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SPE3002 Entrerpeneurship - Financing and Starting a Business

SPE3002 Entrerpeneurship - Financing and Starting a Business

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SPE3002/SPK5002 COMMERCE AND ENTREPRENEURSHIP

WEEK 13 1 – 6 OCTOBER 2006

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 1

AGENDA Starting and Financing a Business

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 2

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 3

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.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 4

The “Secrets” to Successful Financing
(continued)

4. The World Wide Web puts at entrepreneur’s fingertips vast resources of information that can lead to financing. 5. Be thoroughly prepared before approaching lenders and investors. 6. Entrepreneurs should not underestimate the importance of making sure that the “chemistry” between themselves, their companies, and their funding sources is a good one.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 5

Three Types of Capital
FIXED

CAPITAL

WORKING

GROWTH

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 6

Three Types of Capital
Capital is any form of wealth employed to produce more wealth for a firm.

 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, salaries, etc.)
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 7

Three Types of Capital
Capital is any form of wealth employed to produce more wealth for a firm.

 Growth - used to help the small
business expand or change its primary direction.

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 8

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.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 9

Sources of Equity Financing
 Personal savings  Friends and family members  Angels  Partners  Corporations  Venture capital companies  Public stock sale
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 10

Sources of Finance

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 11

List of Sources
 Equity (common stock, preferred    
stock) Loans: long term, short term Lease finance Inter corporate deposits Bank cash credit and overdraft limits

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 12

List of Sources (Continued)
   
Debentures Fixed deposits Grants from government agencies Supplier credit and deferred payments  Credit cards

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 13

Modes of Acquisition
 Primary market: public issue, rights issue      
(flotation costs) Secondary market (listing costs) Private placement (individual or institution) Banks and mutual funds Pension funds, insurance companies Debenture issue Fixed deposits
email: drhamka@yahoo.com slide 14

Mohd. Khata Bin Jabor

Basis for Comparison -- Attributes
 Holding period (Duration)

 Repayment terms
 Interest rate  Other strings attached  Pledges and collaterals  Finance marketing costs and lead time
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 15

Legal Structure and Time Lines
 Limited Liability Partnership  Multiple funds under on VC firm

 Fund life about 8-10 years
 First four-five years of investing

 Next four-five years of harvesting
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 16

Personal Savings
 The first place an entrepreneur should look
for money.  The most common source of equity capital for starting a business.  Outside investors and lenders expect the entrepreneur to put some of her own capital into the business before investing theirs.  Sweat equity and personal risk equity (nonmonetary)
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 17

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.  Survey: 10% of business owners turn to family and friends for capital.  Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 18

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.”  Settle the details up front.  Create a written contract.  Treat the money as “bridge financing.”  Develop a payment schedule that suits both parties.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 19

Angels
 Angels - private investors who back
emerging entrepreneurial companies with their own money.  Fastest growing segment of the small business capital market.  An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000.

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 20

Angels
 Sophisticated investor who invests in
early stage companies
 250,000 + angels in US  Invest $5 bill - $10 Bil, 20K – 30K annually  Typical investment = $25K - $250K  High net worth  Wants to invest in experienced industry

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 21

Angels
 Key: finding them!
Accessing Angels  Not in the Yellow Pages  Networking  ACE-net.org

 Angels almost always invest their
money locally and can be found through “networks.”
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 22

Angels
 The typical angel accepts 30% of the
proposals presented to him and has invested an average of $131,000 in 3.5 businesses.  What do angels look for?
 Exciting ideas (with clear potential)  A way to help a trusted friend

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 23

Angels
 Advantages
 Early stage resource  Value-added money : network, advice, commitment

 Disadvantages
 No follow-on funds  Give-up equity  Over-control from angel
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 24

Venture Capital

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 25

Venture Capital
 $21.7 billion in 2005  2,939 investments  Down from $104 billion & 7,832 deals in
2000  Pool of capital invested in rapidly growing companies  Private Partnerships
 General partners – manage  Limited partners – provide funds
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 26

Venture Capital

(Continued)

 30% of all venture capital investments
come from corporations.  About 900 large corporations across the globe invest in start-up companies.  Capital infusions are just one benefit; corporate partners may share marketing and technical expertise.

