1. Chapter 10: Business Plan1 Copyright 2002 Prentice Hall Publishing Company Sources of Funds: Equity and Debt

2. Chapter 10: Business Plan2 Copyright 2002 Prentice Hall Publishing Company The “Secrets” to Successful Financing 1. Choosing the right sources of capital is a decision that will influence a company for a lifetime. 2. The money is out there; the key is knowing where to look. 3. Creativity counts. Entrepreneurs have to be as creative in their searches for capital as they are in developing their business ideas.

3. Chapter 10: Business Plan3 Copyright 2002 Prentice Hall Publishing Company The “Secrets” to Successful Financing (continued) 4. The World Wide Web puts at entrepreneur’s fingertips vast resources of information that can lead to financing. 5. Be thoroughly prepared before approaching lenders and investors. 6. Entrepreneurs should not underestimate the importance of making sure that the “chemistry” between themselves, their companies, and their funding sources is a good one.

4. Chapter 10: Business Plan4 Copyright 2002 Prentice Hall Publishing Company Three Types of Capital n Fixed - used to purchase the permanent or fixed assets of the business (e.g., buildings, land, equipment, etc.) n Working - used to support the small company’s normal short-term operations (e.g., buy inventory, pay bills, wages, salaries, etc.) n Growth - used to help the small business expand or change its primary direction. Capital is any form of wealth employed to produce more wealth for a firm.

5. Chapter 10: Business Plan5 Copyright 2002 Prentice Hall Publishing Company Equity Capital n Represents the personal investment of the owner(s) in the business. n Is called risk capital because investors assume the risk of losing their money if the business fails. n Does not have to be repaid with interest like a loan does. n Means that an entrepreneur must give up some ownership in the company to outside investors.

6. Chapter 10: Business Plan6 Copyright 2002 Prentice Hall Publishing Company Sources of Equity Financing n Personal savings n Friends and family members n Angels n Partners n Corporations n Venture capital companies n Public stock sale

7. Chapter 10: Business Plan7 Copyright 2002 Prentice Hall Publishing Company Personal Savings n The first place an entrepreneur should look for money. n The most common source of equity capital for starting a business. n Outside investors and lenders expect the entrepreneur to put some of her own capital into the business before investing theirs. n Sweat equity and personal risk equity (non-monitary)

8. Chapter 10: Business Plan8 Copyright 2002 Prentice Hall Publishing Company Friends and Family Members n After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business – friends and family members. n Survey: 10% of business owners turn to family and friends for capital. n Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop.

9. Chapter 10: Business Plan9 Copyright 2002 Prentice Hall Publishing Company Friends and Family Members n Guidelines for Family and Friendship Financing Deals:  Consider the impact of the investment on everyone involved. Keep the arrangement “strictly business.”  Settle the details up front.  Create a written contract.  Treat the money as “bridge financing.”  Develop a payment schedule that suits both parties.

10. Chapter 10: Business Plan10 Copyright 2002 Prentice Hall Publishing Company Angels n Angels - private investors who back emerging entrepreneurial companies with their own money. n Fastest growing segment of the small business capital market. n An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000.

11. Chapter 10: Business Plan11 Copyright 2002 Prentice Hall Publishing Company Angels n Key: finding them! n Angels almost always invest their money locally and can be found through “networks.” n The typical angel accepts 30% of the proposals presented to him and has invested an average of $131,000 in 3.5 businesses. n What do angels look for?  Exciting ideas (with clear potential)  A way to help a trusted friend

12. Chapter 10: Business Plan12 Copyright 2002 Prentice Hall Publishing Company Corporate Venture Capital n 30% of all venture capital investments come from corporations. n About 900 large corporations across the globe invest in start-up companies. n Capital infusions are just one benefit; corporate partners may share marketing and technical expertise.

13. Chapter 10: Business Plan13 Copyright 2002 Prentice Hall Publishing Company Venture Capitalist Companies n More than 3,000 venture capital firms operate across the United States. n Most venture capitalists seek investments in the $3,000,000 - $10,000,000 range in companies with high-growth and high- profit potential. n Business plans are subjected to an extremely rigorous review – less than 1% accepted.

14. Chapter 10: Business Plan14 Copyright 2002 Prentice Hall Publishing Company Venture Capitalist Companies n Most venture capitalists take an active role in managing the companies in which they invest. n Many venture capitalists focus their investments in specific industries with which they are familiar. n Most often, venture capitalists invest in a company across several stages.

