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Financing venture
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Financing Venture
Common Misconceptions about Entrepreneurial Financing
The Diverse Nature of Business Financing Financing Smaller Businesses with
Modest Growth Potential Financing High Growth, High Potential
Ventures
Common Misconceptions about Entrepreneurial Financing
Venture Capitalists Fund Most Businesses
Banks Lend to Start-ups
SBA lends money directly to entrepreneurs
Entrepreneurs Tend to Rely on One Single Source of Funding
Government Grants are a Good Source of Money for Small Businesses
The Diverse Nature of Business Financing
The Nature of the Business Model
Aspirations of the Entrepreneur
The Stage of Development of the Business Venture
Fitting the Pieces of the Financing Puzzle Together
Financing a Small Business - Modest GrowthFigure 9.1
Pre-launch Start-up Growth Transition
Bootstrapping
Self, friends, and family
Equity financing
Debt financing
Financing a High-Growth, High-Potential Venture
Figure 9.2Pre-launch Start-up Growth Transition
Bootstrapping
Seed financing from angels
Equity financing from VCs
Debt financing
Outline: Chapter 10Start-up Financing From the Entrepreneur, Friends
and Family
Self-financing Advantages and Disadvantages of Self-
financing Friends and Family Financing Structure of Funds Invested
Loan Equity
Most Common Sources of FinancingFigure 10.1
Pre-launch Start-up Growth Transition
Self, friends, and family
Advantages and Disadvantages of Self-Financing
Table 10.1
Advantages DisadvantagesRelative ease of securing funding
May limit size and scope of start-up
Avoid complexity created by adding partners
May limit ability to grow
Better alignment with entrepreneur’s aspirations
Increases exposure to personal risk from business failure
No dilution of profits or gains Entrepreneur may lack all necessary experience, contacts, skills, and/or knowledge
Eventual exit process is often simpler
Copyright 2009 Cornwall, Vang & Hartman
Friends and Family Financing
Determine True Motivations
Use a Formal Business Plan
Provide Accurate, Objective, and Full Information about the Business
Keep Boundaries
Tax Planning
Outline: Chapter 11Bootstrapping
Why bootstrap? Bootstrapping Administrative Overhead Bootstrapping Employee Expenses Bootstrapping Operating Expenses Bootstrap Marketing The Ethics of Bootstrapping
Bootstrapping Throughout the Life of a VentureFigure 11.1
Pre-launch Start-up Growth Transition
Bootstrapping
Bootstrapping
Defined as the “process of finding creative ways exploit opportunities to launch and grow businesses with the limited resources available for most start-up ventures.”
Cornwall, J. (2010). Bootstrapping. Englewood Cliffs, NJ: Pearson/Prentice-Hall.
Why Bootstrap? Often necessary for small businesses to
get started Difficulty in raising money for growth Preserves the value and wealth of a
business “Extend the Runway” Reduce risk associated with debt
financing
Rules of Bootstrapping
Rule #1: Overhead matters
Rule #2: Employee expenses are usually the highest single recurring cost
Rule #3: Minimize operating costs
Rule #4: Marketing matters, but know your customers and how they make decisions
Bootstrapping Administrative Overhead
Space Furnishings and office equipment Administrative salaries
Bootstrapping Employee Expenses
Employee “stretching” Independent contractors Employee leasing and temporary
employees Student interns Equity compensation Non-monetary benefits
Bootstrapping Operating Expenses
Outsourcing Just-in-time inventory techniques Effective cost accounting
Copyright 2009 Cornwall, Vang & Hartman
Bootstrap Marketing Know your customer Focus on the impact of message, not
“volume” Focus on benefits for customer Understand the market niche Spend your marketing dollars wisely Marketing is a process, not an event
The Basic Bootstrap Marketing Tools
Word of Mouth Business cards Blogs Brochures Banners and signs Newsletters Direct mailing/e-mailing Publicity
Word of Mouth
Motivate customers to talk about business
Create incentives to spread the word
Ask customers to “sell”
Create a “buzz” campaign
Viral marketing
Business Cards
Design is important
Include needed data about business
Use quality paper
Use color
Include description and/or slogan
Use both side of card
Outline: Chapter 12External Sources of Funds: Equity
Angel Investors Strategic Partners Private Placement SBIC The Downside of Equity Financing Working with Outside Investors
Equity FinancingFigure 12.1
Pre-launch Start-up Growth Transition
Equity financing
Downside of Equity Financing
Dilution of ownership The risk of sharks Dynamics of adding on new partners
Working with Equity Investors
Business plan Confidentiality agreement Letter of Intent Modifications of shareholder agreements Communication with shareholders
Outline: Chapter 13External Sources of Funds: Debt
Short-term debt Long-term debt Forms of debt overlooked by
entrepreneurs Working with bankers Downside of debt Developing a Financing Plan
Debt FinancingFigure 13.1
Pre-launch Start-up Growth Transition
Debt financing
Short-term Debt
Expected to be paid within one year Most often used to finance short-term
expenditures such as inventory, supplies, payroll, etc.
Short-term Debt
Trade debt Institutional Creditors
Banks Asset-based lenders Factors
Long-term Debt Beyond one year
Most often used to fund fixed asset purchases
Long-term Debt
Banks: term loans Leasing companies Real estate lenders
Criteria for Lending by Bankers
Ability of the business to generate enough cash flow to easily make interest and principle payments
Entrepreneur’s ability to personally pay back the loan if the business fails
Assets to serve as collateral
Key Loan Documents
Loan proposal Loan document Personal guarantees
Downside of Debt
Increased risk during economic slowdown Impact on proceeds from business sale Restrictive covenants Personal guarantees
Example of Assets and Potential Funding GeneratedTable 13.1
Asset Estimated value
Percentage financed
Potential funding generated
Customer Purchase Orders
$50,000 70% $35,000
Accts. Receivable (<60 days)
$80,000 70% $56,000
Inventory $20,000 30% $ 6,000Leasehold Improvements
$10,000 50% $ 5,000
Building $120,000 70% $84,000Undeveloped Land
$40,000 40% $16,000
Equipment $15,000 80% $12,000Total of Business Funding Sources
$335,000 $214,000
Copyright 2009 Cornwall, Vang & Hartman
Outline: Chapter 14Financing the High Growth Business
What Venture Capitalists and Private Equity Funds Provide – The Four “C’s”
Integrating Profitability into the Business Plan Stages of the Firm Stages of Business Funding The Dark Side of Venture Capital Financing Initial Contact with a Venture Capitalist Initial Public Offering (IPO) The Process of the IPO
Financing a High Growth VentureFigure 14.1
Pre-launch Start-up Growth Transition
Venture capital equity financing
The “Four Cs” of Venture Capital
Capital
Contacts
Counsel
Credibility
Stages of High Growth Business Funding
Initial stage First round financing Second round financing Late round financing
Initial Stage Funding File for incorporation Write business plan Find office and development space Completion of initial design Hire key development personnel Complete prototype unit Complete prototype testing
First Round Financing Secure key vendors Hire key service or manufacturing personnel Rent or build manufacturing facility Purchase manufacturing equipment Market testing First sales contract Production of first manufactured unit First 100, 1000, 10000 units, etc.
Second Round Financing
Break-even level of sales Development of next generation of product
Late Round Financing Initial public offering Sale of business
Initial Contact with a Venture Capitalist
Funding amount Duration Summary of the project Use of funding Confirm how the transaction will be liquidated Existing investment in the project Names of bankers, lawyers, accountants and
consultants Unusual or sensitive information
Venture Capital Term Sheet
Amount the venture capitalist wishes to invest. Percentage of ownership to the venture capitalist. The nature of the investment such as loan, stock, warrants,
etc. Governance rights of the venture capitalist. Right to eventually register shares for a public offering. Remaining conditions to be met by the entrepreneur such
as periodic reports, financial statements, etc. An estimate of valuation of the company. Specific requirements on what the money is to be used for
or specific assets that must be purchased with the funds.
