Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 16-1.

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 16-2

Chapter 16

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.

Choosing the right sources of capital can be as important as the right form of ownership or the right location

The money is out there; the key is knowing where to look

Creativity countsThe Internet provides easy access to vast resources

of information that can lead to financing

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Raise only as much money as you really needBe thoroughly prepared before approaching potential

lenders and investorsLooking for “smart” money is more important than

looking for “easy” moneyPlan an exit strategy

Layered financing

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Possible Sources of Equity Financing


The money required to launch a new business is known as seed capital

Once there is a proven business model and a growing customer base, additional growth capital may be needed

Capital: any form of wealth employed to produce more wealthCash, inventory, plant, and equipment

Entrepreneurs need two different types of capital: Fixed and working

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Fixed CapitalFixed capital: provides funding for the purchase

of a business’s permanent or fixed assets, such as buildings, land, computers, and equipmentMoney cannot be used for other purposes – it’s

frozen

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Working CapitalWorking capital: represents a business’s

temporary funds; it is the capital used to support a company’s normal short-term operationsAccountants define working capital as current

assets minus current liabilities

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Equity capital: represents the personal investment of the owner (or owners) and any investment from outside sources in a businessSometimes called risk capital because these

investors assume the primary risk of losing their funds if the business fails

Does not have to be repaid with interest like a loan does

But, an entrepreneur must give up some ownership in the company to outside investors

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Funding from FoundersThe first place an entrepreneur should look for

money The least expensive source of funds

Half of start-ups with employees launch with less than $50,000 and without employees for less than $10,000

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Lenders and investors expect entrepreneurs to invest in their own business Personal savings

Sweat equity Other personal assets Unsecured personal credit Second mortgage on property Pledging other personal assets Working a second job Bootstrapping

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Friends and Family MembersAfter emptying her own pockets, an entrepreneur

should turn to those most likely to invest in the business - friends and family members

GEM study: Amounts invested from friends and family

members are smallInvestments from friends and family members

make up 36% of a typical start-up’s total capitalSBA study:

Inherent dangers lurk in family/friendly business deals, especially those that flop

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Guidelines for family and friendship financing deals:Keep the arrangement strictly businessValidate the business planEducate “naïve” investors Never accept more than the investor can afford to

loseCreate a written contractTreat the money as “bridge financing”Develop a payment schedule that suits both partiesKeep everyone informed

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CrowdfundingHistorically, investing in startups was done by

accredited investors who have the knowledge and financial ability to assume the risks that come with such investments

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Can also raise money using crowdfunding Uses the Internet to generate many small

contributions from a large number of people to fund a business

Primarily used to help raise money to support social causes, help fund struggling artists, or support local small business start-up

Money received was considered a contribution or a donation rather than an investment

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Jumpstart Our Business Startups (JOBS) Act of 2012 significantly expands the use of crowdfundingThose who provide funding can become equity

investors with ownership in the businessAnyone can invest some amount in a business start-up

Entrepreneurs are no longer limited to seeking funding only from accredited investors

Use social media to attract moneyKeep in mind that crowdfunding can create new

complexities because of differing expectations among investors

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AcceleratorsMany communities and universities have

established accelerator programs that offer new entrepreneurs a small amount of seed capital and a wealth of additional supportY Combinator and TechStars

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Accelerators help move entrepreneurs from the idea stage to a point when the business has a proven story and a successful business model that they can pitch for more significant fundingMost important contribution is the coaching and

mentoring from angel investors and experienced entrepreneurs

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AngelsAngel investors: private investors who invest in

emerging business start-ups in exchange for equity stakes in the companyIdeal for companies that are too big for friends and

family investors, but too small for VC companiesMost likely to finance start-ups with capital

requirements in the $10,000 to $2 million rangeCenter for Venture Research study: 268,000 angels

invest $22.9 billion a year in 67,000 small companies

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Angel Financing


Most angels prefer to maintain a low profile so the key is finding them! Angels almost always invest their money locally and

can be found through networkingTypical angel accepts 14.5% of the proposals

presented and invests an average of $50,000 in one company per year

An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000

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Angel networks and angel capital funds, dubbed “super-angels” operate like miniature versions of professional venture capital firms and draw on their skills, experience, and contacts to help the start-ups in which they invest succeed

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Strategic Investments Through Corporate Venture Capital15% of all venture capital investments come from

corporationsAverage CVC investment = $3.5 million

About 300 large corporations across the globe invest in start-up companies

Capital infusions are just one benefit; corporate partners may share marketing and technical expertise

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Corporate Venture Capital


Venture capital companies (VCs): private, for-profit organizations that raise money from investors to purchase equity positions in young businesses that they believe have high growth and high profit potential, producing annual returns of 500 to 1,000 percent over five to seven yearsMore than 400 venture capital firms operate across

the U.S.

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Venture Capital Funding


Policies and Investment StrategiesInvestment size and screening

Average VC investment is $7.2 millionScreening process is extremely rigorous!VCs typically invest in less than 1% of the business

plans they receiveGEM study: Only one in 1,000 businesses in the

U.S. attract VC

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Stage of investmentMost VCs invest in the early or rapid-growth stages of

development GEM study: only one in 10,000 worldwide receive VC

at start-up!

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Venture Capital Funding by Stage


Advice and contactsProvide management advice and access to valuable

networks of contacts of suppliers, employees, customers, and other sources of capital

ControlEntrepreneurs must give up a portion of their

businesses in exchange for fundingSome VCs take an active role, others are passive

investors

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Investment preferencesMost of the start-up businesses that attract venture

capital today are in the biotechnology, software, energy, and medical device industries

Competent managementThe key to success is the management team!

Competitive edgeGrowth industryViable exit strategyIntangible factors

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Public Stock Sale (“Going Public”)In an initial public offering (IPO), a company raises

capital by selling shares of its stock to the general public for the first timeEffective way of raising large amounts of capitalBut, can be expensive and time-consuming

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IPOs


Once a company makes an IPO, nothing will ever be the same againNo longer under the exclusive ownership and

control of the entrepreneurFocus is now on the interests of all stockholders

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The IPO ProcessChoose the underwriterNegotiate a letter of intentPrepare the registration statementFile with the SECWait to go effectiveRoad showSign formal underwriting agreementMeet state requirements

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Investment bankers underwriting IPOs look for:Consistently high growth ratesScalabilityHigh profit potentialThree to five years of audited financial statements

that meet or exceed SEC standardsA solid position in a rapidly growing industryA sound management team with experience and a

strong board of directors

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Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 16-1.

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