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Sources of Capital

lnformal Risk Capitat, Venrure Capital, and Going public

and his Mesa Petroleum Co.-:-^-------r. Walker brought these capabilities to a series of start-up companies. gave him the ability to get along any_ where.. nuwgv€t. This appealed to ' Walker. even if they have to be dragged to that realization-as Pickens did to staid management teams with his hofile takeover bids. Thunderbird. walker noticed that many of the people he respected in this industry were leaving to work on riskiec more nontraditional and st¡mulating ventures.OPENING PROFILE SCOTT WALKER Some entrepreneurs are born and others are created through focus.. includíng one very successfül financial technology firm. and desire' Scott Walker is the latter style. he centered much of his effort on the oil and gas industry including working with T. Thii training. Based in Dallas. Boone Pickens.. so he searched for an established entrepreneur who could show him the basics.Walker selected a graduate school that would initiate his career as an entrepreneur. Nor was the idea that L.s Bank and GE capital. After a number of years in banking with such firms as Lloyd. and to be self-sufficíent. the notorious corporate raider of the 1980s.... Walker graduated in 19gl with an MBA. Pickens pridedhimself on being abletosee undervalued assets and subsequently make a profit when outside part¡es and the mar_ ket recognized that value. Howeve¡ '' he did not feel that he understood all the details of howto successfully build a new venture. That lesson was not lost on Walker. energy. Walker was born an Air Foice brat his family was posted at stations across the coun- trythroughout his ctrll¿hoo¿. The banking world and its activity in mergers and acquisitions was the first professional stop forWalker. developing his own lifelong learning curriculum in creating opportunities and taking risks. provided an environment for learning how an interesting idea can become a business-as well as exposure to the broader world as - . businesses need to be responsive to their shareholders and stakeholders. 30s . energy. playing to hís strengths and providing a new channelI for rvt ttt) his Ettttgy. to be comfortable with different types of people. including six different grade schools and three high schools in three different states.j '" " ' ''' ': ' represented by students and faculty from around the globe. After receiving a BA from Utah State University in 1977. the Garvin School of International Management. .

After a short time. or lvR (the "press 1 for. This opportunity was lthe establishment of] a not-fo¡:profit [educational assistancel company. His second act was .Walker was the second employee and CFO of the fledgling technology firm in 1995. The revenue model for TelePay reflected the "many small slices" nature of the transaction industry-the consumers paid a small incremental fee above the amount owed for the convenience of not writing a check or visiting an office. and ACH or electronic checks.000 transactions to 10 mil- to bring on a sen¡or sales executive who could leverage the loyalty of the existing customers into references for new prospects. or POPs. lt remains a portion of the Internet backbone today' firf taste of risk taking was exhilarating. remain with the lion transactions. Both early decisions proved correct: the company's infrastructure has readily grown with the client base' and two of its initial four employees. a $200 million company. on advice from conley.306 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE That person was W¡ll¡am Conley. This company. After one year of hard work w¡th few paychecks. walker hired the right person. another friend. Once inside. the firrn was sold to GTE. he was ready for a new challenge. one2one Learning Foundation. provided individualized curricufum programs for children not enrolled in tradit¡onal public or pr:ivate institutions. company today. which was called TelePay. Walker returned to the corporate world as CFO of Precept BusinessServices. This was the chance to put all that he had learned as an apprentice into his own company. to assist with the sale of a small company Norton's father had invested in three years earlier. A wide range of payment choices. including credit cards. ATM debit cards. so his first decision was to completely rebuild the system on a single software platform. The biller did not pay for the setup or ongoing maintenance of the service' walker recognized the potential and joined it as president and cEo in early 1999. it became clear to Walker that the ongoing talks were not going to lead to a transaction with the buyer and he requested a 30-day leave from his curfent responsibilit¡es to clean up the company and find someone else to buy it. . . a friend and successful serial business builder. as well as the sales executive. when there were only four employees. The firm provided large recurring billers with a way to have their consumers pay their bills using an automated telephone service known as ¡nteractive voice response. While serving as CFO of the foundation. where securities are While that issued in a business combination transaction. was offered to provide not only speed but also great flexibility for the consumer." technology). He gathered useful experience in the process of taking a company public. as he wasinstrumental in achieving that status for Precept through an 5-4 registration. The key to success was to ensure that the resulting architecture would scale up from 1. who was start¡ng an Internet backbone infrastructure company to provide Internet points of presence. he discovered that there was a great concept hiding inside this poorly managed company. He saw that TelePay had very loyal clients despite a number of nagging technical glitches. Walker was approached by Clint Norton. When Conley again touched base with Walker in 1998. This expensive investment requ¡red trusting that the person could deliver new clients quickly.

BillMatrix is serving as the $350 cornerstone of Fiserv's greater role in the overall payment business. telecom. Aloe Gator. thereby keeping the majority contror of the company and all of the decision-making processes in the hands of the senior "*". walker's ability to make skillful employees. The company continually looks to add other innovations to its service as they become available.isk). walker led the company in a buyout process with a large number of interested parties. This was the second largest acquisition in dollar value for Fiserv which has built itself primarily by acquisition into a $3. the electronic payments industry was considered a hot area and the time was ripe for maximizing the value of an acquisition. The resulting transaction was an acquisition of BillMatrix by Fiserv Inc. a lease was signed on 90. After listening to his problems. over dinner that night with three other individuals. we must always act with the highest ethics and integrity. Multiple technologies are used for real-time connectivity to clÍent systems for data verification and immediate posting of payments. mechanical and production . wisconsin.CHAPTER 11 SOURCES. Jim owned a sun care line. In early 2006.u"r. based upon what is good for the business and good for the clients (but not necessarily those with the least r.s Formula (about g16+ million revenues)-one of the largest operations in North Texas. (NASDAe: FlSv) of and consumer finance industriesWalker's organization has over 175 employees and a strong reputation for operational excellence and exceptional client service in the electronic payments industry. for f million in August 2005. Jim Tehan.OFCAPITAL 3O7 venture capital f. offices. A self-service client information portal delivers real-time payment data to client personnel.000 clients worldwide and 22. has created a strong organizatiori. Since the deal could not be closed in August 2006. His mantra to the employees is: "we handle two of the most important things for óur clients_ their money and their customers. BillMatrix serves a diverse client base of over 125 companies today. insurance. and he and Tehan decided at that time to acquire an existing contract filler.4 billion company with over 16. " n 2005. Inteinet-based payments were added to the telephone service as use of that channel is now expected by consumers. Jim was com- plaining about all of the problems he had with contract fillers. In November. Walker concluded that all these problems were correctible. a growth engine for ¡ts core business of financial technology and services. The company has been at the forefront in applying new technology to electronic bill payments since its restart by walker in 1999. Walker made the decision to build a contract filler company from scratch. walker was meeting with an old friend. including those in the utilities. The company's largest customer was Victoria's Secret ($ 12 million contract). They looked at a company-Nature.o¡ g¡owth.000 square feet of empty warehouse space.

