New Venture Financing
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  • Our business year ending July 2002 was difficult because of the economic slowdown and the after effects of Sept 11. However we managed to still grow our sales by 1.9% year over year. One key factor was the growing significance of the new Centaur product, introduced in 2000 (blue area) In 2003 (ending July) we saw a bit of a decline 1.8%, despite our best efforts to stave off the effects of the recession. Again, the graph shows clearly how much more severe the decline would have been without the new product (Centaur)

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  • 1. IPFW Business Plan Competition Pre-competition Program Financing and Capital Sourcing Options By Dr. Bill Todorovic Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940 E-mail: [email_address] Web: http://users.ipfw.edu/todorovz /
  • 2. The Nature of a Firm and Its Financing Sources
    • Factors That Determine Financing
      • Firm’s economic potential
      • Maturity of the company
      • Nature of its assets
      • Owners’ preferences for debt or equity
  • 3. Sources Of Funds Personal Friends and Family Angels Venture Capitalist Banks Government Customers/Suppliers IPO Amount Company Size Start-up Going Concern Beginning of Production ?
  • 4. Sources of Financing 0 10 20 30 40 50 60 70 80 Personal Savings Family Members Partners Personal Charge Cards Friends Bank Loans Private Investors Mortgaged Property Venture Capital Other Percentage of Entrepreneurs Using Source of Financing Sources of Financing
  • 5. Critical Financing Factors
    • Accomplishments and performance to date.
    • Investor’s perceived risk.
    • Industry and technology.
    • Venture upside potential and anticipated exit timing.
    • Venture anticipated growth rate
    • Venture age and stage of development.
  • 6. Critical Financing Factors
    • Investor’s required rate of return
    • Amount of capital required and prior valuations of the venture
    • Founders’ goals regarding growth, control, liquidity, and harvesting.
    • Relative bargaining positions.
    • Investor’s required terms and covenants.
  • 7. Debt or Equity?
    • Entrepreneurs typically prefer debt
      • Allows them to appropriate as much as of the benefit as possible + retain sole control
      • Can default
    • Debt is unattractive to investors in emerging technology
      • Usually little collateral or predictable cash flow
      • Information asymmetry is lessened by ownership position – shared ownership gives some control
      • High interest rate to offset risk will stifle growth or cause default
  • 8. Debt or Equity Financing?
    • Potential Profitability
    • Financial Risk
    • Voting / Control
  • 9. Tradeoffs Among Potential Profitability, Financial Risk, and Voting Fig. 13.1 Equity financing Debt financing HIGH LOW LOW HIGH Equity Financing Debt Financing Potential Profitability Financial Risk/Control
  • 10. Debt Versus Equity With no debt and all equity: Equity: Owners get to keep all of the profits in return for accepting the risk of lower returns $28,000 income on total assets of $200,000 14% return on assets ($28,000 ÷ $200,000) 14% return on $200,000 ($28,000 ÷ $200,000) No debt equals $200,000 equity
  • 11. Debt Versus Equity (Cont’d) Debt is Risky: Lenders have first claim on profits and must be paid even if there are no profits. $28,000 income on total assets of $200,000 14% return on assets ($28,000 ÷ $200,000) 18% return on $100,000 ($18,000 ÷ $100,000) $100,000 debt (10% cost) equals $100,000 equity With $100,000 debt and $100,000 equity:
  • 12. Sources of Funds Fig. 13.3 Debt Equity Personal Savings Other Individual Investors Business Suppliers Asset-Based Lenders Commercial Banks Government-Sponsored Programs Community-Based Financial Institutions Large Corporations Venture Capital Firms Sale of Stock Friends and Relatives
  • 13. The Banker’s Perspective
    • Bankers’ Concerns!
    • The Five C’s of Credit
      • Character of the borrower
      • Capacity of the borrower to repay the loan
      • Capital invested in the venture by the borrower
      • Conditions of the industry and economy
      • Collateral available to secure the loan
  • 14. Questions Lenders Ask
    • Lender’s Questions
      • What are the strengths and qualities of the management team?
      • How has the firm performed financially?
      • How much money is needed?
      • What is the venture going to do with the money?
      • When is the money needed?
      • When and how will the money be paid back?
      • Does the borrower have qualified support people, such as a good public accountant and attorney?
  • 15. Financial Information Required for a Bank Loan
    • Three years of the firm’s historical statements
    • The firm’s pro forma financial statements
    • Personal financial statements
  • 16. Negotiating a Loan
    • Terms of Loans
      • Interest rate
      • Loan maturity date
      • Repayment schedule
      • Loan covenants
  • 17. Getting to know your friendly neighborhood Venture Capitalist…
  • 18. The myth… and the reality
    • The myth: VCs support good people and good ideas
    • The reality: VCs invest in industries with double digit growth in the middle of the S-curve
      • Appropriate management team
      • Specialty funds (earlier and later stages on the S-curve)
      • Limits the risk to management risk
      • Produces attractive exit opportunities
  • 19. Present Day Situation
    • Myth: There is less available capital
    • Fact: The industry has plenty of money, but limited appetite for new investment
    • Fact: Investor attitudes toward risk have changed
  • 20. The venture capital industry
    • Accounts for about 2/3 of private-sector external equity financing of high tech firms in U.S., but less than 1% of all equity in SMEs
    • VC sensitive to capital gains tax, ability of institutional investors to contribute to high risk funds, and performance of the stock market (especially IPOs)
    • Highly specialized by industry, location and stage
  • 21. VC fills a void
    • Gap between innovation and traditional sources of debt
    • Risk inherent in startups typically justify interest rates higher than allowed by law
    • VCs must balance high returns for their investors against sufficient upside potential for entrepreneurs to keep them motivated
  • 22. What VCs get out of it
    • 10X return on capital over 5 years
    • VCs management fees and high growth funds
    • Fund structured with limited and general partners and a life of 7-10 years
  • 23. What VCs Do?
