financing your business glencoe entrepreneurship: building a business financing the small business...

Financing Your Financing Your BusinessBusinessFinancing Your Financing Your BusinessBusiness

Glencoe Entrepreneurship: Building a Business

Financing the Small Business Start-UpFinancing the Small Business Start-Up

Obtaining Financing and Growth Obtaining Financing and Growth CapitalCapital

19.1Section

19.2Section

1919


Financing the Small Business Start-Up

SECTIONSECTION 19.119.1

Chapter 19 Financing Your Business

• Describe the resources available to entrepreneurs to start a business.

• Compare and contrast sources of financing for start-up ventures.• Describe the importance of financial planning.

Section Objectives





Most start-up funds come from an entrepreneur’s personal resources, such as savings; however, there are other common sources of funding.

The Main Idea





Content Vocabulary

bootstrappingfactorequity capitalequityrisk capitalangel

venture capitalventure capitalistdebt capitaloperating capitalline of credittrade credit





One of the unique talents of entrepreneurs is finding the resources to launch a business. This requires understanding the differences between:

short-term needs, those associated with activities not part of normal operations; and

long-term capital needs, relating to preparation for future growth.

Entrepreneurial Resources





Most entrepreneurs get their businesses started by bootstrapping.

bootstrapping

operating a business as frugally as possible and cutting all unnecessary expenses, accomplished by borrowing, leasing, and partnering to acquire resources

bootstrapping

operating a business as frugally as possible and cutting all unnecessary expenses, accomplished by borrowing, leasing, and partnering to acquire resources

Bootstrapping





Bootstrapping involves:

• hiring as few employees as possible• leasing anything you can• being creative

Bootstrapping





Bootstrapping entrepreneurs can also ask suppliers to allow for longer payments terms, ask customers to pay in advance, or sell their accounts receivable to a factor.

factor

an agent who handles an entrepreneur’s accounts receivable for a fee

factor

an agent who handles an entrepreneur’s accounts receivable for a fee

Bootstrapping





The main sources for start-up money for entrepreneurs include:

• friends• family• others who believe in the entrepreneur

Start-Up Money

These resources come in several forms, such as savings, credit cards, loans, and investments.





Some sources of financing include:

• banks• finance companies• investment companies• government grants

Financing the Start-Up





To obtain equity capital as a source of funding for a business, the owner must give equity to obtain the financing.

equity capital

cash raised for a business in exchange for an ownership stake in the business

equity capital

cash raised for a business in exchange for an ownership stake in the business

Sources of Equity Financing

equity

an ownership in a business

equity

an ownership in a business





Equity funding is sometimes called risk capital.

risk capital

money invested in companies where there is financial risk

risk capital

money invested in companies where there is financial risk



13

Forms of Equity

Financing

Personal savings

Friends and family

Private investors

PartnersVenture capitalists

State-sponsored venture

capital funds





An angel often invests because of his or her belief in a business concept and the founding team.

angel

a private, nonprofessional investor, such as a friend, a relative, or a business associate, who funds start-up companies

angel

a private, nonprofessional investor, such as a friend, a relative, or a business associate, who funds start-up companies






An existing business can use venture capital financing to raise large amounts of money to achieve its goals.

venture capital

a source of equity financing for small businesses with exceptional growth potential and experienced senior management

venture capital

a source of equity financing for small businesses with exceptional growth potential and experienced senior management






Venture capitalists often provide managerial and technical expertise to small businesses.

venture capitalists

individual investors or investment firms that invest venture capital professionally

venture capitalists

individual investors or investment firms that invest venture capital professionally






Sources of debt capital are far more numerous than sources of equity capital, but the entrepreneur must be certain the business can generate enough cash flow to repay the loan.

debt capital

money raised by taking out loans, which must be repaid with interest

debt capital

money raised by taking out loans, which must be repaid with interest

Sources of Debt Financing


18

Sources ofDebt

Financing

Banks Trade credit

Minority enterprise

development programs

Commercial finance

companiesSBA loans

Small business

investment companies





Banks were once the primary source of operating capital, but today they are much more conservative in their lending practices.

operating capital

money a business uses to support its operations in the short term

operating capital

money a business uses to support its operations in the short term






An established business can usually get a line of credit from a bank, which it can borrow against.

line of credit

an arrangement whereby a lender agrees to lend up to a specific amount of money at a certain interest rate for a specific period of time

line of credit

an arrangement whereby a lender agrees to lend up to a specific amount of money at a certain interest rate for a specific period of time






Some businesses may seek trade credit from other companies in their industry as a form of debt financing.

trade credit

credit one business grants to another business for the purchase of goods or services; a source of short-term financing provided by one business within another business’s industry or trade

trade credit

credit one business grants to another business for the purchase of goods or services; a source of short-term financing provided by one business within another business’s industry or trade






Financial planning involves finding the right kind of financial resources at the right time in the right amount.

