IPFW Business Plan Competition Pre-competition Program

1. IPFW Business Plan CompetitionPre-competition Program Financing and Capital Sourcing Options By Dr. Bill Todorovic Richard T. Doermer School of Business and Management Neff Hall 340L, Tel. (260) 481 6940 E-mail: todorovz@ipfw.edu Web: http://users.ipfw.edu/todorovz/

2. The Nature of a Firm andIts Financing Sources • Factors That Determine Financing • Firm’s economic potential • Maturity of the company • Nature of its assets • Owners’ preferences for debt or equity

3. Beginning of Production ? Going Concern Start-up Sources Of Funds Company Size Personal IPO Friends and Family Banks Angels Government Venture Capitalist Customers/Suppliers Amount

4. Sources of Financing Other Venture Capital Mortgaged Property Private Investors Bank Loans Friends Personal Charge Cards Partners Family Members Personal Savings 0 10 20 30 40 50 60 70 80 Percentage of EntrepreneursUsing Source of Financing Sources of Financing

5. Critical Financing Factors • Accomplishments and performance to date. • Investor’s perceived risk. • Industry and technology. • Venture upside potential and anticipated exit timing. • Venture anticipated growth rate • Venture age and stage of development.

6. Debt or Equity? • Entrepreneurs typically prefer debt • Allows them to appropriate as much as of the benefit as possible + retain sole control • Can default • Debt is unattractive to investors in emerging technology • Usually little collateral or predictable cash flow • Information asymmetry is lessened by ownership position – shared ownership gives some control • High interest rate to offset risk will stifle growth or cause default

7. Equity Equity HIGH financing Financing Potential Profitability Debt Debt LOW Financing financing LOW HIGH Financial Risk/Control Tradeoffs Among Potential Profitability,Financial Risk, and Voting Fig. 13.1

8. No debt $28,000 14% return 14% return income on on $200,000 equals on assets total assets ($28,000 ÷ $200,000) ($28,000 ÷ $200,000) of $200,000 $200,000 equity Debt Versus Equity With no debt and all equity: Equity: Owners get to keep all of the profits in return for accepting the risk of lower returns

9. With $100,000 debt and $100,000 equity: $100,000 debt (10% cost) $28,000 18% return 14% return income on on $100,000 equals on assets total assets ($18,000 ÷ $100,000) ($28,000 ÷ $200,000) of $200,000 $100,000 equity Debt Versus Equity (Cont’d) Debt is Risky: Lenders have first claim on profits and must be paid even if there are no profits.

10. The Banker’s Perspective • Bankers’ Concerns! • The Five C’s of Credit • Character of the borrower • Capacity of the borrower to repay the loan • Capital invested in the venture by the borrower • Conditions of the industry and economy • Collateral available to secure the loan

11. Financial Information Requiredfor a Bank Loan • Three years of the firm’s historical statements • The firm’s pro forma financial statements • Personal financial statements

12. Getting to know your friendly neighborhood Venture Capitalist…

13. The myth… and the reality • The myth: VCs support good people and good ideas • The reality: VCs invest in industries with double digit growth in the middle of the S-curve • Appropriate management team • Specialty funds (earlier and later stages on the S-curve) • Limits the risk to management risk • Produces attractive exit opportunities

14. Present Day Situation Myth: There is less available capital Fact: The industry has plenty of money, but limited appetite for new investment Fact: Investor attitudes toward risk have changed

15. VC fills a void • Gap between innovation and traditional sources of debt • Risk inherent in startups typically justify interest rates higher than allowed by law • VCs must balance high returns for their investors against sufficient upside potential for entrepreneurs to keep them motivated

16. What VCs get out of it • 10X return on capital over 5 years • VCs management fees and high growth funds • Fund structured with limited and general partners and a life of 7-10 years

17. What VCs Do?

18. The Overhang: Uninvested Capital Complements of Thompson Venture Economics

19. Angels • Well to do private individuals • Geography and industry specific • Invest lower amount than VC • Often a good source of industry experience

20. Finding Angels • Private Individuals • Professionals (lawyers, accountants, bankers) • Local small business development centers • Internet associations (e.g., Technology Capital Network at MIT)

21. Other Sources of Financing • Community-based financial institutions • Large corporations • Stock Sales • Private placement • Initial public offering (IPO)

22. Why Companies Invest? • Preemption of new rivals • Replace core earnings lost because of an emerging technology • Apply existing competitive advantage in a rapidly growing market • And some degree of autonomy: • JVs, alliances, flexible internal management structures

23. Government-Sponsored Programsand Agencies • Small Business Administration (SBA) loans • Guaranty loan • Direct loan • Small business investment centers (SBICs) • Small Business Innovative Research (SBIR) • State and Local Government Assistance

24. Business Suppliers andAsset-Based Lenders • Trade Credit (Accounts Payable) • Short-duration financing (30 days) • Amount of credit available is dependent on type of firm and supplier’s willingness to extend credit

25. Business Suppliers andAsset-Based Lenders (cont’d) • Equipment Loan and Leases • Leases • Free up cash for other purposes • Leaves lines of credit open • Provides a hedge against obsolescence

26. Business Suppliers andAsset-Based Lenders (cont’d) • Asset-based Loan • Factoring • Accounts are sold to factor at a discount to invoice value • Factor can refuse questionable accounts • Factor charges fees for servicing accounts and for amount advanced to firm prior to collection

27. Formal Vs. Informal Investors • Funding structure and flexibility • The fit to the mold • Involvement in the business • Rigidity of relationship with the firm

28. Discussion?

30. Low Level Investment Lower Long-term Income Potential (Lower Capacity) Complements of: Timmons/Spinelli New Venture Creation, sixth edition

31. First Things First • Burn rate • OOC (out of cash) • Search out capital markets • Increase cash flow

32. Strategy Refinement • Market niche • Suppliers and customers • Diversification or specialization • Reduce fixed costs • Plan for contingency

33. Management Refinement • Management skill, experience and know how • Control of Finance • Turnover

34. When the market is down • Increase Your Effectiveness and Efficiency • Be Creative • Pursue different sources of capital

35. Building to Grow

36. Create Value Shareholders Customers Employees Contingency Plan Best Case Scenario Worst Case Scenario Most Likely Scenario • Good Team • Every business is built on people • Good Decisions • Solid Financing • Persistence Increase Value Reduce Risk

37. Example 1Sales Growth; ODG

38. The Sound Advice • Monitor Cash Flow (especially if growth is high) • 100 fastest growing companies • Entrepreneur of the year award • Contingency Plan – get the timing right • Emphasize long term growth • Manage your risk factor

39. Example 2:Ergo Distributor • Sales growth 400-500% • Single supplier – No substitutes • Great financial ratios • Cash flow problems • May go bankrupt in couple of years LESSON: Use your intuition

40. Who invests in VC funds? • Typically pension funds, financial firms, insurance companies, endowments and high net worth individuals • Small percentage of total funds • Expect returns of 25%-30% • Most are structured as limited partnerships • Other forms include: • Corporate VC funds • Private funds • Publicly listed funds • Labour sponsored funds (in Canada)