Entrepreneurship & Small Business Management

1. Entrepreneurship & Small Business Management Frank Moyes Leeds School of BusinessUniversity of ColoradoBoulder, Colorado Funding

2. Today’s Agenda • Funding • Sources • Bank debt • Visitors: Jay Thompson and Pat O’Brien of Wells Fargo Bank • Valuation • Entrepreneurship interviews Funding

3. Next Week • Marshalling Resources • Strategic Alliances • Jurismonitor case • Speaker: David Hunter CEO of Encrypt Corporation • Deal structure: David Kendal, attorney Funding

4. How Are Going to Fund Your New Venture? • Personal Resources • Friends & family • Debt • Equity • Grants • Non-traditional Funding

5. 0 Personal Resources • Sources • Savings • Mortgage on house • Credit cards • Skin in the game – best indicator of commitment • Advantages • Prove the concept • Establishes value before go to outside investors • Disadvantages • Pressures on family Funding

6. Friends & Family • Easy negotiation • Need formal agreement • Advantages • Maintain control • Disadvantages • Unsophisticated investors • Different kind of obligation • Auntie Em’s life savings • Turn a good friend to an enemy? Funding

7. 0 Equity • Sources • F & F • Angels • Private Placement • Venture Capital • Corporate venture subsidiaries • IPO (Initial Public Offering) • Advantage • Permanent capital • Disadvantages • Give up piece of company (dilution) • Responsibilities to investor • Exit for investor – achieve a return Funding

8. 0 Debt • Banks • SBA • Credit unions, S & L’s • Factoring receivables & inventory • Commercial financing co • Commercial Finance companies • Mezzanine • Sits on balance sheet between debt and equity • Debt, but doesn't have to be repaid right away • Equity, warrants • Guido Funding

9. 0 Debt • Advantages • No dilution • Disadvantages • Very difficult to obtain in early stages • Must pay back • Interest expense • Personal guarantee • Lack of value-add money Funding

10. Borrowing from Banks • Types of loans • How banks look at borrowers? • How do you approach a bank? • Personality of a bank • SBA Loans Funding

11. Types of Bank Loans • Short term loans • One time • Line of credit • Term loans • Monthly installments • Balloon • Secured and unsecured Funding

12. How Banks Look at Borrowers? • Attitude toward risk • 4 C’s: credit history, character, capacity, collateral • How are you going to repay it? • Not: “If I default, there are assets to cover it.” • Banks don’t like work out situations • Cash flow loans and • Realizable assets • Accounts Receivable • Inventory • Personal guarantees Funding

13. How Do You Approach a Bank? • Establish a good credit history • Borrow when you don’t need it • Business Plan • Costs & fees • Loan processing fee • Interest rates • Services provided Funding

14. Personality of a Bank • Banks have different policies • Big company or small company • Aggressive or cautious • New companies or established • How important are relationships? • Shop around – new customers seem to get better deals than existing • Keep them informed of how your business is doing – no surprises Funding

15. Small Business Administration (SBA) Loans • Loan made by a bank, but guaranteed by the feds • What are the criteria for receiving a SBA loan? • How differ from a traditional bank loan? • Fees • Interest rates Funding

16. 0 Equity • Sources • F & F • Angels • Private Placement • Venture Capital • Corporate venture subs • IPO (Initial Public Offering) • Advantage • Permanent capital • Disadvantages • Give up piece of company (dilution) • Responsibilities to investor • Exit for investor – achieve a return Funding

17. Angels • Sophisticated investor who invests in early stage companies • 250,000 + angels in US • Invest $5 bill - $10 Bil, 20K – 30K companies annually • Typical investment = $25K - $250K • High net worth individuals • Usually wants to invest in industry where has experience • Accessing Angels • Not in the Yellow Pages • Networking • ACE-net.org Funding

18. 0 Angels (cont’d) • Advantages • Early stage resource • Value-added money : network, advice, commitment • Disadvantages • No follow-on funds • Give-up equity • Over-control from angel Funding