AN OVERVIEW One of the most difficult problems in the new venture creation process is obtaining frnancing. and the first official product batch was filled in early April. The major difference between ProCore and all the rest of the indus- try was that the company employed an internal operating system to manage and monitor by batch. Today.308 PART 4 FROM THE BUSINESS PI-AN TO FUNDING THE VENTURE rooms. was open for business in early March 2007. the payment of which is only indirectly related to the sales and profrts of the venture. The company has quality stan- will not be compromised. Since ProCore is now up and running and the foundation has been built. The focus of ProCore is on quality and partnership.5 million.26 million and in 2008. usually a loan. The com: pany. Scott Walker under- stands how to successfully finance and capitalize a venture. ProCore Laboratories. Debt financing is a hnancing method involving an interest-bearing instrument. Some of Walker's amust have" basic principles applied in this start-up: integrity. customer sales will increase. ProCore is now the largest contract filler in North Texas. For the entrepreneur. With ProCore. Walker is dedicated to being an "entrepreneurial philanthropist. . and the ability to pay bills on t¡me. ProCore's rep- utation spread quickly throughout the industry. Positive cash flow was achieved by December that year." While he is a generous rnonetary donor to his alma mater-Thunderbird School of Global Management-he also provides the more important gift of time with students who are looking for the same knowledge he needed early in his career. above-standard quality. a solid management team (especially the entrepreneur in charge). First year dards that (2007) revenues were around $1. Debt or Equity Financing debt financíng Obtaining borrowed funds for the comp¿ny Two types of hnancing need to be considered: debt irnancing and equity hnancing. Walker proved that it is more about the philosophy of running a company versus having direct experience in the industry. and a warehouse were built utilizing both new and used equipment. The company proved that if it could provide cons¡stent product quality in every batch. the cornpany is flourishing while many of its competitors have shut down operations. no debt. $8. Tehan's goal is to build the company to $500+ million in revenues. Walker is now taking the next stepjumping into a new industry: distribution. the company rarely needs to seek out new customers as rnany come directly to the company. Among his many talents. projected revenues in 2009 are $25+ million. available financing needs to be considered from the perspective of debt versus equity and using internal versus external funds. As a result. In this time of economic turmoil. ethics. His goal is to help the next generation get a quicker start on their ventures by sharing his knowledge about how to build a strong business around a good idea. the focus of this chapter.

CHAPTER 11 SOURCESOFCAPITAL 309 Typicall¡ debt financing (also called asset-based financing) requires that some asset (such or land) be used as collateral. Internal or Externat Funds Financing is also available from both internal and external funds. A hnal method of internally generating funds is collecting bills (accounts receivable) more quickly. and other working-capital items. A short-term. should be on a rental basis (preferably on a lease with an option to buy). a prac"on. debt (as opposed to equity) financing allows the entrepreneur to retain a larger ownership portion in the venture and have a greater retum on the equity. This will help the enüep. and accounts receivable. Key factors favoring the use of one type of hnancing over anotñer are the availability of funds. reduction in working capital.u"h a piece of machinery.Key account holders should not be irritated by implementation of this practice. Long-term debt (lasting more than one year) is frequently used to purchase some asset . with part of the value of the asset (usually from 50 to 80 percent ofthe total value) being used as collateral for the long-terrn loan particularly when mterest rates are low. as . which together make up the capital structure óf the venture. Usually. taking a few extra days to pay can generate needed short-term funds. The entrepreneur needs to be careful that the debt is not so large that regular interest payments become difficult if not impossible to make. not an ownership basis. such as in a small ice cream stand or pushcart in the mall or at a sporting event. the start-up years involve putting all the profrts back into the venture. sale of assets. In some cases' the equity may be entirely provided by the owner. In every new venture. or the operation of the business. extended payment terms. the money is usually used to provide working capital to hnance inventory accounts receivable. ^ equity frnancing Obtaining funds for the company in exchange for ownership All ventures will have some equity. Equity financlng does not require collateral and offers the investor some form of ownership position in the venture. internal source of funds can be obtained by reducing short-term assets: inventory cash. land' or a building. a situation that witl inhibit growth anddevelopment and possibly end in bankruptcy. Assets. house. as a car. The funds most frequently employed are intemally generated funds. even outside equity investors do not expect any payback in these early years. as all ventures are owned by some pgrson or institution. machine. Internally generated funds can come from several sources within the company: profits. There can also be an additional fee."o"* cash. plant. there is always equity funding involved that is proviáed by the owner. sometimes referred to as points. This equity funding provides the basis for debt funding. for using or being able to borrow the money. and the prevailing interest rates. an enrrepreneur meets financial needs by emptoying a combination of debt and equity financing. The needed funds can sometimes be obtained by selling littleused assets.Although care must be taken to ensure good supplier relations and continuous sources ofsupply. the assets ofthe venture."*" tice that is particularly critical during the staft-up phase ofthe company's operation. as long as there is noia high level of inflation and the rental terms are favorable. The investor shares in the profits of the venture. Debt financing requires the entrepreneur to pay back the amount of funds bonowed as well as a fee expressed in terms of the interest rate. whenever possible. Sometimes an entrepieneur can generare the needed cash for a period of 30 to 60 days through extended payment terms from suppliers. The amount of equity involved will ofcourse vary by the nature and size of the venture. If the financing is short term (less than one year). Although the owner may sometimes not be directly involved in the day-to{ay management of the venture. Larger ventures may require multiple owners' including private investorS and venture capitalists. The funds are typically repaid from the resulting sales and profits during the year. as well as any disposition of its assets on a pro rata basis based on the percentage of the business owned.

and other sources (2 percent).. new ventures are started without the personal funds of the entrepr€neur.. pay their bills to supplying companies in 60 to 90 days. or the discount offered for prompt payment. The typical sources ofpersonal funds include savings. SBA loans (1 percent). bank loans (16 percent). [f a company wants this mass merchandiser to carry its product. and he obtained over $15. Mass merchandisers. commercial banks. Whenever an entrepreneur deals with items external to the hrm. ethical dilemmas can sometimes occur. credit cards (10 percent). ¡¡..000 in eatly payment savings in 2002 alone... Altemative sources of external financing need to be evaluated on three bases: the length of time the funds are available.. life insurance. but they are absolutely essential in attracting outside funding.1. venture capital.'. or Few. government loan programs and grants. Con¡¡o¡ . particularly with people and institutions that could become stakeholders. the sale of another business (l percent). The firms in the"Entrepreneur2N3 Hot 100" list got start-up capital from savings (61 percent)' private investors (31 percent). particularly from banks. private investors. each of the sources indicated in Table I l. I needs to be evaluated along these three dimensions. certain customers have established payment practices.. and private placement) indicated in the table a¡e discussed at length in the following pages. One entrepreneur who is very successful at leveraging the discounts from vendors is home product distributor Jeff Schreiber. family and friends. . R&D limited partnerships.'-. In selecting the best source of funds. the costs involved.r The other general source of funds is external to the venture. friends and family (18 percent). Schreiber always tries to take advantage of any discounts for prompt payments. and the amount of company control lost. regardless of a supplying company's accounts receivable policy. PERSONAL FUNDS if any. Not only are these the least expensive funds in terms of cost and control.310 PART 4 FROMTHEBUSINESSPLANTOFUNDINGTHEVENTURE Cos! .. and venture capitalists. the size of the company. The more frequently used sources of funds (self. home equity lines of credit (17 percent). for example. it will have to abide by this payment schedule.

