Financial resources for new ventures

Financial Resource for New Venture

Final-unit

Introduction Financial resource are essential for business, but particular requirements change as enterprise grows. Obtaining those resources in the amount needed and at the time when they are needed can be difficult for entrepreneurial ventures because they are generally considered more risky than established enterprises. As we shall see, financing means more than merely obtaining money; it is very much a process of managing assets wisely to use capital efficiently.

The Problem• Need cash for start-up expenses• Need cash to fund R&D• Need to pay for services provided• But, at startup, the Venture has no revenues

Factors influencing financial decisionThe critical issue is to assure sufficient cash flow for operations, as well as to plan financing that coincides with changes in the enterprise. Businesses obtain cash through two general sources, equity or debt, and both can be obtained from literally hundreds of different sources. We must introduce ways of acquiring financial resources for ventures in the start-up and early development stages. And mostly at first we focus on asset management, equity funding, venture capital, debt financing, and government programs.

Asset managementAsset management, broadly defined, refers to any system that monitors and maintains things of value to an entity or group. It may apply to both tangible assets such as buildings and to intangible concepts such as intellectual property and goodwill. Asset management is a systematic process of deploying, operating, maintaining, upgrading, and disposing of assets cost-effectively.

Asset management for the start-up entrepreneur is a matter of determining what is needed to support sales, and then gaining access to those assets at the optimum costs. The term “gaining access” is used because there are alternatives other than a cash purchase of assets. Equipment can be leased, for example, and office furniture can be rented; even pictures and plants can be obtained through office rental centers. Manufactured products initially can be subcontracted rather than made, thereby avoiding the expense of procuring materials, equipment, and plant facilities. Entrepreneurs, therefore, have choices about what assets to obtain, when they must be obtained, and how to gain access to them.

Inventory decisionMost retailers and wholesalers must have inventory in their possession before they can generate sales, and for start-up enterprises, suppliers normally require cash on delivery(COD) until entrepreneurs establish themselves as reliable customers. In many instances, entrepreneurs also have no choice among suppliers, particularly if the merchandise is brand-name inventory such as Reebok shoes or Compaq computers sold through distributors with protected territories. Consequently, new ventures are faced with cash outlays in exchange for salable merchandise. Through careful planning, however, it is possible to plan inventory purchasing so that stock is acquired and restocked as cash becomes available.

30 days + 38 days - 22 days = 46 days

Cash-Flow Gap Created by Pattern of Sales

Inventory Merchandise is replenished every 30 days

Inventory Merchandise is replenished every 30 days

ReceivablesSales are fully converted to

cash in 38 days

ReceivablesSales are fully converted to

cash in 38 days

Payables Vendor bills are paid on average every 22 days

Payables Vendor bills are paid on average every 22 days

CashThe cycle of payments and receipts yields

cash in 46 days

CashThe cycle of payments and receipts yields

cash in 46 days

Use of assets to generate cash flow

and receivables

Use of assets to generate cash flow

and receivables

Cash and credit sales result in

slightly delayed collection period

Cash and credit sales result in

slightly delayed collection period

COD and credit for inventory

compasses cash flow

COD and credit for inventory

compasses cash flow

Cycle results in shortage or cash for inventory and

monthly bills

Cycle results in shortage or cash for inventory and

monthly bills

Accounts Receivable decisionsAn account receivable is a consumer’s promise to pay later, and it is an asset owned by the entrepreneur that can be sold or used as collateral. The value of a receivable, however, is no greater than its profitability of being paid. New ventures without track records collecting their receivables subsequently find it difficult to sell or borrow against these assets; therefore, careful asset management practices are important.

Contd…

In most instances, managing receivables is similar to managing inventory; decisions about either directly affect cash flow. Receivables and inventories also affect on another. Poor purchasing will affect sales and reduce the value of receivables in two ways: sales can suffer because of weak merchandise, or the entrepreneur may resort to careless credit terms to induce sales, thereby generating doubtful accounts. The logical answer to both problems is to pursue a plan whereby inventory is purchased in a timely manner and consumer credit is coordinated with supplier credit terms

Equipment decisionsEquipment is important to a business because it can help earn profits, not because it has residual asset value. A computer system, for example, is a depreciating asset, and its residual value declines every day whether it is being used or not. Vehicles, office machines, furniture, store fixtures, production machinery, handling equipment, and tools depreciate systematically. They also become obsolete, often quite rapidly. Therefore, an equipment asset standing idle is simply an unadjusted expense, not an investment. An efficiently utilized asset contributes to business earnings.

