Parenting for Technology Businesses

Entrepreneurship and Mentoring

for Technical Start-Ups

Followed by a networking session with light refreshments

Prof Russell Smith MD PhD

Holder of the Queen’s Award for Enterprise Promotion

Operational Programme II – Cohesion Policy 2007-2013

Empowering People for more Jobs and a Better Quality of Life

Event part-financed by the European Union

European Social Fund (ESF)

Co-financing rate: 85% EU Funds; 15% National Funds

Investing in your future

1

2

Part 1: Assessing the idea

3

Commercial due diligence (1/2)

Science

IP outputs and strategy

Management and facilities

Markets and competition

Commercialisation strategy

Financial considerations

4

Commercial due diligence (2/2)

Due diligence is not just about ticking boxes

It is more than an administrative function

It is about knowing what questions to ask

It is about building up an overall picture – Evaluating the credibility of a project

– Assessing whether it can deliver on its promises

– Estimating the benefits and return on investment

5

How to approach the science

Science should be reviewed by peers

– Appropriate expertise as required

– Review commercial issues separately

A few pointers:

– Methodology and processes; are they sensible?

– Data outputs; are they realistic, use of statistics?

– Research tools and ethical approvals

– Is this an area that has had difficulty in the past?

– Is the science going to generate products or services?

6

IP outputs and strategy (1/2)

Is there IP coverage now or will there be in the future?

– Type of IP (patents, copyright, know-how…)

– Strength of coverage

– Geographical scope

Does it cover a platform technology or specific product

or service?

Evidence of search reports and examination

Quality of IP agents and advice

7

IP outputs and strategy (2/2)

Any need for third-party commercial licences?

Who owns existing IP and who will own future IP?

– Single vs Joint ownership

Is there a sensible IP strategy going forward?

– Evidence of portfolio build-up?

Is there evidence of any disputes?

– Funders, collaborators, institutions

– Third party actions

Future IP costs

Publication strategy

8

Management and Facilities

Is the team involved realistic?

– Does it have the right expertise?

– Has the team / individual members done this before?

Are there gaps in the team?

– Can they bring the right people on board?

Will they have enough time to devote to this project?

Are there facilities / space to house the people?

How will the team support new employees?

– Approvals from university etc

– What about things like insurance, training etc

9

Project Benefits and Outputs

Benefits relating to:

– Customers

– Income generation

– Cost savings

– Publication and

dissemination of results

Before considering the

commercial opportunity,

need to be clear on what

the project outputs are:

– New technology platforms

– Software

– Research tools

– Practice guidelines

– Questionnaires

– Protocols

– Toolkits

10

Markets and competition (1/4)

What are the outputs of the project?

– Is it a product or a service?

– Will there be a clearly-defined product or service

profile?

What sector will the product fall into?

– For example:

A clear technology product (Patent?)

Computer software (Copyright and/or patent?)

11

Markets and competition (2/4)

Who is the customer and the payer?

– The user? Corporate or individual?

– Another organisation

– Impact of environmental considerations?

Scale of opportunity

– Within the country

– Within a group of countries (eg EU)

– Broader appeal with full international potential

12

Markets and competition (3/4)

What is the market potential?

– Current market size and segmentation

– Market dynamics

Established vs emerging

– Future growth potential

– Key product / service differentiators

Is there a market for the product / service?

13

Markets and Competition (4/4)

What is the competition?

– Types of competition?

Market entry barriers

– Low vs high barriers

– Regulatory hurdles to entry

– Manufacturing and distribution costs

– Marketing and sales costs

14

Commercialisation strategy

The management company

– Typically SME

– Often with researchers as founders

Need to beware:

– Weak management (eg too much research focus)

– IP position

– Financial vulnerability/viability

– Understanding of the commercial strategy

– Loss of rights and dilution of returns

15

Financial considerations

Are they asking for too much or too little cash?

Do the costs look reasonable?

Will the investment (grant) take the work to a

meaningful milestone point?

What additional investment will be required after any

initial project has finished?

– Many proposals under-estimate late development and

commercialisation costs

Linking funding to performance milestones or time

– Be prepared to remove funding on poor performance

16

Conclusions

Face-to-face meetings can be much better

than desk research and analysis

Need to have a clear understanding of the risk

elements and focus resources appropriately

Cannot predict every eventuality

Don’t be afraid to ask obvious questions!

17

Part 2: Assessing the team

18

Lead researcher

Main review of science “contracted” to the independent peers - assumes careful selection of peer reviewers (critical)

CV for lead researcher?

Other interests and activities?

References for lead researcher?

Summary of grants received and outcomes?

Publication list for lead researcher – Any evidence of commercial applicability?

19

Assessing existing or potential CEO

CV and experience of leading other teams

Awareness of relevant science (not critical)

Communication ability (written and oral)

Understanding of IP and strategy

“Feel” for potential products and sector

Ability to build team rapidly (good network)

including professional advisers and interims

Experience of raising finance (debt and equity)

20

CEO – CV and experience

Mixture of science and business

Most likely science first (ideally PhD) and

business second (MBA not essential)

Business is global! Evidence of global

business and market experience beneficial

Any “easy” due diligence (eg websites)

Take up references!

