Money and Startups: Funding Strategies and Stories
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A lunch presentation by Randall Howard to Ignite, a group of mostly grad students considering starting businesses, and presented on Wed 3 Feb, 2010. The key questions about Money raising in Startups discussed are: - Do you really need it? - Where will it come from? and - What will you do with it?
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Money and Startups: Funding Strategies and Stories
- 1. Money and Startups“Do You Really Need It?”“Where Will It Come From?” &“What Will You Do With It?” Randall Howard General Partner, VERDEXUS
- 2. Agenda: Startups and Money Illuminating a Complex Topic: Strategiesand Stories from the Trenches: Who Is Randall? And why am I qualified to discuss this? Money: funding your passion Money: Alignment and sources & types Venture 2.0 – a playbook for leaner times How to apply Money Investors & entrepreneurs: selection & working together Questions: responding to your needs VERDEXUS © 2010 2 “A person starts dying when they stop dreaming” Brian Williams
- 3. Who is Randall? Why Should I Listen A passionate technologist & entrepreneurial serial executive Who loves to build – innovative products and companies: Directly involved with building a dozen technology based products Involved with building a half dozen companies + 8 acquisitions Involving lifetime revenues of almost $400 million, millions of users Now, with partners at Verdexus, investing using hands-on,“Venture 2.0” playbook: To date have raised or funded $80 Million of VC, IPO and/or Angel investment Yet, it’s not all about me. It’s about assembling and empowering great teams And, by the way, I’ve made $10 million of mistakes VERDEXUS © 2010 3 “Making the impossible, merely difficult” Randall Howard
- 4. Who Is Randall?Serial Entrepreneur in Technology (1) VERDEXUS 2001-present) Boutique transatlantic firm combining investment & hands-on management, which can focus on “special” situations: management buyouts, corporate divestitures, roll ups Focus on software-driven businesses: Web 2.0, Mobile Media, etc. Sample recent transactions: Coreworxexit & Iotuminvestment Coreworx 2004-2006: Waterloo-based enterprise software company, Norwegian spin out Coreworx is a comprehensive solution purpose built to enhance the design, build, operation and maintenance of major capital projects Venture funding of $10.1 million (2005), $5.5 million (2007) Management team: ex Bluegill/CheckFree, OpenText, MKS, GE, PCDocs VERDEXUS © 2010 4
- 5. Who Is Randall?Serial Entrepreneur in Technology (2) Previously at MKS: Founder/CEO built public company from scratch Enterprise software vendor in Application Lifecycle Management Waterloo-based with 60% of employees outside Canada Revenues: 66% North America (2% Canada) + 34% Europe Grew to US$45 million revenue and 375 employees Completed 7 M&A transactions and 1 divestiture Way back when: Software Architect/business development for Coherent from Mark Williams Company, Chicago Software lead at research think tank, Computer Communications Networks Group at University of Waterloo VERDEXUS © 2010 5
- 6. Money: Funding Your Passion Whether or not to fund with external investors A key decision, with major implications Largely about control versus ability to build a company bigger than yourself Passion trumps money Contrary to legend, the “quick flip” or “get rich quick” start up ethos rarely works Finally, investors need a return and/or an exit “Success in technology is about accelerating a brand into a short window in time” – Rick Serafini, Trimark VERDEXUS © 2010 6
- 7. Aligning Funding Strategy Types of start up businesses: Traditional businesses: Services, retail, manufacturing, etc. Key metrics: inventory, backlog, utilization, bricks and mortar Knowledge based businesses: IT (software, web, mobile), media, green technologies, life sciences (pharma & biotech), nanotechnology & materials, and many more Key assets: intellectual property and people Geography: global versus regional Family and “life style” businesses VERDEXUS © 2010 7 “Entrepreneur …has no safety net underneath them”Henry Kravis
