Transcript Business Models - Molde University College

Chapter 12: Early-Stage Business Development:
Human and Financial Capital
 Questions answered in this chapter:
• What are the key considerations in the business
planning process?
• What are the different sources of human capital that
can play a role in a startup business?
• What are the typical sources of funding for an earlystage startup business?
• What elements are needed for a successful pitch to
investors?
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Chapter 12: Human and Financial Capital
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What is a Startup?
 A startup is a business that is in the process of
developing the underlying infrastructure needed to
support future growth
 A startup is a business engaging in the the following
three basic processes:
• Developing and refining the offering and strategy to go
to market
• Obtaining initial funding to begin operations
• Building a capable management team to handle
operations
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Chapter 12: Human and Financial Capital
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Relationship between Human and Financial Capital
 Human and financial capital resources can
influence the business planning process and, in turn,
be influenced by the business plan
• Human capital resources may include entrepreneurs,
management team, strategic advisors and partners, and
logistical advisors and partners
• Sources for financial capital include debt financing and
equity financing
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Exhibit 12-1:
Startup Business Investment Stages
Early Stage
Financing
Stages
Investment
Investment
Purpose
Purpose

Type
Typeof
of
Investors
Investors
Source:
Startup
Startup
Financing
Financing
Seed
SeedStage
Stage





Expansion Stage
Validate the
business concept
(e.g. build
prototype,
develop business
plan, conduct
market research)

Angel investors
Traditional VC
Consulting firms
Online VC firms
Incubators

Build
management
team and
complete
product
development



Angel investors
Traditional VC
Consulting firms
Incubators
SecondSecond
SecondStage
Stage
Financing
Financing
First-Stage
First
First-Stage
Financing
Financing

Expand
production,
marketing, or
sales
capabilities


Traditional VC
Corporations
Later Stage

Provide working
capital once
shipping products
or providing
services


Mezzanine
Mezzanine
Financing
Financing

Traditional VC
Corporations
Fuel substantial
growth (typically
provided to
business that
are at least
break even)




Traditional VC
Corporations
Buyout firms
Investment banks
Bridge
Bridge
Financing
Financing

Prepare for
initial public
offering,
usually
planned in the
next 6 months
to a year

Traditional VC
Corporations
Buyout firms
Investment
banks



Gold Book of Venture Capital Firms, Bob Zider,
“How Venture Capital Works,” Harvard Business Review
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Exhibit 12-2:
Probability of Startup “Success”
Number of businesses
that go from:
6 in 1,000,000
Idea to IPO
6 in 1,000
Business Plan to IPO
1 in 10
Funding to IPO
Source:
Saratoga Venture Finance; High Tech Startup Pg. 8
2
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Exhibit 12-3:
The Relationship Between Human and Financial Capital
Financial Capital Resources
Human Capital Resources
Equity
Entrepreneur
Entrepreneur
Bootstrapping
Bootstrapping
Management
ManagementTeam
Team
Strategic
StrategicAdvisors
Advisors
&&Partners
Partners



Business
Business
Planning
Planning
Process
Process

Venture
VentureCapital
Capital
Corporate
CorporateVentures
Ventures
Holding
HoldingCompany
Company
Advisory Board
Board of Directors
Strategic Partners
Debt
Trade
TradeCredit
Credit
Logistical
Logistical Advisors
Advisors
&&Partners
Partners

