Healthcare Fundraising 101

Funding Op*ons for Life Science Companies May 6, 2014

The Panel Jeremy Halpern Partner, Nu@er McClennen & Fish jhalpern@[email protected] @startupboston

Yumin Choi Partner, HLM Venture Partners [email protected] @yuminvc

Paul Hartung President and CEO, Cognotpix, Inc PHartung@cognop*x.com

Funding the Company

Assuming you plan to be a “high growth” company…

What are your funding op*ons?

Entrepreneurship comes in many types

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NORMAL GROWTH COMPANY

HIGH GROWTH COMPANY

EXTREME HIGH GROWTH COMPANY

SOCIAL VENTURE COMPANY

•  Includes all service businesses

•  Exploiting a local market need

•  Team has ‘great jobs’

•  Growth by adding resources one by one

•  Exit will be based on value of cash flow (mature biz.)

•  Growth profile ultra-scalable

•  Team focus is exit •  Revenue $40M+

with lots of room for growth (5 yr.)

•  Based on $20M+ investment

•  Exit targeted to IPO or by ‘large’ M&A event

•  Goal is to fulfill a social need

•  Has mission orientation

•  Team needs to support mission

•  Growth profile often one resource at a time

•  Exit …much harder to find fit

•  Company can grow fast (on-line) or has a scalable system

•  Team often motivated by exit

•  $10m revenue in 5 yrs & market size allows significant additional growth

•  Capital efficient total investment$2-4M

•  Exit by M&A

Close Up: Extreme High Growth vs High Growth

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Capital Needs

Time

High Risk

Low Risk

Formal Venture Capital

M&A or IPO

Crystallize Ideas

Demonstrate Product

Early Scaling Growth

Sustained Growth

Angel Group (or Micro-cap) Syndication

Angels or Accelerators or Micro-cap

funds Angels or Accelerators or Micro-cap

funds Business Angels

Market Entry

M&A

Later VC Rounds

Extreme High Growth High Growth

Friends, Family & Founders

Friends, Family & Founders

High Growth Company Characteris*cs •  Disrup*ve Innova*on with Strong value proposi*on

–  Correla*on between Large Unmet Need : Solu*on •  High Margin Product (Ra*o of Revenue : COGS)

–  Some*mes Massive Volume Products where innova*on is incremental

•  High Rate of Revenue Growth over sustained period •  Scalable (Fixed cost is a low percent of Revenue) •  No major barriers to con*nued growth (ex. blocking IP; geography;

regulatory) •  Repeatable sales and distribu*on model with many credit worthy

customers •  Large Total Addressable Market (TAM) •  Defensible innova*on able to withstand compe**on and changing

condi*ons •  [Capital efficient]

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Return on Equity Return on Debt Income High Return

NON PROFIT ORGANIZATION

Capital Source View

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Debt- Pay it back Fixed Amounts

Equity – Ownership stake % of Future Value

Charity $$

Impact / Tax Write off


HIGH GROWTH

(COMPANY)

EXTREME HIGH GROWTH (COMPANY)

Risk / Return


Match Funding Sources

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HIGH GROWTH COMPANY

EXTREME HIGH GROWTH COMPANY


•  Friends family, founders

•  Debt Bank and other

•  (Future) Crowd funding (portal style)

Early on •  Accelerators •  Individual Angels •  Micro Cap VCs •  Seed from VC Later stages •  Venture Funds •  Strategic VCs •  Angel

Syndication

•  Friends family, founders

•  Charity$$ •  Crowds (Kick-

starter) •  Impact Angels •  (Future)

Crowd funding (portal style)

•  Angels •  Angel Groups •  Angel Group

Syndication •  Angel List •  Micro-cap Funds •  (Future) Crowd

funding (portal style)

•  Increasingly Strategic Corporate VCs

Non-‐Equity Sources •  Accelerators (some) •  Kickstarter type dona5ons

•  Pre-‐orders from end-‐customers •  Credit from vendors •  Strategic VCs •  Strategic NREs •  Distribu5on Contracts Common Theme: Providing early cash in exchange for a beHer commercial opportunity

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Equity Sources •  Accelerators (some) •  Friends & Family Common Theme: Suppor5ng success of the entrepreneur; business terms vary

•  Portal Funding •  Early Angels •  Super Angels •  Angel Groups •  Micro VC •  Tradi5onal VC (1st Round)

Common Theme: All are looking for –  sale (or IPO) of the Company at 4-‐10 x original investment –  Capital gains treatment on all sale proceeds –  Preferen5al treatment on subop5mal exit versus the founders

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Sources of Equity Capital Must have exits for equity model to work!!

–  2011 US IPOs -‐ $36B –  2011 US M&A -‐ $57B –  2011 US Private Equity -‐$35B

•  Exit sources extremely variable … health of economy •  All exits: indica*ve of future cash flow or market control

Idea Stage • Friends family, founders

• Grants • Crowds (Kick-‐ starter)

Demonstrate Product & Market Interest • Accelerators • Individual Angels • Angel Groups • Accelerators • Micro Cap VCs

Market Entry & Early Growth •  Crowdfunding (portal style) •  Angel Groups •  Angel Group SyndicaSon •  Angel List •  Micro-‐cap Funds

Early Scaling Growth •  Most Venture Funds

•  Angel SyndicaSon

Repeatable Growth • Most Venture Funds

• Strategic VCs • Angel SyndicaSon

• Private Equity

High Growth Capital by Stage &Amount

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Venture Stage

Investment Size

Friends & Family

Vendors

Angels

Traditional VC

Angel Groups

Corporate Venturing

Grants

Customers

Crowdfunding

Portal Funding

AngelList

Micro VC

Equipment Financing

Founder

Capital Sources: Size & Cost

Investment Size

Investment “Cost”

Traditional VC

Micro VC

Equipment Financing

Angel Groups Angels

AngelList

Corporate / Strategic Venture

Customers

Portal Funding

Vendors

Founder Friends & Family

Crowdfunding

Grants

Venture Debt Bank

Loans

Personal Loans

Private Equity

So What is Equity Anyway?

