entrep finance chapter 09 secure funding

H a n d o u t f o r E n t r e p r e n e u r s h i p 1 0 1 P a g e | 182

Part Three: The Enterprise

SESSION 9: Secure Funding

Overview: In this session, we look at the ways to find money for your business. We talk about

raising money and securing the necessary funding. You need long-term investment capital for

buying machines and factories (the fixed assets). You also need short-term working capital for

buying raw materials.

The young entrepreneur may have winning plans and impressive projects, but he still needs to

find the money to start the enterprise. The first and logical source of funding is personal savings

and personal assets. Afterwards comes investment money from relatives or friends.

When funding comes from other people, you can distinguish between many kinds of external

investors. Some investors are kind and patient; many are brutal and impatient. Venture capital

(such as funds from angel investors) usually comes in at an early stage in the company’s

development. Later on, larger-sized private-equity investors come in to bring the company to a

higher level. After some years of successful operation, the company will be able to approach a

bank for further financing. An aggressive bank can provide long-term capital on easy terms,

based on an impressive business plan alone. A conservative bank would provide small amounts

of short-term loans if there is collateral. Collateral is property that could be confiscated in case

of non-payment of loans.

At a later stage, the business owner may be able to sell some shares of stock to raise big money

for a corporate expansion.

Introduction Part One. How to access funding 1. Easy or difficult? 2. Personal resources 3. Size of the initial financing 4. Steps from start to finish 5. Sources of funding Part Two. Where to Access the Funds 1. Your personal money 2. Family as a source of funding 3. Friends & Contacts 4. Angel Investors


5. Venture Capitalists 6. Private-Equity Funding Part Three: Two general types of capital 1. Loans from banks and lending institutions 2. Stock Financing: from equity investors.

Learning Objectives At the end of this session, you should be able to:

Learn how to secure the financial resources to start a business Understand the steps you must take to determine the necessary funding

Know where to seek the necessary funding Determine if you can supply funding with your own money Discuss the pros and cons of using your personal money for business Learn the pros and cons of tapping your family as a source of funding Appreciate the reasons why angel investors invest in unknown start-up

companies Know how to make convincing presentations to venture capitalists to ask for

funding

Understand the motivation of private-equity funders Understand the types of debt financing: secured and unsecured loans.

Understand the pros and cons of stock financing STORY FROM REAL LIFE Starting a small business is a lot like having a new baby, just as business owner Mark Drager discovered. "Both consume all of your time, money and energy!" he says. Drager is President of Phanta Media (www.phantamedia.com), a Toronto-area multimedia design and development company providing a full range of video, graphics, and interactive marketing services. The company helps businesses communicate with prospects, clients, and staff. Drager decided it was time to be his own boss in late 2006. He launched his media communications firm about the same time he had a daughter. He also had to ask his mother for some money to start the business.


"Borrowing money from family members is very motivating because failure is not an option…you have to pay them back!" recalls Drager. Drager did not regret giving up his career and predictable income. Although spending long hours building his company and raising a daughter at the same time is not easy, he says he is happier than ever before. "It's so rewarding to be focused on these things that matter so much to me," he says. Source: Visa.ca

Introduction For your business idea to stand on its own feet, you must secure the funds needed to implement the idea. This fact creates a paradox for the new entrepreneur. You are starting a business with the intention of making money. But it usually takes a large amount of money just to get started.

Paradox – a mystery or

contradiction.

“Money is the seed of money, and the first guinea is sometimes more difficult to acquire than the second million.” Jean Jacques Rousseau, French philosopher. *A guinea used to be a unit of money in France.

There are several sources available to fulfill your initial capital requirement. The source that you choose depends on how much you need to start your business, and on your priorities of needs.

“Only one thing is certain about a new venture. It’s going to turn out very different from its business plan.” William Congelton, venture capitalist

Every business has different financial requirements. A store that will sell fast-moving consumer goods could be set up for $200,000. A business that needs a small factory and machines may need $1 million to get started. A business that depends solely on artistic designers can quickly get started if the entrepreneur promises to pay salaries for at least one year. Rent for office space can be a small amount compared to the salaries.


Ask Yourself

Am I committed to make my business work? (Those who commit to make the business work can be bold enough to ask for funding.)

Am I brave in asking for funding to support my business idea?

Is there anything that makes me hesitate to ask for funding from external sources?

Maybe my business idea is not very good, that’s why I am ashamed to ask?

1. How To Access Funding Easy or difficult? Take a look at the list of ―easy to access‖ and ―difficult to access‖ sources of funding for your enterprise below. Money that is easy to access includes your personal money and assets or funds from relatives and friends. Money from strangers is more difficult to access. You may approach venture-capital firms or private-equity funders, but they take time to convince.

“Easy to Access” Sources of funding

“Difficult to Access” Sources

Your personal savings Your personal loans Your personal productive assets Money from relatives Money from friends

Venture-capital firms Venture-capital funds Private-Equity firms Other equity investors. Bank loans. Bonds.

