Part III Overheads

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Part III Overheads

  1. 1. Outline: Chapter 9 Financing Over the Life of a Venture <ul><li>Common Misconceptions about Entrepreneurial Financing </li></ul><ul><li>The Diverse Nature of Business Financing </li></ul><ul><li>Financing Smaller Businesses with Modest Growth Potential </li></ul><ul><li>Financing High Growth, High Potential Ventures </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  2. 2. Common Misconceptions about Entrepreneurial Financing <ul><li>Venture Capitalists Fund Most Businesses </li></ul><ul><li>Banks Lend to Start-ups </li></ul><ul><li>SBA lends money directly to entrepreneurs </li></ul><ul><li>Entrepreneurs Tend to Rely on One Single Source of Funding </li></ul><ul><li>Government Grants are a Good Source of Money for Small Businesses </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  3. 3. The Diverse Nature of Business Financing <ul><li>The Nature of the Business Model </li></ul><ul><li>Aspirations of the Entrepreneur </li></ul><ul><li>The Stage of Development of the Business Venture </li></ul><ul><li>Fitting the Pieces of the Financing Puzzle Together </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  4. 4. Financing a Small Business - Modest Growth Figure 9.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Bootstrapping Self, friends, and family Equity financing Debt financing
  5. 5. Financing a High-Growth, High-Potential Venture Figure 9.2 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Bootstrapping Seed financing from angels Equity financing from VCs Debt financing
  6. 6. Outline: Chapter 10 Start-up Financing From the Entrepreneur, Friends and Family <ul><li>Self-financing </li></ul><ul><li>Advantages and Disadvantages of Self-financing </li></ul><ul><li>Friends and Family Financing </li></ul><ul><li>Structure of Funds Invested </li></ul><ul><ul><li>Loan </li></ul></ul><ul><ul><li>Equity </li></ul></ul>Copyright 2009 Cornwall, Vang & Hartman
  7. 7. Most Common Sources of Financing Figure 10.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Self, friends, and family
  8. 8. Advantages and Disadvantages of Self-Financing Table 10.1 Copyright 2009 Cornwall, Vang & Hartman Advantages Disadvantages Relative 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
  9. 9. Friends and Family Financing <ul><li>Determine True Motivations </li></ul><ul><li>Use a Formal Business Plan </li></ul><ul><li>Provide Accurate, Objective, and Full Information about the Business </li></ul><ul><li>Keep Boundaries </li></ul><ul><li>Tax Planning </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  10. 10. Outline: Chapter 11 Bootstrapping <ul><li>Why bootstrap? </li></ul><ul><li>Bootstrapping Administrative Overhead </li></ul><ul><li>Bootstrapping Employee Expenses </li></ul><ul><li>Bootstrapping Operating Expenses </li></ul><ul><li>Bootstrap Marketing </li></ul><ul><li>The Ethics of Bootstrapping </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  11. 11. Bootstrapping Throughout the Life of a Venture Figure 11.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Bootstrapping
  12. 12. Bootstrapping <ul><li>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.” </li></ul><ul><li>Cornwall, J. (2010). Bootstrapping . Englewood Cliffs, NJ: Pearson/Prentice-Hall. </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  13. 13. Why Bootstrap? <ul><li>Often necessary for small businesses to get started </li></ul><ul><li>Difficulty in raising money for growth </li></ul><ul><li>Preserves the value and wealth of a business </li></ul><ul><li>“ Extend the Runway” </li></ul><ul><li>Reduce risk associated with debt financing </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  14. 14. Rules of Bootstrapping <ul><li>Rule #1 : Overhead matters </li></ul><ul><li>Rule #2 : Employee expenses are usually the highest single recurring cost </li></ul><ul><li>Rule #3 : Minimize operating costs </li></ul><ul><li>Rule #4 : Marketing matters, but know your customers and how they make decisions </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  15. 15. Bootstrapping Administrative Overhead <ul><li>Space </li></ul><ul><li>Furnishings and office equipment </li></ul><ul><li>Administrative salaries </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  16. 16. Bootstrapping Employee Expenses <ul><li>Employee “stretching” </li></ul><ul><li>Independent contractors </li></ul><ul><li>Employee leasing and temporary employees </li></ul><ul><li>Student interns </li></ul><ul><li>Equity compensation </li></ul><ul><li>Non-monetary benefits </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  17. 17. Bootstrapping Operating Expenses <ul><li>Outsourcing </li></ul><ul><li>Just-in-time inventory techniques </li></ul><ul><li>Effective cost accounting </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  18. 