SPE3002 Entrerpeneurship - Financing and Starting a Business

7/30/2019 SPE3002 Entrerpeneurship - Financing and Starting a Business

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Mohd. Khata Bin Jabor email: [email protected] slide 1

WEEK 13

1 6 OCTOBER 2006


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AGENDA

Starting and

Financing a Business


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The Secrets to Successful

Financing

1. Choosing the right sources of capital is adecision that will influence a company for alifetime.

2. The money is out there; the key is knowingwhere to look.

3. Creativity counts. Entrepreneurs have to be

as creative in their searches for capital asthey are in developing their business ideas.


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The Secrets to Successful

Financing (continued)

4. The World Wide Web puts atentrepreneurs fingertips vast resources ofinformation that can lead to financing.

5. Be thoroughly prepared beforeapproaching lenders and investors.

6. Entrepreneurs should not underestimate

the importance of making sure that thechemistry between themselves, theircompanies, and their funding sources is agood one.


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Three Types of Capital

WORKING GROWTH

FIXED

CAPITAL


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Fixed - used to purchase the permanent orfixed assets of the business (e.g., buildings,land, equipment, etc.) Working - used to support the small

companys normal short-term operations

(e.g., buy inventory, pay bills, wages,salaries, etc.)

Capitalis any form of wealth employed to produce more wealthfor a firm.


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Growth - used to help the smallbusiness expand or change its primarydirection.

Capitalis any form of wealth employed to produce more wealthfor a firm.


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Equity Capital

Represents the personal investment of theowner(s) in the business.

Is called risk capitalbecause investorsassume the risk of losing their money if thebusiness fails.

Does nothave to be repaid with interest likea loan does.

Means that an entrepreneur must give upsome ownership in the company to outsideinvestors.


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Sources of Equity Financing

Personal savings

Friends and family members

Angels Partners

Corporations

Venture capital companies Public stock sale


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Sources of Finance


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List of Sources

Equity (common stock, preferredstock)

Loans: long term, short term

Lease finance

Inter corporate deposits

Bank cash credit and overdraft limits


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List of Sources (Continued)

Debentures Fixed deposits

Grants from government agencies

Supplier credit and deferredpayments

Credit cards


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Modes of Acquisition

Primary market: public issue, rights issue(flotation costs)

Secondary market (listing costs)

Private placement (individual orinstitution)

Banks and mutual funds

Pension funds, insurance companies

Debenture issue

Fixed deposits


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Basis for Comparison -- Attributes

Holding period (Duration)

Repayment terms

Interest rate

Other strings attached

Pledges and collaterals

Finance marketing costs and lead time


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Legal Structure and Time Lines

Limited Liability Partnership

Multiple funds under on VC firm

Fund life about 8-10 years

First four-five years of investing

Next four-five years of harvesting


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Personal Savings

The firstplace an entrepreneur should lookfor money.

The most common source of equity capital

for starting a business. Outside investors and lenders expect the

entrepreneur to put some of her own capitalinto the business beforeinvesting theirs.

Sweat equity and personal risk equity (non-monetary)


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Friends and Family Members

After emptying her own pockets, anentrepreneur should turn to those mostlikely to invest in the business friends

and family members. Survey: 10% of business owners turn to

family and friends for capital.

Careful!!! Inherent dangers lurk infamily/friendly business deals, especiallythose that flop.


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Friends and Family Members

Guidelines for Family and FriendshipFinancing Deals:

Consider the impact of the investment oneveryone involved. Keep the arrangement

strictly business.

Settle the details up front.

Create a written contract.

Treat the money as bridge financing. Develop a payment schedule that suits both

parties.


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Angels

Angels - private investors who backemerging entrepreneurial companies withtheir own money.

Fastest growing segment of the smallbusiness capital market.

An excellent source of patient money for

investors needing relatively small amountsof capital often less than $500,000.


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Angels

Key: finding them!Accessing Angels

Not in the Yellow Pages

NetworkingACE-net.org

Angels almost always invest their

money locally and can be foundthrough networks.


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Angels

The typical angel accepts 30% of theproposals presented to him and hasinvested an average of $131,000 in 3.5

businesses.What do angels look for?

