Keys to Financing the New Venture
Alec Johnson, .
University of St. Thomas
The Problem
“Small business management is cash flow management.” Dr. Robert Pricer, Weinert Applied Ventures Program, Unviersity of Wisconsin
“Cash is King.” Dave Stassen, Partner, St. Paul Venture Capital
“You’re not an entrepreneur until you’ve written payroll checks on Friday and spent the weekend collecting the cash to cover them.” Keith Streckenbach, founder and CEO of
Entrepreneurial Finance vs.
Corporate Finance
Differences from Corporate Finance
Diversification and Value
Involvement of Investors
Harvesting
The Problem - Objectives
Minimize Cost
Maximize Return
Maintain Control
Maximize Ownership
Minimize Involvement
Minimize Risk
Entrepreneur
Investor
The Problem - Management
What is the Ultimate Task of an Entrepreneur?
Job #1 is Risk Management
Largest risk is Financial and question becomes “How?”
The Problem - Structure
Type, . Do I use debt, equity or some combination.
Timing, . When do I need it?
Amount, . How much do I need?
Type – Two General Classes
Debt
Represents a fixed cost
Represents more risk
Cheapest type of outside financing
Equity
No interest payment
No obligation to repay
Most Expensive type of financing
Sources of Debt Financing
Friends and Family
Banks
Leasing
Factoring
Bank Financing
Commercial banks are the largest source of external capital for growing firms.
Problems:
Lack of collateral
Lack of earnings history
Leasing
Often used technique to acquiring assets without having to purchase them.
Two types of Leases:
Operating Lease
Capital Lease
Factoring
Factors buy company’s accounts receivables at a discount.
Recall R&R case.
Gets cash to company quickly, but must have cost of factor available in profit margin.
Equity
When to use equity?
Every company has some form of equity.
Founders raise equity when:
there is no collateral to secure debt
insufficient cash flow to secure debt
required growth capital more than banks can provide.
Types of Equity Instruments
Typically used in small business placements:
Common Stock
Preferred Stock
Types of Equity Instruments
Common Stock Characteristics:
Most common form of issuance
Last in liquidation = ?
Represents Entire ownership of firm.
Types of Equity Instruments
Preferred Stock Characteristics:
Pays dividends
Preference in liquidation
Types of Equity Instruments
Preferred Stock Characteristics:
Looks a lot like Debt!
Used by Venture Capitalists to gain position in liquidity event while minimizing risk.
Types of Equity Investors
Angel Investors
Venture Capitalists
Types of Equity Investors: Angels
Typical Angel Investor
Private individual (not an institutional fund)
Age: 47 –54 years
Gender: Male
Net Worth: $1,000,000 +
Types of Equity Investors: Angels
Typical Angel Investor
Education: Bachelors or greater
Average Investment: $59,000
Preferred Stage: Start-up (56%) and infant or young (24%)
Types of Equity Investors: Angels
Typical Angel Investor
Required Rate of Return: 15% - 45%
Length of Investment 3 – 10 years
“Patient Money”
Types of Equity Investors: Venture Capital
Typical Venture Capital Firms
Institutional Firm
Raises money from various sources, including Angels
Creates “pool” of capital, a fund.
Develops portfolio of firms under management
Types of Equity Investors: Venture Capital
Typical Venture Capital Firms
Average Investment: $1 M to $50 M per investment.
Industries: High Growth, early or later stages
Services Provided: None to direct management decision making and board control.
Required Rate of Return: 10X in 3-5 years.
Typically invest using Preferred Stock
Venture Capital Investments, Q2 2001
% of Venture Capital invested in Midwest!
Timing – Sources of New Venture
Financing*
IPO
Venture Capital
Banks/Lessors
Angels/Partner
Entrepreneur/
Friends/Family
Exit
Rapid Growth
Early Growth
Start-Up
Development
*Adapted from: Smith and Smith, Entrepreneurial Finance, 2000
Timing - Cash Needs
Goal is to manage risk to business and to investor.
Minimize risk by staging investments
Establish stages by developing solid business plan and financial projections!
Case Study – Ascend Medical
Facts:
Development stage Medical Device company.
Prototype of catheter for stroke victims nearly complete.
Market need unclear.
FDA process is three years and $30M in expense
No guarantee of approval.
Case Study – Ascend Medical
Analysis – Type?
Debt is not an option.
Angels to get the product through prototype development, further market study, conduct focus groups with doctors. $500,000.
Venture Capital to take it through FDA process and initial market launch. $45M
Case Study – Sporto
Facts:
Start up phase winter apparel company
One season’s sales under it belt
Moderate growth plans
Required funds: $ M
Needs immediate funds of $100,000 to expand sales organization and $ M to expand product line and related marketing expenses over the next 18-24 months
Case Study – Sporto
Analysis – Type?
Venture Capital not an option – growth too slow
All debt not an option – unless financials can demonstrate adequate cash flow and plenty of collateral available.
