X

The New and Improved (and Permanent) R&D Tax Credit

Research and Development is a critical component of most early-stage technology companies. It can also be a significant cost center in the beginning days of your startup. To help facilitate continued innovation and development, the Economic Recovery Tax Act of 1981 created what is essentially known as the R&D Tax Credit. The credit allows a dollar-for-dollar reduction of taxes for any qualified R&D expenditures. Examples of qualified expenses are costs associated with testing, design, compatibility, functionality and production.

One catch with the R&D Tax Credit was that it was continually renewed, but with an expiration date. Between 1981 and 2015, the R&D Tax Credit was renewed by Congress almost twenty times. As of 2015, it has now been made permanent, with a few updates to the law as a result:

  • It enhances the credit for eligible small businesses ($50 million or less in revenue).
  • Beginning in 2016, qualifying small businesses can now take the credit against alternative minimum tax.
  • It allows very small businesses (under $5 million revenue) to claim a credit up to $250,000 against some payroll taxes.

That last point is great news for startups – particularly those that are not currently profitable (and therefore do not have to pay corporate taxes). If your company is paying payroll taxes for your employees, you can now offset some of those payroll taxes with the new enhanced R&D Credit.

The other two points could also mean big things for your business. It’s important to speak with your tax professional, or contact our tax team at EGFS, to discuss how the R&D Tax Credit might apply to your company.

Anjum Tunuli is the Chief Tax Officer for Early Growth Financial Services.

Disclaimer: This article has been written for informational purposes only, and is not intended to provide, and should not be relied on for, tax or accounting advice. You should consult your Early Growth Financial Services tax representative, or your own tax and accounting advisors before beginning your tax work.

The Venn Diagram That Will Change How You Fundraise

This article is co-authored with Ryan Janssen – VC investor and entrepreneur.

Growth is expensive. And cash is king. Yet financing strategy is the most overlooked component of the business plan.

Financing strategy is something to think about from the very outset of your business, but this technique is applicable for anyone with a business model that has prospects for a hockey-stick growth curve and/or that needs multiple rounds of capital to get to an exit.

But how will that number magically fuel your growth? Have you critically evaluated what is achievable, against what you need? Hoping you’ll “figure out how to pay for your growth later” is like buying a lottery ticket for your business.

Here’s how to build a strong financing plan that will keep the lights on and impress potential investors:

Step 1: Find the overlap between your cash needs and your ability to fundraise

First, you need to start thinking of your fundraising strategy as an input to your business plan, rather than an output.

A fundraise is the equilibrium point between:

  • the cash you need
  • the check size that investors would write for your business

You’re seeking product-market fit, except in this case the product is your business, and the market is the venture capital market. The task here is to work out what it will it take, at each proposed round of funding, for your company (the “product”) to be sufficiently appealing to investors to write the check size that you need (the “market”).

That’s where you get Company/Investment fit.

Company-Investment Fit_Graph1

Let’s look at each side of this Venn diagram more carefully:

A. Your Cash Needs:

The required check size starts with summing up your cash flows until the next round, but it requires more strategic thought than that.

The real art here is understanding when that next round will happen.

You need to time your next round with a natural “gear change” for the company, where you have achieved enough proof points to justify a round to get you the next set of milestones (for example, expansion to a new market).

You also must build sensitivity around every part of this calculation: assume your fundraise will take six months longer, your CAC (cost of customer acquisition) will be 25% more expensive and your payback period is twice as long as you hope.

This is where you need to get real around cash burn, and potential cash burn, as it applies to the strategy you’ve laid out and the consequential operating requirements. It’s where you can clearly see that a significant competitive advantage can accrue from being able to do things with higher efficiency and/or leverage than competitors.

