part iii overheads
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Outline: Chapter 9Outline: Chapter 9Financing Over the Life of a Financing Over the Life of a VentureVenture Common Misconceptions about
Entrepreneurial FinancingThe Diverse Nature of Business
Financing Financing Smaller Businesses
with Modest Growth PotentialFinancing High Growth, High
Potential Ventures
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Common Misconceptions Common Misconceptions about Entrepreneurial about Entrepreneurial FinancingFinancingVenture 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
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The Diverse Nature of The Diverse Nature of Business Financing 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
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Financing a Small Business - Modest Financing a Small Business - Modest GrowthGrowthFigure 9.1 Figure 9.1
Pre-launch Start-up Growth Transition
Bootstrapping
Self, friends, and family
Equity financing
Debt financing
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Financing a High-Growth, High-Financing a High-Growth, High-Potential VenturePotential VentureFigure 9.2Figure 9.2
Pre-launch Start-up Growth Transition
Bootstrapping
Seed financing from angels
Equity financing from VCs
Debt financing
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Outline: Chapter 10Outline: Chapter 10Start-up Financing From the Entrepreneur, Start-up Financing From the Entrepreneur, Friends and Family Friends and Family
Self-financingAdvantages and Disadvantages
of Self-financing Friends and Family FinancingStructure of Funds Invested
◦Loan◦Equity
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Most Common Sources of Most Common Sources of FinancingFinancingFigure 10.1Figure 10.1
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Pre-launch Start-up Growth Transition
Self, friends, and family
Advantages and Disadvantages of Advantages and Disadvantages of Self-FinancingSelf-FinancingTable 10.1Table 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
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Friends and Family Friends and Family FinancingFinancingDetermine True Motivations Use a Formal Business PlanProvide Accurate, Objective, and
Full Information about the Business
Keep BoundariesTax Planning
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Outline: Chapter 11Outline: Chapter 11BootstrappingBootstrapping
Why bootstrap?Bootstrapping Administrative OverheadBootstrapping Employee ExpensesBootstrapping Operating ExpensesBootstrap MarketingThe Ethics of Bootstrapping
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Bootstrapping Throughout the Life of a Bootstrapping Throughout the Life of a VentureVentureFigure 11.1Figure 11.1
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Pre-launch Start-up Growth Transition
Bootstrapping
BootstrappingBootstrapping
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.
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Why Bootstrap?Why Bootstrap?Often necessary for small
businesses to get startedDifficulty in raising money for
growthPreserves the value and wealth
of a business“Extend the Runway”Reduce risk associated with debt
financing
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Rules of BootstrappingRules of BootstrappingRule #1: Overhead mattersRule #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
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Bootstrapping Administrative Bootstrapping Administrative Overhead Overhead
SpaceFurnishings and office
equipment Administrative salaries
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Bootstrapping Employee Bootstrapping Employee ExpensesExpensesEmployee “stretching”Independent contractors Employee leasing and temporary
employeesStudent interns Equity compensation Non-monetary benefits
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Bootstrapping Operating Bootstrapping Operating ExpensesExpensesOutsourcingJust-in-time inventory
techniquesEffective cost accounting
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Bootstrap MarketingBootstrap MarketingKnow your customerFocus on the impact of message,
not “volume”Focus on benefits for customerUnderstand the market nicheSpend your marketing dollars
wiselyMarketing is a process, not an
eventCopyright 2009 Cornwall, Vang & Hartman
The Basic Bootstrap Marketing The Basic Bootstrap Marketing ToolsToolsWord of MouthBusiness cardsBlogsBrochuresBanners and signs NewslettersDirect mailing/e-mailingPublicity
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Word of MouthWord of MouthMotivate customers to talk about
businessCreate incentives to spread the
wordAsk customers to “sell”Create a “buzz” campaignViral marketing
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Business CardsBusiness CardsDesign is importantInclude needed data about
businessUse quality paperUse colorInclude description and/or sloganUse both side of card
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BlogsBlogsBe consistent in bloggingDo not blog merely to promote
businessTake time to create quality blogBe patient – blogging takes time
to build followingBe cautious what you write!
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Outline: Chapter 12Outline: Chapter 12External Sources of Funds: External Sources of Funds: EquityEquityAngel InvestorsStrategic PartnersPrivate PlacementSBICThe Downside of Equity
FinancingWorking with Outside Investors
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Equity FinancingEquity FinancingFigure 12.1 Figure 12.1
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Pre-launch Start-up Growth Transition
Equity financing
Downside of Equity Downside of Equity FinancingFinancing
Dilution of ownershipThe risk of sharks Dynamics of adding on new
partners
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Working with Equity Working with Equity InvestorsInvestors Business plan Confidentiality agreement Letter of Intent Modifications of shareholder
agreements Communication with shareholders
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Outline: Chapter 13Outline: Chapter 13External Sources of Funds: DebtExternal Sources of Funds: Debt
Short-term debt Long-term debt Forms of debt overlooked by
entrepreneurs Working with bankersDownside of debtDeveloping a Financing Plan
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Debt FinancingDebt FinancingFigure 13.1 Figure 13.1
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Pre-launch Start-up Growth Transition
Debt financing
Short-term DebtShort-term Debt
Expected to be paid within one year
Most often used to finance short-term expenditures such as inventory, supplies, payroll, etc.
