MassChallenge Bootcamp

Sources of Capital: Mass Challenge July 7, 2011 Jean Hammond - Angel Investor, Member Golden Seeds, Launchpad Venture Group and Hub Angels Dan Allred - Senior Relationship Manager, Silicon Valley Bank Phil Holberton SBIR consultant …. Babson and Brandeis Miguel Granier –Founder/Director Invested Development Ed Mallen – CEO TimeTrade

Funding Options High Growth Business Model Angel & Venture Term Sheets Pitching the Business Plan Preparing for Growth & Exits Building a Fundable Team Non-Dilutive Capital Alternatives TCN Roundtable Curriculum Negotiation & Valuation

TCN Programs Financing Roundtables Special Events Expert Lunch Series Venture Coaching Interactive Expert Panel Breakfasts and Evening Events on Early Stage Fundraising topics. Small working lunch sessions led by Experts for member entrepreneurs. 1-Day Venture Fast Track Mixers Co-Promotions and Partnership Events Networking Events Team Building Fairs Large Panel Presentations Members-only tailored Mentoring Program led by teams of serial entrepreneurs.

Agenda Capital Sources: What is your company’s growth profile, how much capital is needed? Where are the funding sources Panel Presentations Equity Funding VCs & angels (and other State Sources) Debt Capital: venture debt Process for SBIR grants Social Entrepreneurship Entrepreneur views Q & A

High Growth Company? Normal Growth Company? How fast will it grow? Factors to Consider How large is the total market? Is technology unique or are there other barriers to entry? How large will your sales and marketing team need to be to address that market? Is the company extremely scalable? What are the cash needs? How long will it take for the business to be profitable? How profitable when scaled? How predictable are the cash flows? How experienced and complete is your team in the industry; have they entered a new or emerging market, and is team successful in start-ups? What are the multiples in the category? These help determine the amount of funding / expected return In general, normal growth ‘revenue companies’ that grow one resource at a time can payback debt capital as they grow

What Stage is this Company? Crystal Stage: Idea to Business Plan and Technology Proof Figuring out if there is a business there Key activity – learning from the market proving technology Entrepreneur / visionary Demonstration Stage: Business Plan to Prototype Good understanding of "successful offering“ Customer discussions started Interest from investors/ advisors- ideally a mentor or a coach Market Entry Stage: Running Market Effectiveness Trials Real entrepreneur team, sweat invested, define marketing trials Product / Service in a ‘Beta’ test or about to ship for revenue Multiple customer/partner discussions underway Starting relationship with marquee customer Supportive ‘door opening’ investors / advisors / mentors Early Growth Stage: Early Repeatable Business Model Complete team – detailed knowledge of challenges this firm faces Technology works – and we can show it (and have patents, etc.) Reference-able relationship with marquee customers Marketing and sales processes… with a repeatable, scalable business model Estimate of total cash required; identification of “deep enough pockets” to match market potential Scaling Stage: Repeatable Growth Mapping of market growth (and capital required) to revenues is understood Equity investors are trying balance return expectations against risk Risk is lower at later stages

Many types of Entrepreneurship: Don’t raise money until you know where you are 5 year growth rate $1-3M >> >> Investment required to reach breakeven Project finance/ Other sources Small CAPEX “normal growth” business (MOST COMMON) Mostly bank debt Home run long shot (VERY RARE!) VC Funding Cheap fast growing business (RARE!) Angel Funding (and some VC) Higher Lower 50% Blended Funds Debt Non-profit Funds

Equity Capital Sources: High Growth Companies Estimate exit potential based on multiples of revenue levels achieved Use projected 4-5 year revenues to estimate exit potential Companies with low profits and/or revenues < $2M: arms length equity capital not interested Angels look for $7-10M revenue targets with room for growth VCs (most) need to see north of $30-40M revenue with great potential No “exact” rules but stage of VC fund and total capital in use will point toward exit expectations Stage Crystallize Idea & Early Demonstration Demonstrate Product & Market Interest $500,000 and $5,000,000 , Early Scaling Growth Repeatable Growth Source Founders, Friends & Family, Grants Accelerators Individual Angels & Angel Groups Most Venture Funds Investment $25,000 to $100,000 $100,000 to $500,000 $5,000,000 and up (initial capital may be smaller) Market Entry & Early Growth Angel Groups and Angel Group Syndication Micro-cap Funds