B. Your Investability:

The “Investability” side of this equation will depend heavily on your business, but there are rules of thumb (for example – raise 12-18 months worth of cash needs, and keep dilution to 20% in each round). It ultimately comes down to showing strong growth, long-term profit potential and a sustainable competitive advantage. While team is a major factor at the outset when track record is scant, milestones take over greater power as you climb the stages of development. Benchmarks are available for certain business types – Christof Janz has a put together a great one for SaaS businesses.

From there, this becomes more art than science. Look at recent fundraises from similar businesses. Understand where you sit on the Hype Cycle and position accordingly. Most importantly, shamelessly solicit feedback from industry insiders and even failed pitches.

Where your needs and investors’ needs meet, a check size happens. And that sweet spot is not a number to set in your spreadsheet – this is the limiting reagent of your business strategy and operations. The key question is: “what can we achieve with [X] amount of capital in [Y] amount of time?”

Step 2: Do it again

Now, it’s time to extend this thinking beyond your next round, all the way through exit-readiness. Plan out all of the future fundraises you’ll need if your business goes according to plan:

Company-Investment Fit_Graph2

Your business evolves over time – in this case, each fundraise is really a new version of your “product,” which will open up new potential investors.

This step is about aligning your ongoing cash needs with a few discrete fundraising events. Unfortunately, it has all of the complexity from the last step, but now everything is a moving target. Try to project ahead in both your operative markets and the financing markets. Figuring out whether the VC market is moving towards an investor-favored market or an entrepreneur-favored market will have a huge impact on your decision-making here.

For example, data shows that the next year or two may be an especially tough time to raise a Series A, so calibrate your plan to have a backup if your Series A takes longer than usual.

Step 3: Iterate

Now, go back and think critically about each of these fundraising events. If any round requires a check size that’s much bigger than your progress milestones can justify, you are lacking “fit” and you need to rethink that part of your plan.

Company-Investment Fit_Graph3

If you’re already running out of cash in your rosy business plan, you’ll never stay liquid when you’re spending real dollars. But this is why we plan ahead!

At this stage, you can adjust almost everything about your business to close this gap:

  • Move financings either earlier or later
  • Adjust your operations plan to reduce expected burn rate
  • Find a way to improve fundraising KPIs, such as user growth rates or addressable market
  • Adjust timing for key (or expensive) strategic expansions
  • Consider supplemental funding sources such as venture debt
  • Reconsider your company’s positioning with investors – this is indeed a factor in every pitch (more on this in a later post)

The key here is to think about your Company/Investment “fit” starting from Step 1 that will drive investor appetites.

If you already have investors, this is a great time to surface your concerns about the future pathway and possible stress points.

In addition to helpful feedback on your plan, you’ll gain insight into your investors’ long-term plans for your partnership.

And if you’re lucky, you may even get advance commitments for those future Venn diagrams.

Step 4: Throw the plan out

All done? Perfect. Now forget about it.

No battle plan survives first contact on the battlefield, and no business plan survives first contact with the target market. The financing plan you’ve just built depends on every other assumption you’ve made, and by the time you’re actually doing your Series B, it will be a different universe.

Company-Investment Fit_Graph4

But that’s ok – being a great entrepreneur is not just about planning, but about being able to persevere and adapt when things don’t go according to plan – which is where most fundraises happen anyway.

Why, then, did you spend the effort to build a financing plan at all?

First, because this depth of thought will wow VCs and other investors. It will show in your pitches and supercharge your fundraising.

Secondly, this exercise is the ultimate gut-check for “is this a venture-scale business?” If you’re not, this process will help you understand why most business should not seek venture capital.

Finally, the cash flows to shareholders are the alpha and omega of your startup, and this process helps you see the convergence of the streams. Looking at your startup within the constraints of capital promotes a “cost of growth” mindset. In this context, you’re well-equipped to evaluate your unit economics, cost of growth, marketing ROI and other fundamentals of your business.

For more information contact Sanjay Gandhi at sgandhi@oxfordvp.com. Avoid other fundraising pitfalls by visiting the knowledge section of the Oxford Valuation Partners website.