at Charles River Ventures who counts himself as a icism. But in February.subscriptions.TheFunded. partner a in for increasing scrutiny and in many cases harsh crit.: has'long had á probtem with authority en he was in college. as welt as $2t0g-a-year As an entrepreneur who has started numerous com. As one venture capitalist succinctly said. didn't apologize.' as much information as they could about my business. "He's always done his own thing. waving his long says. The idea was to create a place to fused to submit a traditional thesis. . but Ressi knew he: ha:d:to do' ihe paper as his senior thesis. But it may be tough to persuade VCs to cut him a The idea forTheFunded was born out of Ressi's ex. the developer of online Establishment. in a cramped confer." reads another. " Ressi retorts: "Anonymity provides entrepreneurs reads one recent post.2005. and Ressi quickly With his latest venture. as venture firms have come volvement and influence. softbank men"'bv Spencer E' Ante' pulled its offer.. . says TheFunded should forbid anonyence room in his Greenwich Village office. Ressi pulls view. the i5-year. previously secretive industry. 9 web Matrix partners.with a comfortable environment to speak their minds mosphere. These outside providers of capital t'eel that the entrepreneur may not be sufficiently committed to the venture if he or she does not have money invested. at the University of a.:. Ressi points to a third com_ freely. He says the site is profitable and nitely needed a kick in the 450 subscribers. so over the wi¡ter ¡n zoó0. "Venture capital defi. It's certainly getting one.'.' ment about a venture employee who was 40 minutes TheFunded could create long-term challenges for late for an appointment. TheFunded has become venture firms are pressuring Ressi for more inthe talk of silicon Valley.. "yes.. younger brother Alex Ressi.*ñ wouldn't accept them. a $10 milf ¡on ¡nvestment from Softbank Capital for a second round of funding. . Georje isn't a big money maker.friend of Ressi's. "I want the entrepreneurs so hnancially committed that when the going gets will be games he founded in 2002...1. The withdrawal set in motion a chain mortgage on a house or car. "There should be more .. :r'. in revenue by selling advertising. he ran I .check after he has so publicly taken on the industry perlence at Game Trust. . He never did get help him evaluate venture capitalists in case he a degree."lt was a very unfriendly at. Ressi dug in his heels and re.. they will work through the problems and not rhrow the keys to the company on my desk.They stole up stuff. A year ago.The Truth about old New Yorker started up TheFunded. and post comments about venture capital fi1ms.'. typicatly to the institutional investors panies." he savs with a smile..juicy stories under titles such as . "How much you wanna bet that guy raise venture rnoney for one of his future he says. he pecked his way through the site. gets fired in a few months?'. who began plrt¡né Establishment:once again. Ressi mous posts.'.. As a frenetic entrepreneur. but his professor something. on 2008issueof BusinessWeek 8bvTheMcGraw-Hill the day the deal was supposed to close. revenue "will easily hit seven figures.'this year." he says. Ressi . .. one recent winter day. Ressi says he had lined up difficult. To date.:SHOW'ME THE MOÑEYM . site that lets entrepreneurs anonymously rank" reTheFunded. chord with other entrepreneurs. Ressi saw a need to shine a spotlight on the who put rnoney i4to venture funds.r. ves newspaper "nHe"nuironaental caffed rhe Green Timestried to turn in copies of The coup failed." 31f : ... Adeo Ressi is taking on the signed up hundreds of members. .-ñ." says neededtoraisemoneyin'thefuture. and then Ressi.Thesitestrucka. "Anonymous comments allow people to make arms and poking at the computer screen.1. ': ed . he likely will try to was obnoxious.

000.312 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENruRE This level of commitment is reflected in the percentage of total assets available that the entrepreneur has committed. the entrepreneur must present the positive and negative aspects and the nature of the risks of the investment opportunity to try to minimize the negative impact on the relationships with family and friends should problems occur. Particular conc€rn should be paid to any hardships that might result should the business fail. FAMILY AND FRIENDS After the entrepreneur.000 depends on the assets avallable. like all sources of capital. as such. It is amazing how short memories become when money is involved. The funds proüded a¡e in the form of debt ftnancing and. Any loan should specify the rate ofinterest and the proposed repayment schedule ofinterest and principal. if it is in the form of equity financing. COMMERCIAL BANKS Commercial banks are by far the source of short-term funds most frequently used by the entrepreneur when collateral is available. which may have a negative effect on employees. Such things as the amount of money involved. This may make them feel they have a direct input into the operations of the venture. family and friends a¡e a common source of capital for a new venture. the rights and responsibilities of the investor. Although this possibility must be guarded against as much as possible. potential future conflicts can be avoided. an indication that he or she truly believes in the venture and will work all the hours necessary to ensure success. One thing that helps to minimize possible difficulties is to keep the business arrangements strictly business. A formal agreement with all these items helps avoid future problems. not because they feel obligated. the terms of the money. not necessarily in the amount of money committed. An outside investor wants an entrepreneur to have committed all available assets. Although it is relatively easy to obtain money from family and friends. facilities. require some tangible guaranty or collateral-some asset with value. If the family or friend is treated the same as any investor. En' trepreneurs should always rem¿mber that it is not the amount but rath¿r the fact that all monies avaílable are committed that mal<es outsüe investors feel comfortable with their commitment level and therefore more willing to invest.üD. or $250. To avoid problems in the future. there are positive and negative aspects. Although the amount of money provided may be small. . Whether this is $1. and what happens if the business fails must all be agreed upon and written down. The timing of any future dividends must be disclosed in terms of an equity investment. or sales and profits. Any loans or investments from family or friends should be treated in the same businesslike manner as if the financing were from an impersonal investor. They are most likely to invest due to their relationship with the entrepreneur This helps overcome one portion of uncertainty felt by impersonal investors-knowledge of the enrepreneur. Finally. All the details of the frnancing must be agreed upon before the money is put into the venture. Each family member or friend should be investing in the venture because they think it is a good investment. Family and friends provide a small amount of equity funding for new ventures. reflecting in part the small amount of capital needed for most new ventures. the entrepreneur should carefully consider the impact of the investment on the family member or friend before it is accepted. $100. the family members or friends then have an ownership posiúon in the venture and all rights and privileges of that position. frequently family and friends are not problem investors and in fact a¡e more patient than other investors in desiring a return on thei¡ investment. It is also beneficial to the entrepreneur to settle everything up front and in writing.

The cost of factoring the accounts receivable is of course higher than the cost of securing a loan against the accounts receivable without factoring being involved. Usually.rnanced depending on its salability. of money borrowed Accounts Receivable Loans Accounts receivable provide a good basis for a loan. if any of the receivables is not collectible. the factor (the bank) sustains the loss. the company acquires the use ofthe equipment through a small down payment and a guarantee to make a specif. or real estate. To ensure repayment. This mortgage hnancing is usually easily obtained to hnance a company's land. car.I 1 SOURCES OF CAPITAL 313 This collateral can be in the form of business assets (land. [n this case.The total amount paid is the selling price plus the hnance charges. . the hnished goods inventory can be financed for up to 50 percent of its value. equipment. not the business. since the bank has more risk when factoring. personal assets (the entrepreneur's house. the commission covering the actual collection. or lease financing. Types of Bank Loans asset base for loans Tangible collateral valued at more than the amount There are several types ofbank loans available. inventory equipment. lO-year basis. In the sale-leaseback arrangement. such as automobile and appliance dealers. sale-leaseback financing. the entrepreneur "sells" the equipment to a lender and then leases it back for the life of the equipment to ensure its continued use. Trust receipts are a unique type of inventory loan used to ftnance floor plans of retailers. stock. sale-leaseback or lease frnancing of equipment is widely used. The costs of factoring involve the interest charge on the amount of money advanced until the time the accounts receivable are collected. plant. a bank may finance up to 80 percent of the value of thei¡ accounts receivable. Rea[ Estate Loans Real estate is also frequently used in asset-based hnancing. Given the entrepreneur's tendency to rent rather than own. or bonds). particularly when the inventory is liquid and can be easily sold. the bank advances a large percentage of the invoice price goods and is paid on a pro rata basis as the inventory is sold.CHAPTER . and protection against possible uncollectible number of payments over a period of time. or the building ofthe venture). when new equipment is being purchased or presently owned equipment is used as collateral. or the assets of the cosigner of the note. When customers such as the govemment are involved. 'fhe asset base for loans is usually accounts receivable. In lease financing. usually on a 3. an entrepreneur can develop a factoring a-rrangement whereby the factor (the bank) actually "buys" the accounts receivable at a value below the face value ofthe sale and collects the money directly from the account. often up to 75 percent ofits value. usually 50 to g0 percent of the value of the equipment can be f. For those creditworthy customers. Equipment financing can fall into any of several categories: frnancing the purchase of new equipment. or another building. Inventory Loans Inventory is another of the firm's assets that is ofúen a basis for a loan. especially if the customer base is well known and creditworthy. financing used equipment already owned by the company. ofthe Equipment Loans Equipment can be used to secure longer-term financing. In trust receipts. these loans are based on the assets or the cash flow of the venture.