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 27

Venture Capitalist Companies
 More than 3,000 venture capital firms
operate across the United States.  Most venture capitalists seek investments in the $3,000,000 - $10,000,000 range in companies with high-growth and high-profit potential.  Business plans are subjected to an extremely rigorous review – less than 1% accepted.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 28

Venture Capitalist Companies
(Continued)

 Most venture capitalists take an active
role in managing the companies in which they invest.  Many venture capitalists focus their investments in specific industries with which they are familiar.  Most often, venture capitalists invest in a company across several stages.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 29

Venture Capital Financing
Amount Financed (in Billions of $)

$25.0 $20.0 $15.0 $10.0 $5.0 $Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

1,800 1,600 1,400 1,200 1,000 800 600 400 200 -

1995

1996 Billions of $

1997

1998

1999

2000

Number of Deals

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

Number of Deals

slide 30

What Do Venture Capital Companies Look For?

 Competent management  Competitive edge  Growth industry  Viable exit strategy  “Intangibles”
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 31

 Revenue model: Sources of revenue

What is the VC Looking For in a BP ?
(service/product mix) Profitability, break even point, growth estimates (revenue, team size) Risks and contingencies: De-risking/risk management/risk containment plan Projected (pro-forma) financial statements Exit strategy (IPO, equity buyer, strategic buyer, Merger & Acquisition) Valuation and offer (equity price, number of shares)
email: drhamka@yahoo.com slide 32


   

Mohd. Khata Bin Jabor

What is the VC Looking For in a BP ?
 Basic value proposition  Market size, segmentation, target
customers, competitors
Points
(Continued)

 Entry barriers, IP protection, Unique Selling

 Technology expertise and domain
knowledge

 Alliance and strategic partnerships  Promoters, Board of Directors, Top
management (VPs)
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 33

Structure of a VC Firm
 General partners 3-5 (themselves
successful entrepreneurs): put about 23% of the corpus  Limited partners (Pension funds, Retirement plans): Put 97% corpus  Corpus = Fund, typically ranges between USD 50M to 2B  Management fee is about 2-3 % per year
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 34

Structure of a VC Firm
 Funds about 5-30 new companies per
year  Employs junior managers for due diligence (associates)  After IPO/Acquisition, general partners keep 20% of gains, limited partners get Principal + 80%

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 35

Role of the VC in the Portfolio Company
 Negotiate aggressive terms  Select strong co-investor  Help in constituting the Board of Directors  Assist in
 Recruitment  Market validation  Strategic relationships

 Pursue liquidity aggressively
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 36

VC Fund Raising Process
 Introduction (phone call, e-mail,
referral)  Submit business plan / executive summary  Presentation  Company visit

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 37

VC Fund Raising Process
 Due diligence (management
reference checks, customer calls, market analysis)  More meeting(s)  Term sheet  Legal / Closing

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 38

VC Decision Making
 Deal flow
 Less then 2% of deals are funded  1 to 2 new deals per year per partner

 Due diligence – in-depth investigation of
the venture & you  Time frame to do a deal: 3 to 12 months  Entrepreneur decision making
 Due diligence  Chemistry is key
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 39

Managing VC Portfolio Companies
 A, B, C, & D Rounds
 Dry powder

 Each round is often staged with
milestones  Board of Directors  Hands-on vs. portfolio approach

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 40

VC Required Return on Investment
ROI 5 yr. Increase

 Seed  Start-Up  Early Stage  Second Stage  Third Stage  Bridge
Mohd. Khata Bin Jabor

80%+ 60% 50% 40% 30% 25%
email: drhamka@yahoo.com

 19x  10x  8x  5x  4x  3x
Bygraves & Zacharakis
slide 41

What Are the Implications to the Entrepreneur of VC ROI?

 The later the stage, the better the deal  The better the management, the better
the deal  The quicker the exit, the better the deal

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 42

Why people want to be VC’s?