Startup Culture Podcast: Robbie Allen + Adam Smith of Automated Insights

Robbie Allen is the founder and CEO of Automated Insights (Ai), a company based in Durham, NC that is at the forefront of Natural Language Generation technology.  Ai takes huge sets of data and has algorithms that write prose in real time at amazing scale.  In this discussion, Square 1’s Zack Mansfield talks with Robbie and Ai’s Chief Revenue Officer, Adam Smith, about how the company started, how they iterated the product and culture over time and how they have been able to be successful both as a business and in keeping employees happy.

What to Do When an Investor Says No

We talk a lot about preparing your startup for fundraising. Preparing a pitch deck. Getting your financials in order. Tapping your network for investor introductions. Putting together a valuation of your business. There are many different angles you have to be aware of when getting ready for your big investor pitch.

But what happens if the investor says no?

There are several valid reasons that an investor will pass on your idea. It could be your product/service doesn’t align with their investment thesis. Or maybe the investor feels that your offering is jumping into a saturated market. And of course there’s always the chance that they just don’t believe in your idea. It happens. But that’s not the end of the road. You should be prepared for this scenario. Here are a few things to keep in mind:

Don’t Make It Personal

You have spent months or years pouring all of your effort into this idea. To have someone come along and say it’s not worth funding can be quite a shock. That shock is ok, but remember to keep your cool. Take a deep breath, and thank the investor for the consideration. Avoid being combative, or questioning the investor’s intent or pedigree. It’s not worth burning a very important bridge in the name of blowing off steam.

Ask Questions

Once you’ve caught your breath, don’t be afraid to ask questions if the investor’s reasoning wasn’t entirely clear. Do you need to rethink your go-to-market strategy? Are the financial projections not impressive enough? Suspiciously impressive? Getting clarity on why the investor passed on your idea can really help inform what direction you and your company should head from here.

Seek Referrals

Just because your offering isn’t a good fit for one investor, doesn’t mean that it’s unappealing to all investors. Even though the investor you’re pitching has passed, they may know of another investor – or investors – that would be interested in hearing your pitch. If that’s the case, respectfully ask for a “warm introduction” to make it easier to get another pitch meeting.

Keep At It

Don’t get discouraged! If you get turned down, find out what needs to be improved and get back to work. Just remember to carefully consider the insight you gained from having that face-to-face investor interaction, and come up with a plan that gets your startup to the next level.

Startup Culture Podcast: Kyle Porter of SalesLoft

In the first episode of his Startup Culture podcast, Zack Mansfield (@zackmansfield) has a conversation with Kyle Porter (@kyleporter), co-founder and CEO of SalesLoft. Kyle shares the origin story of SalesLoft and how he “almost ran the company into the ground.” A shift in focus to a values-centered approach was a transformational event for the company and has been a core reason for its success. Kyle shares practical tidbits on how he manages the team on a daily basis, how he evaluated shared values when raising $10MM+ in venture capital and the tactics he employs to lead the team in transparency.

Explaining Public vs. Private Market Valuations

The number of IPOs we are seeing in the market has decreased significantly. So far this year, 31 companies have gone public in the U.S., down from 69 in the first five months of 2015 and 115 in the same period in 2014. Of public offerings in the first quarter of 2016, none of them were tech companies. It’s been a long cold winter for tech IPOs and the market did not begin to thaw until Dell’s cybersecurity unit, SecureWorks, went public in April with a price below its indicated range and a smaller offering than planned.

Why is it that we are seeing so few tech IPOs?

In a nutshell, tech companies are reluctant to go public because of the high valuation these companies are getting in the private markets is impossible to get in the public markets. We can understand the rationale behind this discrepancy better by looking at, first, the reasons why the private market valuations for tech companies are so high and, second, the reasons why the public markets are unwilling to match these valuations.

Let’s first analyze what causes the extremely high private market valuations for tech companies.