These self-liquidating loans are frequently used for seasonal financing and for building up inventories.000 loan. These decisions are based on both quantifiable information and subjective judgments.:Hffi:i"'ffillü . company pays a "commitment fee" to ensure that the commercial bank will make the loan when requested and then pays lnterest on any outstanding funds borrowed from the bank. Past financial statements (balance sheets and lncome statements) are reviewed in terms of key profitability and credit ratios.::Ji. Character Loans When the business itself does not have the assets to support a loan. with only interest paid the frrst year. installment loans. inventory turnover.000 certificate of deposit as collateral for his son's $40. The debt incurred is usually repáid according to a fixed interest and principal schedule. the entrepreneur may need a character (personal) loan. and character monev'fo co*u'anies iH'.aiH"T3.r'i:n ii :fjji. mature companies) can make funds available for up to 10 years. In extremely rare instances. These loans (usually available only to strong. the loan must be repaid or reduced to a certaiil agreed-upon level ona periodic basis. Straíght Commercial Loans A hybrid of the installment loan is the straight commercial loan. the entrepreneur can obtain money on an unsecured basis for a short time when a high credit standing has been established. the entrepreneur's capital invested. such as when seasonal financing is needed. Regardless of geographic location. Frequently.ilj lT. capacity. and conditions.:'liJ. One entrepreneur's father pledged a $50. howeveq can sometimes start being repaid in the second or third year of the loan. since they do not want to incur bad loans.i. straight commercial loans. The principal. long-term loans. These loans frequently must have the assets ofthe entrepreneur or other individual pledged as collateral or the loan cosigned by another individual. commercial loan decisions are made only after the loan offrcer and loan committee do a careful review of the borrower and the hnancial track record of the business. particularly to new ventures. long-term loans are used. capital. homes. Long-Term Loans When a longer time period for use of the money is required. and commitment .'"T . Instaltment Loans Installment loans can also be obtained by a venture with a track record of sales and profits.. These loans are usually for 30 to 40 days. collateral. Assets that are frequently pledged include cars. by which funds are advanced to the company for 30 to 90 days. land' and securities. These short-term funds are frequently used to cover working capital needs for a period of time.314 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENruRE Cash Flow Financing The other type of debt financing frequently provided by commercial banks and other ficonventíonalhanklaan nancial institutions is cash flow financing. Banks are generally cautious in lending money. aging of accounts receivable. These conventional bank loans include lines Standardwavbanks lend of credit. Bank Lending Decisions One problem for the entrepreneur is determining how to successfully secure a loan from the bank.2 The bank lending decisions are made according to the five Cs of lending: character.

sales. This information provides the loan offtcer and loan committee with insight into the credinvorthiness of the individual and the venture as well as the ability of the venture to make enougfi sales and proht to repay the loan and the interest. and repayment schedule. amount and use of the loan. and profitability are also evaluated to determine the ability to repay the loan. This intuitive part ofthe loan decision becomes even more important when there is little or no track record. a nonproprietary product or service (one not protected by a patent or license). land and building. an altemative is a guaranty fmm the Small Business Administration (SBA). The entrepreneur should evaluate the track record and lending procedures of several banks to secure the money needed on the most favorable terms available. and then carefully present the case for the loan to the loan offrcer. select the one that has had positive loan experience in the particular business area. debt refinancine. the entrepreneur should borrow the maximum amount that can possibly be repaid as long as the prevailing interest rates and the terms. Presenting a positive business image and following the established protocol are necessary to obtain a loan from a commercial bank. an entrepreneur is missing the necessary track record. The Basic 7(a) Loan Guaranty is the SBA s primary business loan program. leasehold improvements. call for an appointment. Generally. business projec- viding tions.CHAPTER -I1 SOURCES OF CAPITAL 3f 5 to the business. andeven. The SBA offers numerous loan programs to assist small businesses. . the SBA is primarily a guarantor of loans made by private and other institutions. a good loan application. generally the application format is a "mini" business plan that consists of an executive summary. Some of the concerns of the loan offrcer and the loan commitÍee can be reduced by pro. ROLE OF THE SBA IN SMALL-BUSINESS FINANCING Frequently. the intuitive factors. conditions. The proceeds from such a loan can be used for a variety ofbusiness purposes. The entrepreneur should evaluate several alternative banks. and restrictions of the loan are satisfactory. This "bank shopping procedure" will provide the needed funds at the most favorable rates. financial statements. Several questions are usually raised regarding this ability. The entrepreneur must present his or her capabilities and the prospects for the company in a way that elicis a positive response from the lender. While the specific loan application format of each bank differs to some extent. particularly the hrst two Cs---character and capacity-are also taken into accounl This part of the loan decision-the gut feeling-is the most diffrcult part to ¿rssess. This program helps qualifred small businesses obtain hnancing when they cannot obtain business loans through regular lending channels. under some conditions. such as working capital. Future projections on market size. business description. When the entrepreneur is unable to secure a regular commercial bank loan. It is essential that the venture generate enough cash flow to repay the interest and principal on the loan in a timely manner. assets. or few assets available. limited experience in hnancial management. [n each of these. machinery and equipmenl furniture and f. Does the entrepreneur expect to be carried by the loan for an ex- Although the answers to these questions and the analysis of the company's records allow the loan officer to assess the quantitative aspects of the loan decision.rxtures. owner/manager profiles. or some other ingredient to obtain a commercial bank loan.

they not only have a model for making the right choices-they have the motivat¡on to do it. 2. But there is one kind of problem the Obama Administration has yet. too. All owners of 20 percent or more are required to personally guarantee SBA loans. Lead by Example. call for creative solutions. being the ethícs czar applies not just to how you lead your organization. members of Congress. A contempt for ethics lies at the heart of almost every top story of the day: Yankee hitter Alex Rodriguez admitting to steroid use. While repayment ability from the flow of the business is of course essential. who should set high standards in you¡ organization and do your level best to live up to them. The most effective way to promote ethical behavior According to the annual USA TodaylGallup Poll. and owner's equity contribution. Eligibility factors for all 7(a) loans include size. is to demonstrate it in all that you do. I her:eby offer six simple rules for ethical leadership at work. A CODE OF CONDUCT FOR ETHICS CZARS WHAT WE NEED IS AN ETHICS CZAR 1. too. the maximum guarantee to the lender by the SBA will be $l million or 50 percent. other criteria include good characteq management capability. use ofproceeds. only 22o/o of Americans held state governors in high esteem. When members of your team see that you tell the truth when it would be easier to be dishonest. When was the last time you told someone she was doing a good job? Yes. but also to how yor¡r lead your life. In fact.t¡m. investor Bernard L. Anyone can take the low road. Praise Generously. Show your team that you are such a person. type ofbusiness. and the availability offunds from other sources. and in your community. or own up to your mistakes rather than blaming someone else. it's the smart thing to do. it's ¡mportant for managers to let employees know when they've gotten off track.I cs wE NEED'AN rtHrcs czAR ever-mounting social and economic problems. tackle. Bankers had it espe- cially rough in the latest poll: Their approval rating fell from 35% to 23%. and the'Piesident is right to look for the best and the brightert to heal our battered economy and bruised infrastructure. But it may be even more important to tell people when they've done To get a 7(a) loan. the entrepreneur must be eligible. but it takes a person of character to take the high road consistently. or at least attempt to do so. Tough . howeveri striving to live an ethical life isn't just the right thing to do. Madoff confessing to running the largest Ponzi scheme in history a report by the Josephson Institute stating that 64% of high school students cheat and 30% steal. even though it malr be the most pervasive one of all. Though the interest rates on the loan are nesotiated between the borrower and the lender thev are subiect to SBA cash 316 : . ure of our leaders-and the rest of us-to take ethics seriously. with your family and friends. The SBA 7(a) loan program has a maximum loan amount of $2 million with the SBA s maximum exposure of $1 million. Even before the Blagojevich scandal hit the news. less than one American in four rates highly the ethical standards of business executives. tu | have argued repeatedly in this column. lt is a distressing is-sue about which everyone iomplains but no oné has been able to address effectively: The widespread fail. or react to a stressful situation with compassion rather than hostility. or stockbrokers. In the case of a $2 million loan.

