Download New Venture Financing

Masters in Engineering and
Management of Technology
Masters in engineering
Design
Introduction to Entrepreneurship
and New Venture Creation
Rui Baptista
New
Venture
Financing
Financial Steps in the Evolution of a
Successful New Firm
3
1. Founding Stage:
4. Harvest Stage:
The entrepreneurial
team begins with a
vision, business model
and strategy
IPO or acquisition
provides returns to
investors and
founders
2. Seed Stage:
3. Growth Stage:
Initial financial capital
Growth capital required
Entrepreneurship - Rui Baptista
Idealized Cash Flow Diagram for a
New Firm
4
Entrepreneurship - Rui Baptista
Early Stage Funding
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Most start-ups will not raise outside capital
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Niche markets that are too small
No sustainable competitive advantage
Strategy relies only on execution, personal
selling and energy of the entrepreneur
Team lacks industry experience
Profit margins that are too low
No Harvest/Exit Upside
Entrepreneurship - Rui Baptista
Financing Rules for Startups
 Choose
ventures with reasonable (low)
capital requirements
 Get operational quickly
 Generate cash
 Stick to high value products
 Control growth
 Focus on cash, not profits or market
share
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Entrepreneurship - Rui Baptista
Sources of Financing for Startups
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Founders
Family and Friends
Professional Investors — Business Angels
Seed Capital
Venture Capital
Bank Loans
Debts to Suppliers
Customer Prepayments Leasing Companies
Established Companies
Government Grants and Credits
Public Stock Offering
Entrepreneurship - Rui Baptista
Sources of Start-up Capital in
the United States
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78.5% - Personal
savings
21.4% - Angels,
employees, partners,
friends
14.4% - Bank loans
12.9% - Family
Members
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6.3% - Venture capital
4.0% - Mortgaged
property
1.1% - Government
guaranteed loan
3.4% - Other
Entrepreneurship - Rui Baptista
Personal Resources
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Offers greatest return, if successful
Investors and venture capital sources usually
require it
Personal funds can be treated as equity or debt
Possible Sources:
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Savings
Severance packages
Personal asset sales
“Moonlighting”
“Bootstraping”
Entrepreneurship - Rui Baptista
“Bootstrap” Financing
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To start a firm by one’s own efforts and to
rely solely on the resources available from
oneself, family, and friends
Often applied to a current business that can
reduce costs from current operation
Usually overlooked as a source to
entrepreneurs
The entrepreneur becomes more efficient and
cost conscious
Entrepreneurship - Rui Baptista
Advantages and Sisadvantages of
“Bootstrap” Financing
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Less pressure on
generating profits fast
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Unable to fund growth
phase
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Easy terms on ownership
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Lack of funding
commitment for the future
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Control by founders
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Loss of advice from
professional investors
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Little time spent on
finding investors
Entrepreneurship - Rui Baptista
“Moonlighting”
Founder still working a regular job
 Income used to support the
entrepreneur during needed cash flow
 When the venture begins paying as
well or better – entrepreneur leaves
job
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Entrepreneurship - Rui Baptista
Angel Financing
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Angels are wealthy individuals, usually experienced
entrepreneurs, who invest in business start-ups in
exchange for equity in the new ventures.
