ESSAM 2011

Startup Financing

Professor Stephen Lawrence

Leeds School of Business

University of Colorado at Boulder

Agenda

Sources of Funding1. Bootstrapping2. Debt3. Government funding4. Non-traditional5. Equity funding

Deal structure & term sheets Valuation

How much money do we need? Review cash flow statements Find periods with negative cash balances Schedule cash infusion(s) to eliminate

negative balances Add safety cushion (~10-25%) Develop funding strategy

Eg, staged funding “tranches”

Startup Financing Cycle

http://enwikipediaorg/wiki/Venture_capital

Cash from operations!

Sources of Funds

1. Bootstrapping

2. Debt

3. Government funding

4. Non-traditional

5. Equity funding

6

Global Capital Structures (1995)

LONG- SHORT-

TOTAL TERM TERM

COUNTRY EQUITY DEBT DEBT DEBT

United Kingdom 68.3% 31.7% N/A N/A

United States 48.4% 51.6% 26.8% 24.8%

Canada 47.5% 52.5% 30.2% 22.7%Germany 39.7% 60.3% 15.6% 44.7%France 38.8% 61.2% 23.5%

43.0%Japan 33.7% 66.3% 23.3%

43.0%Italy 23.5% 76.5% 24.2%

52.3%Source: Scott Besley and Eugene F. Brigham, 2005. Essentials of Managerial Finance, 13th Ed.

1. Bootstrapping

Start-up without much capital

“Pick yourself up by your bootstraps”

What is Bootstrapping?

“Launching ventures with modest personal funds” Bhide

Using Other People’s Resources (OPR) Timmons

Scrooge mode

Bootstrapping Examples

Make vs. buy (do it yourself) Hire temps/subcontractors vs. employees

Employee benefits Modest office and location vs. prestige

Virtual offices Used furniture and equipment vs. new PR (public relations) vs. advertising

Sources for Internal Funds

Profits Sale of assets and little-used assets Working capital reduction Extended or discounted payment terms – suppliers Collecting bills (accounts receivable) more quickly Short-term internal source of funds:

Reducing short-term assets: inventory, cash, and other working-capital items

Extended payment terms from suppliers

Bootstrapping Benefits

Requires less capital Lowers risk Improves decision making Enhances flexibility Focus on profitability Investors love it Establishes culture

A Bhide, Bootstrap Finance, HBR

Greatest Source of Money?

2 Debt

Sources of Debt Funding

Credit cards Bank loans

Typically insist on a secured loans Second mortgage on house or property Use equipment & facilities to secure loan Revolving lines of credit

Investment banks Less “expensive” than equity Disadvantage: Must be paid regularly

3 Government Funding

Types of Government Assistance Direct loans & subsidies Research grants Tax benefits

Invest tax reductions Production tax reductions

Support for hiring new employees Employee training / retraining Et cetera, et cetera …

4 Non-Traditional Funding

Nontraditional Funding Sources Customers

Development Prepay Co-invest

Trade credit (vendor terms & conditions) Leasing vs buying Factoring receivables (loans against

invoices) Loans secured by inventory

5 Equity Funding

Equity Funding

Most “expensive” form of financing! Give up ownership (equity)

A. Private Placement Friends, family, and fools Well to-do investors

B. Angels “Professional” investors working alone or in

syndicates Colorado Capital Alliance (wwwanglecapitalcom)

C. Venture Capitalists

5A. Private Placement

Funding from private investors, also called angels (family or friends or wealthy individuals)

Types of investors Investor can influence nature and direction of the business

to some extent May be involved in the business operation Entrepreneur needs to consider degree of involvement

Private offerings A formalized method for obtaining funds from private

investors Faster and less costly

Family and Friends

Likely to invest due to relationship with entrepreneur Advantage: easy to obtain money; more patient than other

investors Disadvantage: direct input into operations of venture

A formal agreement must be written to include: Amount of money involved Terms of the money Rights and responsibilities of the investor What happens if the business fails

Entrepreneur must consider impact on personal relationship

5B. Angels – Informal Risk Capital Consists of a virtually invisible group of

wealthy investors (business angels) Often will form syndicates Investments range between $10,000 to

$2,000,000 Provide funding, especially in start-up (first-

stage) financing Contains the largest pool of risk capital in the

United States

5C. Venture Capital

A professionally managed pool of equity capital A long-term investment discipline, usually occurring

over a five-year period Found in the:

Creation of early-stage companies Expansion and revitalization of existing businesses Financing of leveraged buyouts of existing divisions of

major corporations or privately owned businesses Venture capitalist takes an equity participation in

each of the investments

Venture Capital Criteria

VC Firm Objective Generation of long-term capital appreciation

through debt and equity investments Criteria for committing to venture:

Strong management team Product and/or market opportunity must be unique Business opportunity must show significant capital

appreciation

Valuation

http://wwwguayacanorg

Company Valuation Factors

Economic outlook- general and industry Comparative data Book (net) value Future earning capacity Dividend-paying capacity Assess goodwill/intangibles Previous sale of stock Market value of similar companies’ stock

Equity Discount Rates

Seed capital 80 to 100%

Startup financing 50 to 70%

First-stage financing 40 to 60%

Second-stage financing 30 to 50%

Bridge financing 20 to 35%

Restart financing variable

Factors Affecting Discount Rates

Total Discount Rate

Base Rate

Systematic Risk

Liquidity

Value Add

Cash Flow Adjustment

Seed Stage 1 Stage 2 Bridge IPO

Just

ifia

ble

Dis

coun

t Rat

e

Sahlman, A Method for Valuing High-Risk, Long-Term Investments, teaching note, HBS 9-288-006

Risk-freeinvestment

Marketsensitivity

Risk of failurepremium

Value ofVC adviceInvestment

not liquid

Team Assignment

How will you fund your venture? About how much money will you need? How big will your business become? What are your long-term goals for your

venture? Hold and operate? Go public? Sell out? Others?

ESSAM 2010

Startup Financing

Professor Stephen Lawrence

Leeds School of Business

University of Colorado at Boulder

EXTRA SLIDES

Bootstrapping – Capital Benefits Need less capital

Reduces financial exposure Reduces equity dilution

Reduces risk Obsolescence Lower sunk costs

Investor's love it Proves concept and management team Reduces risk

Bootstrapping – Flexibility Benefits Fluctuating conditions and uncertainty Difficulty in predicting what resources are

needed Make changes quickly Permits strategic experiments Cost of making a mistake is minimized

Mistakes less likely to be fatal Inexperienced entrepreneurs can screw-up Don’t have the pressure of high growth

Bootstrapping – Problem Solving Accelerates problem identification

Reveals hidden problems (Like zero inventory in JIT) Forces management to solve them

Focus is on sales and profits Price for profitability Reduces costs

Lower fixed costs Higher variable costs, but high Gross Profit Margin solves Lower break-even point

Establishes a problem-solving culture