Technopreneurship Week 13

Identify the types of financing available.Understand the role of commercial banks in financing new ventures, the types of loans available, and bank lending decisions.Know the basic stages of venture funding.Be aware of the informal risk-capital market.Understand the nature of the venture-capital industry and the venture-capital decision process.Explain several valuation approaches of a company.

One of the most difficult problems in the new venture creation process is obtaining financing. For the entrepreneur, available financing needs to be considered from the perspective of debt versus equity and using internal versus external funds.Two types of financing need to be considered:1. Debt financing2. Equity financing

A financing method involving an interest-bearing instrument, usually a loan, the payment of which is only indirectly related to the sales and profits of the venture. Typically, debt financing (also called asset-based financing) requires that some asset (such as a car, house, plant, machine, or land) be used as collateral.

Requires the entrepreneur to pay back the amount of funds borrowed as well as a fee expressed in terms of the interest rate. There can also be an additional fee, sometimes referred to as points, for using or being able to borrow the money.

If the financing is short term (less than one year), the money is usually used to provide working capital to finance inventory, accounts receivable, or the operation of the business. The funds are typically repaid from the resulting sales and profits during the year. Long-term debt (lasting more than one year) is frequently used to purchase some asset such as a piece of machinery, land, or a building, with part of the value of the asset (usually from 50 to 80 percent of the total value) being used as collateral for the long-term loan.

Does not require collateral and offers the investor some form of ownership position in the venture. The investor shares in the profits of the venture, as well as any disposition of its assets on a pro rata basis based on the percentage of the business owned.Key factors favoring the use of one type of financing over another are the availability of funds, the assets of the venture, and the prevailing interest rates. Usually, an entrepreneur meets financial needs by employing a combination of debt and equity financing.

Financing is also available from both internal and external funds. The type of funds most frequently employed is internally generated funds.Internally generated funds can come from several sources within the company: profits, sale of assets, reduction in working capital, extended payment terms, and accounts receivable. In every new venture, the start-up years involve putting all the profits back into the venture; even outside equity investors do not expect any payback in these early years.

The other general source of funds is external to the venture.Alternative sources of external financing need to be evaluated on three bases:1. The length of time the funds are available2. The costs involved3. The amount of company control lost.

1. Personal Funds2. Family and Friends3. Commercial Banks

Few, if any, new ventures are started without the personal funds of the entrepreneur. Not only are these the least expensive funds in terms of cost and control, but they are absolutely essential in attracting outside funding, particularly from banks, private investors, and venture capitalists. The typical sources of personal funds include savings, life insurance, or mortgage on a house or car. These outside providers of capital feel that the entrepreneur may not be sufficiently committed to the venture if he or she does not have money invested.

After the entrepreneur, family and friends are a common source of capital for a new venture. They are most likely to invest due to their relationship with the entrepreneur. This helps overcome one portion of uncertainty felt by impersonal investors knowledge of the entrepreneur. Family and friends provide a small amount of equity funding for new ventures, reflecting in part the small amount of capital needed for most new ventures.

Commercial banks are by far the source of short-term funds most frequently used by the entrepreneur when collateral is available. The funds provided are in the form of debt financing and, as such, require some tangible guaranty or collateral some asset with value. This collateral can be in the form of business assets (land, equipment, or the building of the venture), personal assets (the entrepreneur's house, car, land, stock, or bonds), or the assets of the cosigner of the note.

There are several types of bank loans available. To ensure repayment, these loans are based on the assets or the cash flow of the venture. The asset base for loans is usually:1. Accounts Receivable2. Inventory3. Equipment4. Real Estate

Accounts receivable provide a good basis for a loan, especially if the customer base is well known and creditworthy. For those creditworthy customers, a bank may finance up to 80 percent of the value of their accounts receivable. When customers such as the government are involved, an entrepreneur can develop a factoring arrangement whereby the factor (the bank) actually "buys" the accounts receivable at a value below the face value of the sale and collects the money directly from the account. In this case, if any of the receivables is not collectible, the factor (the bank) sustains the loss, not the business.

