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The Venture Capital Financing Process(Part Deux)

Venture capital (VC) funding is typically used by enterprises that are early-stage, high-risk, high-potential growth startup companies.  Many times they are already generating revenue for their product or service, even though they may not be profitable yet.

Round and round we go

In the venture capital game financing rounds typically have names that relate to the class of stock being sold:

    The seed round is where company insiders provide start-up capital.

    The Angel round is where early outside investors can buy common stock.

Under normal circumstances the company will have advanced its cause by the time of the next round.  As a result, each subsequent round of venture capital reflects a different valuation (i.e. if the company is prospering, the Series B round will value company stock higher than Series A, and Series C will have a higher stock price than Series B).

On the other hand, if the company is not prospering, it can still get subsequent Series-rounds of financing, but the valuation will be lower than the previous series: this is referred to as a “down round.”

These “down rounds” may also include “strategic investors” who participate in the round and also offer value in their area of expertise such as marketing or technology assistance.

After a “down round” where the company fails to meet established growth objectives they can essentially re-start under a new group of funders. These rounds are identified as series AA, BB, etc.

After that we get into the ‘Alphabet Soup Rounds’

The first of the Alphabet rounds is known as "A round" or "A round financing".  This is the first round of financing for a new business venture after the seed capital is received.  In most instances this will be the first time that company ownership is offered to outside investors.

By this point in time the company should be generating some revenue but is probably not yet profitable.  The investors at this stage are venture capital funds or angel investors who are willing to accept higher risk for the prospect of higher returns.

As the company grows and requires even more capital, each subsequent round of preferred stock issued to investors takes on the next letter in the alphabet.  This way investors know where they stand in the pecking order of claiming future profits.

At each stage, the company gets revalued.

The second round of financing for a company by private equity investors or venture capitalists is known as Series B.  This round usually takes place once certain milestones have been reached by the organization.

The third round of financing is called, guess what? Series C and usually represents an additional expansion stage for the company.  At this stage the company has proven successful in the market and has the potential for an even larger market.

Series Round D financing (along with series C) represent the final stages in the Early Financing cycle. Usually these are the final steps in the company’s growth cycle before the IPO (Initial Public Offering) or the sale of the company to another group of investors.

During the Series A, B, C, etc. rounds of financing, the company typically receives money from investors in exchange for preferred stock.  As a side note insiders, seed capital investors and angel investors usually receive common stock. Private equity investors generally prefer convertible preferred stock to common stock.

Holders of preferred stock have a greater claim to a company’s assets and earnings. In addition if a company is forced to liquidate in order to pay creditors and bondholders, common stock holders receive no money until after preferred shareholders are paid out.

THE VENTURE CAPITAL STORY

With the media frenzy that Facebook has caused on the way to a possible $100 billion IPO, I thought it might be appropriate to discuss the venture capital process and how it affects both the company and the market.

As a credit professional, I’ve dealt with established Fortune 1000 companies as well as quite of few start-ups.  Along the way I’ve had to come up with a few ways to establish acceptable thresholds of risk depending upon where the companies were in their growth stages and what sort of risk was hanging in the balance.

Venture capital is provided to early-stage companies, with high potential (and high-risk) for growth. They make their money by having equity in the firms in which they invest.  So, to put it mildly, they have “skin in the game.”

All venture capital is private equity, but not all-private equity is venture capital.

If the enterprise is a small venture, then perhaps they can rely on such capital sources as family funding, loans from friends, personal bank loans or crowd funding.

Some ventures have access to rare funding resources called Angel investors. These are private investors who are using their own capital to finance a ventures’ need but they take a passive role regarding company management.

For more ambitious projects, something a bit more substantial is in order.  For these situations often times a pooled investment (often an LLC) will provide funding that is too risky for standard capital markets or bank loans.

THE STAGES OF A START-UP FUNDING

Seed stage funding - Typically used to pay for market research and development. Seed capital is generally provided by those with a connection to the new enterprise although it could come from the founders themselves. It is not unusual for seed funding to come from family, friends or angel investors.  These investment dollars tend to be lower (in quantity) and the risk very high.

First stage (start-up stage) – A business plan gets presented to the venture capital firms, a management team gets formed to run the venture, if a board of directors exists, a member of the venture capital firm will take a seat on the board of directors. After reading the business plan and the proper consultation, the investor decides whether or not the idea is worth further development.

Second stage – At this stage the idea has now been transformed into a tangible product and is likely being produced and sold.  The venture is striving to reach the break-even point. The management team must prove its’ mettle to the venture capitalists. The VC firm will monitor how management navigates the development process and deals with competitors.