Sources of equity financeEquity is a capital invested in a business by its owners, and it is “at risk” on a permanent basis. Because it is permanent, equity capital creates no obligation by an entrepreneur to repay investors, but raising equity requires sharing ownership. New ventures often have difficulty attracting equity investors until they survive the initial start-up stage, but as they become more firmly established, equity sources become more accessible.

Incremental changes in new ventures

Financial Needs & Equity Sources With Growth

Start-upBeginning inventory, fixtures, equipment, and facility

Start-upBeginning inventory, fixtures, equipment, and facility

Development Expanded need for start-up items, higher operating costs and receivables

Development Expanded need for start-up items, higher operating costs and receivables

Increased receivables & inventory replenishment, new equipment , expanded facilities and operations

Increased receivables & inventory replenishment, new equipment , expanded facilities and operations

ExpansionMajor expenses for operations, equipment, new facilities, large inventory and receivables

ExpansionMajor expenses for operations, equipment, new facilities, large inventory and receivables

Personal, family, and informal

investors

Personal, family, and informal

investors

Informal capital, limited private

stock placements

Informal capital, limited private

stock placements

Private stock placement, informal investors, formal &

informal venture capital in rapid- growth period

Private stock placement, informal investors, formal &

informal venture capital in rapid- growth period

Venture capital, private stock

placement, with potential for

public offering

Venture capital, private stock

placement, with potential for

public offering

Rapid growthRapid growth

Early growthEarly growth

Expanded options for equityExpanded options for equity

Personal SourcesEntrepreneurs must look first to individual resources for start-up capital. These include cash and personal assets that can be converted to cash through refinancing, and second mortgages can be obtained for home equity. Life insurance policies may also have accumulated equity, and other assets such as stamp and coin collections have capital value. These are not unusual sources, but some assets also can be converted to business use, including personal trucks or vans, computers, telephone answering systems, furniture, and tools, among others.

Informal Risk CapitalBeyond family and friends, there are many wealthy individuals who enjoy investing in new ventures. Wealthy investors made typical in investment range in risky ventures to broaden their portfolios. This equity pool is called informal risk capital because investors find entrepreneurs through personal contacts, and they often invest on hunches or recommendations; they seldom engage in complex investment analysis.

Venture CapitalMoney provided by investors to start-up firms and small businesses with perceived long-term growth potential. This is a very important source of funding for start-ups that do not have access to capital markets. It typically requires high risk for the investor, but it has the potential for above-average returns.

Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies or ventures with limited operating history, which cannot raise funds by issuing debt. The downside for entrepreneurs is that venture capitalists usually get a say in company decisions, in addition to a portion of the equity.

Venture capital differs from traditional financing sources in that venture capital typically:

• Focuses on young, high-growth companies• Invests equity capital, rather than debt• Takes higher risks in exchange for potential higher

returns• Has a longer investment horizon than traditional

financing• Actively monitors portfolio companies via board

participation, strategic marketing, governance, and capital structure

Source of Debt FinancingDebt financing includes both secured and unsecured loans. Security involves a form of collateral as an assurance the loan will be repaid. If the debtor defaults on the loan, that collateral is forfeited to satisfy payment of the debt. Most lenders will ask for some sort of security on a loan. Few, if any, will lend you money based on your name or idea alone.

• Short-term loans are typically paid back within six to 18 months.

• Intermediate-term loans are paid back within three years.

• Long-term loans are paid back from the cash flow of the business in five years or less.

Solutions(Typical Funding Sources)

• Equity Investments– Equity in exchange for Cash– Equity in exchange for Services

• Debt– Commercial Bank Debt

• Business Loans• Lines of Credit• Credit Cards

– Debentures– Debt convertible to Equity