Funding for Entrepreneurs

Brandon S. Cohen, Associate LecturerCollege of Business and InnovationUniversity of ToledoST-S Suit 1010419.530.5689

Overview (30,000 Feet) Business Model Elevator Pitch Financial Statements (Historical v. Proforma) Sources and Uses Valuation and Cap Table Funding Sources

◦ Grants◦ Friends and Family◦ Angels◦ Venture Capital ◦ Private Equity◦ Peer-to-Peer Networks, “Crowdfunding” and Bootstrapping

Exit Strategy

Content

Fundraising is a process Investor types have different investment criteria – know

the criteria for each investor type Big Money investors desire to mitigate risk

◦ Business Risk - e.g. Is the entrepreneur experienced?◦ Technology Risk – e.g. How far along is the technology to

market; is there IP to protect the “invention”? Big Money investors in the face of significant risk will

demand a high ROI What type of investment are you selling: Debt,

convertible debt, common stock, preferred shares – each type of investment has a different impact on the company and founders ownership position

Overview (30,000 Feet View)

Three to five sentence pitch that can be given in 1 to 2 minutes to describe your business, its value proposition and why the market will pay you for your product.

◦ Why is this important?

Elevator Pitch

Investors generally will invest in an understandable and scalable business model◦ Number 1 criteria: Show the investor how you intend to make money.◦ Generally, between $2mm and $4mm in revenue, the business has a functional and

proven business model. Raising money at this point is less about do you have a business model that can work and more about how fast can you grow.

Business Model Canvass Value Proposition: What are you building, for who and why? Customer Segments: Users, influencers, recommenders, decision makers, economic buyers

and saboteurs. (Sales/Distribution) Channels: Direct, Indirect, OEM etc. Customer Relationships: Sales cycle and how do we get customers into the sales channel. Revenue Streams: Strategy to generate cash from each customer segment (upfront fees,

licensing, subscription). Key Resources: What physical, financial, human or intellectual assets do you have available

to make your company successful. Key Partners: External companies whose products are services combine with your value

proposition to create a complete solution to satisfy your customer. Key Activities: What are you doing everyday to make your business successful. (In this class,

develop value proposition, identify customer segments, create surveys, contact customers) Cost Structure: What are the costs involved in delivering your product and or service – both

fixed and variable; what is the gross profit margin per unit!!!

Business Model

http://www.businessmodelgeneration.com/downloads/business_model_canvas_poster.pdf

Business Model Canvass

Income Statement, Balance Sheet and Statement of Cash Flows

Historical ◦ Why is this a challenge for an early stage business?

Proforma◦ Why is this a challenge for an early stage business,

especially one where the product is not yet fully developed and the lead time to market is in the not so foreseeable future – like a biotech invention?

Financial Statements

Revenue Assets Cash Flows from OperationsUNMC 38,000$ Cash 54,732$ Net Income (350,808)$ Hurley 5,000 Accounts Receivable 38,000 Depreciation Amortization Expense 25,500$ Miscellaneous 3,667 Inventory 2,980 Change in Accounts Receivable (38,000)$

