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By Tim Scott

We want to help you secure funding for your next idea or innovation, and help you push into new and exciting markets. So last post we started to count down the “Top 10 Things You Must Do To Secure Funding For Your Business”.

If you missed it, here’s a quick recap:

  • Number 10: Have a detailed Business Plan
  • Number 9: Be clear about your Financial Requirements
  • Number 8: Be able to articulate your ideas in an Elevator Pitch
  • Number 7: Present the strengths and weaknesses of your Management Team
  • Number 6: Define your Business Strategies

Let’s finish the Top 10 …

Number 5 What is your Debt Structure

Your debt structure depends on a number of variables, most importantly your own commitment to your plan. You should always be the first investor – your financial commitment to your idea is what every future investor looks for. Be engaged both personally and financially. Family and friends are typically the next stop when you’re looking for investment funds. Just be sure to treat them as you would any other investor – by providing them with clarity of purpose, detailed information, and a proper exit strategy so they can see how their money will be used and when they will see a return on their investment. The next level of investor is usually a bank or lending institution. Your last stop is with an Angel investor or a Venture Capital organization

Number 4 Prepare a realistic Financial Forecast

The Venture Capital organizations and lenders I’ve spoken with over the years say the single most disappointing element of any plan is that not enough critical thinking went into preparing the forecasts. So ask yourself, “How are our financials verified?” It’s easy to create a financial forecast based on a simple extrapolation of calculated market penetration – many people do that – but those who do are sorely disappointed when their plans don’t align with reality. Instead, make sure your roll-out strategy is consistent with realistic market uptake and a conservative cash flow. That will be more accurate and give you a better picture.

Number 3 Define your Exit Strategy

Simply put – how will your investors get their money back and how will you get out of this business. It sounds easy but in fact this is a difficult, time consuming and potentially painful exercise. The structure should take into account all investors, how each investment has been structured (straight investment to a note, convertible debenture, common class shares, preferred shares, etc.) as well as management ownership. All will have an impact on how an exit will, or could, work. Make sure you seek accounting and tax guidance and speak with experienced legal council to ensure the best results.

Number 2 Show the Path of Sustainable Growth

How are you going to feed the fire? What is your process of defining ongoing activities to ensure sustainable growth? Is your plan to grow organically or by partnering? What are the activities necessary to keep your product or innovation fresh?

And finally …

The Number 1 requirement that often makes or breaks funding success – Be Prepared!

Obvious, yes, but taking the time to work through Numbers 10 – 2 – to define your plan and your strategy will bring you much closer to success.

You may ask, “So if I follow all the steps above, will I always be successful in finding funding for my idea?” Maybe, maybe not. What you can be sure of is by following the guidelines above – you will have looked at your situation, your technology and your opportunities and come to a clear conclusion of real product-to-market potential. And keep in mind, just because one person or lending institution says No, does not mean you don’t have a great idea. Keep pursuing your dream, but follow the old Boy Scout motto, “Be Prepared”!

If you have any questions about developing your new product or innovation, give me a call at 905-273-3530 or email me at tim.scott@riccentre.com. I’m here to help you succeed!

The RIC Centre (Research, Innovation, Commercialization) is a non-profit organization that provides business and technical services to small and medium enterprises (SMEs) to commercialize their innovation. Tim Scott is the RIC Centre’s Entrepreneur in Residence. In his capacity, he meets with early stage companies and advising them on moving their business models to the next level. RIC’s interests reside in the aerospace, advanced manufacturing, emerging technologies and life sciences sectors. Visit http://www.riccentre.com for more information.

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By Andrew Maxwell

In recent blogs, I have tried to address many of the questions raised by entrepreneurs looking for financing. You can download a guide that we prepared for entrepreneurs pitching to the Dragons in CBC Dragons’ Den.

In this blog, I will answer the two specific questions raised in the previous blog.  How do you raise large amounts of money without giving up too much equity and how do you develop an exit strategy to maximize the likelihood of receiving investment?

How do you raise large amounts of money without giving up too much equity?

In a previous blog, I identified that you can decide how much money you need to raise from third-party equity investors, by first working out the negative cash flow for the first three years of the business, and then identifying sources of non-equity finance (debt, government grants, customer advances etc.). From this you can calculate how much cash in exchange for equity you need to raise.  However, if you ask for all of this at the beginning, then your equity will be significantly diluted. If you obtain the same amount in stages, then you can give up a smaller amount of equity if you have increased the value of your company at each stage. This puts you in a better equity position and increases the likelihood of being able to attract further investment subsequently.

Here is a working example:

Alternate A:

Initial company valuation  $500,000 – $2 million investment required: investor requires 80% of company’s equity (limits your equity and precludes raising larger amounts at subsequent rounds).

