financing venture

Financing Venture

Common Misconceptions about Entrepreneurial Financing

The Diverse Nature of Business Financing Financing Smaller Businesses with

Modest Growth Potential Financing High Growth, High Potential

Ventures

Common Misconceptions about Entrepreneurial Financing

Venture Capitalists Fund Most Businesses

Banks Lend to Start-ups

SBA lends money directly to entrepreneurs

Entrepreneurs Tend to Rely on One Single Source of Funding

Government Grants are a Good Source of Money for Small Businesses

The Diverse Nature of Business Financing

The Nature of the Business Model

Aspirations of the Entrepreneur

The Stage of Development of the Business Venture

Fitting the Pieces of the Financing Puzzle Together

Financing a Small Business - Modest GrowthFigure 9.1

Pre-launch Start-up Growth Transition

Bootstrapping

Self, friends, and family

Equity financing

Debt financing

Financing a High-Growth, High-Potential Venture

Figure 9.2Pre-launch Start-up Growth Transition

Bootstrapping

Seed financing from angels

Equity financing from VCs

Debt financing

Outline: Chapter 10Start-up Financing From the Entrepreneur, Friends

and Family

Self-financing Advantages and Disadvantages of Self-

financing Friends and Family Financing Structure of Funds Invested

Loan Equity

Most Common Sources of FinancingFigure 10.1


Self, friends, and family

Advantages and Disadvantages of Self-Financing

Table 10.1

Advantages DisadvantagesRelative ease of securing funding

May limit size and scope of start-up

Avoid complexity created by adding partners

May limit ability to grow

Better alignment with entrepreneur’s aspirations

Increases exposure to personal risk from business failure

No dilution of profits or gains Entrepreneur may lack all necessary experience, contacts, skills, and/or knowledge

Eventual exit process is often simpler

Copyright 2009 Cornwall, Vang & Hartman

Friends and Family Financing

Determine True Motivations

Use a Formal Business Plan

Provide Accurate, Objective, and Full Information about the Business

Keep Boundaries

Tax Planning

Outline: Chapter 11Bootstrapping

Why bootstrap? Bootstrapping Administrative Overhead Bootstrapping Employee Expenses Bootstrapping Operating Expenses Bootstrap Marketing The Ethics of Bootstrapping

Bootstrapping Throughout the Life of a VentureFigure 11.1


Bootstrapping

Bootstrapping

Defined as the “process of finding creative ways exploit opportunities to launch and grow businesses with the limited resources available for most start-up ventures.”

Cornwall, J. (2010). Bootstrapping. Englewood Cliffs, NJ: Pearson/Prentice-Hall.

Why Bootstrap? Often necessary for small businesses to

get started Difficulty in raising money for growth Preserves the value and wealth of a

business “Extend the Runway” Reduce risk associated with debt

financing

Rules of Bootstrapping

Rule #1: Overhead matters

Rule #2: Employee expenses are usually the highest single recurring cost

Rule #3: Minimize operating costs

Rule #4: Marketing matters, but know your customers and how they make decisions

Bootstrapping Administrative Overhead

Space Furnishings and office equipment Administrative salaries

Bootstrapping Employee Expenses

Employee “stretching” Independent contractors Employee leasing and temporary

employees Student interns Equity compensation Non-monetary benefits

Bootstrapping Operating Expenses

Outsourcing Just-in-time inventory techniques Effective cost accounting


Bootstrap Marketing Know your customer Focus on the impact of message, not

“volume” Focus on benefits for customer Understand the market niche Spend your marketing dollars wisely Marketing is a process, not an event

The Basic Bootstrap Marketing Tools

Word of Mouth Business cards Blogs Brochures Banners and signs Newsletters Direct mailing/e-mailing Publicity

Word of Mouth

Motivate customers to talk about business

Create incentives to spread the word

Ask customers to “sell”

