Masters in Engineering and Management of Technology Masters in engineering Design

Masters in Engineering and Management of Technology

Masters in engineering Design

Introduction to Entrepreneurship and New Venture Creation

Rui Baptista

New Venture Financing

Entrepreneurship - Rui Baptista3

Financial Steps in the Evolution of a Successful New Firm

1. Founding Stage:

The entrepreneurial team begins with a vision, business model and strategy

1. Founding Stage:

The entrepreneurial team begins with a vision, business model and strategy

2. Seed Stage:

Initial financial capital

2. Seed Stage:

Initial financial capital

3. Growth Stage:

Growth capital required

3. Growth Stage:

Growth capital required

4. Harvest Stage:

IPO or acquisition provides returns to investors and founders

4. Harvest Stage:

IPO or acquisition provides returns to investors and founders


Idealized Cash Flow Diagram for a New Firm

Cumulative Cash Flow ($millions)

-3

+3

+2

+1

20

10 30 40 50 Time (months)

Cash Breakeven

0

-1

-2


Early Stage Funding

Most start-ups will not raise outside capital Niche markets that are too small No sustainable competitive advantage Strategy relies only on execution, personal

selling and energy of the entrepreneur Team lacks industry experience Profit margins that are too low No Harvest/Exit Upside


Financing Rules for Startups

Choose ventures with reasonable (low) capital requirements

Get operational quicklyGenerate cashStick to high value productsControl growthFocus on cash, not profits or market

share


Sources of Financing for Start-ups

Founders Family and Friends Professional Investors — Business Angels Seed Capital Venture Capital Bank Loans Debts to Suppliers Customer Prepayments Leasing Companies Established Companies Government Grants and Credits Public Stock Offering


Sources of Start-up Capital in the United States

78.5% - Personal savings

21.4% - Angels, employees, partners, friends

14.4% - Bank loans 12.9% - Family

Members

6.3% - Venture capital 4.0% - Mortgaged

property 1.1% - Government

guaranteed loan 3.4% - Other


Personal Resources

Offers greatest return, if successful Investors and venture capital sources usually

require it Personal funds can be treated as equity or debt Possible Sources:

Savings Severance packages Personal asset sales “Moonlighting” “Bootstraping”


“Bootstrap” Financing

To start a firm by one’s own efforts and to rely solely on the resources available from oneself, family, and friends

Often applied to a current business that can reduce costs from current operation

Usually overlooked as a source to entrepreneurs

The entrepreneur becomes more efficient and cost conscious


Advantages and Sisadvantages of “Bootstrap” Financing

Less pressure on generating profits fast

Easy terms on ownership

Control by founders

Little time spent on finding investors

Unable to fund growth phase

Lack of funding commitment for the future

Loss of advice from professional investors


“Moonlighting”

Founder still working a regular job Income used to support the

entrepreneur during needed cash flow When the venture begins paying as

well or better – entrepreneur leaves job


Angel Financing

Angels are wealthy individuals, usually experienced entrepreneurs, who invest in business start-ups in exchange for equity in the new ventures.

Usually take interest in management Popular source in the US – in 1996, estimated

250,000 angels investing $10-$20 billion in 30,000 firms each year

Entrepreneurs and business angels are often connected through intermediary companies – Angel Networks


Angel Investment Criteria

Seek start-ups within the industry that the angel has experience

Located near company Recommended by trusted associates/connections Entrepreneurs with attractive personal characteristics

such as integrity and ‘coachability’ Good rapport with management team Good market and growth potential for the opportunity Exit strategy of merger, IPO, or buyback Expected performance smaller than with venture capital

(ROI of 30% to 50%; sales growth of 10-20% per year) Seeking an investment of $100,000 to $1 million in

exchange for minority ownership, less than 40%


Venture Capital Financing

Venture capital is a source of funds for new ventures that is managed by investment professionals on behalf of the investors in the venture capital fund

Requires a robust market, margin, and money-making features: High net profit potential – minimum 10 to 15% and durable Attractive returns for investors – 40-70% ROI Growth of more than 20% Gross Margins of 40% and durable Quick to break-even and positive cash flow

The number of startups with venture capital is extremely small: there were about 8200 VC investments in 2000 in the US, while the number of startups/year is 1 to 3 million

A significant part of the VC investments happens at a later stage – growth/IPO


Risk-Reward Profile for Various Investments

50

40

30

20

10

0

Treasury Bonds

Corporate Bonds

Franchises

Imitations, Improvements

Innovations, Technology

Strong Growth Companies

Acquisitions

Money Market Funds

Risk: Low Medium High

Chance of 0 30% 60% Total Loss

E x p e c t e d

A n n u a l

R e t u r n

(%)


Characteristics of an Attractive Venture Capital Investment

Outstanding opportunity: potential to become a leading firm in a high growth industry with few competitors

Highly competent and committed management team and high human capital (talent)

Strong competitive abilities and a sustainable competitive advantage

Viable exit or harvest strategy Reasonable valuation of the new venture Founders capital invested in the venture. Recognizes competitors and has a solid competitive strategy A sound business plan showing how cash flow turns positive

within a few years Demonstrated progress on the product design and good sales

potential


Venture Capital Criteria

Quick to gain customer base Product/service creates or adds significant value to customer Customers are reachable and receptive

Competitive advantages “First mover” advantages Patents, trade secrets, special know-how Control over prices or costs Special relationships with customers or suppliers

Attractive value creation and realization Low to moderate capital needs Viable exit strategy Good Risk/reward balance Good capital market timing


Bank Loans

Strongly based on character and background Banks loan on assets but require demonstration

of capacity to repay (cash-flow, management experience, competitive position, financial projections)

Capital structure – about 30% loan + equity (own funds)

Collateral – marketable assets; personal guarantees

Requires business and key-person insurance coverage


Government Financing

Government intervenes in the financing of new ventures to remedy market failure – incomplete markets occur when the risk perceived by the entrepreneur is significantly lower than the risk perceived by the financing institution

Market failure is usually more serious at the very early stage of development of new business ideas, and in particular for ideas that require large initial investments and a long pre-market development period

Financing can take the form of direct grants/subsidies, guaranteed loans, or low interest rates

Portuguese Government Agency for Small Business: IAPMEI (http://www.iapmei.pt/)


Growth Financing and Harvest

Initial Public Offering (IPO): the first public equity issue of stock made by a company

Advantages Raising new capital with the possibility of later, additional offerings Liquidity — Ability to convert ownership to cash, potential of

harvest for investors and founders Visibility — Build brand and reputation

Disadvantages Costs and effort for mounting the operation Disclosure requirements and scrutiny of operations Perceived pressures on achieving short-term results Possible loss of control to a majority shareholder


Valuation

The valuation rule is the algorithm by which an investor such as an angel or venture capitalist assigns a monetary value to a new venture:

Initial Equity Value: M0

Expected Earnings of the Firm: G1+G2+…GN

Initial Market Value: MN = M0 + G1+G2+…GN

Capital Return at IPO: R = MN / M0 - 1


Terms of an Investment Deal

Percent ownership for the investor group or business angel Timing of investment and IPO Control exerted by investor Vesting periods for ownership by the entrepreneurial team Rights to require an IPO Type of security Reservation of ownership for employees (stock option

pool) Anti-dilution provisions Milestones of achievement, if there are multiple tranches

(steps) to the investment

Documents

Masters in Engineering and Management of Technology Masters in engineering Design