An SBIC in Formation
A New Markets Initiative Investment Fund
Serving the Business Development Needs of
America’s First Nations
Program Architecture Developed by
Sovereign Advisers
First Nations Enterprise Development Fund
Structured Finance + Economic Development
Overview
Situation statement (rationale for investor focus)
General trends affecting tribal nations (wealth accumulation and concentration; endemic poverty and unemployment)
Gaming revenues
Reservation opportunities v. lack of sophisticated business investment evaluation process (reactive posture v. proactive approach to deal generation)
Lack of financing for business development on reservation lands (ex: sovereign immunity issue)
Emerging Markets Economic Development Finance System: the Exitbond® Model for financing reservation business development
• Mission to be served by fund (ex: LMI focus; advantages of availability of risk capital partners; compare with developing nations)
• General template (i.e., limited life joint venture structure)
• ACM model (Alon® Transparent Ceramic Armor)
• Sector preferences and rationale
• General plan of operation (ex: siting of ventures on reservation lands (HUBZones) or proximate to reservations (LMI employee preference policy)
• Portfolio company technical assistance
• Create monetization options for fund (limited partners)
Cashflow earnout and interim distributions of portfolio company E&P to fund investors
Exit investment and distribute cash or public securities to fund investors
Sale of fund’s stake to host nation Sale of portfolio company to strategic or financial buyer Initial public offering of portfolio company Management buyout of fund’s stake Company buyback of fund’s stake
• Fund as interface between tribes and industry (“the undiscovered country”)
LLC Governance
Managing Members
SBA Approved Management Team
Advisory Board
Investor Nominees
Optional
Non-Manager Member(s)
Sponsoring Institution(s)
Refer to
below
Organization First Nations Enterprise Development Fund organizational structure
Fund Participation Open to All North American Tribes
Sponsoring Tribe(s) Passive Financial Participation
SBIC B
Admittance of Non-Tribal Investors into Fund
Examples
Banks HoldingGaming Deposits(Linked Deposits)
GamingConcessionaires(Ex.: Harrah’s)
LP
LP
LLC
GP
A
FundCapitalization and
Follow On Participation
Management
Limited Partnership
A
Advantages
Availability of Risk-Sharing Partners Reduced Financial Commitment from Individual Tribes Separation of SBIC Management and Ownership as Required by Federal Regulations
B
Management of Fund Assets
Provided by SBA Approved
Management Team
A
Investment Strategy
• Strategy
Provide both equity and mezzanine financing in connection with the formation of technology commercialization manufacturing joint ventures, preferably involving defense applications Limited appetite for opportunities involving consolidations and roll-ups having applications within targeted sectors (constraints include limited opportunities and weak IPO demand)
• Stage
Commercialization of emerging proprietary technologies in high growth sectors (i.e., manufacturing expansion stage
• Sectors
PRIORITY
Advanced materials Imaging systems Nanotechnology Optics Space sciences and satellite systems
SECONDARY
Alternative energy Artificial intelligence and neural net systems Medical technology Microwave and communications technology Industrial Robotics
RATIONALE
Emerging technologies with expansion stage investment opportunities Exceptional market capture opportunities and market growth rates Defense contract potential, representing excellent utilization of HUBZone status of reservation lands and /or LMI employees, and other preference incentive programs Defense contracting margins, in conjunction with federal preference incentives, enable manufacturing operations to be conducted in relatively remote areas such as reservation lands which entail higher transportation costs Avoidance of sectors characterized by overnight obsolescence and ability to uncover value and investment opportunities resulting from capital flight to Internet and e-commerce (ex.: satellite systems) Ability to attract co-investment interest from other funds Presence of targeted industrial clusters within fund’s focus area and university sponsored research programs
• Characteristics
Small private R&D firms possessing proprietary technologies with significant prior years funded research, on the threshold of significant commercialization opportunities, preferably involving defense agency manufacturing contracts Prime defense contractors seeking access to federal preference incentives
