Mark T. Schenkel, Ph.D. Assistant Professor in Entrepreneurship FINANCING AND SOURCES OF FUNDING FOR NEW VENTURES
Mark T. Schenkel, Ph.D.
Assistant Professor in Entrepreneurship
FINANCING AND SOURCES OF FUNDING FOR NEW
VENTURES
What Makes Entrepreneurial Finance “Different” from Traditional Finance . . . ?
Lack of history upon which to assess risk What’s the β?Without it, what should the market risk
premium be? . . . Criteria to identify if “big winner” potential exists (Bhide)
Lack of ability to compare against other firms when industry is new
Lack of short term profit potential in the immediate future
Lack of liquidity . . . CASH IS KING!!! (e.g., Sahlman)
Implications . . .
Entrepreneurial finance involves useful ways of thinking about cash, risk, and value (Sahlman, 1992) . . . that is, itTeaches skepticism (there are fewer ‘true’
opportunities from a financial perspective than we often think!)
Helps us identify the ‘right’ questions to ask and narrow down the potential options, which in turn enable us to make better decisionsEx: Is “Fit” an “Opportunity”?
Discovery Driven Planning (Market, Margin, Me) New Venture Strategy
Ex: If I use X financing now and Y financing later, have I created incentives for all stakeholders to work together?
Implications . . . Helps us identify the ‘right’ questions to ask
and narrow down the potential options, which in turn enable us to make better decisionsEx: Is “Fit” an “Opportunity”?
Discovery Driven Planning (Market, Margin, Me) New Venture Strategy
Ex: Explicit and hidden costs of using other people’s money . . . (Bhide)Danger of misallocation . . . Throwing money at
symptomsDiminished flexibility . . .
“Operational lock” Credibility issues . . . “What to you mean, didn’t we get it right
the 1st time?” If I use X financing now and Y financing later, have I created
incentives for all stakeholders to work together?
Key Theme . . .
Horse race between capital, greed and opportunity . . . (Sahlman)
Investing in new ventures is cycle process . . . involves both positive ebbs and flows
People matter . . . Perceptions, judgments, and actions.
CASH FLOW
Example of Cash Flow Cycle Over the Life Cycle of a Business
Profits
Cash flow
Start-up to Early Stage Growth Stage Maturity
0
Reasons for Cash Flow Problems
Difficulty in collecting receivables Seasonality of sales Unexpected variation in sales Policies on how payments to suppliers Large expenditures up front for projects Capital projects Ineffective inventory management
Measuring Cash Flow
Cash Flow from Operating Activities
Cash Flow from Investing Activities
Cash Flow from Financing Activities
• Internal (i.e., Bootstrapping)
• Debt
• Equity
PRIMARY TYPES OF FUNDING (I.E., SOURCES) . . . ?
Bootstrapping
Techniques and tools that can help achieve the same outcomes while greatly reducing costs.
Why Bootstrap?Often necessary for small businesses to get
started (New Ventures are generally “poor fit” for traditional lending models (Bhide, 1992)
Preserves the value and wealth of a business
Difficulty in raising and using money for growth
E.g., danger of misallocation (Bhide, 1992)
E.g., diminished flexibility (operational – path dependence effects of missing on 1st attempt (Dierckx & Cool, 1989); credibility loss with lenders (Bhide, 1992))
Bootstrap Marketing
Know your customerImpact of message more important than
“volume”Remember your market space or niche
and the benefits you bring . . . spend your marketing dollars carefully
Marketing is a process, not an event
Examples . . . ?
Human Resources Bootstrapping
Employee “stretching”Independent contractors Employee leasing and temporary
employeesStudent interns Equity compensation Non-monetary benefits
Examples . . . ?
Administrative Overhead Bootstrapping
Space
Furnishings and office equipment
Administrative salaries
Operations & Inventory Bootstrapping
Outsourcing
Just-in-time inventory techniques
Effective cost accounting
DEBT FINANCING
Short-term Debt FinancingExpected to be paid within one year
Most often used to finance short-term expenditures such as inventory, supplies, payroll, etc.Trade debt
Banks
Asset-based lenders
Factors
Long-term Debt
Beyond one year
Most often used to fund fixed asset purchasesBanks: term loansLeasing companiesReal estate lenders
Overlooked Forms of Debt
Property leases
Long-term employment agreements
SBA or other government backed lending programs
6 C’s: Criteria for Lending by Bankers 1. Character of founder and key leaders2. Capital – equity . . . “skin in the game”Venture 3. Capacity – cash flow capability to easily
make interest and principle payments & awareness
4. Conditions – industry trends, seasonality, operational changes, world events, etc.
5. Collateral – “hard” assets to pledgeBanker6. Common sense – what does your gut tell
you?
Downside of Debt
Increased risk during economic slowdown
Impact on proceeds from business sale
Restrictive covenants
Personal guarantees
EQUITY FINANCING
Sources of Equity Funding
Funding from the entrepreneur
Family and friends (and “fools”!)
Strategic partners
Angel investors
Private placement
SBICs
Venture Capitalists
Potential Downsides of Equity Financing
Dilution of ownership
The risk of sharks
Dynamics of adding on new partners
Working with Equity Investors
1. Business plan
2. Confidentiality agreement
3. Letter of Intent
4. Modifications of shareholder agreements
Creating an Array of Financing
Prioritize financing needs based on forecasts
Focus financing only on what is critical for operations
Create an inventory of all assets and what proportion of each can be financed
Creating an Array of Financing
Asset Percentage financed
Purchase Orders 70%
A/R (<60 days) 70%
Inventory 30%
Leasehold Improvements
50%
Building 70%
Undeveloped land 40%
Equipment 80%
Creating an Array of Financing
Identify best source of financing for each asset
Multiple funding sources are likely
Remember to bootstrap!
Venture Capital: Stages of High Growth Business Funding
1. Initial stage
2. First round financing
3. Second round financing
4. Late round financing
Initial Stage Funding
File for incorporationWrite business planFind office and development spaceCompletion of initial designHire key development personnel Complete prototype unitComplete prototype testing
First Round Financing
Secure key vendors Hire key service or manufacturing
personnelRent or build manufacturing facilityPurchase manufacturing equipmentMarket testingFirst sales contractProduction of first manufactured unitFirst 100, 1000, 10000 units, etc.
Second Round Financing
Break-even level of sales
Development of next generation of product
Late Round Financing
Initial public offering
Sale of business