Funding

Entrepreneurship & Small Business Entrepreneurship & Small Business

ManagementManagement

Entrepreneurship & Small Business Entrepreneurship & Small Business

ManagementManagement

Frank MoyesFrank MoyesLeeds School of BusinessLeeds School of BusinessUniversity of ColoradoUniversity of ColoradoBoulder, ColoradoBoulder, Colorado

Funding

Today’s AgendaToday’s Agenda

FundingFunding SourcesSources Bank debtBank debt

Deal structure: David Kendal, attorneyDeal structure: David Kendal, attorney ValuationValuation

Funding

Next WeekNext Week

Term Sheet negotiationTerm Sheet negotiation

Funding

VC Required Return on InvestmentVC Required Return on Investment

SeedSeed 20x 20x Start-UpStart-Up 10x 10x Early Stage 8xEarly Stage 8x Second Stage 5xSecond Stage 5x Third StageThird Stage 4x 4x BridgeBridge 3x 3x

Return DCFCash on Cash

80% 80% 60%60% 50%50% 40%40% 30%30% 25%25%

Bygraves & Zacharakis

Funding

What do Investors Look For?What do Investors Look For? Management teamManagement team

ExperienceExperience Expertise in industryExpertise in industry PassionPassion

Commitment of CEOCommitment of CEO Market potential: size & growthMarket potential: size & growth Stage of developmentStage of development Scalable product or serviceScalable product or service ProprietaryProprietary Profitability Profitability Acceptable valuation - returnAcceptable valuation - return

Funding

What Methods Are Used To Value What Methods Are Used To Value Entrepreneurial Ventures?Entrepreneurial Ventures?

VC method (see Bygraves & Zacharakis)VC method (see Bygraves & Zacharakis) Financial projectionsFinancial projections Market comps for similar companiesMarket comps for similar companies

Multiple of earningsMultiple of earnings Multiple of salesMultiple of sales

Investor ROIInvestor ROI Usually not a cash flow streamUsually not a cash flow stream Pre-money & post moneyPre-money & post money

Tangible book valueTangible book value P/E ratioP/E ratio Discounted cash flow is not a good method for valuing early Discounted cash flow is not a good method for valuing early

stage companies!stage companies!

Funding

How Are Going to Fund How Are Going to Fund Your New Venture?Your New Venture?

Personal ResourcesPersonal ResourcesFriends & familyFriends & familyDebtDebtEquityEquityGrantsGrantsNon-traditional Non-traditional

Funding

Personal ResourcesPersonal Resources

SourcesSources SavingsSavings Mortgage on houseMortgage on house Credit cards Credit cards

Skin in the game – best indicator of commitmentSkin in the game – best indicator of commitment AdvantagesAdvantages

Prove the conceptProve the concept Establishes value before go to outside investorsEstablishes value before go to outside investors

DisadvantagesDisadvantages Pressures on familyPressures on family

Funding

Friends & FamilyFriends & Family

Easy negotiationEasy negotiation Should have a formal agreementShould have a formal agreement AdvantagesAdvantages

Maintain controlMaintain control DisadvantagesDisadvantages

Unsophisticated investorsUnsophisticated investors Different kind of obligationDifferent kind of obligation Turn a good friend to an enemy?Turn a good friend to an enemy?

Funding

EquityEquitySourcesSources

F & FF & F AngelsAngels Private PlacementPrivate Placement Venture CapitalVenture Capital Corporate venture subsidiariesCorporate venture subsidiaries IPO (Initial Public Offering)IPO (Initial Public Offering)

AdvantageAdvantage Permanent capitalPermanent capital

DisadvantagesDisadvantages Give up piece of company (dilution)Give up piece of company (dilution) Responsibilities to investorResponsibilities to investor Exit for investor – achieve a returnExit for investor – achieve a return

Funding

AngelsAngels

Sophisticated investor who invests in early stage Sophisticated investor who invests in early stage companiescompanies 250,000 + angels in US250,000 + angels in US Invest $5 bill - $10 Bil, 20K – 30K companies annuallyInvest $5 bill - $10 Bil, 20K – 30K companies annually Typical investment = $25K - $250KTypical investment = $25K - $250K High net worth individualsHigh net worth individuals Usually wants to invest in industry where has experienceUsually wants to invest in industry where has experience

Accessing AngelsAccessing Angels Not in the Yellow PagesNot in the Yellow Pages NetworkingNetworking ACE-net.orgACE-net.org

Funding

Angels (cont’d)Angels (cont’d)

AdvantagesAdvantages Early stage resourceEarly stage resource Value-added money : network, advice, commitmentValue-added money : network, advice, commitment

DisadvantagesDisadvantages No follow-on fundsNo follow-on funds Give-up equityGive-up equity Over-control from angelOver-control from angel

Funding

Private PlacementPrivate Placement Private offering to a focused group of investors Private offering to a focused group of investors

Accredited investorsAccredited investors SEC & Blue Sky Laws applySEC & Blue Sky Laws apply If less than $1 million, then any number of small investorsIf less than $1 million, then any number of small investors

Sam AdamsSam Adams AdvantagesAdvantages

Quicker & less expensive than IPOQuicker & less expensive than IPO SEC regulations are not as onerousSEC regulations are not as onerous

DisadvantagesDisadvantages Give up equityGive up equity Lack of advice / mentoring Lack of advice / mentoring Can be complicated, expensive & take a lot of timeCan be complicated, expensive & take a lot of time Minority investorsMinority investors

Funding

IPOIPO Public offering to buy ownership in an organizationPublic offering to buy ownership in an organization AdvantagesAdvantages

Obtain cash for opportunities that would otherwise be Obtain cash for opportunities that would otherwise be unaffordableunaffordable

More capital with less stock dilutionMore capital with less stock dilution To achieve liquidity for owners and investorsTo achieve liquidity for owners and investors

DisadvantagesDisadvantages Costly and time consumingCostly and time consuming Change of leadership focusChange of leadership focus

Funding

GrantsGrants State, regional and municipal State, regional and municipal

development agenciesdevelopment agencies CapCoCapCo

FederalFederal SBIR (Small Business Innovation SBIR (Small Business Innovation

Research)Research) CREDA (Cooperative Research & CREDA (Cooperative Research &

Development Agreement)Development Agreement) Research – university & corps.Research – university & corps. FoundationsFoundations freemoney.comfreemoney.com

Advantage: no equity or debtAdvantage: no equity or debt Disadvantage:Disadvantage:

Red tape and stringsRed tape and strings Grant mentalityGrant mentality

Funding

Non-traditional Funding SourcesNon-traditional Funding Sources

CustomersCustomers SuppliersSuppliers Joint ventures and strategic partnersJoint ventures and strategic partners Leasing of equipmentLeasing of equipment Broker/PromotersBroker/Promoters Microloans – banks & non-profits <$25,000Microloans – banks & non-profits <$25,000 IncubatorsIncubators Equity for professional servicesEquity for professional services

Funding

GovernmentGovernment

SBIC’s – a “government VC”SBIC’s – a “government VC” 450 in the US450 in the US Backed by the SBABacked by the SBA $13 bill since 1958$13 bill since 1958

Small Business Development Centers – state and local Small Business Development Centers – state and local organizations finance job creationorganizations finance job creation

Funding

DebtDebt

BanksBanksSBASBACredit unions, S & L’sCredit unions, S & L’sFactoring receivables & inventoryFactoring receivables & inventoryCommercial Finance companiesCommercial Finance companiesMezzanineMezzanine

Sits on balance sheet between debt and equitySits on balance sheet between debt and equity Debt, but doesn't have to be repaid right awayDebt, but doesn't have to be repaid right away Equity, warrantsEquity, warrants

Guido Guido

Funding

DebtDebt

AdvantagesAdvantages No dilutionNo dilution

DisadvantagesDisadvantages Very difficult to obtain in early stagesVery difficult to obtain in early stages Must pay backMust pay back Interest expenseInterest expense Personal guaranteePersonal guarantee Lack of value-add moneyLack of value-add money

Funding

Borrowing from BanksBorrowing from Banks

Types of loansTypes of loans How banks look at borrowers?How banks look at borrowers? How do you approach a bank?How do you approach a bank? Personality of a bankPersonality of a bank SBA LoansSBA Loans

Funding

Types of Bank LoansTypes of Bank Loans

Short term loansShort term loans One timeOne time Line of creditLine of credit

Term loansTerm loans Monthly installmentsMonthly installments BalloonBalloon

Secured and unsecuredSecured and unsecured

Funding

How Banks Look at Borrowers?How Banks Look at Borrowers? Attitude toward riskAttitude toward risk 4 C’s: credit history, character, capacity, collateral4 C’s: credit history, character, capacity, collateral How are you going to repay it?How are you going to repay it?

Not: “If I default, there are assets to cover it.”Not: “If I default, there are assets to cover it.” Banks don’t like work-out situationsBanks don’t like work-out situations

Cash flow loans Cash flow loans Realizable assetsRealizable assets

Accounts ReceivableAccounts Receivable InventoryInventory

Personal guaranteesPersonal guarantees

Funding

How Do You Approach a Bank?How Do You Approach a Bank?

Establish a good credit historyEstablish a good credit history Borrow when you don’t need itBorrow when you don’t need it

Business PlanBusiness Plan Costs & feesCosts & fees

Loan processing feeLoan processing fee Interest ratesInterest rates

Services providedServices provided

Funding

Personality of a BankPersonality of a Bank

Banks have different policiesBanks have different policies Big company or small companyBig company or small company Aggressive or cautiousAggressive or cautious New companies or establishedNew companies or established

How important are relationships?How important are relationships? Shop around – new customers seem to get better deals Shop around – new customers seem to get better deals

than existingthan existing Keep them informed of how your business is doing – no Keep them informed of how your business is doing – no

surprisessurprises

Funding

Small Business Administration Small Business Administration (SBA) Loans(SBA) Loans

Loan made by a bank, but guaranteed by the fedsLoan made by a bank, but guaranteed by the feds Criteria for receiving a SBA loan similar to bank loan, Criteria for receiving a SBA loan similar to bank loan,

but will take a greater riskbut will take a greater risk FeesFees Interest ratesInterest rates

Funding

Factors Affecting Discount RatesFactors Affecting Discount Rates

Total Discount Rate

Base Rate

Systematic Risk

Liquidity

Value Added

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 failureadjustment

Value ofVC adviceInvestment

not liquid