Students to Start-Ups

Entrepreneurial Skills Workshop Series

Center for Entrepreneurship and Innovation

Presents:

Finding Start-Up Capital

By Jim Chamberlain

Start-Up Costs & Capital Sources Start-Up Cash Investment

Fixed Capital Investment  Start-Up  Growth  Maintenance Working Capital Investments  Start-Up  Growth  Maintenance Cash Outlays Until Breakeven

Start-Up Costs & Capital Sources

Fixed Capital  How do you calculate how much your business needs at start-up and to maintain growth  Do not confuse the justification with how it will be financed. Justify first, then determine how to finance the investments Sales Forecast - 24 to 36 months  How much “capacity” investment is required?

 How fast will you grow?  New products or services?

Start-Up Costs & Capital Sources Working Capital Investments

 The excess of current assets over current liabilities or the amount of cash required to fund the business on a day-to-day basis  An indication of short-term financial strength  Don’t be under-capitalized Working Capital = Current Assets minus Current Liabilities

Start-Up Costs & Capital Sources Working Capital Investments

 How do you calculate how much your business needs at start-up and during periods of growth?

Sales Forecast – 24 to 36 Months  Working Capital increases and decreases with sales. It is a

variable

investment.



Example: Figure $.20 increase for every incremental sales dollar increase

.

Start-Up Costs (Investments)

Fixed Capital Office Furniture Vehicles Tenant Improvements Printing Machines Total Fixed Capital – Start-Up Vehicles Printing Machines Total Fixed Capital – Year Two $ 2,000 20,000 10,000 20,000 $ 52,000 $ 20,000 10,000 $ 30,000

Start-Up Costs (Investments)

Working Capital Operating Cash Inventories Prepaid Rent Prepaid Insurance Total Working Capital – start-up Cash losses – first six months Total Working Capital – Year One Required Working Capital – Year Two

(Based on a $50,000 increase in sales)

$ 10,000 15,000 5,000 8,000 $ 38,000 $ 25,000 $ 63,000 $ 10,000

Capital Sources How Businesses Are Really Funded

Seed Cash

– Percentage of

Inc

500 CEOs surveyed (2002) who launched their company with seed capital (including personal assets) of:  Less than $1,000  $1,000 - $10,000  $10,001 - $20,000  $20,001 - $50,000  $50,001 - $100,000  More than $100,000 14% 27% 10% 15% 12% 22%

Capital Sources Does seed capital effect long-term profitability or growth rate?

 Only 65% of companies that started with more than $100,000 were in the black after one year compared with 83% of those businesses that were launched with $1,000 to $10,000.

Source

: Inc

Magazine

Capital Sources Percent of CEO’s who got some capital by these means:

 Private Equity  Personal Loans  Bank Debt  Venture Capital  Supplier Financing 82% 19% 19% 9% 5% Source:

Inc

Magazine

Capital Sources Equity Funding

 Financing your business by selling a minority equity interest. This cash is less risky but more expensive. Valuation issues must be addressed. Initial and target valuation calculations must be made.

 43% of founders started the company alone  The rest had:  1 partner  2-3 partners  4+ partners 12% 36% 9%

Capital Sources Private Equity and Venture Capital Funding

The average angel investor is:  Between 48 and 59 years old  Has a postgraduate degree  Has experience in management and building a company  Typically invests between $25,000 and $250,000 per deal in one to four deals per year

Capital Sources

Private Equity and Venture Capital Funding  Angel investors tend to like proprietary products and non-capital intensive businesses. They anticipate future rounds of financing.

Capital Sources

Private Equity and Venture Capital Funding Angel investors look for: 1. Market niches – potential to dominate or be #1 or #2 in the industry 2. Advanced technology and a disruptive model (going to change things) 3. Compelling and sustainable advantage – not “me too” 4. Planned exit in 4-6 years 5. Reasonable valuation 6. Performance equal to 5 -10 times original investment 7. ROI equal to 30-40% per year 8. Sitting on your board but not having control 9. Higher risk business models

Capital Sources

Bank Loans or Debt Financing 1. Banks will loan 2.5 – 4.0 times Cash Flow – usually based on EBITDA 2. Banks would like to see a 3-5 year track record or a history of business experience 3. Debt is less expensive but more risky than equity 4. Banks will not lend on pure projections: You must have a history of cash flow or a current personal guarantee.

