1 Outline: Chapter 9 Financing Over the Life of a VentureCommon Misconceptions about Entrepreneurial Financing The Diverse Nature of Business Financing Financing Smaller Businesses with Modest Growth Potential Financing High Growth, High Potential Ventures Copyright 2009 Cornwall, Vang & Hartman

2 Common Misconceptions about Entrepreneurial FinancingVenture Capitalists Fund Most Businesses Banks Lend to Start-ups SBA lends money directly to entrepreneurs Entrepreneurs Tend to Rely on One Single Source of Funding Government Grants are a Good Source of Money for Small Businesses Copyright 2009 Cornwall, Vang & Hartman

3 The Diverse Nature of Business FinancingThe Nature of the Business Model Aspirations of the Entrepreneur The Stage of Development of the Business Venture Fitting the Pieces of the Financing Puzzle Together Copyright 2009 Cornwall, Vang & Hartman

4 Financing a Small Business - Modest Growth Figure 9.1Pre-launch Start-up Growth Transition Bootstrapping Self, friends, and family Equity financing Debt financing Copyright 2009 Cornwall, Vang & Hartman

5 Financing a High-Growth, High-Potential Venture Figure 9.2Pre-launch Start-up Growth Transition Bootstrapping Seed financing from angels Equity financing from VCs Debt financing Copyright 2009 Cornwall, Vang & Hartman

6 Outline: Chapter 10 Start-up Financing From the Entrepreneur, Friends and FamilySelf-financing Advantages and Disadvantages of Self- financing Friends and Family Financing Structure of Funds Invested Loan Equity Copyright 2009 Cornwall, Vang & Hartman

7 Most Common Sources of Financing Figure 10.1Pre-launch Start-up Growth Transition Self, friends, and family Copyright 2009 Cornwall, Vang & Hartman

8 Advantages and Disadvantages of Self-Financing Table 10.1Relative 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 Copyright 2009 Cornwall, Vang & Hartman

9 Friends and Family FinancingDetermine True Motivations Use a Formal Business Plan Provide Accurate, Objective, and Full Information about the Business Keep Boundaries Tax Planning Copyright 2009 Cornwall, Vang & Hartman

10 Outline: Chapter 11 BootstrappingWhy bootstrap? Bootstrapping Administrative Overhead Bootstrapping Employee Expenses Bootstrapping Operating Expenses Bootstrap Marketing The Ethics of Bootstrapping Copyright 2009 Cornwall, Vang & Hartman

11 Bootstrapping Throughout the Life of a Venture Figure 11.1Pre-launch Start-up Growth Transition Bootstrapping Copyright 2009 Cornwall, Vang & Hartman

12 Bootstrapping 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.” Cornwall, J. (2010). Bootstrapping. Englewood Cliffs, NJ: Pearson/Prentice-Hall. Copyright 2009 Cornwall, Vang & Hartman

13 Why Bootstrap? Often necessary for small businesses to get startedDifficulty in raising money for growth Preserves the value and wealth of a business “Extend the Runway” Reduce risk associated with debt financing Copyright 2009 Cornwall, Vang & Hartman

14 Rules of BootstrappingRule #1: Overhead matters Rule #2: Employee expenses are usually the highest single recurring cost Rule #3: Minimize operating costs Rule #4: Marketing matters, but know your customers and how they make decisions Copyright 2009 Cornwall, Vang & Hartman

15 Bootstrapping Administrative OverheadSpace Furnishings and office equipment Administrative salaries Copyright 2009 Cornwall, Vang & Hartman

16 Bootstrapping Employee ExpensesEmployee “stretching” Independent contractors Employee leasing and temporary employees Student interns Equity compensation Non-monetary benefits Copyright 2009 Cornwall, Vang & Hartman

17 Bootstrapping Operating ExpensesOutsourcing Just-in-time inventory techniques Effective cost accounting Copyright 2009 Cornwall, Vang & Hartman

18 Bootstrap Marketing Know your customerFocus on the impact of message, not “volume” Focus on benefits for customer Understand the market niche Spend your marketing dollars wisely Marketing is a process, not an event Copyright 2009 Cornwall, Vang & Hartman

19 The Basic Bootstrap Marketing ToolsWord of Mouth Business cards Blogs Brochures Banners and signs Newsletters Direct mailing/ ing Publicity Copyright 2009 Cornwall, Vang & Hartman

20 Word of Mouth Motivate customers to talk about businessCreate incentives to spread the word Ask customers to “sell” Create a “buzz” campaign Viral marketing Copyright 2009 Cornwall, Vang & Hartman

21 Business Cards Design is important Include needed data about businessUse quality paper Use color Include description and/or slogan Use both side of card Copyright 2009 Cornwall, Vang & Hartman

22 Blogs Be consistent in blogging Do not blog merely to promote businessTake time to create quality blog Be patient – blogging takes time to build following Be cautious what you write! Copyright 2009 Cornwall, Vang & Hartman