18. Bootstrap Marketing <ul><li>Know your customer </li></ul><ul><li>Focus on the impact of message, not “volume” </li></ul><ul><li>Focus on benefits for customer </li></ul><ul><li>Understand the market niche </li></ul><ul><li>Spend your marketing dollars wisely </li></ul><ul><li>Marketing is a process, not an event </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  19. 19. The Basic Bootstrap Marketing Tools <ul><li>Word of Mouth </li></ul><ul><li>Business cards </li></ul><ul><li>Blogs </li></ul><ul><li>Brochures </li></ul><ul><li>Banners and signs </li></ul><ul><li>Newsletters </li></ul><ul><li>Direct mailing/e-mailing </li></ul><ul><li>Publicity </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  20. 20. Word of Mouth <ul><li>Motivate customers to talk about business </li></ul><ul><li>Create incentives to spread the word </li></ul><ul><li>Ask customers to “sell” </li></ul><ul><li>Create a “buzz” campaign </li></ul><ul><li>Viral marketing </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  21. 21. Business Cards <ul><li>Design is important </li></ul><ul><li>Include needed data about business </li></ul><ul><li>Use quality paper </li></ul><ul><li>Use color </li></ul><ul><li>Include description and/or slogan </li></ul><ul><li>Use both side of card </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  22. 22. Blogs <ul><li>Be consistent in blogging </li></ul><ul><li>Do not blog merely to promote business </li></ul><ul><li>Take time to create quality blog </li></ul><ul><li>Be patient – blogging takes time to build following </li></ul><ul><li>Be cautious what you write! </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  23. 23. Outline: Chapter 12 External Sources of Funds: Equity <ul><li>Angel Investors </li></ul><ul><li>Strategic Partners </li></ul><ul><li>Private Placement </li></ul><ul><li>SBIC </li></ul><ul><li>The Downside of Equity Financing </li></ul><ul><li>Working with Outside Investors </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  24. 24. Equity Financing Figure 12.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Equity financing
  25. 25. Downside of Equity Financing <ul><li>Dilution of ownership </li></ul><ul><li>The risk of sharks </li></ul><ul><li>Dynamics of adding on new partners </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  26. 26. Working with Equity Investors <ul><li>Business plan </li></ul><ul><li>Confidentiality agreement </li></ul><ul><li>Letter of Intent </li></ul><ul><li>Modifications of shareholder agreements </li></ul><ul><li>Communication with shareholders </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  27. 27. Outline: Chapter 13 External Sources of Funds: Debt <ul><li>Short-term debt </li></ul><ul><li>Long-term debt </li></ul><ul><li>Forms of debt overlooked by entrepreneurs </li></ul><ul><li>Working with bankers </li></ul><ul><li>Downside of debt </li></ul><ul><li>Developing a Financing Plan </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  28. 28. Debt Financing Figure 13.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Debt financing
  29. 29. Short-term Debt <ul><li>Expected to be paid within one year </li></ul><ul><li>Most often used to finance short-term expenditures such as inventory, supplies, payroll, etc. </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  30. 30. Short-term Debt <ul><li>Trade debt </li></ul><ul><li>Institutional Creditors </li></ul><ul><ul><li>Banks </li></ul></ul><ul><ul><li>Asset-based lenders </li></ul></ul><ul><ul><li>Factors </li></ul></ul>Copyright 2009 Cornwall, Vang & Hartman
  31. 31. Long-term Debt <ul><li>Beyond one year </li></ul><ul><li>Most often used to fund fixed asset purchases </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  32. 32. Long-term Debt <ul><li>Banks: term loans </li></ul><ul><li>Leasing companies </li></ul><ul><li>Real estate lenders </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  33. 33. Criteria for Lending by Bankers <ul><li>Ability of the business to generate enough cash flow to easily make interest and principle payments </li></ul><ul><li>Entrepreneur’s ability to personally pay back the loan if the business fails </li></ul><ul><li>Assets to serve as collateral </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  34. 34. Key Loan Documents <ul><li>Loan proposal </li></ul><ul><li>Loan document </li></ul><ul><li>Personal guarantees </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  35. 35. Downside of Debt <ul><li>Increased risk during economic slowdown </li></ul><ul><li>Impact on proceeds from business sale </li></ul><ul><li>Restrictive covenants </li></ul><ul><li>Personal guarantees </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  36. 36. Example of Assets and Potential Funding Generated Table 13.1 Copyright 2009 Cornwall, Vang & Hartman 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% $ 6,000 Leasehold Improvements $10,000 50% $ 5,000 Building $120,000 70% $84,000 Undeveloped Land $40,000 40% $16,000 Equipment $15,000 80% $12,000 Total of Business Funding Sources $335,000 $214,000
