MGS 4500 ENTREPRENEURSHIP – NEW VENTURE MANAGEMENT 3.0 entrepreneurship 2e a process perspective

1. MGS 4500 ENTREPRENEURSHIP – NEW VENTURE MANAGEMENT 3.0 entrepreneurship 2e a process perspective Chapter 6 – Financial Resources for New Ventures: How to Get Them, How to Manage Them Alan W. Urech 406 Aderhold Learning Center October 1, 2008 between 7:15 – 9:45pm

2. Eight Learning Objectives: • Explain the basic principles of financial management including balance sheets, income statements, cash flow statements • Explain why it is difficult for entrepreneurs to raise money from external investors and identify specific solutions to problems • Explain why entrepreneurs typically raise little start-up capital and explain the timing of entrepreneurial finance

3. Eight Learning Objectives: • Define debt and equity financing and explain how they differ • Describe the different sources of capital for new ventures • Describe the equity finance process from start to finish and explain why equity financing in new ventures is typically staged

4. Eight Learning Objectives: • Describe how venture capitals calculate the cost of the capital that they provide to new ventures • Explain why direct and indirect social ties are important to raising money from external investors

5. Measuring the New Ventures Current Financial Statements 3 Basic Financial Statements: Balance Sheets Income Statement Statement of Cash Flows These three statements provide a good picture of the company’s financial health

6. Measuring the New Ventures Current Financial Statements • Balance Sheets are the most basic Financial Statements • They provide a picture of the company’s assets, liabilities, and the owners’ equity.

7. Measuring the New Ventures Current Financial State: Balance Sheets • Assets: • Fixed Assets (property, buildings, equipment and furniture) • Current Assets(cash or items that can be readily converted to cash • Liabilities: • Long-Term Liabilities (loans, mortgages on property, etc) • Current Liabilities (expenses payable within a year

8. Measuring the New Ventures Current Financial State: Income Statement • Income statements (or profit and loss statements) are the results of a company’s operations during a specific period of time. • Net sales (sales minus returned goods and discounts) • Cost of sales (cost to produce and deliver its goods to customers) • Operating Expenses (cost of administration, not directly linked to sales) • Profit Margins (dividing net income by net sales, reflected in a percentage figure,, is a return on sales)

9. Measuring the New Ventures Current Financial State: Statement of Cash Flows • A Statement of Cash flowshows changes in a company’s cash during a specific period of time. Like your bank statement • Indicate: • Operating Activities • Investing Activities • Financing Activities

10. Measuring the New Ventures Current Financial State: Statement of Cash Flows Pitfalls: How Profitable New ventures can Fail A supplier expects to be paid within 30 days and the customers try to leverage their money and want 90 days to pay Cash Flow is very, very important

11. Measuring the New Ventures Current Financial State: Forecasting: Predicting the New Venture’s Financial Outcomes Proforma Financial Statements project future events rather than summarize historical ones: Proforma Balance Sheet Proforma Income Statements Proforma Statement of Cash Flow

12. Measuring the New Ventures • Current Financial State: • Proforma Balance Sheets show • current assets and liabilities and • projects their changes • Proforma Income Statement show projected sales, costs of sales, and operating expenses to project future net income • Proforma Statement of Cash Flows does the same for projected inflows and outflows of cash

13. Raising Capital For New Ventures: Why It’s Often Difficult: Three Problems in raising capital Entrepreneurs are reluctant to disclose information to investors Entrepreneurs can use superior information to benefit themselves and not the company Limited information about the Entrepreneur and opportunity causes Adverse Selection (Investors who can’t tell the difference between a winner and one that isn’t going to win.

14. Raising Capital For New Ventures: • Contract Provisions • Covenants: Restrictions on someone’s actions • Barring the Entrepreneur from purchasing or selling assets or issuing or buying back shares without the investors’ permission • Mandatory Redemption Rights: Entrepreneur must give back the investor’s investment on demand

15. Raising Capital For New Ventures: • Contract Provisions • Convertible Securities – Allows investors to convert preferred stock, which gets preferential treatment into common stock at the investor’s discretion • Forfeiture and Antidilution Provisions – Provisions that require Entrepreneurs to lose a portion of ownership of their ventures if they fail to meet agreed-upon milestones • Control Rights – Rights to determine how to use a Venture’s assets (take 30 percent ownership but 51% of the BOD