Third stage – The capital that is provided to a company with an established commercial production and a basic marketing set-up, looking for market / plant expansion, acquisitions, and product development. At this stage the company should be enjoying revenue growth but may not yet realize a profit.

Mezzanine stage – This is late-stage venture capital, usually describing a company which is somewhere between startup and IPO. To be even more exact Mezzanine Financing is for a company expecting to go public usually within 6 to 12 months.  The expectation is that the proceeds from a public offering will repay this financing or at least establish an opening price for the IPO.

The further along the process a company goes, less risky the VC-firm’s investment becomes.

                                            

 

OLDER WORKERS…YOUNGER WORKERS…A HUGE RECESSION…COULD A LOGJAM BE BREWING?

 A recent article proclaimed that there would be 32.4 million replacement job openings between 2008 and 2018, as baby-boomers exit the workforce.  The first thought that came to mind was, “Really…how can we be certain that these folks can even afford to retire?”

A completely different article stated that young Americans seemed to be having a much tougher time finding work than older workers. It seems that the overall workforce is getting older. Workforce participation of workers over 55 has risen 11 percent since December 2007.

The consensus seems to point to the fact that many workers will need to remain in the workforce to approximately 70 years of age in order to replenish the losses of recent years.  Think about that. Of course this is assuming that they are able to find someone willing to employ them at that point in their lives.

But even if older workers decide to stick around an additional 5 years, think about the impact that decision will have on the following generations of workers.

Hypothetically speaking, a 65-70 year old worker remaining in the workforce has an impact on the average 45-50 year old worker, who in turn impacts the work life of the average 25-30 year old worker and so it goes.

Through in the greatest economic downturn since the Great Depression and you can see where this is headed.

The truth is a little murkier than what we would think intuitively. No one owns any particular job. The economy is always creating new opportunities. As we know, businesses get created and others go the way of the dinosaurs.  In addition, how often is a younger person in direct competition for the position currently held by an older worker?

Do you think that older workers end up hurting the younger set by sticking around longer?

Millions of iPhones and not many job opportunities for U.S. workers

I was reading an interesting article the other day about American technology and how it has NOT translated into American jobs.

President Obama asked Steven Jobs what would it take to make iPhones in the United States?  In a nutshell, Jobs informed the President that that wasn’t going to happen.  And the thing that really surprised me was that the central issue wasn’t cheap labor.  Rather, it’s the ability of overseas factories to ramp up at a moment’s notice, provide the sort of flexibility, attention to detail and skill level that is unheard of in America.

According to this article Apple earned over $400,000 in profits per employee last year. Back in the day, when American companies were in their heyday they traditionally hired tons of U.S. workers. That doesn’t seem to be the case these days. Profits and efficiency are top patriotism and loyalty to the homeland.

This story explains why the U.S. economy (and its’ corporations) can grow and enjoy huge profits without any substantive gains in employment.

Some of these factories house thousands of workers inside company’s dormitories.  They can get them up in the middle of the night and work them around the clock in 12-hour shifts.

How can the U.S. compete with that?           

Not that long ago, Apple products were made in America. Today, not so much.

Just imagine, 70 million iPods, 30 million iPads and 59 million other Apple products that are being manufactured overseas instead of in the U.S.A.

What happened?

For starters, innovation, leadership and a massive technologically skilled workforce.

Apparently, the cost of labor isn’t a major stumbling block.  The cost of labor is actually dwarfed when compared with the cost of buying parts and managing supply chains from hundreds of companies.  One company, Foxconn Technology, has many facilities in Asia, Eastern Europe, Mexico and Brazil.  It assembles approximately 40% of the world’s consumer electronics. 

Are you beginning to see a pattern here? Products manufactured abroad but sold in massive quantities in the good ol’ U.S. of A.

Has the manufacturing industry here completely missed the boat or is this just an unavoidable turn of events? After all, every empire has its’ rise and fall.

If we can’t compete in America what does this mean for our middle class employment options?

MAKING SERIOUS PLANS IN A CHAOTIC ENVIRONMENT

The financial world can be a volatile place. These days major changes that have far reaching impact your finances can take place in the twinkling of an eye.

When I think about the speed with which conditions change I’m always reminded of March 6, 2008.  Shares of the nation’s fifth largest investment bank had dropped nearly 20% in the previous ten days.

Ten days later Bear Stearns was swallowed up by former competitor J.P. Morgan Chase.

The period immediately following World War II up until at least 1980 was probably the most continuously prosperous period United States history. Chances are, those whose working careers spanned that period firmly believe that future generations will never have it as good as they had it.  And I'd be inclined to agree with that opinion. 