“Success is going from failure to failure with great enthusiasm.” Winston Churchill

Graphic:

Conception to Newborn Seed Capital

Infancy to Childhood Venture Capital

Childhood to Teen-age Private Equity

Teenage to Maturity short-term bank loans, Stock Financing Maturity Long-term bank loans. Bonds.

Venture Capital Firm: a company that channels investments

to new ventures.


Venture Capital Fund: a pile of money that was assembled

for the purpose of investing in new ventures. The fund may be

advised or administered by a venture capital firm.

Private-equity firms

send investments into young and promising private companies. Their aim is to capture

the ―high-growth stage‖ in young companies. You must find the money to finance your enterprise. Since you are an entrepreneur, money is as important for your business as air, water, and food are for a person‘s survival. Without adequate funding, your business will not start. It cannot run.

Personal resources. If you are a committed entrepreneur, you should not be afraid to invest your personal money. You should not hesitate to engage the money of your relatives and close friends if you really believe in the goodness of your business idea. Just one important note: Even if you get money from sources friendly to you, you are still obliged to write a good business plan. Serious business plans, are not just for the benefit of non-family investors. Serious business plans, are also for making a pitch to family & related investors. All the more, should you write a serious business plan, if the investment comes from your personal money.

Pitch: a presentation to investors

for the purpose of obtaining investment funds

Money is a subject that fascinates everyone. In fact, the American economist and diplomat, John Kenneth Galbraith once said that, “Money differs from an automobile or a cancer, in that it is equally important to those who have it, and to those who do not.”

Size of the initial financing. Two schools of thought exist regarding initial financing.

The first maintains that the more money you can raise at the beginning, the better.


The second school of thought maintains that in the case of early financing, ―less is more.‖ That means that you should raise only the amount of money that is absolutely essential for the operation of the company at each stage of growth.

The arguments for both points of view have merit. They are as follows:

High Initial Financing Low Initial Financing

Permits you to survive unexpected

setbacks and delays.

Allows additional flexibility in taking advantage of new opportunities as they arise.

Eases the problem of obtaining credit from suppliers and banks.

Makes the entrepreneur feel secure in the critical initial phase.

Limited capitalization prevents

major losses, something that will allow you to preserve long-term credibility with the financial community.

Keeps attention and energies focused on the principal objectives.

If you sell too much stock, you may be selling too cheaply.

If you raise too much money, you might spend it unwisely.

Pros and cons of raising more money than you need:

Advantages

Disadvantages

Raising more money than you need acts as a security blanket. It is like having money in the bank. For some people the security it offers is necessary, while for others, it is not.

The feeling of security might come with terms that strangle the young business: too much profit-sharing with the bank, too soon. If you borrow money and you are unable to pay it back in cash, you may have to pay it back in the form of ownership shares. You would therefore give up control and/or a piece of the business.

“Wealth is like sea-water; the more we drink, the thirstier we become.” Arthur Schopenhauer, German philosopher.


Before we finalize where to get funding or from whom, let us look at what you need to determine. Steps from start to finish

Sources of funding


Ask yourself

Would I target first the source of funding that is “easy to access”?

Am I confident enough about my new business venture to ask for funding from my relatives?

Am I too shy to approach relatives? Do I prefer to approach strangers?

Am I confident enough about my new business venture to ask for funding from perfect strangers? (They may be high-level professionals, but they are strangers, nonetheless.)

2. Where To Access Funding

Personal money. For many entrepreneurs, the practical first source of funding for the new company is personal savings. You can borrow via a mortgage on your home. You can buy raw materials using a personal credit card. You could sell an item of value to raise cash. But there are pros and cons to using your own money.

Glossary: Mortgage: a loan based on the value of your house or your land. If you fail to pay the loan, the lender may

confiscate your house or your land.


Pros and cons of putting up the funding using your own money:

Pros Cons

My own money is easiest to manage. My money is instantly disposable. No need to wait long. No need to convince other people. The accounting process is simpler. I don‘t owe anybody else.

You may not have enough cash in the first place. The business may need more than you have. You may have cash, but it may already be committed to supporting a family. If the money is diverted to business, the family members may suffer. You may be understandably reluctant to put up everything you own. If you risk all you have and the venture does not work, what will you fall back on? You may get financially ruined.

Later on, you can approach outside investors. But at the very start, your own money must also be convincingly invested in your new business venture. You cannot get funding from other people‘s money without also showing your long-term commitment to the project with the example of your own resources.

Long-term. An investor wants to hear that you are 110% committed to the business for the long-term. He does not want to hear that you plan to abandon the business after a few years.

Your own resources. One of the first questions an investor will ask an entrepreneur is, ―How much of your total assets have you personally invested?‖ (You must have some of your personal money in the venture. How can you expect an investor to put their hard-earned money into a venture, if you won‘t? )

Ask Yourself (Keep all your answers confidential.)

How much are my personal savings?

Do I have any assets that I could bring into a new business venture? (For example, your own sports equipment could be displayed in a shop that rents out sports equipment.)

Would I be able to borrow from a bank at all? Can I find someone who can guarantee my bank loan?