Technology CommercializationManufacturing Joint Venture
Reservation Investment Strategy
Technology Research Company or Manufacturing Company or
Academic Institution
Proprietary Technology
First NationsEnterprise
Development Fund
Federal Incentive Programs
Small Disadvantaged BusinessIncentive Program
Certified Small Disadvantaged Businesses May Reveive a 10% Bid Price Evaluation
Adjustment
HUBZone ProgramEnterprises Located on Reservation Lands
or Employing 35% HUBZone Residents May Receive an Additional 10% Bid Price
Evaluation Adjustment and Access to Federal Set Aside Contracts (Estimated at
Approximately $6 Billion Annually)
Department of DefenseIncentive Preference Payments
ProgramPrime Defense Contractors May Receive
5% Incentive Payments for Subcontracting with 51% Indian-Owned Organizations
Section 8(a) ProgramCertified 8(a) Contractors May Access
Federal Set Aside Contracts
Advantages Risk Partner Labor Access
Facility Federal
Preference Contracts
Fund Contributes Capital in
Exchange for Majority Stake
with Governance by Separate
Board
Ownership Interest in Form of
Preferred Stock Equivalent (e.g., LLC Membership
Interest with Special
Allocation)
Technology Transfer to
Special Purpose Corporation (MBE) with
Reversionary Interest to Contributor
Possible 39% ITC for Future LMI Investment
in Joint Venture
Fund Creates Enterprise and
Develops Value for
Ultimate Sale to Host Nation
Creation of Special Purpose Corporation
Minority Business EnterpriseHUBZone Location / Employees
Build to Suit Manufacturing Facility Contributed by Host Nation
(Reservation Employment and Lease Income to Tribe with Possible Equity
Stake in Venture) Non-GovernmentCommercial Contracts
Federal GovernmentPreference Programs
Commercial Production
Venture LeasingTechnology Commercialization Joint Ventures
R&D Firm
Technology Commercialization
Potential
Enterprise Development Fund
Machinery and Equipment
Operating Capital
Machinery & Equipment Financing
Provided by Manufacturer with Debt Guarantee
Provided by Fund with Contingent
Interest Rate Indexed to Production Revenues
Subsidiary Manufacturing
Corporation
Machinery& Equipment
Operating Capital
Cashflow Earnout from
Operating Income of Subsidiary Corporation
M&E Leasing Facility and Operating
Capital Loan
M&E Put
A
A
49%Stake
% Income Allocation
51%Stake
Technology Transfer
ProductionContracts[OperatingRevenue]
Preference Return of Operating Capital Loan Secured by Senior Claim on Earnings and Profits of Joint Venture Subsidiary
ConsolidationInvestment Strategy
Fund Investors
Enterprise Development
Fund(LLC)
49%-
90%
% Ownership of Consolidation Platform
(LLC) by Industry Management
Team
% Ownership of Consolidation Platform
(LLC) by Fund
LLC
Consolidation Platform
10%-51% Held in Form
of Managemen
t Stock Option Plan
Management Team Compensation is Subordinated to Stipulated Minimum Performance Results
Exit via IPO or Sale to
Strategic or
Financial Buyer
Acquisition and Amalgamation of Portfolio Companies
Actual % Ownership of Consolidation Platform by Fund Depends Upon Whether Investments are Eligible for “New Markets” Qualification
• Lead v. co-invest
Fund is anticipated to originate the majority of the investments, thus acting as the lead investor Corporate joint venture partner will make contributions of value to the venture, thus acting in the capacity of an industry co-investor
RATIONALE
Unique nature of fund (investor base; federal preference programs; reservation-based manufacturing; etc.) Superior valuation
• Transaction size
Fund’s participation in a typical technology commercialization manufacturing joint venture is estimated to be in the $500,000 – $2 million range
RATIONALE
Cost of plant and equipment Ability to add value
POTENTIAL ISSUES
Lack of tribal corporation codes (use of Delaware corporation code) Unskilled labor pool (manufacturing activities conductive to training
programs) Lack of industrial buildings (arrange tribal build to suit or off-
reservation build to suit by private investor or lease proximate existing facility)
Deal Generation
• Sources
Prospective transactions are expected to be cultivated on a proactive (v. reactive) basis through implementation of a company
visitation program targeting prime defense contractors for referral of investment opportunities involving suppliers and subcontractors, as well as specialty R&D houses
EXAMPLE