46,667$ Total Current Assets 95,712$ Change in Inventory (2,980)$ Operatinng Expenses Depreciable Assets (Software) 100,000$ Change in Accounts Payable 3,520$ Executive Compensation 138,995$ Accumulated Depreciation (3 yr Life) 25,000 Change in Accrued Expenses 7,500$ Software Development 72,775 Net Depreciable Assets 75,000$ Total Cash Flows from Operations (355,268)$ Marketing-Travel and Ent. 50,384 Intellectual Property 20,000$ Cash Flows from InvestingMarketing- Web 25,880 Amortization (30 Year blended) 500 Software and Intellectual Property (120,000)$ Salaries and Wages -Admin 23,714 Net Amortizable Assets 19,500$ Total Cash Flows from Investing (120,000)$ Consulting Compensation 4,238 Total Assets 190,212$ Cash Flows from FinancingLegal 3,934 Change in Long-term Debt (Accrued Interest) 30,000$ Office Expenses 22,143 Liabilities & Owner's Equity Change in Common Stock ($2 par) -$ Rent and Utilities 10,000 Accounts Payable 3,520$ Change in Preferred Stock 500,000$ Transfer-New Bank 10,000 Accrued Expenses 7,500 Total Cash Flows from Financing 530,000$ Insurance 5,750 Total Current Liabilities 11,020$ Net Change in Cash Balance 54,732$ Tax and Accounting 1,933 Long-term Debt - Software Licenses 2,229 Accrued LT Interest Preferred Units 30,000 Operating Expenses 371,975$ Total Liabilities 41,020$ EBITDA (325,308)$ Common Stock - Depr. 25,000$ Preferred Stock 500,000 Amort. 500$ Retained Earnings (350,808) EBIT (350,808)$ Total Owner's Equity 149,192 Int -$ Total Liab. & Owner's Equity 190,212$ EBT (350,808)$ Taxes -$ Net Income (350,808)$

ABC COStatement of Cash Flows

1/1/14 - 9/30/14Income Statement

1/1/14 - 9/30/14

ABC CO ABC COBalance Sheetas of 9/30/2014

Financial Statements Example

2014 2015 2016 2017 2018

Revenue $104,100 $319,500 $4,204,500 $8,632,500 $15,697,500Commissions+ 15% -$ $47,925 $315,338 $431,625 $784,875COGS (HARDWARE) $3,850 $11,550 $159,250 $327,250 $589,750Gross Profit Margin $100,250 $260,025 $3,729,913 $7,873,625 $14,322,875

Operating ExpensesSalaries and Wages -$ $400,000 $400,000 $2,290,000 $2,748,000FICA -$ $60,000 $60,000 $343,500 $412,200Health Insurance -$ $0 $75,000 $187,500 $225,000Marketing 20,000$ $15,602 $223,795 $472,418 $941,850Travel and Entertainment 62,000$ $20,000 $250,000 $500,000 $600,000Rent 10,000$ $10,000 $30,000 $50,000 $60,000Utils 2,000$ $0 $20,000 $20,000 $24,000Web Hosting 2,000$ $20,000 $30,000 $50,000 $60,0001099 and Software Dev 340,000$ $200,000 $750,000 $230,000 $276,000Software Licenses 2,000$ $10,000 $20,000 $20,000 $24,000Total Operating Expenses $438,000 $735,602 $1,858,795 $4,163,418 $5,371,050

EBITDA ($337,750) ($475,577) $1,871,118 $3,710,208 $8,951,825Depreciation / Amortization $10,000 $50,000 $200,000 $250,000 $300,000EBIT ($347,750) ($525,577) $1,671,118 $3,460,208 $8,651,825Interest $0 $0 $200,000 $250,000 $250,000EBT ($347,750) ($525,577) $1,471,118 $3,210,208 $8,401,825Taxes $0 $0 $0 $1,454,512 $4,579,103Net Income ($347,750) ($525,577) $1,471,118 $1,755,695 $3,822,722

ABC COProForma Income Statements

Years 1 -5

Revenue Assumptions

Proforma (Future)

2014 2015 2016 2017 2018AssetsCash 164,188$ 480,367$ 1,568,912$ 2,456,758$ 4,180,622$ Accounts Receivable 25,063$ 65,006$ 932,478$ 1,968,406$ 3,580,719$ Inventory 2,750$ 8,250$ 113,750$ 233,750$ 421,250$ Total Current Assets 192,001$ 553,623$ 2,615,140$ 4,658,914$ 8,182,591$ Depreciable Assets (Software) 50,000$ 250,000$ 1,000,000$ 1,250,000$ 1,500,000$ Accumulated Depreciation (5 yr Life) 10,000$ 60,000$ 260,000$ 510,000$ 810,000$ Net Depreciable Assets 40,000$ 190,000$ 740,000$ 740,000$ 690,000$ Total Assets 232,001$ 743,623$ 3,355,140$ 5,398,914$ 8,872,591$