If I truly believe in the value of my new business venture, would I risk 100% of my personal money in it?

If not 100%, what percent of my money would I risk in the new venture?


Family as a source of funding. After yourself, the next source of funding will be your family--your parents, brothers and sisters, cousins, uncles, aunts--anyone in your family. For those who are married, you may tap the family of your wife or husband. Some entrepreneurs are reluctant to ask relatives and colleagues for money, stating that ―it would be the last place‖ they would go for funding. Are they so repulsive? In practical terms, relatives should be more receptive to your ideas than private-equity funds or banks. Relatives know you. They understand your abilities. They support you. Aside from being more accessible, funds from relatives come at a lower cost. You can easily raise the money and pay less profit-sharing fee on the investment, or offer less equity than a bank or venture capitalist would require. Moreover, public sources of funding at the ―seed and start-up phases‖ of your company‘s development may simply be unavailable, making funds from family and friends the most accessible and perhaps the only source of capital. As for the downside, borrowing from your family poses large personal risk. If your business fails, your relative will lose money. The equity share you promised might become worthless. Had you borrowed from outside sources, it would be simpler. Declaring bankruptcy would save you from your creditors. Sitting across the dining-room table from family-member creditors at family gatherings who have lost money in your business can be very awkward and difficult. If your creditors are your in-laws, it could be even worse. Your husband or wife will be in the middle, pushed or pulled by both sides. Your day-to-day life may become unbearable. If you don‘t want to ever face this prospect, then you should rule out borrowing from family. Friends and contacts. Next to your family, the best people to turn to are friends and colleagues. Like your family, you will have to keep in touch with friends, smile at them at every reunion and party, even though you both know that a certain common venture failed miserably. You may be sad about it. But the friend might be angry about it. He might tell people bad things about you. Up to this point all your potential investors are people you know. The next group of investors represents a radical departure: people you don‘t know. Angel investors. An angel investor is a rich individual who invests in early-stage companies in exchange for equity ownership in the business. An angel investor expects good payoffs from investing in unknown and unappreciated companies before they become known and appreciated. They like the fun of being involved in a small business with great potential. They frequently mix personal goals


with financial interests. For them, nurturing a business to life and growth, is almost like being

on a mission, or being a proud father. Many angel investors are self-made millionaires. Most of them accumulated their investable cash through business, often by owning and then selling a company that they had started. How wealthy are these angel investors? An angel investor‘s net worth could be between $1 million and $10 million. Angel investors are also called freelance venture capitalists. They are the primary source of capital among early-stage companies.

Angel Investors in the USA

Inc Magazine Survey in 1996 found 250,000 angels invested over $20 billion that year

Small Business Administration estimates $65 billion US dollars invested each year, by angel investors in 60,000 early-stage companies

The angel investment market is 2x to 5x bigger than that of the later-stage venture-capital industry

Websites to find angel investors

www.ventureworthy.com

www.capitalrush.com

www.asianfn.com

www.vcaonline.com

Unlike venture capitalists and bankers, angel investors generally do not belong to associations or trade groups. Locating angel investors requires much legwork and creativity on the part of the entrepreneur.

http://www.ventureworthy/

http://www.capitalrush/

http://www.asianfn/

http://www.vcaonline/


Inspiration If you want to become really wealthy, open your own business. Most people associate a high net worth with a large monthly income, but in fact most individuals with sizeable fixed salaries do not possess a great deal of so-called wealth. According to Forbes Magazine, in year 2004, 72% of America’s wealthiest people were first-generation entrepreneurs, up from 63% in 1984.

Investors need to have enough money and enough time to monitor their investments.

If you have less than $1 million, you might not have enough money to risk on serious start-up ventures.

If you have more than $10 million, then you have enough money to invest in small enterprises. The question is, ―Do you have the time to monitor the investments?‖

If you have the money but not the time, try this:

employ full-time managers to oversee your investments for you. place money in ―venture capital funds.‖ Let the directors of the

funds make the decisions and do all the work.

In such cases, the investor simply observes the process and collects dividends.

Debate: Do start-ups run better? Thomas Hellmann and Manju Puri of Stanford University studied 173 high-technology firms in Silicon Valley from 1994 to 1997 and concluded that indeed they do. Start-ups with venture capital funding were more likely to quickly hire marketing executives and also more likely to replace their founders with an outside CEO with experience, thus avoiding one of the pitfalls of new companies, which is relying too long on a founding entrepreneur who had the initial idea but lacks management knowhow to guide the company.

STORY FROM REAL LIFE Sandy Lerner and Len Bosack started Cisco Systems in 1984. They put a used mainframe in their garage and persuaded friends and relatives to work for deferred pay.


They financed their venture by running up bills on their credit cards and at one point in 1986, Lerner took a job to provide more cash. In 1987, Cisco received funding from Sequoia Capital. Firms tend to receive venture capital funding after the high initial uncertainties about the size of the market and the profitability of the business have been reduced. When Cisco got funding, it faced a serious shortage of cash but it was making money. Angel investors are a subset of venture capitalists. Venture capitalists are a subset of private-equity funders.

