Students to Start-Ups Entrepreneurial Skills Workshop Series

Students to Start-UpsEntrepreneurial Skills Workshop Series Presents: Finding Start-Up Capital

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What is “Students to Start-ups”? Students to Start-Ups • Workshop Series • One-on-One Counseling • Future (web and/or pod casts, CD, etc.)

Finding Start-Up Capital By Jim Chamberlain

Start-Up Costs & Capital Sources Start-Up Cash Investment Fixed Capital Investment • Start-Up • Growth • Maintenance Working Capital Investments • Start-Up • Growth • Maintenance Cash Outlays Until Breakeven

Start-Up Costs & Capital Sources Fixed Capital • How do you calculate how much your business needs at start-up and to maintain growth • Do not confuse the justification with how it will be financed. Justify first, then determine how to finance the investments Sales Forecast - 24 to 36 months • How much “capacity” investment is required? • How fast will you grow? • New products or services?

Start-Up Costs & Capital Sources Working Capital Investments • The excess of current assets over current liabilities or the amount of cash required to fund the business on a day-to-day basis • An indication of short-term financial strength • Don’t be under-capitalized Working Capital = Current Assets minus Current Liabilities

Start-Up Costs & Capital Sources Working Capital Investments • How do you calculate how much your business needs at start-up and during periods of growth? Sales Forecast – 24 to 36 Months • Working Capital increases and decreases with sales. It is a variable investment. • Example: Figure $.20 increase for every incremental sales dollar increase.

Start-Up Costs (Investments) Fixed Capital Office Furniture $ 2,000 Vehicles 20,000 Tenant Improvements 10,000 Printing Machines 20,000 Total Fixed Capital – Start-Up $ 52,000 Vehicles $ 20,000 Printing Machines 10,000 Total Fixed Capital – Year Two $ 30,000

Start-Up Costs (Investments) Working Capital Operating Cash $ 10,000 Inventories 15,000 Prepaid Rent 5,000 Prepaid Insurance 8,000 Total Working Capital – start-up $ 38,000 Cash losses – first six months $ 25,000 Total Working Capital – Year One $ 63,000 Required Working Capital – Year Two $ 10,000 (Based on a $50,000 increase in sales)

Capital Sources How Businesses Are Really Funded Seed Cash – Percentage of Inc 500 CEOs surveyed (2002) who launched their company with seed capital (including personal assets) of: • Less than $1,000 14% • $1,000 - $10,000 27% • $10,001 - $20,000 10% • $20,001 - $50,000 15% • $50,001 - $100,000 12% • More than $100,000 22%

Capital Sources Does seed capital effect long-term profitability or growth rate? • Only 65% of companies that started with more than $100,000 were in the black after one year compared with 83% of those businesses that were launched with $1,000 to $10,000. Source: Inc Magazine

Capital Sources Percent of CEO’s who got some capital by these means: • Private Equity 82% • Personal Loans 19% • Bank Debt 19% • Venture Capital 9% • Supplier Financing 5% Source: Inc Magazine

Capital Sources Equity Funding • Financing your business by selling a minority equity interest. This cash is less risky but more expensive. Valuation issues must be addressed. Initial and target valuation calculations must be made. • 43% of founders started the company alone • The rest had: • 1 partner 12% • 2-3 partners 36% • 4+ partners 9%

Capital Sources Private Equity and Venture Capital Funding The average angel investor is: • Between 48 and 59 years old • Has a postgraduate degree • Has experience in management and building a company • Typically invests between $25,000 and $250,000 per deal in one to four deals per year

Capital Sources Private Equity and Venture Capital Funding • Angel investors tend to like proprietary products and non-capital intensive businesses. They anticipate future rounds of financing.

Capital Sources Private Equity and Venture Capital Funding Angel investors look for: • Market niches – potential to dominate or be #1 or #2 in the industry • Advanced technology and a disruptive model (going to change things) • Compelling and sustainable advantage – not “me too” • Planned exit in 4-6 years • Reasonable valuation • Performance equal to 5 -10 times original investment • ROI equal to 30-40% per year • Sitting on your board but not having control • Higher risk business models

Capital Sources Bank Loans or Debt Financing • Banks will loan 2.5 – 4.0 times Cash Flow – usually based on EBITDA • Banks would like to see a 3-5 year track record or a history of business experience • Debt is less expensive but more risky than equity • Banks will not lend on pure projections: You must have a history of cash flow or a current personal guarantee. • Three sources of repayment • Cash Flow • Liquidation value of assets • Personal Guarantees of each 25% equity owner