2OO9 issue of BusinessWeex by special permission. and this is where you come in. B maximums. lt does.000 and Some differences occur in SBA Express loans (maximum guarantee of 50 percent) and export working capital loans (maximum guararitee of 90 percent). but living by the above guidelines will make your own corner of the world a more dignified place to be. lenders are charged a guaranty and sewicing fee for each approved loan. lt often takes very little effort to make a big difference. copyrighr @ 2009 by The McGraw-Hill Companies.000 or less and 75 percent for loans between $150. For example. So urce: Reprinted from March 13. You just may end up being the most effect¡ve czar of them all. since others may not step up to the plate. take courage. ..htm. of $50. which are pegged to the prime rate and may be hxed or variable. "We Need an Ethics Czar to Battle a Widespread Breakdown in Standa¡ds. rc ine s sWe ek magazine: www-businessweek-com/managing/ contenlmar2O09 /ca200903 13 869 I 03. PhD.000 or more must not exceed prime plus 2. They won't. $ I million.25 percenrif the matu_ rity is less than seven years. The SBA can guaraRtee 85 percent ofthe loan for loans of$150. These fees can be passed on to the borrower and vary depending on the amount of the loan.Don't assume problems will take care of themselves." by Bruce Weinstein. You can't solve every problem in the world. To help offset the costs of the SBA loan programs. however. a fixed-rate loan Most of the loans have the same gua¡antee features. Inc.

Another more recent SBA loan program that many entrepreneurs have used is the SBA Microloan. the SBA has several other programs. Second. The sponsoring company usually has the base technology but needs funds . When the technology is successfully developed in later years. as well as the ensuing rewards. or even real estate in order to expand or modemize. The sponsoring company does not guarantee results but rather performs the work on a best-effort basis. Consequently. gram is usually $1 million. these profits for tax purposes are at the lower capital gains tax rate as opposed to the ordinary income rateThe final component. Major Elements limited partner A party in a partnership agreement that usually supplies money and has a few responsibilities generalpartner The overall coordinating party in a partnership agreement The three major components of any R&D limited partnership are the contract.000 to small businesses for working capital or the purchase of inventory. This program provides short-term loans of up to $35. since the risks. and the limited partnership. The second component involved in this contract is the limited partners. being compensated by the partnership on either a hxed-fee or a cost-plus arrangement. supplies. The 504 loan program provides fixed-rate financing to enable small businesses to acquire machinery. A typical R&D partnership arrangement involves a sponsoring company developing the technology with funds being provided by a limited partnership of individual investors. machinery. are shared. R&D limited partnerships are particularly good when the project involves a high degree of risk and significant expense in doing the basic research and development. The maximum of the pro. whereby the sponsoring company agrees to use the funds provided to conduct the proposed research and development that hopefully will result in a marketable technology for the partnership. with the loan being guaranteed in full by the SBA. The entrepreneur should check with the SBA to see whether a loan program is available. The SBA also provides such loans as Home and Personal Property Disaster Loans. a 7(m) loan program. acts as the general partner developing the technology. including a loan from a Community Development Company (CDC) backed by a 100 percent SBA-guaranteed debenture. This method of financing provides funds from investors looking for tax shelters.318 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE In addition to the 7(a) loan program. hxtures. any tax benefrts ofthe losses in the early stages ofthe R&D limited partnership are passed directly to the limited partners. if a loan cannot be obtained without the SBA guarantee- RESEARCH AND DEVELOPMENT LIMITED PARTNERSHIPS res earch and d. and the loan can take a variety of forms. The typical contract has several key features. equipment. the sponsoring company. the partners share in the prohts. The first is that the liability for any loss incurred is borne by the limited partners. Physical Disaster Business Loans. the sponsoring company. and Military Reservist Economic Injury Disaster Loans. The small business receives the loan from a bank or other organization. The contract specihes the agreement between the sponsoring company and the limited partnership. In some instances. or equipment. there are some tax advantages to both the limited partnership and the sponsoring company. furniture. Similar to the stockholders of a corporation. the limited partners have limited liability but are not a total taxable entity. The loan cannot be used to pay existing debts.e velnp me nl limiled partnerships Money given to a firm for developing a technology that involves a tax shelter Research and development limited partnerships are another possible source of funds for entrepreneurs in high-technology areas. offsetting other income and reducing the partners' total taxable incomes.

Procedure An R&D limited partnership generally progresses through three stages: the funding stage. Here the sponsoring company and the partners form ajoint venture to manufacture and market the products developed from the technology. time and money are expended. a royalty based on the sale of the products developed from the technology is paid by the sponsoring company to the R&D limited partnership. An R&D limited partnership frequently takes a minimum of six months to establish and $50. To give up . the sponsoring company performs the actual research.000 in costs for a major effort. or cap. An alternative is to incorporate the R&D limited partnership itself and then either merge it into the sponsoring company or continue as a new entity. And the track record is not as good. Typically. [n this situation. andjoint ventures. royalty partnerships. the agreement allows the company to buy out the partnership inte¡est in the joint venhrre at a specifled time or when a specified volume of sales and prof. the development stage. There are three basic types of arrangements for doing this: equity partnerships. The sponsoring company usually retains the rights to use this base technology to develop other products and to use the developd technology in the future for a license fee. A final exit arrangement is through a joint venture. A possible alternative to the equity partnership arrangement is a royalty partnership. and the money is invested for the proposed R&D effort. It is this base technology that the company is offering to the partnership in exchange for money. Usually. Among the several benehts is that an R&D limited partnership provides the funds needed with a minimum amount of equity dilution while reducing the risls involved. the sponsoring company and the limited partners form a new. There are some costs involved in this financial arrangement. Second. All the terms and conditions of ownership. In the typical equity partnership anangement. First. and the exit stage. In the funding stage. Benefits and Costs As with any financing arrangement. are carefully documented. Frequently. the entrepreneur must carefully assess the appropriateness of establishing an R&D limited partnership in terms of the benefrts and costs involved.CHAPTER 11 SOURCESOFCAPITAL 319 to further develop and modify it for commercial success. it is more expensive to establish than conventional financing. in which the sponsoring company and the limited partners commercially reap the benehts of the effort. a contract is established between the sponsoring company and limited partners. as well as the scope of tbe resea¡ch. The royalty rates typically range from 6 to 10 percent of gross sales and often decrease at certain established sales levels. Sometimes. These can increase to a year and $400. On the basis of the formula established in the original agreement.000 in professional fees.rt has been reached. In addition. a cross-licensing agreement is established whereby the partnership allows the company to use the technology for developing other products. the restrictions placed on the technology can be substantial. is placed on the cumulative royalties paid. as most R&D limited partnerships are unsuccessful. the limited partners' interest can be transferred to equity in the new corporation on a tax-free basis. In the development stage. Ifthe technology is subsequently successfully developed the exit stage commences. an upper limit. jointly owned corporation. the sponsoring company's financial statements are strengthened through the attraction of outside capital. using the funds from the limited partners.

Sgovemment to small technology-based businesses The entrepreneur can sometimes obtain federal grant money to develop and launch an innovative idea. Genentech was so successful in developing human growth hormone and gamma interferon products from its hrst $55 million R&D limited partnership that it raised $32 million through a second partnership six months later to develop a tissue-type plasminogen activator. evaluates. Small businesses . The Small Business Innovation Resea¡ch (SBIR) program. Each agency develops topics and publishes solicitations describing the R&D topic it wilt fund. GOVERNMENT GRANTS SBIR grunts program Grants from the U. Syntex Corporation raised $23. Indeed.5 million in an R&D limited partnership to develop five medical diagnostic products. there are numerous examples of successful R&D limited partnerships. And rhe list goes on. Examptes In spite of the many costs involved. and selects the research proposals for funding. Eleven federal agencies are involved in the program (see Table 1 1. the exit from the partnership may be too complex and involve too much frduciary responsibility. These costs and benehts need to be evaluated in light of other financial alternatives available before an R&D limited partnership is chosen as the funding vehicle.2). was creaúed as part of the Small Business Innovation DevelopmentAcL The act requires that all federal agencies with R&D budgets in excess of $100 million award a portion of their R&D funds to small businesses through the SB/R grants progran. R&D limited partnerships offer one hnancial alternative to fund the development of a venture's technology.320 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE the technology developed as a by-product of the primary effort may be too high a price to pay for the funds. Third. Trilogy Limited raised $55 million to develop a high-performance computer. designed for the small business. This act not only provides an opportunity for small businesses to obtain resea¡ch and development money but also offers a uniform method by which each participating agency solicits.

. Inc. copgight @ 2008 by The McGraw- Hill Companies. "From 40l(k) Nest Egg to Seed Money. BusinessWeek Issue 41 13. 321 . 64. p.' by Brian Burnsed.Source: Reprinted from the December 22.20O8 issue of BusinessWeek by special permission.

regardless of the agency. there is no employment stipulation in the STTR program. The SBIR grant program has three phases. with at least 40 percent of the research conducled by the small business and at least 30 percent conducted by the partnering . Each agency. Each of these annual solicitations contains documentation on the agency's R&D objecúves. All these.m0 for 24 months of further research and development. also participate in the SBIR program. and selection and evaluation criteria. and has any organizational structure (corporation. The money is to be used to develop prototype products or services. Federal agencies with budgets over $l billion are required to set aside 0. while in the SBIR program. follows the standard proposal format. which is somewhat standardized. Funds from the private sector or regular goverDment procurement contracts are needed to commercialize the developed technologies in Phase III. and obt¿ined a commitment for follow-on private-sector financing in Phase III for commercialization. Finally. The objective here is to determine the technical feasibility of the research effort and assess the quality of the company's performance through a relatively small monetary commitment. Successful projects are then considered for further federal funding support in Phase II. deadlines. awards are granted to those projects that have the best potential for commercialization. While a comparison of the SBIR and STTR programs is found in Table 11. research data.2) publish solicitations describing the areas of research they will fund. the STTR program requires research partners at universities or other nonproht institutions. the Department of Energy (DOE). A small business receiving a Phase II award has demonstrated good research results in Phase I. Knowledgeable scientists or engineers then evaluate those that pass the screening on a technological basis. due dates. Phase III does not involve any direct funding from the SBIR program. Another grant program available to the entrepreneur is the Small Business Technology Transfer (STTR) program. In contrast. The proposal. Five agencies participate in the STTR programthe Department of Defense (DOD). Phase II awa¡ds are up to $750. the Department of Health and Human Services (DHHS). employs 500 or fewer individuals. except DHHS. sole proprietorship). The government agencies participating (indicated in Table I 1. for the duration of the project.322 PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENruRE submit proposals directly to each agency using the required format. or cooperaftve agreement. Second. Phase II is the principal R&D effort for those projects showing the most promise at the end of Phase I. the principal investigator must have his or her primary employment with the small business receiving the award. and the National Science Foundation (NSF). Any patent rights. developed a proposal of sound scientific and technical merit. proposal format. the National Aeronautics and Space Administration (NASA). technical data. The second step involves the submission of the proposal by a company or individual. Phase I awards are up to $100. partnership. which was established by the Small Business Technology Transfer Act of 1992. the two programs differ in two major ways: First. and software generated in the research are owned by the company or individual.3 percent for small businesses. using its established evaluation criteria evaluates each proposal on a competitive basis and makes awa¡ds through a contract grant. The SBIR grant program is one viable method of obtaining funds for a technologybased entrepreneurial company that is independently owned and operated.000 for six months of feasibility-related experimental or theoretical research. which is 25 pages maximum. not by the govemment. Each agency screens the proposals it receives.3. Procedure Applying for an SBIR grant is a straightforward process.

atwhich time the employee should be fully productive. particularly in deciding where to locate his or her company. and local levels. . These training grants often t¿ke the form of paying 50 percent of the salary of the employee for up to the first year. state.CHAPTER 11 SOURCESOFCAPITAL 323 nonproht institution. The SBIR program has a maximum of 33 percent [phase I] and 50 percent [Phase II] in consulting costs. The procedure for obtaining an STTR award is the same as for the SBIR award- Other Government Grants There are other grants available to the entrepreneur at the federal. These take many different forms and vary greatly depending on the objectives of the level of government involved and the geographic area. Many of the states and cities in the United States also have grant incentive programs for developing technology and technology companies located in the particular state andlor providing jobs in labor surplus areas. Often in terms of locating or building a facility in the state or city. these incentives take the form of a tax reduction for a period of time. Sometimes the federal and some state governments provide training grants to companies locating in anüor hiring in what has been determined to be a labor surplus area. Companies locating in these areas often ger some rax reductions at the state and federal levels for a period of time. Grants are also available in many countries and cities throughout the world. The entrepreneur should investigate all possible grants available.

every 6 months thereafter. Rule 505. Regulation D requires the issuer of a private offering to file five copies of Form D with the Securities and Exchange Commission (SEC) 15 days after the hrst sale. Still othen are more passive in nature. or lawyers in making thei¡ investment decisions. The entrepreneur issuing the private offering carries the burden of proving that the exemptions granted have been met. It also provides rules governing the notices of sale and the payment of any commissions involved. also called angels. desiring no active involvement in the venture at all. Since this process was established primarily to protect unsophisticated investors. financial planners. Some investors want to be actively involved in the business. These sophisticated investors still need access to material information about the company and its management. technical experts.324 PART 4 FROM TI. in large part due to the numerous regulations and requirements involved. This involves completing the necessary documentation on the degree of sophistication of each potential investor. and may even be involved to some degree in the business operation. The date . can influence the naJure and di¡ection of the business to some extent. Private Offerings private olfering A formalized method for obtaining funds from private ilvestors A formalized approach for obtaining funds from private investors is through a private offering. others desire at least an advisory role in the di¡ection and operation of the venture. What constitutes material information? Who is a sophisticated investor? How many is a limited number? Answers to these questions are provided in Regulation D. a private offering is faster and less costly when a limited number of sophisticated investors are involved who have the necessary business acumen and ability to absorb risk. Public offerings involve a gneaa deal of time and expense. who may be family and friends or wealthy individuals. The degree of involvement in the day-to-day operations ofthe venture is an important point for the entrepreneur to consider in selecting an investor. and 30 days after the ñnal sale.{E BUSINESS PLAN TO FUNDINGTHEVENruRE PRIVATE PLACEMENT Another source of funds for the entrepreneur is private investors. Each offering memorandum presented to an investor needs to be numbered and must contain instructions that the document should not be reproduced or disclosed to any other individual. Regutation D Regulalion D Laws governing a private offering D contains (l) broad provisions designed to simplify private offerings. (2) general definitions of what constitutes a private offering. Types of Investors An investor usually takes an equity position in the company. and Rule 506. A private offering is different from a public offering or going public (as discussed in Chapter I 2) in several ways. Business angels are discussed in more detail in Chapter 12. Each investor is primarily interested in recovering his or her investment plus a good rate of return. and (3) specifrc operating Regulation rules-Rule 504. The process of registering the securities with the Securities and Exchange Commission (SEC) is an arduous task requiring a significant number of reporting procedures once the frrm has gone public. Individuals who handle thei¡ own sizable investments frequently use advisors such as accountants.

