Download - New Venture Financing
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IPFW Business Plan CompetitionIPFW Business Plan CompetitionPre-competition ProgramPre-competition Program
IPFW Business Plan CompetitionIPFW Business Plan CompetitionPre-competition ProgramPre-competition Program
Financing and Capital Sourcing Financing and Capital Sourcing OptionsOptions
ByByDr. Bill TodorovicDr. Bill Todorovic
Richard T. Doermer School of Business and Management Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940Neff Hall 340L, Tel. (260) 481 6940
E-mail: E-mail: [email protected] Web: Web: http://users.ipfw.edu/todorovz/
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The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources
The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources
• Factors That Determine Financing
–Firm’s economic potential
–Maturity of the company
–Nature of its assets
–Owners’ preferences for debt or equity
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Sources Of FundsSources Of FundsSources Of FundsSources Of Funds
Personal
Friends and Family
Angels
Venture Capitalist
Banks
Government
Customers/Suppliers
Start-up
Going ConcernBeginning of Production ?
IPO
Amount
Company Size
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Sources of FinancingSources of FinancingSources of FinancingSources of Financing
0 10 20 30 40 50 60 70 80
Personal Savings
Family Members
Partners
Personal Charge Cards
Friends
Bank Loans
Private Investors
Mortgaged Property
Venture Capital
Other
Percentage of Entrepreneurs
Using Source of Financing
Sources of Financing
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Critical Financing FactorsCritical Financing FactorsCritical Financing FactorsCritical Financing Factors
•Accomplishments and performance to date.
•Investor’s perceived risk.
•Industry and technology.
•Venture upside potential and anticipated exit timing.
•Venture anticipated growth rate
•Venture age and stage of development.
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Debt or Equity?Debt or Equity?Debt or Equity?Debt or Equity?
• Entrepreneurs typically prefer debt– Allows them to appropriate as much as of the benefit as
possible + retain sole control
– Can default
• Debt is unattractive to investors in emerging technology– Usually little collateral or predictable cash flow
– Information asymmetry is lessened by ownership position – shared ownership gives some control
– High interest rate to offset risk will stifle growth or cause default
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Equityfinancing
Debtfinancing
HIGH
LOW
LOW HIGH
EquityFinancing
DebtFinancing
PotentialProfitability
Financial Risk/Control
Tradeoffs Among Potential Profitability,Tradeoffs Among Potential Profitability,Financial Risk, and VotingFinancial Risk, and Voting
Tradeoffs Among Potential Profitability,Tradeoffs Among Potential Profitability,Financial Risk, and VotingFinancial Risk, and Voting
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$28,000
income on
total assets
of $200,000
14% return
on assets
($28,000÷ $200,000)
14% return
on $200,000
($28,000÷ $200,000)
No debt
equals
$200,000
equity
With no debt and all equity:
Debt Versus EquityDebt Versus EquityDebt Versus EquityDebt Versus Equity
Equity:Equity: Owners get to keep all of the profits Owners get to keep all of the profits in return for accepting the risk of lower in return for accepting the risk of lower
returnsreturns
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$28,000
income on
total assets
of $200,000
14% return
on assets
($28,000 ÷ $200,000)
18% return
on $100,000
($18,000÷ $100,000)
$100,000 debt
(10% cost)
equals
$100,000
equity
With $100,000 debt and $100,000 equity:
Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)
Debt is Risky:Debt is Risky: Lenders have first claim on Lenders have first claim on profits and must be paid even if there are profits and must be paid even if there are
no profits.no profits.
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The Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s Perspective
• Bankers’ Concerns!
• The Five C’s of Credit–Character of the borrower–Capacity of the borrower to repay the loan–Capital invested in the venture by the borrower–Conditions of the industry and economy–Collateral available to secure the loan
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Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan
Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan
• Three years of the firm’s historical statements
• The firm’s pro forma financial statements
• Personal financial statements
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Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…
Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…
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The myth… and the realityThe myth… and the realityThe myth… and the realityThe myth… and the reality
• The myth: VCs support good people and good ideas
• The reality: VCs invest in industries with double digit growth in the middle of the S-curve
– Appropriate management team – Specialty funds (earlier and later stages on the S-
curve)– Limits the risk to management risk – Produces attractive exit opportunities
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Present Day SituationPresent Day SituationPresent Day SituationPresent Day Situation
Myth: There is less available capital
Fact: The industry has plenty of money, but limited appetite for new investment
Fact: Investor attitudes toward risk have changed
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VC fills a voidVC fills a voidVC fills a voidVC fills a void
• Gap between innovation and traditional sources of debt
• Risk inherent in startups typically justify interest rates higher than allowed by law
• VCs must balance high returns for their investors against sufficient upside potential for entrepreneurs to keep them motivated
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What VCs get out of itWhat VCs get out of itWhat VCs get out of itWhat VCs get out of it
• 10X return on capital over 5 years
• VCs management fees and high growth funds
• Fund structured with limited and general partners and a life of 7-10 years
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What VCs Do?What VCs Do?What VCs Do?What VCs Do?
