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Part IV: Start-up Financial Strategy Chapter 11: Funding the Technology Start-up Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-1 Chapter Overview • Risks and stages of funding • The cost of raising capital • Government funding sources • Seed capital • Start-up funding • Funding biotechnology Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-2 Risks and Stages of Funding First Customer Marketing Risk R&D Risk Manufacturing Risk Revenue Seed Self Funding Friends and Family Private Investors SBIR/STTR Management Risk Initial Public Offering Early Stage Private investors Some Venture Capital Strategic Partners SBA Loans SBIC Bank Debt Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Growth and Mezzanine Venture Capital Public Equity Strategic Partners 11-3 Risk Points • Seed capital stage – Funding for product development and business launch – Risk associated with technical feasibility and manufacturing • Early stage or start-up – Secure first customer – Risk associated with capturing enough customers for product acceptance • Growth stage – Focus on managing growth – Risk associated with systems and controls Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-4 Cost of Raising Capital • Up-front costs: preparation of financial statements, business plan, prospectus, legal advice, marketing to potential investors • Back-end costs: investment banking fees, legal fees, marketing costs, brokerage fees, state and federal fees. • Total costs can be as high as 25% of total amount raised Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-5 Bootstrapping • Borrow, partner, lease • Get into business quickly to prove the concept • Hire as few employees as possible • Lease or share as much as possible • Use other people’s resources – Favorable terms from suppliers – Customers pay a portion up front Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-6 Government Funding Sources • Small Business Innovation Research Grants (SBIR) – Phase 1: up to $100,000 – Phase 2: up to about $750,000 • Small Business Technology Transfer Research Program (STTR): partnerships between research institutes and small technology companies • Small Business Investment Company (SBIC) – Private VC firms licensed by SBA, provide long-term loans • The Small Business Administration (SBA) – Partners with commercial banks to guarantee 75% of loan value Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-7 Seed Capital • Friendly money – people you know – Money from strangers will require a private placement memorandum and prospectus to meet “blue sky” laws • Debt Financing – Banks typically do not lend to start-ups – Credit cards, commercial finance companies • Equity arrangements – Be careful of trading equity for services because it is more expensive at this stage – Difficult to get rid of a person who doesn’t work out • Strategic Partnerships and Intermediaries – Associating with a successful large company can give a stamp of approval – R&D partnerships share the risk of development Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-8 Start-up Funding • Risk factors for investors – Degree of uncertainty – Asymmetric information in favor of the entrepreneur – Asset base is principally intangible (e.g. IP, know-how) – Market conditions are often erratic Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-9 Angel Investors & Networks • Private investors who are the principal source of informal capital • Fund up to about $1 million • Invest in people first, technology and market second • Major risks include moral hazard and information asymmetry • Invest in familiar industries • Seek annual returns greater than 20% Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-10 Unlikely Angel Deals Characteristics Not Favorable to Private Investment by an Angel A “me-too” type of product A poorly defined vision for the company No intellectual property No management team, a solo entrepreneur Business location more than 100 miles away Weak management team with no experience Mature or fading industry Exit time more than 7 years away Return on investment less than 15 percent Unfamiliar business or industry Not enough market research with customer Minority position with no voting rights Weak competitive analysis Too many co-investors Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-11 Funding Biotechnology • Challenges – 7-9 years to bring a new drug to market – Technology is typically unproven at early stages – Most biotechnology is licensed from universities and research institutes, not owned by company – Difficult to calculate the value of biotech firms because of intangibles Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-12 Stages of Biotech Funding • Seed stage – Typically government grants to fund research – Investor capital sought on basis of technical strength and initial market research • First-round Funding: FDA Phase I Testing – Assess safety of drug, procedure, or device – Typically $15-$20 million required • Second-round Funding: The Business Model – FIPCO: Fully Integrated Pharmaceutical Company • Difficult entry and depends on IPO – Licensing Model • Focus on development and testing, then licensing develop of applications and clinical trials to large pharma Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-13 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 11-14