Think about it. Back then there were no economic challenges coming from India, China, or Brazil let alone Lithuania, Egypt, Nigeria, Qatar and others.  Industries that the U.S. once dominated are now largely outsourced to other countries.

The Crash of 1987

The Dow hit a new high on August 25, 1987 at a record 2722.44 points. Then, it started to head down. On October 19, 1987, the stock market crashed. To be exact, the Dow dropped 508 points or 22.6% in a single trading day.

During this crash, 1/2 trillion dollars of wealth were erased.

The Crash of 2000

During the dot-com boom period from 1992-2000, the markets and the economy experienced a period of record expansion.  The NASDAQ peaked at 5132.52. Conversely, the end of the dot-com prosperity boom led to many dot-coms running out of capital and were eventually acquired or liquidated.

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

The Great Recession (late-2000s financial crisis) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.  As a result, national governments had to bailout major banks, large financial institutions collapsed, and stock markets around the world endured severe downturns. In many areas, the “mortgage meltdown” all but destroyed housing market, leading to numerous evictions, foreclosures and prolonged unemployment.

Since peaking in the second quarter of 2007, household wealth is down $14 to $16 trillion.

It has been stated that the housing market (especially new home construction) is a major contributor to the health of the U.S. economy. 

With this being the case my question is simply, “How can any sane individual commit to a 30 year financial obligation when the U.S. economy tends to undergo major dislocations every 5-15 years?”

HARD CHOICES IN THE TECH WORLD

I’ve always loved Apple products.  I mean for quite a few years. I’ve been an admirer of their ability to provide products that are way ahead of the curve.  They’ve always been able to bring items to the market even before customers knew that they needed or desired them.

In the last five or so years we, as a nation have become addicted to our iphones, MacBooks, ipads, etc. These products have become a way of life.

For the first time ever Apple has released a list of their suppliers.  In addition, they also graded each one. Many of them did not receive a favorable grade.

One, in particular Foxconn appears to be especially egregious. Just imagine 12 to 14 year old kids working 70 hours per week in massive factories.  They don’t even go home after work. They go back to their dorms on the company campus. 

These kids contemplate suicide on a regular basis. In 2010 ten Foxconn factory workers committed suicide by jumping off of factory rooftops due to the unbearable working conditions. 

These companies also test their employees for STD’s.  They also give the females pregnancy tests. They don’t want their employees to have any relationships or sex because that could affect productivity.

The company’s response? They installed nets to prevent future jumpers.

As an Apple consumer would you feel like an accomplice in allowing human rights violations to take place worldwide?  Would this information make you think about this when you’re using your Apple products?

Hearing stories of children being separated from their families and being forced to work long hours has to impact your feelings.  But will it affect you enough to alter your purchasing decisions?  As an Apple devotee that’s a really hard choice.

The way I see it we as consumers have two choices: Demand a change regarding the working conditions where these items are manufactured or start purchasing our high-tech products from other companies. 

I know this is really hard but what does your moral compass tell you to do?  As for me, I’m going to have to think long and hard about making future purchases from the company that I’ve always admired.

MONEYBALL IN CORPORATE AMERICA?

 During the fall of 2011 the film Moneyball was released.  I read the book years ago when it was issued and as a fan of both the author, Michael Lewis and the ball club (Oakland A’s), I loved it.

The book centers on how a professional baseball team managed to successfully compete against competitors that had much deeper pockets than they did.

The front office brain trust of  General Manager / owner Billy Beane, Paul DePodesta(Assistant to the General Manager) and J.P. Ricciardi(Director of Player Personnel) among others brought the practice of sabermetrics into the world of sports.  

The secret of the Oakland Athletic’s success hinged on their ability to place a premium on skill sets that were vastly different than the skill sets that other club’s traditionally valued.

As a result the Oakland A’s enjoyed several years of success by pursuing players with high on-base percentages and pitchers that managed get opposing batters out even though they didn’t light up the radar gun.

The main theory at play is that baseball traditionalists have overpaid for certain attributes of their players while others were totally overlooked.

All of this started me thinking, “Isn’t it at least possible that there could be key differences between the traits employers value greatly and the traits that really make an employee more valuable?”

Let’s take a look at a few and see:

Overvalued Skill / attribute – A degree from “designer label” institution.

For some reason employers tend to be dazzled by prospective employees that have received degrees from Harvard, UC, Stanford, Wharton, etc. I have no issue with education but I can’t believe that people who graduate from these institutions have a monopoly on brainpower.

Undervalued Skill / attribute - Self-motivated worker.

