’t understand your business…

• watch for “political” reasons behind certain standpoints• vc’s invested in your company for their own reasons• their risk assessment may differ from yours• attempt to get these issues out on the table, rather than lurking in the corner as a hidden agenda.

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contributions by vcs

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2.3 Exits

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Exits • Because:

• VC’s invest in a company for a limited time• They want their money back after that period

• VC’s exit by selling their shares to someone else...• Generally the whole company is sold to another company• Sometimes the company goes to the stock exchange and they sell their shares

• Working with VCs implies accepting the fact that you will probably sell your company...

• ...They will check whether you acknowledge this fully

• The attitude may be different with industrial investors and some private equity funds

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IPO: initial public offering

• description: sell the shares of the company to the public to be traded on a stock exchange • advantages:

• conversion to cash for investors• major shareholders usually maintain control• high potential return

• disadvantages: • company must have tremendous growth potential to receive IPO• costly process• uncertain outcome• major shareholders may be limited as to how much, when, and how they can sell stock

• Ablynx 85 million fresh cash in company

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Possible trade exchanges for IPO• NASDAQ

• 2664 companies listed, Euro 3,1 trillion

• London SE: AIM• 1.194 companies listed, Euro 92,7 billion

• NYSE: Euronext: Alternext• 154 companies: 141 in Paris, 11 in Brussels, 2 in Amsterdam for Euro 5 billion

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Trade sale• Business bought outright by another existing company

• Advantages: • Investors and entrepreneurs receive cash (or stock)• Often purchased by strategic partner with important complementary assets• Management contract can be negotiated

• Disadvantages: • Fit must be appropriate• Potential management changes• Corporate identity may disappear

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Other exits• ‘50/50 acquisition’ = merger

• description: join with an existing company

• advantages: • may receive stock and some cash• resources are combined• current management may stay

• disadvantages: • new partners or bosses• less control• may receive little or no cash

• Buy-out• description: one or more stockholders buy out the others

• advantages: • seller receives cash• other owners remain in control of

the company • disadvantages

• seller must be willing• buyers must have sufficient cash to

buy others• often paid via cash flow of

company: drain on resources of company

• bankruptcy• 10 to 20% of cases...

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frequency of exit routes

– http://www.rotman.utoronto.ca/cmi/news/schwienbacher.pdfTuesday 12 November 13

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Liquidity events

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