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About Alan Wink

Alan Wink, Director – Capital Markets at EisnerAmper LLP, assists clients with capital budgeting, capital structuring and capital sourcing. Alan has 20 years of financial and consulting experience, having served as Director of the Interfunctional Management Consulting Program at Rutgers Graduate School of Management, a program he helped build into one of the largest business school-based management consulting practices in the country. He started his career in accounting, spending six years on the audit staff of a Big 4 accounting firm and a Fortune 500 Company. Alan left the accounting field to expand his horizons in the area of Corporate Finance. Alan spent several years as Director of Financial Analysis for AmBase Corporation (NYSE), where he led approximately $2 billion of corporate acquisition activity. He is also a past Vice President of Capricorn Management, a $100 million private equity fund specializing in restructuring and turnaround opportunities. In addition, Alan is a leader in the firm’s Technology Group, providing a variety of industry-specific services to technology and life sciences firms, including business and strategic planning, marketing and competitive analyses, financing assistance, and operational and financial benchmarking. He has worked with many early stage and emerging growth companies on developing the appropriate capital structure for their position in the business life cycle. He maintains an active contact base with angel investors, venture capital funds and private equity funds. Alan also understands the level of returns private investors are trying to realize and devises strategies that allow both entrepreneurs and their investors to achieve desired return thresholds.

Since When Doesn’t Profitability Matter?

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Startup Profitability - There’s certainly enough lack-of-profitability blame to go around. There are the GPs and LPs who fancy themselves as Las Vegas high-rollers who take the capital and “let it ride.” Why not? They are in the risk-taking business and they might have a $20 billion fund sitting there for the purpose of investing. And they’re certainly not looking to invest in Treasuries that have low risk and low return. “The road to profitability is clear as day,” they say. “How can it miss?”

CEOs (which could stand for Chief Evangelical Officer) for startups are often true believers that they have the next unicorn. Sure, they may have a great idea and a 30,000-foot vision, but do they have the organizational skills to hire, train and supervise as well has hold management accountable? Let’s just say it’s easier said than done when those key managers are your brother-in-law and college roommate. The problem may then become compounded by their temporary success. They are able to raise too much private capital too quickly, which incentivizes them to stay private that much longer.

The board of directors has some culpability, too. They often become so blinded by looking forward to that glorious IPO day when the CEO gets his or her photo-op ringing the bell at the NYSE. But, in actuality, they were enablers who should have spent more time reviewing the balance sheets, crunching the numbers, developing a long-term strategic plan, and calling the CEO on the carpet for a track record of red ink.

What Startups Can Learn From WeWork

Take the case of WeWork. Its founder and CEO, Adam Neumann, is an entrepreneur who had tried his hand at the apparel market and then the children’s market—both to little success. Enter Softbank. This Japanese based bank has a presence in 37 U.S. cities and a lot of cash to invest, namely $100 billion. Softbank went all in on Neumann’s latest start-up: workspace services. However, WeWork was rife with conflicts of interest and poor managerial oversight, over-leveraged and—worst of all— hemorrhaging cash. By 2018, WeWork had lost $2 billion. And while IPO talk was rampant, profits were nowhere on the horizon. Eventually, Softbank (who, let’s not forget, was all in) had to recapitalize WeWork and wound up losing $40 billion. The IPO is on hold, Neumann has parachuted out, and layoffs loom for approximately 4,000 employees.

Startup Leaders Shoud Be Asking the Right Questions

Who’s going to step up and be the adult in the room? It really falls on everyone involved to ask the right questions. But just what are those “right” questions? Here are a few that company leadership and investors should be asking to help establish a clear path to profitability and ROI:

  • How much cash will we actually need? No more of this blank-check mindset.
  • How do we best deploy it? The key word in that sentence being “best.”
  • How big can we get, and how big do we want to get? Not everyone can be or should be Amazon.
  • Is there a clear and realistic path to profitability in the near future? See first bullet.

