Obtaining Financing for Your Entrepreneurial Business. November 18, 2009

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1 Obtaining Financing for Your Entrepreneurial Business November 18, 2009

2 Financing Keys To Success Believe in yourself and your idea Presenting your idea With Passion Simplicity ( elevator pitch ) Clarity (narrow your focus) Honesty/Believability Have a detailed/flexible business plan Know your business/competitors Anticipate and develop plan for handling setbacks and changes, which are inevitable

3 Financing Keys To Success Be ready for the why questions: Why does the world need your product/service? Why will people buy from you? