Part III Overheads

Outline: Chapter 9Outline: Chapter 9Financing Over the Life of a Financing Over the Life of a VentureVenture Common Misconceptions about

Entrepreneurial FinancingThe Diverse Nature of Business

Financing Financing Smaller Businesses

with Modest Growth PotentialFinancing High Growth, High

Potential Ventures

Copyright 2009 Cornwall, Vang & Hartman

Common Misconceptions Common Misconceptions about Entrepreneurial about Entrepreneurial FinancingFinancingVenture 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 The Diverse Nature of Business Financing 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 Financing a Small Business - Modest GrowthGrowthFigure 9.1 Figure 9.1

Pre-launch Start-up Growth Transition

Bootstrapping

Self, friends, and family

Equity financing

Debt financing


Financing a High-Growth, High-Financing a High-Growth, High-Potential VenturePotential VentureFigure 9.2Figure 9.2


Bootstrapping

Seed financing from angels

Equity financing from VCs

Debt financing


Outline: Chapter 10Outline: Chapter 10Start-up Financing From the Entrepreneur, Start-up Financing From the Entrepreneur, Friends and Family Friends and Family

Self-financingAdvantages and Disadvantages

of Self-financing Friends and Family FinancingStructure of Funds Invested

◦Loan◦Equity


Most Common Sources of Most Common Sources of FinancingFinancingFigure 10.1Figure 10.1



Self, friends, and family

Advantages and Disadvantages of Advantages and Disadvantages of Self-FinancingSelf-FinancingTable 10.1Table 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


Friends and Family Friends and Family FinancingFinancingDetermine True Motivations Use a Formal Business PlanProvide Accurate, Objective, and

Full Information about the Business

Keep BoundariesTax Planning


Outline: Chapter 11Outline: Chapter 11BootstrappingBootstrapping

Why bootstrap?Bootstrapping Administrative OverheadBootstrapping Employee ExpensesBootstrapping Operating ExpensesBootstrap MarketingThe Ethics of Bootstrapping


Bootstrapping Throughout the Life of a Bootstrapping Throughout the Life of a VentureVentureFigure 11.1Figure 11.1



Bootstrapping

BootstrappingBootstrapping

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?Why Bootstrap?Often necessary for small

businesses to get startedDifficulty in raising money for

growthPreserves the value and wealth

of a business“Extend the Runway”Reduce risk associated with debt

financing


Rules of BootstrappingRules of BootstrappingRule #1: Overhead mattersRule #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 Bootstrapping Administrative Overhead Overhead

SpaceFurnishings and office

equipment Administrative salaries


Bootstrapping Employee Bootstrapping Employee ExpensesExpensesEmployee “stretching”Independent contractors Employee leasing and temporary

employeesStudent interns Equity compensation Non-monetary benefits


Bootstrapping Operating Bootstrapping Operating ExpensesExpensesOutsourcingJust-in-time inventory

techniquesEffective cost accounting


Bootstrap MarketingBootstrap MarketingKnow your customerFocus on the impact of message,

not “volume”Focus on benefits for customerUnderstand the market nicheSpend your marketing dollars

wiselyMarketing is a process, not an

eventCopyright 2009 Cornwall, Vang & Hartman

The Basic Bootstrap Marketing The Basic Bootstrap Marketing ToolsToolsWord of MouthBusiness cardsBlogsBrochuresBanners and signs NewslettersDirect mailing/e-mailingPublicity


Word of MouthWord of MouthMotivate customers to talk about

businessCreate incentives to spread the

wordAsk customers to “sell”Create a “buzz” campaignViral marketing


Business CardsBusiness CardsDesign is importantInclude needed data about

businessUse quality paperUse colorInclude description and/or sloganUse both side of card


BlogsBlogsBe consistent in bloggingDo not blog merely to promote

businessTake time to create quality blogBe patient – blogging takes time

to build followingBe cautious what you write!


Outline: Chapter 12Outline: Chapter 12External Sources of Funds: External Sources of Funds: EquityEquityAngel InvestorsStrategic PartnersPrivate PlacementSBICThe Downside of Equity

FinancingWorking with Outside Investors


Equity FinancingEquity FinancingFigure 12.1 Figure 12.1



Equity financing

Downside of Equity Downside of Equity FinancingFinancing

Dilution of ownershipThe risk of sharks Dynamics of adding on new

partners


Working with Equity Working with Equity InvestorsInvestors Business plan Confidentiality agreement Letter of Intent Modifications of shareholder

agreements Communication with shareholders


Outline: Chapter 13Outline: Chapter 13External Sources of Funds: DebtExternal Sources of Funds: Debt

Short-term debt Long-term debt Forms of debt overlooked by

entrepreneurs Working with bankersDownside of debtDeveloping a Financing Plan


Debt FinancingDebt FinancingFigure 13.1 Figure 13.1



Debt financing

Short-term DebtShort-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 DebtShort-term Debt