Angels
Angels
Commercial
CommercialBank
Bank
Loans
Loans
Necessary: Legal council, CPA
Supporting: Intermediaries,
Consulting Firms, Incubators
3
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Elements of a solid business planning process
 The major elements of a business planning process
include the following:
•
•
•
•
•
•
•
•
•
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Defining the value proposition
Framing the market opportunity
Detailing how to reach customers
Developing an implementation plan
Evaluating potential external influences
Articulating the revenue model
Calculating preliminary financial projections
Establishing critical milestones
Summarizing the advantage
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Human Capital
 The role of human capital in a startup business is
especially critical because, for a time, it is the only
resource available
 When investors consider funding an early-stage
company, they assess its human capital
•
•
•
•
Who is the entrepreneur?
Does she have the drive to see this business through?
Who is on the management team?
Will they be able to execute?
 The human capital attracts the financial capital
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The Trials and Tribulations of the
Entrepreneur
 From the outset, the entrepreneur is faced with
reconciling several difficult paradoxes:
• Being visionary vs. being realistic. The entrepreneur is
faced with the challenge of coming up with unique ideas
that are grounded in reality
• Generating quick returns vs. investing in the future. The
entrepreneur is challenged with staying the course to
build the organization while meeting the demands of the
investors who are needed to build the organization in
the first place
• Optimism vs. pragmatism. While optimism is an
essential motivating force, it must be balanced with the
pragmatism to evaluate potential weaknesses of the
business
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Characteristics of Successful Entrepreneurs
 Key characteristics common to successful entrepreneurs
include the following:
• Natural problem solvers. Entrepreneurs are those who are able to
make observations about the needs of industries, markets, and
everyday life and find the best way to meet these needs
• Willingness to take risks. Entrepreneurs are willing to leave stable
jobs and guaranteed salaries for their enterprises
• Drive. The entrepreneur’s personal drive is especially important in
the early stages, when his enthusiasm spurs the drive of other
employees
• Flexibility. The ability to adapt and react quickly are especially
important in the fast-changing Internet environment
• Vision. The most successful entrepreneurs are not driven by money,
but by a vision or a passion consistently pursued
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The Entrepreneur and the Idea
 Some of the most common types of business ideas
include the following:
• Introduce a new product (new software—MP3)
• Introduce a new service (overnight delivery—FedEx)
• Improve an existing model of business (selling books on
the Internet—Amazon.com)
• Create demand (free one hour delivery service—
Kozmo.com)
• Build a brand—the first-mover advantage (eToys.com,
Pets.com, eParty.com)
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The Management Team
 The core team consists of individuals essential to
the early formative days of the startup who will fill
the following three roles:
• Technology specialist: is the person who understands
the specific mechanics of how the product works, how it
is manufactured, and how it can be utilized
• Sales and marketing specialist: is the person with an indepth understanding of the startup’s customer
• Execution specialist: is the person who keeps everything
in perspective in the startup’s development making the
vision for the business a reality
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The Management Team (cont’d)
 Extended management team can be created on an
as-needed basis, depending on how quickly the
startup is growing
•
•
•
•
•
•
•
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Chief operating officer
Chief financial officer
VP of marketing
VP of sales
VP of business development
Chief people officer
General counsel
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Strategic Advisors and Partners
 Strategic advisors and partners provide the startup with
strategic direction, advice, and in many instances credibility
for the organization as a whole
• Advisory board members serve as an outsourced resource to fill a
particular need and may receive stock options in exchange for their
expertise
• The board of directors consists of individuals who will be
responsible for the well-being of the company, as well as holding
the management team accountable for its actions when the business
formalizes operations
• A strategic association is the agreement of two entities to work
together and exchange expertise in areas where they lack core
competencies
• A strategic alliance is a legally binding contractual agreement to
share resources on a project for a particular timeframe
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Logistical Advisors and Partners
 Logistical advisors and partners differ from the
strategic advisors and partners in that they are
more involved in the day-to-day operations of the
business
• Necessary logistical advisors and partners include
certified public accountants (CPA) and legal counsel
• Supporting logistical advisors and partners serve as
outsourced, human-capital leverage for the startup and
may include intermediaries, consultants, and incubators
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Financial Capital
 Sources of debt financing (commercial banks, trade credit)
 Sources of equity financing (owner’s equity, “angels”,
venture-capital)
 Strategic investors are concerned how a certain business
compliments their current activities (exposure to cuttingedge technology or business model, collaboration in
research and development for a product, etc.)
 Financial investors are concerned with return on investment
(ROI), internal rate of return, cost of capital, and return on
equity
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Table 12-1: Common Sources of Debt and Equity Financing for Startups
Source
Debt
Commercial Banks
Trade Credit
Other Debt Sources
Equity
Owner’s Equity
Angels
Venture
Other Equity (primarily Friends and Family)
Total
Percent
52.33%
19.94%
17.01%
15.38%
47.67%
27.12%
4.89%
2.42%
13.24%
100.00%