Financial Planning for Your Business





Financial planning involves:

• Identifying the stages of growth in your business• Identifying milestones that require resources• Identifying business advisers• Hiring an excellent management team

Financial Planning for Your Business





After You Read

1. Describe the resources available to entrepreneurs to start their business.

Most entrepreneurs start their businesses by bootstrapping or using personal resources such as friends, family, savings, credit cards, loans, and investments.

Most entrepreneurs start their businesses by bootstrapping or using personal resources such as friends, family, savings, credit cards, loans, and investments.





After You Read

2. Compare and contrast sources of financing for start-up ventures.

Entrepreneurs have two options: equity or debt financing. Equity sources trade cash for some portion of ownership, or equity, in a business. With debt financing, an entrepreneur borrows money and repays it with interest, and retains full ownership of the business. However, the loan must be carried as a liability on the business’s balance sheet. For this approach to be successful, your business must generate enough cash flow to repay the loan.

Entrepreneurs have two options: equity or debt financing. Equity sources trade cash for some portion of ownership, or equity, in a business. With debt financing, an entrepreneur borrows money and repays it with interest, and retains full ownership of the business. However, the loan must be carried as a liability on the business’s balance sheet. For this approach to be successful, your business must generate enough cash flow to repay the loan.





After You Read

3. Describe the importance of financial planning.

Financial planning provides you with a better chance of securing the money you need when you need it in the right amount.

Financial planning provides you with a better chance of securing the money you need when you need it in the right amount.

Obtaining Financing and Growth Capital


SECTIONSECTION


19.219.2

• Describe the information needed to obtain financing.• Explain the types of growth financing available to

entrepreneurs.• Describe how to calculate start-up capital requirements.

Section Objectives



SECTIONSECTION


19.219.2

Additional sources of funding become available when entrepreneurs are ready to grow their businesses.

Entrepreneurs must calculate business milestones and financial needs so they can communicate this information to potential funders.

The Main Idea



SECTIONSECTION


19.219.2

Content Vocabulary

pro formacharactercapacitycapitalcollateralconditions

due diligenceprivate placementinitial public offering (IPO)stock working capitalcontingency fund



SECTIONSECTION


19.219.2

To obtain financing, you must create pro forma financial statements to include in your business plan.

pro forma

proposed or estimated financial statements based on predictions of how the actual operations of the business will turn out

pro forma

proposed or estimated financial statements based on predictions of how the actual operations of the business will turn out

How to Obtain Financing



SECTIONSECTION


19.219.2

Venture capitalists rarely invest in start-up companies, but when they do, they expect:

• A tenfold return on their investment in five to seven years (for start-up companies)

• A five- to seven-times return on their investment (for businesses in the growth stage)

• A business with large market potential, growing at least 20% each year

What Venture Capitalists Expect



SECTIONSECTION


19.219.2

Private investors, or angels, expect:

• businesses they understand• investing with like-minded investors• ten times their investment at the end of five years• a strong management team

What Private Investors Expect



SECTIONSECTION


19.219.2

Commercial lenders like banks rely on the five Cs to determine the acceptability of a business loan applicant:

C

C

C

C

C

Character

Capacity

Capitol

Collateral

Conditions

What Bankers Expect



SECTIONSECTION


19.219.2

A bank must believe in the character of the entrepreneur.

character

a borrower’s reputation for fair and ethical practices, including business experience, dealings with other businesses, and reputation in the community

character

a borrower’s reputation for fair and ethical practices, including business experience, dealings with other businesses, and reputation in the community

What Bankers Expect



SECTIONSECTION


19.219.2

Banks consider the capacity of a business to pay its debts.

capacity

the ability of a business to pay a loan in view of its income and obligations

capacity

the ability of a business to pay a loan in view of its income and obligations

What Bankers Expect



SECTIONSECTION


19.219.2

Banks place a strong emphasis on whether a business has a financially stable capital structure.