Create a “buzz” campaign

Viral marketing

Business Cards

Design is important

Include needed data about business

Use quality paper

Use color

Include description and/or slogan

Use both side of card

Outline: Chapter 12External Sources of Funds: Equity

Angel Investors Strategic Partners Private Placement SBIC The Downside of Equity Financing Working with Outside Investors

Equity FinancingFigure 12.1


Equity financing

Downside of Equity Financing

Dilution of ownership The risk of sharks Dynamics of adding on new partners

Working with Equity Investors

Business plan Confidentiality agreement Letter of Intent Modifications of shareholder agreements Communication with shareholders

Outline: Chapter 13External Sources of Funds: Debt

Short-term debt Long-term debt Forms of debt overlooked by

entrepreneurs Working with bankers Downside of debt Developing a Financing Plan

Debt FinancingFigure 13.1


Debt financing

Short-term Debt

Expected to be paid within one year Most often used to finance short-term

expenditures such as inventory, supplies, payroll, etc.

Short-term Debt

Trade debt Institutional Creditors

Banks Asset-based lenders Factors

Long-term Debt Beyond one year

Most often used to fund fixed asset purchases

Long-term Debt

Banks: term loans Leasing companies Real estate lenders

Criteria for Lending by Bankers

Ability of the business to generate enough cash flow to easily make interest and principle payments

Entrepreneur’s ability to personally pay back the loan if the business fails

Assets to serve as collateral

Key Loan Documents

Loan proposal Loan document Personal guarantees

Downside of Debt

Increased risk during economic slowdown Impact on proceeds from business sale Restrictive covenants Personal guarantees

Example of Assets and Potential Funding GeneratedTable 13.1

Asset Estimated value

Percentage financed

Potential funding generated

Customer Purchase Orders

$50,000 70% $35,000

Accts. Receivable (<60 days)

$80,000 70% $56,000

Inventory $20,000 30% $ 6,000Leasehold Improvements

$10,000 50% $ 5,000

Building $120,000 70% $84,000Undeveloped Land

$40,000 40% $16,000

Equipment $15,000 80% $12,000Total of Business Funding Sources

$335,000 $214,000


Outline: Chapter 14Financing the High Growth Business

What Venture Capitalists and Private Equity Funds Provide – The Four “C’s”

Integrating Profitability into the Business Plan Stages of the Firm Stages of Business Funding The Dark Side of Venture Capital Financing Initial Contact with a Venture Capitalist Initial Public Offering (IPO) The Process of the IPO

Financing a High Growth VentureFigure 14.1


Venture capital equity financing

The “Four Cs” of Venture Capital

Capital

Contacts

Counsel

Credibility

Stages of High Growth Business Funding

Initial stage First round financing Second round financing Late round financing

Initial Stage Funding File for incorporation Write business plan Find office and development space Completion of initial design Hire key development personnel Complete prototype unit Complete prototype testing

First Round Financing Secure key vendors Hire key service or manufacturing personnel Rent or build manufacturing facility Purchase manufacturing equipment Market testing First sales contract Production of first manufactured unit First 100, 1000, 10000 units, etc.

Second Round Financing

Break-even level of sales Development of next generation of product

Late Round Financing Initial public offering Sale of business

Initial Contact with a Venture Capitalist

Funding amount Duration Summary of the project Use of funding Confirm how the transaction will be liquidated Existing investment in the project Names of bankers, lawyers, accountants and

consultants Unusual or sensitive information

Venture Capital Term Sheet

Amount the venture capitalist wishes to invest. Percentage of ownership to the venture capitalist. The nature of the investment such as loan, stock, warrants,

etc. Governance rights of the venture capitalist. Right to eventually register shares for a public offering. Remaining conditions to be met by the entrepreneur such

as periodic reports, financial statements, etc. An estimate of valuation of the company. Specific requirements on what the money is to be used for

or specific assets that must be purchased with the funds.