- 8. Money: Sources and Types (1) In order of increasing sophistication & structure: Own money, friends & family and bootstrapping Alternatives to conventional investment: Government programs – e.g. IRAP, HRDC Customer funding – consulting, funded development Partnerships (e.g. Microsoft BizSpark), incubators, EIRs Angels and high net worth (varying sophistication) Institutional (highly structured): Venture capital and private equity IPO and public markets Strategic investors and corporate venturing VERDEXUS © 2010 8
- 9. Money: Sources and Types (2) Debt versus Equity Term sheet – is gold, take it seriously Common or preferred shares Convertible debentures Protective Covenants Dilution Smaller piece of bigger pie 90% of $1 million = $900K versus1/3 of $10 million = $3.3 million Control Control freaks “Founderitis” And other hazards of the founder (and investor!) VERDEXUS © 2010 9
- 10. Verdexus Venture 2.0 Playbook:Building Zero to Exit for Less Capital New Way to Build a Business: Small is beautiful Virtualize & outsource everything Even virtualize management Low lifecycle cost to build company ($2-5 vs. $20-50 million!) Experience, execution at low cost (low monthly burn) Cash must be the “CEO’s Mistress” (or master) Exit as “new home” for business - some scaling costs deferred to buyer In other words: Plan the work Work the plan Convert to Sales Find a new home VERDEXUS © 2010 10 “Constraints breed creativity” Sergey Brin
- 11. Venture 2.0: Staging Burn & Revenue VERDEXUS © 2010 11 Get to Well Formed Company (target business model) fast, with least cash VC/Series A is a vanishing breed, esp. in Canada Therefore, stretch Friends & Family, Angel Rounds and alternative sources
- 12. Typical Growth Stages VERDEXUS © 2010 12 3. Mature Repeatable Systems + Reinvention > $50 million 2. Expansion $1-50 million Global expansion Product + core Customers/partners 1. Startup Pre-revenue
- 13. How to Apply Money Use of proceeds: Fit to stage (pre/post product/customer/revenue), expansion, etc. Almost never for take-outs (secondaries) Sales, marketing and expansion are easiest sell Product development is more challenging Business plan, including budget is key: Accurate forecasts versus targets 3 years is typical, 5 is often way too futuristic Should fund company to next key milestone In context of total lifecycle funding needs (Start to exit) VERDEXUS © 2010 13
- 14. Choosing Your Investor The “Pitch” becomes ever more important But, really it’s not Dragons Den Like in hiring, culture and fit is important Really about aligning goals and values for long term Cast a wide net: Get ideas from many people to define yourfunding strategy Be open minded in your search Be tenacious and persistent: Funding may test your entrepreneurial limits VERDEXUS © 2010 14
- 15. Overcome Black Hat/White Hat Syndrome Entrepreneurial founders rarely communicate well with investors: Focus is on innovation and overcoming obstacles Investors rarely understand entrepreneurs: Focus is on identifying and mitigating risks Both groups must learn to be bilingual To translate expectations of each to help entrepreneurs to reduce risk while fulfilling their dreams VERDEXUS © 2010 15 “Fortune favours the bold” Virgil
- 16. Personal Growth:My Entrepreneurial Toolkit “Fearless Passion”* “Don’t Drink Your Own Bathwater” “Embrace Change” “Taste the Cash Burn” “The Power of Two (or Three)” *See my blog:http://randalljhoward.com/2008/07/10/et-personal-growth VERDEXUS © 2010 16 16
- 17. What Others Are Saying... And, I polled social media for ideas: ALEX: “yes, beg, spend”, “...it depends on the startup – low six figures to big money...” DOUG: “Too many ask for too little to ‘maintain control’ of a sinking ship” MARIANNA: “1. Do you need It? - Yes; 2.How to get It? - Credit Cards, 3F (friends, family & fools) 3. What to do with it? - Spend on developers, developers, developers...” SHAI:"always be raising." VERDEXUS © 2010 17
- 18. Questions? VERDEXUS © 2010 18 “Turbulent times may well be the best time for an entrepreneur to start a new business”
Notes de l'éditeur
- Questions about how many have a business plan or want to start a business?How many don`t know?