Liabilities & Owner's EquityAccounts Payable $36,500 $61,300 $154,900 $346,951 $447,588Accrued Expenses 18,250 30,650 77,450 173,476 223,794 Total Current Liabilities 54,750 91,950 232,349 520,427 671,381 Long-term Debt - - - - - Total Liabilities 54,750$ 91,950$ 232,349$ 520,427$ 671,381$ Common Stock (Par TBD) 25,000$ 25,000$ 25,000$ 25,000$ 25,000$ Preferred Stock 500,000$ 1,500,000$ 2,500,000$ 2,500,000$ 2,000,000$ Retained Earnings (347,750)$ (873,327)$ 597,791$ 2,353,487$ 6,176,209$ Total Owner's Equity 177,250$ 651,674$ 3,122,791$ 4,878,487$ 8,201,209$ Total Liab. & Owner's Equity 232,000$ 743,624$ 3,355,141$ 5,398,914$ 8,872,590$

ABC COProforma Balance Sheet

For the Year End of Year 5

Proforma

ABC COProforma Statement of Cash Flows

For the Year End of Year 52014 2015 2016 2017 2018

Cash Flows from OperationsNet Income (347,750)$ (525,577)$ 1,471,118$ 1,755,695$ 3,822,722$ Depreciation Expense 10,000$ 50,000$ 200,000$ 250,000$ 300,000$ Change in Accounts Receivable (25,063)$ (65,006)$ (867,472)$ (1,035,928)$ (1,612,313)$ Change in Inventory (2,750)$ (8,250)$ (105,500)$ (120,000)$ (187,500)$ Change in Accounts Payable 36,500$ 61,300$ 93,599$ 192,052$ 100,636$ Change in Accrued Expenses 18,250$ 30,650$ 46,800$ 96,026$ 50,318$

Total Cash Flows from Operations (310,813)$ (456,883)$ 838,545$ 1,137,845$ 2,473,864$ Cash Flows from Investing

Depreciable Assets (Software) (50,000)$ (200,000)$ (750,000)$ (250,000)$ (250,000)$ Total Cash Flows from Investing (50,000)$ (200,000)$ (750,000)$ (250,000)$ (250,000)$

Cash Flows from FinancingChange in Long-term Debt -$ -$ -$ -$ -$ Change in Common Stock ($1 par)* 25,000$ -$ -$ -$ -$ Change in Preferred Stock 500,000$ 1,000,000$ 1,000,000$ -$ (500,000)$

Total Cash Flows from Financing 525,000$ 1,000,000$ 1,000,000$ -$ (500,000)$ Net Change in Cash Balance 164,188$ 343,117$ 1,088,545$ 887,845$ 1,723,864$

Proforma

Sources and UsesSources Year 1 Year 2 Revenue $104,000 $320,000 Investment (Desired)

$500,000 $1,000,000

Total $604,000 $1,320,000Uses Salaries $0 $460,000 Marketing $20,000 $15,000 Equipment $50,000 $250,000 Working Capital $534,000 $595,000

How does one value a business? The pre-money valuation and post money

valuation are important because it lets the current owners know how much of the business they still own after the investment.

What is the market willing to absorb? Discounted Cash Flows (based on

proforma)? Book Value (Accounting measure, never

good for the owner)? Market Research on comparables?