Initial Public Offering
Advantages Disadvantages
Diversification and liquidity
Reporting costs
Ability to raise new cash
Disclosure of information
Valuation Maintenance of control
Future business deals
Publicity
Process of the IPO
1. Selecting an investment banking firm
2. The decision to underwrite or not underwrite
3. Getting the paperwork in order and certifying the price of the offering
4. The road show
5. Determine the size of the book
6. The first day of trading
Outline: Chapter 13Business Valuation
General concepts that guide the determination of value
Basic information required for a valuation Estimating a firm’s cash flow and determining its
value Definition of cash flow Estimating the cash flow for a particular year
Concepts that Guide the Determination of Value
1. Fair market value
2. Going-concern value
3. Highest and best use
4. Future benefits
5. Substitutes and alternatives
6. Discounted cash flow analysis
7. Objectivity
Information Required for a Valuation
Income statements and/or tax returns Balance sheet Rates of return consistent with the risk
level Interviews with current owners and staff Assessment of future business environment
Discounted Cash Flow Incorporates all other principles Income-oriented approach Can use EBITDA Needs a required rate of return
Perceived Rates of Return Publicly traded company 12-18% Privately held company 20-35% Angel investors 20-50% Venture capitalists 35-80%
Estimating Cash Flow
EBIT +owner’s salary -reasonable salary +depreciation +personal expenses =EBITDA -equipment purchased -inventory investment =Free Cash Flow
Calculating Value
Enter zero for Cf0
Enter each year’s unique free cash flow For final year enter the sum of the
terminal cash flow and the year’s free cash flow
Enter required rate of return as interest rate
Calculated NPV is the value of the firm
Market Comparison Approach Price/Earnings Price/Pre-tax Earnings Price/Cash Flow Price/EBITDA Price/Dividend Price/Sales Price/Assets Price/Book Value Price/Customer Price/Unit
Market Comparison Problems
Line of business Geographic area Age of assets Listing status Costs of inputs Level of
establishment
Sale terms
Standing of ownership
Size
Financing
Time period
Similar buyer
Outline: Chapter 14Exit Planning
Self-assessment revisited The ethical side of the entrepreneur’s
transition A model of exit planning Exit options The process of selling a business Post exit issues
Exit Planning
The process of preparing for the transition of both the entrepreneur and the business
Exit Through Ownership Transfer
Type of Exit Advantages Disadvantages
Asset Sale Cash sale Immediate tax on full sale
Clean break Lower face value sale price
Earn-out possible
Stock Sale Higher face value of sale price
Potential volatility of stock from sale
Tax deferment of sale price
Restrictions on sale of stock
Exit Through Partial or Limited Transfer
Type of Exit Advantages Disadvantages
Merger Potential synergies
Cultures may clash
Tax deferment of sale price
Limited opportunity for immediate cash
IPO Taking some cash out possible
Limits on sale of stock
Can bring in professional management
Exit Through Partial or Limited Transfer(Continued)
Type of Exit Advantages Disadvantages
Strategic Alliance Reduces risk to existing value
May be long time, if at all, to actual exit
ESOP Can maintain business culture
May be long time, if at all, to actual exit
Family Business Transfer
Can maintain business culture
Challenges of generational succession
Exit Through Bankruptcy
Type of Exit Advantages Disadvantages
Bankruptcy Orderly end to business
Ethical challenges
Results in no realization of wealth from business
Can hurt entrepreneur’s
ability to fund future deals
Exit Through Liquidation
Type of Exit Advantages Disadvantages
Liquidation May result in more value, especially for service business
No value for going concern
Can be viewed as “failure”
Exit Planning1. Re-examine owners’ aspirations2. Evaluate timing issues 3. Consider ethical issues of exit plans4. Set specific financial goals, and the timeframe
to achieve these goals, based on owners’ aspirations related to wealth
5. Establish a specific plan to meet financial goals 6. Begin external audit or review7. Evaluate possible exit options
Figure 14.4
Sale Process of a Business
Initial Inquiry
Letter of Intent
Deal Price and Basic Structure Agreed Upon
Purchase Agreement and Closing
Due Diligence
10 % of deals proceed to next stage
50 % of deals proceed to next stage
50 % of deals proceed to next stage