Initial Public Offering

Advantages Disadvantages

Diversification and liquidity

Reporting costs

Ability to raise new cash

Disclosure of information

Valuation Maintenance of control

Future business deals

Publicity

Process of the IPO

1. Selecting an investment banking firm

2. The decision to underwrite or not underwrite

3. Getting the paperwork in order and certifying the price of the offering

4. The road show

5. Determine the size of the book

6. The first day of trading

Outline: Chapter 13Business Valuation

General concepts that guide the determination of value

Basic information required for a valuation Estimating a firm’s cash flow and determining its

value Definition of cash flow Estimating the cash flow for a particular year

Concepts that Guide the Determination of Value

1. Fair market value

2. Going-concern value

3. Highest and best use

4. Future benefits

5. Substitutes and alternatives

6. Discounted cash flow analysis

7. Objectivity

Information Required for a Valuation

Income statements and/or tax returns Balance sheet Rates of return consistent with the risk

level Interviews with current owners and staff Assessment of future business environment

Discounted Cash Flow Incorporates all other principles Income-oriented approach Can use EBITDA Needs a required rate of return

Perceived Rates of Return Publicly traded company 12-18% Privately held company 20-35% Angel investors 20-50% Venture capitalists 35-80%

Estimating Cash Flow

EBIT +owner’s salary -reasonable salary +depreciation +personal expenses =EBITDA -equipment purchased -inventory investment =Free Cash Flow

Calculating Value

Enter zero for Cf0

Enter each year’s unique free cash flow For final year enter the sum of the

terminal cash flow and the year’s free cash flow

Enter required rate of return as interest rate

Calculated NPV is the value of the firm

Market Comparison Approach Price/Earnings Price/Pre-tax Earnings Price/Cash Flow Price/EBITDA Price/Dividend Price/Sales Price/Assets Price/Book Value Price/Customer Price/Unit

Market Comparison Problems

Line of business Geographic area Age of assets Listing status Costs of inputs Level of

establishment

Sale terms

Standing of ownership

Size

Financing

Time period

Similar buyer

Outline: Chapter 14Exit Planning

Self-assessment revisited The ethical side of the entrepreneur’s

transition A model of exit planning Exit options The process of selling a business Post exit issues

Exit Planning

The process of preparing for the transition of both the entrepreneur and the business

Exit Through Ownership Transfer

Type of Exit Advantages Disadvantages

Asset Sale Cash sale Immediate tax on full sale

Clean break Lower face value sale price

Earn-out possible

Stock Sale Higher face value of sale price

Potential volatility of stock from sale

Tax deferment of sale price

Restrictions on sale of stock

Exit Through Partial or Limited Transfer


Merger Potential synergies

Cultures may clash

Tax deferment of sale price

Limited opportunity for immediate cash

IPO Taking some cash out possible

Limits on sale of stock

Can bring in professional management

Exit Through Partial or Limited Transfer(Continued)


Strategic Alliance Reduces risk to existing value

May be long time, if at all, to actual exit

ESOP Can maintain business culture

May be long time, if at all, to actual exit

Family Business Transfer

Can maintain business culture

Challenges of generational succession

Exit Through Bankruptcy


Bankruptcy Orderly end to business

Ethical challenges

Results in no realization of wealth from business

Can hurt entrepreneur’s

ability to fund future deals

Exit Through Liquidation


Liquidation May result in more value, especially for service business

No value for going concern

Can be viewed as “failure”

Exit Planning1. Re-examine owners’ aspirations2. Evaluate timing issues 3. Consider ethical issues of exit plans4. Set specific financial goals, and the timeframe

to achieve these goals, based on owners’ aspirations related to wealth

5. Establish a specific plan to meet financial goals 6. Begin external audit or review7. Evaluate possible exit options

Figure 14.4

Sale Process of a Business

Initial Inquiry

Letter of Intent

Deal Price and Basic Structure Agreed Upon

Purchase Agreement and Closing

Due Diligence

10 % of deals proceed to next stage



financing venture

Economy & Finance

venture capitalist

cash flow

long time

small businesses

vang amp

deals proceed

1copyright

business