On BootstrappingOn BootstrappingMGT 709 New Venture CreationMGT 709 New Venture Creation

AgendaAgenda

Note on Attracting StakeholdersNote on Attracting Stakeholders AdamsAdams BankruptcyBankruptcy NanoGeneNanoGene DragonflyDragonfly

Adams On BootstrappingAdams On Bootstrapping Raise the right amount of capital at the Raise the right amount of capital at the

right stage of developmentright stage of development Market risk is higher than technical risk (in Market risk is higher than technical risk (in

IT at least)IT at least) The risk you will launch a product and point it The risk you will launch a product and point it

in the wrong directionin the wrong direction Higher risk means less likely to get cashHigher risk means less likely to get cash Get the right product to the right market with a Get the right product to the right market with a

reasonable amount of moneyreasonable amount of money

Why raising too much money is a problem?Why raising too much money is a problem?

Company becomes output-oriented not Company becomes output-oriented not execution orientedexecution oriented Temptation to spend, spend, spendTemptation to spend, spend, spend

My experience at FastpacMy experience at Fastpac

Only tangible progress towards proving the business Only tangible progress towards proving the business model countsmodel counts

Ownership becomes dilutedOwnership becomes diluted High risk means low valuationHigh risk means low valuation Employees not as motivatedEmployees not as motivated Second round investors less interestedSecond round investors less interested

AlternativeAlternative

Value inflection points = execution milestonesValue inflection points = execution milestones Raise new finance only after you pass a milestoneRaise new finance only after you pass a milestone Raise only what you need to get to the next Raise only what you need to get to the next

milestonemilestone Building infrastructure is never validating the marketBuilding infrastructure is never validating the market

Get infrastructure done as quickly as possible – use pre-Get infrastructure done as quickly as possible – use pre-arranged deals or outsourcearranged deals or outsource

How long would it take you to find some reputable How long would it take you to find some reputable and economical people to do tax, banking, payroll, and economical people to do tax, banking, payroll, and legal services in Las Vegas?and legal services in Las Vegas?

The Big TwoThe Big Two

#1 Market validation#1 Market validation See earlier lectureSee earlier lecture

#2 Develop a profitable business model#2 Develop a profitable business model Is demand sufficient to generate profits?Is demand sufficient to generate profits?

Focus and speed help hereFocus and speed help here

Both these are “must-dos” to raise seed Both these are “must-dos” to raise seed capitalcapital

Other MilestonesOther Milestones

Recruit senior executives and key advisorsRecruit senior executives and key advisors People willing to bet their reputations and careers on the People willing to bet their reputations and careers on the

opportunityopportunity

Hire quality managers and individual contributorsHire quality managers and individual contributors Predict up front who you will need to hire and when – quarter by Predict up front who you will need to hire and when – quarter by

quarterquarter The team is what enables you to executeThe team is what enables you to execute

Product evolution:Product evolution: prototype and develop the productprototype and develop the product

Sign on brand name customers – ultimate validationSign on brand name customers – ultimate validation Establish partnershipsEstablish partnerships Line up investorsLine up investors

Lead, strategic, otherLead, strategic, other

Some Big RulesSome Big Rules

Big rule #1: NEVER RUN OUT OF CASHBig rule #1: NEVER RUN OUT OF CASH things will cost more than you thinkthings will cost more than you think

Big Rule #2: Everything will take TWICE Big Rule #2: Everything will take TWICE as long as you thinkas long as you think

Concept of the Virtuous CircleConcept of the Virtuous Circle

Attracting StakeholdersAttracting Stakeholders

All stakeholders take a risk in supporting a All stakeholders take a risk in supporting a new venturenew venture Investors, employees, suppliers, customersInvestors, employees, suppliers, customers Need additional inducements or may not Need additional inducements or may not

participate at allparticipate at all Risk depends on the irreversibility of the Risk depends on the irreversibility of the

investment investment Specific investments are more risky, sunk costsSpecific investments are more risky, sunk costs Make fungible investmentsMake fungible investments

Reduce asset specificityReduce asset specificity

Reusable, off the shelf inputsReusable, off the shelf inputs Reduces supplier riskReduces supplier risk Reduces employee training riskReduces employee training risk Reduces customer investment in learning, Reduces customer investment in learning,

search, and adaptationsearch, and adaptation Problem is that these inputs can be easily Problem is that these inputs can be easily

imitated and therefore not source of CAimitated and therefore not source of CA Make specific investments in area of greatest Make specific investments in area of greatest

payoffpayoff Undertake phased developmentUndertake phased development

Avoid the risk averseAvoid the risk averse

Select stakeholders who are the most willing to Select stakeholders who are the most willing to and capable of bearing riskand capable of bearing risk Diversified portfoliosDiversified portfolios

