Transcript BOOTSTRAPPING - Belmont University

FINANCING AND SOURCES OF
FUNDING FOR NEW VENTURES
Mark T. Schenkel, Ph.D.
Assistant Professor in Entrepreneurship
What Makes Entrepreneurial Finance “Different”
from Traditional Finance . . . ?
 Lack of history upon which to assess risk
 What’s the β?
 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!!! (e.g.,
Sahlman)
Implications . . .
 Entrepreneurial finance involves useful ways of
thinking about cash, risk, and value (Sahlman,
1992) . . . that is, it
 Teaches 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 decisions
 Ex: Is “Fit” an “Opportunity”?
 Discovery Driven Planning (Market, Margin, Me)
 New Venture Strategy
 Ex: 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 decisions
 Ex: Is “Fit” an “Opportunity”?
 Discovery Driven Planning (Market, Margin, Me)
 New Venture Strategy
 Ex: Explicit and hidden costs of using other people’s money
. . . (Bhide)
 Danger of misallocation . . . Throwing money at symptoms
 Diminished flexibility . . .
 “Operational lock”
 Credibility issues . . . “What to you mean, didn’t we get it right the 1st time?”
 If I use X financing now and Y financing later, have I created incentives for
all stakeholders to work together?
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.
CASH FLOW
Example of Cash Flow Cycle Over the Life
Cycle of a Business
Profits
0
Cash flow
Start-up to Early Stage
Growth Stage
Maturity
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
PRIMARY TYPES OF FUNDING
(I.E., SOURCES) . . . ?
• Internal (i.e., Bootstrapping)
• Debt
• Equity
Bootstrapping
Techniques and tools that can help achieve
the same outcomes while greatly reducing
costs.
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 customer
 Impact 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
 Examples . . . ?
Human Resources Bootstrapping
 Employee “stretching”
 Independent contractors
 Employee leasing and temporary employees
 Student interns
 Equity compensation
 Non-monetary benefits
 Examples . . . ?
Administrative Overhead Bootstrapping
 Space
 Furnishings and office equipment
 Administrative salaries
Operations & Inventory Bootstrapping
 Outsourcing
 Just-in-time inventory techniques
 Effective cost accounting
DEBT FINANCING
Short-term Debt Financing
 Expected 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
purchases
 Banks: term loans
 Leasing companies
 Real estate lenders
Overlooked Forms of Debt
 Property leases
 Long-term employment agreements
 SBA or other government backed lending
programs
6 C’s: Criteria for Lending by Bankers
Character of founder and key leaders
2. 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
Banker
6. Common sense – what does your gut tell you?
1.
Downside of Debt
 Increased risk during economic slowdown
 Impact on proceeds from business sale
 Restrictive covenants
 Personal guarantees
EQUITY FINANCING
Sources of Equity Funding
 Funding from the entrepreneur
 Family and friends (and “fools”!)
 Strategic partners
 Angel investors
 Private placement
 SBICs
 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.
Letter of Intent
4.
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
Purchase Orders
A/R (<60 days)
Inventory
Leasehold
Improvements
Building
Undeveloped land
Equipment
Percentage
financed
70%
70%
30%
50%
70%
40%
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 incorporation
 Write business plan
 Find office and development space
 Completion of initial design
 Hire key development personnel
 Complete prototype unit
 Complete prototype testing
First Round Financing
 Secure key vendors
 Hire key service or manufacturing personnel
 Rent or build manufacturing facility
 Purchase manufacturing equipment
 Market testing
 First sales contract
 Production of first manufactured unit
 First 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