STORY FROM REAL LIFE Compaq Computers was a venture capitalist‘s dream. The founders were all senior managers at Texas Instruments and they had a solid business plan and a technologically superior product. They managed to raise $20 million in venture capital and never looked back. Compaq had an experienced team, venture capital, and a plan that allowed it to act like a sophisticated company from the start.

Equity Capital: public and private.

Private Equity: late-stage and early-stage.

Venture Capital (early stage):

individual and institutional

Angel Investors: Individuals in early-stage venture capital


Venture capitalist. Venture capital is money invested by individuals or venture capital firms in small and high-risk businesses. In return, they generally receive equity ownership (ownership of a portion) in the companies in which they invest, usually in the form of stock. Friends, family, and angel investors are a subset of venture capitalists in the early stages. Banks and lending institutions are not venture capitalists because they do not accept equity (share ownership) in the companies to which they lend money. Neither do they take risks based on business plan projections. Venture capitalists are professional investors. They like to invest in a proven concept and a solid business plan. If the concept is not yet proven, they might allocate a tiny bit of money for product development. (They may say, ―Here is some money. Build your invention. Show me your process. Let us see if it works. If yes, then venture capital can come in.‖) This small amount of money is called seed funding, because it is like planting a seed. It is also called incubation, like nurturing an infant. STORY FROM REAL LIFE The beginnings of the private equity industry date back to 1946 when two venture capital firms were founded. Their names were: American Research and Development Corporation (ARDC) and J.H. Whitney & Company. Before 1945, venture capital investments were called ―development capital‖. Georges Doriot, also called the ―father of venture capitalism‖, founded ARDC. He founded a management school in France called INSEAD. His method was to raise capital from institutional investors to encourage private sector investments in businesses run by soldiers who fought in World War Two. ARDC scored a major success story when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) turned into $355 million after the DEC‘s initial public offering in 1968. The first venture-backed startup is Fairchild Semiconductor. It produced the first commercially practicable integrated circuit. It was funded in 1959 by Venrock Associates.


Few individuals start with ideas and all the human capital necessary to secure VC funding. Only 5% of the INC 500 most successful companies started with venture capital funding. A typical venture capitalist may look at over 300 business plans a year and invest in three.

Glossary: INC 500 and INC 5000 show the fastest growing companies in America. INC is a

business magazine. In terms of their own source of money, there are two types of Venture-Capital Firms:

Equity firms – they have equity capital from shareholders, and they purchase equity shares in small businesses.

Leveraged firms – borrow money from government or private sources, and lend it to the small business at high rates.

Because leveraged firms borrow their capital, they can only offer loans or convertible debentures to start-ups. With a loan, the small business makes payments. With a convertible debenture, the venture capitalist makes a loan and then retains the option to convert the loan to shares in the company, at a future date. These kinds of venture capitalists are also referred to as ―small business investment companies.‖

Glossary: Convertible Debenture: a venture capitalist lends to a start-up but retains the option to

convert the loan into shares in the company at a future date. What we normally associate with the larger ―venture capitalists‖ are private-equity funds. Their money consists of equity from shareholders. They purchase shares in small businesses (called investee companies) using their own capital. Once they sell those shares in investee companies at a profit, they remit the original capital and the profit to the private-equity firm‘s stockholders. Step One: Investors entrust money to the private equity fund. Money from shareholders is administered by the private-equity fund, to be placed in investee companies.


Step Two: Once they sell their shares in investee companies at a profit, the private-equity fund remits the original capital and the profit to the private-equity firm‘s stockholders.

Glossary: An investee company is a company that has received investment money from

an investor.


Ordinarily, venture capitalists would prefer deals that are large, not small. This way, they would have fewer but presumably better-quality investee companies. Such a preference for large deals might give unexpected benefits for entrepreneurs. (―I had asked for $2 million and yet I received an investment of $5million.‖) But there could be a bad surprise later on for the entrepreneur who has $3 million that he does not really need. He might spend the extra $3 million anyway since it is available. And he might be unable to pay back the loan later on, earning him a nasty lawsuit. There are economies that grow fast when investments are fueled by cheap money or abundant investments. The same economies go into crisis when the money cannot be paid back, and the nasty lawsuits get filed.

Most entrepreneurs do everything to prove the workability of their idea to prospective investors. But in reality, what investors want to test is the personality of the entrepreneur and his management team. They believe that the business is made or broken depending on the capabilities of the people handling it.

Ask Yourself

I was told that it would be difficult to raise money from venture capitalists. Will that stop me from trying?

Am I persistent enough to keep on trying even if things are already very difficult? Can you develop yourself to be strong inside, so that nothing in the outside world

can make you sad for very long?

Private-equity funds. Private-equity funds are collected sums of money that are intended for young and promising private companies. The aim is to capture the ―high-growth stage‖ in young companies. From experience, investments in young companies can deliver better investment profits than investments in large companies that are stable or ―slow-growth.‖ Venture capital is a subset of private equity. Venture capital deals with the stages of ―incubation or infancy‖ to ―very young company.‖ The money that goes into private-equity funds tends to come from institutions. Institutions are corporations that make it their core business to look for investments, to make investments, and to monitor investments.


By contrast, the dominant source of money for a venture-capital fund would be wealthy individuals.

A wealthy individual would be: (1) A person with net worth of $1million. (2) A person with $200,000 a year in individual income, or (3) A family with $300,000 a year in joint income. Anyone else with less wealth might not be allowed by US regulators to invest in venture-capital projects. Venture capital investing is a risky venture, thus not everybody should be putting their money in such an unsafe investment. US regulators like to ensure that only ―qualified people‖ be participating in such risky ventures. Qualified people are those with the money and the financial backing to withstand potential losses

from risky ventures.

Definition of ―High-Growth Stage‖: strong growth in sales and profits in the first few years of the life of a company. Sales and profits can double (meaning, grow 100%) each year for the first few years. Once the sales growth tapers off, the business may be reaching a mature stage of growth. It may need funding to fuel another ―spurt‖ in growth, or another high-growth stage.


3. Two General Types of Capital

No matter what is the stage of funding, there really are two major types of capital.

Debt, in the form of loans, and

liabilities. Money to be paid back.

Equity, representing part-ownership in the firm. Money of the owners.

Characteristics Of Different Types Of Capital

Sources of Funds Type of Capital Characteristics

Debt Bank loans (also known as ―senior‖ debt) Loans from investors, that are ―subordinate‖ to the bank loans.

Banks have legal priority in terms of getting paid profit-sharing fee, or getting their money back, in case anything goes wrong with the business. A loan to the company by a private investor can be paid back after the bank is fully paid. Since it has to wait until after the bank gets paid back, the private loan is called ―subordinated debt.‖ The bank has priority. It has ―seniority.‖

Equity Preferred shares Common shares

Preferred shares are investments that have a fixed annual dividend. They behave almost like loans that charge an annual profit-sharing fee. They do not usually have voting rights. Common shares are investments that may not have a fixed annual dividend. In return for the lack of dividends, the value of the common shares can go up over time, producing capital gains for the majority owner. Common shares have voting rights. Common shareholders are decision-makers and members of the board.


Banks and lending institutions

Banks and other financial and non-financial institutions can be classified as the most ‗impersonal‘ sources of funds. They do not invest to derive any human satisfaction, but only to earn profit-sharing income from your venture. Therefore, their investment evaluation criteria are also very stringent and regulated.

Banks and lending institutions traditionally do not like to lend money to start-up businesses. The reason is very simple. They are not risk takers. They prefer to lend on the basis of assets that can be confiscated in case payments are not made. They know that many small businesses fail. Banks can loan seed money if the loan can be secured fully by assets. If you are lucky, you can find a lending institution which grants loans without need for collateral. A loan which does not require collateral is called an unsecured loan. This type of loan is granted only to creditworthy customers.

Glossary: Unsecured Loan: a loan which does not require collateral.

Secured loans are the majority of cases: loans secured by collateral, such as fixed assets or real property.

Ask Yourself Do I have good credit standing? Have I always paid back money that I have borrowed from other people?

Stock financing

Stock financing is usually chosen by companies that need additional long-term finance, as opposed to initial or seed capital.

If your business is a corporation, you may chose to issue common or preferred stock to finance the company. This type of arrangement allows the investing public to receive a


share of the profits, yet permits the officers of the corporation to retain control over the management of the company. The pros and cons of financing with common stock are as follows:

Advantages Disadvantages

A corporation is not legally

obligated to make dividend payments to stockholders, so long as the Board of Directors acts in the best interest of the corporation.

Stock improves the credit rating of the company because it increases the amount of capital in the company.

Listed shares of stock are attractive to some investors because they generally give gains that are higher than inflation.

If the business owner sells

common stock, the buyers will get corporate voting rights. If they have majority ownership, they can vote to kick out the entrepreneur from the company that he started.

Shareholders share in the profits of the company through dividends for many, many years. If the business owner wishes to keep these dividends to himself, he should get a loan and pay it all back in a few years, instead of selling shares of common stock.

Companies may also issue preferred stock. Preferred stock offers one distinct advantage: it does not have corporate voting rights. Owners of preferred stocks are almost like lenders. Lenders only care about receiving profit-sharing fees. In the case of preferred shareholders, they only care about cash dividends. (They don‘t care if the common stock goes up in value. It‘s not their game. They are happy to own the preferred shares. ) When is the best time to sell ownership shares? The best time is when you can get the best price for your shares. Usually, the best price is easy to demand when the stock markets are doing well in a bull market.

Glossary Bull Market: a market where prices have been rising for many weeks or months already, like a bull charging up a hill. The opposite is a bear market, where prices are falling, as

if a bear was clawing them down. How old should the company be before the founder starts selling shares of stock? The company should be old enough to be sufficiently strong in revenues and profits. If you


sell shares of stock when revenues are still weak, you cannot get a good price for the shares. By selling shares, you would be giving away too big a percentage of ownership. Better to wait until the company is well developed. Pros and cons of selling ownership shares at an early stage of the company

Advantages Disadvantages

You get to raise long-term money that does not require frequent profit-sharing fees. If you sold common shares, you would not be obliged to pay cash dividends every year. You can go for several years without paying out cash dividends.