- Our topic is MoneyIt`s a big and complex topic, and it really can`t be separated from issues of product, maturity, marketing, sales, channel, strategy, etc.However, I`m going to shortchange all those on the assumption that you`re hearing lots about them from othersAnd, I`m going to try to give you a send of how big, complex and quite frankly challenging, the issue of funding your business really isAnd, hopefully, you`ll hear a few war stories on the way.
- This conversation is my life – I am passionately excited about the prospect of building things – products, companies, etc.I started as a technologist (degree in computer science and pure math) and turned that passion for identifying and building out new technology (mostly software) based innovations into business.My career has been almost totally in the areas of software and information technology, although I acted as a first outside director for a biotech spinoff a number of years ago.Does that have relevance for you, most of whom as I understand it are in life sciences, materials, agribusiness, etc.?Well, yes, because the paths set by software businesses over the last couple of decades have set the stage for almost all businessesHave built from scratch (startups) to major public companies – Now, with a hands-on investment firm I founded, I’m building a small focused portfolio of companies through leveraging capital and strategic management experienceAnd, never underestimate my last point – most of my ability to guide you comes less from my successes and way more from my mistakes. Fail early and fail oftenI’ve learned that everyone needs to learn by their own failures – but the ability to seek and intenralize advice from mentors, advisors, teams members, etc. is a key to business success
- You can read these next two slides for yourselves in the handouts, butSuffice to say, I’ve built a lot of businesses, raised a lot of money, had a lot of fun andProbably seen more permutations of situations than many
- So, let’s get started with the topic of moneyI’m assuming that I’m speaking to a group whose businesses will be knowledge based – ie. To one degree or another based on strong portfolio of intellectual property and innovation.You will quite possibly be building a global, versus local, business and while maybe not the next RIM or Google, might well be ultimately very successful and sold for loads of moneyI make this distinction because much of the focus here will be on this type of high growth business where you are building a business way bigger than you are.There’s nothing wrong with more traditional family businesses or “life style” businesses, where control and personal quality of life are more important, they’re just not what I’m focusing on today.The distinction is important. If you build a business, it will be a lot more about your personal passion (or even better your ability to fire up a team with passion) than about money and income statements, balance sheets and total enterprise valueYou could build your business with no outside money but it would grow more slowly, and particularly in technology businesses, the pace of innovation means that a better funded competitor could outrun you by outmarketing and outselling you
- To clarify, at through my career and at Verdexus, I’ve focused on building innovative, globally leading technology businesses. Such businesses tend to have the most scope for professional finance but are not the only ones.This slide talks about the landscape:First, note that separation between traditional and knowledge based businesses that I’ve already touched on. It’s a large space and I suspect that most of you would be categorized in this area. I’m on the board of an insurance company and even they are coming to see that rather than just selling a financial product (ie. Insurance) they are really all about selling knowledge. The knowledge based revolution is disrupting more and more business sectors from newspapers, travel agents to the record store. And, I believe we’re just at the beginning of this revolutionAgain, I stress that family businesses may well be the majority but the control issues around most family structures don’t necessarily mix well with family business
- This is an overall landscape. Relative emphasis has shifted, so old advice may no longer be relevantDuring my career, I’ve taken companies public, raised Venture Capital both in the US, Canada and Europe, and worked closely with Angel and strategic investorsInvestment is definitely not “one size fits all” but about evaluating alternatives, talking to lots of people and seeing what fits your particular needs at a particular time(ie. What worked 10-15 years ago not relevant. What worked in 2005 also may not be relevant)Talk about decline of VC as well as public markets in funding KBIsAnd how Angels and Angel Networks are filling the gapRecently neglected areas like gov’t funding and strategic investment has risen.Mention GPI, Bioenterprise, Communitech, etc. and EIRs but assume others will focus on this
