TechAlert - July, 2006
Welcome to the July 2006 edition of TechAlert, the monthly newsletter of the Illinois Technology Development Alliance. Our issues feature articles of great interest to entrepreneurs, to investors interested in leading-edge, high-tech opportunities, and to established companies who are looking for innovative solutions to pressing business needs.
- ITDA Expands Staff to Increase Client Services
- NASA Illinois Commercialization Center (NICC) Moves to ITDA
- DoD/Navy Technology Development Opportunities Seminar July 6-A Recap
- June Monday Morning Meeting Retrospective
- Entrepreneur Briefcase-Negotiating Valuation & Terms: By John McBlain-KB Partners
- SunPhocus Technologies LLC uses Patented Holograms to Enhance Solar Products
- NASA Technology Development Opportunities Seminar - August 17, 2006
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President’s Corner
Welcome to the July edition of TechAlert.
It’s been a busy and productive summer here at ITDA. We’ve added three experienced new members to our team to broaden our services to our clientele. Under a new agreement with NASA, our organization was selected to operate the NASA Illinois Commercialization Center with the goal of assisting Illinois and regional companies in developing and commercializing advanced technologies, both into and out of NASA.
This month you will also read about several ITDA initiatives aimed at helping small and early stage businesses in Illinois and the surrounding regions understand the funding and resource opportunities offered by NASA and the Department of Defense.
In July, representatives from the DoD traveled here to put on an education event for ITDA clients and others interested in developing advanced technologies that meet federal needs. On August 17th, NASA is sending out a team to provide the same type of education for NASA funding and resource programs, so if you are interested, visit our web site and enroll.
ITDA understands these federal programs and has experience and contacts that we can apply to assist you with the process of applying for grants or program funding. We know what it takes to be successful, and we want to help. If we can’t help you, we’ll do our best to refer you to someone who can.
Our organization hosted nearly 100 people at our June Monday Morning Meeting where three exciting companies presented their business plans. We continue to expand our new web site (www.illinoistechnology.com) to be an easy-click source of information about events, publications, funding, and ITDA programs and expertise. More than 16,000 subscribers now receive our publications, funding alerts, and event announcements electronically. Click here to subscribe (http://www.illinoistechnology.com/stay_informed/) or pass this link along to people you know.
ITDA’s mission is to grow the high technology economy of this state. We are committed to providing targeted programs and best-practices expertise to our constituents. TechAlert is one of the ways we communicate with you. I encourage you to read this issue from end to end and email us your opinion at info@itda.biz. We want to hear what you think.
Tom Thornton
President
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ITDA Expands Staff to Increase Client Services
In a move to further increase their support of innovative technologies and start-up ventures in Illinois and surrounding regions, ITDA recently added three experienced new hires. Arun Bhatia was named Venture Development Director; Keith Brumbaugh is Director of Commercialization, and Jack Curley becomes Director of Client Services.
“We welcome these three new associates to our team,” says Tom Thornton, ITDA President. “They bring experience, enthusiasm, and technical expertise that will significantly impact ITDA’s services to our clients and the regional technical community.”
Bhatia recently completed his MBA from the University of Chicago. He also holds a master’s degree in bio-technology from Illinois Institute of Technology of Chicago and has been working part-time at ITDA for the last year. His responsibilities include screening and selecting clients; providing mentoring, consulting, technical assistance; identifying and coordinating external resources of benefit to ITDA clients, and deal sourcing and due diligence for prospective investment opportunities. He will apply a special focus toward life science companies.
“This job combines my two passions,” Bhatia says, “life science and business. I look forward to interacting with scientists and researchers in state organizations and schools of medicine who are interested in launching businesses as well as working with clients in other technical industries.”
Brumbaugh and Curley were formerly part of the NASA Illinois Commercialization Center (NICC) which recently became part of ITDA. (See “NASA Illinois Commercialization Center Moves to ITDA” in this newsletter.) Between them, the two bring more than a decade of specific experience in connecting NASA agencies and departments with both small and large companies to develop and commercialize advanced technologies.
Under the NICC contract, Curley will focus on outreach and client services for technology based companies interested in exploring opportunities within NASA. “Joining ITDA significantly extends the portfolio of services we can offer our clients,” says Curley, who holds a bachelor’s degree in electrical engineering from the University of Illinois Urbana-Champaign and an MBA from the University of Chicago.
“Now, if a particular technology isn’t a NASA fit,” he says, “we can refer the company to some of ITDA’s Navy contacts, or if it doesn’t fit there, we might recommend that the company try to gain interest from angel investors or venture groups through the Monday Morning Meetings.”
Brumbaugh earned his undergraduate degree in economics and political science from Kent State University, Kent, OH and his MBA from the Virginia Polytechnic Institute (Virginia Tech) in Blacksburg, VA. A four-year U.S. Army veteran who served two tours in the Vietnam War, Brumbaugh was with Rockwell International for more than 15 years and has extensive consulting experience with corporations, government agencies, and the military.