The cost of factoring the accounts receivable is of course higher than the cost of securing a loan against the accounts receivable without factoring being involved, since the bank has more risk when factoring. The costs of factoring involve the interest charge on the amount of money advanced until the time the accounts receivable are collected, the commission covering the actual collection, and protection against possible uncollectible accounts.

Inventory is another of the firm's assets that is often a basis for a loan, particularly when the inventory is liquid and can be easily sold. Usually, the finished goods inventory can be financed for up to 50 percent of its value. Trust receipts are a unique type of inventory loan used to finance floor plans of retailers, such as automobile and appliance dealers. In trust receipts, the bank advances a large percentage of the invoice price of the goods and is paid on a pro rata basis as the inventory is sold.

Equipment can be used to secure longer-term financing, usually on a 3-to 10-year basis. Equipment financing can fall into any of several categories: financing the purchase of new equipment, financing used equipment already owned by the company, sale-leaseback financing, or lease financing. When new equipment is being purchased or presently owned equipment is used as collateral, usually 50 to 80 percent of the value of the equipment can be financed depending on its salability. Given the entrepreneur's tendency to rent rather than own, sale-leaseback or lease financing of equipment is widely used.

In the sale-leaseback arrangement, the entrepreneur "sells" the equipment to a lender and then leases it back for the life of the equipment to ensure its continued use. In lease financing, the company acquires the use of the equipment through a small down payment and a guarantee to make a specified number of payments over a period of time. The total amount paid is the selling price plus the finance charges.

Real estate is also frequently used in asset- based financing. This mortgage financing is usually easily obtained to finance a company's land, plant, or another building, often up to 75 percent of its value.

The other type of debt financing frequently provided by commercial banks and other financial institutions. These conventional bank loans include lines of credit, installment loans, straight commercial loans, long-term loans, and character loans.

is perhaps the form of cash flow financing most frequently used by entrepreneurs. In arranging for a line of credit to be used as needed, the company pays a "commitment fee to ensure that the commercial bank will make the loan when requested and then pays interest on any outstanding funds borrowed from the bank.

can also be obtained by a venture with a track record of sales and profits. These short-term funds are frequently used to cover working capital needs for a period of time, such as when seasonal financing is needed. These loans are usually for 30 to 40 days.

A hybrid of the installment loan is the straight commercial loan, by which funds are advanced to the company for 30 to 90 days. These self-liquidating loans are frequently used for seasonal financing and for building up inventories.

When a longer time period for use of the money is required, long-term loans are used. These loans (usually available only to strong, mature companies) can make funds available for up to 10 years. The debt incurred is usually repaid according to a fixed interest and principal schedule. The principal, however, can sometimes start being repaid in the second or third year of the loan, with only interest paid the first year.

When the business itself does not have the assets to support a loan, the entrepreneur may need a character (personal) loan. These loans frequently must have the assets of the entrepreneur or other individual pledged as collateral or the loan cosigned by another individual. Assets that are frequently pledged include cars, homes, land, and securities. In extremely rare instances, the entrepreneur can obtain money on an unsecured basis for a short time when a high credit standing has been established.

One problem for the entrepreneur is determining how to successfully secure a loan from the bank. Banks are generally cautious in lending money, particularly to new ventures, since they do not want to incur bad loans. Regardless of geographic location, commercial loan decisions are made only after the loan officer and loan committee do a careful review of the borrower and the financial track record of the business. These decisions are based on both quantifiable information and subjective judgments.

1. Character2. Capacity3. Capital4. Collateral5. Conditions

Past financial statements (balance sheets and income statements) are reviewed in terms of key profitability and credit ratios, inventory turnover, aging of accounts receivable, the entrepreneur's capital invested, and commitment to the business. Future projections on market size, sales, and profitability are also evaluated to determine the ability to repay the loan.

Several questions are usually raised regarding this ability. Does the entrepreneur expect to be carried by the loan for an extended period of time? If problems occur, is the entrepreneur committed enough to spend the effort necessary to make the business a success? Does the business have a unique differential advantage in a growth market? What are the downside risks? Is there protection (such as life insurance on key personnel and insurance on the plant and equipment) against disasters?