5. Three sources of repayment  Cash Flow   Liquidation value of assets Personal Guarantees of each 25% equity owner

Capital Sources

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Negatives to a Banker Getting involved with something outside your normal business model Absentee management / ownership Divorce Burnout Growing beyond owner’s capacity to operate the business Parent turns over business to son or daughter Computer conversions Relocation and / or expansion of facility Companies “hit the wall” at:  Manufacturing companies at $2 million in sales     Distribution companies at $4 million in sales Retailers at 3 stores and distance Service companies at 12 employees Contractors at 2 or more big jobs

Capital Sources

Questions a Banks Will Ask You: 1. Do you have a Business Plan?

2. How much experience do you have in this industry?

3. How is your credit and how much personal debt do you have?

4. How much is your down payment? Is it at least 25%?

5. How much collateral do you have?

6. Who is the competition?

7. Do you have personal and business insurance?

8. Do you have services of an accountant and attorney?

9. Have you ever filed for bankruptcy?

10. Do you have 2-4 years of tax returns available?

Capital Sources

Small Business Administration  The SBA does not loan money. It guarantees (to the bank) approximately 85% of the loan proceeds to you. Five to ten year payback terms. Interest rates of prime plus 2 – 4% depending on the program and terms.

 This reduces the banker’s risk, thereby enabling the loan to be approved. They use basic credit standards:  Character  Management ability  Cash Flow  Equity  Feasible Business Plan  Sufficient collateral

Capital Sources SBA Eligibility

(there are exceptions)

 Must be “for profit”  Must be an operating company. SBA does not allow speculation or investment companies.

 Must be a small business:  Manufacturing  Wholesaling  Services 500 -1,000 employees less than 100 employees receipts test for each classification

Capital Sources

SBA Eligibility  Cannot be a business in lending, life insurance, real estate development or rental property.

 Gambling, promoting religion, pyramid sales plans, consumer marketing cooperatives and persons of poor character are ineligible.

 Individuals must be lawfully in the U.S.  Business cannot be located outside the U.S.

 Import businesses may be ineligible Go to www.SBA.gov for a complete list of ineligible businesses. Also, a good resource for minority and micro-loan plans.

Exit Many of the CEO’s plan to cash out

41% of CEO’s started the company with at least one exit strategy in mind. Some had several: Those strategies included:  Going Public:  Selling to a private buyer:  Leaving the company to heirs: 47% 80% 7%

Capital Sources

Mistakes Entrepreneurs Make When Raising Capital 1.

Don’t understand share prices or valuations 2.

Confuse broad market with served market 6.

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5.

Make unrealistic assumptions about an exit strategy Don’t understand long term capital needs Have no clue about competition Don’t understand that marketing beats technology 9 out of 10 times Write a poor executive summary Use “off the wall” numbers or pull numbers from thin air Lack focus; e.g. many products or niches 10. Develop too simplistic of a market plan / analysis 11. Underestimate expenses 12. Rely on financial plans with major inconsistencies; e.g. numbers don’t match or tie 13.

Speak in “techno-jargon”. No one understands what they are saying

Capital Sources

Best Ways to Irritate a Private Investor 1.

Lying to investors or not being forthright; omission of material information 2.

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Inability to answer direct questions with direct answers Surprises; e.g. problem with credit checks, hidden liabilities or debts Over hype or exaggerate upside Your story always changes Arguing with investors 7.

8.

Late for meetings Excessive secrecy or legalese; expect investor to sign NDA 9.

Investing capital in fancy facility and furniture 10. Fail to attract top talent

Capital Sources Lease Financing

 Many start-ups may want to consider lease financing for their fixed capital needs.

 Leasing sometimes shifts the risk of ownership, such as technological obsolescence onto the lessor thus freeing the lessee to finance working capital needs.

 There also may be possible tax advantages in certain cases that makes leasing less expensive on an after-tax basis.

Questions

Jim Chamberlain [email protected]

Additional Resources

 Web www.SCORE114.org/business_library_3.html

Additional Resources

 Web Venture Funding Blog http://www.allensblog.typepad.com/  People UCI Center for Entrepreneurship and Innovation [email protected]

SCORE Orange County www.score114.org

Students to Start-Ups

Entrepreneurial Skills Workshop Series

UPCOMING WORKSHOPS March 21 st

Driving Growth Through Distribution Channels and Sales Management

April 4 th

Nuts & Bolts of Business Structure and Licensing

April 18 th

Refine Your Unique Value Proposition

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