Brumbaugh will concentrate on evaluating technologies and business expansion needs. “ITDA’s focus is on the needs of the technology community in Illinois and the area,” he says, “and on finding the most economical way to have most impact in creating revenue and jobs for Illinois companies and helping them grow. That lines up perfectly with our charter as a NASA Commercialization Center.”
ITDA’s mission is targeted and specific, but the team is flexible. “In a small company like this,” Bhatia says, “you have a title but you wear a lot of different hats. Sometimes we are more of a consultant; sometimes we are in a business development role, and other times we are whatever the start-up company needs that day. It’s challenging and keeps us on our toes.”
In addition to regular programs such as the Monday Morning Meeting, commercialization consulting, and helping clients identify technology matches with the Department of Defense and NASA, the ITDA is working on some special initiatives.
“We’ve had success with assisting corporations in IP spinouts, so we’re looking to see how we can replicate that process and make it successful again,” Thornton says. “We want to continue to leverage our internal and external resources to efficiently and effectively evaluate IP to enough of an extent that we can match it to an existing market or government need. These talented new people will be a great asset in that effort. ”
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NASA Illinois Commercialization Center (NICC) Moves to ITDA
Under a new agreement with NASA and the Glenn Research Center in Cleveland, OH the Illinois Technology Development Alliance (ITDA) will be providing commercialization services for NASA technologies. Illinois is one of very few states chosen to receive this type and level of direct NASA resource.
The NASA Illinois Commercialization Center (NICC), formerly under the direction of Battelle of Columbus, OH is now part of ITDA. Additionally, Keith Brumbaugh, now Director of Commercialization, and Jack Curley, now Director of Client Services, join the ITDA team. The two directors have in-depth knowledge and expertise in identifying and facilitating a technology fit between NASA and regional companies.
“We visualize this as a seamless transfer,” Brumbaugh says. “We’ll be focusing on what we have done for the last five years—facilitating technology transfers in and out of NASA, and we’ll also be doing new things because we’ll have access to the full set of ITDA’s programs and services.” One of the initial major programs of this new group is hosting the NASA Technology Development Opportunities Seminar to be held on August 17th (see final article in this TechAlert regarding conference agenda and registration).
The addition of the NASA Commercialization Center extends ITDA’s core competencies. “Our mission complements the overall mission of ITDA,” Brumbaugh adds. “It’s our job to assist start-up businesses in finding business partners, venture partners, investment partners, and manufacturing partners—anyone who can help create jobs and revenue for the technology sector in Illinois.”
Transferring advanced technologies in and out of NASA
The Commercialization Center works to ”spin-in” technologies from companies that have the potential to meet NASA needs by helping those companies gain resources, connections, and support either through strategic partnerships or government funding. The Center also seeks to identify potential “spin-out” technologies from inside NASA and to facilitate the transfer or licensing of those patents and intellectual property to Illinois companies for commercial use.
The Center’s mission is one of match-making. “We meet with all comers initially,” Curley explains, “but we aren’t a procurement play. If a company has a product to sell, whether to NASA or to some other part of the government, we refer them to agencies that handle that. Our job is to look for and find advanced or developing technologies.” Like most of ITDA’s services, the Commercialization Center performs assessments and their NASA-related consulting work is at no charge.
Facilitating the regional development of new, advanced technologies
“Once we think there is potential,” Curley says, “we do a one-on-one technology assessment to determine just what the company has—whether it’s an idea or a product and where they are along the arc of development.”
This assessment and commercialization process evaluates a business according to nine levels of technology readiness from concept (1) to commercial deployment (9). After assessing a company’s needs, Curley and Brumbaugh assist in identifying potential resources for funding and commercialization. Some programs that source funding are more likely to go with a small company’s technology if they are partnered with a known entity that has more credibility.
“We meet many companies with bright ideas,” Curley says, “but a lot of times the company is a couple of guys in a garage so we look at matching them to a strategic partner with name recognition. It’s a big success when we form these kinds of partnerships. Whether the larger company becomes the entrepreneur’s customer, backs them financially, or buys them out, it’s a win for the small company and for us.”
The ITDA team will also help an entrepreneur put together an application worthy of NASA funding. “Our clients are good technically,” Curley says, “but when it comes to applying for these opportunities, they sometimes don’t have the words. We want to be sure they are putting their best foot forward and that they include the information sought for by the agency or department within NASA.”
“We don’t write grant applications for them,” Brumbaugh adds, “but we supply an outline and a format. We assess, evaluate, and give them guidance and leadership in how best to apply.” Just by participating in the process, the companies learn how to present themselves verbally and on the page. “Even if they don’t win the funding,” Curley says, “they can present themselves better down the road.”
Once Curley and Brumbaugh find a match, they step into the background but continue to shepherd the project. “We put together milestones and then monitor progress to make sure that things are flowing as agreed upon or expected,” Curley says. “If there is a hitch, we try to then get back involved and unknot the situation.”
Strong client focus and connections with regional technology community
“Our focus is on the impact to our client,” Brumbaugh says, “and how we can we best help them grow and develop their technology to increase or create revenue and new technology jobs.”
In addition to NASA and the Glenn Research Center, Curley and Brumbaugh have a strong, established network of contacts within the technology community in Illinois and surrounding regions. They have a data base of thousands of existing NASA clients and relationships with many large Illinois companies, including Caterpillar, Lucent, Tellabs, Boeing, and Motorola.
The management teams of large enterprises are willing to consider outside technologies and are more open to buying a technology than in the past. “We vet opportunities for some of the Fortune 100 companies within the state,” Curley says. “They’ll tell us, if you come across anybody working in these areas, let us know. Things are happening too quickly. They know they can’t do it all in house.” The group also works with regional colleges and universities and with these institutions incubator companies.
“If we do a good job, Brumbaugh says,” we’ll have satisfied companies, meet the mission of NASA by spinning out and promoting NASA technologies for commercial use, and meet the ITDA mission of helping create new high technology businesses, making this region a technical hub that serves commercial markets and the government.”
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DoD/Navy Technology Development Opportunities Seminar Recap
When we think of advanced technologies suitable for the Department of Defense (DoD), we are more likely to think of robots and reconnaissance vehicles than of ear plugs, water purification pens, or high-energy bars, but in fact all five of these products are the result DoD program opportunities.
Cynthia E. Gonsalves, Associate Director, Transfer and Transition, Office of the Deputy Under Secretary of Defense, and Cathy Nodgaard, Associate Director of the Navy SBIR Program, Office of Naval Research, shared these and other technology success stories at the recent DoD/Navy Technology Development Opportunities Seminar sponsored by the Illinois Technology Development Alliance (ITDA), a designated DoD partnership intermediary.
The seminar, held July 6 at the University of Chicago’s Gleacher Center, introduced small technology companies to Department of Defense programs and opportunities for technology development. About 100 people attended the event, which covered Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (SBTT) programs as well as other DoD programs and funding opportunities that aren’t as highly advertised.
This event was a call to action,” says John Noel, Vice President and Program Manager at ITDA. It was special because the DoD program managers came out to personally talk about their resources and needs. The whole point was to let the technology community in Illinois and the surrounding area know that there are many opportunities within DoD for technology funding and many places that small companies can go for assistance.”
The audience of nearly 100 was specifically targeted toward companies in the technology community and businesses that want to put out product and develop new technology for the Department of Defense.
DoD priorities include technologies that reduce demands on service people in the field; increase the power or potency of weaponry; or reduce the logistics footprint of equipment. The Department targets capabilities that serve counter terrorism; urban operations; detection and response, and applications in power, energy, and manufacturing.
Private investment is difficult to get for early stage companies,” Noel says. “Public capital isn’t necessarily easier, but the availability of Public capital for early stage companies is considerable when compared to Private capital.”
For example, the Navy SBIR program (www.navysbir.com) is mission-oriented and uses small businesses to develop innovative research and development to addresses Navy needs. Per topic, the Navy receives an average of 12 proposals and grants an average two Phase I awards of $75,000 each. About 40 percent of Phase I proposals go to Phase II (up to $750,000 in funding). In 2005, about a third of STTR proposals went to Phase I, and an estimated third of those qualified for Phase II.
Another exciting example of a program than can accelerate technology commercialization is the DoD’s Technology Transition Initiative (TTI) (http://www.acq.osd.mil/iti/about.html). This program drives the transition of new technologies from DoD science and technology labs into operational capabilities for the armed forces by licensing DoD-developed technologies to companies. The initiative includes funding, cost sharing, and a series of programs that result in an acquisition/procurement path for resulting products.
More than 250 TTI partnerships have been established between companies and DoD labs. In 2005 more than 400 patent license agreements were reached. DoD TechMatch (www.dodtechmatch.com) provides a single location for information on DoD labs, test facilities, and patents. The goal of the site is to match companies with potential opportunities.
The DoD also offers its Mentor-Protégé Program to assist small businesses in successfully competing for prime contract and subcontract awards by partnering with large companies under individual, project-based agreements. (http://www.acq.osd.mil/osbp/mentor_protege/index.htm)
We want to excite the Illinois technology community about the programs and support structure available to them and to offer the benefit of the shared experience of people who have done it,” Noel says. “Regional companies are looking for capital. The federal government has needs. ITDA can help Illinois companies find a program, build a team, and go after it.”
Copies of all presentations from this event containing more information about available programs and weblinks can be downloaded from (http://www.illinoistechnology.com/events/).
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June Monday Morning Meeting Retrospective
At the June 12 Monday Morning Meeting, the audience heard from three entrepreneurial companies that are using advanced technologies to create products and services that ordinary people can use everyday.
EyeNet Enforcement Systems of Orland Park, IL provides effortless 3D identification systems; Receller, Inc. of LaGrange, IL offers a quick and easy service to list items for sale on eBay, and OrthoAccel Technologies, Inc. of Chicago has a patented technology that has the potential to speed up orthodontia.