You’ve got love an employee who doesn’t have to be told to do everything. We all need direction on the job but someone who is naturally inclined towards taking positive action on their own is worth their weight in gold.

Overvalued Skill / attribute -  Prospective applicant must be currently employed.

I can’t say that I really understand this one. Let me get this straight, people who are currently employed are by default, more qualified than those who are currently unemployed? Many unemployed are that way through no fault of their own.

Undervalued Skill / attribute - Creative problem solver (Thinks “outside of the box”).

You can’t put a price on this skill set. The ability to think outside the box and/or be a creative problem solver is possibly the most valuable an employee can have. Imagine a workplace brimming with creative, problem solving employees…awesome!

Overvalued Skill / attribute - Experience using today’s “hot” technology.

Often employers are really excited about employees that have a decent level of expertise in the hottest software applications: HTML5, Ruby on Rails, SAP, and Oracle to name a few. I understand this but sometimes this expertise is valued more highly than behavior-based skills.

Undervalued Skill / attribute -  Positive attitude / Professional behavior.

During the course of one’s work life it’s stating the obvious to say that things won’t always go swimmingly. Working with someone who has an upbeat, “can do” attitude along with a touch of humor makes the worst working environments a little more tolerable. 

Overvalued Skill / attribute – Applicants with a high G.P.A. from school.

A G.P.A. can tell you a lot about a person.  However, my opinion is that it is a poor barometer of the type of performance you will receive while on the job. To succeed in the workplace you need real world skills, and you won’t acquire those spending “all-nighters” in the library. The ability to think quickly, organize effectively and communicate clearly should be weighted heavier than one’s GPA (In my opinion).

Undervalued Skill / attribute - Conscientious employees who watch over the company’s money as if it was their own.

I’m not encouraging overzealous behavior in this instance. Everyone can appreciate an employee that doesn’t abuse sick time, lunch breaks and never fails to give a full days work for a full days pay.  Unfortunately there’s never a shortage of folks that treat company supply cabinets as if it’s their personal toy box.

What other examples of “Moneyball” values in the workplace can you think of?

   

LESSONS I'VE LEARNED FROM MY ORGANIZATIONAL MEMBERSHIPS

I’m currently a member of several professional networking groups.  One of them is a thriving community outreach organization with established professional relationships throughout the greater Bay Area.  It has been in existence for about 10 years.

Another organization has been in existence for several decades but it is clearly floundering.  Members of this second group seem a bit disconnected, some are a bit negative, and the membership roster seems to be waning.

Like I said, one organization has been in existence since 2002 and the other has been around for at least 30 years.  They are not carbon copies of each other but they still serve very similar functions.

As I’ve observed both groups in action I’ve come away with a few key observances that I feel would be applicable to just about any organization:

1) Establish and maintain key relationships. One of the main differences between one organization and the other is that the newer one has established deep roots and contacts within the business community while the much older organization hasn’t.

2) Provide indisputable value for your customers and/or clients.  Another big difference is that the newer organization provides a valuable service to its’ members and there really is no doubt about it. The other, more established organization provides a valuable service however its’ value is not as apparent.

3) Find ways to remove or neutralize the negative individuals within your organization. When you’re talking about a volunteer organization, it becomes a bit more challenging to deal with negative personalities.  Needless to say negative members can destroy the entire core of any organization.

4) Establish the core mission of your organization and don’t be afraid to re-visit it periodically.  Why does your organization exist? Can you still meet the goals that have been set?  Has the landscape changed in such a way that you can no longer meet those goes?

5) Develop opportunities for everyone in the organization to be a contributor.  If your members (or employees) don’t feel that their contributions don’t matter, your organization will soon be in trouble. Make it easy for them to do so.  Create new vehicles to make this happen if necessary.

6) Benefits or company profits don’t just happen.  This should be common sense, but trust me, for many people it isn’t.  So many people fail to make the connection between the effort that they put forth and the benefits that they receive.

The American Dream...R.I.P?

I recently received a Tweet from Leslie Marshall regarding a new movie, “The American Dream”.  Her tweet questioned whether the American dream was dead or should maybe be redefined.

That got me to thinking about the origin and current status of the American dream.

According to Webster’s dictionary the definition of American Dream is as follows: the ideals of freedom, equality, and opportunity traditionally held to be available to every American.

The term, American Dream was originally coined by James Truslow Adams in 1931, a U.S. writer and historian, in “Epic of America.” 

[The American Dream is] "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position." [Adams] 

Wow! Over the years that definition has been completely hijacked. Today the American dream seems to be defined by: getting married, having a job that allows you to buy lots of material things, the proverbial house complete with a white picket fence, and of course a family of 2.5 kids.