  37. 37. Outline: Chapter 14 Financing the High Growth Business <ul><li>What Venture Capitalists and Private Equity Funds Provide – The Four “C’s” </li></ul><ul><li>Integrating Profitability into the Business Plan </li></ul><ul><li>Stages of the Firm </li></ul><ul><li>Stages of Business Funding </li></ul><ul><li>The Dark Side of Venture Capital Financing </li></ul><ul><li>Initial Contact with a Venture Capitalist </li></ul><ul><li>Initial Public Offering (IPO) </li></ul><ul><li>The Process of the IPO </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  38. 38. Financing a High Growth Venture Figure 14.1 Copyright 2009 Cornwall, Vang & Hartman Pre-launch Start-up Growth Transition Venture capital equity financing
  39. 39. The “Four Cs” of Venture Capital <ul><li>Capital </li></ul><ul><li>Contacts </li></ul><ul><li>Counsel </li></ul><ul><li>Credibility </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  40. 40. Stages of High Growth Business Funding <ul><li>Initial stage </li></ul><ul><li>First round financing </li></ul><ul><li>Second round financing </li></ul><ul><li>Late round financing </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  41. 41. Initial Stage Funding <ul><li>File for incorporation </li></ul><ul><li>Write business plan </li></ul><ul><li>Find office and development space </li></ul><ul><li>Completion of initial design </li></ul><ul><li>Hire key development personnel </li></ul><ul><li>Complete prototype unit </li></ul><ul><li>Complete prototype testing </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  42. 42. First Round Financing <ul><li>Secure key vendors </li></ul><ul><li>Hire key service or manufacturing personnel </li></ul><ul><li>Rent or build manufacturing facility </li></ul><ul><li>Purchase manufacturing equipment </li></ul><ul><li>Market testing </li></ul><ul><li>First sales contract </li></ul><ul><li>Production of first manufactured unit </li></ul><ul><li>First 100, 1000, 10000 units, etc. </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  43. 43. Second Round Financing <ul><li>Break-even level of sales </li></ul><ul><li>Development of next generation of product </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  44. 44. Late Round Financing <ul><li>Initial public offering </li></ul><ul><li>Sale of business </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  45. 45. Initial Contact with a Venture Capitalist <ul><li>Funding amount </li></ul><ul><li>Duration </li></ul><ul><li>Summary of the project </li></ul><ul><li>Use of funding </li></ul><ul><li>Confirm how the transaction will be liquidated </li></ul><ul><li>Existing investment in the project </li></ul><ul><li>Names of bankers, lawyers, accountants and consultants </li></ul><ul><li>Unusual or sensitive information </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  46. 46. Venture Capital Term Sheet <ul><li>Amount the venture capitalist wishes to invest. </li></ul><ul><li>Percentage of ownership to the venture capitalist. </li></ul><ul><li>The nature of the investment such as loan, stock, warrants, etc. </li></ul><ul><li>Governance rights of the venture capitalist. </li></ul><ul><li>Right to eventually register shares for a public offering. </li></ul><ul><li>Remaining conditions to be met by the entrepreneur such as periodic reports, financial statements, etc. </li></ul><ul><li>An estimate of valuation of the company. </li></ul><ul><li>Specific requirements on what the money is to be used for or specific assets that must be purchased with the funds. </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  47. 47. Initial Public Offering Copyright 2009 Cornwall, Vang & Hartman Advantages Disadvantages Diversification and liquidity Reporting costs Ability to raise new cash Disclosure of information Valuation Maintenance of control Future business deals Publicity
  48. 48. Process of the IPO <ul><li>Selecting an investment banking firm </li></ul><ul><li>The decision to underwrite or not underwrite </li></ul><ul><li>Getting the paperwork in order and certifying the price of the offering </li></ul><ul><li>The road show </li></ul><ul><li>Determine the size of the book </li></ul><ul><li>The first day of trading </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  49. 49. Outline: Chapter 13 Business Valuation <ul><li>General concepts that guide the determination of value </li></ul><ul><li>Basic information required for a valuation </li></ul><ul><li>Estimating a firm’s cash flow and determining its value </li></ul><ul><li>Definition of cash flow </li></ul><ul><li>Estimating the cash flow for a particular year </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  50. 50. Concepts that Guide the Determination of Value <ul><li>Fair market value </li></ul><ul><li>Going-concern value </li></ul><ul><li>Highest and best use </li></ul><ul><li>Future benefits </li></ul><ul><li>Substitutes and alternatives </li></ul><ul><li>Discounted cash flow analysis </li></ul><ul><li>Objectivity </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  51. 