Exciting ideas (with clear potential)

A way to help a trusted friend


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Angels

Advantages Early stage resource

Value-added money : network, advice,

commitment Disadvantages

No follow-on funds

Give-up equity

Over-control from angel


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Venture Capital


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Venture Capital

$21.7 billion in 2005 2,939 investments

Down from $104 billion & 7,832 deals in

2000 Pool of capital invested in rapidly growing

companies

Private Partnerships General partners manage

Limited partners provide funds


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Venture Capital

30% of all venture capital investmentscome from corporations.

About 900 large corporations across theglobe invest in start-up companies.

Capital infusions are just one benefit;corporate partners may share marketing

and technical expertise.

(Continued)


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Venture Capitalist Companies

More than 3,000 venture capital firmsoperate across the United States.

Most venture capitalists seek investments in

the $3,000,000 - $10,000,000 range incompanies with high-growth and high-profitpotential.

Business plans are subjected to anextremely rigorous review less than 1%accepted.


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Venture Capitalist Companies

Most venture capitalists take an activerole in managing the companies inwhich they invest.

Many venture capitalists focus theirinvestments in specific industries withwhich they are familiar.

Most often, venture capitalists invest ina company across several stages.

(Continued)


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Venture Capital Financing

$-

$5.0

$10.0

$15.0

$20.0

$25.0

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

1995 1996 1997 1998 1999 2000

Amoun

tFinanced(in

Billionsof$)

-200400600

8001,0001,2001,4001,6001,800

NumberofDeals

Billions of $ Number of Deals


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What Do Venture CapitalCompanies Look For?

Competent management

Competitive edge

Growth industry

Viable exit strategy

Intangibles


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What is the VC Looking For in a BP ? Revenue model: Sources of revenue

(service/product mix) Profitability, break even point, growth

estimates (revenue, team size)

Risks and contingencies: De-risking/riskmanagement/risk containment plan

Projected (pro-forma) financial statements

Exit strategy (IPO, equity buyer, strategicbuyer, Merger & Acquisition)

Valuation and offer (equity price, number ofshares)

Wh t i th VC L ki F i BP ?


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What is the VC Looking For in a BP ?

Basic value proposition

Market size, segmentation, targetcustomers, competitors

Entry barriers, IP protection, Unique Selling

Points Technology expertise and domain

knowledge

Alliance and strategic partnerships

Promoters, Board of Directors, Topmanagement (VPs)

(Continued)


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Structure of a VC Firm General partners 3-5 (themselves

successful entrepreneurs): put about 2-3% of the corpus

Limited partners (Pension funds,Retirement plans): Put 97% corpus

Corpus = Fund, typically rangesbetween USD 50M to 2B

Management fee is about 2-3 % peryear


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Structure of a VC Firm Funds about 5-30 new companies per

year

Employs junior managers for duediligence (associates)

After IPO/Acquisition, general partnerskeep 20% of gains, limited partners getPrincipal + 80%


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Role of the VC in the PortfolioCompany

Negotiate aggressive terms Select strong co-investor

Help in constituting the Board of Directors

Assist in Recruitment

Market validation

Strategic relationships

Pursue liquidity aggressively


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VC Fund Raising Process

Introduction (phone call, e-mail,referral)

Submit business plan / executive

summary Presentation

Company visit


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VC Fund Raising Process

Due diligence (managementreference checks, customer calls,market analysis)

More meeting(s) Term sheet

Legal / Closing


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VC Decision Making

Deal flow Less then 2% of deals are funded

1 to 2 new deals per year per partner

Due diligence in-depth investigation ofthe venture & you

Time frame to do a deal: 3 to 12 months

Entrepreneur decision making Due diligence

Chemistry is key


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Managing VC Portfolio Companies

A, B, C, & D Rounds

Dry powder

Each round is often staged withmilestones

Board of Directors

Hands-on vs. portfolio approach


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VC Required Return on Investment

Seed 80%+

Start-Up 60% Early Stage 50%

Second Stage 40%

Third Stage 30%

Bridge 25%

ROI5 yr.

Increase 19x

10x 8x

5x

4x

3xBygraves & Zacharakis


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What Are the Implications to theEntrepreneur of VC ROI?