21

CEO – Communication ability

This is, perhaps, one of the key skills

Should be able to communicate clearly with

both the written word (not just research

papers!) and also with oral presentations

Is it possible to see the Executive Summary

from a previous business plan and a funding

presentation (under CDA perhaps?)

22

CEO – Understanding of IP and strategy

Does the individual ask the right questions? – Who owns the IP?

– What searches have been done and what is the current opportunity? Any third parties involved?

– Who developed and what is the protection strategy?

– Who funds protection? Will they want reimbursement?

– Who are the professional advisers?

– What is the attitude of the inventor?

23

CEO – “Feel” for products & sector

Does the person have an understanding of the

sector and current trends? If not, how would

they gain that information (eg commission a

report from a university business school)?

What products and/or services look attractive

to the candidate and why?

Could those products or services be prioritised

at the present time?

24

CEO - Networks and teams

Does the individual have a ready-made

network of people to help straight away?

– Professional advisers (accounts and lawyers)

– Finance person (used to raising money)

– Commercial person (used to selling things)

– Operations person (used to running projects)

– Manufacturing person (used to making products)

– Regulatory person (used to gaining approvals)

25

CEO - Experience of raising finance

What forms of finance (and how much) has the

person raised (debt and equity)?

What experience with private investors, VCTs

and venture capital companies?

Understanding of any investor tax issues

Recommended share allocation split between

parties and who wrote their last Shareholder

Agreement? (sorts the real-life people from the

textbook people!)

26

CEO - Professional advisers

Ideally, CEO sources all that you need… – Need accountants (interview three)

– Need lawyers (interview three)

– Both of the above must be corporate and not general

– Willing to work on contingency?

– Recent clients? Take up references

Make a phone call (people say more when not in writing)

27

Finance Director

May or may not be an accountant

Must have raised both debt and equity finance

Must have their own panel of, or access to groups of, investors

Must have good relationships with corporate banking

Must understand investor tax issues

Must be able to create management accounts

Good if could take on HR responsibilities

28

Commercial Director

Apprenticeship often important – may have no formal qualifications whatsoever!

Must have good CV and history of moving rapidly through the ranks from field sales, regional manager, national manager etc

Must come across as determined (but not aggressive), driven to succeed

Evidence of good management skills

Can they bring anyone with them?

29

Operations Director

Needs to have good attention to detail without

losing sight of the “big picture”

Evidence of ability to work within teams

Good understanding of capital expenditure and

operational expenditure for planning purposes

Lateral thinker

Good communicator – ability to say “no”!

30

Manufacturing Director

Experience in relevant sector

Good relationships with suppliers

Understanding of supply, manufacturing and

distribution chain

Expertise in managing inventories

Relevant knowledge of regulations

Clarity of thinking regarding what work to do

“in-house” and what to “contract out”

31

Regulatory Director

Must have experience in relevant field

Good written and oral skills essential

Team player but willing to lead and take

decisions when needed

May need to be a Board appointment in order

to drive strategic decision-making

Must work closely with all department heads

32

Scientific Advisory Board

Leading scientists from research

establishments and from industry

SAB usually meets once every 4-6 months

Helps review recent science/results and define

both research and development strategies

Key is to focus on the potential products and

services based on commercial intelligence

Must have the respect of the Lead Researcher

since SAB advice may sometimes disappoint!

33

Part 3: Building the business

34

Raising Equity Finance: The documentation “Holy Trinity”

The Business Plan

The Cash Flow Forecast

The Funding Presentation

And we also need:

– Shareholder Agreement

35

The funding presentation

An illustrated version of the Executive Summary from the Business Plan

Usual to have around 15 minutes

Probably no more than 10 slides

Need to convey the key messages but with more chance to illustrate than is possible in the Executive Summary

36

Important to get key corporate information across

Be clear about your corporate plan

The funding presentation isn‟t the place to open negotiations

Be clear about share price, % of equity released, share options, finance round closing date, shareholder agreement etc

All decided ahead of speaking to financiers

37

Let‟s look at what a high-growth business might look like

A company with the following share structure:

– 60% equity to the founders

Inventor 25%

employer of the inventor 25%

management team 10% (CEO 5%)

– 30% equity for start-up funding (>25%) – these are

the shares bought by the investor(s)

– 10% equity to a share option scheme – additional

shares for current & new employees

38

What is the share option pool for?

To give incentives to current staff

To attract high-quality senior staff including the

CEO and others

To bind staff to the business (three years?)

To reduce cash burn since smaller salaries

may be acceptable

39

How do share options work?

The right to buy shares in the company at

today‟s valuation at some later time

Potential capital gain if shares can then be sold

later for a higher price

May attract tax benefits (EMI in UK)

Options may „vest‟ over 3 to 5 years and may

have performance target conditions

40

How do we get these parties to work to a common goal?

Full account must be taken of the needs of the

inventor, the management team and the

investors right from the outset – views may

not be in harmony

Need to capture everything in a plan that all

parties can agree to… the business plan

41

Equity finance: how is the company valued?