and general partners of the issuing company. no general advertising or solicitation through public media can be involved- ties law by damaged investors have almost no statute of limitations. At the close of the offering.Still.CHAPTER 11 SOURCESOFCAPITAL 325 that the investor (or the designated representative) reviews the company's informationthat is. executive officers.rhes ' This rule per- tr#. ttre offering needs to verify and note that no persons other than those recoided were "o.000 in each of the last two years. ar¡d (5) directors.T"":l excess of $2ffi. its books and records-as well as the date(s) of any discusrionl"tw""o the company and the investor need to be recorded. goes one step further than Rule 505 by allowing an issuing company to sell an unlimited number of securities to 35 investors and an unlimited number of accredited investors and relatives of issuers. as the time does not .niony contactod re- Rule 505 mits the sare period.

Also. A business usually needs capital when it can least afford the time to raise it. If this is not enough of an incentive. and operating costs. Second. the entrepreneur may not be paying enough attention to the important areas of marketing. Unsophisticated investors are particularly a problem as they often object to a company's moving away from the focus and direction outlined in the business plan that attracted their investment. One company's CEO spent so much time raising capital that sales and marketing were neglected to such an extent that the forecasted sales and proht figures on the pro forma income statements were not met for the f. or the restoration of the monies involved. This emphasis on short-term performance can be at the expense of the long-term success of the company. ful manager would .326 PART 4 FROM THE BUSINESS PLANTO FUNDINGTHEVENTURE begin until the person harmed discovers or should reasonably be expected to discover the improper disclosure. Fourth. the entrepreneur is under pressure to continuously grow the company so that an initial public offering can occur as soon as possible. This can hamper the direction. During this time. and creativity ofthe entrepreneur. It can cause a company to hire more staffbefore they are needed and to move into more costly facilities. outside capital may cause disruption and problems in the venture. Capital is not provided without the expectation of a return. Given the number of lawsuits and the litigious nature of U.3 This approach is particularly important at st¿rt-up and in the early years of the venture when capital from debt financing (i. The same concept could apply to outside funded companies that may have the tendency to substitute outside capital for income. outside capital has other costs as well. First. without any individual lawsuit involved. One successnever hire a person as one of his commission salespeople if he or she "looked too prosperous. it should be kept in mind that the SEC can take administrative. sometimes before the business should be giving one. society. Third. Finally. This led to investor concern and irritation that. outside capital can decrease the company's flexibility. in turn. product development. in terms of loss of ownership) is more expensive.. This action can result in fines. he or she would not push ha¡d to sell.S. the availability of capital increases the impulse to spend.e. A company can easily forget the basic axiom of venture creation: staying lean and mean. imprisonment. the entrepreneur needs to be extremely careful to make sure that any and all disclosures are accurate.rrst three years after the capital infusion. In addition to the monetary costs. sales. outside capital often decreases a firm's drive for sales and profits. An individual can frle suit as a single plaintiff or as a class action on behalf of all persons similarly affected. BOOTSTRAP FINANCING One alternative to acquiring outside capital that should be considered is bootstrap financing. required more of the CEO's time. it usually takes between three and six months to raise outside capital or to find out that there is no outside capital available. civil. drive. This can substantially demoralize the entrepreneur who likes the freedom of not working for someone else. in terms of higher interest rates) or from equity hnancing (i.. particularly if certain equity investors are involved." He felt that if a person was not hungry. This attitude can encumber a company to such an extent that the needed change cannot be implemented or else is implemented very slowly after a great deal of time and effort has been spent in consensus building. or criminal action as well.e. Courts have awarded large attorney's fees as well as settlements when any securities law violation occurs. The suit may be brought in federal court in any jurisdiction in which the defendant is found or lives or transacts business.

collateral. the new entrepreneur faces significant difficulties in acquiring capital at start-up. In spite of the potential problems. banks tend to be cautious about lending and carefully weigh the five cs: character. receiving some tax advantages and sharing in future profits. which would be too slow or nonexistent if internal sources of funds were used. selling unused assets. the entrepreneur should not forget to stay intimately involved with the basics of the business. A contract is formed between a sponsoring company and a limited partnership. when considering external financing. While Savings can also be obtained by asking for bulk packaging insread of paying more for individually wrapped items as well as using co-op advertising with a channel member so that the cost of the advertisement is shared. such as using profits. capacity. an entrepreneur should first explore all methods of internal financing. the entrepreneur may find it necessary to seek additional funds through external financing. Outside capital should be sought only after all possible internal sources of funds have been explored. A special method of raising capital for high-technology firms is a research and development (R&D) limited partnership. the entrepreneur needs to consider the length of time. After all internal sources have been exhausted. While capital is needed throughout the life of a business. Not every entrepreneur will qualify under the bank's careful scrutiny. Commercial bank loans are the most frequently used source of short-term external debt financing. When this occurs. Before seeking outside financing. And when outside funds are needed and obtained. Consignment hnancing can also be used to help conserve cash. and condition. capital. The partnership bears the risk of the research. and amount of control of each alternative financial arra n gement. cost. In either case. including a fee to use the . The 5BA guarantees a percentage of the loan. an alternative for an entrepreneur is the Small Business Administration Guaranty Loan.CHAPTER 11 SOURCESOFCAPITAL 327 Bootstrap hnancing involves using any possible method for conservins cash. IN REVIEW SUMMARY All business ventures require capital. reducing working capital. allowing banks to lend money to businesses that might otherwise be refused. and collecting accounts receivable promptly. which may be asset-based or may take the form of cash flow financing. This source of funding requires collateral. an entrepreneur at times needs some capital to finance growth. obtaining credit from suppliers. The only possible limitation in bootstrap frnancing is the imagination of the entrepreneur. External financing can be in the form of debt or equity. Some vendors allow entrepreneurs to place a standing order for the entire amount riod of time but take shipment and make payment only as lower price of a larger order without having to carry the cost some examples.