Sources of Equity Funds for Entrepreneurs Sources: Money Tree and UNH Venture Center Sources: Money Tree and UNH Venture Center Angels (est.): Angel groups ~10-15%, Informal networks and one-time-investors ~15-20%, Super angels ~25-30%, Family offices ~35-45%

Equity Capital: Goal is Increasing Value Do you want 90% of $1M Firm or 10% of a $100M Enterprise Remember it’s the area of the pie slice not the % All parties agree … focus on building value Equity requires an exit

Equity: Friends & Family, Angel or VC ?? No right answer Family funds are flexible but losses hurt those you care about Do NOT leave it to “what you thought you heard” www.virginmoneyus.com/ Investors in Your Backyard: How to Raise Business Capital from the People You Know by Asheesh Advani Angels May coach more especially at the beginning Often very interested in ‘early’ exits… for angels a 2.5x exit in 2 years is the same (58% IRR) return as a 10x exit in 5 years VCs Support CEOs with CEO forums etc.… very active role in hiring Connections, connections… lots of exit experience Swing from the fences… BUT a 10-15x return on $20-50M in is a big return Rational approach -- understand capital requirements of your business and the multiples for your type of play in your industry

Process with Average Angel Group Application – on line Combined with an introduction Screening – we read, phone call, or hold a meeting Presentation – at our forum meeting We assess interest in deal (at least 5 people) Due diligence – starts with a 2 hour meeting Investigate market, business model, product, team about 1-1.5 months Deal negotiation Valuation, terms, expectation alignment Documents Closing – signatures & $$ Board relationship and quarterly reporting

Company Attributes that Improve Odds with Angel Groups Factors Companies getting angel investment Companies that don’t CEO Some experience or ‘coachable’, wants listen CEO talks about him or her ‘expertise’ forever Team Enthusiastic! match to required skills, “owners” One person, says no one will work without $$ Unique, Need A neat idea, could be big Talks to customers- needed Seems ‘me too’ “ my” idea -doesn’t talk to mkt. Stage Lots done, working code, just needs mkt. entry $$ Idea and ppt., or a complex science project, or “old” Market size, str. Market is big and can be reached Market is huge or Market extremely fragmented Total investment Cash flow breakeven soon, Can use more $$ Needs $10-20M more after this round Valuation Willing discuss a range of values & funding strategies Is fixated on a very unrealistic high value

Angel (group) Attributes that Lead to Deals Each angel group gets 10-20 applications for each presentation and ¼ of those presenting get funded Despite the huge amount ($20B)* of angel money, there are always more entrepreneurs (other presenters at same meeting) A Champion (at an angel group) is most important Champion has expertise to match company Champion and CEO having fun together Group respects Champion Work is done by convivial team Due diligence completed quickly Terms negotiation fast (lawyers work) Level of interest is similar to funds required by company

Selecting a VC Talk with fellow entrepreneurs, VC friends and service providers Check compatibility with focus, stage, and investment size Learn as much as you can, including Competitive investments Successful investments Interests/background of partners Develop a prioritized list of funding sources Plenty of organizations and on-line sources to help Wherever possible, get an introduction Other VCs, entrepreneurs, attorneys

Engaging Feedback Solicit input to gauge VCs interest and fit Understand investor assumptions VCs can add value even when your company isn’t an investment candidate for their firm Don’t argue their reasoning, ask questions to test your hypotheses Give yourself time between VC meetings to be able to react to the feedback Don’t overshop it without initial feedback Keep the door open so you can follow-up Remember these are long-term relationships with hopefully multiple rounds of funding; keep the VCs as your friends

Responding to Feedback Give yourself time between VC meetings to be able to react to the feedback Don’t overshop it without initial feedback Keep the door open so you can follow-up Remember these are long-term relationships with hopefully multiple rounds of funding; keep the VCs as your friends When you do follow-up, refer to their feedback and how it helped shape your thinking Know that sometimes it’s a good business, but just not VC-backable