Although the answers to these questions and the analysis of the company's records allow the loan officer to assess the quantitative aspects of the loan decision, the intuitive factors, particularly the first two Cs character and capacity are also taken into account. This part of the loan decision the gut feeling is the most difficult part to assess. The entrepreneur must present his or her capabilities and the prospects for the company in a way that elicits a positive response from the lender. This intuitive part of the loan decision becomes even more important when there is little or no track record, limited experience in financial management, a nonproprietary product or service (one not protected by a patent or license), or few assets available.

In evaluating the appropriateness of financing alternatives, particularly angel vs. venture capital financing, an entrepreneur must determine the amount and the timing of the funds required, as well as the projected company sales and growth. Conventional small businesses and privately held middle-market companies tend to have a difficult time obtaining external equity capital, especially from the venture-capital industry. Most venture capitalists like to invest in software, biotechnology, or high-potential ventures like Fred Smith's Federal Express. The three types of funding as the business develops are indicated in Table 12.1.

1. Early-stage financing is usually the most difficult and costly to obtain. Two types of financing are available during this stage:a. Seed capital b. Start-up capital

The most difficult financing to obtain through outside funds, is usually a relatively small amount of funds needed to prove concepts and finance feasibility studies.Since venture capitalists usually have a minimum funding level of above $500,000, they are rarely involved in this type of funding, except in the case of high-technology ventures of entrepreneurs who have a successful track record and need a significant amount of capital.

involved in developing and selling some initial products to determine if commercial sales are feasible. These funds are also difficult to obtain. Angel investors are active in these two types of financing.

2. Expansion or development financing is easier to obtain than early-stage financing.Venture capitalists play an active role in providing funds here. As the firm develops in each stage, the funds for expansion are less costly.Generally, funds in the second stage are used as working capital to support initial growth. In the third stage, the company is at breakeven or a positive profit level and uses the funds for major sales expansion.Funds in the fourth stage are usually used as bridge financing in the interim period as the company prepares to go public.

3. Acquisition financing or leveraged buyout financing is more specific in nature. It is issued for such activities as traditional acquisitions, leveraged buyouts (management buying out the present owners), and going private (a publicly held firm buying out existing stockholders, thereby becoming a private company).

There are three risk-capital markets that can be involved in financing a firm's growth:1. The informal risk-capital market2. The venture-capital market3. The public-equity market

Although all three risk-capital markets can be a source of funds for stage-one financing, the public-equity market is available only for high-potential ventures, particularly when high technology is involved. Recently, some biotechnology companies raised their first stage financing through the public-equity market since investors were excited about the potential prospects and returns in this high-interest area.

The most misunderstood type of risk capital. It consists of a virtually invisible group of wealthy investors, often called business angels, who are looking for equity-type investment opportunities in a wide variety of entrepreneurial ventures. Typically investing anywhere from $10,000 to $500,000, these angels provide the funds needed in all stages of financing, but particularly in start-up (first-stage) financing.

Venture capital is one of the least understood areas in entrepreneurship. Some think that venture capitalists do the early-stage financing of relatively small, rapidly growing technology companies. It is more accurate to view venture capital broadly as a professionally managed pool of equity capital.

To be in a position to secure the funds needed, an entrepreneur must understand the philosophy and objectives of a venture-capital firm, as well as the venture-capital process.The objective of a venture-capital firm is to generate long-term capital appreciation through debt and equity investments. To achieve this objective, the venture capitalist is willing to make any changes or modifications necessary in the business investment. Since the objective of the entrepreneur is the survival of the business, the objectives of the two are frequently at odds, particularly when problems occur.

A typical portfolio objective of typical venture-capital firms in terms of return criteria and risk involved is shown in Figure 12.4 .Since there is more risk involved in financing a business earlier in its development, more return is expected from early-stage financing (50 percent ROI) than from acquisitions or leveraged buyouts (30 percent ROI), die late stage in development. The significant risk involved and the pressure that venture-capital firms feel from their investors (limited partners) to make safer investments with higher rates of return have caused these firms to invest even greater amounts of their funds in later stages of financing.