as a nation of taxpayers. Interview three small-business owners about things they do (or have done) to bootstrap the financing of their business. Does it use the five Cs? Which of the five Cs appears to be the most important? 2 Obtain a loan application from the local bank and categorize each question in terms of which of the five Cs it is attempting to assess. Businesses can apply for grants ' 'l 1 agencies. Why don't all firms use bootstrap financing? Are there any dangers with this approach? What are the benefits of having some financial slack (e. When making a private offering. from RESEARCH TASKS Interview a business loan officer at a bank to determine the bank's lending criteria for small businesses and new businessei. A less expensive and less complicated alternative to a public offering of stock is a private offering. Should the government provide grants for entrepreneurs starting new businesses? Should the government guarantee loans for small businesses that are missing the necessary track record.9. assets.328 PART 4 FROMTHE BUSINESS PLANTOFUNDINGTHEVENTURE research in developing any future products. what source is most likely to say yes? Why is this the case? ls the entrepreneur exploiting a personal relationship with this potential source of capital? What are the consequences of using this source of capital if the business goes bankrupt? 2. The entrepreneur has the advantage of acquiring needed {unds for a minimum amount of equity dilution while reducing his or her own risk in the venture. The entrepreneur needs to consider all possible sources of capital and select the one that will provide the needed funds with minimal cost and loss of control. or other ingredients to obtain a commercial bank loan? What benefit do we. 505. Individual investors frequently require an equity position in the company and some degree of control. state. the entrepreneur must exercise care in accurately disclosing information and adhering precisely to the requirements of the SEC. the entrepreneur can seek private funding. Other federal. receive from such grants and loan guarantees? 3. and 506-an entrepreneur can sell private securities. Usually. 3. and local (city) grants are often available. How effective were these techniques? Be prepared to present this list to the class and describe how the techniques work. Securities violations can lead to lawsuits against individuals as well as the corporation. Then search the Internet for government grants that might be applicable for you and your business. CLASS DISCUSSION is the cheapest source of funds? When all other sources turn down your request for funding. as occurred in the case of Scott Walker a successful entrepreneur indeed. Finally. Government grants are another alternative available to small businesses through the Small Business Innovation Research (5BlR) program. some extra cash in reserve)? What are the costs of that financial slack? 1- What . different sources of funds are used at various stages in the growth and development of the venture. Choose a type of business you would like to run. By following the procedures of Regulation D and three of its specific rules-504. 1..

they also need to develop investing skills. p. Published by the Federal Reserve Bank of Minnesota.7lg. such as information technology and electronics. Nancy. Angels who back such ventures can earn impressive long-term returns-one study c¡tes a rate of return of about 27 percent. 14. This article. But others see opportunity. Cruickshank. defines social enterpriíe as a fundraising strategy put in place by nonprofit organizations (e.CHAPTER 1. while many angels are current or former entrepreneurs.6 times the investment in j. are steep.28. pp. which evaluates the importance of entrepreneurial teamwork in venture capítalists' decisions to fund a venture. (February 2006). no. and that background can prove invaluable. Inc.I SOURCES OF CAPITAL 329 SELECTED READINGS Bari Kate. the author of this article chronicles the prevalent trends in venture capital deals at the start of the new millennium.. positioned in the Community Dividend section. and other ingredients that go into starting a business. 259.120 ventures last yea7 according to the Ltniversity of New Hampshire's Center for venture Research. the land of plenty is no longer a promised tand. no. (January 1. the venture capitalists are the ones who'll set the stage. This article. on average. Dahf. Advice such as "achieving a dáubte bottom line. The entrepreneurial teams examined in this research are exclusively involved in high-technology pursuits.'1. p. vol.. Angel investors invest in promising start-ups too young and raw to attract the attention and money of professional venture capitalists. The dot'com boom of the 1990s has convinced young entrepreneurs that whatever the gadget. no. Team Performance Management. Darren.24. vol. st¡ll.g. (2008). From venture capitalists to angel investors to strategic busrness competitors. discovery. of course. Instil [sic] Confidence in Your Brand lf you Want to Secure Venture Capital Funds. The author of th¡s opinion piece cites the coveted criteria. This article highlights the ever-changing climate of venture capital funding: who's en vogue. some soul exists who will front the money. The risks. and properly assessing the organization's readiness are invaluable tips for the nonprofit entrepreneur. Facing the Capital Gap. Fedgazette..21. studies show that the best time to start a business is when the economy is down. Farrelf. How Angel Investors Get rheir wings. 112. Howeve4 with economic crunches on the horizon.25_27. Girl scouts of America cookie sales).6. Entrepreneurial Team-starts and Teamwork: Taking the Investors' Perspective. christopher: (April 28. and why raising $200. That's because entrepreneurs with good ídeas wiil find cheaper land. Kate Bar4 who heads Minnesota's Nonprofits Assistance Fund.5 years. Gimmon. 2009).2. published in a British periodical. 2008). 2OO9). BusinessWeek. labol supplier contracts. suggests helpful hints for nonprofit organizations seeking commercial fundíng for their benevolent works. confirms that in times of duress. who's déclassé.000 <an be more difficult than raising $s million. Eli. The credit crunch and economic downturn have some angels feeling skittish. The author of this research is an lsraelibusiness professor who bases his hypothesis on . Reyo/ution. and which start-up firms do venture capital firms love to hate. 327-39. or gizmo. someone out there has a nickel for you. while recognizing the volatility in investor temperaments. ínnovation. the Fedgazette includes educational commentary for the general public about the economy and investing. vol. if any funding is círculating. or 2. no. (January 2.200 angels pumped $26 biilion into 57. pp. This article includes the results of a research project. Guidance for Building a social Ent€rprise.

Employee Equity Incentives and Venture Capitalist lnvolvement: Examining the Effects on IPO Performance.and non-immigrant-owned businesses. vol. in the absence of equity and credit markets. for example. pp.. pp.4. Geigel Scott W. no. According to the results of the study. no. ObviouslSt in tímes of economic downturn. The Wisconsin Angel Network. Michael's College in Vermont. 30. James W.330 PART 4 FROM THE BUSINESS PLAN TO FUNDINGTHEVENTURE previous evidence that teamwork has a favorable effect on the success of entrepreneurial undertakings.2. offers proof that accepting venture capital funding can ensure the success of a business. 2. vol. Pineda. While the addítional ínflux of cash is often welcome. Yovanna. the employees of these potential initial public offering firms are in better stead if their company has received ve ntu re ca o i ta I f u ndi nq. U. Her research paper describes the importance of personal relationships and social status in securing business funding in turn-of-thecentury Argentina. . and other financial institutions. while 214 were owned by native lsraelis. Rayasam. compare the borrowing tendencies between these two groups: ímmigrant. (June 2008)..8. no. California's Silicon Valley is considered the mecca of venture capital firms: progressive. (August 1. Heilbrunn. 13. Renuka. Westerman. pp. The authors of this study.41. the immigrant businesses tended to assume /ess debt and had unique sources of capital at their Businesses. should it choose to go public. The author of this article is a Latin American history and economics professor at St. forward-thinking individuals who recognize the importance of providing seed funds. no. Many times entrepreneurs are hesitant to operate within the confines of other people's money. for such naysayers. Companies Are Finding Funds Outside of Traditional VC Hubs.4344. Linda A. has secured tax incentives for the state's wealthy individuals who choose to invest in fledgling enterpnses. banks. Also.Financial Funding of lmmigrant Journal of Developmental Entrepreneurship. Yet. 13.5. Kushnirovich. This article. 409-23. Who Needs Silicon Valley? Thanks to New State Programs. 167-44. faculty of lsrael's Ruppin Academic Center. namely Argentina. This 2008 article includesthe results of a study conducted among lsraeli businesses between the years 2000 and 2005. '10. Whíle the capitalist economies of Europe and North America were swelling with the boom of industry. for example. According to this article. lsrael's non-immigrant-owned businesses had more acc€ss to capital from the Israeli government. Nonna. state governments are creating training programs that coach wealthy individuals on the benefits of assisting start-ups. disposal. (December 2008). 2008). Sources of Finance and Reputation: Merchant Finance Groups in Argentine Industrialization. seasoned entrepreneurs realize these handouts come at a price: independence. Latin American Research Review. 3-30. Cyr. The author's thesis explores how five small-business lenders managed to fund Argentina's industrial revolution. /nc. was devoid of even an established banking system. investors. Sibylle. vol. Journal of Developmental Entrepreneurship. these once well-recognized fonts of wealth dehydrate and inventors are left with nowhere to turn. do not value entrepreneurial teamwork as much as do British and lsraeli investors.. 1890-1 930. Latin America. One-hundred fifty-three of the responding busrnesses were owned by immigrants from the former Soviet Union. (June 2006). vol. The author's conclusions examine the habits of venture capitalists and angel investors from different geographical regions: U. pp.5.