Selling stock in a brand-new company is like cutting down a newly planted tree for lumber. It‘s a premature move. There is not enough wood on the tree. The type of investor from whom one is able to raise initial capital may not be the kind of director you want to grant voting power once your company really gets started. He might be a nasty investor.

Ask Yourself

Since I don’t know much about the stock market, will I study all about it?

Will I start learning more about the stock market (all over the world) in my spare time?

Do I realize that the attitude of a true winner is: “Nothing can stop me. I should at least give it a try. I should at least try my best.”

Conclusion Before you raise money, you should carefully examine your company‘s needs, projecting how you will use the capital to help your business grow. Remember that raising money always comes at a price. Your objective should be to raise only the amount you need at the cheapest price possible. Once you have identified the best source of capital, understand the process for obtaining the money. Plan and budget for both the time and expense of raising capital. Acquiring the capital in readily-usable cash could take weeks or months.


Points To Remember 1. Without funding or capital, your business idea—no matter how good it is—will not

amount to anything. 2. To get funding, you need to determine how much money you need, convince an

investor that your company will be profitable, that it needs the amount you say it needs, offer him incentives, profit-sharing fee, or collateral, and make arrangements to pay back the borrowed money or give cash dividends as return on investment.

3. Sources of funding for your business include personal savings, loans, assets, money from relatives and friends, venture capital firms, private-equity firms, banks or lenders and other equity investors.

4. You should consider investing your own money in your business to show your investor you believe in your company. After all, your personal savings is the easiest to manage and access and the accounting process is simpler. The disadvantage of this is that you might not have enough, or you might need the money later on for yourself or your family.

5. When tapping your family and friends for funding, the advantage is that their funds are easily accessible and they may ask for lower profit-sharing. The problem with this method is the large probability of personal risk that when your business loses money, your relatives and friends may lose money too, and this might put a strain on your relationship.

6. Angel investors put money in start-ups to enjoy the huge pay-offs and the sense of mission and adventure in supporting a company before it grows big.

7. Private-equity funds put money in small firms to capture the ―high-growth‖ stage. 8. Secured loans are backed up by collaterals like fixed assets or real property.

Unsecured loans do not require collateral, but need to be paid back in a short period of time and are granted only to creditworthy customers.

9. The advantages of stock financing are the following: a corporation is not legally obligated to make payments to stockholders; listed stock improves the credit rating of the company; stocks are attractive to some investors because they give capital gains that are higher than inflation.

10. The disadvantage of stock financing is: common stock owners have voting rights. Control over the company will be transferred to the new stockholders, if they have majority. Shareholders share in the profits of the company through dividends for a very long time.

Glossary Angel investor: a rich individual who invests in early-stage companies in exchange for equity ownership in the business. Bankruptcy: declaration that the company is unable to pay back its loans. Bear Market: when prices are falling, as if a bear was clawing them down.


Bull Market: a market where prices have been rising for many weeks or months already, like a bull charging up a hill. Capitalization: funds used to start operating your company. Collateral: property or other belongings that the bank can confiscate if you fail to pay your loan. Common shares: certificates of part-ownership in a company. Common shares have voting rights. Convertible debenture: With a convertible debenture, the venture capitalist makes a loan and then retains the option to convert the loan to shares in the company, at a future date. Dividend: money paid regularly to a company‘s shareholders or owners. Equity: ownership or part-ownership. Equity firms: an investment company formed by cash contributions from shareholders. High-Growth Stage : strong growth in sales and profits in the first few years of the life of a company INC 500 and INC 5000: the fastest growing companies in America, as monitored by a business magazine. Investee company : a company that has received investment money from an investor. Leveraged firms : a kind of venture capital company that borrows money from government or private sources. Mortgage: a loan based on the value of your house or your land. If you fail to pay the loan, the lender may confiscate your house or your land. Niche: specialized area, or specialty. Paradox : a mystery or contradiction. Pitch: A presentation to investors for the purpose of obtaining investment funds Preferred shares: are investments that have a fixed annual dividend. They behave almost like loans that require an annual profit-sharing payment. They do not usually have voting rights. Private-equity firms : Private-equity funds are collected sums of money that are intended to be invested in young & promising private companies. The aim is to capture the ―high-growth stage‖ in young companies. Subordinate: less important than something senior. Subordinated debt: debt that will be paid only after certain senior creditors have already been paid. Venture capital funds : a pile of money that was assembled for investing in new ventures. The fund may be advised or administered by a venture capital firm. Venture capital firms : a company that channels investments to new ventures.

Review Questions

1. Why it is important to secure the financial resources to be able to start a business.


2. What are the steps to take to determine the necessary funding?

3. Where can one seek the necessary funding?

4. Can you supply funding from your own personal money?

5. What are the pros and cons of using my personal money for business.

6. What are the pros and cons of tapping your family as a source of funding?

7. What are the reasons why angel investors invest in unknown start-up

companies?