  1. Investors are willing to pay forward for future growth in the private markets due to the hyper growth tech companies are showing on the top line. For example, if you have a company reaching $2mm in revenue this year, but tracking to do $15mm of revenue next year and $50mm in 2 years, investors need to incorporate this growth into the valuation. Perhaps a fair multiple on a company that’s doing $15mm in revenue is 10x, or $150mm valuation, but if the following year the company does $50mm in revenue, even applying a 5x multiple here would imply a $250mm valuation. It’s easy to see here that when a business is in the hyper growth stage, the forward year in which an investor chooses to apply a multiple will change the valuation outcome dramatically.
  2. Founders themselves also play a role in the high valuations. Founders are willing to accept and typically want high valuations because it means that they don’t have to give away as many of their shares to raise a lot of capital. Quite simply, if each share is worth more money, founders can give away less. In this way, they are able to dilute their own ownership less to get more cash.
  3. A simple supply and demand analysis will shed light on the high valuations. For real private tech darlings, everyone wants to get into the fund raise. There is a lot of money in private markets, all competing for promising private companies. Demand for investment opportunities in promising tech companies is great, but the supply can’t possibly meet the demand, which eventually increases the valuation price. This is why we observe today that people are willing to pay above a rational valuation to become an investor in hopes that the hyper growth will continue and it will still become a good investment down the road.

Having understood step one, we can now look at the reasons why public market investors are unwilling to match these valuations.

  1. Unlike private market investors, public market investors have no downside protection. While private market investors have the privilege of being issued preferred equity, public market investors enjoy no such privilege and there’s no clause for getting their money back if everything goes south. Therefore, they are less willing to pay for a high valuation.
  2. Public market investors typically apply competitors’ median valuation multiple to largely decide an appropriate value to new IPOs. Investors may give a premium for outsized growth, but the forward year they are willing to apply is typically no more than 1 year out.
  3. Valuation multiples are essentially representative of a company’s future growth expectations. As company growth slows, multiples get lower. No company can grow at 500+% growth forever. Particularly given how much later tech companies are going public these days, they are typically out of their hyper growth stage, and thus their multiples should reflect this.

Square 1 Expands Central Region Banking Team

Square 1 Bank, a division of Pacific Western Bank, today announced that it has strengthened its banking team that serves the Central U.S. with recent new hires.

Based in Chicago, Jeff Lampe joins Square 1 as managing director, and will oversee the technology banking practice in the Midwest. He brings nearly twenty years of experience in venture capital, private equity funding and startup operating experience to his new role. Prior to joining Square 1, he served senior roles with two Midwestern-based technology focused venture funds, where he oversaw equity and debt financings and worked with startups as a lead investor, board member and observer. Lampe holds an MBA from the University of Notre Dame and a BS in Management from Purdue University. He is also a Chartered Financial Analyst. “It has been a great privilege to create meaningful partnerships with an array of Midwestern entrepreneurs and investors for almost twenty years. I am excited to continue that shared goal with Square 1 in my new role,” said Lampe.

Senior vice president Steven DiPasquale joined Square 1 from Comerica Bank, where he was instrumental in establishing the bank’s technology and life sciences practices in Houston and supported the Austin market. Prior to Comerica, he served in a variety of roles across the Southeast with RBC Bank and Silicon Valley Bank. In addition to his depth of experience, DiPasquale brings an extensive network of investors and entrepreneurs across the U.S. He earned a BBA in Finance from Texas A&M University. DiPasquale added, “I look forward to expanding Square 1’s client base in Texas as we continue to support the innovations coming out of the technology and life sciences sectors.”

Recent hires in the region’s technology group include Barrett Edgington in Utah and Garon Patterson in Chicago.

  • Edgington joins Square 1 as vice president and brings more than eight years of experience in venture capital funding and operations within venture-backed technology startups. In his new role, he will open Square 1’s first office in Utah and build the company’s reach across the state supporting existing clients and new prospects. Edgington attended Brigham Young University where he received an MBA and BS in Strategy.
  • Patterson joins Square 1 as technology banker and focuses on managing client relationships throughout the Midwest. Prior to Square 1, Patterson was a commercial banking officer at First Midwest Bank where he developed new relationships with middle-market companies in Chicagoland.