The later the stage, the better the deal

The better the management, the better

the deal The quicker the exit, the better the

deal


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Why people want to be VCs?

Partnership General partners

Limited partners

Management fees 2%

Specialize in an industry

Carried interest 80/20 Series of funds


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Going Public

Initial public offering (IPO) - when acompany raises capital by selling shares ofits stock to the public for the first time.

Typical year: about 550 companies makeIPOs.

Few companies with sales below $10 millionin annual sales make IPOs.

A common exit strategy for investors (butneeds strong justification)


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Initial Public Offerings

0

200

400

600

800

1000

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

Number

ofIPOs

$0.0$10.0$20.0$30.0$40.0

$50.0$60.0$70.0$80.0

M

oneyRaise

d($billions

)

Number

$ Raised (Billions)


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Advantages of Going PublicAbility to raise large amounts ofcapital

Improved corporate image

Improved access to future financingAttracting and retaining key

employees

Using stock for acquisitions

Listing on a stock exchange


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Disadvantages of Going Public

Dilution of founders ownership Loss of control

Loss of privacy

Reporting to the SEC Filing expenses

Accountability to shareholders

Pressure for short-term performance Timing

D bt Fi i


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Debt Financing Must be repaid with interest.

Is carried as a liability on the companysbalance sheet.

Can be just as difficult to secure as equity

financing, even though sources of debtfinancing are more numerous.

Can be expensive, especially for small

companies, because of the risk/return tradeoff. Convertible loans (very popular if IPO might be

used as an exit strategy)


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Sources of Debt Capital

Commercial/Retail banks

Investment Banks

Financial Institutions

Retail Banks and Financial


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Retail Banks and FinancialInstitutions

Commercial banks as market-makers in debtfunds

Accept deposits from general public and giveloans to general public as well as corporate

Net Interest Margin (NIM) is the main sourceof bank income

Losses can occur due to adverse movement

of interest rates and non-performing assets orbad loans

Banks spend a lot of time to estimate thecredit rating of loanees


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Loan Offer from a Bank

Prime Lending Rate (PLR)

Term structure of interest rates

Credit spread

Collaterals and covenants


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Commercial Banks

Cash flow is the key Relationships!

Short-term loans

Commercial loans (prime +, unsecured) Lines of credit (limit tied to working

capital)

Floor planning (ID numbers)

Intermediate and long-term loans Installment loans and contracts

...the heart of the financial market for small businesses!


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Commercial banks

Asset-based lenders


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Asset-Based Borrowing

Discounting accountsreceivable

AccountsReceivable

Inventory financing


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Commercial banks

Trade credit (materials suppliers)

Equipment suppliers Commercial finance companies (security

interests, guarantees, high interest)

Saving and loan associations (realproperty)

Asset-based lenders$$


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Stock brokerage houses (margin loans) Insurance companies

Credit unions

Bonds (industrial development bonds)

(continued)

S f C


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Private placements (insurance companies,etc)

Small Business Investment Companies(SBICs) usually options or convertibleloans

Small Business Lending Companies(SBLCs)

(continued)


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Investment Banks Matchmakers

Fee-based referral services

Help in private equity placement

Structured (OTC) deals

Globalized capital markets (FCCBs, ECBs)

GDR, ADR issues


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Internal Methods of Financing

Factoring - selling accounts receivableoutright

Leasing assets rather than buying them

Credit cards

Internet Resources on VC and


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Internet Resources on VC andPrivate Equity

www.ventureeconomics.com

www.v1.com (Dow Jones Venture One)

www.vnpartners.com (Venture NetPartners)

www.vnpartners.com/primer.htm

British Venture Capital Association www.bvca.co.uk

What to Include in a Financial


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What to Include in a FinancialAnalysis and Plan

When does the business have to buy resources,such as supplies, raw materials, and people?

When does the business have to pay for them?

How much capital equipment is required tosupport a dollar of sales?

How long does it take to acquire a customer?

How long before the customer sends the

business a check?

More Questions


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More Questions

For businesses just starting out, the amount of money

available up-front is a key to survival. For all businesses,long-term financial health determines health.