Contact corporate development officers of the following firms to discuss opportunities involving the DoD Indian-Owned Subcontractor Preference Payments Program
Boeing Honeywell Lockheed Martin Lucent Technologies Motorola Northrop Grumman Raytheon TRW
• Attractive aspects to joint venture partner
Contribution in form of manufacturing contracts; technology; processes Miitigation of direct financial risk through fund’s position in deal
(financial partner) Negligible balance sheet impact Access to federal preference contracts (HUBZone set asides) Access to DOD 5% preference payments Eligibility for bid pricing adjustment (HUBZone status) Eligibility for 25% LMI investment tax credit (if cash contributed) Eligibility for Native American employment wage tax credit Eligibility for accelerated depreciation on building and equipment
• Miscellaneous sources
We also expect to generate deal flow through a variety of other means, focusing on networking referral sources in geographic regions where there is a cluster or concentration of industrial sectors in which the fund will have an interest; for example, the biotech industry located in San Diego or the optics industry concentrated in Tucson. We will work with universities, technical institutions and industry organizations to establish an identity which will assist in generating financing referrals to the fund.
Examples
Referrals from the Defense Advanced Research Projects Agency (“DARPA”) regarding contractors having commercialization opportunities Small Manufacturing Executives of Tucson Arizona Innovation Network The Enterprise Network Arizona Small Business Association Arizona Department of Commerce Economic development councils throughout the State of Arizona Small Business Development Centers (“SBDCs”) Statewide venture forums; for example, the Arizona venture capital network Various other regional, state and local manufacturing and technology councils SBIR phase III grant recipients R&D 100 Award Winners University of Arizona, and other universities and academic institutions offering technology transfer and commercialization opportunities as well as network referrals
Financial institutions (i.e., bank referrals with respect to companies requiring equity financing rather than debt, or requiring equity or subordinated debt financing as a credit enhancement for senior bank debt financing) Corporate attorneys Certified Public Accountants (both local and regional practices as well as national firms) Other business professionals, including risk management firms (i.e., commercial insurance brokers and consultants); business brokers; business valuation consultants and appraisers; etc.
Portfolio company founders and CEOs (assessment of complimentary and competitive technologies and companies)
Targeted advertising in industry trade publications Sponsoring; co-sponsoring; or participating as exhibitors or panelists at industry conferences Developing co-investment partnerships with other SBICs and midsize to large equity funds offering financial participation in transactions which they originate
Publication and distribution of newsletter to both prospective portfolio investment companies and potential referral sources, featuring market and financial data as well as activities of interest regarding the fund and the fund managers
• Collaborative Investment relationships
EXAMPLES OF RECENT COLLABORATIVE RELATIONSHIPS
We engaged in exploratory discussions involving possible co-investment activity with the following firms
Coronado Ventures (Tucson, Arizona) Diamond Ventures (Tucson, Arizona) MagnetCapital (Phoenix, Arizona) Arizona Multi-Bank (Phoenix, Arizona)
• Deals reviewed
We reviewed approximately twenty investment proposals, representing the following sectors
Aerospace manufacturing Alternative construction materials manufacturing Consumer products manufacturing E-commerce Nanotechnology manufacturing
We declined to invest in any of the submittals we received
• Collaborative investment with Advanced Ceramics Research
Instead we approached a local “R&D 100 Award” winning, “Inc. 500” company to create a manufacturing joint venture on the Pascua Yaqui Reservation (Advanced Ceramics Manufacturing)
• Formation of SBIC
To replicate the reservation business investment model represented bythe Advanced Ceramics Manufacturing joint venture, we have determinedto pursue the formation of a supra-regional SBIC in conjunction with aproactive deal generation strategy
Our objective is to utilize the SBIC as the vehicle for creating a sustainableeconomy for all participating tribal nations
