13–1

IPFW Business Plan CompetitionIPFW Business Plan CompetitionPre-competition ProgramPre-competition Program

IPFW Business Plan CompetitionIPFW Business Plan CompetitionPre-competition ProgramPre-competition Program

Financing and Capital Sourcing Financing and Capital Sourcing OptionsOptions

ByByDr. Bill TodorovicDr. Bill Todorovic

Richard T. Doermer School of Business and Management Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940Neff Hall 340L, Tel. (260) 481 6940

E-mail: E-mail: todorovz@ipfw.edu Web: Web: http://users.ipfw.edu/todorovz/

13–2

The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources

The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources

• Factors That Determine Financing

–Firm’s economic potential

–Maturity of the company

–Nature of its assets

–Owners’ preferences for debt or equity

13–3

Sources Of FundsSources Of FundsSources Of FundsSources Of Funds

Personal

Friends and Family

Angels

Venture Capitalist

Banks

Government

Customers/Suppliers

Start-up

Going ConcernBeginning of Production ?

IPO

Amount

Company Size

13–4

Sources of FinancingSources of FinancingSources of FinancingSources of Financing

0 10 20 30 40 50 60 70 80

Personal Savings

Family Members

Partners

Personal Charge Cards

Friends

Bank Loans

Private Investors

Mortgaged Property

Venture Capital

Other

Percentage of Entrepreneurs

Using Source of Financing

Sources of Financing

13–5

Critical Financing FactorsCritical Financing FactorsCritical Financing FactorsCritical Financing Factors

•Accomplishments and performance to date.

•Investor’s perceived risk.

•Industry and technology.

•Venture upside potential and anticipated exit timing.

•Venture anticipated growth rate

•Venture age and stage of development.

13–7

Debt or Equity?Debt or Equity?Debt or Equity?Debt or Equity?

• Entrepreneurs typically prefer debt– Allows them to appropriate as much as of the benefit as

possible + retain sole control

– Can default

• Debt is unattractive to investors in emerging technology– Usually little collateral or predictable cash flow

– Information asymmetry is lessened by ownership position – shared ownership gives some control

– High interest rate to offset risk will stifle growth or cause default

13–9Fig. 13.1

Equityfinancing

Debtfinancing

HIGH

LOW

LOW HIGH

EquityFinancing

DebtFinancing

PotentialProfitability

Financial Risk/Control

Tradeoffs Among Potential Profitability,Tradeoffs Among Potential Profitability,Financial Risk, and VotingFinancial Risk, and Voting

Tradeoffs Among Potential Profitability,Tradeoffs Among Potential Profitability,Financial Risk, and VotingFinancial Risk, and Voting

13–10

$28,000

income on

total assets

of $200,000

14% return

on assets

($28,000÷ $200,000)

14% return

on $200,000

($28,000÷ $200,000)

No debt

equals

$200,000

equity

With no debt and all equity:

Debt Versus EquityDebt Versus EquityDebt Versus EquityDebt Versus Equity

Equity:Equity: Owners get to keep all of the profits Owners get to keep all of the profits in return for accepting the risk of lower in return for accepting the risk of lower

returnsreturns

13–11

$28,000

income on

total assets

of $200,000

14% return

on assets

($28,000 ÷ $200,000)

18% return

on $100,000

($18,000÷ $100,000)

$100,000 debt

(10% cost)

equals

$100,000

equity

With $100,000 debt and $100,000 equity:

Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)

Debt is Risky:Debt is Risky: Lenders have first claim on Lenders have first claim on profits and must be paid even if there are profits and must be paid even if there are

no profits.no profits.

13–13

The Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s Perspective

• Bankers’ Concerns!

• The Five C’s of Credit–Character of the borrower–Capacity of the borrower to repay the loan–Capital invested in the venture by the borrower–Conditions of the industry and economy–Collateral available to secure the loan

13–15

Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan

Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan

• Three years of the firm’s historical statements

• The firm’s pro forma financial statements

• Personal financial statements

13–17

Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…

Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…

13–18

The myth… and the realityThe myth… and the realityThe myth… and the realityThe myth… and the reality

• The myth: VCs support good people and good ideas

• The reality: VCs invest in industries with double digit growth in the middle of the S-curve

– Appropriate management team – Specialty funds (earlier and later stages on the S-

curve)– Limits the risk to management risk – Produces attractive exit opportunities

13–19

Present Day SituationPresent Day SituationPresent Day SituationPresent Day Situation

Myth: There is less available capital

Fact: The industry has plenty of money, but limited appetite for new investment

Fact: Investor attitudes toward risk have changed

13–21

VC fills a voidVC fills a voidVC fills a voidVC fills a void

• Gap between innovation and traditional sources of debt

• Risk inherent in startups typically justify interest rates higher than allowed by law

• VCs must balance high returns for their investors against sufficient upside potential for entrepreneurs to keep them motivated

13–22

What VCs get out of itWhat VCs get out of itWhat VCs get out of itWhat VCs get out of it

• 10X return on capital over 5 years

• VCs management fees and high growth funds

• Fund structured with limited and general partners and a life of 7-10 years

13–23

What VCs Do?What VCs Do?What VCs Do?What VCs Do?