Alternate B:

Initial company valuation  $500,000 – $2 million investment required, raised in tranches ($250,000; $500,000; $1.25 million). $250,000 received from investor for 33% of company. Company uses this to attract IRAP funding and complete prototype – company value increases to  $1.5 million. $500,000 received from investor for 25% of company (You retain 50%). Company uses this to attract first customer and leverage debt financing, to increase company value to $3.75 million.

$1.25 million received from investor for 25% of company (You retain 37.5% or more than double the equity had you raised the $2 million at one time).
How do you identify an exit strategy to increase the likelihood of receiving investment?

While achieving business milestones identifies points at which you can increase the value of the business, it also helps you develop a realistic exit strategy, by focusing on company valuation, how you can determine it and increase it.

Valuations are based on the price someone is willing to pay for your business, and in practice, most start-up exits are due to a sale to a third-party.

Planning for this exit strategy is both a pre-requisite for obtaining an investment and helps you make decisions once you have obtained the investment that make such an acquisition likely. Potential investors expect you to suggest an exit strategy, both because they figure you know the business and industry better than them and because they want to see you are conscious of the need to develop a business strategy that aligns with the exit strategy.
In general, I assume that your exit strategy is an acquisition by another industry player as this is the most frequent scenario. The three most common acquirers are: direct competitors (who offer similar products or service and can consolidate), suppliers (who see how your business can enhance the value of their solution) and distributors or customers (who understand your business and can expand it faster than you).

Identifying these potential partners helps you make decisions around business value and encourages you to develop an ongoing strategy that maximizes the likelihood that they will be interested in making an offer to acquire your business, whether this is to remove you as a competitor or enhance their own market position by increasing their product or service offering.

In this blog, so far I have discussed strategy and finance issues that affect the likelihood of receiving an investment offer. However, there are many other factors that both impact the likelihood of receiving an offer and the likelihood of the business achieving success once the investment has been received.

Specifically, the investor is looking to develop a good “chemistry” with the entrepreneur, both to take the risk of making the investment, and to act as a “litmus test” of how future interactions will develop. Many have likened the investment process to “courtship” and the post investment interaction to “marriage”.

In the next blog, we will discuss how the investor relies on signals during the courtship process, to decide to get married, based on their anticipation about how both the future business and interpersonal relationship will develop.

Andy is currently working at the Canadian Innovation Centre and pursuing a Ph.D. in the area of new venture creation at the University of Waterloo. In his spare time, he enjoys teaching technology entrepreneurship at UTM and the University of Waterloo.


The RIC blog is designed as a showcase for entrepreneurs and innovation. Our guest bloggers provide a wealth of information based on their personal experiences. Visit RIC Centre for more information on how RIC can accelerate your ideas to market.

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By Andrew Maxwell

The four most common questions I am asked by entrepreneurs seeking to grow their businesses are:

  1. What do I need to do to get ready for external financing?
  2. How do I persuade the investor my business is viable?
  3. How much should I ask for initially?
  4. When should I ask for more?

The answers to all of these are interrelated, and I will answer each in turn.

Today I want to talk about What do I need to do to get ready for external financing?
There are two important things to do when asking for an external equity investment. First, you need to look at the opportunity from the perspective of a potential investor to see if investing makes sense. Second, you need to consider the consequences of having a long-term investor as a partner.  To look at the deal from the point of view of the investor you need to ask if they are going to make an adequate return on their investment. This requires you to persuade them that they can make a return of between 25 – 35% per annum.

Over six years, a $100,000 investment would require a return of about $380,000 (note that the average investment period for an initial investor is five – seven years). You need to show them that such a return is likely, and that there are potential exit strategies (such as an IPO or acquisition by a third part) that will realize this return. Many great opportunities fail to raise money, because there is no viable exit strategy for the investor. This is why thinking about the opportunity from the perspective of the investor is so important.

Justifying the amount the investor will receive at exit

The money the investor will receive is based on the estimated value of the business at the time, multiplied by the percentage of equity the investor owns. While the percentage of equity has other implications, which we shall discuss subsequently, it is a critical component in the investment decision.

For example, if you can justify a business valuation in the future, based on a multiplier of future profit or revenue, then it is relatively simple to calculate how much equity the investor should have. Typically, a multiplier might be one times revenue or 10 times profit (multiplier can be calculated based on industry standard multipliers on public exchanges).  A company with revenue of $1.9 million in six years could be valued at $1.9 million. Using our calculation above, that the investor would require $380,000, would mean that the investor needs 20% of the equity.