In these late-stage investments, there are lower risks, faster returns, less managerial assistance needed, and fewer deals to be evaluated.The venture capitalist does not necessarily seek control of a company, but would rather have the firm and the entrepreneur at the most risk. The venture capitalist will want at least one seat on the board of directors. Once the decision to invest is made, the venture capitalist will do anything necessary to support the management team so that the business and the investment prosper.

Whereas the venture capitalist expects to provide guidance as a member of the board of directors, the management team is expected to direct and run the daily operations of the company. A venture capitalist will support the management team with investment dollars, financial skills, planning, and expertise in any area needed.

Since the venture capitalist provides long-term investment (typically five years or more), it is important that there be mutual trust and understanding between the entrepreneur and the venture capitalist.There should be no surprises in the firm's performance. Both good and bad news should be shared, with the objective of taking the necessary action to allow the company to grow and develop in the long run. The venture capitalist should be available to the entrepreneur to discuss problems and develop strategic plans.

1. The company must have a strong management team that consists of individuals with solid experience and backgrounds, a strong commitment to the company, capabilities in their specific areas of expertise, the ability to meet challenges, and the flexibility to scramble wherever necessary.

A venture capitalist would rather invest in a first-rate management team and a second-rate product than the reverse. The management team's commitment should be reflected in dollars invested in the company. Although the amount of the investment is important, more telling is the size of this investment relative to the management team's ability to invest. The commitment of the management team should be backed by the support of the family, particularly the spouse, of each key team player.

A positive family environment and spousal support allow team members to spend the 60 to 70 hours per week necessary to start and grow the company. One successful venture capitalist makes it a point to have dinner with the entrepreneur and spouse, and even to visit the entrepreneur's home, before making an investment decision. According to the venture capitalist, I find it difficult to believe an entrepreneur can successfully run and manage a business and put in the necessary time when the home environment is out of control."

2. The product and/or market opportunity must be unique, having a differential advantage in a growing market.Securing a unique market niche is essential since the product or service must be able to compete and grow during the investment period. This uniqueness needs to be carefully spelled out in the marketing portion of the business plan and is even better when it is protected by a patent or a trade secret.

3. The business opportunity must have significant capital appreciation.The exact amount of capital appreciation varies, depending on such factors as the size of the deal, the stage of development of the company, the upside potential, the downside risks, and the available exits. The venture capitalist typically expects a 40 to 60 percent return on investment in most investment situations.

The venture-capital process that implements these criteria is both an art and a science. The element of art is illustrated in the venture capitalist's intuition, gut feeling, and creative thinking that guide the process. The process is scientific due to the systematic approach and data-gathering techniques involved in the assessment.

The process starts with the venture-capital firm establishing its philosophy and investment objectives. The firm must decide on the following: the composition of its portfolio mix, including the number of start-ups, expansion companies, and management buyouts; the types of industries; the geographic region for investment; and any product or industry specializations.

1. Preliminary Screening2. Agreement on Principal Terms3. Due Diligence4. Final Approval

The preliminary screening begins with the receipt of the business plan. A good business plan is essential in the venture-capital process. Most venture capitalists will not even talk to an entrepreneur who doesn't have one. As the starting point, the business plan must have a clear-cut mission and clearly stated objectives that are supported by an in-depth industry and market analysis and pro forma income statements.

The executive summary is an important part of this business plan, as it is used for initial screening in this preliminary evaluation. Many business plans are never evaluated beyond the executive summary.When evaluating the business, the venture capitalist first determines if the deal or similar deals have been seen previously. The investor then determines if the proposal fits his or her long-term policy and short-term needs in developing a portfolio balance.

In this preliminary screening, the venture capitalist investigates the economy of the industry and evaluates whether he or she has the appropriate knowledge and ability to invest in that industry.The investor reviews the numbers presented to determine whether the business can reasonably deliver the ROI required. In addition, the credentials and capability of the management team are evaluated to determine if they can carry out the plan presented.

The second stage is the agreement on principal terms between the entrepreneur and the venture capitalist.The venture capitalist wants a basic understanding of the principal terms of the deal at this stage of the process before making the major commitment of time and effort involved in the formal due diligence process.

