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Are you thinking about what you need to fund your company? Where do you start? Funding is not “one size fits all”. Every company has to approach their pathway to funding with a unique approach. Join our fundraising experts for an in-depth discussion of what options you have for funding and how to decide which paths are right for you and your company. We’ll have a specific focus on life science focused companies and technologies and the funding choices available for them.
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Funding Op*ons for Life Science Companies May 6, 2014
The Panel Jeremy Halpern Partner, Nu@er McClennen & Fish jhalpern@[email protected] @startupboston
Yumin Choi Partner, HLM Venture Partners [email protected] @yuminvc
Paul Hartung President and CEO, Cognotpix, Inc PHartung@cognop*x.com
Funding the Company
Assuming you plan to be a “high growth” company…
What are your funding op*ons?
Entrepreneurship comes in many types
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NORMAL GROWTH COMPANY
HIGH GROWTH COMPANY
EXTREME HIGH GROWTH COMPANY
SOCIAL VENTURE COMPANY
• Includes all service businesses
• Exploiting a local market need
• Team has ‘great jobs’
• Growth by adding resources one by one
• Exit will be based on value of cash flow (mature biz.)
• Growth profile ultra-scalable
• Team focus is exit • Revenue $40M+
with lots of room for growth (5 yr.)
• Based on $20M+ investment
• Exit targeted to IPO or by ‘large’ M&A event
• Goal is to fulfill a social need
• Has mission orientation
• Team needs to support mission
• Growth profile often one resource at a time
• Exit …much harder to find fit
• Company can grow fast (on-line) or has a scalable system
• Team often motivated by exit
• $10m revenue in 5 yrs & market size allows significant additional growth
• Capital efficient total investment$2-4M
• Exit by M&A
Close Up: Extreme High Growth vs High Growth
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Capital Needs
Time
High Risk
Low Risk
Formal Venture Capital
M&A or IPO
Crystallize Ideas
Demonstrate Product
Early Scaling Growth
Sustained Growth
Angel Group (or Micro-cap) Syndication
Angels or Accelerators or Micro-cap
funds Angels or Accelerators or Micro-cap
funds Business Angels
Market Entry
M&A
Later VC Rounds
Extreme High Growth High Growth
Friends, Family & Founders
Friends, Family & Founders
High Growth Company Characteris*cs • Disrup*ve Innova*on with Strong value proposi*on
– Correla*on between Large Unmet Need : Solu*on • High Margin Product (Ra*o of Revenue : COGS)
– Some*mes Massive Volume Products where innova*on is incremental
• High Rate of Revenue Growth over sustained period • Scalable (Fixed cost is a low percent of Revenue) • No major barriers to con*nued growth (ex. blocking IP; geography;
regulatory) • Repeatable sales and distribu*on model with many credit worthy
customers • Large Total Addressable Market (TAM) • Defensible innova*on able to withstand compe**on and changing
condi*ons • [Capital efficient]
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Return on Equity Return on Debt Income High Return
NON PROFIT ORGANIZATION
Capital Source View
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Debt- Pay it back Fixed Amounts
Equity – Ownership stake % of Future Value
Charity $$
Impact / Tax Write off
NORMAL GROWTH COMPANY
HIGH GROWTH
(COMPANY)
EXTREME HIGH GROWTH (COMPANY)
Risk / Return
SOCIAL VENTURE COMPANY
Match Funding Sources
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NORMAL GROWTH COMPANY
HIGH GROWTH COMPANY
EXTREME HIGH GROWTH COMPANY
SOCIAL VENTURE COMPANY
• Friends family, founders
• Debt Bank and other
• (Future) Crowd funding (portal style)
Early on • Accelerators • Individual Angels • Micro Cap VCs • Seed from VC Later stages • Venture Funds • Strategic VCs • Angel
Syndication
• Friends family, founders
• Charity$$ • Crowds (Kick-
starter) • Impact Angels • (Future)
Crowd funding (portal style)
• Angels • Angel Groups • Angel Group
Syndication • Angel List • Micro-cap Funds • (Future) Crowd
funding (portal style)
• Increasingly Strategic Corporate VCs
Non-‐Equity Sources • Accelerators (some) • Kickstarter type dona5ons
• Pre-‐orders from end-‐customers • Credit from vendors • Strategic VCs • Strategic NREs • Distribu5on Contracts Common Theme: Providing early cash in exchange for a beHer commercial opportunity
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Equity Sources • Accelerators (some) • Friends & Family Common Theme: Suppor5ng success of the entrepreneur; business terms vary
• Portal Funding • Early Angels • Super Angels • Angel Groups • Micro VC • Tradi5onal 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 – Preferen5al treatment on subop5mal exit versus the founders
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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: indica*ve of future cash flow or market control
Idea Stage • Friends family, founders
• Grants • Crowds (Kick-‐ starter)
Demonstrate Product & Market Interest • Accelerators • Individual Angels • Angel Groups • Accelerators • Micro Cap VCs
Market Entry & Early Growth • Crowdfunding (portal style) • Angel Groups • Angel Group SyndicaSon • Angel List • Micro-‐cap Funds
Early Scaling Growth • Most Venture Funds
• Angel SyndicaSon
Repeatable Growth • Most Venture Funds
• Strategic VCs • Angel SyndicaSon
• Private Equity
High Growth Capital by Stage &Amount
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Venture Stage
Investment Size
Friends & Family
Vendors
Angels
Traditional VC
Angel Groups
Corporate Venturing
Grants
Customers
Crowdfunding
Portal Funding
AngelList
Micro VC
Equipment Financing
Founder
Capital Sources: Size & Cost
Investment Size
Investment “Cost”
Traditional VC
Micro VC
Equipment Financing
Angel Groups Angels
AngelList
Corporate / Strategic Venture
Customers
Portal Funding
Vendors
Founder Friends & Family
Crowdfunding
Grants
Venture Debt Bank
Loans
Personal Loans
Private Equity
So What is Equity Anyway?
