Company Financing

NDA Imposed Writer’s Block Lifted

Posted on March 10, 2008. Filed under: Company Financing |

This morning our capital investment partner, McCarthy Capital Corporation, formally released the annoucement of their investment in our future growth.  Many people have written about how “painful” this process can be, and it is certainly a lot of work, but it was (and continues to be) an awesome learning experience.  Now that I am free again to talk about this process, I hope to have time to go back and share some of the lessons learned.  The most important lesson though can’t be understated — choose your investment partner and your counsel wisely!  I can’t speak highly enough of our relationships with the team at McCarthy and our counsel, Kutak Rock.  If you haven’t gone through this process before, it can be highly confusing and intimidating.  I can’t imagine going through it if we didn’t trust both our investment partner and our counsel completely.

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Options, Leverage, and Focus in the Startup

Posted on November 8, 2007. Filed under: Company Financing |

Two roads diverged in a wood, and I–
I took the one less traveled by,
And that has made all the difference.
The Road Not Taken” Robert Frost

Whenever you’re faced with multiple paths forward, choose the most difficult one. It is almost always the right one.
Thomas Cannon (my first boss)

I’ve worked for some great leaders in my career, and I’ve tried to learn from each of them. They each seem to have a few gems which they hold as core beliefs which govern their decision making and how they run their businesses. Working with John for the past two years has been no different. This is his third company after leading each of his first two to positive acquisitions. It is fun for me to watch which things he’s refining in this third company, and which core tenets still apply. One of these tenets is that John likes to ensure that we have options at key inflection points. If you don’t have options, you don’t have the opportunity to make decisions — to lead. So, we’ve worked very hard through these first two years to look into the future and work to ensure that we have multiple options at each critical juncture in the growth of the business.

About 90 days ago, John and I sat down and agreed that we were approaching another milestone point in the growth of the business, and that we needed to work hard to give ourselves options for this next step. In our case this next step will be the launch of the 2.0 release of our COBRApoint SaaS application and the simultaneous launch of our BPO services. We started with the goal of securing three simple options —

(1) “stay the course” meaning continue on our current path and grow organically;
(2) secure a strategic relationship with a large industry partner who will potentially make a stratetgic investment in our company and who will actively drive our system and services into their existing customer base in return for equity and/or revenue share;
(3) secure a capital partner to fund a significant ramp in our marketing and sales and customer support efforts to stimulate more rapid growth in return for equity share.

When we first defined this high-level goal, we didn’t consider these to be mutually exclusive options. In other words, options 2 and 3 were intended to simply be accelerated market penetration strategies with the potential trade-offs of reduced revenue or equity in return for more rapid growth.  Given the right opportunities, we may have even chosen to pursue both options 2 and 3 simultaneously.

The result though has produced several very interesting and attractive options which, for the most part, are mutually exclusive.  We still have the “stay the course” option, but we have two potential options from a capital partner (one significantly more aggressive than the other), and we have found two potential strategic industry partners.  The interesting twist is that three of these options — the agressive option with the captial partner and each strategic industry partner option — will require some unique and significant development work and the bulk if not all of our attention for at least the next year or more.  They also require slightly to radically different approaches to capturing the market.  The great news is that each of these three has the potential to be a real “home run,” but given our size and maturity, we must realistically now pick only one option and then focus on execution.  We simply don’t have the bandwidth at this stage in our growth to try to do more than one of these options at a time, and to try to do so would at best result in two half realized opportunities and at worst…

So here is what we’ve learned. 

(1) Having options is good.

(2) Having options is even better, because having options provides you significant leverage in negotiating the best possible deal for the option you choose.

(3) For most startup companies, when faced with several mutually exclusive options, you must pick one and only one and focus your attention and resources on executing the chosen path.

Stay tuned for the path we choose, as I’m sure it will color the future of this blog just as it will the future of the company.  By the way, having to make these kinds of decisions is what makes startups so much fun!

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Imprecise Precision and Company Valuation

Posted on November 6, 2007. Filed under: Company Financing, Other |

My Eagles aren’t so good this year, and I’m the kind of sports fan who ties my emotions pretty tightly to the fate of my team (at least until the last whistle blows and I go back to being my kids’ dad).  I don’t get loud or violent when my team stinks, but I do get negative, and when I’m feeling a little less than sunny, I can spot flaws and find faults in just about anything.  So, while the Eagles were putting the nation to sleep last night against the Cowboys, I had plenty of opportunity to give some thought to something which I realized has made me uneasy me for some time now.

Why do NFL referees make such a big show out of bringing the chains on the field to precisely measure whether a team has made a first down when they’re using the highly imprecise spot of the ball to make this determination?  Is this a P.T. Barnum sucker kind of show?  You have a head linesman on the sideline sometimes as far away as the entire width of the field (or more if he’s behind the play) who comes running in from the sidelines at the end of a play to dictate where the ball was down and place the ball for the next play.  There is no way he gets the spot exactly right.  In general, I’m OK with this.  Human error is part of the game.  What bothers me is them bringing the chains on the field to check to see whether the highly imprecise spot of the ball resulted in the nose of the ball precisely breaking the plane of the first down marker.  Whether or not my team gets the first down may have a precise impact on the outcome of the game, and yet this is often based on a highly imprecise spot of the ball.  Short term imprecision may play a part in producing a highly precise result in the long run.

I’m finding that pre-money valuations from potential capital investors are starting to engender the same kind of emotions in me in that a very imprecise pre-money valuation may ultimately result in a very precise result to my family in the long run.  Ask the VC provides a good and simple explanation of how VC’s determine pre-money valuations here.  As above, in general, I’m fine with the way this process works.  For relatively early stage investments, pre-money valuation is simply an entry into a formula that spits out share price to determine equity ownership percentages relative to the amount of the investment.  In many cases the entrepreneur and the investor can even start at the desired result and work backwards together to produce the pre-money valuation.  Clearly this isn’t a precise science.  What is a company worth when it has some product, little or no revenue, and a defined but not yet proven market?  If a knowledgeable entrepreneur has one capital investor with whom they really want to work, and the entrepreneur and the investor can both amicably agree to a deal which results in an investment amount and an equity share which they both believe is reasonable, then as far as I’m concerned this was a good deal for both parties — a classic win-win.

The difficultly starts to set in though when the entrepreneur has multiple possible sources for funding and all of them have different opinions about how the company should approach the goal of dominating the market.  Different approaches may produce different opinions about a company’s pre-money valuation, require different investment amounts, and result in different ultimate equity shares.  Take for example a company who may be talking to a “classic” venture capital firm, a “classic” private equity firm, and a public company interested in making a strategic investment.  All three by their very nature have different investment philosophies and different goals for their investments.  They may also have very different opinions about the value of the entrepreneur’s “product” in its relation to the market which will produce different company valuations.  Again, taken independently, each deal may be “fair” as a stand alone deal, and I suspect that just about every company has faced a “fork in the road” at one time or another and had to choose their direction.  Will option A which gives me less equity result in a more valuable company meaning my smaller equity percentage is actually worth more?  I’m learning quickly that this is the kind of stuff which separates the winners from everyone else.  In my next post I’ll discuss our current personal fork in the road and the options facing us.

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How should we fund the growth of our company?

Posted on October 15, 2007. Filed under: Company Financing |

In an ideal world, my great aunt twice removed on my father’s side would have left me a nice parting gift of $20M on her way to meet St. Peter.  Of course, if she’d done this I might have been too busy attempting to become King of the Mountain in Aspen or, if Lori had her way, opening a string of soup kitchens, to ever think about starting a company.

Since this didn’t happen, we find ourselves 2 years into our self-funded to date company looking at our funding options for moving forward.  I love working with John since his strategic mind is always working to ensure we have multiple options for a future need long before we get to the point where the need is critical.  Our options right now are probably similar to most companies at our stage — proven ability to deliver product and land customers but not yet profitable. 

1.  We can continue to grow organically using our own money and/or debt to fund operations until we break even.  To do this we’ll need to continue to keep expenses low which means our ramp will be relatively long.

2.  We can pursue funding from traditional or not-so-traditional venture capital firms.  Traditional or not, a good VC firm will bring us assistance in growing our company professionally and a healthy, experienced outsider’s perspective on our plans.  John and I both appreciate and value the need for professional management, but we’re also both “entrepreneurial” at heart.  The right VC could help us.  On the downside, they’ll not only take equity, but even if they only acquire a minority ownership stake, the company will no longer be “ours.”