 Partnership
 General partners  Limited partners

 Management fees 2%  Specialize in an industry  Carried interest – 80/20  Series of funds
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 43

Going Public
 Initial public offering (IPO) - when a
company raises capital by selling shares of its stock to the public for the first time.  Typical year: about 550 companies make IPOs.  Few companies with sales below $10 million in annual sales make IPOs.  A common exit strategy for investors (but needs strong justification)
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 44

Initial Public Offerings
1000
Number of IPOs

800 600 400 200 0
81 83 85 87 89 91 93 95 97 19 19 19 19 19 19 19 19 19 19 99

$80.0 $70.0 $60.0 $50.0 $40.0 $30.0 $20.0 $10.0 $0.0

Money Raised ($ billions)

Number $ Raised (Billions)

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 45

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
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 46

Disadvantages of “Going Public”
 Dilution of founder’s ownership  Loss of control  Loss of privacy  Reporting to the SEC  Filing expenses  Accountability to shareholders  Pressure for short-term performance  Timing
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 47

Debt Financing
 Must be repaid with interest.  Is carried as a liability on the company’s
balance sheet.  Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous.  Can be expensive, especially for small companies, because of the risk/return tradeoff.  Convertible loans (very popular if IPO might be used as an exit strategy)
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 48

Sources of Debt Capital

 Commercial/Retail banks  Investment Banks  Financial Institutions

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 49

 Commercial banks as market-makers in debt    
funds Accept deposits from general public and give loans to general public as well as corporate Net Interest Margin (NIM) is the main source of bank income Losses can occur due to adverse movement of interest rates and non-performing assets or bad loans Banks spend a lot of time to estimate the credit rating of loanees
email: drhamka@yahoo.com slide 50

Retail Banks and Financial Institutions

Mohd. Khata Bin Jabor

Loan Offer from a Bank
 Prime Lending Rate (PLR)  Term structure of interest rates  Credit spread

 Collaterals and covenants
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 51

Commercial Banks
...the heart of the financial market for small businesses!

 Cash flow is the key  Relationships!  Short-term loans
 Commercial loans (prime +, unsecured)  Lines of credit (limit tied to working capital)  Floor planning (ID numbers)

 Intermediate and long-term loans
 Installment loans and contracts
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 52

Sources of Debt Capital
 Commercial banks

Asset-based lenders

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 53

Asset-Based Borrowing
 Discounting accounts
receivable
 Inventory
Accounts Receivable

financing

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 54

Sources of Debt Capital
 Commercial banks
 

Asset-based lenders Trade credit (materials suppliers)  Equipment suppliers  Commercial finance companies (security interests, guarantees, high interest)  Saving and loan associations (real property)
email: drhamka@yahoo.com

$$

Mohd. Khata Bin Jabor

slide 55

Sources of Debt Capital
(continued)

 Stock brokerage houses (margin loans)  Insurance companies  Credit unions  Bonds (industrial development bonds)

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 56

Sources of Debt Capital
 Private placements (insurance companies,
etc)  Small Business Investment Companies (SBICs) – usually options or convertible loans  Small Business Lending Companies (SBLCs)
(continued)

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 57

Investment Banks
 Matchmakers

 Fee-based referral services
 Help in private equity placement

 Structured (OTC) deals
 Globalized capital markets (FCCBs, ECBs)

 GDR, ADR issues
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 58

Internal Methods of Financing
 Factoring - selling accounts receivable
outright  Leasing assets rather than buying them  Credit cards

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 59

Internet Resources on VC and Private Equity
 www.ventureeconomics.com  www.v1.com (Dow Jones Venture One)  www.vnpartners.com (Venture Net
Partners)  www.vnpartners.com/primer.htm  British Venture Capital Association  www.bvca.co.uk
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 60

What to Include in a Financial Analysis and Plan
When does the business have to buy resources, such as supplies, raw materials, and people?
When does the business have to pay for them? How long does it take to acquire a customer? How long before the customer sends the business a check? How much capital equipment is required to support a dollar of sales?
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 61

More Questions
For businesses just starting out, the amount of money available up-front is a key to survival. For all businesses, long-term financial health determines health.