- Here are three major considerations when you choose types of money:The language of raising money starts with Term Sheets (ie. The structure of how investors will give your startup money), definitive agreements (ultimately that multi-page term sheet might spawn 5 to 25 or more agreements like subscription agreements, shareholders agreements, indemnity agreements, etc – I’m hoping you have a separate session on legal issues as that’s not our focus today).Getting a term sheet is like getting hired, winning the lottery or being nominated for an academy award. No matter what the terms, take it seriously (i’ve seen typically younger founders act like term sheets grow on trees and that’s definitely not true) and remember, the investor(s) preparing the term sheet has put a lot of time and effort into getting thereAlso, it’s not like Credit Card debt or going to the bank. You really are bringing in a financial partner who should add more than money. But, presumably that partner will be working with you (for better or worse) from the time of investment until you sell the company. This is not about paying back with interest – you are almost always giving up a piece of the pieI’m sure most of you know about shares – when you buy shares on the stock market, you are buying “common shares” – typically voting and all with same rights. That’s the vanilla of shares. Preference shares typically have lots of provisions attached to them, including being in preference to the commons when distributions happen (including company sold or going bankrupt). They are commonly used by sophisticated venture capital and other investors to attach protective covenants (limitations on what the company and board can do without specific approval of the investors in the preference shares). Recently, convertible debentures have been in vogue. They look like debt (to be repaid with interest – sometimes 8, 12 or even higher %) but typically are designed to convert into shares (common or pref) at some future date. On large reason for this is to avoid establishing a VALUATION for the business at an early stage.Valuation gets to the issue of dilution - you definitely need to give up some of your business to investors. Many founders focus too much on what they are giving up (looking backwards) versus what they are building (looking forwards) – if you’re serious, don’t fall into that trap.Talk about Waterloo Maple, the professor founder and a company that took 23 years to get to a great exit – but lots of pain along the way. Founder would rather “go down with the ship” than cede control – i was first outside director in this business in the early 1990’s and it was a real learning experience. So much so that now investors have a name for this disease that many founders catch – “Founderitis”
- -Qualified out: this won’t build the next Google, nor all types of business, but is a reasoned response to a tight funding environment-developed with our partners in Silicon Valley, which is the source of much innovation – another variant you could check out is Y Combinator, which is aimed at building even smaller playsThis Playbook is a half day workshopp that we and our advisors do with CEOs, but the short answer is that:Many companies can be built more cheaply – thanks to virtualization, fractionalized executive teamsLess readily available external finance (especially in the $10’s of millions) means this is necessaryAlso this model has evolved at the intersection of the above two trends, butObviously doesn’t work for all companies – it may be expensive to develop a novel pharmaceutical or to build that particle acceleratorAt Verdexus, we’ve chosen to focus on capital efficient types of IT-based businessesFor you and your business or idea, consider carefully the cost to build your business over the entire lifecycle – from inception to exit or cash flow positiveAnd try to develop a plan as to how to break that into digestible chunks
- Key question to test audience’s understanding of cash burn over life cycle:“Negative Burn” is good – what is “Negative Burn”Another way to visualize what I just talked about is to look at the milestones of a company from inception to well formed.This means that the company has a “mature” business model – ie. It is of sufficient size and scale that the various costs have reached some kind of target model. Typically, this also means that the company is profitable.Stretch Friends, Family (and sometimes fools) as long as you can – max your credit card, etc. –Traditionally, Series A refers to your first professional (institutional or VC) round – the name comes from the type of preferred shares issued: Series A Preferred Shares-Later round then are Series B, C, D, etc. – One company I worked with had done 5 such rounds and was, believe it or not, on Series EWith the vanishing of Canadian Venture Capital – this makes stretching F&F and the alternative investments like Angel investors and Angel Groups much more importantAs a founding entrepreneur, especially if you come from a technical field, you really need to understand or seek help on understanding and managing you cash burn from day 1These days, sadly it’s often a race to cash flow/revenue while burning the least cash
