_CHAPTERTE Getting Financing or Funding OPENING PROFILE BIZOOK! Raising Money Through a Variety of Sources wwrw.bizooki.com In 2008 Andy Tabar, a student at Belmont University, was tweaking his start-up, Bizooki, a Web-based company that helps businesses become more efficient by uitllzing global talent. The idea behind Bizook is that many businesses need technical projects completed more efficiently, like the preparation of Web sites, interactive CD-ROMs, or marketing research, but don't have in-house expertise, By outsourcing the task to the most efficient global provider, the task can be completed inexpensively and on time. Bizooki acts as a matchmaker—bringing together businesses that need these types of tasks completed with a network of global providers. Although Bizooki didn’t take a large sum of money to launch, the way Tabar has funded Bizooki is instructive for aspiring entrepreneurs, Rather than trying to raise money from investors or bankers, he has relied on a combination of bootstrapping, loans from friends and family, and creative sources of financing Taber's experience raising and managing money started at an early age. As a high school student, he built Web sites, strictly on a cash basis. He didn't need much money because he was essentially selling his time, When he graduated from high schol, he brushed up on his knowledge of how to obtain credit, knowing that at some point he'd need external funding. The fist step he took was to obtain an ExxonMobil credit card—not because he needed the credit but to start establishing a credit history Tabar, who grew up in Ohio, chose Belmont University in Nashville primarily because of its entrepreneurship program. He experimented with a number of business ideas before setting on Bizooki, Along the way, he utilized several techniques to either raise money or gain access to resources in creative ways. One example is that as a freshman, he applied for membership to the university's Practicing Student Entrepreneur Program (also called the “hatchery"). Through the hatchery, Tabar and about 70 of his classmates gained access to desks, computers, phones, fax machines, and copy machines, along with the opportunity to brainstorm business ideas with one anether. Another example, which is becoming increasingly popular among student entrepreneurs, is that he entered several business plan competitions. He won Belmont's top award in 2006 and 2008, netting $5,000 in cash both times He also won $5,000 in the University of Evansville’s competition in 2008. The cost savings and money generated by these techniques helped Tabar flesh out his idea for Bizooki and get the company off the ground. He borrowed several small amounts of money from an interesting source: Rather than going through a bank, he ragistered with Prosper com, a peer-to-peer lending network. Prosper is an online auction Web site that matches people who want to borrow money with people who are willing to make loans. Tabar obtained several loans of around $5,000 apiece through Prosper, but he used Prosper as a platform to obtain loans primarily from friends and family rather than outsiders. Prosper provides a convenient, formal, and legitimate 315316 \Learning ‘Objectives After studying this chapter you should be ready to: {| Explain why most entrepreneurial ventures need to raise money during their early life [Identify the three sources | of personal financing av | to entrepreneurs ble | Provide examples of how | entrepreneurs bootstrap | te raise money or cut costs A entity the three steps involved in properly preparing ‘to raise debt or equity | financing Discuss the difference between | equity funding and debt financing ©. Explain the role of an elevator | speech in attracting financing for an entrepreneurial venture Describe the difference between a business angel and a venture capitalist explain why an inital public offering (IPO) io an important | milestone in an entreprencurial venture | |e Discuss the SBA Guaranteed || Loan Program Explain the advantages of leasing for an entrepreneurial venture PART £1 MOVING FROM AN IDEA TO AN ENTREPRENEURIAL FIRM format for people to loan money to one another, even if they know one another before the loan is made. Although Tabar hasn't tried it yet, he Is also considering utilizing Zopa com, which is a similar online peer-to-peer lend. ing network. Looking forward, Tabar anticipates needing additional sources of funds, 1s Bizooki grows or to launch additional ventures He has met a number of angel investors, primarily through the entrepreneurship program at Belmont But he hasn't taken any of their offers, which he believes will work to his advantage in the long run, He believes that moving cautiously, and only taking money from an investor when the timing is tight to grow the invest- ment, builds credibility and trust in the investment community. He also continues to build his credit history if bank financing becomes an attractive alternative." rn general, start-ups often have difficulty raising money because they are unknown and