1. 13–1 National Formosa University Pre-competition Financing and Capital Sourcing Options By Dr. Bill Todorovic Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940 http://users.ipfw.edu/todorovz /

2. 13–2 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. 13–3 Sources Of Funds Personal Friends and Family Angels Venture Capitalist Banks Government Customers/Suppliers Start-up Going Concern Beginning of Production ? IPO Amount Company Size

4. 13–4 Sources of Financing 01020304050607080 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. 13–5 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. 13–6 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. 13–7 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. 13–8 Debt or Equity Financing? Potential Profitability Financial Risk Voting / Control

9. 13–9 $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 With no debt and all equity: Debt Versus Equity Equity: Owners get to keep all of the profits in return for accepting the risk of lower returns

10. 13–10 $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: Debt Versus Equity (Cont’d) Debt is Risky: Lenders have first claim on profits and must be paid even if there are no profits.

11. 13–11 Fig. 13.3 Sources of Funds

12. 13–12 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

13. 13–13 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?

14. 13–14 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

15. 13–15 Negotiating a Loan Terms of Loans –Interest rate –Loan maturity date –Repayment schedule –Loan covenants

16. 13–16 Getting to know your friendly neighborhood Venture Capitalist…

17. 13–17 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

18. 13–18 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

19. 13–19 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

20. 13–20 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

21. 13–21 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

22. 13–22 What VCs Do?

23. 13–23 When the Market is Down…

24. 13–24 AngelsAngels Well to do private individuals Geography and industry specific Invest lower amount than VC Often a good source of industry experience

25. 13–25 Finding Angels Private Individuals Professionals (lawyers, accountants, bankers) Local small business development centers Internet associations (e.g., Technology Capital Network at MIT)

26. 13–26 Other Sources of Financing Community-based financial institutions Large corporations Stock Sales –Private placement –Initial public offering (IPO)

27. 13–27 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

28. 13–28 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

29. 13–29 Building to Grow

30. 13–30 Complements of: Timmons/Spinelli New Venture Creation, sixth edition Low Level Investment Lower Long-term Income Potential (Lower Capacity)