- Yet another way to look at company growth stagesThis is important for several reasons:Define your milestones around stagesInvestors often specialize in particular stages as wellThe issues and investors of getting to your first revenue, customer and product are much different than expansionTypically VERDEXUS focuses on Stage 2As an entrepreneur, learn to think of the hurdles (milestones) on your race to market dominance
- Understanding Stages brings us to a very important topic that should be a key focus- the use of proceedsThis is a section in the Term Sheet for an investor, but before that you need to have mapped out in your business plan (and investor pitch information) the amount you need to raise and what you will do with it.Ideally, the money will last long enough to make significant progress in milestones and stageThat would mean that the company would also be more valuable and hence the dreaded dilution of the raise might be small.But, things to go wrong and you need to think about making sure your cash needs are realistic and allow for some failuresThings always take longer, cost more, and way more things go wrong than most entrepreneurs anticipate, and most investors adjust entrepreneurs assumptions to account for thatInvestors like to fund business expansion and to feel that the money will help reduce risks and build value simultaneouslySince revenues are so important, you need to find ways to accurate forecast what your revenues will be over the next year – this is called forecasting vs targeting and i should say it is very very difficult. If I could always master this, I might be on TV as a noted psychic. Nonetheless, you investors quickly drill through simple targeting (putting a line in the sand and getting there with hope and wishful thinking)
- -really about founders and their credibility to explain and execute on the business plan-sadly becoming a bit of a beauty contest – over time pitching has become mainstream and with scarce money CEOs have had to become better and better at it-this is really about sales – as a startup CEO, whether your background is engineering or biology, you will be largely about selling (not always your product) but definitely your idea and company-ideas change so best to explore all your options – in the mid-1990’s at MKS, we had revenues of about $15 million and I looked at 3 options:Selling the business – i had received a very attractive offerUS Venture Capital – we received a term sheetSpecial Warrants (quasi-public institutional money, but passive with no board or advisory value add) –The Special Warrants were by far the most attractive valuation and that’s what we as a senior board and shareholder group ultimately decided on, but to this day I still wonder if one of the other two options might have ultimately been more attractive – The key point is that we really looked a wildly different approaches to find the right one for us at the time-TENACITY - most extreme was Ian McLellan, CEO of Arise (where I was an early advisor/investor) that was in continuous fundraising (and almost pre-revenue) for almost 11 years.
- I’ll start to wrap up with one other topic:Investors and entrepreneurs really view the world through different coloured glasses. – I call this the Black Hat/White Hat Syndrome – many are too young to remember the old westerns where the good cowboys wore white hats and the villains always wore black –Well, the world of startups and investors isn’t that simple, but many inexperienced founders act as though it wasBoth as I matured from a young aggressive entrepreneur into a more seasoned and rounded senior executive and as I’ve acted both as an investor and in management, I’ve had to learn to bridge between these two camps.As the slide says, Entrepreneurs want (in my words) “TO make the impossible merely difficult” – they look at market or product challenges as obstacles to be overcome in making their dream come true. Many Entrepreneurs are out to change the world – or at least their part of the world viewInvestors see their role as Board members and advisors as to help the entrepreneurs to identify and to mitigate risks. These are risks that many founders don’t even realize exist. This is a valuable role and it’s magic when the two perspectives can combine to help a company to be strongerInvestors, too, can be extreme. I’ve been on Boards of Venture Capital investors who acted like C3PO – the worry wart robot from Star Wars – Everything must exist in balance
- -Passion fuels entrepreneurs-but personal growth and development is almost essential for success-above are some of the top things I think are important attributes and skills to develop – 18 months ago, I wrote a series on my blog to expand on these notions.
- And to bring social media into the room, I asked on various places like Twitter & Facebook for comments on our 3 key questions about MONEY: - DO you need it? - How to get it? - Spend on developersJust presenting commentary from a small number of responses – 1) a long time technology analyst on Wall Street and Bay Street, one a senior business development and corporate development executive, one who has worked hard to finance a mid-cost startup to its first institutional round and one who is, as she says, doing a more modest budget startup on credit cards
- Now for questions