19. 0 Venture Capital • Overview • $40 Bil in 2003; 3,000-3,500 investments • Partnership: limited & general • Advantages • Greatest value-added money • Consulting, mentoring, network • Validation of your concept • Disadvantages • Loss of equity, maybe control. But, achieve your dream • Must have common objectives • Exit strategy • Why people want to be VC’s Funding

20. Venture Capital Required Rates of Return • Seed 60%+ 10x+ • Start-Up 50% 8x • Early Stage 40% 5x • Second Stage 30% 4x • Exit 25% 3x ROI Increase Funding

21. Private Placement • Private offering to a focused group of investors • Accredited investors • SEC & Blue Sky Laws apply • If less than $1 million, then any number of small investors • Sam Adams • Advantages • Quicker & less expensive than IPO • SEC regulations are not as onerous • Disadvantages • Give up equity • Lack of advice / mentoring • Can be complicated, expensive & take a lot of time • Minority investors Funding

22. What do Investors Look For? • Management team • Experience • Expertise in industry • Passion • Commitment of CEO • Market potential: size & growth • Stage of development • Scalable product or service • Proprietary • Profitability • Acceptable valuation - return Funding

23. IPO • Public offering to buy ownership in an organization • Advantages • Obtain cash for opportunities that would otherwise be unaffordable • More capital with less stock dilution • To achieve liquidity for owners and investors • Disadvantages • Costly and time consuming • Change of leadership focus Funding

24. State, regional and municipal development agencies CapCo Federal SBIR (Small Business Innovation Research) CREDA (Cooperative Research & Development Agreement) Research – university & corps. Foundations freemoney.com Advantage: no equity or debt Disadvantage: Red tape and strings Grant mentality Grants Funding

25. Non-traditional Funding Sources • Customers • Suppliers • Joint ventures and strategic partners • Leasing of equipment • Broker/Promoters • Microloans – banks & non-profits <$25,000 • Incubators • Equity for professional services Funding

26. Government • SBA Loans • SBIC’s – a “government VC” • 450 in the US • Backed by the SBA • $13 bill since 1958 • Small Business Development Centers – state and local organizations finance job creation Funding

27. 0 What Methods Are Used To Value Entrepreneurial Ventures? • Tangible book value • P/E ratio • Discounted cash flow is not a good method for valuing early stage companies! • VC method (see Bygraves & Zacharakis) • Financial projections • Market comps for similar companies • Multiple of earnings • Multiple of sales • Investor ROI • Usually not a cash flow stream • Pre-money & post money • % of Board seats Funding

28. Risks Market Strategic Operational Technology Financial Macro-economic Funding

29. How Assess Risk? • Stage of Development • Management Team • Commitment of CEO • Experience • Knowledge of industry • Make forecasts • Proprietary Product or Service • Market • Profitability • Valuation Funding

30. Stages of Development Mapped with Funding • Seed (proof of concept) • Personal • Start-up (set-up production & sales) • Angels • PPO • Early stage (full-scale operations & mkt) • VC • Government Funding

31. 0 Stages of Development Mapped with Funding • Second stage (expansion) • VC • Financial institutions • Debt • Reinvestment • Exit (harvest) • IPO Funding

32. Seed capital 80 to 100% Startup financing 50 to 70% First-stage financing 40 to 60% Second-stage financing 30 to 50% Bridge financing 20 to 35% Restart financing variable 0 Discount Rates Funding

33. 0 Factors Affecting Discount Rates Total Discount Rate Risk of failureadjustment Cash Flow Adjustment Value ofVC advice Value Added Investmentnot liquid Justifiable Discount Rate Liquidity Marketsensitivity Systematic Risk Risk-freeinvestment Base Rate Seed Stage 1 Stage 2 Bridge IPO Funding Sahlman, A Method for Valuing High-Risk, Long-Term Investments, teaching note, HBS 9-288-006.