“I am pleased to grow our team by welcoming Jeff, Steve, Barrett and Garon to Square 1,” said Ken Fugate, managing director and head of the Central banking team. “They all share our entrepreneurial spirit and bring extensive networks in the venture space and significant industry experience. I look forward to partnering with them in expanding Square 1’s presence throughout the Midwest, Texas and Rocky Mountain regions.”

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW). For more information, visit www.square1bank.com.

Media Contact
Square 1 Bank, a division of Pacific Western Bank
Dee McDougal
919.597.7479
dmcdougal@square1bank.com

Square 1 Bank Announces Credit Facility to Payzer

Square 1 Bank, a division of Pacific Western Bank, today announced that it has provided a $1.5 million credit facility to new client Payzer, a mobile and cloud-based financial tool. Proceeds from the facility will be used to fund the launch of new SaaS and transactional products.

Based in Charlotte, NC, Payzer helps contractors grow and manage their businesses by enabling them to close sales and collect payments in the field. With Payzer’s “all-in-one” solution, users can accept and manage payments and customer profiles as well as make instant loans—all via their mobile devices. The platform provides the flexibility and accessibility contractors need to offer a full range of payment and financing options for their customers and employees.

“Payzer has experienced a tremendous amount of growth in the past two years,” said Joe Giordano, co-founder and chief executive officer of Payzer. “This partnership with Square 1 will enable our company to innovate and expand our team while continuing to provide first-class service to our customers.”

Patrick Cahill, vice president in Square 1’s technology banking practice, added, “Payzer has a strong group of founders and investors who have experienced significant momentum in the fintech and payment industries. We are excited to partner with their team as they transform the way contractors and subcontractors conduct business and streamline the payment process in a historically paper-heavy industry.”

About Payzer

Payzer, LLC is a software and payments technology company with 31 employees based in Charlotte, NC.  Payzer is the All-in-One Financial Tool that helps contractors grow their business. Payzer’s mobile and cloud based platform allows customers to accept credit cards, debit cards, and electronic checks in the field or at the home office with real-time tracking across their organization, provide instant financing up to $55,000 using a mobile phone, tablet, or PC and control purchases by giving employees Visa Debit Purchasing Cards rather than a company credit card. Payzer offers competitive rates for credit and financing and requires no sign-up fee, no contract and no cancellation fees. To register for an account with Payzer, visit www.payzer.com or call 1 866 488 6525.

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW).  For more information, visit www.square1bank.com.

Media Contact
Square 1 Bank, a division of Pacific Western Bank
Dee McDougal
919.597.7479
dmcdougal@square1bank.com

Square 1 Bank Announces Credit Facility to NICO Corporation

Square 1 Bank, a division of Pacific Western Bank, today announced that it has provided an $8 million credit facility to new client NICO Corporation, an Indianapolis-based developer and manufacturer of neurosurgery medical devices. Facility funds will be used to support the company’s continued growth and to perform a randomized controlled trial evaluating the clinical effectiveness of early surgical intervention using NICO’s BrainPath® device following intracerebral hemorrhage, the deadliest, most costly and debilitating form of stroke.

Founded in 2007, NICO develops access, tissue removal and tissue preservation technology for minimally disruptive corridor neurosurgery. Specifically, NICO’s instruments allow entry into limited-access surgical sites such as cranial, ENT, spinal and otolaryngology areas. Its BrainPath tool is helping to redefine the notion of “inoperable” brain surgery through non-invasive subcortical access to treat primary and secondary brain tumors, vascular abnormalities and secondary bleeds. In creating new technology and devices, NICO enables healthcare institutions to meet the new healthcare benchmark of “Triple Aim,” which seeks to balance and optimize clinical and economic outcomes for the patient, medical practice and society.