The third stage, detailed review and due diligence, is the longest stage, involving anywhere from one to three months. There is a detailed review of the company's history, the business plan, the resumes of the individuals, their financial history, and target market customers. The upside potential and downside risk are assessed, and there is a thorough evaluation of the markets, industry, finances, suppliers, customers, and management.

In the last stage, final approval, a comprehensive, internal investment memorandum is prepared. This document reviews the venture capitalist's findings and details the investment terms and conditions of the investment transaction. This information is used to prepare the formal legal documents that both the entrepreneur and venture capitalist will sign to finalize the deal.

One of the most important decisions for the entrepreneur lies in selecting which venture capital firm to approach. Since venture capitalists tend to specialize either geographically by industry (manufacturing industrial products or consumer products, high technology, or service) or by size and type of investment, the entrepreneur should approach only those that may have an interest in the investment opportunity. Where do you find this venture capitalist?

An entrepreneur should carefully research the names and addresses of prospective venture-capital firms that might have an interest in the particular investment opportunity. There are also regional and national venture-capital associations. For a nominal fee or none at all, these associations will frequently send the entrepreneur a directory that lists their members, the types of businesses their members invest in, and any investment restrictions. Whenever possible, the entrepreneur should be introduced to the venture capitalist. Bankers, accountants, lawyers, and professors are good sources for introductions.

A problem confronting the entrepreneur in obtaining outside equity funds, whether from the informal investor market (the angels) or from the formal venture-capital industry, is determining the value of the company. This valuation is at the core of determining how much ownership an investor is entitled to for funding the venture. This is determined by considering the factors in valuation. This, as well as other aspects of securing funding, has a potential for ethical conflicts that must be carefully handled.

1. The first factor, and the starting point in any valuation, is the nature and history of the business .2. The valuation process must also consider the outlook of the economy in general as well as the outlook for the particular industry.3. The third factor is the book value (net value) of the stock of the company and the overall financial condition of the business.4. While book value develops the benchmark, the future earning capacity of the company, the fourth factor, is the most important factor in valuation .

5. The fifth valuation factor is the dividend-paying capacity of the venture .6. An assessment of goodwill and other intangibles of the venture is the sixth valuation factor .7. The seventh factor in valuation involves assessing any previous sale of stock .8. The final valuation factor is the market price of the stocks of companies engaged in the same or similar lines of business .

Calculations of financial ratios can also be extremely valuable as an analytical and control mechanism to test the financial well-being of a new venture during its early stages. These ratios serve as a measure of the financial strengths and weaknesses of the venture, but should be used with caution since they are only one control measure for interpreting the financial success of the venture. There is no single set of ratios that must be used, nor are there standard definitions for all ratios. However, there are industry rules of thumb that the entrepreneur can use to interpret the financial data. Ratio analysis is typically used on actual financial results but can also provide the entrepreneur with some sense of where problems exist in the pro forma statements as well.

Current RatioAcid Test Ratio

This ratio is commonly used to measure the short- term solvency of the venture or its ability to meet its short-term debts. The current liabilities must be covered from cash or its equivalent; otherwise the entrepreneur will need to borrow money to meet these obligations. The formula and calculation of this ratio when current assets are P108,050 and current liabilities are P40,500 is:Current assets / Current liabilities = 108,050 / 40,500 = 2.67 times

While a ratio of 2:1 is generally considered favorable, the entrepreneur should also compare this ratio with any industry standards. One interpretation of this result is that for every dollar of current debt, the company has P2.67 of current assets to cover it.This ratio indicates that company is liquid and can likely meet any of its obligations even if there were a sudden emergency that would drain existing cash.

This is a more rigorous test of the short-term liquidity of the venture because it eliminates inventory, which is the least liquid current asset. The formula given the same current assets and liabilities and inventory of P10,450 is:(Current assets-inventory) / Current liabilities = (108,050-10,450) / 40,500 = 2.40 timesThe result from this ratio suggests that the venture is very liquid since it has assets convertible to cash of P2.40 for every dollar of short-term obligations. Usually a 1:1 ratio would be considered favorable in most industries.