Private equity with debt mix is viable option
Factoring after sales grow, leasing office equipment
Alternative?
Case Study – Sporto
Analysis – Timing?
Could split rounds up, reduce overall cost of capital.
Rounds are close enough that it might make sense to raise all at one time.
Unless founder gets lucky? Example
The Big Picture – Business Plan
Competitor Analysis
Environmental Trends
Customer Analysis
Business Plan
Functional Plans
Pro formas
Financing
Evaluation-CMOPs
Business Plans
What is a business plan?
Something you produce because the bank expects it?
Something you produce because every says you should?
?
Business Plans – Make Your Argument
Argument contains some consistent themes
What is the product or service?
Who is MOST likely to buy it?
How much are they willing to pay for it?
How many of “THEM” are there?
Business Plans – Make Your Argument
Argument contains some consistent themes
Who is MOST likely to buy it?
Where and How will they purchase the product?
How will I let them know about it?
Does my team have the ability to execute the plan?
“Everything should be made as simple as possible, but not more so.”
Albert Einstein
Business Plan-The Purpose
A Sales Document to Raise Capital
A Road Map to Developing a Successful Organization-Do we have a product the market wants and do we have an organization that can see it to market?
The Plan makes an argument for why the business will be successful!!!!!
Business Plan Outline
Executive Summary
Company History
Major Products/Services
Marketplace
Competition
Marketing Plan
Operations-Manufacturing
Management Team
Risks
Financial Analysis
Company Description
What business are you in?
What are your:
products or services?
customers?
applications? (Different uses and needs satisfied
What is your distinctive competence?
What is your competitive advantage?
What is your Mission Statement
Sustainable Competitive Advantage
Versus Distinctive Competence
Ask the question “What do we have that can’t be replicated by our competitors?” vs. “What are we good at?”
Mission Statement
What do we do?
How do we do it?
Who do we do it for?
Example: Brew – On - Premise
Market Analysis & Marketing
Industry description and outlook
Target markets (segments)
Competition
Reaction from prospective customers
Marketing activities (strategy/pricing)
Selling activities
The Key is your Feasibility Study
Example 1: Brew on Premise
$423 ($527)
$32,703
367,085 (54%)
Dane County,
Wisconsin
$449 ($585)
$35,322
225,339 (52%)
Boulder County,
Colorado
Median Rent (upper quartile)
Median Income
Total Population (% age 24-55)
Example 1 - Brew on Premise
Counties are comparable
15 batches per day in Boulder
Ratio of target population :1
Expected revenues for Badgerland to reach 24 batches per day after 2 years of operation.
Example 2 – Ascend Medical
Different approach to argument
Focus isn’t one likely demographic
Focus is on treatable number of cases
Example 2 – Ascend Medical
Process:
Population growth through 2010 (Source: US Census)
“Target” population not important. All medical research data based on incidence in US population.
Medical data implies number of treatable cases by type of stroke.
Example 2 – Ascend Medical
Process:
Once number of treatable cases established by type of stroke, can then establish type of treatments received.
Those requiring clot removal (vs. stenting, etc.) are established as likely candidates for this procedure.
356,000 treatable cases today, growing to 560,000 in 2010.
Management and Ownership
Key management positions
Background of personnel
Board of Directors
Ownership
Starting a business is about building a successful organization and working in a “team.”
Does your team cover all the necessary roles or have you developed a plan to cover areas that are weak?
Management
Franchise
Software, Medical Device, etc.
Low
High
Moderate
Granite Gear
Level of Sophistication
Product Development
Level of Complexity
Franchise
Software, Medical Device, etc.
none
high
moderate
Granite Gear
Time To Market
Franchise
Software, Medical Device, etc.
short
high
moderate
Granite Gear
Time to Profitability
Franchise
Software, Medical Device, etc.
Short < 6 months
High >24 months
Moderate 9 to 18 months
Granite Gear
Market Risk
Franchise
Software, Medical Device, etc.
High
Low
Moderate
Granite Gear
Product Acceptance
Capitalization
Franchise
Software, Medical Device, etc.
Low < $50,000
High > $2M
Moderate $500K to $2M
Granite Gear
Risks
Competitive Risks
Technological Risks
Organizational Risks
Main Point: Identify them and develop a plan to deal with them if and when they arise.
Funds Required and Their Uses
How much money do you require now?
How much will you require over the next five years?
How will the funds be used?
Funds Required and Their Uses
Debt/Equity mix
What terms do you ask? (Let the commercial money market help you select winners)
Do you plan to “harvest?” Be explicit about the deal you offer…
Financial Data
Historical financial statements and projections for the next five years
Key assumptions
Appendices
Resumes
Pictures of products
Sales literature
Supporting published market studies or trade journal articles
Patents
The Big Picture
Competitor Analysis
Environmental Trends
Customer Analysis
Business Plan
Functional Plans
Proformas
Financing
Evaluation-CMOPs