Raising Money ? Your Diligence: Checking out ANY Investor Know the social rules of the road – get introduced, as high as possible up the food chain! Check the investment history Check out things like stage of the fund The investment size is close enough to fit If possible, find the best-fit partner Be sure to make your presentation fit Call the CEOs of the portfolio and find out how the investor behaves Get members of your advisory board or board to play an active role

MassDevelopment - www.massdevelopment.com Emerging Tech Fund for manufacturing facilities & equipment Massachusetts Life Sciences Center - www.masslifesciences.com Accelerator loan program for early-stage companies Life Sciences Tax Incentive Program - Cooperative Research Grants BDC Capital - www. bdc newengland.com SBA 504 and specialty financing (brownfields, recycling, etc.) MA Community Development Finance Corp . - www.mcdfc.com Gap financing to promote jobs Massachusetts Workforce Training Fund - www.detma.org/workforce Matching grants for workforce development Business incubators with a range of services and networks (ATMC in Fall River, Enterprise Center at Salem State College) MA QUASI-PUBLIC LENDERS & INVESTORS

MCRC - MA Capital Resource Company – www.masscapital.com Finances manufacturing, distribution and service companies MCRC’s Life Insurance Initiative Capital for economic development MA Economic Stabilization Trust www.commcorp.org/trust Manufacturers, including restructures Mass Technology Development Corp . - www.mtdc.com Equity & sub debt for early stage technology companies since 1982 Usually $250-$500K Jobs – leverage – technical innovation – nurture entrepreneurship Mass Technology Collaborative - www.mtpc.org Debt/equity for renewable energy technology firms MA QUASI-PUBLIC LENDERS & INVESTORS

Federal, State, City Business Support MSBDC – MA Small Business Development Centers 6 SBDCs throughout the state MA Export Center PTAC/ Government Contracting Types of loans SBA Backed Bank Loans 504s Department of Commerce Export Loans Other federal agency resources, i.e., USDA

Examples of Equity Investors in Boston Angel Groups Hub Angels Common Angels Launchpad Mass Medical Angels Walnut Group Golden Seeds Boston Harbor Smaller VCs ($25-150 million funds) Launch Capital Long River Founders Collaborative Next Stage Bigger VCs ($250+ million funds) Castile Polaris Highland Atlas Charles River 406 Venrock Oxford Bioscience NorthBridge

TimeTrade makes a “click-to-schedule” capability for websites, e-mail, and social media that changes the way you do business. ‘ Click-to-Schedule” creates new customers more quickly than you can now, and increases the satisfaction level of customers you already have.

Who Uses TimeTrade? 30 million Click-to-Schedule prospecting, sales and Customer-care appointments each year 4,000 TimeTrade customers

Financing Personal & Business Networking Venture Firms Network Angels to Angel Firms Business Case and Sales model Developed Develop the Relationships Early Scaling Apparent Banks Integral to the Process Debt, Business Modeling, Networks Angel Networks High Net Worth individuals Experienced Entrepreneurs Angels

Financing Technology: Trends in debt & equity termsheets Dan Allred Silicon Valley Bank (617) 796-6904 [email_address] Twitter: @dgallred http:// danallred.tumblr.com

Technology Risk vs. Market Risk

Funding sources: the lines are blurring

Debt vs. Equity Debt Lower risk: first money to be paid back Relatively inexpensive First lien on company assets Negative covenants Equity Higher risk: lives & dies with the company Very expensive Unsecured (typically) BOD governance

Primary uses of debt Financing assets Working capital Fixed assets Financing growth Growth capital “Venture debt” Special situations Bridge loans Financing “near” assets

Think like a lender The traditional credit model Primary source of repayment: cash-flow Question: what is the probability that cash-flow will be sufficient to support operations and repay the loan? Secondary source of repayment: collateral value Question: what is the probability that the liquidation value of the assets would be sufficient to repay the loan should the cash-flow prove insufficient?