Source: “Venture Capital and Angels Provide Just Over 7% of Funding for Private Companies.” Business Wire, April 23, 1999.
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Debt Financing
 Trade credit is credit extended to a business by its suppliers.
It is an interest-free loan covering the time period from when
supplies are delivered to when the invoice is due
• Suppliers typically offer trade credit to buyers with an established
track record of making prompt payments
• Hidden interest rate cost
 Commercial bank loan is, typically, an installment loan in
which the business borrows a certain amount of money for a
specified period with either a fixed or variable interest rate
• Commercial banks evaluate a business’ loan application by
assessing the likelihood of loan repayment
• Bank loans can be relatively difficult to obtain, especially for earlystage businesses with little collateral and no positive cash flow
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Equity Financing: Bootstrapping
 Bootstrapping is the art of using personal resources to
finance the early stages of a startup
• Bootstrapping may include taking a personal loan, mortgaging a
home, using credit cards or savings accounts
• Bootstrapping provides the most viable option for the entrepreneur
when the startup is in the earliest stages of business, especially
during the stages that involve proving the business concept
• Bootstrapping allows the entrepreneur to control the company and
refine his business strategy without pressure from outside investors
• The disadvantage of bootstrapping is that it is unlikely to provide
sufficient cash for a good business concept to grow quickly beyond
the earliest stages
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Equity Financing: “Angels”
 “Angels” are wealthy individuals who invest personal
capital in startups in exchange for equity or sometimes a
seat on the board of directors
• Its critical for the entrepreneur to develop a network of individuals
within the industry to gain introductions to potential financiers
because “angels” seldom look at unsolicited business plans
• Business plans are evaluated based on the quality of the
management team, market potential for the business idea, and the
track record of the entrepreneur
• Typically, “angels” are more flexible in accepting changes in the
original business plan if it is necessary
• “Angels” tend to be more involved in the day-to-day” operations of
startups
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Equity Financing: Venture Capital
 Venture-capital firms are usually private partnerships or
closely held corporations that raise money from a group of
private investors
• A venture-capital firm typically invests $250,000 to $10 million in
a business in exchange for a 30 to 40 percent equity stake and a
seat on the board of directors
• In addition to receiving cash, the entrepreneur receives guidance
for building the startup
• Venture capitalists, typically, charge management fees on the order
of 1 to 5 percent of the capital investment in a startup
• A venture-capital firm seeks opportunities that will return 10 times
the original investment within five years, but realizes that each
investment is a gamble and that only 10 percent are likely to
succeed
• The biggest disadvantage of venture capital funding is the source’s
concern with the bottom line
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Exhibit 12-5: Increase in Venture Capital Investments in Internet Related
Businesses from 1999 - 2000
30
Investment in Billions of Dollars
Additional dollars invested in 2000
Dollars invested in 1999
+98%
20
+116%
+190%
10
+115%
+100%
+18%
0
Software /
Database
ISP
Infrastructure
ECommerce
Content
Business
Services
Category
Source: PricewaterhouseCoopers Moneytree Report 2000
6
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Table 12-2: First Quarter 2000 Top Twenty Venture Deal Makers
Firm
Location
Deals
BancBoston Capital and Ventures
Boston, MA
45
Chase Capital Partners
New York, NY
45
Bessemer Venture Partners
Wellesley Hills, MA
33
New Enterprise Associates
Baltimore, MD
29
Oak Investment Partners
Westport, CT
28
Accel Partners
Palo Alto, CA
26
US Venture Partners
Menlo Park, CA
26
Sprout Group
New York, NY
23
Norwest Equity Partners
Minneapolis, MN
22
Crescendo Venture Management LLC
Minneapolis, MN
21
Crosspoint Venture Partners
Woodside, CA
21
Sequoia Capital
Menlo Park, CA
21
Battery Ventures L.P.
Wellesley, MA
20
Canaan Partners
Rowayton, CT
20
CMGI Ventures
Andover, MA
20
Mayfield Fund
Menlo Park, CA
20
Charler River Ventures
Waltham, MA
19
Mellon Ventures Inc.
Pittsburgh, PA
19
Technology Crossover Ventures (TCV)
Palo Alto, CA
19
Draper Fisher Jurvetson
Redwood City, CA
18
[i] Source: Pricewaterhousecoopers MoneyTree Survey Q1 2000.
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Equity Financing: Corporate Ventures
 Large corporations sometimes set up venture funds as a
subsidiary that can make investments on behalf of the parent
company, referred to as either corporate venture or “direct
investors”
• Corporate-venture funds invest in complimentary business for
primarily strategic reasons
• In exchange for cash, capital ventures seek an equity stake in the
company and access to the company’s technology or product
• Established corporations can offer the operational expertise as well
as the credibility and visibility that come from associating with an
established high-profile parent
• Because the investments are strategic rather than financial, the
pricing of deals with corporations tends to favor the entrepreneur
more than deals with venture-capital firms
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Table 12-3: Fourth Quarter 2000 Corporate Venture Funds.
Company
Amount of Fund
(MM)
Target Sector
Compaq
$100
Data storage hardware, software and services
Corning
$50
Fiber-optic networking technologies
Intel
$300
Network infrastructure, wireless
Koor Industries
(KOR)
$250
Israeli-based information technology
Liberante
Technologies
(LBRT)
$50
Interactive television
Merck
$100
Health-care information technology
Nokia
$500
Wireless applications and hardware
Qualcomm
$500
Digital wireless technology and services
Source: Jim Evans. “Corporate Venture Grows Bold.” The Industry Standard. January 10, 2001.
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Exhibit 12-4:
Summary of Primary Financial Capital Resources
Source
Debt
Financing
Trade Credit
Commercial
Bank Loan
Bootstrapping
Angels
Credit extended to a business by its suppliers