3.  We are fortunate to have several large, public companies expressing strong interest in working closely with us and in making a strategic investment in our company.  On the plus side here, they seem less interested in being involved in how we run our company than the VCs are.  On the downside, we’ve found that the corporate development teams in large companies seem to be more rigid than the VCs regarding valuation and percentage equity for their investment.  I guess this makes sense.  The VCs are more involved so they’re more willing to take a risk regarding the valuation and equity percentage.  Of course, they’re also thinking way ahead of us about B and C rounds of financing.

4.  A fourth option we could choose is to license our source (with a highly restrictive non-compete and IP protection agreement) to one of our prospective customers who would rather run our system in-house than in our hosted, SaaS model.  The revenue growth curve in any SaaS model is a long one.  A large one-time license fee from this customer (plus annual maintenance for new releases) would easily solve our funding needs for the next year or more.  In my earlier life selling COTS enterprise software, this would be our no-brainer choice.  The downside is that even a large upfront payment for a source code license from this customer would be significantly less than they would pay us in our normal model over a 5 year relationship.  This is compounded even more in our case since software license/subscription fees is not where we make our money.  Our model is to give access to our software for free in return for processing insurance premium payments on behalf of our customers.  If we give this customer our source so they can run our system in-house, we’ll likely never get their premium processing business.

5.  Our last option is an angel investor.  I’ve been surprised how easy it is to find wealthy individuals who like to do angel investing.  I’ve also found that there is no real rule here — some like to be very involved; some don’t want to be involved at all.  In some ways angels are like VCs on a smaller and perhaps less formal scale, though “cash on cash return” is a question we’ve gotten often from potential angel investors, but we’ve yet to have a VC ask us this.  The biggest drawback for us where angels are concerned right now is that most of them want to invest somewhere between $25K and $500K.  I’m sure there are angels out there with really big pockets who will go higher, but they’re a little harder to find.  At this stage in our growth, if we only take $500K it might as well be from a loan with no loss of equity.

So, we’re actively working all of these options right now except for the angel option.  If anyone has personal experience or advice, I’m all ears.

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Why?

Posted on October 12, 2007. Filed under: Company Financing |

My daughter turns 3 next week, and my son is not quite 4 1/2.  Lori and I hear, “Why?” a lot.  One of the many things I love about Lori is that she never seems to get tired of trying her best to answer each “Why?”  So, why am I writing this blog?

We’ve (my business partners and I) recently begun the process of exploring our options for future growth.  We can continue to grow organically; we can accept venture funding; we can accept a stratetgic investment from a large company; we can license the source code for our SaaS application to a large company who would like to run the system themselves internally; or we can accept funding from an angel.  We see positives and negatives in each scenario.  I’ll do my best to briefly outline each in my next post.  The reason I chose to start this blog though is this:

Before this week, I’d never seen a VC term sheet in my life.  I’ve negotiated hundreds of software license agreements, reseller agreements, and service agreements; I’ve poured through ERISA and COBRA regs and many state laws for health insurance continuation; I’ve even done my best to understand how GLB and PCI compliance laws/rules apply to our business; but I’d never seen a VC term sheet.  I’m not a fan of negotiating anything from a positition of weakness, so I went looking for help.  I found exactly what I was looking for in some outstanding blogs.  I found both VC general partners and entrepreneurs who shared their knowledge and experience in frank, easy to understand language I could understand.  I owe the authors of these blogs a great deal of thanks.  I won’t pretend here to be an expert in any of the topics I discuss like these authors are, but I would like to share some of what we learn in building this business in the hopes that I might, one day, write something which helps someone else.

The blogs which helped me so much?  Here they are:

Feld Thoughts by Brad Feld
Ask the VC by Brad Feld and Jason Mendelson
A VC by Fred Wilson
Venture Hacks by Nivi and Naval Ravikant
Ask the Wizard by Dick Costolo

Thank you to each of you.

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  • About

    Mark Waterstraat

    VP Sales

    Benaissance

    www.benaissance.com

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