Think like a “venture lender” A twist on the traditional credit model Primary source of repayment: cash-flow from future equity Question: what is the probability that the investors will provide additional equity sufficient to support operations and repay the loan? Secondary source of repayment: enterprise value Question: what is the probability that the enterprise value (IP, customer base, licenses, etc.) is sufficient to repay the loan should the venture support prove insufficient?

Venture debt termsheets Uses of capital General corporate purposes Financing specific fixed assets Security First priority lien on all business assets Typically a negative pledge on IP Structure 6-9 month interest-only draw period followed by ~30-36 month principal repayment Few financial covenants Standard negative covenants (i.e. consents needed for M&A, subordinate financing, changes in management, etc.) Pricing Interest rates in the high single digits to low double digits Warrants typically equal to ~0.25-1.00% fully diluted ownership

Think like a working capital lender Another twist on the traditional credit model Primary: cash-flow within the working capital cycle Question: what is the probability that the accounts receivable are collectable in a timeframe sufficient to revolve the loan? Secondary: collateral value of working capital assets Question: what is the probability that the Bank could collect the accounts receivable and liquidate the other working capital assets after the Company ceases operations?

Working capital termsheets Uses of capital Financing working capital assets such as A/R and inventory Sometimes includes a portion available to finance POs Security First priority lien on all business assets Typically a negative pledge on IP Structure Revolving line of credit with formula borrowing base (i.e. 80% of A/R) Financial covenants to measure liquidity (i.e. balance sheet covenant) & performance to plan (i.e. income statement covenant) Standard negative covenants (similar to prior slide) Pricing Prime based interest rates ranging from Prime to mid double digits based on liquidity levels Commitment fee ~0.5-1.0% and perhaps unused line fees as well Warrants may be included if there is an element of “venture risk”

Questions? Dan Allred Silicon Valley Bank (617) 796-6904 [email_address] Twitter: @dgallred http:// danallred.tumblr.com

Using SBIR Grants in Your Funding Strategy Phil Holberton Material Courtesy of NIH

SBIR - Grant Awards Innovation Basic and Applied Research Proof of Principle

SBIR Purpose and Goals Small Business Innovation Development Act of 1982 Stimulate technological innovation Use small business to meet Federal R&D needs Foster and encourage participation by minorities and disadvantaged persons in technological innovation Increase private-sector commercialization innovations derived from Federal R&D

PHASE I – R43 Feasibility Study $150K and 6-month (SBIR) SBIR: 3-Phase Program PHASE II – R44 Full Research/R&D $1M and 2-year Award (SBIR) Commercialization plan required PHASE III Commercialization Stage Use of non-SBIR Funds

SBIR Eligibility Criteria Organized as for-profit U.S. business Small: 500 or fewer employees, including affiliates PD/PI’s primary employment must be with small business concern at time of award and for duration of project period At least 51% U.S.- owned by individuals and independently operated or At least 51% owned and controlled by another (one) business concern that is at least 51% owned and controlled by one or more individuals

DOD HHS NASA DOE NSF DHS USDA DOC ED EPA DOT SBIR Participating Agencies $672M

Lessons Learned Along the Way Do Homework & Research Possibilities Connect and Network with Program Officials Ask Questions Be Respectful and Professional Program Managers - Want Us to Succeed 9 Grants = $2.6 Million

Phil Holberton Phone: 781-259-9719 Email: [email_address] Start Now

FUNDING OPTIONS FOR SOCIAL ENTREPRENEURS An overview of funding resources available to for- and not-for-profit Social Entrepreneurs

DEFINING THE DIFFERENCE What is a Social Entrepreneur? A social entrepreneur recognizes a social problem and uses entrepreneurial principles to organize, create, and manage a venture to achieve social change ( Wikipedia ) Are all Social Enterprises/Ventures not-for-profit? Social Enterprise can be for- or not-for-profits. Leverage revenue-generating models and don’t rely on grant financing alone (or at all) Funding Options for Social Entrepreneurs

GOING BEYOND THE IDEA (PRE-SEED) How to get those first few dollars Forget the bank! Risk/return might be too high even for F3… Leveraging the mission to get financing Seek out grants, awards, competitions and fellowships that match your mission and current requirements Funding Options for Social Entrepreneurs