Startup Leaders Need to Keep It Real

Entrepreneurs and their teams need to obsessively develop accurate financial projections about what they can do for investors, how much capital they need to raise in subsequent rounds and how it will  be deployed, and what the long-term plan for growth is. It shouldn’t become rote for CEOs to present to the board and investors yet another hockey-stick sales curve chart where projected revenues start off slowly and then quickly explode with growth.

Another threat to keeping it real is overestimating the ability of the startup to scale quickly as demand increases. Managing growth is arguably the most difficult task in launching a business. Startups should plan and budget for research and development to stay ahead in their field and avoid disruption. The talent, equipment and facilities supporting research is expensive and needs to be accurately reflected in the company’s cash needs.

Entrepreneurs who are prepared for a due diligence review will have a complete overview of current expenses versus revenue and a conservative projection of how that will change in the first five years. Proposals that do not show a maximum amount of transparency, including all of the company’s financials presenting an accurate picture of how the company burns through cash, should also be a red flag.

IPO

Those three glorious letters. It’s a day for the whole team (underwriters, investors, the CEO, staff and the board) to pop open the champagne—moderately priced; you’re still a start-up after all. But again, it all gets back to profitability. Take Uber. The day it went public, it was trading at $45 per share. As of this writing, it is at $25. Why? Lack of profitability. Many IPOs face this problem because in pursuit of the next unicorn, the team took their eyes off the profitability ball. In fact, there’s a decent chance that their IPO value is less than prior private rounds. This trend actually holds frighteningly uncertain prospects for capital markets.

There’s an old adage in venture capital funding that “if you’re going to fail, fail quickly.” And while many VC investments do fail, if you do have strong corporate governance, deploy cash smartly, and have a realistic path to profitability, you’re in a much better position to pop the champagne—moderately priced, of course.

How to Prepare for the Rigors of Due Diligence

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Startup Funding Due Diligence

Be ready to answer questions before they are asked.

So, you’re ready to talk to investors about your fast-growing startup and to begin the process of attracting seed capital to scale up the business and reach the next milestone.

Congratulations. It’s a great time for entrepreneurs. Last year was a record year for venture capital investment, and this year promises to follow suit. 2019 is on track to be the second consecutive year that venture capital investment exceeded $100B.

But, make no mistake. Just because investors are writing more checks for bigger sums does not mean they are lowering their expected returns or cutting back on transaction  due diligence. Quite the contrary. To find potential winners among the most robust startup ecosystem in recent memory, investors will be looking for those who distinguish themselves by providing the most important data before it is even requested.

Here are a few tips for entrepreneurs to ensure you have the right answers – and start out on the most confident footing when dealing with potential investors. Remember, you only have one chance to make a first impression.

The diligence process builds upon first impressions and shows investors not only that you have a viable concept, but that you and your team have the necessary skills to  grow and manage a rapidly expanding business, where you fit into your industry or sector and how you will effectively  manage your capital deployment. It’s crucial to show that the due diligence information/data room was not prepared hastily , but part of a process of ongoing self-assessment. Of equal importance, it shows that you are employing good governance and accounting practices for maximum transparency and compliance.

It’s wise to create a secure virtual “data room” through a service like Digify, that allows all required users to log in and view the curated documents in a setting, where confidentiality and security are highly valued

Due diligence information will fall into three broad categories:

Commercial

A business should detail your product or service, how it is additive or disruptive, your competitive environment and competitive advantages, projected sources of revenue and a thorough understanding of strengths, weaknesses, opportunities and threats. Data providing evidence of the potential size of the market is also very important. Investors certainly like to invest in companies that are scalable in very large potential markets.

Financial

A complete overview of current expenses versus revenue and a projection of how, in a conservative scenario, that will change within the next five years or so — about the time frame for investors to decide whether to stay in or exit.