The event was co-sponsored by the West Suburban Technology Enterprise Center (WESTEC) of Naperville, IL and the Illinois Technology Development Association (ITDA). More than 100 investors, entrepreneurs, public officials, and other parties interested in the start-up space attended.
“Joel Dryer moderated and once again did a fantastic job,” says Cary Nourie, ITDA Vice President and Program Manager. “The presenters receive a value directly from Joel because of his coaching during the session and his experience. He’s a seasoned entrepreneur; he knows how to do it, and he doesn’t hold back.”
OrthoAccel Technologies, Inc provides orthodontia technology
OrthoAccel Technologies (info@orthoaccel.com) provides a service almost anyone can appreciate. The company’s patented technology speeds up the process of moving teeth during juvenile or adult orthodontia.
The technology applies cyclic force via an add-on appliance to standard orthodontia. Teeth move into the correct position in less time, and the result is more permanent than with existing appliances and techniques.
Kirk A. Purcell, CEO, is one of five-member team who formed OrthoAccel to commercialize a patented technology developed by a researcher at University of Illinois at Chicago. “Our goal in attending the Monday Morning Meeting was to get exposure to potential investors,” he says. “We’re an early stage start-up seeking about $4M to get us to market.”
Purcell says that this amount would cover expenses through the next two to three years while the company completes initial prototype development and clinical testing to gain FDA approval.
Receller, Inc makes listing items on eBay as easy as snapping a picture
If you’ve ever listed an item for sale on eBay, you know that the whole listing process can be intimidating. It’s time-consuming and frustrating for people who have listed before, but for the first-time user it can be overwhelming.
For less than $10 per listing, Receller, Inc. will take away all that selling pain. One of the founders of Receller got the idea for the company when it took him more than four hours to list a set of snow tires.
“You can send us a photo of anything you have around the house that you want to sell,” says John Plummer, founder and business development at Receller. “We will tell you which of the 52,000 categories to choose. We write the title they way it should be and the description for the people who are buyers. We know what eBay features to use, and we’ll tell you which shipping options are best for you and what time your listing should end.”
Receller listings are based on the company’s extensive knowledge of eBay listing best practices. A quick visit to the Receller web site (www.receller.com) allows you to sign up for the service. Then all that’s required is that you email a picture of the item you want to sell. A highly trained Receller coach will call you back, take your information over the phone, and create your customized eBay listing in about 15 minutes or less.
Receller fees range from $3.95 to $19.95, which is for listing cars and trucks or other motorized vehicles. The more items you list in a month, the less each one costs.
Plummer says that eBay has been a terrific business partner in many ways. “They rallied all the category managers and key business managers in a room, and they don’t do that for just anyone who joins their development community,” he says. “They have helped make our product better, kept doors open, and put key people inside to help move it along.”
“Receller represents a huge opportunity with a clear value proposition,” Nourie says. “The entrepreneurs are coachable, experienced, and they’ve put their own money into building their company. We see a lot of companies that want to present at the Monday Morning Meeting, and it’s rare that we get one of this quality.”
EyeNet Enforcement Systems sells effortless identification solutions
EyeNet Enforcement Systems (www.eyenet.us) specializes in effortless identification systems. The company’s products utilize cameras with 3D facial recognition software to grant or deny access more accurately than with fingerprint systems. EyeNet’s automatic license plate recognition system digitally reads reflective and non-reflective license plates for access control.
“3D facial recognition is much different and better than 2D,” says Thomas Tarach, CEO and President of EyeNet Enforcement Systems, “and so accurate that it can tell identical twins apart. It’s virtually impossible to trick the system.”
Very little cooperation is needed from the user. “All they have to do is walk up and look into the camera,” Tarach says. “If they hide their features, they won’t get in, so they can’t wear a mask. The system is sensitive to body heat, so they also have to be alive.” Every entry is time-stamped, photographed, and recorded. There is the capability to generate automatic alerts via message or audible alarm to security officials, a cell phone, a PDA, or a computer.
EyeNet acquires or licenses varying levels of technology, much of it from other countries that have been dealing with terrorism decades longer than this country has. “EyeNet has a product, a market, and a customer,” Nourie says. “They are in the security business, and Homeland Security is a growing opportunity. With border control becoming a very big issue, they have a technology that can potentially address that, too.”
EyeNet has been in business more than a year and has initial orders from a Fortune 100 company for a test quantity. “We are preparing for a ramp up and doing everything we can to prepare to deliver customer service and support,” Tarach says. “The product is fully developed; initial response is great, and the market is out there. Our challenge is to keep up with the demand.”
ITDA and WESTEC facilitate networking between entrepreneurs and sources of expertise and capital.
Every third Monday Morning Meeting is held at the Northern Illinois University Naperville campus. “We consistently have a good turn-out in Naperville,” says Nourie. “Christy Snider at WESTEC does an excellent job of managing our meetings there. She’s responsible for getting such high numbers into the room.” WESTEC is one of eight centers located throughout the state and funded by the Illinois Department of Commerce & Economic Opportunity (DCEO).