Typically installment loans where business
borrows a specific amount of money with an
interest rate for a specified length of time to be
repaid in installments until paid in full

Using personal resources to finance the early
stages of a startup

Wealthy individuals who invest personal capital
in startups













Equity Financing
Venture
Capital
Private partnerships or closely held corporations
that raise money from investors which is invested
in companies that hold promise for a liquidity
event






Corporate
Ventures
Key Advantages & Disadvantages of Use
Primary Criteria for
Investment Selection
What is it?
Venture funds set up by large corporations




Pros
Those buyers with an established track
record of making prompt payments

Likelihood of loan repayment
Amount of cash on hand
Existence of positive cash flow
Current burn rate

Provides cash without losing equity

Difficult for e-commerce startups to obtain given criteria
for investment
Entrepreneur’s belief in his own
business

Retain firm equity
Gain valuable operational experience

Unlikely to provide enough cash to sustain extended
growth
Referral through network connections
Businesses in early stages of
development
Personal objectives for investment
Market potential
Nature of the business concept
Quality of management team (if any)
Track record of the entrepreneur

Angel can provide expertise, networks, and
credibility to help the entrepreneur build the
business
Can provide referral to additional funding
sources
Tend to negotiate terms more favorable for
entrepreneurs than VCs

Difficult to locate
Investors can decide to get very operationally involved
with the startup, creating potential conflicts with the
entrepreneur
One angel alone is unlikely to provide enough capital
for operations
Dealings with multiple angels can cause operational
and logistical complications
Referral through network connections
Potential return on investment in three
to five years
Firm’s strategic objectives
Existence of proprietary technology or
concept for sustainable advantage
Items italicized for angels

Able to provide large amounts of cash to
sustain growth
Expertise in particular industries can provide
coaching expertise and industry contacts to
create a management team
Quality firm provides name brand recognition
and publicity

Degree to which business complements
corporations current strategic objectives
Right to utilize technology developed in
the venture
Items italicized for angels

Provide operational expertise
Provide credibility and visibility for the
business through corporations brand name
Provide large amounts of cash
Financing terms tend to be more favorable
than that of VCs
Patient capital


Potential conflict of interest with parent company can
cause problems
Complicated intellectual property rights discussions if
business later seeks VC funding
Slow to make investment decisions
Note:
Company that offers cash in exchange for equity
in companies with an operational, rather than
financial focus. Equity stakes typically range
from 25-50%.



Patient capital due to operational focus
Ability to learn from other portfolio companies
Investors usually very experienced in specific
industry

Requires a large equity stake, and thus control

Usually defined by particular focus of
the holding company
Items italicized for angels










Holding
Company
Can provide an interest free loan
Cons










Certain terms could carry a costly implied interest rate
Difficult for e-commerce startups to obtain
Objectives are primarily financial, which can create
conflicts with the entrepreneur’s vision for the company
Requires high equity stake
Entrepreneur must give up a certain degree of control
Difficult to locate and obtain
There are additional sources of financing that provide services in exchange for equity rather than cash for equity (incubators, consulting firms, etc.)
Items italicized for angels are those criteria common to multiple sources of funding
5
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The Business Plan
 A business plan should provide the following information to
a potential investor
• Description of the product or service that will be offered and the
value proposition for the customer
• Summary of the size and nature of the market opportunity
• Explanation of the revenue model
• Profiles of the management team, advisory board, and board of
director members describing specific relevant skills and expertise
• Clear articulation of the startup’s core competencies and
sustainable competitive advantage
• Summary of financials and financing needs
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