23 Outline: Chapter 12 External Sources of Funds: EquityAngel Investors Strategic Partners Private Placement SBIC The Downside of Equity Financing Working with Outside Investors Copyright 2009 Cornwall, Vang & Hartman

24 Equity Financing Figure 12.1Pre-launch Start-up Growth Transition Equity financing Copyright 2009 Cornwall, Vang & Hartman

25 Downside of Equity FinancingDilution of ownership The risk of sharks Dynamics of adding on new partners Copyright 2009 Cornwall, Vang & Hartman

26 Working with Equity InvestorsBusiness plan Confidentiality agreement Letter of Intent Modifications of shareholder agreements Communication with shareholders Copyright 2009 Cornwall, Vang & Hartman

27 Outline: Chapter 13 External Sources of Funds: DebtShort-term debt Long-term debt Forms of debt overlooked by entrepreneurs Working with bankers Downside of debt Developing a Financing Plan Copyright 2009 Cornwall, Vang & Hartman

28 Debt Financing Figure 13.1 Copyright 2009 Cornwall, Vang & HartmanPre-launch Start-up Growth Transition Debt financing Copyright 2009 Cornwall, Vang & Hartman

29 Short-term Debt Expected to be paid within one yearMost often used to finance short-term expenditures such as inventory, supplies, payroll, etc. Copyright 2009 Cornwall, Vang & Hartman

30 Short-term Debt Trade debt Institutional Creditors BanksAsset-based lenders Factors Copyright 2009 Cornwall, Vang & Hartman

31 Long-term Debt Beyond one yearMost often used to fund fixed asset purchases Copyright 2009 Cornwall, Vang & Hartman

32 Long-term Debt Banks: term loans Leasing companies Real estate lendersCopyright 2009 Cornwall, Vang & Hartman

33 Criteria for Lending by BankersAbility of the business to generate enough cash flow to easily make interest and principle payments Entrepreneur’s ability to personally pay back the loan if the business fails Assets to serve as collateral Copyright 2009 Cornwall, Vang & Hartman

34 Key Loan Documents Loan proposal Loan document Personal guaranteesCopyright 2009 Cornwall, Vang & Hartman

35 Downside of Debt Increased risk during economic slowdownImpact on proceeds from business sale Restrictive covenants Personal guarantees Copyright 2009 Cornwall, Vang & Hartman

36 Example of Assets and Potential Funding Generated Table 13.1Estimated value Percentage financed Potential funding generated Customer Purchase Orders $50,000 70% $35,000 Accts. Receivable (<60 days) $80,000 $56,000 Inventory $20,000 30% $ 6,000 Leasehold Improvements $10,000 50% $ 5,000 Building $120,000 $84,000 Undeveloped Land $40,000 40% $16,000 Equipment $15,000 80% $12,000 Total of Business Funding Sources $335,000 $214,000 Copyright 2009 Cornwall, Vang & Hartman

37 Outline: Chapter 14 Financing the High Growth BusinessWhat Venture Capitalists and Private Equity Funds Provide – The Four “C’s” Integrating Profitability into the Business Plan Stages of the Firm Stages of Business Funding The Dark Side of Venture Capital Financing Initial Contact with a Venture Capitalist Initial Public Offering (IPO) The Process of the IPO Copyright 2009 Cornwall, Vang & Hartman

38 Financing a High Growth Venture Figure 14.1Pre-launch Start-up Growth Transition Venture capital equity financing Copyright 2009 Cornwall, Vang & Hartman

39 The “Four Cs” of Venture CapitalContacts Counsel Credibility Copyright 2009 Cornwall, Vang & Hartman

40 Stages of High Growth Business FundingInitial stage First round financing Second round financing Late round financing Copyright 2009 Cornwall, Vang & Hartman

41 Initial Stage Funding File for incorporation Write business planFind office and development space Completion of initial design Hire key development personnel Complete prototype unit Complete prototype testing Copyright 2009 Cornwall, Vang & Hartman

42 First Round Financing Secure key vendorsHire key service or manufacturing personnel Rent or build manufacturing facility Purchase manufacturing equipment Market testing First sales contract Production of first manufactured unit First 100, 1000, units, etc. Copyright 2009 Cornwall, Vang & Hartman

43 Second Round FinancingBreak-even level of sales Development of next generation of product Copyright 2009 Cornwall, Vang & Hartman

44 Late Round Financing Initial public offering Sale of businessCopyright 2009 Cornwall, Vang & Hartman

45 Initial Contact with a Venture CapitalistFunding amount Duration Summary of the project Use of funding Confirm how the transaction will be liquidated Existing investment in the project Names of bankers, lawyers, accountants and consultants Unusual or sensitive information Copyright 2009 Cornwall, Vang & Hartman

