Forms of entre- preneurial capital

Chapter 14

Sources of capital forentrepreneurial ventures

Objectives1. To be able to distinguish among the five forms of entrepreneurial capital2. To consider how to attract financing from your family and how to bootstrap a business3. To identify how informal investors differ from other parts of the funding community4. To differentiate between debt and equity as methods of financing5. To examine commercial loans, social lending and public stock offerings as sources of capital6. To understand the stages of venture investing7. To study the market for venture capital and to review venture capitalists’ evaluation criteria for new

ventures8. To discuss the importance of evaluating venture capitalists for a ‘best fit’ selection9. To discuss private placements as an opportunity for equity capital10. To examine the business angel market11. To describe new forms of entrepreneurial capital beyond financial capital12. To be familiar with Islamic finance and micro-credit13. To understand the criteria used by impact investors14. To appreciate the need for raising natural capital as part of an entrepreneurial venture.

But first

• Where does the money for new start-ups usually come from?

• What about later as the company grows?• Can you think of some creative ways to raise

funds?• Has anyone ever used crowdfunding?• Have you ever tried to raise money from your

family?

?

The times, they are a-changin’

• Funding in the new era is not simply be thrown at companies in the hope that one in 10 is wildly successful.

• Today, funding goes only to entrepreneurs who thoroughly understand their customers’ requirements and who can ensure the funder from the beginning that every product delivers on its value.

Forms of entre- preneurial capital

Sources of financial capital

• Where to find start-up capital?• What type of capital to use and when?• Entrepreneurs have a number of sources of

financial capital as their ventures develop.• The level of risk and the stage of the firm’s

development help determine the appropriate source of financing for entrepreneurial ventures.

• On the left are sources of capital we cover in this chapter.

Each in its own timeFamily

Bootstrap

Informal investors

Banks

Venture capitalists

Angel investors

Micro-credit

Peer-to-peer

Crowdfunding

Natural capital

• a

Sources of financial capital

• Entrepreneurs have a number of sources of financial capital as their ventures develop.

• Notice that the level of risk and the stage of the firm’s development should determine the appropriate source of financing for the entrepreneurial ventures.

How to get money from your family

• Have you heard of the ‘kitchen table pitch’?

• Know their motivations. • Debt is better than equity for relatives • Do follow-up with a written memo.• Try to treat them as if they were

strangers. Have a lawyer prepare the promissory note.

•

• Try to avoid a repayment schedule. • Don’t give voting stock. • Be sure to read Chapter 7 on Family

Business.

Informal investing

• Informal investors are often from the 4Fs:–Friends, family, founders and ‘foolhardy investors’–Neighbours, work colleagues and even strangers

• Expected returns are affected by altruism–Strangers expect higher returns than parents–Men expect higher returns than women–Older persons expect lower returns than younger–Entrepreneurs expect higher returns than non-

entrepreneurs

Debt versus equity?• Equity financing is best

in the early start-up stages

• Use of debt to finance a new venture involves a payback of the funds plus a fee (interest) for the use of the money (for example, to a bank).

Debt financing through banks

• Short-term borrowing for working capital.• Long-term debt to finance the purchase

of property or equipment. • Banks will ask:

–What do you plan to do with the money? –How much do you need? –When do you need it? –How long will you need it? –How will you repay the loan?

Other formsof debt financing

Equity financing

•What kinds of people or organisations might buy ownership in a new venture and why?

•Can you sell shares in your business before you make money?

?

Equity financing• No obligation to repay• But, the entrepreneur gives up part

ownership• Equity capital can be raised in two ways:

–Public stock offerings, called initial public offering (IPO)

–Private placements, which involves private investors purchasing shares or sometimes bonds

Early 19th-century German quity ledger

Early 19th-century German quity ledger

Equity financing

Public stock offering (by IPO)• ‘Initial public offering’ (IPO)• First-ever sale of shares to the public• ‘Going public’ or ‘floating’• The IPO market has been a rollercoaster since the

late 1990s

Nasdaq welcomes Facebook’s IPO.

Private placements

• The ideal small-business candidate for private placement is a company looking for growth or expansion funding.

• A private placement is suitable when you need an injection of capital to jump to the next level of growth and you have a proven track record of profitability.

Venture capital in the new era

• There was a time when an entrepreneur with a bright idea could just walk into a venture capitalist’s office in Silicon Valley or Shanghai and get a heap of money to develop that idea.

• Now those days are gone. • But we are still building the same

innovative and world-changing products

Venture capital in the new era

• Venture capitalists can provide:–capital for start–ups and expansion –market research and strategy –management consulting functions –contacts with prospective customers and suppliers –assistance in negotiating technical agreements –help in management and accounting controls –help in employee recruitment –help in risk management –guidance with government regulations.

Funding stages with VCs

Myths about VC• Venture capital firms want to own

control of your company and tell you how to run the business.

• Venture capitalists are satisfied with a reasonable return on investments.

• Venture capitalists are quick to invest.

• Venture capitalists are interested in backing new ideas or high-technology inventions – management is a secondary consideration.

• Venture capitalists need only basic summary information before they make an investment.

Venture capitalists’ objectives

• Different objectives from other capital lenders. • Interested in security and return on investment (ROI). • Best advice: delay outside investment as long as possible and to build

as much value as you can into your business before you seek VC• Table 14.3 provides some commonly sought targets. • 20-30% ROI would not be considered too high

Top factors VCs use to evaluate your proposal

• Timing of entry• Key success factor

stability• Educational

capability• Lead time• Competitive rivalry

• Entry wedge imitation• Scope• Industry-related

competence• See detailed Table 14.4

Factors in venture capitalists’ evaluation process

Business angels

• Wealthy people looking for investment opportunities.

• Range from passive (backing others’ judgements) through to hands-on

• Angels invest as individuals (often as part of a group) whereas venture capital generally comes via a company

Types of angel investors

New forms of entrepreneurial capital

• Most textbooks stop here, but we carry on!

• More to capital-raising than venture capital or bank loans. –Islamic finance–Finding an ‘impact investor’–Micro-credit–Peer-to-peer lending–Crowdfunding–Raising natural capital

Islamic finance

Iran’

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Engaging in entrepreneurial endeavours is encouraged and even demanded in the teachings of Islam.

Impact investing• Impact investing that prevents future

market meltdowns and avoids climate change.

• Investing in recycling, solar, wind, water and biofuels, greener transportation.

• Formerly called socially responsible investing (SRI), sustainable investing or ethical investing.

• Centres on the Principles for Responsible Investment (PRI)

At 3rd pages add

glossary: impact investor,

SRI,PRI

Micro-credit

• Very small loans to entrepreneurs who lack collateral

• Informal financial service providers

• Member-owned organisations• Non-governmental organisation

(NGOs)• Banks servicing ‘pre-banking

customers’Available from Asia/Pacific Cultural Centre for UNESCO (ACCU).

Peer-to-peer lending • Social lending removes costly

intermediaries known as banks • Bringing pools of borrowers together

with individual investors.• Loan of $1000 to a specific

borrower is often funded by $25 investments from 40 different lenders.

• Social lending sites charge fees of 2-4%

Lending Club is the world’s largest online marketplace connecting borrowers and investors.

• Kickstarter $1b+ since 2009.

• Entrepreneurs collect funds through the Internet by ‘open invitation’ to finance their projects/ventures

• Usually there is a reward to the funding community for success

Raising natural capital

•Natural capital is typically sold, used, discarded and then dumped back onto the ground.

•Entrepreneurial activity does not actually create or destroy the Earth’s resources. It only changes the location, form and value (usually it is downgraded value) of those resources.

•Since 1997, we have lost at least US$20 trillion a year globally in non-marketed ecosystem services.

•Every product has a ‘hidden history’ that we rarely appreciate

Raising natural capitalExamples of Natural Capital

Atmospheric stabilisation CO2/O2 balance, stratospheric ozone, SO2 levelsClimate stabilisation Greenhouse gas production, cloud formation

Disturbance avoidance Storm protection, flood control, drought recovery and how vegetation structure helps control environmental variability

Water stabilisation Supply water for agriculture use (irrigation), industrial use or transportationWater supply Water storage by watersheds, reservoirs and aquifersErosion control and sediment retention Prevention of soil loss by wind, runoff, storage of silt in lakes, wetlands, drainage

Soil formation Weathering of rock and accumulation of organic materialNutrient cycling Nitrogen fixation, nitrogen/phosphorus, etc. nutrient cyclesWaste treatment Waste treatment, pollution control, detoxificationPollination Providing pollinators for plantsBiological control Predator control of prey species

Habitat Nurseries, habitat for migratory species, regional habitats for locally harvested species, wintering grounds

Raw materials Lumber, fuels, fodder, crops, fisheries

Genetic resources Medicine, products for materials, science, genes for plant resistance and crop pests, ornamental species

Recreation Ecotourism, sports fishing, swimming, boating, etc.Cultural Aesthetic, artistic, education, spiritual, scientific, Indigenous sites

Natural capital in a can of coke1. Bauxite mined in Australia 2. Ore carrier carries it to Sweden or

Norway3. Hydroelectric dams provide cheap

electricity to smelt into aluminium metal4. Shipped to roller mills in Germany. 5. Heated to 500 Celsius and rolled to

eighth of an inch. 6. Sent to England, where sheets are

punched and formed into cans7. Washed, dried, painted with a base

coat, and then product information. 8. Lacquered, flanged, sprayed inside

with a protective coating 9. Palletised, forklifted and warehoused.

10. Shipped to the bottler, where they are washed and cleaned

11. Filled with water, flavoured syrup, phosphorus, caffeine,carbon dioxide gas.

12. Sugar is harvested from beets in France 13. Phosphorus comes from Idaho14. Caffeine is shipped from England.15. Cartons are made from Sweden or Siberia 16. Palletised again, shipped to distribution

warehouse, and supermarket17. The consumer buys 12 ounces of the

phosphate – tinged, caffeine-impregnated, caramel-flavoured sugar water.

18. Drinking takes a few minutes; throwing the can away takes a second.