CHAPTER 8 SOURCES OF EQUITY FINANCING

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

The Secrets to Successful Financing

4. The World Wide Web puts at entrepreneurs fingertips vast resources of information that can lead to financing 5. Be thoroughly prepared before approaching lenders and investors 6. Looking for smart money is more important than looking for easy money

Three Types of Capital

Fixed - used to purchase the permanent or fixed assets of the business (e.g. buildings, land, equipment, etc.) Working - used to support the small company's normal short-term operations (e.g. buy inventory, pay bills, wages, or salaries, etc.) Growth - used to help the small business expand or change its primary direction

Equity Capital
Represents the personal investment of the owner(s) in the business Is called risk capital because investors assume the risk of losing their money if the business fails Does not have to be repaid with interest like a loan does Means that an entrepreneur must give up some ownership in the company to outside investors

Sources of Equity Financing

Personal savings Friends and family members Angels Partners Venture capital companies Corporations Public stock sale

Personal Savings
The first place an entrepreneur should look for money The most common source of equity capital for starting a business GEM study: Average cost to start a business in U.S. is

$70,200 Typical entrepreneur provides 67.9% of the initial capital requirement

Friends and Family Members

After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business - friends and family members Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop

Friends and Family Members

Guidelines for family and friendship financing deals:

Consider the impact of the investment on

everyone involved Keep the arrangement strictly business Educate nave investors Settle the details up front Never accept more than the investor can afford to lose

Friends and Family Members

Guidelines for family and friendship financing deals:

Create a written contract Treat the money as bridge financing Develop a payment schedule that suits both
parties Have an exit plan Keep everyone informed

Friends and Family Members

Ideal source of financing for companies that have outgrown the capacity of friends and family members but are still too small to attract the interest of venture capital companies

Angels
Private investors who invest in emerging business start-ups in exchange for equity stakes in the company Fastest growing segment of the small business capital market Center for Venture Research study: 234,000 angels invest $25.6 billion a year in 51,000 small companies

Angels
Most likely to finance deals in the $10,000 to $2 million range Key: finding them! Angels almost always invest their money locally and can be found through networking Another avenue: Angel capital networks on the World Wide Web

Angels
Typical angel accepts 12% of the proposals presented and has invested an average of $80,000 in 3.5 businesses An excellent source of patient money for investors needing relatively small amounts of capital often less than $500,000

Corporate Venture Capital

About 300 large corporations across the globe invest in start-up companies 19% of all venture capital investments come from corporations

Average CVC investment = $2.97 million Capital infusions are just one benefit; corporate partners may share marketing and technical expertise

Venture Capital Companies

More than 1,300 venture capital firms operate across the U.S. Most venture capitalists seek investments in the $3,000,000 to $10,000,000 range in companies with high-growth and high-profit potential

Average VC investment = $7.4 million

Venture Capital Companies

Usually take an active role in managing the companies in which they invest Focus their investments in specific industries with which they are familiar Invest in a company across several stages Most common stages: Expansion Later-stage Early-stage

Venture Capital by Stages

Start-up/Seed This is the initial stage in which companies are just beginning to develop their ideas into products or services. Typically, these businesses have been in existence less than 18 months and are not yet fully operational. Early stage These companies are refining their initial products or services in pilot tests or in the market. Even though the product or service is available commercially, it typically generates little or no revenue. These companies have been in business less than three years. Expansion stage These companies products or services are commercially available and are producing strong revenue growth. Businesses at this stage may not be generating a profit yet, however. Later stage These companies products or services are widely available and are producing ongoing revenue and, in most cases, positive cash flow. Businesses at this stage are more likely to be generating a profit. Sometimes these businesses are spin-offs of already established successful private companies.

What Do Venture Capital Companies Look For?

Competent management Competitive edge Growth industry Viable exit strategy Intangibles

Going Public
Initial public offering (IPO) - when a company raises capital by selling shares of its stock to the public for the first time Since 2000, average number of companies making IPOs is 211 Few companies with annual sales below $25 million make IPOs

Advantages of "Going Public"

Ability to raise large amounts of capital Improved corporate image Improved access to future financing Attracting and retaining key employees Using stock for acquisitions Listing on a stock exchange

Disadvantages of "Going Public"

Dilution of founder's ownership Loss of control Loss of privacy Regulatory requirements and reporting to the SEC Filing expenses

Disadvantages of "Going Public"

Accountability to shareholders Pressure for short-term performance Loss of focus Timing

End of Chapter 8