Identifying the exit strategy

In Canada, most successful exits are based on the acquisition of the business by a third-party, that believes they can manage the business for greater growth or profitability, whether directly, or by integrating it with their other business. The identification of potential third-party acquirers is thus important for the entrepreneur raising capital. It both helps the investor see a potential exit strategy, and can increase the value of the business by creating a bidding war between potential acquirers.   Acquirers are likely to be interested if:

  1. The business is large or strategic enough to impact their business
  2. They see a defensive opportunity that reduces your ability to hurt them
  3. They see an offensive opportunity to leverage both companies existing resources

Embedding potential exit strategy into the business plan can be critical. For example, if a large company only makes acquisitions of companies with greater than $10 million revenues, obtaining this level of revenue is critical. This may require the company to purse a more aggressive sales strategy, which may involve attracting a higher level of initial equity. In addition, getting your business on the “radar screen” of a potential acquirer may be important.

In fact, many acquisitions are done by companies who initially collaborate with the smaller company, for example as a supplier or channel partner.  Alternately, many acquisitions have been stimulated by an aggressive action by a small company that makes the potential acquirer take notice, for example by taking a strategic customer away from them. Importantly, the potential acquirer must be able to see how integrating your business with their own enhances shareholder value.

Reducing the investment risks

Investors are also concerned about the risks of failure and need to know there is a reasonable probability that the venture will not fail. Risks are viewed in three categories:

  1. Market risk, that customers will not want the product, or that competitor actions will inhibit your success
  2. Performance risk, that the technology does not work, or there are production or other operational issues
  3. Financial risk, that the company will run out of money, or require too much money to get the point where it can attract additional funds (revenue, debt, equity or from the government)

An entrepreneur seeking investment needs to show the potential investor that each of these risks have been identified and mitigated. We will discuss each in turn, in the next blog.

Andy is currently working at the Canadian Innovation Centre and pursuing a Ph.D. in the area of new venture creation at the University of Waterloo. In his spare time, he enjoys teaching technology entrepreneurship at UTM and the University of Waterloo.


The RIC blog is designed as a showcase for entrepreneurs and innovation. Our guest bloggers provide a wealth of information based on their personal experiences. Visit RIC Centre for more information on how RIC can accelerate your ideas to market.

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Reposted from Maple Leaf Angels

PART 2

By Craig Hayashi

In Friday’s post I spoke with Jim Pullen, partner at Concert Partners about how to engineer value into a company to maximize exit potential. As managing director at Regent Associates; the company studied 250 M&A transactions, and developed a framework to rank and assess a company on various factors that were proven to drive exit valuation. The various categories of the framework are Financial, Market & barriers to entry, Human Resources, Strategic fit and Governance.

Read Part 1 where we discussed Financial and  Market & barriers to entry. Today we look at Human Resources, Strategic fit and Governance.

Human resources

In the category of human resources, the model looks at both technical skills and management skills. “In the early stages of a start-up the founders are the key people that have the technical skill set to drive innovation and the leadership qualities to drive the company forward,” says Jim.

“As companies grow, it is important to distribute these skill sets deeper across the company. Often after an exit, the founders will want to leave, either since they have the largest financial gain or they just prefer to be entrepreneurs rather than work in a large corporation. As such, a buyer will place a premium on a deep management team where the company can continue to innovate and execute even with the loss of the founders.”

Strategic fit

This factor relates to the degree that the company that is being acquired is a strategic fit into the buyer’s product portfolio. “We have seen cases where buyers are willing to pay a 50%-70% price premium for a company that fills out a missing piece of the buyer’s product portfolio and gives them access to the IP and expertise of the company they are acquiring,” says Jim. “That being said, companies should not lose sight of their customers and try to build a company that serves the needs of a few companies they feel may acquire them. There is always the risk the targeted buyers will acquire another company or develop something internally. Partnerships are an excellent way to lay the foundation with a potential buyer. A partnership is a low-commitment way that a potential buyer can start to get deeper experience with a company. If things work out well and strategic synergies start to develop then this can help lead to a deeper relationship such as exclusive arrangement or acquisition.”

Governance

The last factor involves good governance. “We have found that a strong board of directors can add a 25% premium to the value of a company,” says Jim. “This is due to the buyer having more assurance that the company was well governed and there will be no unexpected surprises the buyer needs to deal with.”

This talk has focused mainly on an exit via an acquisition because this is the most likely exit scenario. “Even in the 90’s when IPOs were more frequent, we found an exit by acquisition was 15 times more likely than IPO,” says Jim. “In this scenario, companies received valuations in the range of 0.5x to 3x revenue or 8x to 20x EBITDA. These are large potential ranges since the valuation of a private company is very subjective. As such, it is important for start-ups to be aware of the factors that drive exit valuation and to ensure they are building these up as they grow their company. The more deeply rooted that these factors are in a company will put the company in a stronger position once they start to attract acquisition interest.”