Capital Sources Negatives to a Banker • Getting involved with something outside your normal business model • Absentee management / ownership • Divorce • Burnout • Growing beyond owner’s capacity to operate the business • Parent turns over business to son or daughter • Computer conversions • Relocation and / or expansion of facility • Companies “hit the wall” at: • Manufacturing companies at $2 million in sales • Distribution companies at $4 million in sales • Retailers at 3 stores and distance • Service companies at 12 employees • Contractors at 2 or more big jobs

Capital Sources Questions a Banks Will Ask You: • Do you have a Business Plan? • How much experience do you have in this industry? • How is your credit and how much personal debt do you have? • How much is your down payment? Is it at least 25%? • How much collateral do you have? • Who is the competition? • Do you have personal and business insurance? • Do you have services of an accountant and attorney? • Have you ever filed for bankruptcy? • Do you have 2-4 years of tax returns available?

Capital Sources Small Business Administration • The SBA does not loan money. It guarantees (to the bank) approximately 85% of the loan proceeds to you. Five to ten year payback terms. Interest rates of prime plus 2 – 4% depending on the program and terms. • This reduces the banker’s risk, thereby enabling the loan to be approved. They use basic credit standards: • Character • Management ability • Cash Flow • Equity • Feasible Business Plan • Sufficient collateral

Capital Sources SBA Eligibility (there are exceptions) • Must be “for profit” • Must be an operating company. SBA does not allow speculation or investment companies. • Must be a small business: • Manufacturing 500 -1,000 employees • Wholesaling less than 100 employees • Services receipts test for each classification

Capital Sources SBA Eligibility • Cannot be a business in lending, life insurance, real estate development or rental property. • Gambling, promoting religion, pyramid sales plans, consumer marketing cooperatives and persons of poor character are ineligible. • Individuals must be lawfully in the U.S. • Business cannot be located outside the U.S. • Import businesses may be ineligible Go to www.SBA.gov for a complete list of ineligible businesses. Also, a good resource for minority and micro-loan plans.

Exit Many of the CEO’s plan to cash out 41% of CEO’s started the company with at least one exit strategy in mind. Some had several: Those strategies included: • Going Public: 47% • Selling to a private buyer: 80% • Leaving the company to heirs: 7%

Capital Sources Mistakes Entrepreneurs Make When Raising Capital • Don’t understand share prices or valuations • Confuse broad market with served market • Make unrealistic assumptions about an exit strategy • Don’t understand long term capital needs • Have no clue about competition • Don’t understand that marketing beats technology 9 out of 10 times • Write a poor executive summary • Use “off the wall” numbers or pull numbers from thin air • Lack focus; e.g. many products or niches • Develop too simplistic of a market plan / analysis • Underestimate expenses • Rely on financial plans with major inconsistencies; e.g. numbers don’t match or tie • Speak in “techno-jargon”. No one understands what they are saying

Capital Sources Best Ways to Irritate a Private Investor • Lying to investors or not being forthright; omission of material information • Inability to answer direct questions with direct answers • Surprises; e.g. problem with credit checks, hidden liabilities or debts • Over hype or exaggerate upside • Your story always changes • Arguing with investors • Late for meetings • Excessive secrecy or legalese; expect investor to sign NDA • Investing capital in fancy facility and furniture • Fail to attract top talent

Capital Sources Lease Financing • Many start-ups may want to consider lease financing for their fixed capital needs. • Leasing sometimes shifts the risk of ownership, such as technological obsolescence onto the lessor thus freeing the lessee to finance working capital needs. • There also may be possible tax advantages in certain cases that makes leasing less expensive on an after-tax basis.

Questions Jim Chamberlain James.Chamberlain@SCORE114.org

Additional Resources • Web www.SCORE114.org/business_library_3.html

Additional Resources • Web Venture Funding Blog http://www.allensblog.typepad.com/ • People UCI Center for Entrepreneurship and Innovation CEI@Merage.uci.edu SCORE Orange County www.score114.org

UPCOMING WORKSHOPS March 21st Driving Growth Through Distribution Channels and Sales Management April 4th Nuts & Bolts of Business Structure and Licensing April 18th Refine Your Unique Value Proposition RSVP CEI@MERAGE.UCI.EDU Students to Start-UpsEntrepreneurial Skills Workshop Series

Thank You!

Students to Start-Ups Entrepreneurial Skills Workshop Series