untested, Founders must frequently use their own money, try to secure grants, or go to friends and family for help. This effort is often a grueling endeavor Many entrepreneurs hear “no” many times before they match up successfully with a banker or investor. In this chapter, we focus on the process of getting financing or funding We begin by discussing why firms raise capital, We follow this with a description of personal financing and the importance of personal funds, capital from friends and family, and bootstrapping in the early life of a firm. We then turn to the different forms of equity, debt, and creative financing available to entrepreneurial ventures We also emphasize the importance of preparing to secure these types of financing THE IMPORTANCE OF GETTING FINANCING OR FUNDING Few people deal with the process of raising investment capital until they need to raise capital for their own firm. As a result, many entre- preneurs go about the task of raising capital haphazardly because they lack experience in this area and because they don’t know much about their choices. This shortfall may cause a business owner to place too much reliance on some sources of capital and not enough on others? Entrepreneurs need to have as full an understanding as possible of the alternatives that are available in regard to raising money. And raising money is a balancing act Although a venture may need to raise money to survive, its founders usually don't want to deal with people who don’t understand or care about their long- term goals ‘The need to raise money catches some entrepreneurs off-guard in that many of them launch their firms with the intention of funding all their needs internally. Commonly, though, entrepreneurs discover that operating without investment capital or borrowed money is more difficult than they anticipated. Because of this, it is important for entrepreneurs to understand the role of investment capital in the survival and subsequent success of a new firm.CHAPTER 10 & GETTING FINANCING OR FUNDING — 317 ‘There are three reasons that most entrepreneurial ventures need to raise money during their early life: cash flow challenges, capital investments, and lengthy produict development cycles. These reasons are laid out in Figure 10.1 Let's look at each reason so we can better understand their importance Cash Flow Challenges As a firm grows, it requires an increasing amount of cash to operate as the foundation for serving its customers, Often, equipment must be purchased and new employees hired and trained before the increased customer base generates additional income The lag between spending to generate revenue and earning income from the firm's operations creates cash flow challenges, particularly for new, often small, ventures as well as for ventures that are growing rapidly If a firm operates in the red, its negative real-time cash flow, usually computed monthly, is called its burn rate. A company’s burn rate is the rate at which it is spending its capital until it reaches profitability. Although a negative cash flow is sometimes justified early in a firm's life—to build plants and buy equipment, train employees, and establish its brand—it can cause severe com- plications. A firm usually fails if it burns through all its capital before it becomes profitable. This is why inadequate financial resources is one of the primary reasons new firms fail” A firm can simply run out of money even if it has good products and satisfied customers. To prevent their firms from running out of money, most entrepreneurs need investment capital or a line of credit from a bank to cover cash flow short- falls until their firms can begin making money. It is usually difficult for a new firm to get a line of credit from a bank (for reasons discussed later) So new ventures often look for investment capital, bootstrap their operations, or try to arrange some type of creative financing, Capital nts Firms often need to raise money early on to fund capi- tal investments. Although it may be possible for the venture's founders to fund its initial activities, it becomes increasingly difficult for them to do so when it comes to buying property, constructing buildings, purchasing equipment, or investing in other capital projects. Many entrepreneurial ventures are able to delay of avoid these types of expenditures by leasing space or co-opting the resources of alliance partners However, at some point in its growth cycle, the firm’s needs may become specialized enough that it makes sense to purchase capital assets rather than rent or lease them. In some industries, firms need to For example, it typically takes about two years and at least $4 million to develop an electronic game.> In the biotech industry, the path to commercial Licensing trventoy must be chased, employes must be seceded pad are averting ms be paid orbelore ashis feernted from sles [bearing | Objective Ti explain wty most [| entrepreneurial ventures [| nec to aise money Eo ating chai cary We FIGURE 10.1 =a ‘Three Reasons Start- Ups Need Funding