Deal Review Process
• Initial review phase
Investment proposals will be entered into a database indexed by both the name of the person or company making the submittal and the industry represented
The preliminary review will include a summary write-up of the proposal and will be scored utilizing the general scoring template presented as an addenda to this presentation
• Periodic review
Proposals will be scheduled for periodic review and discussion at quarterly intervals
• Discussion with product users and “hands on” industry personnel regarding market acceptance potential of product(s)
Development of a Transaction
• Management
Evaluation (technical personnel v. business skills) Previous history (track record) Determine company management and governance process
• Business plan and product(s) analysis
Single or multiple product line Market growth rate and trendline Competitive assessment Margin analysis and sustainability Projections review and assessment Environmentally friendly
• Consultant review
• Equity pricing model
• Discuss deal with prospective co-investors
• Negotiate terms sheet
• Due diligence procedure
• Engage counsel
• Negotiate build to suit facility on or off reservation, or negotiate lease of existing facility
Structuring an Investment
• Reservation manufacturing joint venture with tribal build to suit
Fund as MBE (pass through entity owned by qualified MBE investors) HUBZone location and employing HUBZone residents Fund holds majority stake in joint venture company (e.g., LLC) Multi-tranche structure comprised of subordinated debt with interest accrual tranche and equity-flavored subordinated debt, yielding a blended Interest rate of approximately 17% with equity value accretion potential, and possibly incorporating a contingent interest rate or PIK component Incorporate M&E put
• Follow-on commitment by host nation in form of build to suit
Construction of manufacturing facility (building)
RATIONALE
Ownership to vest with host tribe Location of building on reservation Employment opportunities for tribal members Pre-leased facility with lease income for term of venture Possible equity stake in venture
• Instrument
LLC membership units (possibly incorporating special allocations) If SubChapter C corporation; cumulative participating convertible preferred (possibly incorporating PIK) Subordinated debt with interest accrual tranche Subordinated debt with warrants or shares Convertible subordinated debt Participating subordinated debt (performance-indexed contingent
interest rate)
• Pricing
Price to yield 20-30% annual IRR Cost basis (51% interest in joint venture) Differential obtained through PIK Compare with equity pricing model
RATIONALE
Commercialization risk Subordinated position Reservation financing Provide access to economical labor pool and federal incentives Arrange build-to-suit for joint venture (by tribe if located on reservation;
by private investor if located proximate to reservation)
Participating with Operating Management
• Portfolio company governance
Joint venture structure
Board structure to generally comprise two directors to be appointed by joint venture partner; two directors to be appointed by fund; and mutual appointment of three outside directors with extensive industry experience acceptable to both parties
• Management incentives
Create stock option arrangement to incentivize management Contingent compensation structure
• Technical assistance
Engage specialized consultants as necessary and provide technical assistance to management
• Formation of linkages
Utilize outside directors’ industry contacts to develop marketing and other alliances with various companies, including licensing and cooperative R&D relationships Identify cross-selling opportunities
Exiting an Investment
• Issues indigenous to Indian reservation joint ventures
HUBZone incentives are location dependent
• Preferred exit strategies
Sale of fund’s stake to host nation Cashflow earnout MBO Company buyback via put agreement Sale of stake in portfolio company to strategic or financial buyer IPO (cashout or distribution of public securities to fund investors)
• Defense technology sector price-earnings matrix
Boeing 15 Honeywell 26 Lockheed Martin 19 Lucent Technologies 53 Motorola 64 Northrop Grumman 9 Raytheon 8 TRW 10
• Distress exits
Exchange of security White knight M&E Liquidation
EXAMPLES
Tauber Aarons Rabin Brothers AssetTrade.com
• Wild card exit option
Monetization of fund’s portfolio via exchange listing as country fund