Source Of Financing For Ventures

What Makes Entrepreneurial Finance “Different” from Traditional Finance . . . ?

Lack of history upon which to assess risk 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!!!

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: 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: Explicit and hidden costs of using other

people’s money . . . (Bhide)Danger of misallocation . . . Throwing money at

symptomsDiminished flexibility . . .

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.

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.

Some Entrepreneurship Myths

1. Capital is important in early stages2. You need a business plan (meaning

precedes action)3. Lone Hero: you have to do it yourself4. You have to have a “big idea”5. Bootstrap Ventures don’t become big

12 satya acharya

Definition: tr.v. boot·strapped, boot·strap·ping, boot·straps

To promote and develop by use of one's own initiative and work without reliance on outside help

adj.

Undertaken or accomplished with minimal outside help.

Being or relating to a process that is self-initiating or self-sustaining.

Bootstrappers: do not rely on investors, but DO rely on customers, fellow bootstrappers and anyone else!

Bootstrapping” as the act of starting a business with little or no external funding. Bootstrappers don’t write lengthy business plans, chase deep-pocketed investors, or indulge in overly academic market research exercises. Instead, they focus all of their considerable energy, brainpower, determination and skills on creating a business that can actually succeed in the real world

Some Bootstrap Principles1. Follow and Develop your Passions

2. Right action by Stage: Ideation, Valley of Death, Growth*

3. Valley of Death – this is where you innovate!

4. Focus on your Customer, not an Investor

5. Opportunistic Adaptation & Serendipity

6. Demo Sell Build

7. Power of team

*Darius Mahdjoubi

Some Bootstrap Principlesbootstrappers have one common goal: launch the

startup and grow it to the point of profit generation for as little money as possible.

1. Minimal debt

Taking out a bank loan to fund a startup can be a good way to get up and running, but also decreases the profit margin of the company while the debt is being paid off.  Those bootstrappers that stay out of debt during the startup process, on the other hand, do not have their revenue shackeled by debt

Some Bootstrap PrinciplesDoes not require giving up a stake in your

startup

Startups that receive external, private investment end up giving away large shares of their company as the investors take on the bulk of the financial risk

A relatively cheap way to obtain a proof of principle for other investors

Let’s be honest - ideas are a dime a dozen.  Granted, private investors are interested in good business ideas, but they are equally interested in your ability to execute the idea

Some Bootstrap Principles Bootstrapping ensures that you build your business on a legitimate,

real-world value proposition. When you’re Bootstrapping, you’re forced to deal with customers and to fulfill their needs from Day One

Bootstrappers initiate the critical sales learning process sooner, not later.

Bootstrapping accelerates time-to-market and time-to-profitability Bootstrappers are less likely to make big, fatal financial mistakes Bootstrappers are forced into unconventional thinking. Necessity

truly is the mother of invention. Without a big cushion of cash, Bootstrappers are constantly forced to solve problems creatively

Bootstrappers have more freedom and flexibility. When you take external funding, you become a slave to your business plan and you have to constantly answer to third parties: banks, private investors, grant agencies, etc

Bootstrappers wind up owning much, if not all, of what they create.

How to Bootstrap a Startup CompanyCash is KingAs Guy Kawasaki puts it,

The reality is that you pay bills with cash, so focus on cash flow. If you know you are going to bootstrap, you should start a business with a small up-front capital requirement, short sales cycles, short payment terms, and recurring revenue. It means passing up the big sale that take twelve months to close, deliver, and collect. Cash is not only king, it’s queen and prince too for a bootstrapper.

How to Bootstrap a Startup CompanyCut your Overhead

Because Cash is King, you should strive to be as frugal as reasonably possible.  Why spend Rs.1000 on a fancy chair when all you need is something to sit on? 

And since you are going to bootstrap your startup, you’ll need to be frugal in all areas of your life. 

Money spent on a fancy car is money that could have gone into your start up.  Get the company off the ground, then buy the car.

How to Bootstrap a Startup CompanyDo it yourself (now!)

Those business owners that bootstrap their company don’t have the luxury of hiring an expert for every problem the business will face.  In fact, it’s highly likely that your company will be understaffed (though one can argue this is a good thing). 

How to Bootstrap a Startup CompanyGuerrilla Marketing

If you bootstrap your company, you aren’t going to have a big budget, much less a big marketing budget. 

Jay Conrad Levinson wrote Guerrilla Marketing for people looking to efficiently and economically expose their company’s brand. 

Guerrilla marketing requires more ingenuity than traditional marketing channels, but for the clever bootstrapper, it’s no less effective.  These days the internet provides additional resources for cheap marketing, such as search engine optimization (SEO).

How to Bootstrap a Startup Company Partner with other firms

Entrepreneurs tend to like to go it alone, but bootstrappers need to remember that they’re playing a man down.  Partnering with other firms can lead to customer acquisition as well as opportunities to barter goods or services between businesses (which is great when cash strapped). 

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

Human Resources Bootstrapping

Employee “stretching”Independent contractors Employee leasing and temporary

employeesStudent interns Equity compensation Non-monetary benefits

Administrative Overhead Bootstrapping

Space

Furnishings and office equipment

Administrative salaries

Operations & Inventory Bootstrapping

Outsourcing

Just-in-time inventory techniques

Effective cost accounting

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

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 pledge Banker6. 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

Sources of Equity Funding

Funding from the entrepreneur

Family and friends (and “fools”!)

Strategic partners

Angel investors

Private placement

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. 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