• Stock = right to residual economic interests upon sale/liquida*on + stockholder vo*ng rights (usually limited to Board of Directors and Sale of the Company)
• Preferred Stock = right to be paid before Common Stock Par*cipa*ng = original investment PLUS a pro rata share of remainder Non-‐Par*cipa*ng = original investment OR a pro rata share
• Common Stock = whatever is let ater all other creditors and preferred stockholders are paid
• Dividend = a right to an addi*onal amount upon liquida*on measured as a func*on of *me 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
14
Equity Type Comparisons
15
Solo Angel Super Angel Angel Group MicroVC VC
Valua*ons High rela*ve to stage
High rela*ve to stage
Low rela*ve to stage
Low rela*ve to stage
Medium
Type -‐ Likely (less likely)
Common (Warrants)
Conv Note (Preferred)
Preferred (Conv Note)
Preferred (Conv Note)
Preferred
Board Seat Maybe 1 or none 1-‐2 of 5 +/-‐ Observer
1 of 5 +/-‐ Observer
1-‐2 of 5 +/-‐ Observer
Audited Financials
No No No (reviewed) Yes Yes
Nega*ve Covenants
No Some*mes Yes Yes Yes
Preemp*ve Rights
No Some*mes Yes Yes Yes
Ver*cal Exper*se
Some*mes Rarely Some Usually Always
Equity Type Comparisons
16
Solo Angel Super Angel Angel Group MicroVC VC
Exit Horizon (from $ in)
7 years 5 years 4 years 5 -‐7 years 4-‐5 years
Exit Range $20m+ $40m+ $50m+ $100m+ $250m+
Structure of an Equity Deal • Company and Investors agree on a “pre-‐money valua*on” (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
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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 “inflec5on point” – Hopefully at a point where risk is removed – Increased PM = so-‐called “up round”
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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 anS-‐diluSon provision entrepreneur may carry more burden than the investors
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What about Conver*ble Debt? • Many seed-‐stage companies use an instrument called Conver5ble Debt. Huh?
• Conver5ble debt is not tradi5onal bank debt • Converts exist for two major reasons
– Investors and Entrepreneurs find it hard to agree on a PM valua5on
– Some5mes quicker and cheaper to document than equity deals (but not really)
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Conver*ble Debt provides Op*onality
• ConverSble Debt = unsecured debt obliga*on of the Company 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 valua*on in the next round
• ater applica*on of a Discount (oten 5 – 20%) • subject to a maximum valua*on amount (the “Cap”)
21
Basic Structure of Conver*ble Debt • Investor loans $ to Company an5cipa5ng 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)
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Conver*ble Debt – Complica*ons! • 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?
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Conver*ble Debt – Solu*ons? • Caps and Floors
– May defeat purpose with signaling
• Default conversion price and security at maturity
• Quick sale preferences (ex. 2x) • Governance provisions • Careful agenSon to conversion condiSons
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Conver*ble Debt – Worse than Equity?
• MulSple liquidaSon preference (circa 2008) – Ex. $500k of Notes with cap at $2m PM – Next Round at $6m PM – Issue Noteholders 3x number of shares – 3x shares equals 3x liquidaSon preference!!
• Without a floor, effecSvely Full Ratchet AnS-‐diluSon
• 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 25
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