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  • 1. Managing Entrepreneurship and Innovation 4. Financing the Venture
  • 2. Lecture contents
    • This lecture will examine:
    • Guiding principles: 4Fs & 3 forms of initial finance, scale, and capital & risk
    • Sources of new venture finance: banks, business angels & venture capitalists
    • What investors are looking for in a venture
    • Structuring new venture finance: funding life cycle, control, risk & harvest
  • 3. The 4 Fs of initial finance
    • Initial investment usually arises from 4 Fs:
    • Founders’ own savings and assets
    • Family money and contributions
    • Friends’ money or assets
    • Foolhardy investors’ sums handed over as a result of silver-tongued persuasion!
  • 4. Three forms of initial finance
    • That start-up capital takes one of three main forms:
    • Personal savings – the simplest form, their own cash reserves or assets
    • Debt – borrowing from a lender, paying interest but retaining control
    • Equity – selling shares for capital, no interest but losing partial control
  • 5. Scale at start-up
    • USA Inc. magazine’s annual list of 500 star small businesses shows that:
    • 25% began with under $5,000
    • 50% began with under $25,000
    • 75% began with under $100,000
    • Only 5% started with over $1 million
    • So small contributions, savings & ‘sweat equity’ are vital to get going
  • 6. Capital and risk
    • The 2 nd , 3 rd & 4 th of 4Fs will expect returns:
    • Supply and demand operate in the capital market as in any other market
    • The price (cost) of capital depends on the expected rate of return
    • The ERR is a function of both perceived risk & the opportunity cost of placing money with this venture, not another
  • 7. Sources of new venture finance
    • Beyond initial start-up, entrepreneurs often gain access to finance through:
    • Banks
    • Business angels
    • Venture capital funds
  • 8. Finance from banks
    • Banks don’t like risk so demand tough searches & real collateral as security
    • They want to see financial literacy & to be kept in touch with venture developments
    • But debt finance has benefits when interest is written off against tax
    • Building relations with bankers gives access to local & financial knowledge
  • 9. The banker’s 5Cs
    • A common banker’s checklist:
    • Character of borrower
    • Capacity to repay
    • Conditions (product, industry, economy)
    • Capital provided (debt/equity ratio)
    • Collateral or security
  • 10. Business angels
    • Important ‘informal’ start-up investors, often wealthy & experienced ex-entrepreneurs:
    • US, 250,000 angels investing $10bn. p.a.
    • UK, 18,000 investing £500m. p.a. with an average deal of £57,000
    • US angels accept 32% p.a. return on avg.
    • Over 80% take an active role in ventures
  • 11. Venture capital funds
    • Partnerships (e.g. Atlas) or VC funds (e.g. 3i) arrange & manage early-round funds:
    • European VCs invested £7.8bn. in 1999, £6.1bn. to UK firms
    • 50% in UK for management buy-outs/ins
    • £1m.+ deals for early-round funding
    • less involvement but higher & quicker returns (40%p.a.) than angels
  • 12. What investors are looking for
    • product/market info. & size, growth rates
    • strategic/competitive dynamics & barriers
    • management team, leadership capabilities
    • management competence & ability
    • financials, time to break-even & return rate
    • fund portfolio & relevance to fund strategy
    • deal structure & stage of investment
  • 13. Structuring finance I
    • Like the venture, finance has a life cycle:
    • Seed/start-up finance
    • 1 st round funding
    • 2 nd round (mezzanine) funding
    • Late-stage funding
    • The ‘informal’ sector tends to focus on 1. & 2. while the ‘formal’ funds will be involved from 2. to 4., often through the life cycle
  • 14. Structuring finance II
    • Investors buy equity & appoint board members to exercise control & influence
    • Teams (of angels) or syndicates (via VCs) spread the risks & share the gains
    • Investments staggered in rounds permit growth milestones & hedge the risks
    • Planned exit strategies (e.g. trade sale, IPO) allow investors to harvest the gain
  • 15. Conclusion
    • Finance is central to new venture formation:
    • Cash is cornerstone to strategic planning
    • Investment is needed to start up & grow
    • Investors provide ideas & experience too
    • Sources depend upon scale and stage
    • Debt/equity balance affects costs & control
    • Understanding risk & return is essential
  • 16. Sources used
    • Birley & Muzyka, Mastering Entrepreneurship ch. 3
    • Wickham, Strategic Entrepreneurship ch.19
    • Freear, Sohl & Wetzel, ‘Angels: personal investors in the venture capital market’
    • Websites of British Venture Capital Assoc., European Venture Capital Assoc., & National Business Angels Network