Investors, suppliers, buyersInvestors, suppliers, buyers Seek those most experienced with bearing riskSeek those most experienced with bearing risk

Investors, employees, suppliers, buyersInvestors, employees, suppliers, buyers ““Bell cows” – visionaries whose participation raises the comfort Bell cows” – visionaries whose participation raises the comfort

level of otherslevel of others Those with excess capacityThose with excess capacity

Employees, suppliers, distributors, investorsEmployees, suppliers, distributors, investors Cultivate risk seekersCultivate risk seekers

Employees, investors, customersEmployees, investors, customers

Convincing StakeholdersConvincing Stakeholders

AttributesAttributes Enthusiasm, belief in product, reliability, perseveranceEnthusiasm, belief in product, reliability, perseverance Phelan and Alder studyPhelan and Alder study

Ham and EggingHam and Egging Everyone else is on board or almost on boardEveryone else is on board or almost on board Ask for small increments of commitment and leverage Ask for small increments of commitment and leverage

that to the next stakeholderthat to the next stakeholder

Basic sales skillsBasic sales skills Develop a decision schedule, know what you need, Develop a decision schedule, know what you need,

anticipate objections, handle advisors, follow upanticipate objections, handle advisors, follow up

BankruptcyBankruptcy

The result of running out of cash to meet The result of running out of cash to meet legal obligations!legal obligations! Chapter 7 – basic liquidationChapter 7 – basic liquidation Chapter 11 – reorganizationChapter 11 – reorganization Chapter 13 – personal debt adjustmentChapter 13 – personal debt adjustment Personal and business causesPersonal and business causes

Voluntary or involuntaryVoluntary or involuntary No need to be insolvent – projected insolvencyNo need to be insolvent – projected insolvency

Chapter 11 good for dealing with potential tort liabilityChapter 11 good for dealing with potential tort liability

Filing for BankruptcyFiling for Bankruptcy

Voluntary - Pay the filing fee at the local Voluntary - Pay the filing fee at the local US district courtUS district court

InvoluntaryInvoluntary Three or more creditors whose claims exceed Three or more creditors whose claims exceed

$x OR one or more creditors if <12 creditors$x OR one or more creditors if <12 creditors No need to demonstrate inability to pay just No need to demonstrate inability to pay just

inability to pay on timeinability to pay on time Sanctions for frivolous applicationsSanctions for frivolous applications Involuntary petitions are rareInvoluntary petitions are rare

Chapter 7Chapter 7 Debtor’s dutiesDebtor’s duties

File a list of creditors, assets and liabilitiesFile a list of creditors, assets and liabilities Surrender non-exempt property and recordsSurrender non-exempt property and records Appear at hearings, attend meetings, cooperateAppear at hearings, attend meetings, cooperate

Duties of trustee:Duties of trustee: Trustee initially interim then elected Trustee initially interim then elected Must expeditiously reduce non-exempt assets to cashMust expeditiously reduce non-exempt assets to cash Examine the validity of all claimsExamine the validity of all claims Provide reportsProvide reports

Exemptions:Exemptions: Interest in a residence (homestead exemption) Interest in a residence (homestead exemption) A motor vehicle, some furnishings, jewelry, tools, life A motor vehicle, some furnishings, jewelry, tools, life

insurance, health aids, pensions and benefits, insurance, health aids, pensions and benefits, criminal compensationcriminal compensation

PriorityPriority

Secured creditorsSecured creditors Priority claimantsPriority claimants

Wages, trustee expenses, Wages, trustee expenses, General unsecured creditorsGeneral unsecured creditors

Discharge from all debts then occursDischarge from all debts then occurs Excludes child support, alimony, certain taxes, Excludes child support, alimony, certain taxes,

student loans, criminal damagesstudent loans, criminal damages Only once every 8 years (under new law)Only once every 8 years (under new law)

A creditor cannot enforce a discharged debt A creditor cannot enforce a discharged debt (except secured debts)(except secured debts)

