Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 16-1

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Chapter 16

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Choosing the right sources of capital can be as important as the right form of ownership or the right location  The money is out there; the key is knowing where to look  Creativity counts  The Internet provides easy access to vast resources of information that can lead to financing 16-3

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Raise only as much money as you really need  Be thoroughly prepared before approaching potential lenders and investors  Looking for “smart” money is more important than looking for “easy” money  Plan an exit strategy  Layered financing 16-4

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Possible Sources of Equity Financing

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  The money required to launch a new business is known as seed capital  Once there is a proven business model and a growing customer base, additional growth capital may be needed  Capital: any form of wealth employed to produce more wealth  Cash, inventory, plant, and equipment  Entrepreneurs need two different types of capital:  Fixed and working 16-6

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Fixed Capital  Fixed capital: provides funding for the purchase of a business’s permanent or fixed assets, such as buildings, land, computers, and equipment  Money cannot be used for other purposes – it’s frozen 16-7

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Working Capital  Working capital: represents a business’s temporary funds; it is the capital used to support a company’s normal short-term operations  Accountants define working capital as current assets minus current liabilities 16-8

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Equity capital: represents the personal investment of the owner (or owners) and any investment from outside sources in a business  Sometimes called risk capital because these investors assume the primary risk of losing their funds if the business fails  Does not have to be repaid with interest like a loan does  But, an entrepreneur must give up some ownership in the company to outside investors 16-9

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Funding from Founders  The first place an entrepreneur should look for money  The least expensive source of funds  Half of start-ups with employees launch with less than $50,000 and without employees for less than $10,

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Lenders and investors expect entrepreneurs to invest in their own business  Personal savings  Sweat equity  Other personal assets  Unsecured personal credit  Second mortgage on property  Pledging other personal assets  Working a second job  Bootstrapping 16-11

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Friends and Family Members  After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business - friends and family members  GEM study:  Amounts invested from friends and family members are small  Investments from friends and family members make up 36% of a typical start-up’s total capital  SBA study:  Inherent dangers lurk in family/friendly business deals, especially those that flop 16-12

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Guidelines for family and friendship financing deals:  Keep the arrangement strictly business  Validate the business plan  Educate “naïve” investors  Never accept more than the investor can afford to lose  Create a written contract  Treat the money as “bridge financing”  Develop a payment schedule that suits both parties  Keep everyone informed 16-13

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Crowdfunding  Historically, investing in startups was done by accredited investors who have the knowledge and financial ability to assume the risks that come with such investments 16-14

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Can also raise money using crowdfunding  Uses the Internet to generate many small contributions from a large number of people to fund a business  Primarily used to help raise money to support social causes, help fund struggling artists, or support local small business start-up  Money received was considered a contribution or a donation rather than an investment 16-15

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Jumpstart Our Business Startups (JOBS) Act of 2012 significantly expands the use of crowdfunding  Those who provide funding can become equity investors with ownership in the business  Anyone can invest some amount in a business start-up  Entrepreneurs are no longer limited to seeking funding only from accredited investors  Use social media to attract money  Keep in mind that crowdfunding can create new complexities because of differing expectations among investors 16-16

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Accelerators  Many communities and universities have established accelerator programs that offer new entrepreneurs a small amount of seed capital and a wealth of additional support  Y Combinator and TechStars 16-17

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Accelerators help move entrepreneurs from the idea stage to a point when the business has a proven story and a successful business model that they can pitch for more significant funding  Most important contribution is the coaching and mentoring from angel investors and experienced entrepreneurs 16-18

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Angels  Angel investors: private investors who invest in emerging business start-ups in exchange for equity stakes in the company  Ideal for companies that are too big for friends and family investors, but too small for VC companies  Most likely to finance start-ups with capital requirements in the $10,000 to $2 million range  Center for Venture Research study: 268,000 angels invest $22.9 billion a year in 67,000 small companies 16-19

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Angel Financing

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Most angels prefer to maintain a low profile so the key is finding them!  Angels almost always invest their money locally and can be found through networking  Typical angel accepts 14.5% of the proposals presented and invests an average of $50,000 in one company per year  An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Angel networks and angel capital funds, dubbed “super-angels” operate like miniature versions of professional venture capital firms and draw on their skills, experience, and contacts to help the start-ups in which they invest succeed 16-22

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Strategic Investments Through Corporate Venture Capital  15% of all venture capital investments come from corporations  Average CVC investment = $3.5 million  About 300 large corporations across the globe invest in start-up companies  Capital infusions are just one benefit; corporate partners may share marketing and technical expertise 16-23

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Corporate Venture Capital

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Venture capital companies (VCs): private, for-profit organizations that raise money from investors to purchase equity positions in young businesses that they believe have high growth and high profit potential, producing annual returns of 500 to 1,000 percent over five to seven years  More than 400 venture capital firms operate across the U.S

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Venture Capital Funding

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Policies and Investment Strategies  Investment size and screening  Average VC investment is $7.2 million  Screening process is extremely rigorous!  VCs typically invest in less than 1% of the business plans they receive  GEM study: Only one in 1,000 businesses in the U.S. attract VC 16-27

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Stage of investment  Most VCs invest in the early or rapid-growth stages of development  GEM study: only one in 10,000 worldwide receive VC at start-up! 16-28

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall Venture Capital Funding by Stage

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Advice and contacts  Provide management advice and access to valuable networks of contacts of suppliers, employees, customers, and other sources of capital  Control  Entrepreneurs must give up a portion of their businesses in exchange for funding  Some VCs take an active role, others are passive investors 16-30

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Investment preferences  Most of the start-up businesses that attract venture capital today are in the biotechnology, software, energy, and medical device industries  Competent management  The key to success is the management team!  Competitive edge  Growth industry  Viable exit strategy  Intangible factors 16-31

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Public Stock Sale (“Going Public”)  In an initial public offering (IPO), a company raises capital by selling shares of its stock to the general public for the first time  Effective way of raising large amounts of capital  But, can be expensive and time-consuming 16-32

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall IPOs

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Once a company makes an IPO, nothing will ever be the same again  No longer under the exclusive ownership and control of the entrepreneur  Focus is now on the interests of all stockholders 16-34

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  The IPO Process  Choose the underwriter  Negotiate a letter of intent  Prepare the registration statement  File with the SEC  Wait to go effective  Road show  Sign formal underwriting agreement  Meet state requirements 16-35

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.  Investment bankers underwriting IPOs look for:  Consistently high growth rates  Scalability  High profit potential  Three to five years of audited financial statements that meet or exceed SEC standards  A solid position in a rapidly growing industry  A sound management team with experience and a strong board of directors 16-36

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall