Published on

Published in: Economy & Finance, Business
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide


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