  • 24. When the Market is Down…
  • 25. The Overhang: Uninvested Capital Complements of Thompson Venture Economics
  • 26. Angels
    • Well to do private individuals
    • Geography and industry specific
    • Invest lower amount than VC
    • Often a good source of industry experience
  • 27. Finding Angels
    • Private Individuals
    • Professionals (lawyers, accountants, bankers)
    • Local small business development centers
    • Internet associations (e.g., Technology Capital Network at MIT)
  • 28. Other Sources of Financing
    • Community-based financial institutions
    • Large corporations
    • Stock Sales
      • Private placement
      • Initial public offering (IPO)
  • 29. Why Companies Invest?
    • Preemption of new rivals
    • Replace core earnings lost because of an emerging technology
    • Apply existing competitive advantage in a rapidly growing market
    • And some degree of autonomy:
      • JVs, alliances, flexible internal management structures
  • 30. Government-Sponsored Programs and Agencies
    • Small Business Administration (SBA) loans
      • Guaranty loan
      • Direct loan
    • Small business investment centers (SBICs)
    • Small Business Innovative Research (SBIR)
    • State and Local Government Assistance
  • 31. Business Suppliers and Asset-Based Lenders
    • Trade Credit (Accounts Payable)
        • Short-duration financing (30 days)
        • Amount of credit available is dependent on type of firm and supplier’s willingness to extend credit
  • 32. Business Suppliers and Asset-Based Lenders (cont’d)
    • Equipment Loan and Leases
    • Leases
        • Free up cash for other purposes
        • Leaves lines of credit open
        • Provides a hedge against obsolescence
  • 33. Business Suppliers and Asset-Based Lenders (cont’d)
    • Asset-based Loan
    • Factoring
        • Accounts are sold to factor at a discount to invoice value
        • Factor can refuse questionable accounts
        • Factor charges fees for servicing accounts and for amount advanced to firm prior to collection
  • 34. Business Suppliers and Asset-Based Lenders (cont’d)
    • Commercial Banks
      • Line of credit
      • Revolving credit agreement
  • 35. Business Suppliers and Asset-Based Lenders (cont’d)
    • Commercial Banks (cont’d)
      • Term loans
      • Chattel mortgage
      • Real estate mortgage
  • 36. Formal Vs. Informal Investors
    • Funding structure and flexibility
    • The fit to the mold
    • Involvement in the business
    • Rigidity of relationship with the firm
  • 37. Discussion?
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  • 48. The Three Phases of Venture Activity
    • Fund Raising/commitments – VC firms raising capital
    • Investment – VC firms putting capital to work
    • Liquidity – VC firms exiting investments
    • These are inextricably tied; if any suffers, they all do
    Complements of Thompson Venture Economics
  • 49. Other sources of funding
    • Debt and bootstrapping
    • Leasing
    • Angel capital
    • Government grants
    • Corporate VC
    • Early entry into public markets
  • 50.  
  • 51. Other Sources of Financing (cont’d)
    • Stock Sales
      • Private placement
        • The sale of a firm’s capital stock to selected individuals
      • Initial public offering (IPO)
        • The issuance of stock that is to be traded in public financial markets
        • Places firm under SEC securities regulations
  • 52.  
  • 53. Complements of: Timmons/Spinelli New Venture Creation , sixth edition Lower Long-term Income Potential (Lower Capacity) Low Level Investment
  • 54. First Things First
    • Burn rate
    • OOC (out of cash)
    • Search out capital markets
    • Increase cash flow
  • 55. Strategy Refinement
    • Market niche
    • Suppliers and customers
    • Diversification or specialization
    • Reduce fixed costs
    • Plan for contingency
  • 56. Management Refinement
    • Management skill, experience and know how
    • Control of Finance
    • Turnover
  • 57. When the market is down
    • Increase Your Effectiveness and Efficiency
    • Be Creative
    • Pursue different sources of capital
  • 58. Building to Grow
  • 59.
    • Create Value
    • Shareholders
    • Customers
    • Employees
    • Contingency Plan
    • Best Case Scenario
    • Worst Case Scenario
    • Most Likely Scenario
    • Good Team
      • Every business is built on people
    • Good Decisions
    • Solid Financing
    • Persistence
    Reduce Risk Increase Value
  • 60. Example 1 Sales Growth; ODG
  • 61. The Sound Advice
    • Monitor Cash Flow (especially if growth is high)
      • 100 fastest growing companies
      • Entrepreneur of the year award
    • Contingency Plan – get the timing right
    • Emphasize long term growth
    • Manage your risk factor
  • 62. Example 2: Ergo Distributor
    • Sales growth 400-500%
    • Single supplier – No substitutes
    • Great financial ratios
    • Cash flow problems
    • May go bankrupt in couple of years
    LESSON: Use your intuition
  • 63. Who invests in VC funds?
    • Typically pension funds, financial firms, insurance companies, endowments and high net worth individuals
    • Small percentage of total funds
      • Expect returns of 25%-30%
    • Most are structured as limited partnerships
    • Other forms include:
      • Corporate VC funds
      • Private funds
      • Publicly listed funds
      • Labour sponsored funds (in Canada)