Chapter 11Chapter 11 Retain assets but pay some portion of future income to Retain assets but pay some portion of future income to

creditorscreditors More value as a going concern than liquidatedMore value as a going concern than liquidated Voluntary or involuntaryVoluntary or involuntary

Court appoints committee of unsecured creditors Court appoints committee of unsecured creditors (usually seven largest) to act as board(usually seven largest) to act as board Fiduciary duty to other creditorsFiduciary duty to other creditors Owner normally continues to run business but trustee may be Owner normally continues to run business but trustee may be

appointedappointed

The planThe plan Owner has 120 days to file a plan, 60 further days to negotiateOwner has 120 days to file a plan, 60 further days to negotiate Any creditor may file a plan after this “exclusivity” periodAny creditor may file a plan after this “exclusivity” period Plan must show how classes of creditors will be treatedPlan must show how classes of creditors will be treated Court must approve plan but must be “fair and equitable”Court must approve plan but must be “fair and equitable” Dissenting creditors must also be protectedDissenting creditors must also be protected

Chapter 13Chapter 13

Chapter 11 for individualsChapter 11 for individuals Not means tested (like Chapter 7 under new Not means tested (like Chapter 7 under new

rules)rules) Can wipe out some taxes and tort claimsCan wipe out some taxes and tort claims Five year repayment planFive year repayment plan Discharge after plan followedDischarge after plan followed Plan must be approved by courtPlan must be approved by court Every 2 years (4 years after Chapter 7 or 11)Every 2 years (4 years after Chapter 7 or 11) Can’t have wages garnished or law suits for plan Can’t have wages garnished or law suits for plan

periodperiod

NegotiationsNegotiations

Different classes will have different interestsDifferent classes will have different interests Different classes of creditors may exchange quicker Different classes of creditors may exchange quicker

resolution for less moneyresolution for less money Debtor toolsDebtor tools

Opportunity cost of ceasing operation on productive Opportunity cost of ceasing operation on productive assets (e.g. finding a new tenant)assets (e.g. finding a new tenant)

Cost of litigationCost of litigation Continued operation more lucrative than liquidationContinued operation more lucrative than liquidation

Creditor toolsCreditor tools Risk of criminal action, personal guarantees, right to Risk of criminal action, personal guarantees, right to

file a plan after exclusivity period, alternatives to file a plan after exclusivity period, alternatives to debtor’s scenariosdebtor’s scenarios

Ways to avoid involuntary Ways to avoid involuntary bankruptcybankruptcy

Have more than 12 creditorsHave more than 12 creditors Have no 3 creditors’ claims exceed $xHave no 3 creditors’ claims exceed $x Maximize exempt assetsMaximize exempt assets

Avoid fraudulent conveyanceAvoid fraudulent conveyance Trustees can recover preferential payments to Trustees can recover preferential payments to

certain creditors (normally those within 90 certain creditors (normally those within 90 days of filing, or one year to insiders)days of filing, or one year to insiders) ““Ordinary course of business” payments are Ordinary course of business” payments are

exemptexempt

Recent changes to bankruptcy law Recent changes to bankruptcy law (Oct, 2005)(Oct, 2005)

A means test for chapter 7 eligibility based on the A means test for chapter 7 eligibility based on the debtor’s income versus the state median income debtor’s income versus the state median income

Mandatory credit counseling Mandatory credit counseling Mandatory debtor educationMandatory debtor education Cash advances and luxury purchases are non-Cash advances and luxury purchases are non-

dischargeabledischargeable New homestead exemption rulesNew homestead exemption rules

no moving to a homestead state, $125K equity capno moving to a homestead state, $125K equity cap A new rule requiring consumers filing chapter 7 to wait A new rule requiring consumers filing chapter 7 to wait

eight years instead of six to file again eight years instead of six to file again Dismissal of petitions for failure to provide a certificate of Dismissal of petitions for failure to provide a certificate of

credit counseling credit counseling Increased reporting requirements for payments from Increased reporting requirements for payments from

employers for 60 days before the bankruptcy filing and a employers for 60 days before the bankruptcy filing and a statement of monthly net income statement of monthly net income

NanoGeneNanoGene

How should the company determine How should the company determine compensation and equity?compensation and equity?

Should they hire Paige MillerShould they hire Paige Miller for what equity/compensation?for what equity/compensation?

What should the new company culture be?What should the new company culture be?

DragonflyDragonfly

Should the Thompsons file for Should the Thompsons file for bankruptcy?bankruptcy?