Valuation

Series BPre 4,500,000$ Raise 1,000,000$ Post 5,500,000$

Post (post dilution) Fully Diluted"A" "B"

Security No. of Units % No. of Units % No. of Units % Dilution Shares Shares18%

Common Units -FoundersAffleck 91 91.00% 2,060,600 66.10% 2,060,600 61.191% 50.176% 2,759,705 2,759,705 45.12%Smith 2 2.00% 48,100.00 1.54% 48,100 1.428% 1.171% 64,419 64,419 1.05%Cheedle 2 2.00% 48,100.00 1.54% 48,100 1.428% 1.171% 64,419 64,419 1.05%Downey, Jr. 5 5.00% 115,700.00 3.71% 115,700 3.436% 2.817% 154,954 154,954 2.53%Jolie 0 0% 60,000 1.92% 60,000 1.782% 1.461% 80,356 80,356 1.31%

Post FounderCruise 0 0% 130,000 4.17% 130,000 3.860% 3.166% 174,105 174,105 2.85%Pitt 0 0% 32,500 1.04% 32,500 0.965% 0.791% 43,526 43,526 0.71%

WarrantsMadonna 0 0% 65,000 2.09% 65,000 1.930% 1.583% 87,053 87,053 1.42%Knowles 0 0% 25,000 0.80% 25,000 0.742% 0.609% 33,482 33,482 0.55%Carter 0 0% 32,500 1.04% 32,500 0.965% 0.791% 43,526 43,526 0.71%

Carter Contingent 107,000 1.75%

Series A Preferred Rockafella 0 0% 500,000 16.04% 750,000 22.272% 18.263% 1,004,454 1,004,454 16.42%Series B Preferred Cool Co 13.636% 750,000 1,125,000 18.39%Series B Preferred House Inc 0 0% - 0.0% - 0.0% 4.55% 250,000 375,000 6.13%Total 100 100% 3,117,500 100% 3,367,500 100% 100% 5,510,000 6,117,000 100%

PostPre

ABC CO Current Dilution Table Series A

2,500,000$ 3,117,500$ Fully Diluted

Cap Table – Ownership Table

Funding Sources Grants – Local, state and federal (non-dilutive, what does this

mean and thus why is it good for business owners?) “Accredited Investors” State Blue Sky Securities Laws… When raising money in a

particular state, you must understand the laws of that state regarding selling unregistered or registered securities

Friends and Family: Rich aunt, loving mom, skeptical dad Angels: Usually wealthy community members looking to help

people and the community Venture Capital: Mercenary investors looking for significant ROI

on investment (often found in big cities where talent and wealth concentration exists)

Private Equity: Similar to Venture Capital, generally more hands on and looking to integrate your idea with other portfolio owned businesses (sometimes exit partner)

Funding Sources – Cont’d Peer to Peer Lending: Alternative financing options for businesses from

unrelated third parties, often completed through the internet.◦ Unsecured or secured loans – may or may not involve a personal guaranty…◦ These loans are often then resold into the market after securitization (multiple, similar

loans are bundled and then sold in a secondary market as a security)…◦ Example: Multi-year equipment lease◦ Lower default rate among borrowers leads to lower interest rates than credit card

transactions Crowdfunding: Raising small amounts of money from a large number

of people, usually through the internet, to help fund a business.◦ Reward-based crowdfunding: entrepreneurs pre-sell their product/service to launch

business without incurring debt or selling equity (easier/no securities laws to deal with).◦ Equity-based crowdfunding: the funder gets unlisted company shares in exchange for

the money pledged. ◦ $5.1bn industry in 2013, most notable through Kickstarter.

Bootstrapping: “Beg, borrower, cheat, steal…” Just kidding. Examples: Credit card (bad); using income from a job (ok); Get it free when possible (good, guerilla marketing); Non-traditional funding, such as Invoice Factoring or Purchase Order Financing (great because you have a sale, but expensive)

Exit Strategy How do your investors get their money back? The private

company’s stock is not readily marketable and cannot be easily sold. Thus, the company founders or management must outline how the private investors get repaid.

Operating entity: Pay back investors out of company revenue growth and corresponding net income (least desired (from venture capital), least pitched)

Acquisition target: Pay back investors from a third party buyout (e.g. Facebook acquires WhatsApp, and the WhatsApp investors get paid out back with Facebook shares which are readily marketable securities on a stock exchange)

Initial Public Offering: Offer shares to the public through a stock exchange (e.g. Twitter sells shares to the public, a year later it’s a $25bn entity and its initial shareholders are not big winners)