Usually take interest in management
Popular source in the US – in 1996, estimated
250,000 angels investing $10-$20 billion in 30,000
firms each year
Entrepreneurs and business angels are often
connected through intermediary companies – Angel
Networks
Entrepreneurship - Rui Baptista
Angel Investment Criteria
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Seek start-ups within the industry that the angel has
experience
Located near company
Recommended by trusted associates/connections
Entrepreneurs with attractive personal characteristics
such as integrity and ‘coachability’
Good rapport with management team
Good market and growth potential for the opportunity
Exit strategy of merger, IPO, or buyback
Expected performance smaller than with venture capital
(ROI of 30% to 50%; sales growth of 10-20% per year)
Seeking an investment of $100,000 to $1 million in
exchange for minority ownership, less than 40%
Entrepreneurship - Rui Baptista
Venture Capital Financing
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Venture capital is a source of funds for new ventures that is managed
by investment professionals on behalf of the investors in the venture
capital fund
Requires a robust market, margin, and money-making features:
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High net profit potential – minimum 10 to 15% and durable
Attractive returns for investors – 40-70% ROI
Growth of more than 20%
Gross Margins of 40% and durable
Quick to break-even and positive cash flow
The number of startups with venture capital is extremely small: there
were about 8200 VC investments in 2000 in the US, while the
number of startups/year is 1 to 3 million
A significant part of the VC investments happens at a later stage –
growth/IPO
Entrepreneurship - Rui Baptista
Risk-Reward Profile for Various Investments
50
E
x
p
e
c 40
t
e
d
Innovations,
Technology
Imitations,
Improvements
A 30
n
n
u
a
l 20
Acquisitions
Strong Growth Companies
R
e
t
u 10
r
n
(%)
Risk:
Franchises
Corporate Bonds
Treasury Bonds
0
Money Market Funds
Low
Chance of 0
Total Loss
16
Medium
High
30%
60%
Entrepreneurship - Rui Baptista
Characteristics of an Attractive
Venture Capital Investment
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Outstanding opportunity: potential to become a leading firm in
a high growth industry with few competitors
Highly competent and committed management team and high
human capital (talent)
Strong competitive abilities and a sustainable competitive
advantage
Viable exit or harvest strategy
Reasonable valuation of the new venture
Founders capital invested in the venture.
Recognizes competitors and has a solid competitive strategy
A sound business plan showing how cash flow turns positive
within a few years
Demonstrated progress on the product design and good sales
potential
Entrepreneurship - Rui Baptista
Venture Capital Criteria
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Quick to gain customer base
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Competitive advantages
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“First mover” advantages
Patents, trade secrets, special know-how
Control over prices or costs
Special relationships with customers or suppliers
Attractive value creation and realization
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Product/service creates or adds significant value to customer
Customers are reachable and receptive
Low to moderate capital needs
Viable exit strategy
Good Risk/reward balance
Good capital market timing
Entrepreneurship - Rui Baptista
Bank Loans
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Strongly based on character and background
Banks loan on assets but require demonstration
of capacity to repay (cash-flow, management
experience, competitive position, financial
projections)
Capital structure – about 30% loan + equity
(own funds)
Collateral – marketable assets; personal
guarantees
Requires business and key-person insurance
coverage
Entrepreneurship - Rui Baptista
Government Financing
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Government intervenes in the financing of new ventures
to remedy market failure – incomplete markets occur
when the risk perceived by the entrepreneur is
significantly lower than the risk perceived by the
financing institution
Market failure is usually more serious at the very early
stage of development of new business ideas, and in
particular for ideas that require large initial investments
and a long pre-market development period
Financing can take the form of direct grants/subsidies,
guaranteed loans, or low interest rates
Portuguese Government Agency for Small Business:
IAPMEI (http://www.iapmei.pt/)
Entrepreneurship - Rui Baptista
Growth Financing and Harvest
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Initial Public Offering (IPO): the first public equity issue of
stock made by a company
Advantages
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Disadvantages
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Raising new capital with the possibility of later, additional offerings
Liquidity — Ability to convert ownership to cash, potential of
harvest for investors and founders
Visibility — Build brand and reputation
Costs and effort for mounting the operation
Disclosure requirements and scrutiny of operations
Perceived pressures on achieving short-term results
Possible loss of control to a majority shareholder
Entrepreneurship - Rui Baptista
Valuation
The valuation rule is the algorithm by which an
investor such as an angel or venture capitalist
assigns a monetary value to a new venture:
Initial Equity Value: M0
Expected Earnings of the Firm: G1+G2+…GN
Initial Market Value: MN = M0 + G1+G2+…GN
Capital Return at IPO: R = MN / M0 - 1
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Entrepreneurship - Rui Baptista
Terms of an Investment Deal
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Percent ownership for the investor group or business angel
Timing of investment and IPO
Control exerted by investor
Vesting periods for ownership by the entrepreneurial team
Rights to require an IPO
Type of security
Reservation of ownership for employees (stock option
pool)
Anti-dilution provisions
Milestones of achievement, if there are multiple tranches
(steps) to the investment
Entrepreneurship - Rui Baptista