GETTING SEED FUNDING Proving the concept Business plan ( how you will scale ) Successful small pilot ( potential not profits ) Team ( buying experience ) Demand not need ( selling not giving ) Where to get your first real investment Scale grants – from larger organizations Mission/Program Related Inv. – from foundations Impact Angels – high-net worth individuals and groups Seed/Super Angel Funds – like ID! Funding Options for Social Entrepreneurs

SCALING THE ENTERPRISE Money, scale, and impact Show them the money (have proven revenue) Show them the scale (illustrate a vast market and product iterations) Show them the impact (measure the improvements) Returning the capital Debt repayment schedule (easy if you have revenue) Exists for equity (the hardest thing in S.E.) Funding Options for Social Entrepreneurs

INVESTED DEVELOPMENT (ID) ID is a Boston-based investment management firm focused on scalable innovations for emerging markets. BSP Fund Seed-stage investment fund committed to supporting entrepreneurs with radically affordable innovations in alternative energy and mobile technologies. BETA provides pre-seed support and co-creates enterprise with innovators whose technologies fit the BSP Fund focus areas. Funding Options for Social Entrepreneurs

These materials have been prepared solely for educational purposes. The presentation of these materials does not establish any form of attorney-client relationship with the author or Foley Hoag LLP. Specific legal issues should be addressed through consultation with your own counsel, not by reliance on this presentation or these materials. Attorney Advertising. Prior results do not guarantee a similar outcome. © Foley Hoag LLP 2011. United States Treasury Regulations require us to disclose the following: Any tax advice included in this document and its attachments was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

The Lawyer’s Perspective – Paul Sweeney Corporate Partner at Foley Hoag LLP Close to 100 angel and venture capital financings (debt and equity) since 1998. SCVNGR (Highland, Google Ventures, Balderton - $15M) Vanu (Charles River Ventures, Norwest - $32 M) Centive (Polaris, TWP - $28 M) Kyruus (Highland, Venrock - $5.5 M) © 2011 Foley Hoag LLP. All Rights Reserved.

General Trends Angel and venture capital has finally begun to flow again since 2008 freeze Valuations are rising in some sectors, although deals still take more time, and terms are trending more favorable to companies and founders Syndicates are still desirable to investors Early stage deal sizes tend to be shrinking Huge need to be quick and lean

What is a term sheet? aka- “Letter of Intent,” “Memorandum of Understanding,” “Agreement in Principle” Basic agreement on the material terms of the transaction Road map, marching orders More detail is generally better (especially for the company/seller)

Non Binding (But…..) Generally not a binding agreement Subject to actual documents being negotiated Subject to due diligence Subject to other closing conditions (consents, etc.) Confidentiality (“No Shop”) No disclosure of terms (and even existence) of the term sheet Exclusivity Investor has some period of exclusivity (45 to 90 days) If you really want to mess up your transaction, this is the place to do it

Founders’ Main Concerns Loss of control over your company Dilution of your personal equity position Stock subject to repurchase if terminated Is the financing adequate for your plans Future capital needs and dilution Success of partnership with angels and VCs – access to key industry contacts, future $, business guidance

Investors’ Main Concerns Accuracy of valuation (both present and projected) Risk level of investment Projected returns on investment (ROI) Liquidity if business in distress (downside protection) Ability to participate in later rounds (upside protection) Influence and control over management and strategic direction

Pre-Money Valuation “ Pre-Money Valuation” = value of the company before the new money is invested Helps calculate price per share, and % of the company being sold Share Price = Pre-Money Valuation Pre-money Shares Outstanding Critical Issue –What shares are counted as “Outstanding”? All outstanding options? All options reserved for issuance under the option pool? Note: The higher this number, the lower the share price, and thus the higher the number of shares issued for the same amount invested

Post-Money Valuation “ Post-Money Valuation” = pre-money valuation + the amount invested. Pop Quiz: New investor values your company at a pre-money valuation of $10,000,000, and offers to invest $5,000,000 into the company. Question: What percentage of the company would the investor own after the investment? A: 33% B: 50% C: It’s too soon after lunch for a math quiz

Key Terms – Pre Money Valuation Pre Money Valuation (Without Option Pool)

Key Terms – Pre Money Valuation Pre Money Valuation (With Option Pool)

CAUTION! Pre-Money Valuation is only one of many economic terms. “ You can name the valuation, if I can name all the other terms.” - Angel / VC Investor

Convertible Preferred Stock Why Convertible Preferred Stock? “ Stock” – All the upside of equity ownership “ Convertible” – Converts into common stock “ Preferred” - Preference over common stock on dividends, distributions, liquidation, redemption, etc.

