Sources of Financing Tool Kit

General sources of information

Useful web SitesInc. Magazine << www.inc.com >>

vFinance.com, Inc. << www.vfinance.com >>– Publicly-owned financial services company that provides investment banking and brokerage services to later-stage

private firms, public companies and high net worth investors.

Price Waterhouse Coopers Entrepreneur Resource Center. New York: Price Waterhouse Coopers.

<< www.pwcerc.com/index.asp >>– Includes advice on getting venture funding and other sources of capital. Includes information on setting a value on a

venture and on business plans.

Useful booksBernstein, Michael C. Raising Capital: The Grant Thornton LLP Guide For Entrepreneurs. Chicago:

Irwin Professional Pub., 1996. – Guides entrepreneurs to the various financing sources that are available.

The Corporate Finance Sourcebook. New York: McGraw-Hill. Annual. – Lists various types of financing sources from commercial banks to venture capitalists.

Bootstrapping

Internally-generated funds (bootstrapping)Definition: Building a business with minimal outside capital. Rely primarily on personalsavings to start and grow through retained earnings.Range of funding: Varies based upon opportunity; $10,000 on averageDistinguishing characteristics: Business is managed in lean manner: attract employees byopportunity to develop skills, expand at affordable rate of growth; focus on cash.Look for: quick break-even, cash generating projects; business opportunities that earnhealthy margins to cover expenses and fund growth.Advantages DisadvantagesEntrepreneur retains control Won’t work for businesses that require a large

up-front investmentLean operations expose problems promptly May not be able to afford top-quality

employeesAvoid complex deals and performancereviews required by investors

Requires willingness to be “scrappy”

Questions to ask: Is my business idea well-suited to being under-capitalized? Do I possess the personal attributes necessary to be successful in this approach?Where to find additional information:

Web sites: US Small Business Association<< http://www.sba.gov/financing/ >>

About.com, Inc.<< http://home.about.com/smallbusiness/index.htm >>

Friends and family

Friends & FamilyDefinition: tapping personal network to raise cash for a venture that is too new (or toosmall) to get funds from other sources.

Range of funding: < $500,000

Distinguishing characteristics: wide variety of investors; capital is often provided fornonfinancial reasons

Return requirements: required return depends upon relationship of investor to entrepreneur.

Advantages DisadvantagesGenerally less time consuming search Can harm amicable relationships if venture

fails.Less due diligence required Lack expertise to provide guidance as venture

growsCheaper capital Unlikely to provide additional fundingEntrepreneur retains ownership Potentially unsophisticated investors may be

difficult to manageQuestions to ask: What will I say to my family investors at Thanksgiving if things aren’t going well?

How might these agreements turn off future investors?

Where to find additional information: Personal and professional networks.

AngelsAngels

Definition: private investors (i.e., wealthy individuals) who manage their own money or areadvised by accountants, lawyers, or other professionals.Range of funding: < $1,000,000Distinguishing characteristics: wide variety of investors; capital is often provided fornonfinancial reasons.Looking for: technologies the investor understands, early stage companies, investmentslocated near where they live.Return requirements: angel investors tend to accept greater risk and lower returns if theidea is attractive for nonfinancial reasons (e.g., intellectual challenge, societal benefits).Advantages DisadvantagesEntrepreneur retains ownership Potentially less sophisticated than other

investorsCheaper capital Unlikely to be source of additional fundsHigher valuation (vs. VCs) Lack of advice, expertise, and contactsLess due diligence vs. other sources Can be barrier in future financing roundsQuestions to ask: What do these angels bring besides money? Expertise? Contacts? Experience? Why are they investing? What will they expect in return? Back-seat drivers? Can i tolerate frustrations that occur with potentially unsophisticated investors?Where to find additional information:The Access to Capital Electronic Network (ACE-Net). Durham, University of New

Hampshire. << https://ace-net.sr.unh.edu/pub/ >>– A national securities offering listing service that addresses the capital gap in the

$250,000 to $5 million range.Garage.com.Palo Alto, CA: << http://www.garage.com/index.shtml >>

- Where early stage high technology companies and investors can get together.Articles:Roberts, Michael J., Howard H. Stevenson and Kenneth P. Morse, “Angel Investing.” HBSNp. 9-800-273 (Boston: Harvard Business School Pulishing, 1993).Van Osnabrugge, Mark, and Robert J. Robinson. Angel Investing: Matching Start-UpFunds with Start-Up Companies: The Guide for Entrepreneurs, Individual Investors, andVenture Capitalists. Jossey-Bass, 2000.