Average Collection PeriodInventory Turnover

Average Collection Period This ratio indicates the average number of days it takes to convert accounts receivable into cash. This ratio helps the entrepreneur to gauge the liquidity of accounts receivable or the ability of the venture to collect from its customers. Using the formula with accounts receivable of P46,400 and sales of P995,000 results in:Accounts receivable / Average daily sales = 46,400 / (995,000/360) = 17 daysThis particular result needs to be compared with industry standards since collection will vary considerably. However, if the invoices indicate a 20-day payment required, then one could conclude that most customers pay on time.

This ratio measures the efficiency of the venture in managing and selling its inventory. A high turnover is a favorable sign indicating that the venture is able to sell its inventory quickly. There could be a danger with a very high turnover that the venture is under stocked, which could result in lost orders. Managing inventory is very important to the cash flow and profitability of a new venture. The calculations of this ratio when the cost of goods sold is P645,000 and the inventory is P10,450 is:Cost of goods sold / Inventory = 645,000 / 10,450 = 61.7 timesThis would appear to be an excellent turnover as long as the entrepreneur feels that he or she is not losing sales because of under stocking inventory.

Debt RatioDebt to Equity

Many new ventures will incur debt as a means of financing the start-up. The debt ratio helps the entrepreneur to assess the firm's ability to meet all its obligations (short and long term). It is also a measure of risk because debt also consists of a fixed commitment in the form of interest and principal repayments. With total liabilities of P249,700 and total assets of P308,500, the debt ratio is calculated below:Total liabilities / Total Assets = 249,700 / 308,500 = 81%This result indicates that the venture has financed about 81 percent of its assets with debt. On paper this looks very reasonable but would also need to be compared with industry data.

This ratio assesses the firm's capital structure. It provides a measure of risk to creditors by considering the funds invested by creditors (debt) and investors (equity).The higher the percentage of debt, the greater the degree of risk to any of the creditors. The calculation of this ratio using the same total liability with stockholder's equity being P58,750 is:Total liabilities / Stockholders Equity = 249,700 / 58,750 = 4.25 timesThis result indicates that this venture has been financed mostly from debt. The actual investment of the entrepreneurs or the equity base is about one-fourth of what is owed. Thus, the equity portion represents a cushion to the creditors.

Net Profit MarginReturn on Investment

This ratio represents the venture's ability to translate sales into profits. You can also use gross profit instead of net profit to provide another measure of profitability. In either case it is important to know what is reasonable in your industry as well as to measure these ratios over time. The ratio and calculation when net profit is P8,750 and the same net sales is P995,000 is:Net profit / Net Sales = 8,750 / 995,000 = 0.88%The net profit margin although low for a firm, would not be of great concern for a new venture. Many new ventures do not incur profits until the second or third year. In this case we have a favorable profit situation.

Measures the ability of the venture to manage its total investment in assets. You can also calculate a return on equity, which substitutes stockholders equity for total assets in the formula below and indicates the ability of the venture in generating a return to the stockholders. The formula and calculation of the return on investment when total assets are P200,400 and net profit is P8,750 is:Net profit / Total assets = 8,750 / 200,400 = 4.4%The result of this calculation will also need to be compared with industry data. However, the positive conclusion is that the firm has earned a profit in its first year and has returned 4.4 percent on its asset investment.

There are many other ratios that could also be calculated. However, for a start-up these would probably suffice for an entrepreneur in assessing the venture's financial strengths and weaknesses. As the firm grows, it will be important to use these ratios in conjunction with all other financial statements to provide an understanding of how the firm is performing financially.

1. One of the most widely used approaches assesses comparable publicly held companies and the prices of these companies' securities. This search for a similar company is both an art and a science. First, the company must be classified in a certain industry, since companies in the same industry share similar markets, problems, economies, and potential of sales and earnings. The review of all publicly traded companies in this industry classification should evaluate size, amount of diversity, dividends, leverage, and growth potential until the most similar company is identified. This method is inaccurate when a truly comparable company is not found.

