Financing the Small Business Start-Up
What you’ll learn… Resources available to entrepreneurs to start their business Compare/Contrast sources of financing for start-up ventures Importance of financial planning Information needed to obtain financing Types of growth financing available to entrepreneurs How to calculate start-up requirements
Finding the resources to launch a business is a creative process. It requires understanding of short-term and long-term needs. Short-Term: Activities that are not part of normal operations Seasonal increase in sales that requires purchasing more inventory than normal Long-Term: Preparation for future growth Acquiring a larger facility or buying new/additional equipment
Bootstrapping The most common way businesses get off the ground!
Involves operating as frugally as possible and cutting all un-necessary expenses Involves borrowing, leasing and partnering to acquire resources You can accomplish this in a few ways: Hire as few employees as possible Leasing anything you can Being creative
Start-Up Money New businesses have no track record to prove it will survive. For this reason, it’s hard to get investors. The main resources for start-up money is usually personal resources. Friends, Family, Others Savings, Credit Cards, Loans, Investments To finance a new business, entrepreneurs can use banks, financial companies, investment companies, and government grants. There are 2 broad types of financing for new ventures Equity Financing Debt Financing
Sources of Equity Financing
Equity Capital: Cash raised for a business in exchange for ownership stake in that business Ex: Investor might invest $50k for a 25% ownership stake Equity funding, AKA: Risk Capital Because of the financial risk involved Successful Business: Investor makes a return on investment Business Fails: Investor loses money
Types of Equity Funding
Personal Savings #1 Source of $. 67% of businesses are started this way, without borrowing money Friends/Family What happens to your relationship with these people if the business fails? Private Investors Angel: Private investor who funds start-up companies. Nonprofessional financing source. Partners Remember the partnership agreement we talked about in Ch. 7 Share responsibilities and costs Venture Capitalists Individual investors or investment firms that invest capital professionally. Provide managerial as well as technical expertise. State Sponsored Venture Capital Funds Local economic development corporations help fund new businesses to create jobs.
Sources of Debt Financing
Money is raised by taking out loans. Not only do you borrow money, but you pay it back with interest. The entrepreneur retains ownership of the business, however must record the liability on the business’ accounting books. Make sure you are certain the business can generate enough cash flow to repay the loan. Compare and contrast long-term vs. short term financing. Do you want a loan out for 30 years, or for 3,5 or 10 years?
Types of Debt Funding Banks Trade Credit
Usually only lend to well-established businesses Trade Credit Credit that one business will grant to another for the purchase of goods or services. Minority Enterprise Development Programs Funded by the private sector & SBA. Owners must be at least 51% ethnic minority, female, or disabled. Also helps secure government contracts & find strategic partners Commercial Finance Companies More expensive alternate to commercial banks. Less conservative than banks, and more willing to take risks. Form of security or collateral is required, such as your home. SBA Loan Small Business Administration. Uses a commercial bank, but guarantees repayment to the lender up to 90% should your business fail. You and anyone with more than 20% ownership in the business must guarantee the loan with personal assets. (Home, Cars, etc) SBIC’s Small Business Investment Companies. Privately managed venture capital companies. Licensed by the SBA to provide equity and debt financing to young, established businesses.
Obtaining Financial and Growth Capital
How To Get Financed! Once you’ve figured out which method your company will use (Equity vs. Debt), you must create pro forma financial statements Pro Forma: Proposed or Estimated financial statements based on predictions of how the operations of the business will turn out. Income Statements, Balance Sheets, Cash Flow, etc. This will give potential investors and other sources of funds a sense of confidence that you know what your doing!
What Venture Capitalists Expect
Venture Capitalists rarely invest in start up companies, but when they do, they look for high-growth firms with BIG potential. Venture Capitalists typically want a 30-70% ROI for a growing company, and a 50% or more for an early stage venture because of the risk involved. Ex: If they give you $2 million for 5 years. They will want their original investment within those 5 years, as well as an additional $600,000-$1 Million on top of that. Your business must generate enough money to pay them off.
What Private Investors Expect
Remember from 19.1, called “Angels”. Unlike Venture Capitalists, they enjoy being involved in the business. Typically invest in the business because they are familiar or understand that industry. Most private investors put between $10-500k into a new business. On average, they aim to get 10x’s their investment at the end of five years. A strong management team will attract private investors
What Bankers Expect Banks must invest conservatively and follow strict rules about how to invest the bank’s money. Very different from that of a venture capitalist Because of that, they are MUCH MORE interested in how you plan, and your ability to repay that loan Cash Flow is a big concern to them You’ve got to be able to cover the business’ monthly expenses AND the loan payment Bankers rely on the 5 C’s to determine your loan application Character-Reputation for business practices Capacity-Ability to pay a loan (Cash Flow) Capital-Net worth of a business Collateral-Security for the loan should you not be able to repay Conditions-Growth, Competition, Economy, etc.
Growth Financing This is financing for an already established business looking to grow! Not start up funding! VC (Venture Capital) Companies Expect returns of 30-70% May require significant ownership, or a seat on the board of directors Requires Due Dilligence-Investigation & analysis by an investor Private Placements Raises capital by selling ownership Private offering or sale of securities (ownership) Investors must meet certain standards, must be “sophisticated” Investors must have a net worth of at least a million dollars IPOs (Initial Public Offerings) Sale of stock in a company on a public exchange 5 steps to becoming a public company with stock on pg List them.
Calculating Start-Up Needs
Start-Up Costs Those that you incur prior to the business opening it’s doors Fig on pg. 420, good example of costs Equipment, furniture, fixtures, etc. Operating Costs AKA working capital Amount of cash needed to carry out daily operations Covers the time between selling your product/service and receiving payment from the customer Contingency Fund Extra amount of money used only when absolutely necessary “Emergency Fund” Some businesses keep enough money in here to operate for 2 or more months.
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