Funding Innovation: Non-Traditional Risk Capital April 17, 2014 Mark Lauinger Director – Tulsa Advisory Services [email protected]

Funding Innovation: Non-Traditional Risk Capital

April 17, 2014

Mark LauingerDirector – Tulsa Advisory Services

[email protected]

Overview:• Investment Landscape • Sources & Trends – Angels & VC Funds• Investment Pricing & Structuring• Summary i2E Capital Funds

Funding Innovation: Risk Capital Markets

Idea or Business?

“We’re selling $100,000 shares in an idea we plan to have after raising enough capital to think about it.”

Funding Innovation: Commercialization Stage

• Concept Bench scale/prototype• Pre-Seed Prototype/Beta customers• Seed Sales/Business Infrastructure• Early Expanding Sales Channels• Growth Profitability/High growth• Mature Quarter over Quarter

Profitability

Innovation Capital: The “Valley of Death”

A N G E L S

S E E D F U N D S

V E N T U R E C A P I T A L

G R A N T S

A C C E L -E R A T O R S

S U P E R A N G E L S

Yrs-Exit Typical Stage IRR Target ROI 6 Concept/Pre-Seed 66% 21.0 5 Seed 60% 10.5 4 Early 53% 5.5 3 Growth 47% 3.2

Source: “Business Angels”, Robert Keeley

Investor: Expected Rates of Return

Innovation Valuation/Total Investment Compatibility Analysis

Seed Early Expansion Later0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

6,1608,272

2,640528

1,596

4,672

5,5115,912

Angels Venture Capital

• US$ 17.60 billion• ~57,000 deals• 35% seed/startup• 47% early stage• 15% expansion capital• Approx. 259,500 individuals

Angel Investors 2009• US$ 17.69 billion• ~2,800 deals• 9% seed/startup• 26% early stage• 65% later/expansion capital• Total 794 firms (not all active)

Venture Capital 2009

Investment Stage

US$

Mil

lio

ns

Early Stage Funding Profile

• Mission: Support the growth, financial stability, and investment success of its member angel groups and their investors

• 325+ angel groups• 10,000+ investors• 20 affiliates• 49 states/provinces

Angel Capital Association

SeedStep Angels History – Started in 2009 with 3 members

Process – Alternating monthly “Screening & Presentation” meetings

Best Practices – Seminars/Workshops

Investments – 29 investments totaling over $4.5M

Growth – Metro & Rural areas with 46 members

Contact – Michael Kindrat-Pratt 405-813-2418, [email protected]

11

Over 100 (4)

51 to 100 (5)

25 to 50 (11)

Under 25 (30)

MT

WY

ID

WA89

OR

NVUT

CA958

AZ

ND

SD

NE

CO56

NM

TX94

OK

KS

AK

LA

MO

IA

MN

WI

IL IN

KY

TN

MS AL GA

FL

SC

NC

VAWV

OH

MI

NY195

PA152

MD- 57

DE

NJ- 62CT

RI

MA- 250

ME

VT

NH

ALASKA

HAWAII

2009 Deals

VC Geographic Coverage

Venture Capital:A Follow-on Business

Initial Investment

Linear (Initial Investment)

Follow-On Rounds

Linear (Follow-On Rounds)

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

20120%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Initial Investment Linear (Initial Investment) Follow-On Rounds Linear (Follow-On Rounds)

• Strong capital efficiency a MUST• Staged funding/capital path a MUST

There are two “predominant” financing strategies: issuing Preferred Equity or Convertible Debt with equity features

The two strategies have distinct advantages and disadvantages

Types of Innovation Financings

Advantages:• Longer-term capital matches lengthy

commercialization timeline• Keeps the Balance Sheet “right-sized”• Aligns ALL parties

Disadvantages: • Requires investment pricing• Typically requires more terms & conditions

Preferred Equity

• The Numbers:─ Pre-Money Valuation─ Aggregate Capital Raise─ Cumulative Dividend Rate─ Stock Option Pool─ Liquidation Preference

• Qualitative Factors:— Investment Comps — Management/Market/Capital — Investment Comps— Terms & Conditions

Preferred Equity Valuation Factors

“And this is where therevenue comes out.”

Pre-Money Valuation Computation

Year 1 Year 2 Year 3 Year 4 Year 5Revenues $270,000 $2,900,000 $9,300,000 $14,400,000 $19,200,000 COGS $70,000 $650,000 $1,800,000 $2,587,500 $3,300,000 Gross Profit $200,000 $2,250,000 $7,500,000 $11,812,500 $15,900,000 Gross Profit % 74% 78% 81% 82% 83%Development $266,000 $130,000 $98,000 $120,000 $122,000 Sales & Marketing $32,000 $281,000 $866,000 $1,300,000 $1,960,000 General & Administrative $233,820 $1,016,394 $2,165,728 $2,929,353 $3,876,564 EBITDA ($331,820) $822,606 $4,370,272 $7,463,147 $9,941,436 AOperating Profit % -123% 28% 47% 52% 52%

Investor Adjustment to EBITDA 50% BAdjusted EBITDA $4,970,718 C = A X B

Exit EBITDA Multiple 7 DExpected Exit Value $34,795,027 E = C X D

Investment $400,000 FRequired Return Multiple 21 G

Expected Value at Exit $8,400,000 H = F X G

Ownership % 24% I = H / E Business PlanValuation

Post Money Valuation $1,656,906 J = F / I $1,600,000 Pre Money Valuation $1,256,906 K = J - F $1,200,000

