Warning: Very business geeky stuff.
Situation: “NatuRi Corp. was a start up, founded in 2005, aiming to manufacture a cholesterol-lowering drug made from the byproducts of rice bran oil production. NatuRi faced several challenges, including securing funding for the organization. NatuRi had captured the attention of at least four potential investors willing to offer an investment. Its managers were challenged to weigh their options and to determine which of the four potential investors currently interested in their venture would be most appropriate for NatuRi’s future growth. In addition, the founders had only a short period of time to decide whether or not to accept a Seed and Series A term sheet from a well known venture capital firm.” What would you recommend to the founders?
The twelve teams competing in the TD Securities Financial Case Competition had three hours to analyze a 24 page Harvard Business School case study and present their recommendation.
I had great time judging the presentations and thought I would share some feedback with the participants.
It was exasperating seeing you guys so close to solving the case but never quite doing so. You would either get the right solution but not back it up with your analysis or did a great analysis but offered improbable recommendations.
It was a hard case especially if you were not familiar with start-up funding and you did a great job identifying the key facts:
- In no way could the founders accept the Seed Note Term Sheet from Waltham Partners. Most of you noted the outrageous valuation (4.5M for 50% stake) and the “suicidal” terms. One term stood out to me; in 6 months, Waltham had the right to not exercise their option and then force NatuRi’s to pay back the $500,000 loan and accrued interest, which would have probably led NatuRi in bankruptcy and allowed Waltham to claim the IP placed as a security.
- The founders were extremely knowledgeable and very experienced. They didn’t need to rely on their investors’ connections and market expertise. The angel investor, even thought he was only bringing money to the table, was therefore a perfectly suitable match. It was also fair to assume his terms would be favorable. In addition, he was offering $1M; twice as much funds that what the founders were seeking. You were too quick dismissing him.
- There were two milestones that would significantly reduce the risk of the venture to potential VCs and would increase the evaluation: (1) being able to manufacture good quality NatuRi, and (2) successfully pass the multiple FDA approval stages. Both could be significantly mitigated within 6 to 12 months.
It would have been interesting to lay out each milestones (in a timeline) and an evaluation of the level of risk, expertise and financial resources needed to achieve each. With this analysis, it would made it clear how to pair each milestones with each investor (angel, VC firm, strategic investor) such as in the chart below:
It’s in the best interest for the founders to structure their financing in way they can mitigate the investors risks by completing milestones and therefore minimize the amount of equity they need to relinquish.
NatuRi had to refuse the deal by Waltham Partners, secure their seed round with the angel which would have provided 12 months of funding; enough time to demonstrate that they are able to manufacture a quality product and pass the first half of the FDA approval process. At the same time, they would be securing their Round A funding for 2007 and exploring an exit in few years with a Proteon acquisition.
You were so close to hitting this case out the ball park but just needed a bit more time to refine your analysis.
Continue to challenge yourself as you learn so much from these competitions and come back to the next TD Securities Financial Case Competition.
Special thanks to Telfer School of Management Finance Society and Julia Polnareva for inviting me.