Incubators

IncubatorsDefinition: incubators nurture young firms by providing financing, management assistance,expandable space.Range of funding: < $2 millionDistinguishing characteristics: provide entrepreneurs with the expertise, networks and toolsthey need to build successful ventures; less active management role than VCs.Return requirements: 50% - 70%

Advantages DisadvantagesOffer office space, funding, recruiting,accounting, legal , & administrativeservices, thus saving the entrepreneur timein establishing basic infrastructure

Nascent industry (limited history)

Some provide access to an organizednetwork (the “networked incubator” definedby Hansen et. al.) that provides competitveadvantage

Limited number of success stories

Entrepreneur relinquishes less equity vs. VCdeals (generally 20-40%)

Entrepreneur can potentially becomeburdened by organizational impediments(e.g., bureaucracy)

Questions to ask: How extensive is the incubator’s network, in terms of strategic partners and advisors? Does the incubator foster partnerships and encourage knowledge sharing across member

companies? Are the companies in the incubator’s portfolio related to one another either by industry

or technology? How do the companies network with one another? Will I be able to retain a significant equity stake (e.g., 60%) in my venture?

Incubators

IncubatorsWhere to find additional information:

Web sites:National Business Incubation Association. Athens, OH. << http://www.nbia.org/ >>

- Features information on business incubation, incubation news, links toincubators and information on conferences.

“The State of the Incubator Marketspace” research report:<< www.hbsp.harvard.edu/hbr/incubator >>

Business Incubation and Internet Accelerators. Philadelphia, PA: Benjamin C. Powell.<< http://www.rednecktech.com/ >>

– Compiled by a PhD candidate at Wharton, lists incubators and resources aboutthem including books, dissertations, articles (updated monthly), local andinternational associations and newsletters, etc.

Article:Hansen, Morten T., Henry W. Chesbrough, Nitin Nohria, and Donald N. Sull. “NetworkedIncubators: Hothouses of the New Economy.” Harvard Busines Review (September-October 2000: 74-85.

Venture capitalists

Venture CapitalistsDefinition: Independently managed, dedicated pools of capital focusing on equity orequity-linked investments in privately held, high-growth companies (Gompers & Lerner, 1999).

Range of funding: varies according to stage Start-up: $ 1 – $ 4 million First stage: $ 4 - $10 million Expansion: $10 - $30+ million

SOURCE: NVCA

Distinguishing characteristics: riskier individual investments, relatively long time horizons(e.g., fund life on 10 years); VCs assume active managerial roles and provide access tonetworks of customers, suppliers, employees, and underwriters.Looking for: people, new technologies, large market opportunities.Return requirements: 35% - 70% annual return depending on financing stage

Start-up (idea stage): 50% - 70% First stage (new business): 40% - 60% Second stage (development): 30% - 50% Third stage (expansion): 25% - 40% IPO: 5% sOURCE: Plummer, 1987

Advantages DisadvantagesDeep pockets Entrepreneur sacrifices equity and controlManagerial and operational expertise Due diligence long and potentially harmfulContacts: customers, suppliers, employees VCs are aggressive on termsBoard expertise Adherence to milestonesRelationships: next stage of financing Time frame or liquidity plan may differ from

entrepreneur’sIPO experience Will replace management (i.e., you)

Venture capitalists

Venture CapitalistsQuestions to ask: Do VCs have experience in similar types of investments? Will they play an active or passive role? Do you enjoy working with the VCs? Are there competing companies in the portfolio? How strong are the firm’s ties to other VCs for additional rounds of finaning? Will they provide contacts to networks of customers, suppliers, and recruiters?

Where to find additional information:Web sites:National Venture Capital Association << http://www.nvca.org/ >>Baker Library Industry Guide: Venture Capital and Private Equity<< http://www.library.hbs.edu/industry/venture-directories.htm >>

Books:Pratt’s Guide to Venture Capital Sources 2000 Edition, David Kwateng, editor (SecuritiesData Publishing).Fitzroy Dearborn International Directory of Venture Capital Funds. Chicago: Fitzroy Dearborn. Annual

- Directory covers over 1,000 funds and is arranged in 5 sections: General Companies; High tecchnology/Medical funds; Minority and Socially-useful funds; Strategic Partners; and VentureCapital Funds outside the U.S.