Make sure you populate your data room with documents that stand up to scrutiny. You will want to make sure you don’t sell the company short in your projections but at the same time do not paint an unrealistically rosy picture. A “hockey stick” earnings chart, with a sharp, consistent earnings spike would set off warnings for any experienced venture capitalist. Provide a vivid picture of earnings before interest, taxes, depreciation and amortization (EBITDA).

Make sure that your financial projections are realistic and achievable. You will not build a lot of confidence with your investors if you are constantly falling short of your revenue and earnings targets. Venture capitalists always advise their portfolio companies: if you are going to fail, fail fast.

Legal

A full disclosure of all regulatory issues facing the company, licenses and warranties and an inventory of intellectual and physical property, including computers and other equipment and real estate, as well as obligations under leases and other agreements.

You should also identify the executives who are essential to the company’s operation, whether they have equity in the business and how much, contract obligations and of course a detailed payroll breakdown with projected changes.

Make sure your data room includes a letter of intent and a  term sheet, precisely detailing in bullet points the nature of the agreement with investors, with nothing left to guesswork or interpretation. Bottom line: What you hope they will give, what they stand to get back, and when.

The first question an investor will ponder is whether your company, marvelous as it may be at inception, is sustainable. You will need to convince them that you can adapt to fast-changing market forces, regulatory shifts and disruption from competitors. Does the company have a strong sales pipeline and the ability to scale up? What are the prospects for acquisition by a larger company? What are your customer acquisition costs and  what is the lifetime value of a customer in current and future dollars? What kind of churn do you expect?

If you put in the hard work to provide confident, realistic answers to these questions, your reward in the end may likely be a higher valuation of the company.

Startup Deals with Big Companies Are on the Rise. Here’s What That Means for Entrepreneurs.

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Corporate Venture Capital (CVC)It’s a great time to be an entrepreneur. With corporate profits high and cash freed up by the 2017 Tax Cuts and Job Act along with a robust economy, investors are hungry for good deals.

So with the right idea and a solid strategy to go to market, startup CEOs in a range of sectors—from technology and pharma to food—should have little trouble getting an audience not only with the early seed angel investors and venture firms, but with savvy portfolio managers from a growing percentage of America’s top companies.

Last year, corporate venture capital (CVC) funding increased about 47% over 2017, while deals increased 32% over the same period, according to a report by CB Insights. There were a record 757 deals and $14.1 billion in funding in the second quarter alone. In the U.S., activity jumped 11%, to $26.5 billion in 1,046 deals. The report cited the top five most active CVCs: Google Ventures, Salesforce Ventures, Intel Capital, Baidu Ventures and Legend Capital.

At the same time, startup valuations are on the rise, with median pre-money valuation for seed rounds jumping from $5 million to $7 million, according to one estimate.  Bobby Franklin, president and CEO of the National Venture Capital Association, said in a statement in January that “heightened activity from corporate and private equity investors” contributed to ”an exceptional 2018 for the venture industry.”

CVCs may have a range of strategic goals in mind for this activity including accessing new technology that allows them to build new revenue streams, access to proven research and talent, or even blocking a fast-growing company from disrupting their business. As one analyst put it, “It’s the ability to see the future of your industry before it happens.”

Mark Zuckerberg,  CEO of Facebook, which helps launch budding application developers through its investment arm, once declared that “if we don’t create the thing that kills Facebook, someone else will.”

But these investors know that it’s not straight profit, but a business of thirds: One third of investments are generally going to be written off, another third are likely to return only the capital and, hopefully, a third will bring about 10x or 20x on the investment.

The great news for entrepreneurs is that corporate investors are often at the table alongside traditional venture capital investors. If presentation skills, confidence, imagination and innovation, (and a fair amount of good luck) align, a startup CEO can gain far more than just a check. It can lead to new global connections and sales channels, process and technology support and, not least, the option of a significant buyout that can finance the next great idea.

Securing a relationship with a CVC is a major coup for a startup. Though the money is important, so is the prestige of getting on the radar of a Samsung, Amazon, or Citi. This vote of confidence far outweighs the value add of a traditional VC, which is not to dismiss the importance of those early believers who often pave the way.

And far from being competitive, CVCs and VCs are most often glad to be sitting at the same table. Shared investment helps minimize risk.

There is no particular secret to attracting this capital. We advise clients to look for introductions from trusted contacts, including lawyers, a VC firm that often partners with CVCs, or incubator/accelerator programs. When discussions begin, due diligence is always key, and the conversation should focus on how your product or service is disruptive and aligns with the corporation’s core mission.

But be confident that a CVC arm will take the long view. After all, whereas a VC firm will spend every five years replenishing depleted funds, a CVC does not have that concern hanging over its head. There’s no need to report back to limited partners in terms of return on their investment.

They spend their own money to buy a stake in a promising, potentially disruptive technology, process or service, which is a much more patient, far-sighted approach.

Reducing the Impact of Dilution on Early-Stage Companies

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Dilution Early Stage Companies

For founders, angel investors and employees of most early-stage companies, dilution is a necessary evil.  For a company to grow and thrive, it must be able to attract outside capital and talent – actions that most likely will require offering equity and diluting the ownership interests of prior investors and team members. The problem is even more serious for those early-stage companies that hit a rough patch in their development and must obtain much-needed investment through a highly dilutive down-round.

Because dilution can be a risk for angel investors and other financing sources, as well as potential employees, top management of early-stage companies often ask how they can minimize dilution. This is possible, albeit difficult. Founders should not be surprised if they have to give up between 10% and 30% of their equity to raise seed capital for a startup. While dilution can be constrained somewhat, as described below, it is important to keep the matter in perspective: Dilution is a normal consequence of a company’s evolution and a key ingredient for future growth and success.

Convertible Instruments Postpone Dilution

One effective means of reducing dilution is by financing growth through the issuance of convertible notes or other convertible debt. In such cases, the exchange ratio will be established and the convertible instrument will convert into equity only after the company has more of an operating history – typically when there is a Series A financing round. Relying on a convertible instrument postpones the inevitable dilution until it is possible to value the business more accurately by a third party – perhaps when the company has a working prototype of its product or service or a beta customer. It can actually be highly efficient to raise capital through a convertible instrument, since the entrepreneurs and investors do not have to wrangle over valuation until a later date.

Establish the Dilution Impact Up Front

Another tactic that can be used to somewhat control dilution is to establish an option pool of equity early on, which the company can use to incentivize current and future employees. I have seen early stage companies set aside an option pool of 10% to 15% of their equity for such purposes and draw down equity from the pool as needed over time. While this may not reduce dilution in the absolute sense, defining the extent of the potential dilution up front does take a great deal of the uncertainty out of the process for founders, angel investors and early-stage employees.

One measure that is not effective is the imposition of anti-dilution provisions in investor term sheets.  Since the anti-dilution clauses tie the hands of the company in attracting future investors or other key employees in the future, they are not recommended.

Capital Planning and Efficiency

The best protection against dilution is for a company to exercise discipline in its deployment of capital, so that it will not need to go outside for significant financing. This will require having a well-defined business plan and strategy that anticipates how far a given round of financing will take the business. For example, what level of capital will be needed to get to a working prototype or to the beta phase with a key customer? Clearly delineating these benchmarks and executing the strategy in an efficient and cost-effective manner will increase the likelihood that future fundraising will be up-rounds.

We are now seeing record levels of dry powder available for startups, with some recent estimates exceeding $121 billion at venture capital firms alone, according to Institutional Investor. At the same time, private equity firms are sitting on large pools of capital, which enables young companies to monetize their values by selling to a PE firm instead of through an IPO or other strategic acquirer. This supply (or, arguably, oversupply) of capital has increased valuations and, thus, has a somewhat dampening effect on dilution. As such, elevated valuations may not be sustained over the long term, and once more down-to-earth valuations become the norm it will be important to consider how best to minimize dilution while still supporting growth.

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