More of an art than a science…

Early-stage (eg university spin-out with no

sales) start-ups may struggle to get a high

valuation (eg 1m Euros in current climate)

Hence 30% equity for cash would generate

300,000 Euros start-up funding

42

Valuation on basis of trading

Obviously doesn‟t apply to start-ups

Upward trend in turnover/profit over years

Need clear reason why debt finance not

possible – perhaps need large capital amount

to fund growth or purchase of another business

Simple multiples of profit often used (5x profit a

common multiple used in UK)

Sector-specific multiples (eg 3.5x Architects)

43

Valuation of start-ups

Need to define “investment” to date

Pragmatic list of resources expended

coupled with…

Robust analysis of market potential and hence

future revenue and profit

Net Present Valuations (NPVs)

Consider University Business School help

44

Sources of early-stage finance – Private Investors

High net-worth individuals

Ability to invest 25k to 250k Euros typically

Many private investors act in groups

Any tax incentives will be extremely important

Very important group for early-stage

45

Tax breaks in the UK

Investors can get tax breaks via EIS relief on

investment and CGT – in other words they can

get a double benefit

But… both schemes require that no entity

owns more than 50% of the business (ie it is

not a subsidiary)… hence need to plan!

46

What do investors want? The rules of equity finance

Must have strong commercial application but

no need for immediate or short-term revenue

Protected IP (eg a good patent family)

Management team capable of delivering

Exit strategy for investor

Of which the most important is

management

47

Early stage strategies – „interims‟ and multiple finance rounds

Interim CEO part of „founding team‟

Interim CEO leads start-up funding of ca 300k -

500k Euros

Interim CEO shapes the company and leads

second round of finance of ca 1-2m Euros

Replace with full-time CEO

Full-time CEO leads later VC finance rounds

48

Multiple finance rounds – „Dilution‟ of ownership

Each finance round issues more shares so

shareholders can be diluted

Example – Company X raises 300k Euros by

issuing 1000 shares and selling 300 for 1k

Euros each (valuation of 1m Euros)

Inventor gets 25% and so has 250 shares

worth 250k Euros in total (paper value only)

49

Second round

Company issues another 1000 shares but this

time values them at 2k Euros each since new

patents and other progress argue for increased

value of the company – raises 2m Euros cash

So – now have 2000 at 2k Euros each making

the company worth 4m Euros post-cash

Inventor‟s stake diluted to 12.5% but worth

500k Euros – smaller stake but bigger value

50

Venture Capital round

Having spent the 2m Euros the company

progresses and is arguably of greater value

Issues 2000 new shares at 3k Euros each –

now have 4000 shares at 3k Euros each giving

a valuation of 12m but with 6m Euros cash

Inventor now has only 6.25% but shares have

a cash value of 750k Euros… only on paper!

51

VC „pref‟ shares

„Pref‟ shares have preferential rights

Rights controlled by shareholder and

investment agreements

Usually gives venture capital company better

rights over disposal of assets in case of failure

Not fair on early investors… but that‟s life!

Never negotiate without experience

52

Dilution - summary of what happened to the inventor:

Round Share price Shares % Euros

1 1k Euros 250/1000 25 250k

2 2k Euros 250/2000 12.5 500k

3 3k Euros 250/4000 6.25 750k

Lower % holding but higher cash value

53

Exit strategy

How do investors get their money back? After

all, they have bought shares not made a loan

Need an exit strategy:

– Trade sale (M&A)

– Management buy out (MBO) unlikely to

form part of initial strategy

– Sale of shares on public market

54

Investor relations

Very important – especially if you want

investors to “follow on” in later finance rounds

Organise any tax forms straight away

Quarterly updates – progress against plan

AGM

Make sure all investors get press releases

before they are released to the media

55

Shareholder Agreement

Defines a set of “rules” that apply to all shareholders

A “private” document between shareholders

Includes provisions to protect the rights of minority shareholders (eg more than 75% approval, or more, for certain decisions)

Defines when shares can be sold

56

Common inclusions:

Mortgages over company assets

Committing to long-term financing

Buying or selling large capital assets

Issuing more shares (dilution)

Joint ventures

Transactions outside normal business

Winding up the company

57

Common inclusions:

Selling and transferring shares

– Prevents “inappropriate” sales (eg to a competitor)

“Drag-along” and “Tag-along” clauses

Key people provisions

Death in service and long-term illness

provisions (especially relating to sale or

transfer of shares)

58

Common inclusions:

May include rules for payments to Directors

May define any loans or special remuneration terms for Directors

May define “good-leaver” and “bad-leaver” terms

Does not remove need for good “Service Agreement” for Directors and “Key Persons”

Thank You!

Any questions?

For more information on events in this series visit

www.um.edu.mt/knowledgetransfer

or email knowledgtransfer@um.edu.mt

Operational Programme II – Cohesion Policy 2007-2013

Empowering People for more Jobs and a Better Quality of Life

Event part-financed by the European Union

European Social Fund (ESF)

Co-financing rate: 85% EU Funds; 15% National Funds

Investing in your future

59