Liquidation Preference Applies when a “liquidation event” occurs (usually M&A) When distributing liquidation proceeds, preferred stock has right to get its money back (and perhaps more) before the common stock gets anything.

Liquidation Preference Sometimes “multiples” are used (1x, 2x, 3x the investment amount). Sometimes accruing dividends are included. “ Preference overhang” is the total amount of proceeds due to the preferred stock – can make the common stock virtually worthless. Three main flavors: Non-participating Participating preferred (without cap) Participating preferred (with cap)

Liquidation Proceeds Source: www.wikipedia.org

Non-Participating Preferred Source: www.wikipedia.org

Participating Preferred Source: www.wikipedia.org

Current Trends (Q1/11 – Q2/11) For Series A financings, 28-50% had some form of participating preferred. For Series B+ financings, 55-72% had some form of participating preferred. Source: Foley Hoag’s Perspectives – June 2011

Antidilution Protection Addresses Investors’ concern re: valuation Protect investors in a “down round” - when new money comes in later at a pre-money valuation (or price per share) that is lower than the previous round’s post-money valuation. All preferred stock converts to common stock at a certain ratio, usually 1-for-1. Anti-dilution protection, if triggered, changes the conversion ratio, resulting in the preferred getting more shares of common upon conversion

Weighted Average Takes into account the proportional relevance (or weight) of each component in the calculation rather than treating each component similarly. Result - the conversion ratio based on the average of the price at which the company sold the new stock, valuing the common stock outstanding at the pre-adjusted conversion price. Sometimes formulated as “broad-based” and sometimes as “narrowly-based” (“narrowly-based” is more favorable to the protected preferred stock.) More typical, and much less onerous to un-protected stockholders, than full ratchet.

Full Ratchet The conversion ratio of the protected preferred stock is “ratcheted down” to the lowest price at which securities are sold in the down-round. This applies even if only one share is sold! Treats all down-rounds the same, irrespective of number of shares actually issued. Very onerous, and not the standard approach. Usually seen in company’s without bargaining leverage, in distress, or with a history of down rounds.

Current Trends (Q1/11 – Q2/11) For Series A financings, 8% had full ratchet; remainder were evenly split between narrowly based and broadly based weighted average. For Series B+ financings, 18% had full ratchet. Source: Foley Hoag’s Perspectives – June 2011

Other Key Terms for Company Dividends Redemption Voting Rights Board Seats “ Protective Provisions” Pre-emptive rights Information rights Registration rights Legal fees / Drafting control

Other Key Terms for Founders Reverse Vesting Non-competition and Non-solicitation Agreements Non-Disclosures and IP Development Agreements Right of first refusal Drag along rights / Tag along rights

Convertible Notes Automatic conversion on qualified financing Discounts are increasingly common; sometimes coupled with a cap on valuation Paid or converted upon acquisition Interest Rate Maturity Date Collateral (secured or not) % needed to amend terms

Final Thoughts Focus on what’s in the best interest of the company. Don’t be afraid to ask “why” when terms are proposed. All money is not created equal. Choose your investors wisely – their belief in YOU is more important than their capital.

Other Resources www.emergingenterprisecenter.com: Glossary (commonly used terms) Ask the Startup Lawyers (common questions and answers; submit your questions!) EEC Perspectives (our quarterly publication tracking terms of New England VC deals) NVCA Model Venture Capital Financing Documents (including model term sheet): www.nvca.org (click “Resources” then “Model Legal Documents”) or use http://bit.ly/bj7Pn Forms are intended as starting point only

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