15. Chapter 10: Business Plan15 Copyright 2002 Prentice Hall Publishing Company

16. Chapter 10: Business Plan16 Copyright 2002 Prentice Hall Publishing Company What Do Venture Capital Companies Look For? n Competent management n Competitive edge n Growth industry n Viable exit strategy n “Intangibles”

17. Chapter 10: Business Plan17 Copyright 2002 Prentice Hall Publishing Company Going Public n Initial public offering (IPO) - when a company raises capital by selling shares of its stock to the public for the first time. n Typical year: about 550 companies make IPOs. n Few companies with sales below $10 million in annual sales make IPOs. n A common exit strategy for investors (but needs strong justification)

18. Chapter 10: Business Plan18 Copyright 2002 Prentice Hall Publishing Company

19. Chapter 10: Business Plan19 Copyright 2002 Prentice Hall Publishing Company Advantages of “Going Public” n Ability to raise large amounts of capital n Improved corporate image n Improved access to future financing n Attracting and retaining key employees Using stock for acquisitions Using stock for acquisitions n Listing on a stock exchange

20. Chapter 10: Business Plan20 Copyright 2002 Prentice Hall Publishing Company Disadvantages of “Going Public” n Dilution of founder’s ownership n Loss of control n Loss of privacy n Reporting to the SEC Filing expenses Filing expenses n Accountability to shareholders n Pressure for short-term performance n Timing

21. Chapter 10: Business Plan21 Copyright 2002 Prentice Hall Publishing Company The Registration Process (S-1 filing) n Choose the underwriter (sells the stock) n Negotiate a letter of intent ($) n Prepare the registration statement (risks) File with the SEC File with the SEC n Wait to “go effective” (limit information) n Meet state requirements

22. Chapter 10: Business Plan22 Copyright 2002 Prentice Hall Publishing Company Simplified Registrations and Exemptions – Get a lawyer n Regulation S-B (small US business only) n Regulation D: Rule 504 - Small Company Offering Registration (SCOR)  Limited legal help required  No SEC filing  Marketing the offering is OK  $1 million max in 12 month period n Regulation D: Rule 505 and 506  Private placements to max of 35 nonaccredited investors  Some limitations on total amount to be raised n Section 4 (6) – Accredited investors

23. Chapter 10: Business Plan23 Copyright 2002 Prentice Hall Publishing Company Simplified Registrations and Exemptions (continued) n Rule 147 (Intrastate offerings) n Regulation A (few restrictions but expensive) n Direct Stock Offering on the World Wide Web (WWW)  Direct Public Offering (DPO)  Prospectus must still meet SEC requirements n Foreign Stock Markets (sometimes easier but often more volatile)

24. Chapter 10: Business Plan24 Copyright 2002 Prentice Hall Publishing Company Debt Financing n Must be repaid with interest. n Is carried as a liability on the company’s balance sheet. n Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous. n Can be expensive, especially for small companies, because of the risk/return tradeoff. n Convertible loans (very popular if IPO might be used as an exit strategy)

25. Chapter 10: Business Plan25 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks

26. Chapter 10: Business Plan26 Copyright 2002 Prentice Hall Publishing Company Commercial Banks n Cash flow is the key n Relationships! n Short-term loans  Commercial loans (prime +, unsecured)  Lines of credit (limit tied to working capital)  Floor planning (ID numbers) n Intermediate and long-term loans  Installment loans and contracts...the heart of the financial market for small businesses!

27. Chapter 10: Business Plan27 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks n Asset-based lenders

28. Chapter 10: Business Plan28 Copyright 2002 Prentice Hall Publishing Company Asset-Based Borrowing n Discounting accounts receivable Accounts Receivable n Inventory financing

29. Chapter 10: Business Plan29 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks n Trade credit (materials suppliers) n Equipment suppliers n Commercial finance companies (security interests, guarantees, high interest) n Saving and loan associations (real property) n Asset-based lenders $$

30. Chapter 10: Business Plan30 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Stock brokerage houses (margin loans) n Insurance companies n Credit unions n Bonds (industrial development bonds) n Private placements (insurance companies, etc) n Small Business Investment Companies (SBICs) – usually options or convertible loans n Small Business Lending Companies (SBLCs) (continued)

31. Chapter 10: Business Plan31 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Economic Development Administration (EDA) n Department of Housing and Urban Development (HUD) n U.S. Department of Agriculture’s Rural Business-Cooperative Service n Local Development Companies (LDCs) n Small Business Innovation Research (SBIR) n Small Business Technology Transfer programs n Small Business Administration (SBA) (concluded) Federally Sponsored Programs:

32. Chapter 10: Business Plan32 Copyright 2002 Prentice Hall Publishing Company Small Business Administration Loan Programs n Low Doc Loan Program n SBAExpress Program n 7(A) Loan Guarantee Program – the most popular SBA loan program n CAPLine Program n International Trade Programs  Export Working Capital Program  International Trade Program

33. Chapter 10: Business Plan33 Copyright 2002 Prentice Hall Publishing Company SBA Loan Programs n Section 504 Certified Development Company Program n Microloan Program ($100 to $25,000) n Prequalification Loan Program (disadvantaged entrepreneurs) n Disaster Loans n 8(A) Loan Program (minority owners)

34. Chapter 10: Business Plan34 Copyright 2002 Prentice Hall Publishing Company State and Local Loan Programs n Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing. n Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans. n Specialty loans (environmental, regional, etc.)

35. Chapter 10: Business Plan35 Copyright 2002 Prentice Hall Publishing Company Internal Methods of Financing n Factoring - selling accounts receivable outright n Leasing assets rather than buying them n Credit cards