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Short-term DebtShort-term Debt
Trade debtInstitutional Creditors
◦Banks◦Asset-based lenders◦Factors
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Long-term DebtLong-term DebtBeyond one year
Most often used to fund fixed asset purchases
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Long-term DebtLong-term Debt
Banks: term loansLeasing companiesReal estate lenders
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Criteria for Lending by Criteria for Lending by BankersBankers
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
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Key Loan DocumentsKey Loan Documents
Loan proposal Loan document Personal guarantees
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Downside of DebtDownside of Debt
Increased risk during economic slowdown
Impact on proceeds from business sale
Restrictive covenantsPersonal guarantees
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Example of Assets and Potential Funding Example of Assets and Potential Funding GeneratedGeneratedTable 13.1Table 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
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Outline: Chapter 14Outline: Chapter 14Financing the High Growth Financing the High Growth BusinessBusiness
What Venture Capitalists and Private Equity Funds Provide – The Four “C’s”
Integrating Profitability into the Business Plan
Stages of the FirmStages of Business FundingThe Dark Side of Venture Capital FinancingInitial Contact with a Venture CapitalistInitial Public Offering (IPO)The Process of the IPO
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Financing a High Growth VentureFinancing a High Growth VentureFigure 14.1 Figure 14.1
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Pre-launch Start-up Growth Transition
Venture capital equity financing
The “Four Cs” of Venture The “Four Cs” of Venture CapitalCapitalCapitalContactsCounselCredibility
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Stages of High Growth Business Stages of High Growth Business FundingFunding Initial stageFirst round financing Second round financing Late round financing
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Initial Stage FundingInitial Stage FundingFile for incorporationWrite business planFind office and development
spaceCompletion of initial designHire key development personnel Complete prototype unitComplete prototype testing
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First Round FinancingFirst Round FinancingSecure key vendors Hire key service or manufacturing
personnelRent or build manufacturing facilityPurchase manufacturing equipmentMarket testingFirst sales contractProduction of first manufactured unitFirst 100, 1000, 10000 units, etc.
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Second Round FinancingSecond Round Financing
Break-even level of salesDevelopment of next generation of
product
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Late Round FinancingLate Round FinancingInitial public offering Sale of business
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Initial Contact with a Venture Initial Contact with a Venture CapitalistCapitalist
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
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Venture Capital Term Venture Capital Term SheetSheetAmount 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.
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Initial Public OfferingInitial Public OfferingAdvantages Disadvantages
Diversification and liquidity
Reporting costs
Ability to raise new cash
Disclosure of information
Valuation Maintenance of control
Future business deals
Publicity
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Process of the IPOProcess 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
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Outline: Chapter 13Outline: Chapter 13Business ValuationBusiness Valuation
General concepts that guide the determination of value
Basic information required for a valuationEstimating a firm’s cash flow and
determining its valueDefinition of cash flowEstimating the cash flow for a particular
year
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Concepts that Guide the Concepts that Guide the Determination of ValueDetermination of Value 1. Fair market value2. Going-concern value3. Highest and best use4. Future benefits5. Substitutes and alternatives6. Discounted cash flow analysis7. Objectivity
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Information Required for a Information Required for a ValuationValuation
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
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Discounted Cash FlowDiscounted Cash FlowIncorporates all other principlesIncome-oriented approachCan use EBITDANeeds a required rate of return
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Perceived Rates of ReturnPerceived Rates of ReturnPublicly traded company
12-18%Privately held company
20-35%Angel investors 20-
50%Venture capitalists
35-80%
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Estimating Cash FlowEstimating Cash Flow
EBIT+owner’s salary -reasonable salary+depreciation+personal expenses=EBITDA -equipment purchased -inventory investment=Free Cash Flow
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Calculating ValueCalculating ValueEnter 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
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Market Comparison ApproachMarket Comparison ApproachPrice/EarningsPrice/Pre-tax EarningsPrice/Cash FlowPrice/EBITDAPrice/DividendPrice/SalesPrice/AssetsPrice/Book ValuePrice/CustomerPrice/Unit
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Market Comparison ProblemsMarket Comparison Problems
Line of businessGeographic areaAge of assetsListing statusCosts of inputsLevel of
establishment
Sale termsStanding of
ownershipSizeFinancingTime periodSimilar buyer
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Outline: Chapter 14Outline: Chapter 14Exit PlanningExit Planning
Self-assessment revisitedThe ethical side of the
entrepreneur’s transitionA model of exit planningExit optionsThe process of selling a businessPost exit issues
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Exit PlanningExit Planning
The process of preparing for the transition of both the entrepreneur and the business
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Exit Through Ownership Exit Through Ownership TransferTransfer
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 Copyright 2009 Cornwall, Vang & Hartman
Exit Through Partial or Limited Exit Through Partial or Limited TransferTransferType of Exit Advantages Disadvantages
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 Copyright 2009 Cornwall, Vang & Hartman
Exit Through Partial or Limited Exit Through Partial or Limited TransferTransfer(Continued)(Continued)Type of Exit Advantages Disadvantages
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
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Exit Through BankruptcyExit Through Bankruptcy
Type of Exit Advantages Disadvantages
Bankruptcy Orderly end to business
Ethical challenges
Results in no realization of wealth from business
Can hurt entrepreneur’s
ability to fund future deals Copyright 2009 Cornwall, Vang & Hartman
Exit Through LiquidationExit Through Liquidation
Type of Exit Advantages Disadvantages
Liquidation May result in more value, especially for service business
No value for going concern
Can be viewed as “failure”
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Exit PlanningExit 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
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Figure 14.4Figure 14.4
Sale Process of a BusinessSale 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
50 % of deals proceed to next stage
50 % of deals proceed to next stage
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