8. What must the entrepreneur be willing to do, when asking venture capitalists for funding.

9. What is the motivation of private-equity funders for making investments?

10. What are secured loans and unsecured loans?

11. What are the pros and cons of stock financing?

Questions for Discussion

1. Most entrepreneurs are obsessed with control. They want to do everything themselves. They don‘t want some outsider telling them what to do. They are looking for investors who will remain as passive as flowers. ―Hand over the money, and afterwards, do not bother me‖ seems to be their attitude. Is this your attitude? Do you think you can go far with this attitude?

2. The investor may be very nosy and insist on being updated every week. You will have to endure this close attention. Do you think you can cheerfully report every week to a person who lent you money?

3. Sometimes, things go wrong, such as a fire in the factory. New ventures are inherently risky. What can go wrong will go wrong. When that happens, investors may panic, get angry, pull out, and refuse to provide any more money. Do you have plans for what do in case of such events?

4. Most of us can reach a point where we just give up. In business, when do we say, ―Forget it, it‘s over.‖ Entrepreneurs need a kind of stubborn power—that ability to seize victory from almost-certain defeat. Have you ever seized victory from the jaws of defeat?

5. There is a story of an entrepreneur whose business failed. He was at his lowest point. He was invited to a friend‘s new house for the weekend. At the time, he


did not have enough money even for food, so he accepted the invitation. He was really depressed. Surprisingly, he found his host to be equally depressed. In the case of the host, the sad news was that the fancy new cabinets that she had ordered from abroad had not yet arrived. She was not able to finish decorating the kitchen in time for the party. Have you ever been sad over something very petty?

6. Read the article found here: http://www.economist.com/sponsor/qfc/index.cfm?pageid=article101. Reread the following paragraph on why there is growing interest among private equity funders on the opportunities in the Middle East and North Africa (MENA) region: ‖ But that‘s only half the story. Until now, many local and international private equity operators have looked to the region only to raise cash; today they are looking to the region for opportunities to invest that cash – and more besides. And while the real estate and construction sectors are attracting the lion‘s share of these investments for the time being, opportunities in private-sector transportation, financial services, travel and tourism, energy, and other sectors are flourishing as never before. The reasons for these shifts are plain: Countries of the GCC region are racing to diversify their economies in efforts reduce their dependence on oil and gas reserves, which may start drying up within a decade. To kick-start the process, governments are investing billions of dollars in infrastructure, much of it in transportation and financial services. And as public sector enterprises increasingly take a back seat, private businesses are set to be at the forefront of the region‘s growth.‖ Now, answer this question: How can angel investors and private equity investors improve the economy in your country or city?

Case Study STORY FROM REAL LIFE In January 1982, former US Secretary of the Treasury William Simon and a group of investors acquired Gibson Greetings, a producer of greeting cards, for $80 million, of which only $1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen months after the original deal, Gibson completed a $290 million Initial Public Offering and Simon made a profit of $66 million. The success of the Gibson Greetings investment attracted the attention of other investors to the boom in leveraged buyouts. Between 1979 and 1989, there were over 2,000 leveraged buyouts valued at $250 billion.

http://www.economist.com/sponsor/qfc/index.cfm?pageid=article101


Case Analysis 1. What does this story say about the profits that can be made by investing in

young companies? 2. When William Simon raised $80 million, of which only $1million was rumored to

have been contributed by the investors, what does that mean? a. Does it mean that William Simon borrowed $79 million from a bank? b. Do you think it is more likely that William Simon raised $79 million in

private-equity investment? 3. A leveraged buyout is a method of buying an entire company, using borrowed

funds. Sometimes, the funds are borrowed at high rates of profit-sharing. Once the company has been purchased, the new owner sets about trying to increase its value. After some years, the company may be sold for three times or five times the purchase price. Is this something that can be done today in your country: buying weak companies, making them strong, and selling the entire company for a much higher value than the purchase price.

4. Once it was revealed that the profits could be large, did other people follow William Simon‘s example in organizing leveraged buyouts?

Learning From The Internet

1. www.missouribusiness.net/sbdc/centers.asp: The Missouri Small Business Development Center helps entrepreneurs to develop the business idea and to find funding.

2. Where to find angel investors: o www.ventureworthy.com o www.capitalrush.com o www.asianfn.com o www.vcaonline.com

3. http://www.economist.com/sponsor/qfc/index.cfm?pageid=article101 : an article in The Economist on the growing interest among private equity investors for the MENA region.

Exercises for SESSION 9: Secure Funding

1. Can you rely on your relatives‘ money? a. If you were to turn to family and friends, would you say that they are

supportive of you and your plans? b. Is there a possibility that family and friends would not support you due to any

bad experience? 2. Group Work: Approach a business in your city and interview a business owner.