Valuation:Pre-Money $1,500Capital $500Post Money $2,000

% Ownership 25%Dividend Rate 8%

Stock Option:Pre-Funding Post Funding

Existing Stock Option Funding Funding Stock OptionFounder 1 40.0% 34.0% 25.5% 30.0% 25.5%Founder 2 40.0% 34.0% 25.5% 30.0% 25.5%Angel 1 20.0% 17.0% 12.8% 15.0% 12.8%Stock Option Pool 0.0% 15.0% 11.3% 0.0% 15.0%Angels-Current 0.0% 0.0% 25.0% 25.0% 21.3% Total 100.0% 100.0% 100.0% 100.0% 100.0%

Altered Pre-Money Valuation $1,853Percentage Impact 23.5%

Capital Raise / Stock Option Pool

Liquidation Preference:Exit Value $500 $2,000 $5,000 $10,000Liquidation Preference Investment $500 $500 $500 $500 Accrued Dividends/Interest (5 yrs.) $200 $200 $200 $200Liquidation Preference Payment $500 $700 $700 $700Distributable Equity $0 $1,300 $4,300 $9,300Investor Equity % 25% 25% 25% 25%Investor Equity Value $0 $325 $1,075 $2,325Total Investor Cash Return $500 $1,025 $1,775 $3,025 % Exit Value-Liquidation Preference 100.0% 51.3% 35.5% 30.3% % Equity-Cap Table 25.0% 25.0% 25.0% 25.0%Increased Effective Ownership Variance 75.0% 26.3% 10.5% 5.3%

Liquidation Preference Illustration

• The Numbers:— Interest Rate— Note Maturity— Conversion Discount— “Qualified” Next Equity Round— Cancellation Repayment Multiples

Convertible Note Valuation

Advantages:• Delays investment (equity) pricing until more

information is available • Simpler investor “terms & conditions”• Simplifies tax treatment

Disadvantages: • Usually shorter-term capital• Typically contributes to “upside down” Balance

Sheet• Can deter follow-on investment

Convertible Debt Financing

i2E Focus

• High growth potential with competitive barriers • Clear product/market fit • Market size & customer accessibility• Capital efficiency & milestone driven model• Companies based in Oklahoma

Time

Profi

t

OK Angel Sidecar FundGrowOK

Seed FundStartOK

SeedStart-UpEarly

Breakeven

Growth

i2E Managed Funds

• Five separate funds totaling over $45 million• Funds designed to create a capital continuum• All Funds require co-investment

Immersion

Program

Immersion Program

• 15-20 week Program in Tulsa/OKC office

• 4-5 post idea stage companies targeting Software/IT

• Specialized services, training & networking

• Access up to $25K early capital investment

• Emphasis on identifying “product/market fit”

Oklahoma Seed Capital Fund

• $25M Fund targeting 4 - 8 investments/year

• Investment Company Characteristics:⁻ Breadth of Company commercialization stage: Concept

thru Early ($0M - $.5M revenues)⁻ Advance technology component with strong

competitive barriers to entry⁻ Product development, market validation, full market

launch⁻ Targeted minimum twelve month funding runway ⁻ Total Capital rounds of $0.2M - $1.5M with minimum

1/3rd co-investment match

StartOK Accelerator Fund: This fund invests in companies that are in the earliest stages or startup stage that have not yet generated any revenue or completed a market launch. This capital will enable them to take their concept or product prototype into beta test phase with potential customers or first sales.

AccelerateOK Fund Profiles

GrowOK Fund: This fund seeks established companies with existing products or services. that are generating revenue in the market place. The fund will enable these companies to expand new products or services and allow even more growth in both revenue and employees.

OK Angel Sidecar Fund: This fund overlays all four of the i2E companion funds, providing leverage and capital to angel investment in Oklahoma companies at any stage of the continuum of business development. This fund essentially doubles the size and scope of angel investment in Oklahoma because it requires a one-to-one co-investment from angel investors and/or angel groups.

Fund Size ~ $3.1M Investment Range ~ $100k - $250k

Fund Size ~ $5.0M Investment Range ~ $750k - $1.0M

Fund Size ~ $5.0M Investment Range ~ $100k - $500k

GrowOK Fund

• $5M Fund targeting 5-7 company investments

• Investment Company Characteristics:⁻ Existing business infrastructure ($5M - $20M revenues)⁻ Diverse existing customers⁻ Strong business growth opportunity⁻ Market expansion OR innovative new product roll-out⁻ Slightly negative to preferred positive EBITDA⁻ Total Capital rounds of $1.5M - $3M⁻ Execution enables future additional bank debt

GrowOK Fund• Investment Structures:

⁻ Convertible Subordinated Note (Interest & repayment multiple)⁻ Convertible Preferred Stock (Dividend & conversion into equity)⁻ Redeemable Preferred Stock (Dividend & repayment multiple)

• Investment Parameters:⁻ $750k to $1M targeted investment size ⁻ 1:1 capital match (Equity and/or Debt) at the deal level⁻ Strong management team & business infrastructure⁻ Large addressable aggregate market⁻ Company does NOT need to be technology based⁻ Ability to pay ongoing interest/dividend

Benefits:• Complements ability to secure incremental

bank financing• Non-Equity participation• Less Governance impact

Redeemable Preferred Equity

• Public/Private Blended Capital Sources • Advanced Technology / High Growth Co’s• Leveraging Local Oklahoma Angel Investment • Continuum Approach Towards Funding• Share and Educate All on Availability and

Nature of Capital Sources • Spur Wealth Creation in Oklahoma

i2E Startup/Early Stage Funding

Thank YouMark LauingerDirector – Tulsa Advisory [email protected]