•  Stock = right to residual economic interests upon sale/liquida*on + stockholder vo*ng rights (usually limited to Board of Directors and Sale of the Company)

•  Preferred Stock = right to be paid before Common Stock Par*cipa*ng = original investment PLUS a pro rata share of remainder Non-‐Par*cipa*ng = original investment OR a pro rata share

•  Common Stock = whatever is let ater all other creditors and preferred stockholders are paid

•  Dividend = a right to an addi*onal amount upon liquida*on measured as a func*on of *me x percentage of original investment . Ex. 6.0% per annum

•  OpSons / Warrants = Contracts allowing holder to purchase an amount of stock in the future at a pre-‐determined price

•  Control Rights = Statutory and Contractual

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Equity Type Comparisons

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Solo Angel Super Angel Angel Group MicroVC VC

Valua*ons High rela*ve to stage

High rela*ve to stage

Low rela*ve to stage

Low rela*ve to stage

Medium

Type -‐ Likely (less likely)

Common (Warrants)

Conv Note (Preferred)

Preferred (Conv Note)

Preferred (Conv Note)

Preferred

Board Seat Maybe 1 or none 1-‐2 of 5 +/-‐ Observer

1 of 5 +/-‐ Observer

1-‐2 of 5 +/-‐ Observer

Audited Financials

No No No (reviewed) Yes Yes

Nega*ve Covenants

No Some*mes Yes Yes Yes

Preemp*ve Rights

No Some*mes Yes Yes Yes

Ver*cal Exper*se

Some*mes Rarely Some Usually Always

Equity Type Comparisons

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Solo Angel Super Angel Angel Group MicroVC VC

Exit Horizon (from $ in)

7 years 5 years 4 years 5 -‐7 years 4-‐5 years

Exit Range $20m+ $40m+ $50m+ $100m+ $250m+

Structure of an Equity Deal •  Company and Investors agree on a “pre-‐money valua*on” (PM) which leads to a price per share

•  Investors put in $X •  Investors then own: X / (X + PM) of the company

Example: PM = $1M X = $0.5M Investors own 0.5/1.5 = 33% Remember: New issuance NOT transfer

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Understand the Funding Path •  We’re talking about 1st funding here •  What is the probable complete funding picture?

– This is only funding – Another small round then probable small exit – Big money needed before exit

•  Each funding event should occur at an “inflec5on point” – Hopefully at a point where risk is removed –  Increased PM = so-‐called “up round”

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Understand the Funding Path, cont.

•  What if things aren’t going so well? – Flat or decreased PM = so-‐called “down round”

•  More money coming in without increased PM means everyone gets diluted, but…

•  Depending on anS-‐diluSon provision entrepreneur may carry more burden than the investors

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What about Conver*ble Debt? •  Many seed-‐stage companies use an instrument called Conver5ble Debt. Huh?

•  Conver5ble debt is not tradi5onal bank debt •  Converts exist for two major reasons

–  Investors and Entrepreneurs find it hard to agree on a PM valua5on

– Some5mes quicker and cheaper to document than equity deals (but not really)

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Conver*ble Debt provides Op*onality

•  ConverSble Debt = unsecured debt obliga*on of the Company that may be converted into equity of the Company.

•  Conversion Trigger = Qualified Financing usually at some

minimum amount of funds (ex. $500,000)

•  If Notes stays as Debt = Get back principal and interest ahead of other equity (behind other creditors typically)

•  If Notes Convert = Convert amount of debt and interest into equity at the valua*on in the next round

•  ater applica*on of a Discount (oten 5 – 20%) •  subject to a maximum valua*on amount (the “Cap”)

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Basic Structure of Conver*ble Debt •  Investor loans $ to Company an5cipa5ng another round of funding •  Investment accrues small interest •  When the funding occurs, investment + interest convert to equity,

usually at a discount (5-‐20% typically)

Example: •  Investors loan $200K to Company •  20% discount •  As of conversion, interest of $10k has accrued •  Next Round PM = $2m •  Conversion Amount = 1/(1 -‐ 0.2)* $210k = $262,500 At Conversion, Noteholders receive 262.5K / (PM + 262.5K + New Money)

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Conver*ble Debt – Complica*ons! •  When does the debt convert? •  What happens if PM of next round is huge? •  Does the investor have any say in things? •  What if there is an equity investment that doesn’t trigger conversion?

•  What happens if it never converts? •  What happens if Company gets bought?

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Conver*ble Debt – Solu*ons? •  Caps and Floors

– May defeat purpose with signaling

•  Default conversion price and security at maturity

•  Quick sale preferences (ex. 2x) •  Governance provisions •  Careful agenSon to conversion condiSons

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Conver*ble Debt – Worse than Equity?

•  MulSple liquidaSon preference (circa 2008) –  Ex. $500k of Notes with cap at $2m PM –  Next Round at $6m PM –  Issue Noteholders 3x number of shares –  3x shares equals 3x liquidaSon preference!!

•  Without a floor, effecSvely Full Ratchet AnS-‐diluSon

•  Preference Overhang –  In prior example Noteholders bought $262,500 of preference for $200,000.

–  All other Series A Holders bought 1:1 preference

•  Not Just a Price Adjustment 25

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