Chapter 7

Bootstrapping and Financing the closely held company

Objectives

• Understand bootstrapping and its importance• Identify different methods of early stage

funding• Learn problems and issues in raising capital• Learn to use a bank to acquire a loan• Learn to prepare and apply for a loan• Build a relationship with a banker• Identify government financing programs

Introduction

• Equity investors provide money to customers in exchange for part ownership in the form of shares to get a financial return on their money.

• Investors typically seek an annual return on equity investments of 30 percent at a minimum – since early stage companies are risky investments.

• Running out of money is the most common reason for small companies to fail.

Securing early stage funding

• Businesses are usually started with funds that come from personal savings or various forms of personal equity of the founder.

• Investors and lenders expect entrepreneurs to put some of their own assets at risk.

• Many businesses are started when the founder is still working a full time job.

• When the business pays well or better than the current job, the entrepreneur can leave the current job and work on building the new business.

Bootstrapping• Some bootstrapping (self funding) techniques:• 1. No or low rent: Use residence for office or workspace. HP was started by two

fresh graduates in a garage. Subletting can offset some of the cost of leasing.• 2. Barter for Goods and Services: For example trade web site development with

small local engineering firm in exchange for machining prototype of product.• 3. Trading Intellectual Property Rights: Dyson traded international rights when he

desperately needed cash.• 4. Renting or leasing equipment: only when it is needed.• 5. Used equipment: to fill short term needs. Also for office furniture .• 6. Access to expensive equipment: check out universities or government labs.• 7. Suppliers and customers help: suppliers may help funding inventory till you

receive payment from customers. Customers may pre pay on future delivery.• 8. Outsourcing: payroll services, book keeping, tax return preparation, legal,

accounting, and consulting services.• 9. Credit cards.

Family, friends, bank loans

• Friends and family are popular sources for start up capital, because they are not wooried about quick profits as professional investors.

• Advantage of bank loans is that entrepreneurs do not have to give up any part of ownership to receive the funds.

Preparing a loan proposal• A loan proposal consists of 7 key parts:• 1. Summary: Name and title, company name and address, nature of business,

amount sought, purpose, and source of repayment.• 2. Management team profiles: Backgrounds and history of the key managers.• 3. Business description: Products and markets, customers and competition,

inventory size, rate of turnover, and market ability. Status of accounts receivable and accounts payable and a list of fixed assets.

• 4. Financial projections: Forecasts for the next 3 years with fallback plans based on industry practices and trends.

• 5. Financial statements: Audited balance sheet and income statement for the past 3 years (if available). Personal financial statements including tax returns for the past 3 years.

• 6. Amount and purpose: How much and why. How funds will be used.• 7. Repayment plans: How you will generate the cash to provide payments for both

the interest and principal.

The four C’s of Lending

• Lenders are looking for a company’s ability to repay its debt.• 1. Character: Talent, reliability, and honesty are used to

describe character.• 2. Cash flow: Banks need to be satisfied that cash flow will be

adequate to cover debt service.• 3. Collateral: Normally involves securing liens or mortgages

against assets such as real estate or equipment.• 4. Contribution: This commitment reduces the lender’s

exposure in the event of a default.

Establishing terms of debt

• Terms of debt: The length of time over which the obligation is amortized or paid off.

• Rates: Most business debt is provided a variable interest rate usually fluctuating with the prime rate (rate banks charge for their best customers).

• Building a relationship with a banker: setting up a checking account at a bank is the first step in building a relationship with a lending institution. You want a loan officer who knows the business and will take a personal interest in the entrepreneur and the company.

Using Government Sources of Funding

• The SBA (Small Business Administration) works with banks and other lending institutions to get loans for small businesses.

• The SBIR (Small Business Innovation Research) program and the ATP (Advanced Technology Program) are among other federal programs that provide funds to small businesses to develop new technologies.

The SBA Loan Application• 1. Application information: Name of owners, background, addresses,

business name, date started, and other statements of business.• 2. Use of Loan Proceeds: Description of how the loan will be used in

business operations.• 3. Collateral Pledged: List of all business and personal assets to secure the

loan.• 4. Disclosures: List existing or previous government financing, personal or

business debts, bankruptcies, and lawsuits.• 5. Personal Balance Sheet: Balance sheet of borrowers.• 6. Financial Statements: Cash flow and use of funds statements.

Summary• Equity investors typically seek an annual return on equity investments of 30 percent at a minimum – since

early stage companies are risky investments.• Running out of money is the most common reason for small companies to fail.• Many businesses are started when the founder is still working a full time job.• When the business pays well or better than the current job, the entrepreneur can leave the current job

and work on building the new business.• Some bootstrapping (self funding) techniques: 1. No or low rent 2. Barter for Goods and Services 3.

Trading Intellectual Property Rights 4. Renting or leasing equipment 5. Used equipment 6. Access to expensive equipment 7. Suppliers and customers help 8. Outsourcing 9. Credit cards.

• 7 key parts of a loan proposal: 1. Summary 2. Management team profiles 3. Business description 4. Financial projections 5. Financial statements 6. Amount and purpose 7. Repayment plans

• The 4 C’s of lending: 1. Character 2. Cash flow 3. Collateral 4. Contribution• Building a relationship with a banker: You want a loan officer who knows the business and will take a

personal interest in the entrepreneur and the company.• The SBA (Small Business Administration) works with banks and other lending institutions to get loans for

small businesses.• The SBA Loan Application: 1. Application information 2. Use of Loan Proceeds 3. Collateral Pledged 4.

Disclosures 5. Personal Balance Sheet 6. Financial Statements.

Home Work

• 1. What rate of return do early investors expect and why?

• 2. What is the most common reason for small companies to fail?

• 3. Name 5 bootstrapping techniques.• 4. Name the 7 key parts of a loan proposal.• 5. Name the 4 C’s of lending.