Is the companys cash flow being carefullymonitored?

How does the companys financial conditioncompare to that of the competition?

Does the company have ready access to cashreserves?

Does the company have a budget?

Are revenue and profits growing?

Whats Wrong With Most


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What s Wrong With Most

Finance Plans?

Waste too much ink on numbers and devote

too little to the information that really matters

to investors. Financial projections for a new company are

an act of careful planning and imagination,

especially detailed, month-by-monthprojections that stretch out for years

Whats Wrong With Most


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What s Wrong With Most

Finance Plans?

An entrepreneurial venture faces far too

many unknowns to predict revenues, let

alone profits.

Few entrepreneurs correctly anticipate how

much capital and time will be required to

accomplish objectives. They are wildlyoptimistic.

Some Numbers Are Essential


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Business plans should contain some numbers.

Numbers should appear mainly in the form of a

business model that shows the key drivers of

the ventures success or failure.In manufacturing, this might be the yield on a

production process; in magazine publishing,

the anticipated renewal rate; or in software, theimpact of using various distribution models.



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The model should also address the break-

even issue:

At what level of sales does the business

begin to make a profit? When does cash flow turn positive?


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Objectives and Milestones

in the Financial Plan

Purpose of Objectives &


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p jMilestones

By mapping actual cost to achieve each milestoneagainst the planned cost, a firm can re-evaluate its

position and predict cash shortfalls in time to take

action.

Preparing milestones and expected cost, a firm shows

it intends to track performance closely against the

business plan. This offers some comfort to potentialinvestors and may prevent the plan from sitting in a

desk drawer once it has served its initial purpose.


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Milestone Examples

Hiring of a full management teamCompleting product specifications

Completing prototype design

Completing prototype

Product testing

First customer shipment

Beginning production

First full quarter of profitability

Attaining $10 million in revenue


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Ownership and Equity Issues

in the Financial Plan

What to Include in


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What to Include inOwnership & Equity

How will equity in the venture be distributed?

Will the founders retain control?

How do the investors get their money out, andwhen?

Will employees be able to earn equity for theirperformance?

How much equity will investors have, and how will

that change over time?

Checklist For The


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Checklist For TheFinancial Plan

1. Explain the assumptions you have made thatform the basis for all of the data contained inyour financial statements. Sales ProductionAccounts Receivable, Accounts Payable

Overhead Expenses Capital Expenditures and Depreciation Etc.

Checklist For The


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2. Prepare the following plans for the first yearbudgets:

Sales

Production

Operating Expenses

Number & salaries of needed staff members

Head Count Plan

Capital Expenditures

Start-up costs, fixtures, equipment, etc.

Checklist For The


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3. Prepare a cash flow until the businessreaches cash break-even point or through

the first year - by individual months.Some considerations are:

Start-up expenditures

Accounts payable proceduresAccounts receivable

Collection periods

Checklist For The


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4. Prepare the five-year cash flow usingquarterly projections.

Use a computer spreadsheet Pitfall: Avoid using straight line projections

Make sure to identify all business expenses

5. Prepare for the first year profit & lossstatement.

Checklist For The


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6. Prepare a 5-year Profit & Loss (P&L)Statement.

First year by quarter

The remaining years annually

7. Prepare a balance sheet for each quarter forthe first year of operation.

Make realistic projections and coordinate withthe Profit & Loss Statement

Checklist For The


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8. Prepare a yearly balance sheet for the firstfive years of operation.

Make realistic projections and coordinate withthe Profit & Loss Statement.

9. Explain how the projections compare with

industry norms.Are the costs, revenues, profits, etc. higher or

lower with similar businesses?

TO FIGURE YOUR COST


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TO FIGURE YOUR COST

OF LIVING, TAKE YOURINCOME AND ADD TEN

PERCENT.

Steve Forbes

Remember:


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Remember:Formulating a Workable Financial Plan

Requires:A willingness to change to an

entrepreneurial orientation

Continued planning and crafting andrevalidation

An opportunistic disposition

Commitment of resources not ownership Reassessment of measured performance

Leadership

SPE3002 Entrerpeneurship - Financing and Starting a Business

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