Venture Capital EEE 4653 Exam 3 OSU (Thomison)

Venture Capital EEE 4653 Exam 3 OSU (Thomison) Convertible Note Capital Market - *Positive Attributes:* -Offers the potential to "bridge" current strong differences in Pre-Money Valuation. -Normally lowers external "closing costs" (i.e. legal, etc.) -Shorten funding timeline -Enables Investors to immediately & easily secure a "senior collateral" position PLUS seamlessly transition into a "para pasu" (i.e. equal) Liquidation Preference with the next investors versus being subordinated. Convertible Note Debt Financing (*When appropriate to utilization*) - -Company will need to raise a SUBSEQUENT larger equity capital funding round. --Current investors WANT capital conversion path into equity ownership. -Key business risk factors may be clarified in the short-term. --Use of current Funds will resolve important product/market risk component. -Targeted current round Equity Investors are concerned about being "hammered" by next Investor group. --Likely next equity lead investor is "unknown" and/or is a different investor class/type (i.e. typically Angels investors transiting into Venture Capitalist). -No existing Company Debt obligations. Debt Capital Preparation Suggestions - -Strong personal credit -Detailed Financial pro-forma statements -Sufficient Lead-time -Quality supporting documentation Debt Capital Preparation Suggestions (*Detailed Financial pro-forma statements*) - -Illustrate ability and means to repay/service debt --Debt Service Ratio 1.25x ((Principal + Interest)/EBITDA) --Debt Coverage Ratio 4.3X (Total Debt/EBITDA) -Detailed "use of funds" with strong preference for asset creation Debt Capital Preparation Suggestions (*Quality supporting documentation*) - -Personal & business tax returns -All legal and/or governance documents: Certificate Good Standing, Bylaws/Articles Incorporation, Board minutes, Capitalization Table -Historical Financial Statements & Bank Statements -Collateral details: Equipment lists, A/R list, inventory list, etc. Debt Capital Preparation Suggestions (*Strong personal credit*) - -High credit score demonstrates ability to manage finances -Address & proactively "clean up" any personal credit issues Debt Capital Preparation Suggestions (*Sufficient Lead-time*) - Proactively apply - minimum 6 month lead time Debt Financings Cons - -Personal Guarantees -Fixed period repayment schedules regardless of business profits -Lender can legally "force" business into bankruptcy -Aggregate capital amounts oriented towards historical/current performance not future - some form of underlying Collateral -Use of Funds tends to be predominantly linked to business assets Debt Financings Pros - -Predominantly no ownership dilution --Except for Convertible Notes or Subordinated Note with "warrants" -Typically a lower cost of capital -Business income tax benefits (interest expense is tax deductible) -Potential for "value add" lenders - Business Advise & Networking --Tends to be Commercial or Community Bankers -Larger number of providers/sources & types of funding Debt Financings Sources - -Yourself -Family/Friends -Angels -Banks (SBA) -Foundations Generic Debt Capital Guidelines - -Maximize repayment maturities while minimizing pre-payment penalties -Opt for "Fixed" rates or ranges around variable -Keep debt lenders informed -Proactively renegotiate if things go well or wrong Generic Debt Capital Guidelines (*Keep debt lenders informed*) - -Continually build strong professional relationship -Provide timely financial & business information Generic Debt Capital Guidelines (*Maximize repayment maturities while minimizing pre-payment penalties*) - Longer maturities lower fixed repayment amounts & thus risk Upfront interest only dramatically enhances growth prospects & lowers risk Generic Debt Capital Guidelines (*Opt for "Fixed" rates or ranges around variable*) - Interest rate stability lowers financial risk (rates in 10 years????) Generic Debt Capital Guidelines (*Proactively renegotiate if things go well or wrong*) - ABSOLUTELY no surprises (lender approvals take time) Investment Presentation "Content Linkage" - -Financial Modeling: -Valuation/Capitalization Table: Investment Presentation "Content Linkage" (*Financial Modeling*) - -Financial Projection Slide - Abbreviated Annual Income Projections (Unit Sales, Gross Profit margins, & EBITDA are key numbers) derived from the Income Statements -"Use of Funds" Slide - Derived from Cash Flow Statement -Funding Sought/Investment Strategy Slide - Future forecasted Capital requirements identified in Balance Sheet and/or Cash Flow Statement Investment Presentation "Content Linkage" (*Valuation/Capitalization Table*) - -Exit Slide - "Market Comps" used in Pre-Money Valuation Computations -Funding Sought/Investment Strategy - Projected current round ownership and forecasted future funding requirement & corresponding "dilution" risks