51. Information Required for a Valuation <ul><li>Income statements and/or tax returns </li></ul><ul><li>Balance sheet </li></ul><ul><li>Rates of return consistent with the risk level </li></ul><ul><li>Interviews with current owners and staff </li></ul><ul><li>Assessment of future business environment </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  52. 52. Discounted Cash Flow <ul><li>Incorporates all other principles </li></ul><ul><li>Income-oriented approach </li></ul><ul><li>Can use EBITDA </li></ul><ul><li>Needs a required rate of return </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  53. 53. Perceived Rates of Return <ul><li>Publicly traded company 12-18% </li></ul><ul><li>Privately held company 20-35% </li></ul><ul><li>Angel investors 20-50% </li></ul><ul><li>Venture capitalists 35-80% </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  54. 54. Estimating Cash Flow <ul><li>EBIT </li></ul><ul><li>+owner’s salary </li></ul><ul><li>-reasonable salary </li></ul><ul><li>+depreciation </li></ul><ul><li>+personal expenses </li></ul><ul><li>=EBITDA </li></ul><ul><li>-equipment purchased </li></ul><ul><li>-inventory investment </li></ul><ul><li>=Free Cash Flow </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  55. 55. Calculating Value <ul><li>Enter zero for Cf 0 </li></ul><ul><li>Enter each year’s unique free cash flow </li></ul><ul><li>For final year enter the sum of the terminal cash flow and the year’s free cash flow </li></ul><ul><li>Enter required rate of return as interest rate </li></ul><ul><li>Calculated NPV is the value of the firm </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  56. 56. Market Comparison Approach <ul><li>Price/Earnings </li></ul><ul><li>Price/Pre-tax Earnings </li></ul><ul><li>Price/Cash Flow </li></ul><ul><li>Price/EBITDA </li></ul><ul><li>Price/Dividend </li></ul><ul><li>Price/Sales </li></ul><ul><li>Price/Assets </li></ul><ul><li>Price/Book Value </li></ul><ul><li>Price/Customer </li></ul><ul><li>Price/Unit </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  57. 57. Market Comparison Problems <ul><li>Line of business </li></ul><ul><li>Geographic area </li></ul><ul><li>Age of assets </li></ul><ul><li>Listing status </li></ul><ul><li>Costs of inputs </li></ul><ul><li>Level of establishment </li></ul><ul><li>Sale terms </li></ul><ul><li>Standing of ownership </li></ul><ul><li>Size </li></ul><ul><li>Financing </li></ul><ul><li>Time period </li></ul><ul><li>Similar buyer </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  58. 58. Outline: Chapter 14 Exit Planning <ul><li>Self-assessment revisited </li></ul><ul><li>The ethical side of the entrepreneur’s transition </li></ul><ul><li>A model of exit planning </li></ul><ul><li>Exit options </li></ul><ul><li>The process of selling a business </li></ul><ul><li>Post exit issues </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  59. 59. Exit Planning <ul><li>The process of preparing for the transition of both the entrepreneur and the business </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  60. 60. Exit Through Ownership Transfer Copyright 2009 Cornwall, Vang & Hartman 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
  61. 61. Exit Through Partial or Limited Transfer Copyright 2009 Cornwall, Vang & Hartman Type 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
  62. 62. Exit Through Partial or Limited Transfer (Continued) Copyright 2009 Cornwall, Vang & Hartman 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
  63. 63. Exit Through Bankruptcy Copyright 2009 Cornwall, Vang & Hartman Type of Exit Advantages Disadvantages Bankruptcy Orderly end to business Ethical challenges Results in no realization of wealth from business Can hurt entrepreneur’s ability to fund future deals
  64. 64. Exit Through Liquidation Copyright 2009 Cornwall, Vang & Hartman Type of Exit Advantages Disadvantages Liquidation May result in more value, especially for service business No value for going concern Can be viewed as “failure”
  65. 65. Exit Planning <ul><li>Re-examine owners’ aspirations </li></ul><ul><li>Evaluate timing issues </li></ul><ul><li>Consider ethical issues of exit plans </li></ul><ul><li>Set specific financial goals, and the timeframe to achieve these goals, based on owners’ aspirations related to wealth </li></ul><ul><li>Establish a specific plan to meet financial goals </li></ul><ul><li>Begin external audit or review </li></ul><ul><li>Evaluate possible exit options </li></ul>Copyright 2009 Cornwall, Vang & Hartman
  66. 66. Figure 14.4 Sale 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 50 % of deals proceed to next stage 50 % of deals proceed to next stage Copyright 2009 Cornwall, Vang & Hartman

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