Are revenue and profits growing? Is the company’s cash flow being carefully monitored? Does the company have ready access to cash reserves? Does the company have a budget? How does the company’s financial condition compare to that of the competition?
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 62

What’s Wrong With Most Finance Plans?
• Waste too much ink on numbers and devote too little to the information that really matters to investors. • Financial projections for a new company are an act of careful planning and imagination, especially detailed, month-by-month projections that stretch out for years
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 63

What’s Wrong With Most Finance Plans?
• An entrepreneurial venture faces far too many unknowns to predict revenues, let alone profits. • Few entrepreneurs correctly anticipate how much capital and time will be required to accomplish objectives. They are wildly optimistic.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 64

Some Numbers Are Essential
•Business plans should contain some numbers. •Numbers should appear mainly in the form of a business model that shows the key drivers of the venture’s success or failure. •In manufacturing, this might be the yield on a production process; in magazine publishing, the anticipated renewal rate; or in software, the impact of using various distribution models.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 65

Some Numbers Are Essential
• The model should also address the breakeven issue: • At what level of sales does the business begin to make a profit? • When does cash flow turn positive?

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 66

Objectives and Milestones in the Financial Plan

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 67

Purpose of Objectives & Milestones
By mapping actual cost to achieve each milestone against the planned cost, a firm can re-evaluate its position and predict cash shortfalls in time to take action. Preparing milestones and expected cost, a firm shows it intends to track performance closely against the business plan. This offers some comfort to potential investors and may prevent the plan from sitting in a desk drawer once it has served its initial purpose.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 68

Milestone Examples
Hiring of a full management team Completing product specifications Completing prototype design

Completing prototype
Product testing Beginning production

First customer shipment
First full quarter of profitability Attaining $10 million in revenue
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 69

Ownership and Equity Issues in the Financial Plan

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 70

What to Include in Ownership & Equity
How will equity in the venture be distributed? Will the founders retain control?

Will employees be able to earn equity for their performance?
How much equity will investors have, and how will that change over time? How do the investors get their money out, and when?
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 71

Checklist For The Financial Plan
1. Explain the assumptions you have made that form the basis for all of the data contained in your financial statements.
      Sales Production Accounts Receivable, Accounts Payable Overhead Expenses Capital Expenditures and Depreciation Etc.
email: drhamka@yahoo.com slide 72

Mohd. Khata Bin Jabor

Checklist For The Financial Plan
2. Prepare the following plans for the first year budgets:
    Sales Production Operating Expenses Number & salaries of needed staff members  Head Count Plan  Capital Expenditures  Start-up costs, fixtures, equipment, etc.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 73

Checklist For The Financial Plan
3. Prepare a cash flow until the business reaches cash break-even point or through the first year - by individual months.
Some considerations are:  Start-up expenditures  Accounts payable procedures  Accounts receivable  Collection periods
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 74

Checklist For The Financial Plan
4. Prepare the five-year cash flow using quarterly projections.
 Use a computer spreadsheet  Pitfall: Avoid using straight line projections  Make sure to identify all business expenses

5. Prepare for the first year profit & loss statement.
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 75

Checklist For The Financial Plan
6. Prepare a 5-year Profit & Loss (P&L) Statement.
 First year by quarter  The remaining years annually

7. Prepare a balance sheet for each quarter for the first year of operation.
 Make realistic projections and coordinate with the Profit & Loss Statement
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 76

Checklist For The Financial Plan
8. Prepare a yearly balance sheet for the first five years of operation.
 Make realistic projections and coordinate with the Profit & Loss Statement.

9. Explain how the projections compare with industry norms.
 Are the costs, revenues, profits, etc. higher or lower with similar businesses?
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 77

TO FIGURE YOUR COST OF LIVING, TAKE YOUR INCOME AND ADD TEN PERCENT.
Steve Forbes

Mohd. Khata Bin Jabor

email: drhamka@yahoo.com

slide 78

Remember:
Formulating a Workable Financial Plan Requires:  A willingness to change to an entrepreneurial orientation  Continued planning and crafting and revalidation  An opportunistic disposition  Commitment of resources not ownership  Reassessment of measured performance  Leadership
Mohd. Khata Bin Jabor email: drhamka@yahoo.com slide 79

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