46 Venture Capital Term SheetAmount the venture capitalist wishes to invest. Percentage of ownership to the venture capitalist. The nature of the investment such as loan, stock, warrants, etc. Governance rights of the venture capitalist. Right to eventually register shares for a public offering. Remaining conditions to be met by the entrepreneur such as periodic reports, financial statements, etc. An estimate of valuation of the company. Specific requirements on what the money is to be used for or specific assets that must be purchased with the funds. Copyright 2009 Cornwall, Vang & Hartman

47 Initial Public OfferingAdvantages Disadvantages Diversification and liquidity Reporting costs Ability to raise new cash Disclosure of information Valuation Maintenance of control Future business deals Publicity Copyright 2009 Cornwall, Vang & Hartman

48 Process of the IPO Selecting an investment banking firmThe decision to underwrite or not underwrite Getting the paperwork in order and certifying the price of the offering The road show Determine the size of the book The first day of trading Copyright 2009 Cornwall, Vang & Hartman

49 Outline: Chapter 13 Business ValuationGeneral concepts that guide the determination of value Basic information required for a valuation Estimating a firm’s cash flow and determining its value Definition of cash flow Estimating the cash flow for a particular year Copyright 2009 Cornwall, Vang & Hartman

50 Concepts that Guide the Determination of ValueFair market value Going-concern value Highest and best use Future benefits Substitutes and alternatives Discounted cash flow analysis Objectivity Copyright 2009 Cornwall, Vang & Hartman

51 Information Required for a ValuationIncome statements and/or tax returns Balance sheet Rates of return consistent with the risk level Interviews with current owners and staff Assessment of future business environment Copyright 2009 Cornwall, Vang & Hartman

52 Discounted Cash Flow Incorporates all other principlesIncome-oriented approach Can use EBITDA Needs a required rate of return Copyright 2009 Cornwall, Vang & Hartman

53 Perceived Rates of ReturnPublicly traded company % Privately held company % Angel investors % Venture capitalists % Copyright 2009 Cornwall, Vang & Hartman

54 -inventory investment =Free Cash FlowEstimating Cash Flow EBIT +owner’s salary -reasonable salary +depreciation +personal expenses =EBITDA -equipment purchased -inventory investment =Free Cash Flow Copyright 2009 Cornwall, Vang & Hartman

55 Calculating Value Enter zero for Cf0Enter each year’s unique free cash flow For final year enter the sum of the terminal cash flow and the year’s free cash flow Enter required rate of return as interest rate Calculated NPV is the value of the firm Copyright 2009 Cornwall, Vang & Hartman

56 Market Comparison ApproachPrice/Earnings Price/Pre-tax Earnings Price/Cash Flow Price/EBITDA Price/Dividend Price/Sales Price/Assets Price/Book Value Price/Customer Price/Unit Copyright 2009 Cornwall, Vang & Hartman

57 Market Comparison ProblemsLine of business Geographic area Age of assets Listing status Costs of inputs Level of establishment Sale terms Standing of ownership Size Financing Time period Similar buyer Copyright 2009 Cornwall, Vang & Hartman

58 Outline: Chapter 14 Exit PlanningSelf-assessment revisited The ethical side of the entrepreneur’s transition A model of exit planning Exit options The process of selling a business Post exit issues Copyright 2009 Cornwall, Vang & Hartman

59 Exit Planning The process of preparing for the transition of both the entrepreneur and the business Copyright 2009 Cornwall, Vang & Hartman

60 Exit Through Ownership TransferType 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 Copyright 2009 Cornwall, Vang & Hartman

61 Exit Through Partial or Limited TransferType 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 Copyright 2009 Cornwall, Vang & Hartman

62 Exit Through Partial or Limited Transfer (Continued)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 Family Business Transfer Challenges of generational succession Copyright 2009 Cornwall, Vang & Hartman

63 Exit Through BankruptcyType 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 Copyright 2009 Cornwall, Vang & Hartman

64 Exit Through LiquidationType of Exit Advantages Disadvantages Liquidation May result in more value, especially for service business No value for going concern Can be viewed as “failure” Copyright 2009 Cornwall, Vang & Hartman

65 Exit Planning Re-examine owners’ aspirations Evaluate timing issuesConsider ethical issues of exit plans Set specific financial goals, and the timeframe to achieve these goals, based on owners’ aspirations related to wealth Establish a specific plan to meet financial goals Begin external audit or review Evaluate possible exit options Copyright 2009 Cornwall, Vang & Hartman

66 Figure 14.4 Sale Process of a BusinessInitial Inquiry 10 % of deals proceed to next stage Letter of Intent Deal Price and Basic Structure Agreed Upon 50 % of deals proceed to next stage Due Diligence 50 % of deals proceed to next stage Purchase Agreement and Closing Copyright 2009 Cornwall, Vang & Hartman