Tarach credits WESTEC (www.westec-itec.org), a partnership among the State of Illinois, Northern Illinois University and the Illinois Institute of Technology, with linking EyeNet and ITDA. “We’ve been working with WESTTEC for months,” Tarach says. “They’ve been a great resource in bringing us to Illinois agencies. We’ve had several presentations with the Illinois Department of Homeland Security and the DCEO as well as our work with ITDA.”
Purcell used the networking session before the meeting to talk to people in the audience and make contacts. “People were there with a purpose,” he says. “The people we met and talked to were very interested as opposed to filling an obligation.”
ITDA coaches entrepreneurs on how to talk about their businesses.
Participants in the Monday Morning Meeting program say that the experienced staff at ITDA taught them to crisply, clearly, and succinctly explain their business plans in a few short minutes to a large, diverse audience.
“I can’t recommend ITDA highly enough,” says Tarach. “One of the great things they do is help you get your presentation together and then critique it, sometimes more than once. Like all entrepreneurs we can get off on tangents that don’t resonate with the audience. We have a great plan, but I articulate it so much better after working with WESTEC and ITDA.”
Plummer says that he wasn’t sure going into it that the trial run with ITDA was going to be useful. “We had talked about our business already so many times,” he said. “But it turned out to be a pleasant surprise; there was a lot of good feedback. That pre-meeting was really valuable. I wish we would have done this two years ago. It would have cut out some paths.”
Monday Morning Meeting process helps clarify business plans.
Purcell sees the Monday Morning Meeting as an important step in an iterative process.
“If you are too set and firm in your ways and you’re not willing to give,” he says, “you will cut off potential activity and funding. We’ve found that criticism is usually based in fact and points up a real weakness, so we’ve gone back to the drawing board a number of times to make our plan stronger.”
Tarach, an experience entrepreneur, characterizes the Monday Morning Meeting as a tremendously positive experience. “I would recommend it to anyone,” he says. “You get an impartial third party source that sees a lot of new businesses and new ideas, and they are able to give you a more objective viewpoint. Then they continue to work together with you to help shape your plan.”
“I thought it was a pretty neat experience,” Plummer says. “Not often do you have a chance to have someone you don’t know totally critique your business without worrying about hurting your feelings. They got it, they understood it, and they gave us some great advice.”
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Negotiating Valuation and Terms
John McBlain
Chief Financial Officer
KB Partners, Chicago, IL
Matching a realistic valuation for an early stage business with terms that are balanced and reasonable is often a significant challenge for business founders and entrepreneurs. When term sheets explode or go awry, it’s usually the result of the expectations that were set when the entrepreneur is in money-raising mode.
Early investors, whether angels or venture capital firms, are looking for projections that will produce revenue and profit. Ultimately the valuation and terms will depend on how much optimism is built into the entrepreneur’s business plan and how aggressive and risky it is. That is why it is so important for entrepreneurs to match investors’ expectations and timeframes to what the company can realistically achieve.
Entrepreneurs’ attorneys often think that entrepreneurs understand more than they actually do.
If you don’t thoroughly understand the impact of a particular term on your company
in ALL imaginable scenarios, keep asking questions until you do.
Set expectations accurately and realistically
To attract investment capital, an entrepreneur must size the future opportunity not just the current business. The excitement for a potential investor is in what the company can be, not in what the entrepreneur already has in hand. However—and this is the dilemma—in projecting the future, the entrepreneur must effectively and honestly match the vision and the operating plan.
As a starting point, entrepreneurs are often well-served to compare projections of what the company is going to accomplish with what the company has accomplished so far. Is the product complete? How certain is the company that the market is there? How large is the potential market? Who is the competition? How complete is the management team?
Entrepreneurs also need to consider how much additional capital will be needed in the future from follow-on investment rounds because this can affect an investor’s return and will certainly be taken into account.
Early stage investors typically seek to project a return of three to five times their investment over three to five years. An entrepreneur should forecast an exit scenario (or several) and then work backward to project the timing of the money that is required. These projections can then be used as a basis for calculating the anticipated return that investors will require. This can help the entrepreneur recognize from an investor’s standpoint what a realistic beginning valuation might be.
Once an investor buys in to the entrepreneur’s projections, the term sheet will be structured around those expectations. The higher the valuation, the riskier it is to investors, and the more they are going to try and protect their position.
If the entrepreneur in enthusiasm and optimism overstates reality
and the company doesn’t achieve the results they promised to get that valuation,
there is a very good chance that the terms will act in ways unfavorable to the entrepreneur.
Investors traunch investments
Often investors set terms that release funds once certain milestones have been met. For example, let’s assume a $5 million total investment. The entrepreneur might receive the first $2 million when the deal is signed. Another $1.5 million might be released when the vice presidents of marketing and engineering are hired, and the company might receive the final $1.5 million after the completion of a prototype or the signing of a distribution agreement.