capital

the net worth of a business, the amount by which its assets exceed its liabilities

capital

the net worth of a business, the amount by which its assets exceed its liabilities

What Bankers Expect



SECTIONSECTION


19.219.2

Banks are more likely to lend to businesses with valuable collateral.

collateral

security in the form of assets that a company pledges to a lender

collateral

security in the form of assets that a company pledges to a lender

What Bankers Expect



SECTIONSECTION


19.219.2

Banks consider all the conditions in which the business operates.

conditions

the circumstances at the time of the loan request, including potential for growth, amount of competition, location, form of ownership, and insurance

conditions

the circumstances at the time of the loan request, including potential for growth, amount of competition, location, form of ownership, and insurance

What Bankers Expect



SECTIONSECTION


19.219.2

If your company has established a successful track record, there are other types of financing available, including:

• venture capital (VC) companies• private placements• initial public offerings (IPOs)

Types of Growth Financing



SECTIONSECTION


19.219.2

If a VC firm is interested in funding your business and decides you have a sound business plan, it will begin due diligence.

due diligence

the investigation and analysis a prudent investor does before making business decisions

due diligence

the investigation and analysis a prudent investor does before making business decisions

Venture Capital (VC) Companies



SECTIONSECTION


19.219.2

Private placement is a way to raise capital by selling ownership interests in your private corporation or partnership.

private placement

private offering or sale of securities directly to a limited number of institutional investors who meet certain suitability standards; ownership interests are called securities

private placement

private offering or sale of securities directly to a limited number of institutional investors who meet certain suitability standards; ownership interests are called securities

Private Placement



SECTIONSECTION


19.219.2

An initial public offering (IPO) is a popular way to raise a lot of money for growth since all proceeds go to the company.

initial public offering (IPO)

the sale of stock in a company on a public stock exchange

initial public offering (IPO)

the sale of stock in a company on a public stock exchange

Initial Public Offering (IPO)



SECTIONSECTION


19.219.2

The CEO of a company that has made an IPO is primarily responsible to the people who own the company stock.

stock

a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings

stock

a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings

Initial Pubic Offering (IPO)



SECTIONSECTION


19.219.2

There are five steps to become a public company with stock for sale on a public exchange.

1. Choose an underwriter or investment banker.

2. Draw up a letter of intent.

3. File a registration statement with the SEC.

4. Announce the offering in the financial press.

5. Do a road show.

Initial Public Offerings (IPOs)



SECTIONSECTION


19.219.2

You will need to calculate exactly how much money you will need to start or grow your business.

This requires estimating start-up costs, which include capital expenditures, working capital (operating costs), and contingency funds.

Calculating Your Start-Up Capital Needs



SECTIONSECTION


19.219.2

Start-up costs are those costs you incur before you start a business.

Start-Up Costs



SECTIONSECTION


19.219.2

Start-up costs may include:

• furniture, fixtures, and equipment• promotion expenses and office supplies• fees and licenses

Start-Up Costs



SECTIONSECTION


19.219.2

Operating costs, often referred to as working capital, cover the time between selling your product or service and receiving payment from the customer.

working capital

the amount of cash needed to carry out the daily operations of a business; it ensures a positive cash flow after covering all operating expenses

working capital

the amount of cash needed to carry out the daily operations of a business; it ensures a positive cash flow after covering all operating expenses

Operating Costs



SECTIONSECTION


19.219.2

Since no one can predict the future, you should include a contingency fund in your start-up calculations.

contingency fund

an extra amount of money that is saved and used only when absolutely necessary, such as for unforeseen business expenses

contingency fund

an extra amount of money that is saved and used only when absolutely necessary, such as for unforeseen business expenses

Contingency Funds



SECTIONSECTION


19.219.2

After You Read

1. Describe the information needed to obtain financing.

After identifying potential sources of investors, you need to prepare estimated financial statements based on predictions of how the actual operations of a business will turn out. Your financial plan must include income statements, cash flow statements, and balance sheets.

After identifying potential sources of investors, you need to prepare estimated financial statements based on predictions of how the actual operations of a business will turn out. Your financial plan must include income statements, cash flow statements, and balance sheets.



