Financing the Small Business Start-Up

What you’ll learn…Resources available to entrepreneurs to start

their businessCompare/Contrast sources of financing for

start-up venturesImportance of financial planningInformation needed to obtain financingTypes of growth financing available to

entrepreneursHow to calculate start-up requirements

Entrepreneurial ResourcesFinding the resources to launch a business is a

creative process. It requires understanding of short-term and long-term needs.Short-Term: Activities that are not part of normal

operations Seasonal increase in sales that requires purchasing more

inventory than normalLong-Term: Preparation for future growth

Acquiring a larger facility or buying new/additional equipment

Bootstrapping

The most common way businesses get off the ground!Involves operating as frugally as possible and cutting

all un-necessary expensesInvolves borrowing, leasing and partnering to

acquire resourcesYou can accomplish this in a few ways:

Hire as few employees as possibleLeasing anything you canBeing creative

Start-Up MoneyNew businesses have no track record to prove it

will survive. For this reason, it’s hard to get investors.The main resources for start-up money is usually personal

resources. Friends, Family, Others Savings, Credit Cards, Loans, Investments

To finance a new business, entrepreneurs can use banks, financial companies, investment companies, and government grants. There are 2 broad types of financing for new venturesEquity FinancingDebt Financing

Sources of Equity FinancingEquity Capital: Cash raised for a business in

exchange for ownership stake in that businessEx: Investor might invest $50k for a 25% ownership

stake

Equity funding, AKA: Risk CapitalBecause of the financial risk involvedSuccessful Business: Investor makes a return on

investmentBusiness Fails: Investor loses money

Types of Equity FundingPersonal Savings

#1 Source of $. 67% of businesses are started this way, without borrowing money

Friends/Family What happens to your relationship with these people if the

business fails?Private Investors

Angel: Private investor who funds start-up companies. Nonprofessional financing source.

Partners Remember the partnership agreement we talked about in Ch. 7 Share responsibilities and costs

Venture Capitalists Individual investors or investment firms that invest capital

professionally. Provide managerial as well as technical expertise.State Sponsored Venture Capital Funds

Local economic development corporations help fund new businesses to create jobs.

Sources of Debt FinancingMoney is raised by taking out loans. Not only do

you borrow money, but you pay it back with interest.The entrepreneur retains ownership of the business,

however must record the liability on the business’ accounting books.

Make sure you are certain the business can generate enough cash flow to repay the loan. Compare and contrast long-term vs. short term financing. Do you want a loan out for 30 years, or for 3,5 or 10 years?

Types of Debt FundingBanks

Usually only lend to well-established businessesTrade Credit

Credit that one business will grant to another for the purchase of goods or services.

Minority Enterprise Development Programs Funded by the private sector & SBA. Owners must be at least 51% ethnic

minority, female, or disabled. Also helps secure government contracts & find strategic partners

Commercial Finance Companies More expensive alternate to commercial banks. Less conservative than banks,

and more willing to take risks. Form of security or collateral is required, such as your home.

SBA Loan Small Business Administration. Uses a commercial bank, but guarantees

repayment to the lender up to 90% should your business fail. You and anyone with more than 20% ownership in the business must guarantee the loan with personal assets. (Home, Cars, etc)

SBIC’s Small Business Investment Companies. Privately managed venture capital

companies. Licensed by the SBA to provide equity and debt financing to young, established businesses.

Obtaining Financial and Growth Capital

How To Get Financed! Once you’ve figured out which method your

company will use (Equity vs. Debt), you must create pro forma financial statementsPro Forma: Proposed or Estimated financial

statements based on predictions of how the operations of the business will turn out. Income Statements, Balance Sheets, Cash Flow, etc.

This will give potential investors and other sources of funds a sense of confidence that you know what your doing!

What Venture Capitalists Expect

Venture Capitalists rarely invest in start up companies, but when they do, they look for high-growth firms with BIG potential.Venture Capitalists typically want a 30-70% ROI for a

growing company, and a 50% or more for an early stage venture because of the risk involved.

Ex: If they give you $2 million for 5 years. They will want their original investment within those 5 years, as well as an additional $600,000-$1 Million on top of that. Your business must generate enough money to pay them

off.

What Private Investors ExpectRemember from 19.1, called “Angels”.

Unlike Venture Capitalists, they enjoy being involved in the business.

Typically invest in the business because they are familiar or understand that industry. Most private investors put between $10-500k into a new

business.On average, they aim to get 10x’s their investment at

the end of five years.A strong management team will attract private

investors

What Bankers ExpectBanks must invest conservatively and follow strict

rules about how to invest the bank’s money. Very different from that of a venture capitalistBecause of that, they are MUCH MORE interested in

how you plan, and your ability to repay that loan Cash Flow is a big concern to them You’ve got to be able to cover the business’ monthly

expenses AND the loan paymentBankers rely on the 5 C’s to determine your loan

application Character-Reputation for business practices Capacity-Ability to pay a loan (Cash Flow) Capital-Net worth of a business Collateral-Security for the loan should you not be able to

repay Conditions-Growth, Competition, Economy, etc.

Growth FinancingThis is financing for an already established business

looking to grow! Not start up funding!VC (Venture Capital) Companies

Expect returns of 30-70% May require significant ownership, or a seat on the board of

directors Requires Due Dilligence-Investigation & analysis by an investor

Private Placements Raises capital by selling ownership Private offering or sale of securities (ownership) Investors must meet certain standards, must be “sophisticated”

Investors must have a net worth of at least a million dollars IPOs (Initial Public Offerings)

Sale of stock in a company on a public exchange 5 steps to becoming a public company with stock on pg. 418.

List them.

Calculating Start-Up NeedsStart-Up Costs

Those that you incur prior to the business opening it’s doorsFig. 19.1 on pg. 420, good example of costsEquipment, furniture, fixtures, etc.

Operating CostsAKA working capitalAmount of cash needed to carry out daily operationsCovers the time between selling your product/service and

receiving payment from the customerContingency Fund

Extra amount of money used only when absolutely necessary“Emergency Fund”Some businesses keep enough money in here to operate for 2

or more months.