“Our partnership with Square 1 comes at a time when NICO is delivering solutions that meet several gaps in the neurosurgery market,” said Jeff Hanthorn, chief operating officer for NICO. “This allows us to continue to support those market needs and clinical needs of the patient through growth and expansion, while embarking on an important clinical trial that holds much promise for leading a change in the standard of care for those suffering from an intracerebral hemorrhage.”

Jay McNeil, managing director of Square 1’s life sciences practice in the Midwest, added, “The NICO team has a proven track record in developing medical devices and minimally invasive surgical instruments. We are excited about the impact NICO’s technology will have on surgical outcomes, and we look forward to serving as their financial partner every step of the way.”

About NICO

NICO Corporation is dedicated to developing technology for the field of corridor neurosurgery and has a mission of revolutionizing minimally invasive neurosurgical care through the creation of innovative breakthrough technologies, proper education and teamwork that result in better clinical and economic outcomes. BrainPath is used to access and navigate through the delicate folds and fiber tracks of the brain by displacing brain tissue as it creates a corridor to the abnormality, all through an opening the size of a dime. Launched in 2012, more than 3,000 BrainPath procedures have been performed to date.

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle, and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW). For more information, visit www.square1bank.com.

Media Contact
Dee McDougal
Square 1 Bank, a division of Pacific Western Bank
dmcdougal@square1bank.com
919.597.7479

Level Up Recap – Roundtable with GE Ventures + Storm Ventures

Square 1’s Level Up series aims to help startup founders and entrepreneurs succeed by sharing best practices and inviting insights from guest speakers and investors that know how to navigate the venture space.

May’s Level Up event featured a roundtable discussion with Lisa Coca from GE Ventures and Ryan Floyd from Storm Ventures. This post is a recap of key takeaways from the lively discussion.

Investor Background

Lisa Coca is responsible for Corporate Venture Investments and Commercial Development at GE Ventures, a firm investing in the enterprise (software, big data/analytics, etc.), energy, healthcare and advanced manufacturing sectors. Investments are primarily based in the U.S. and have ranged from as small as $100K to $20MM-$30MM. Ninety percent of their investments are made with a strategic or economic focus, where GE has a clear path to becoming a customer or service provider.

Ryan Floyd is a founding partner of Storm Ventures, an $800MM firm focusing on early stage (Series A and B) investments in the enterprise sector. At Storm, enterprise is defined as any type of B2B sales. The firm is currently investing out of their fifth fund, totaling $180MM . While Storm has dabbled in some seed investing, the firm typically likes to come in at the Series A stage and invest $2MM and $5MM. Their geographic focus is on the Bay Area.

Advice for Startups

Capital is up for grabs. Both Coca and Floyd believe there is still plenty of capital out there looking for great investment opportunities. Things appear to have stabilized from a valuation perspective, so it doesn’t feel as difficult to raise capital as the media portrays it to be. That said, companies are much more capital-efficient these days and the bar is higher in terms of the amount of traction they are expected to have before either Storm or GE Ventures will invest. It’s not enough to just have a product—customer traction is also expected.

Do your homework. Entrepreneurs are encouraged to do their homework in identifying the right investors for their businesses. There is more transparency in the market today than ever before so founders are expected to find investors that understand their space and can add value.

Partner up. Corporate VCs can be great partners for startups—helping them with validation, beta testing, etc. However, pairing VCs with business-unit-level champions inside the organization is critical in making these partnerships work.

Be laser-focused. Entrepreneurs need to stay focused on moving their companies forward at all times and shouldn’t rely on outside partners to drive the business for them. When relying on outside help, entrepreneurs often put their companies at risk; therefore, they are encouraged to maintain a laser focus on creating value. In the end, that’s what they get rewarded for.

© 2005-2016 Square 1 Bank, a division of Pacific Western Bank. Member FDIC. All rights reserved.