13–1

National Formosa UniversityNational Formosa UniversityPre-competition Pre-competition

National Formosa UniversityNational Formosa UniversityPre-competition Pre-competition

Financing and Capital Sourcing Financing and Capital Sourcing OptionsOptions

ByByDr. Bill TodorovicDr. Bill Todorovic

Richard T. Doermer School of Business and Management Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940Neff Hall 340L, Tel. (260) 481 6940

http://users.ipfw.edu/todorovz/

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The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources

The Nature of a Firm andThe Nature of a Firm andIts Financing SourcesIts Financing Sources

• Factors That Determine Financing

–Firm’s economic potential

–Maturity of the company

–Nature of its assets

–Owners’ preferences for debt or equity

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Sources Of FundsSources Of FundsSources Of FundsSources Of Funds

Personal

Friends and Family

Angels

Venture Capitalist

Banks

Government

Customers/Suppliers

Start-up

Going ConcernBeginning of Production ?

IPO

Amount

Company Size

13–4

Sources of FinancingSources of FinancingSources of FinancingSources of Financing

0 10 20 30 40 50 60 70 80

Personal Savings

Family Members

Partners

Personal Charge Cards

Friends

Bank Loans

Private Investors

Mortgaged Property

Venture Capital

Other

Percentage of Entrepreneurs

Using Source of Financing

Sources of Financing

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Critical Financing FactorsCritical Financing FactorsCritical Financing FactorsCritical Financing Factors

•Accomplishments and performance to date.

•Investor’s perceived risk.

•Industry and technology.

•Venture upside potential and anticipated exit timing.

•Venture anticipated growth rate

•Venture age and stage of development.

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Debt or Equity?Debt or Equity?Debt or Equity?Debt or Equity?

• Entrepreneurs typically prefer debt– Allows them to appropriate as much as of the benefit as

possible + retain sole control

– Can default

• Debt is unattractive to investors in emerging technology– Usually little collateral or predictable cash flow

– Information asymmetry is lessened by ownership position – shared ownership gives some control

– High interest rate to offset risk will stifle growth or cause default

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$28,000

income on

total assets

of $200,000

14% return

on assets

($28,000÷ $200,000)

14% return

on $200,000

($28,000÷ $200,000)

No debt

equals

$200,000

equity

With no debt and all equity:

Debt Versus EquityDebt Versus EquityDebt Versus EquityDebt Versus Equity

Equity:Equity: Owners get to keep all of the profits Owners get to keep all of the profits in return for accepting the risk of lower in return for accepting the risk of lower

returnsreturns

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$28,000

income on

total assets

of $200,000

14% return

on assets

($28,000 ÷ $200,000)

18% return

on $100,000

($18,000÷ $100,000)

$100,000 debt

(10% cost)

equals

$100,000

equity

With $100,000 debt and $100,000 equity:

Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)Debt Versus EquityDebt Versus Equity (Cont’d) (Cont’d)

Debt is Risky:Debt is Risky: Lenders have first claim on Lenders have first claim on profits and must be paid even if there are profits and must be paid even if there are

no profits.no profits.

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The Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s PerspectiveThe Banker’s Perspective

• Bankers’ Concerns!

• The Five C’s of Credit–Character of the borrower–Capacity of the borrower to repay the loan–Capital invested in the venture by the borrower–Conditions of the industry and economy–Collateral available to secure the loan

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Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan

Financial Information RequiredFinancial Information Requiredfor a Bank Loanfor a Bank Loan

• Three years of the firm’s historical statements

• The firm’s pro forma financial statements

• Personal financial statements

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Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…

Getting to know your friendly neighborhood Getting to know your friendly neighborhood Venture Capitalist…Venture Capitalist…

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The myth… and the realityThe myth… and the realityThe myth… and the realityThe myth… and the reality

• The myth: VCs support good people and good ideas

• The reality: VCs invest in industries with double digit growth in the middle of the S-curve

– Appropriate management team – Specialty funds (earlier and later stages on the

S-curve)– Limits the risk to management risk – Produces attractive exit opportunities

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Present Day SituationPresent Day SituationPresent Day SituationPresent Day Situation

Myth: There is less available capital

Fact: The industry has plenty of money, but limited appetite for new investment

Fact: Investor attitudes toward risk have changed

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VC fills a voidVC fills a voidVC fills a voidVC fills a void

• Gap between innovation and traditional sources of debt

• Risk inherent in startups typically justify interest rates higher than allowed by law

• VCs must balance high returns for their investors against sufficient upside potential for entrepreneurs to keep them motivated

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What VCs get out of itWhat VCs get out of itWhat VCs get out of itWhat VCs get out of it

• 10X return on capital over 5 years

• VCs management fees and high growth funds

• Fund structured with limited and general partners and a life of 7-10 years

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What VCs Do?What VCs Do?What VCs Do?What VCs Do?

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AngelsAngelsAngelsAngels

• Well to do private individuals

• Geography and industry specific

• Invest lower amount than VC

• Often a good source of industry experience

13–25

Finding AngelsFinding AngelsFinding AngelsFinding Angels

• Private Individuals

• Professionals (lawyers, accountants, bankers)

• Local small business development centers

• Internet associations (e.g., Technology Capital Network at MIT)

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Other Sources of FinancingOther Sources of FinancingOther Sources of FinancingOther Sources of Financing

• Community-based financial institutions

• Large corporations

• Stock Sales–Private placement–Initial public offering (IPO)

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Why Companies Invest?Why Companies Invest?Why Companies Invest?Why Companies Invest?

• Preemption of new rivals• Replace core earnings lost because of an

emerging technology• Apply existing competitive advantage in a

rapidly growing market• And some degree of autonomy:

– JVs, alliances, flexible internal management structures

13–28

Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies

Government-Sponsored ProgramsGovernment-Sponsored Programsand Agenciesand Agencies

• Small Business Administration (SBA) loans–Guaranty loan–Direct loan

• Small business investment centers (SBICs)

• Small Business Innovative Research (SBIR)

• State and Local Government Assistance

13–29

Building to GrowBuilding to GrowBuilding to GrowBuilding to Grow

13–30Complements of: Timmons/Spinelli New Venture Creation, sixth edition

Low Level Investment

Lower Long-

term Income

Potential (Lower

Capacity)