16. Raising Capital For New Ventures: Thoughts on Investors Investors minimize their exposure by Usually specialize by industry Specialize by Stage of Development Geographically invest locally Syndication – Get other investors to help them Usually require Entrepreneurs to invest their own money in the venture

17. Raising Capital For New Ventures: Amount and Timing of Start-Up Capital 60% of all ventures need less than $5,000 to start; 3% need more than $10,000 Avoid Negative Cash Flow (Burn Rate): Look for money when it is not needed

18. Raising Capital For New Ventures: Amount and Timing of Start-Up Capital Breakeven Analysis: Amount of sales needed to cover all costs 4 Steps can improve Cash Flow challenges Minimize Accounts Receivables Reduce Inventory Reduce Spending Delay Accounts Payable

19. Raising Capital For New Ventures: Amount and Timing of Start-Up Capital Types of Capital Private Equity: Assigning part of the equity in a new venture. Investors become part owners (most common because doesn’t require fixed payments, Entrepreneur can’t lose more than they put into the venture) Debt financing: Financial obligation to return the capital provided plus interest (Good because Entrepreneur keeps all success but Bad because if a loss, could lose more funds than put in)

20. Raising Capital For New Ventures: • Sources of Capital • Here are a few areas to explore: • Savings • Friends, Family and Fools • Business Angels • Venture Capitalists • Corporations • Banks • Asset-Based Lenders • Factoring Organizations • Government Programs

21. Raising Capital For New Ventures: Structure of Venture Finance The Equity Financing Process Introduction of Entrepreneur to Investor (usually must be referred by someone the investor knows and trusts) Evaluation of the Business Plan – Due Diligence (legal term that refers to the effort by investors to verify information about the new venture) Negotiate Terms of Deal

22. Raising Capital For New Ventures: Structure of Venture Finance: Evaluating the Business Plan Due Diligence includes 3 parts: Investigation of the Business (market, business model, and the IP) The Legal Entity(Organizational form, BOD, Patents, Trademarks) Financial Statements and Records

23. Raising Capital For New Ventures: • Evaluating the Business Plan • Staging of Financing includes: • Milestones (target achievements) • Staging or Traunching (periodic investment) • Based on how the venture is doing • Allows investor to withhold funds • Manages uncertainty of investing

24. Raising Capital For New Ventures: Evaluating the Business Plan Cost of Capital is very important!! Why do Investors demand a high return on Capital? New Ventures are Risky (1 in 10 succeed) Investors can’t diversify their risk (dependent on the industry performance as a whole) Illiquidity Premium (extra compensation because they can’t sell their investments)

25. Bottom Line on Investment: Don’t take other people’s money if you don’t have to take it Take Debt before Private Equity: It is much cheaper

26. Raising Capital For New Ventures: Cost of Capital Pre-Seed Stage: Entrepreneur had an idea (70—100% rate of return expected) Seed Stage: Entrepreneur has formed a legal entity with partial venture team, has a business plan (60-80% rate of return expected) First Stage: Entrepreneur has organized the company (40-60% rate of return expected) Second Stage: Produced and sold initial versions of the product and organization is up and running (20-40% rate of return expected)

27. Raising Capital For New Ventures: Cost of Capital is Usually Calculated by the Venture Capital Method (some methodologies) Level of Income when becomes sold or acquired Per Price-Earnings ratio for acquisitions and public offerings Terminal Value of the investment by multiplying projected income by the price-earnings ratio Discount rate, based on desired rate of return Portion of ownership by dividing investment amount by the net present value of the terminal value

28. Raising Capital For New Ventures: Social Capital Personal Contactsare very important; Entrepreneurs must have people skills. Tap your social network for investment capital They know the Entrepreneur Invoke sanctions against people who harm other people Efficient way to gather information Create positive or negative attributions about people

29. Raising Capital For New Ventures: • Social Capital • Behaviors that encourage Investment • Make a good impression – must be trustworthy and have character • Be able to quickly and easily explain the business plan • Make Business plan appealing to investors

30. Bottom Line on Investments: • Don’t take other people’s money if you don’t have to. • Take Debt before Private Equity: It is much cheaper in many ways • Show the business opportunity not the product • Be Passionate in your belief

31. Questions about the Chapter!!