Trade debtInstitutional Creditors

◦Banks◦Asset-based lenders◦Factors


Long-term DebtLong-term DebtBeyond one year

Most often used to fund fixed asset purchases


Long-term DebtLong-term Debt

Banks: term loansLeasing companiesReal estate lenders


Criteria for Lending by Criteria for Lending by BankersBankers

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 DocumentsKey Loan Documents

Loan proposal Loan document Personal guarantees


Downside of DebtDownside of Debt

Increased risk during economic slowdown

Impact on proceeds from business sale

Restrictive covenantsPersonal guarantees


Example of Assets and Potential Funding Example of Assets and Potential Funding GeneratedGeneratedTable 13.1Table 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


Outline: Chapter 14Outline: Chapter 14Financing the High Growth Financing the High Growth BusinessBusiness

What Venture Capitalists and Private Equity Funds Provide – The Four “C’s”

Integrating Profitability into the Business Plan

Stages of the FirmStages of Business FundingThe Dark Side of Venture Capital FinancingInitial Contact with a Venture CapitalistInitial Public Offering (IPO)The Process of the IPO


Financing a High Growth VentureFinancing a High Growth VentureFigure 14.1 Figure 14.1



Venture capital equity financing

The “Four Cs” of Venture The “Four Cs” of Venture CapitalCapitalCapitalContactsCounselCredibility


Stages of High Growth Business Stages of High Growth Business FundingFunding Initial stageFirst round financing Second round financing Late round financing


Initial Stage FundingInitial Stage FundingFile for incorporationWrite business planFind office and development

spaceCompletion of initial designHire key development personnel Complete prototype unitComplete prototype testing


First Round FinancingFirst Round FinancingSecure key vendors Hire key service or manufacturing

personnelRent or build manufacturing facilityPurchase manufacturing equipmentMarket testingFirst sales contractProduction of first manufactured unitFirst 100, 1000, 10000 units, etc.


Second Round FinancingSecond Round Financing

Break-even level of salesDevelopment of next generation of

product


Late Round FinancingLate Round FinancingInitial public offering Sale of business


Initial Contact with a Venture Initial Contact with a Venture CapitalistCapitalist

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 Venture Capital Term SheetSheetAmount 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 OfferingInitial Public OfferingAdvantages 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 IPOProcess 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 13Outline: Chapter 13Business ValuationBusiness Valuation

General concepts that guide the determination of value

Basic information required for a valuationEstimating a firm’s cash flow and

determining its valueDefinition of cash flowEstimating the cash flow for a particular

year


Concepts that Guide the Concepts that Guide the Determination of ValueDetermination of Value 1. Fair market value2. Going-concern value3. Highest and best use4. Future benefits5. Substitutes and alternatives6. Discounted cash flow analysis7. Objectivity


Information Required for a Information Required for a ValuationValuation

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 FlowDiscounted Cash FlowIncorporates all other principlesIncome-oriented approachCan use EBITDANeeds a required rate of return


Perceived Rates of ReturnPerceived Rates of ReturnPublicly traded company

12-18%Privately held company

20-35%Angel investors 20-

50%Venture capitalists

35-80%


Estimating Cash FlowEstimating Cash Flow

EBIT+owner’s salary -reasonable salary+depreciation+personal expenses=EBITDA -equipment purchased -inventory investment=Free Cash Flow


Calculating ValueCalculating ValueEnter 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 ApproachMarket Comparison ApproachPrice/EarningsPrice/Pre-tax EarningsPrice/Cash FlowPrice/EBITDAPrice/DividendPrice/SalesPrice/AssetsPrice/Book ValuePrice/CustomerPrice/Unit


Market Comparison ProblemsMarket Comparison Problems

Line of businessGeographic areaAge of assetsListing statusCosts of inputsLevel of

establishment

Sale termsStanding of

ownershipSizeFinancingTime periodSimilar buyer


Outline: Chapter 14Outline: Chapter 14Exit PlanningExit Planning

Self-assessment revisitedThe ethical side of the

entrepreneur’s transitionA model of exit planningExit optionsThe process of selling a businessPost exit issues


Exit PlanningExit Planning

The process of preparing for the transition of both the entrepreneur and the business


Exit Through Ownership Exit Through Ownership TransferTransfer

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 Copyright 2009 Cornwall, Vang & Hartman

Exit Through Partial or Limited Exit Through Partial or Limited TransferTransferType 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 Copyright 2009 Cornwall, Vang & Hartman

Exit Through Partial or Limited Exit Through Partial or Limited TransferTransfer(Continued)(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 BankruptcyExit Through Bankruptcy


Bankruptcy Orderly end to business

Ethical challenges

Results in no realization of wealth from business

Can hurt entrepreneur’s

ability to fund future deals Copyright 2009 Cornwall, Vang & Hartman

Exit Through LiquidationExit Through Liquidation


Liquidation May result in more value, especially for service business

No value for going concern

Can be viewed as “failure”


Exit PlanningExit 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 14.4Figure 14.4

Sale Process of a BusinessSale 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




Economy & Finance

Part III Overheads