The American dream can be described as the fundamental character or spirit of our culture.  The belief that we all enjoy certain freedoms and those freedoms include the opportunity for prosperity and success. 

Of course reality is far from this but is it possible to create a new ethos and work towards that?  I don’t agree that the dream is dead. I don’t think it ever truly existed for millions of Americans.  These days the percentage is growing ever smaller so this movie and question is particularly topical.

Naturally, with 2012 being an election year, I expect the demise of the American dream to be front and center during much of the campaign.

The same way that a flame cannot exist without oxygen, or life cannot exist without water, the American Dream to continue to exist, let alone flourish unless certain economic conditions also exist.  Personally, I don’t think that we have put enough effort into maintaining those necessary conditions in order for opportunities to expand.

People need a sense of their own power. They have to believe that they matter.  Right now I don’t see that happening.

Ranking the Most Beloved CEO’s Ever(Part 3)

 Here we are, the final installment of  “ranking the most beloved CEO’s ever”.  Without further ado, let’s see who rounds out the top of this list.  You can see part 1 here and part 2 here.

5) Lee Iacocca became an iconic figure during the late 1970’s and early 1980’s by engineering a tremendous turnaround at the Chrysler corporation. In doing so, Iacocca became the standard by which all other CEO’s were measured. When Iacocca arrived at Chrysler, during a time of record losses at the company, he cut inventories by $1 billion, reduced the white-collar staff by 50 percent, and turned Chrysler around—not with government loans, but with $1.5 billion in loan guarantees. Iacocca repaid the loans ahead of time and the Treasury made a profit of $300 million.

4) Warren Edward Buffett is arguably America’s best known, best respected investor, businessman, and philanthropist. He is one of the most successful investors in history, the primary shareholder and CEO of Berkshire Hathaway.

In 1999, Buffett was named the top money manager of the 20^th century by the Carson Group and was also listed among Time’s 100 Most Influential People in the world.  In 2011 he was awarded the Presidential Medal of Freedom by President Barack Obama.
Known as the "Oracle of Omaha" or the "Sage of Omaha" Buffett is noted for his adherence to the value investing philosophy and for his personal frugality despite his immense wealth. He is consistently ranked among the world’s wealthiest individuals with an estimated net worth of approximately $50 billion. Buffett is also known for his pledge to give away 85 percent of his fortune to the Gates Foundation.

3) Henry Ford was the American founder of the Ford Motor Company and father of modern assembly lines used in mass production. His introduction of the Model T automobile revolutionized transportation and American industry. As owner of the Ford Motor Company he became one of the richest and best-known people in the world. A prolific inventor, Ford was awarded 161 U.S. patents. One key Ford component that more CEO’s should apply today is that he insisted on paying his workers a living wage…so that they could afford to purchase his automobiles. Logical, don’t you think?

2) Sam Walton - Legendary founder of the Wal-Mart empire.  Walton is said to have become the youngest Eagle Scout in the history of  the state of Missouri.  Walton worked at JC Penney as a management trainee, served in the U.S. military and graduated from college with a B.A. in Business Administration.  In 1945 he purchased a Ben Franklin variety store where he pioneered many of concepts that made him such a huge success.

Although he died in 1992, Time included him on a list of the 100 most influential people of the 20^th century. Before his death, Walton received the Presidential Medal of Freedom from President George H.W. Bush. Sam Walton was ranked by Forbes as the richest man in the United States from 1982 to 1988.  Wal-Mart Stores (including Sam’s Clubs) make up the world’s largest company. Not bad for a “plainspoken hayseed”.

1) Steven Paul Jobs was an American businessman, co-founder and CEO of Apple Inc. and former CEO of Pixar Animation Studios. In the late 1970s, Jobs, and Apple co-founder Steve Wozniak, created one of the first commercially successful personal computers.

Jobs was a true visionary, in the early 1980s he was among the first to see the commercial potential of the mouse-driven graphical user interface.  Jobs resigned from Apple in 1985 and founded NeXT, a computer platform development company specializing in the higher education and business markets. In 1986, he acquired the computer graphics division of Lucasfilm Ltd which was spun off as Pixar Animation Studios. In1997 NeXT computer was bought out by Apple Computer Inc. bringing Jobs back to the company he co-founded.  Steve Jobs was listed as Fortune Magazine's Most Powerful Businessman of 2007. His work driving forward the development of products that are both functional and elegant has earned him a devoted following. 

Do you agree with most (or any) individuals that I've listed? Would you have included others? Perhaps changed the order? Let me know your thoughts.