If the entrepreneur achieves the milestones by the target dates, the investor is obligated to invest; however, if the milestones are not met, the investor has an option to invest, but it is no longer a requirement. If the investor elects to invest even though milestones haven’t been met, the entire round may be revalued at a lower price.
I’ve seen more than once where the VC sets a milestone that requires the hiring of a new key executive—often a CEO. The founders of the company agree so they can get the investment but they aren’t enthusiastic. They drag their feet and eventually come to the point where they need more capital, but they haven’t satisfied the terms by hiring that new CEO.
Money is never free, especially when you need it because you haven’t accomplished what you were supposed to accomplish. When milestones are missed, the entrepreneur is against the wall without a lot of choice. To get the money, he or she will have to do what the venture capitalists require.
Any milestone that you accept that you aren’t fully committed to or don’t see a way to achieve
is a time bomb waiting to go off.
Anti-dilution terms
Because the future of an early stage company is so uncertain, an investor could be putting money into a venture whose value will go down before it goes up. To mitigate this risk, investors typically seek anti-dilution protection to preserve their percentage of ownership and to protect against price dilution that can occur from a later round of financing that is priced below the price of their investment.
With full-ratchet anti-dilution, the fully diluted ownership percentage of the outstanding common shares is reduced to offset an upward adjustment in the ownership percentage of the investors’ shares. If the share decline is significant enough, the common shares can be wiped out.
With weighted-average anti-dilution provisions an investor’s conversion price is adjusted upward according to the size and the price of the dilutive follow-on round. This doesn’t have nearly the same adverse impact on the entrepreneur as full-ratchet.
If possible, negotiate to replace full-ratchet with weighted-average anti-dilution terms.
Liquidation preferences
An investor may negotiate to be paid some pre-set amount when the company is sold, liquidated, or dissolved. It’s fairly common for a liquidation preference to be a 1X participating, which means that an investor gets their initial investment repaid off the top before the entrepreneur or any other common shareholders receive anything.
A liquidation preference may not be a problem if things go well, but if there are a lot of investment rounds each with its own liquidation preference, this can create a very high hurdle for selling the company before there is any money for the common shareholders.
If the investment is seen as very risky, investors may want to negotiate a multiple liquidation preference where they will receive 2X or 3X of their investment from the proceeds generated by the liquidation before common shareholders receive anything.
For example, assume that an investor with a 2X preference put in $5 million in return for 50 percent ownership. Five years later the company sells for $25 million. That investor would have the choice of $10 million (2X the original $5 million investment) or $12.5 million, which is 50 percent of the sales value of the company.
An investor may also negotiate to receive common shares based on the investor’s original percentage of ownership. This is known as participating preferred. Using the example above, an investor would receive $17,500 ($10 million for the 2X plus 50 percent of the remaining $15 million or $7,300).
Sometimes, depending how strong a the entrepreneur’s negotiating position is, an investor may receive the preference up to a certain multiple of his or her investment, say 5X, and then will receive no additional money until the preference is removed.
The higher the pre-money valuation an entrepreneur demands,
the more likely an investor will seek a participation feature.
Dividends
Preferred stock has dividends. A non-cumulative dividend gets paid if and when declared by the board. A cumulative dividend gets paid whether the board approves it or not.
It is not uncommon for investors of early stage companies to seek a 10 percent cumulative dividend with a 1X preference. However, the entrepreneur should be aware that in seven years a 10 percent dividend compounds to a 1X, making the effective preference in this example 2X. If a company takes five to seven years to exit, a 10 percent cumulative dividend can significantly reduce the amount of money left to divide among the common shareholders.
Negotiate a 3 to 5 percent non-cumulative dividend.
Redemption rights
When setting valuation investors may require the right to exchange their stock for money plus accrued dividends at some future specified date, typically five to seven years out. Any VC that invests in a later round will make sure that the right of earlier round is co-terminus with their right.
When a company under-performs or when the founders of a successful company drag their feet on exiting, investors may be able use the redemption rights provisions to force a sale of the company.
Negotiate a redemption date as far in the future as possible.
Voting rights
In the life of any company, there are always actions and decisions that require a vote of the shareholders. Raising more money, changing the rights of the class, borrowing money beyond a certain amount, or selling the company—are examples of actions that require a vote of the class.
Typically approvals require from a simple to a two-thirds majority. As the percentage for approval gets higher, it becomes easier and easier for one investor to block a vote.
Blocking rights can work for and against the entrepreneur. An investor that owns 40 percent of the stock can block any action that requires a two-thirds majority vote. On the other hand, when things don’t work out, a blocking right can keep current investors and entrepreneurs from being washed out in future down rounds; Entrepreneurs should consider structuring the percentage so that it takes at least two parties to block a vote.
It’s very important for entrepreneur to know which investors have blocking rights.
Board of Directors
The entrepreneur must be comfortable with the board. Not every entrepreneur has a choice, but if a potential advisor has a style that rubs you the wrong way, if you can avoid taking money or having that person on your board you (and probably they) will be much better off.