2. A second widely used valuation approach is the present value of future cash flow. This method adjusts the value of the cash flow of the business for the time value of money and the business and economic risks. Since only cash (or cash equivalents) can be used in reinvestment, this valuation approach generally gives more accurate results than profits. In using this method, the sales and earnings are projected back to the time of the valuation decision when shares of the company are offered for sale. The period between the valuation and sale dates is determined, and the potential dividend payout and expected price/earnings ratio or liquidation value at the end of the period are calculated. Finally, a rate of return desired by investors is established, less a discount rate for failure to meet these expectations.

3. Another valuation method, used only for insurance purposes or in very unique circumstances, is known as replacement value. This method is used when, for example, there is a unique asset involved that the buyer really wants. The valuation of the venture is based on the amount of money it would take to replace (or reproduce) that asset or another important asset or system of the venture.

4. The book value approach uses the adjusted book value, or net tangible asset value, to determine the firm's worth. Adjusted book value is obtained by making the necessary adjustments to the stated book value by taking into account any depreciation (or appreciation) of plant and equipment and real estate, as well as necessary inventory adjustments that result from the accounting methods employed. The following basic procedure can be used:

Book valueAdd (or subtract) any adjustments such as appreciation or depreciation to arrive at figure on next line the fair market value.Fair market value (the sale value of the company's assets).Subtract all intangibles that cannot be sold, such as goodwillAdjusted book valueSince the book valuation approach involves simple calculations, its use is particularly good in relatively new businesses, in businesses where the sole owner has died or is disabled, and in businesses with speculative or highly unstable earnings.

5. The earnings approach is the most widely used method of valuing a company since it provides the potential investor with the best estimate of the probable return on investment. The potential earnings are calculated by weighting the most recent operating year's earnings after they have been adjusted for any extraordinary expenses that would not have normally occurred in the operations of a publicly traded company. Appropriate price-earnings multiple is then selected based on norms of the industry and the investment risk. A higher multiple will be used for a high-risk business and a lower multiple for a low-risk business. For example, a low-risk business in an industry with a seven-times-earnings multiple would be valued at P4.2 million if the weighted average earnings over the past three years were P0.6 million (seven times $0.6 million).

6. An extension of the earnings approach method is the factor approach, wherein the following three major factors are used to determine value: earnings, dividend-paying capacity, and book value. Appropriate weights for the particular company being valued are developed and multiplied by the capitalizedvalue, resulting in an overall weighted valuation.

7. A final valuation approach that gives the lowest value of the business is liquidation value. Liquidation value is often difficult to obtain, particularly when cost and losses must be estimated for selling the inventory, terminating employees, collecting accounts receivable, selling assets, and performing other closing-down activities. Nevertheless, it is also good for an investor to obtain a downside risk value in appraising a company.

In addition to valuating the company and determining the percentage of the company that may have to be given up to obtain funding, a critical concern for the entrepreneur is the deal structure, or the terms of the transaction between the entrepreneur and the funding source. In order to make the venture look as attractive as possible to potential sources of funds, the entrepreneur must understand the needs of the investors as well as his or her own needs.

The needs of the funding sources include:1. The rate of return required2. The timing and form of return3. The amount of control desired4. The perception of the risks involved in the particular funding opportunity.

Whereas certain investors are willing to bear a significant amount of risk to obtain a significant rate of return, others want less risk and less return. Still, other investors are more concerned about their amount of influence and control once the investment has been made.

The entrepreneur's needs revolve around similar concerns, such as the degree and mechanisms of control, the amount of financing needed, and the goals for the particular firm. Before negotiating the terms and structure of the deal with the venture capitalist, the entrepreneur should assess the relative importance of these concerns in order to negotiate where needed.Both the venture capitalist and entrepreneur should feel comfortable with the final deal structure, and a good working relationship needs to be established to deal with any future problems

1. Interview a business loan officer at a bank to determine the bank's lending criteria for small businesses and for new businesses. Do they use the five Cs? Which of the five Cs appears to be the most important?2. Obtain a loan application from the local bank and categorize each question in terms of which of the five Cs it is attempting to assess.Search the Internet for government grants that might be applicable.