SECTIONSECTION


19.219.2

After You Read

2. Explain the types of growth financing available to entrepreneurs.

Venture capital (VC) companies are unlikely sources but may be an option to companies with a proven concept and a huge growth potential. Private placement is a way to raise capital by selling ownership interests in a private corporation or partnership. Initial public offerings (IPOs) are sales of stock in a company on a public stock exchange.

Venture capital (VC) companies are unlikely sources but may be an option to companies with a proven concept and a huge growth potential. Private placement is a way to raise capital by selling ownership interests in a private corporation or partnership. Initial public offerings (IPOs) are sales of stock in a company on a public stock exchange.



SECTIONSECTION


19.219.2

After You Read

3. Describe how to calculate start-up capital requirements.

Entrepreneurs can figure start-up costs by talking to suppliers, vendors, manufacturers, distributors, and others in their industry. Entrepreneurs need to figure capital expenditures, which are costs to purchase equipment and facilities. Next, entrepreneurs need to calculate working capital, how much cash is needed to carry out daily operations. Finally, they must figure contingency funds, extra money used for unforeseen business expenses.

Entrepreneurs can figure start-up costs by talking to suppliers, vendors, manufacturers, distributors, and others in their industry. Entrepreneurs need to figure capital expenditures, which are costs to purchase equipment and facilities. Next, entrepreneurs need to calculate working capital, how much cash is needed to carry out daily operations. Finally, they must figure contingency funds, extra money used for unforeseen business expenses.



SECTIONSECTION


19.219.2

ENTR 452, Chapter 3ENTR 452, Chapter 3(Entrepreneurial Strategy)(Entrepreneurial Strategy)



SECTIONSECTION


19.219.2NEW ENTRY

New entry refers to:

Offering a new product to an established or new market.

Offering an established product to a new market.

Creating a new organization.

Entrepreneurial strategy – The set of decisions, actions, and reactions that first generate, and then exploit over time, a new entry.

More simply: strategy is the planning and pursuit of Sustainable Competitive Advantage (SCA)



SECTIONSECTION


19.219.2

1. Cost Leadership (Broad Scope)

2. Differentiation (Broad or Narrow Scope)

3. Focus/Niche (Narrow Scope)

Think about your customers, what image you want to convey and the type of pricing/profit margin you expect when you are establishing your firm.

3 PRIMARY STRATEGIC OPTIONS



SECTIONSECTION


19.219.2GENERATION OF A NEW ENTRY OPPORTUNITY

Resources are a source of competitive advantage (CA) – they are the basic building blocks to a firm’s functioning and performance.

To be a source of CA, resources must be:• Valuable.• Rare.• Inimitable.

Draw from knowledge, technical and market experience, information from contacts.



SECTIONSECTION


19.219.2

You will never have perfect knowledge of all possible outcomes.

The trade-off between more information and the likelihood that the window of opportunity will close provides a dilemma for entrepreneurs.

GENERATION OF A NEW GENERATION OF A NEW ENTRY OPPORTUNITYENTRY OPPORTUNITY



SECTIONSECTION


19.219.2FIRST MOVER ADVANTAGES

Cost advantages.

Less competitive rivalry. The opportunity to secure important supplier and distributor channels. A better position to satisfy customers.

The opportunity to gain expertise through participation.



SECTIONSECTION


19.219.2

The entrepreneur must first determine the key success factors which may change early on

Environmental changes are highly likely

Demand uncertainty – hard to determine customer base

Technological uncertainty

Adaptation

FIRST MOVER FIRST MOVER DISADVANTAGESDISADVANTAGES



SECTIONSECTION


19.219.2

Choose a niche strategy

Choose an imitation strategy. This can: Reduce the entrepreneur’s costs

associated with R&D. Reduce customer uncertainty over the

firm. Make the new entry look legitimate from

day one.

RISK REDUCTION STRATEGIES RISK REDUCTION STRATEGIES FOR NEW ENTRYFOR NEW ENTRY



SECTIONSECTION


19.219.2

There is a need to properly manage the “liabilities of newness” which arise from:

The costs of learning new tasks. Conflict arising from overlap or gaps in responsibilities. Unestablished informal structures of communication.

In order to do this, a new firm needs to: Educate and train employees. Facilitate conflict over roles. Promote activities that foster informal relationships and a

functional corporate culture.

RISK REDUCTION STRATEGIES RISK REDUCTION STRATEGIES FOR NEW ENTRYFOR NEW ENTRY

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