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IPFW Business Plan Competition Pre-competition Program Financing and Capital Sourcing Options By Dr. Bill Todorovic Department of Management and Marketing Neff Hall 340L, Tel. (260) 481 6940 E-mail: [email protected] Web: http://users.ipfw.edu/todorovz/ Copyright © by South-Western College Publishing. All rights reserved. 13–1 The Nature of a Firm and Its Financing Sources • Factors That Determine Financing –Firm’s economic potential –Maturity of the company –Nature of its assets –Owners’ preferences for debt or equity Copyright © by South-Western College Publishing. All rights reserved. 13–2 Sources Of Funds Start-up Beginning of Production ? Going Concern Company Size Personal IPO Friends and Family Angels Venture Capitalist Banks Government Customers/Suppliers Amount Copyright © by South-Western College Publishing. All rights reserved. 13–3 Sources of Financing Sources of Financing Other Venture Capital Mortgaged Property Private Investors Bank Loans Friends Personal Charge Cards Partners Family Members Personal Savings 0 10 20 30 40 50 60 70 80 Percentage of Entrepreneurs Using Source of Financing Copyright © by South-Western College Publishing. All rights reserved. 13–4 Critical 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. Copyright © by South-Western College Publishing. All rights reserved. 13–5 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 Copyright © by South-Western College Publishing. All rights reserved. 13–7 Debt or Equity Financing? • Potential Profitability • Financial Risk • Voting / Control Copyright © by South-Western College Publishing. All rights reserved. 13–8 Tradeoffs Among Potential Profitability, Financial Risk, and Voting HIGH Potential Profitability Equity Equity financing Financing Debt Financing financing LOW LOW HIGH Financial Risk/Control Fig. 13.1 Copyright © by South-Western College Publishing. All rights reserved. 13–9 Debt Versus Equity With no debt and all equity: No debt $28,000 income on total assets of $200,000 14% return 14% return on assets on $200,000 ($28,000÷ $200,000) ($28,000÷$200,000) equals $200,000 equity Equity: Owners get to keep all of the profits in return for accepting the risk of lower returns Copyright © by South-Western College Publishing. All rights reserved. 13–10 Debt Versus Equity (Cont’d) With $100,000 debt and $100,000 equity: $100,000 debt (10% cost) $28,000 income on total assets of $200,000 14% return 18% return on assets on $100,000 ($28,000 ÷ $200,000) ($18,000÷$100,000) equals $100,000 equity Debt is Risky: Lenders have first claim on profits and must be paid even if there are no profits. Copyright © by South-Western College Publishing. All rights reserved. 13–11 The 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 Copyright © by South-Western College Publishing. All rights reserved. 13–13 Financial Information Required for a Bank Loan • Three years of the firm’s historical statements • The firm’s pro forma financial statements • Personal financial statements Copyright © by South-Western College Publishing. All rights reserved. 13–15 Getting to know your friendly neighborhood Venture Capitalist… Copyright © by South-Western College Publishing. All rights reserved. 13–17 The 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 Scurve) – Limits the risk to management risk – Produces attractive exit opportunities Copyright © by South-Western College Publishing. All rights reserved. 13–18 Present 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 Copyright © by South-Western College Publishing. All rights reserved. 13–19 VC 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 Copyright © by South-Western College Publishing. All rights reserved. 13–21 What VCs get out of it • 10X return of 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 Copyright © by South-Western College Publishing. All rights reserved. 13–22 What VCs Do? Copyright © by South-Western College Publishing. All rights reserved. 13–23 The Overhang: Uninvested Capital Buyouts 200 Venture 150 100 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 0 1981 50 1980 Annual Committed Capital ($M) 250 Year Complements of Thompson Venture Economics Copyright © by South-Western College Publishing. All rights reserved. 13–25 Angels • Well to do private individuals • Geography and industry specific • Invest lower amount than VC • Often a good source of industry experience Copyright © by South-Western College Publishing. All rights reserved. 13–26 Finding Angels • Private Individuals • Professionals (lawyers, accountants, bankers) • Local small business development centers • Internet associations (e.g., Technology Capital Network at MIT) Copyright © by South-Western College Publishing. All rights reserved. 13–27 Other Sources of Financing • Community-based financial institutions • Large corporations • Stock Sales –Private placement –Initial public offering (IPO) Copyright © by South-Western College Publishing. All rights reserved. 13–28 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 Copyright © by South-Western College Publishing. All rights reserved. 13–29 Government-Sponsored Programs and 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 Copyright © by South-Western College Publishing. All rights reserved. 13–30 Business Suppliers and Asset-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 Copyright © by South-Western College Publishing. All rights reserved. 13–31 Business Suppliers and Asset-Based Lenders (cont’d) • Equipment Loan and Leases • Leases Free up cash for other purposes Leaves lines of credit open Provides a hedge against obsolescence Copyright © by South-Western College Publishing. All rights reserved. 13–32 Business Suppliers and Asset-Based Lenders (cont’d) • Asset-based Loan • Factoring Accounts 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 Copyright © by South-Western College Publishing. All rights reserved. 13–33 Business Suppliers and Asset-Based Lenders (cont’d) • Commercial Banks –Line of credit –Revolving credit agreement Copyright © by South-Western College Publishing. All rights reserved. 13–34 Business Suppliers and Asset-Based Lenders (cont’d) • Commercial Banks (cont’d) –Term loans –Chattel mortgage –Real estate mortgage Copyright © by South-Western College Publishing. All rights reserved. 13–35 Formal Vs. Informal Investors • Funding structure and flexibility • The fit to the mold • Involvement in the business • Rigidity of relationship with the firm Copyright © by South-Western College Publishing. All rights reserved. 13–36 Discussion? Copyright © by South-Western College Publishing. All rights reserved. 13–37