Good advice indeed. Whether you are an entrepreneur or investor, if you rank your start-up that you are involved with across these factors, there are probably going to be a few areas you identify that can be strengthened. Starting to strengthen these areas now will help the company operationally in the short term and also provide benefit in the long term by building in stronger value that a buyer will place on the company.

Craig Hayashi is a founding board director of Maple Leaf Angels, Ontario’s largest and most active angel investment group with more than 40 members and approximately $6m in financings closed since the group’s inception in 2007. Follow Craig at www.mapleleafangels.com and www.startupnorth.ca

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Reposted from Maple Leaf Angels

PART 1

By Craig Hayashi

Entrepreneurs launch, employees get involved, and investors invest in start-ups for a variety of reasons and motivations. Underlying each group’s individual motivations is a desire/dream of hitting it big with an exit and getting a cash-out for the hard work and belief placed in the company. It’s clearly in everybody’s best interest to ensure the company receives the maximum possible value as a result of the exit. But what is the best way to do this and when does this work need to start?

To find out more, I spoke with Jim Pullen, partner at Concert Partners. Jim helps advise entrepreneurs on how to engineer value into a company to maximize exit potential. He also leads workshops on planning for exits given by the ISCM Investment Network. Previously he was managing director at Regent Associates, a European company specializing in mergers and acquisitions for technology companies where he worked in London and then Boston.

A few years ago, Regent Associates did a study of 250 M&A transactions that they were involved within the technology space over a span of 8 years. This covered transactions in Europe, US, and Canada. Specifically they wanted to find out the key areas that buyers looked for in a transaction so they could better advise their clients on how they could best position themselves to drive a higher exit valuation. Based on this study, they developed a framework as to how they could rank and assess a company on various factors that were proven to drive exit valuation.

“A good example of this framework in action is with a client that had approached us wanting to be sold,” says Jim. “We reviewed the company against the framework and felt they would be undervalued based on low scores against some of the framework areas. We advised them to develop these areas of their business and then come back to us. The company successfully improved themselves and when they came back to us 18 months later we were able to sell them for a 40% premium over the valuation we felt they would have received when they first approached us”.

The various categories of the framework are Financial, Market & barriers to entry, Human Resources, Strategic fit and Governance. When working with clients, Jim typically scores the company in each factor in the framework. These scores are compared to a company’s peers to help focus on the areas where the company can improve to optimize the value a buyer will see in the company.

Today we look at Financial and Market & barriers to entry.

Financial

This category includes basic financial metrics such as profitability and revenue growth. Companies with high profit margins and high rates of revenue growth will obviously command a higher valuation.

Other aspects include the type of revenues a company generates. Due to their nature, recurring revenues can add to the valuation of a company as it makes the company’s cash flow more predictable.

“The SaaS model is the example most technology entrepreneurs would think of in terms of a recurring revenue business model,” says Jim.
“However, even if the company does not have a business model that supports SaaS, they can look to adapt their model to provide more recurring revenues. For example, a company that sells big-ticket one-off products could look to build up more of an offering around maintenance and post-sales services for their product where they can sign their clients into multi-year maintenance contracts. This will give the company more of a recurring revenue stream and insulate them from a peaky revenue stream.”

“Companies with strong cash generation are also more attractive to buyers,” says Jim. “Such a company can take on more debt that can be used to finance growth. It also makes a leveraged buy-out an exit possibility.”

Market & barriers to entry

In this category the factors include the strength of customer relationship and degree of uniqueness the company enjoys in its market. “Companies that have a direct and strong relationship with the end users/purchasers of their product will get a higher exit valuation,” says Jim. “If a company sells through a channel and fails to build up a relationship with the end client, they run the risk of the channel swapping them out for another product that may offer the channel partner a better financial relationship. Even if they sell through channel partners, it is important for companies to build up strong relationships with end users.”

“We have also found that a company’s brand plays a large role in the value a buyer is willing to place on a company,” says Jim. “We have found that a strong brand can make up to 70% of the value in a company. Companies should proactively cultivate their brand to ensure they are recognized and well-regarded in their space.”

In terms of barriers to entry, companies should use many mechanisms to defend their position. This can include things such as legal protection though patents and trademarks, relationships through exclusive arrangements with key suppliers, and internal expertise through strategic hiring. “Anything a company can do to make it harder for competitors to enter their space will help command a premium on valuation,” states Jim.

On Monday we continue with Human Resources, Strategic fit and Governance.

Craig Hayashi is a founding board director of Maple Leaf Angels, Ontario’s largest and most active angel investment group with more than 40 members and approximately $6m in financings closed since the group’s inception in 2007. Follow Craig at www.mapleleafangels.com and www.startupnorth.ca

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