However, an entrepreneur will never get an angel or venture round without adding an angel or venture investor board member. In an early round an investor might even insist on two seats. Typically these board members who are there to protect their investments are not compensated for sitting on the board although their expenses are reimbursed.
It is important to attract board members who are ready to carry water. Ideally they will have a thorough knowledge of the space. In the early stage the Board is vital--as advisors on strategy, hiring and recruiting, and in making key contacts. As the company becomes more mature, the management team will be expected to execute on their own, and the Board will focus more setting up an appropriate exit.
The board can hire and fire management, so the better relationship an entrepreneur has with a board the better he or she is going to do.
Seek Board members who are compatible, ready to participate, and bring complementary skills.
Conclusion
When an entrepreneur is negotiating valuation, remember that it is very easy for common shareholders to be wiped out if valuations are too aggressive, the plan is too risky, or the company doesn’t perform.
When entrepreneurs are raising pre-VC money, they will meet angels, attorneys, and experienced individuals from organizations like ITDA. Among these resources, the entrepreneur needs to identify people whose judgment they trust and who they can use as a sounding board.
It’s a challenge to walk that fine line between vision and what the company can realistically accomplish in its first two to five years, but entrepreneurs who project things that they know they can’t achieve are asking for trouble.
If you really perform well, everything works out; everyone gets rich, and no one complains. It’s when a company doesn’t perform that terms agreed to at valuation can become very onerous. If the business doesn’t meet expectations and has a flat or down round, the entrepreneur may be more severely diluted than if he or she had accepted a lower valuation in the beginning.
A lower initial valuation means lower expectations, affording entrepreneurs more room
to handle the surprises and setbacks that naturally occur in the start-up environment.
John McBlain is CFO of KB Partners, a leading Chicago-based venture capital firm focused on investments in early-stage technology companies in the Midwest. McBlain has significant experience in finance and strategic planning. He is a CPA and received his MBA with distinction from the J.L Kellogg Graduate School of Management and his BA from Grinnell College, Grinnell, IA.
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Sun Phocus Technologies Uses Patented Holograms to Enhance Solar Products
In the United States, buildings account for 36 percent of the total energy used and 65 percent of electricity consumption. So why, in this era of rapidly escalating costs of conventional energy, don’t more architects design more buildings that take advantage of renewable energy?
“We’ve solicited feedback from more than 250 architectural firms around the world,” says Mike Mehawich, Director of Marketing at Sun Phocus Technologies in Chicago (www.sunphocus.com). “Most are interested in using solar technology in their designs, but they face two big problems. Solar modules are expensive, and they often detract from the appearance of buildings. Our product addresses both of those concerns.”
HoloSun™ technology improves solar efficiency and aesthetics
Sun Phocus Technologies is bringing to market a holographic film which has the potential to make solar modules more efficient in an aesthetically pleasing way. The company’s technology is based on a proprietary 3D hologram that directs and filters sunlight onto solar or photovoltaic (PV) cells which then produce electricity. The hologram is imaged into a transparent film, and the resulting product, HoloSun™, is incorporated into building integrated photovoltaic (BIPV) modules or panels that produce solar energy.
“Incoming sunlight strikes the HoloSun™ holographic film,” explains Mehawich. “The hologram captures the light while eliminating certain wavelengths and then concentrates and redirects beneficial wavelengths onto adjacent PV cells.” A HoloSun™ enhanced module requires fewer PV cells to produce a desired level of power.
“Reducing the number of PV cells needed in a module without affecting output can significantly lower a manufacturer’s costs,” Mehawich says. “Our alpha prototype demonstrated a 25 percent power increase over standard modules, and the company believes that further enhancements to the technology may allow output increases of up to 75 percent. That means more power from fewer solar cells.”
Builders and architects may find BIPV modules easier to incorporate using familiar construction techniques and potentially easier to cost-justify because they become multifunctional materials that both displace conventional building materials and produce electricity. Initially, Sun Phocus is marketing to companies that produce BIVP solar window modules, which are basically solar cells sandwiched between layers of glass.
Sun Phocus targets $2.7 billion market
Sun Phocus estimates the North American market potential for solar windows to be between $2.5 and $3 billion. “Many architectural firms that we surveyed,” Mehawich says, “are seeing significant interest among their clients to incorporate solar windows into building facades and related elements such as awnings, canopies, and skylights. We see a huge market, and we believe that our technology will help accelerate growth.”
Sun Phocus technology is particularly attractive and adaptable to this market as a solar concentrator that is compatible with plain glass. It’s thin, transparent and all that is really visible is a slight rainbow effect; by reducing the number of PV cells required, HoloSun™ frees up more inches of clear glass.
“HoloSun™ doesn’t obscure the glass in any way,” says Mehawich. “Other than the rainbow colors you might see at certain angles, you can’t tell it’s there. It’s almost invisible. We let a window be a window.”
Mehawich says that there are other products in the marketplace that concentrate light, but they use mirrors, lens and other mechanical components. “From an aesthetics standpoint, you wouldn’t really want to put them on a window,” he says, “because then you wouldn’t be able to see through the glass.” He anticipates that modules incorporating Sun Phocus film will be priced lower than other types of solar modules because fewer PV cells will be required. These modules would also have the added benefit of helping to reduce a building’s cooling load due to selective filtering of light.
