1. Introduction to Entrepreneurship and New Venture Creation Rui Baptista
Masters in Engineering and Management of Technology Masters in engineering Design
Introduction to Entrepreneurship and New Venture Creation
Rui Baptista

2. New Venture Financing

3. Financial Steps in the Evolution of a Successful New Firm
1. Founding Stage:
The entrepreneurial team begins with a vision, business model and strategy
4. Harvest Stage:
IPO or acquisition provides returns to investors and founders
2. Seed Stage:
Initial financial capital
3. Growth Stage:
Growth capital required
Entrepreneurship - Rui Baptista

4. Idealized Cash Flow Diagram for a New Firm
Entrepreneurship - Rui Baptista

5. Entrepreneurship - Rui Baptista
Early Stage Funding
Most start-ups will not raise outside capital
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

6. 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
Entrepreneurship - Rui Baptista

7. Sources of Financing for Start-ups
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

8. Sources of Start-up Capital in the United States
6.3% - Venture capital
4.0% - Mortgaged property
1.1% - Government guaranteed loan
3.4% - Other
78.5% - Personal savings
21.4% - Angels, employees, partners, friends
14.4% - Bank loans
12.9% - Family Members
Entrepreneurship - Rui Baptista

9. Entrepreneurship - Rui Baptista
Personal Resources
Offers greatest return, if successful
Investors and venture capital sources usually require it
Personal funds can be treated as equity or debt
Possible Sources:
Savings
Severance packages
Personal asset sales
“Moonlighting”
“Bootstraping”
Entrepreneurship - Rui Baptista

10. “Bootstrap” Financing
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

11. Advantages and Sisadvantages of “Bootstrap” Financing
Less pressure on generating profits fast
Easy terms on ownership
Control by founders
Little time spent on finding investors
Unable to fund growth phase
Lack of funding commitment for the future
Loss of advice from professional investors
Entrepreneurship - Rui Baptista

12. 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
Entrepreneurship - Rui Baptista

13. Entrepreneurship - Rui Baptista
Angel Financing
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

14. Angel Investment Criteria
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

15. Venture Capital Financing
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:
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

16. Risk-Reward Profile for Various Investments
Entrepreneurship - Rui Baptista

17. Characteristics of an Attractive Venture Capital Investment
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

18. Venture Capital Criteria
Quick to gain customer base
Product/service creates or adds significant value to customer
Customers are reachable and receptive
Competitive advantages
“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
Low to moderate capital needs
Viable exit strategy
Good Risk/reward balance
Good capital market timing
Entrepreneurship - Rui Baptista

19. Entrepreneurship - Rui Baptista
Bank Loans
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

20. Entrepreneurship - Rui Baptista
Government Financing
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 (
Entrepreneurship - Rui Baptista

21. Growth Financing and Harvest
Initial Public Offering (IPO): the first public equity issue of stock made by a company
Advantages
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
Disadvantages
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

22. 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
Entrepreneurship - Rui Baptista

23. Terms of an Investment Deal
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