Find out how much funding is required to go into his line of business. Report in

http://www.missouribusiness.net/sbdc/centers.asp--

http://www.ventureworthy.com/

http://www.capitalrush/

http://www.asianfn/

http://www.vcaonline.com/

http://www.economist.com/sponsor/qfc/index.cfm?pageid=article101


class in groups of 4 members each.

3. Research. Find out the minimum of assets and working capital that should go into the following small businesses. You may need working capital for the first three months or the first nine months until the business is running in a stable way:

a. Dental Clinic. If three dentists decide to go into business together by

operating a dental clinic, they will rent space, furnish it with dental chairs, hire an appointments clerk, and start receiving patients. The three dentists will equally share the costs of the operation and they will divide the profits equally among themselves. The assets are the clinic with its dental chairs and furniture. The working capital should pay for the salary of the appointments clerk or receptionist, the monthly rent, and the utilities (lights and water).

b. Bakery. A bakery will need special ovens, pots, pans, and utensils. It will also need to hire bakers who know how to produce different varieties of loaf bread or pastries. The assets are the ovens and kitchen equipment. The working capital should pay for the raw materials like wheat flour, eggs, and chocolate.

c. A Hardware Store. A stand-alone hardware store will need a piece of land, a structure to house the goods, cabinets and shelves, and the items for sale: pipes, lumber, valves, iron, nails, and other ―hardware‖ and minor construction equipment for homeowners to purchase. Alternatively, the hardware store could simply rent commercial space in a mall instead of buying land and building a structure. It could rent space in an existing shopping mall, and stuff the space with the goods for sale. This would minimize the start-up cost, savings on land and structure, but it would mean extra monthly expenses in the form of rent.

4. Discuss what type of funding you would employ for the following:

a. Think of a business idea that would sell very well in the coming year. It can

be a store, a service, a small factory, or a buy-and-sell operation. Write it down.

b. Estimate whether this business project would need money in the hundreds or thousands or millions. Make a rough estimate such as ―between one million and two million.‖

c. For this new business venture, would you dare to employ your own money? Personal savings, Personal credit card, or Loans against personal assets.

d. Would you have access to money from angel investors like friends or family who are sympathetic to your aspirations?


e. Can you get a private loan guarantee? A private loan guarantee comes from someone who is well-known by the bank you are borrowing from (let‘s say, he is one of their main clients), and who can tell the bank that you will pay your debt. In case you can‘t, he will pay it himself.

5. Research. Find out what venture capital funds operate in your city. Find out if

they make grants to entrepreneurs to develop a business idea.

Find out what type of documentation is required by the venture capital fund from the entrepreneur.

Often, the venture capitalist will need to see that: (1) your young company is able to get a purchase order for the new product. (2) your young company is able to find people who are willing to pay a monthly fee for a service or a publication. (3) your young company is able to get people to buy the item from stores, where the item is placed on display, on a trial basis.

Once your business idea becomes an ―engine of growth,‖ in terms of strong sales, you can get more and more venture capital funding. With greater funding, your engine of growth will get more ―fuel‖ to keep going, until such time that it can support itself. Once it can support itself, it becomes ―commercially viable.‖ Then it can stop depending on the venture capital funding, for survival. The company can

survive and prosper on its own.

6. Compile a list of Internet sources, associations, publications that will help you to approach the right Angel Investors, or the right Private-Equity Funders.

7. Let us say that you are an entrepreneur, and you wish to select a potential investor. Among potential investors, some are suitable and others are unsuitable. You have to match your proposed business with their typical investment. Read this table, then look for investors in your city that are either suitable or unsuitable for your investment requirement.

Suitable prospective investors Unsuitable prospective investors

Their typical investment has the same size, and is in the same line of business, as the investment you are about to propose to them.

They don‘t invest in the type of product or type of industry, of your new venture.

They make real investments. They just like to talk, about investments.


They are not really interested in adding more work to their work load.

They are most interested to hear, what you have to say. Beware, they might want to copy your idea.

They are often unwilling to grant you an appointment.

They are overly and suspiciously eager to grant you an appointment.

They are reluctant to listen to your pitch, unless it is a quick type of pitch that can be delivered while you are both riding the elevator in a building.

They are overly and suspiciously eager to listen to the whole business proposal.

8. Research. Select a venture capital firm. Check how many deals they have done recently. Check what actual investments they have made. Tell your classmates, whether they were suitable or unsuitable as potential investors in your company.

9. Prepare a quick presentation to a potential funding source. Think of a

business idea, and speak extemporaneously, following an outline.

Presentation outline 1 (Sample)

What is my business idea What is the potential Who is the market: individuals or companies. Why they would want to buy this product How would I bring this product to market How much money do I need from you How will you recover your investment Risk and returns

Management Profile

Presentation outline 2 (alternative)

What is the product What is the market for this product Is it a fast-growing market How we can take advantage of this trend How much money do I need from you Will you be investing in the form of equity or debt. How will you recover your investment Risks and returns

Management Profile

End of session 09.

entrep finance chapter 09 secure funding

Economy & Finance

small business

investment money

business idea

borrowing money

unit of money

aboutraising money

seed of money

largeamount of money