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The Overhang: Uninvested CapitalThe Overhang: Uninvested Capital
0
50
100
150
200
250
Year
Ann
ual C
omm
itted
Cap
ital (
$M)
Complements of Thompson Venture Economics
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AngelsAngelsAngelsAngels
• Well to do private individuals
• Geography and industry specific
• Invest lower amount than VC
• Often a good source of industry experience
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Finding AngelsFinding AngelsFinding AngelsFinding Angels
• Private Individuals
• Professionals (lawyers, accountants, bankers)
• Local small business development centers
• Internet associations (e.g., Technology Capital Network at MIT)
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Other Sources of FinancingOther Sources of FinancingOther Sources of FinancingOther Sources of Financing
• Community-based financial institutions
• Large corporations
• Stock Sales–Private placement–Initial public offering (IPO)
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Why Companies Invest?Why Companies Invest?Why Companies Invest?Why Companies Invest?
• Preemption of new rivals• Replace core earnings lost because of an
emerging technology• Apply existing competitive advantage in a
rapidly growing market• And some degree of autonomy:
– JVs, alliances, flexible internal management structures
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Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies
Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies
• Small Business Administration (SBA) loans–Guaranty loan–Direct loan
• Small business investment centers (SBICs)
• Small Business Innovative Research (SBIR)
• State and Local Government Assistance
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Business Suppliers andBusiness Suppliers andAsset-Based LendersAsset-Based Lenders
Business Suppliers andBusiness Suppliers andAsset-Based LendersAsset-Based Lenders
• Trade Credit (Accounts Payable)
Short-duration financing (30 days)
Amount of credit available is dependent on type of firm and supplier’s willingness to extend credit
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Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)
Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)
• Equipment Loan and Leases
• LeasesFree up cash for other purposesLeaves lines of credit openProvides a hedge against
obsolescence
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Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)
Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)
• Asset-based Loan
• FactoringAccounts are sold to factor at a discount to invoice
value
Factor can refuse questionable accounts
Factor charges fees for servicing accounts and for amount advanced to firm prior to collection
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Formal Vs. Informal InvestorsFormal Vs. Informal InvestorsFormal Vs. Informal InvestorsFormal Vs. Informal Investors
• Funding structure and flexibility
• The fit to the mold
• Involvement in the business
• Rigidity of relationship with the firm
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Discussion?Discussion?Discussion?Discussion?
13–52
13–53Complements of: Timmons/Spinelli New Venture Creation, sixth edition
Low Level Investment
Lower Long-
term Income
Potential (Lower
Capacity)
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First Things FirstFirst Things FirstFirst Things FirstFirst Things First
• Burn rate
• OOC (out of cash)
• Search out capital markets
• Increase cash flow
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Strategy RefinementStrategy RefinementStrategy RefinementStrategy Refinement
• Market niche• Suppliers and customers• Diversification or specialization• Reduce fixed costs• Plan for contingency
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Management RefinementManagement RefinementManagement RefinementManagement Refinement
• Management skill, experience and know how
• Control of Finance
• Turnover
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When the market is downWhen the market is downWhen the market is downWhen the market is down
• Increase Your Effectiveness and Efficiency• Be Creative• Pursue different sources of capital
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Building to GrowBuilding to GrowBuilding to GrowBuilding to Grow
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Create Value• Shareholders• Customers• Employees
Contingency Plan• Best Case Scenario• Worst Case Scenario• Most Likely Scenario
Good TeamEvery business is built on people
Good DecisionsSolid FinancingPersistenceReduce Risk Increase
Value
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Example 1Example 1Sales Growth; ODGSales Growth; ODG
Example 1Example 1Sales Growth; ODGSales Growth; ODG
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
1993 1995 1997 1999 2001 2003
Argo Centaur Drive Systems/Gears/Couplings Other
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The Sound AdviceThe Sound AdviceThe Sound AdviceThe Sound Advice
• Monitor Cash Flow (especially if growth is high)–100 fastest growing companies–Entrepreneur of the year award
• Contingency Plan – get the timing right• Emphasize long term growth• Manage your risk factor
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Example 2:Example 2:Ergo Distributor Ergo Distributor
Example 2:Example 2:Ergo Distributor Ergo Distributor
• Sales growth 400-500%• Single supplier – No substitutes• Great financial ratios• Cash flow problems• May go bankrupt in couple of years
LESSON: Use your intuition
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Who invests in VC funds?Who invests in VC funds?Who invests in VC funds?Who invests in VC funds?
• Typically pension funds, financial firms, insurance companies, endowments and high net worth individuals
• Small percentage of total funds– Expect returns of 25%-30%
• Most are structured as limited partnerships• Other forms include:
– Corporate VC funds– Private funds– Publicly listed funds– Labour sponsored funds (in Canada)