Sun Phocus participates in ITDA Monday Morning Meeting
Mehawich presented Sun Phocus Technologies business case at the April Monday Morning Meeting sponsored by ITDA and Illinois Institute of Technology. “The staff helped us solidify our strategic direction,” he says, “and they worked with us to figure out a roadmap to get it commercialized in the most efficient way possible. They gave us high level advice and helped us refine our business model.”
The Sun Phocus team was used to doing longer presentations and ITDA helped tailor the company’s message. “At the Monday Morning Meeting you only get 10 minutes to explain your technology, marketing strategy, and business model,” Mehawich says. “It’s very challenging but also very important because when you are talking with investors you need to be able to communicate clearly and quickly.”
Mehawich was actively seeking the audience’s feedback on three potential models for the business, and he says that the questions he was asked helped spotlight the areas that needed focus. “The questions were certainly tough,” he says, “but they were good, legitimate questions asking for clarification and bringing up important points for us to consider. Joel Dryer, the moderator, helped us move through it.”
Next steps
Sun Phocus is targeting to collect detailed performance data from lab scale proto-types by early fall. Mehawich says that within a year, the company plans to begin pilot manufacturing in their space at IIT’s state-of-the-art incubator facility. “We’ve added to the IP by developing innovative manufacturing techniques,” he says. “By next summer, we plan to be producing larger pieces for UL certification and further tests.”
Sun Phocus is developing marketing materials and will continue to build relationships with architects and other ‘green’ building advocates. The company is also in contact with potential strategic manufacturing partners.
“We use photo-sensitive materials,” says Mehawich, “but our manufacturing requirements are not too out of the ordinary. For example, it should be relatively easy to slot our processes into the existing manufacturing systems of a company that is doing coated glass. They key challenge will be producing the volumes that we are projecting based on forecasted demand.”
The next major step for Sun Phocus is to raise additional capital to begin manufacturing beta product for a proof-of-concept project with a strategic partner. As an exit strategy, Sun Phocus might be a likely acquisition candidate for a business that is in complimentary products such as a glass manufacturer or a developer of (BIPV) modules.
“I see this technology as something that has potential for financial gain as well as social and environmental benefits,” Mehawich says.
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NASA Technology Development Opportunities Seminar–
August 17, 2006
ITDA announces the NASA Technology Development Opportunities Seminar, a half-day event on August 17 designed to educate and inform any company or entrepreneur in the technology arena that is interested in exploring how they might work with NASA to develop or apply advanced technology.
“NASA offers a wealth of opportunities for small and large companies,” says Jack Curley, ITDA Director of Client Services. “We want to show people the kind of opportunities and resources that are available and then explain the kind of assistance that we can provide to help them through the process.”
NASA announced their Small Business Innovation Research (SBIR) and Small Business Technology Transfer (SBTT) opportunities for this year on July 7 (www.sbir.nasa.gov); the deadline to respond is September 7. This seminar is especially timely and appropriate for any company interested in pursuing these funding opportunities.
Gynelle Steele, SBIR Program Manager at NASA’s Glenn Research Center in Cleveland, OH, will talk about the NASA SBIR/STTR Program. Bill Saettel, NASA Glenn Marketing Liaison Specialist, will talk about NASA Space Act Agreements, which are funding programs that present a different opportunity set than SBIRs.
The session will also feature several local companies that have successfully navigated the NASA process to collectively secure more than $1 million in NASA funding. These leaders will talk about the technologies they have that attracted NASA and then will describe their experience in applying for NASA funding. They will also talk about working with NASA to develop technology.
Mil Ovan, Co-founder and Senior Vice President of Firefly Energy of Peoria, IL will speak about his company’s successful experience with Space Act Agreements. Wayne Staney, President of Alien Works, Urbana, IL and Dr. Sivalingam Sivanantham, President, EPIR Technologies of Bolingbrook, IL will discuss how their firms followed the SBIR process and received more than $800,000 in grants. Ouri Wolfson, Ph.D., of the University of Illinois Chicago and Pirouette Software, will talk about the steps his company took to gain more than $70,000 in STTR funds.
“These young companies prove that gaining NASA funding is doable. If they can do it, so can other early stage businesses,” says Tom Thornton, President of ITDA. “Our goal with this seminar is to inform, educate, and encourage other entrepreneurial companies to step forward and reach for these resources.”
The seminar will be held at the University of Chicago’s Gleacher Center, 350 N. Cityfront Plaza Drive, Room 408, Chicago. (Directions: http://chicagogsb.edu/visit/gleacher/) Doors open at 7:30 a.m. for registration and an hour of informal networking. The session will begin at 8:30 a.m. and end by noon. The fee is $25 in advance and $35 at the door. Seating is limited to the first 60 registrants. Enroll here.
© 2006, Illinois Technology Development Alliance.
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