Articles:Sahlman, William, “Aspects of Financial Contracting in Venture Capital,” Journal ofApplied Corporate Finance, Summer 1998.Gompers, Paul, and Josh Lerner. "Venture Capital." In The Technology ManagementHandbook, 1-16:1-21, edited by Richard C. Dorf. New York: CRC Press, 1999.

Commercial bank loans

Commercial Bank LoansDefinition: loans secured by assets, receivables, inventories, personal assets.Range of funding: < $500,000Distinguishing characteristics: maturities up to ten years. (e.g., real estate, equipment,personal assets).Look for: low-risk ventures, shorter-term loans, collateral.Return requirements: Lower than equity investors such as VCs (willing to accept lowerrisk).

Advantages DisadvantagesEntrepreneur retains ownership Set schedule of principal and interest

paymentsMore borrowing allows for potentiallygreater return on equity

Covenants may be restrictive

Opportunity cost is justified during periodsof low interest rates.

Heavy use of debt can inhibit growth

Questions to ask: How much money do I need, and how soon do I expect to pay it back? Am I willing to provide a personal guarantee?

Where to find additional information:Web sitesMembers. Washington, DC: America's Community Bankers.<< http://www.acbankers.org/About/membersites.asp >>

-Lists community banks by state.

Bank Data: Individual Banks. Washington, DC: Federal Deposit Insurance Corporation.<< http://www.fdic.gov/bank/individual/index.html >>

-Includes directories of banks, including online banks, and financial information onindividual banks.

Association:Independent Banker’s Association of America: 800 – 422 – 8439

SBA loans

SBA LoansDefinition: Loan with maturity of 5-20 years; interest charges similar to that of commercialbanks.Range of funding: SBA Express: <$150,000; SBA Guaranty < $2 millionDistinguishing characteristics: SBA Guaranty Loan extended to riskier ventures; SBAguarantees payment of 75-85% of principalLook for: repayment ability from the cash flow of the business, good character,management capability, collateral (land and buildings are required for longer repaymentschedule), and owner's equity commitment.Return requirements: lower than equity financing sources.

Advantages DisadvantagesAlternative for those unable to getcommercial bank loans (e.g., higher riskventures)

SBA Guaranty loan requires additionalpaperwork (vs. commercial bank loan)

SBA Express provides a response within36 hours of receiving application

Special eligibility requirements (e.g., type andsize of business, use of loan funds)

International Trade Loans guaranteed up to$1,250, 000 for a combination of fixed-asset (facilities and equipment) financingand Export Working Capital Program(EWCP) assistance

Owners of 20% or more are required topersonally guarantee loan

Questions to ask: Are there alternative sources that require less bureaucratic procedures? Do I qualify for special programs for minority and or women applicants?

Where to find additional information:

<<http://www.sba.gov/ >>

Strategic partnerships

Strategic PartnershipsDefinition: Cash infusion from established company in exchange for entrepreneurialventure’s capabilites, products, or services.Range of funding: < $3 millionDistinguishing characteristics: alternative source for ventures unwilling to assume debtburden or accept low equity valuation.Look for: complementary strengths that will lead to growth.Return requirements: vary based upon company, industry, and nature of partnership (e.g.,some corporate partners are willing to pay for technology or other capabilities).

Advantages DisadvantagesExtensive resources Bureaucracy: slow decision-making processGenerally pay higher price per sharecompared to other investors

Goals of corporate partner may not be alignedwith entrepreneur’s

Build credibility in industry Corporate partner will focus on core businessQuestions to ask: Is it possible to establish a relationship through marketing or technology agreements

without relinquishing equity? Are the people I am contracting with likely to stay with the partner company, or might I

be hostage to corporate politics?Where to find additional information:

Dow Jones Interactive << http://www.library.hbs.edu/dji.htm >> Searchable archive of 6,000 international publications

One Source Global Business Browser << www.library.hbs.edu/onesource.htm >> Covers 189 countries worldwide