13–25

The Overhang: Uninvested CapitalThe Overhang: Uninvested Capital

0

50

100

150

200

250

Year

Ann

ual C

omm

itted

Cap

ital (

$M)

Complements of Thompson Venture Economics

13–26

AngelsAngelsAngelsAngels

• Well to do private individuals

• Geography and industry specific

• Invest lower amount than VC

• Often a good source of industry experience

13–27

Finding AngelsFinding AngelsFinding AngelsFinding Angels

• Private Individuals

• Professionals (lawyers, accountants, bankers)

• Local small business development centers

• Internet associations (e.g., Technology Capital Network at MIT)

13–28

Other Sources of FinancingOther Sources of FinancingOther Sources of FinancingOther Sources of Financing

• Community-based financial institutions

• Large corporations

• Stock Sales–Private placement–Initial public offering (IPO)

13–29

Why Companies Invest?Why Companies Invest?Why Companies Invest?Why Companies Invest?

• Preemption of new rivals• Replace core earnings lost because of an

emerging technology• Apply existing competitive advantage in a

rapidly growing market• And some degree of autonomy:

– JVs, alliances, flexible internal management structures

13–30

Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies

Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies

• Small Business Administration (SBA) loans–Guaranty loan–Direct loan

• Small business investment centers (SBICs)

• Small Business Innovative Research (SBIR)

• State and Local Government Assistance

13–31

Business Suppliers andBusiness Suppliers andAsset-Based LendersAsset-Based Lenders

Business Suppliers andBusiness Suppliers andAsset-Based LendersAsset-Based Lenders

• Trade Credit (Accounts Payable)

Short-duration financing (30 days)

Amount of credit available is dependent on type of firm and supplier’s willingness to extend credit

13–32

Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)

Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)

• Equipment Loan and Leases

• LeasesFree up cash for other purposesLeaves lines of credit openProvides a hedge against

obsolescence

13–33

Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)

Business Suppliers andBusiness Suppliers andAsset-Based Lenders (cont’d)Asset-Based Lenders (cont’d)

• Asset-based Loan

• FactoringAccounts are sold to factor at a discount to invoice

value

Factor can refuse questionable accounts

Factor charges fees for servicing accounts and for amount advanced to firm prior to collection

13–36

Formal Vs. Informal InvestorsFormal Vs. Informal InvestorsFormal Vs. Informal InvestorsFormal Vs. Informal Investors

• Funding structure and flexibility

• The fit to the mold

• Involvement in the business

• Rigidity of relationship with the firm

13–37

Discussion?Discussion?Discussion?Discussion?

13–52

13–53Complements of: Timmons/Spinelli New Venture Creation, sixth edition

Low Level Investment

Lower Long-

term Income

Potential (Lower

Capacity)

13–54

First Things FirstFirst Things FirstFirst Things FirstFirst Things First

• Burn rate

• OOC (out of cash)

• Search out capital markets

• Increase cash flow

13–55

Strategy RefinementStrategy RefinementStrategy RefinementStrategy Refinement

• Market niche• Suppliers and customers• Diversification or specialization• Reduce fixed costs• Plan for contingency

13–56

Management RefinementManagement RefinementManagement RefinementManagement Refinement

• Management skill, experience and know how

• Control of Finance

• Turnover

13–57

When the market is downWhen the market is downWhen the market is downWhen the market is down

• Increase Your Effectiveness and Efficiency• Be Creative• Pursue different sources of capital

13–58

Building to GrowBuilding to GrowBuilding to GrowBuilding to Grow

13–59

Create Value• Shareholders• Customers• Employees

Contingency Plan• Best Case Scenario• Worst Case Scenario• Most Likely Scenario

Good TeamEvery business is built on people

Good DecisionsSolid FinancingPersistenceReduce Risk Increase

Value

13–60

Example 1Example 1Sales Growth; ODGSales Growth; ODG

Example 1Example 1Sales Growth; ODGSales Growth; ODG

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

1993 1995 1997 1999 2001 2003

Argo Centaur Drive Systems/Gears/Couplings Other

13–61

The Sound AdviceThe Sound AdviceThe Sound AdviceThe Sound Advice

• Monitor Cash Flow (especially if growth is high)–100 fastest growing companies–Entrepreneur of the year award

• Contingency Plan – get the timing right• Emphasize long term growth• Manage your risk factor

13–62

Example 2:Example 2:Ergo Distributor Ergo Distributor

Example 2:Example 2:Ergo Distributor Ergo Distributor

• Sales growth 400-500%• Single supplier – No substitutes• Great financial ratios• Cash flow problems• May go bankrupt in couple of years

LESSON: Use your intuition

13–63

Who invests in VC funds?Who invests in VC funds?Who invests in VC funds?Who invests in VC funds?

• Typically pension funds, financial firms, insurance companies, endowments and high net worth individuals

• Small percentage of total funds– Expect returns of 25%-30%

• Most are structured as limited partnerships• Other forms include:

– Corporate VC funds– Private funds– Publicly listed funds– Labour sponsored funds (in Canada)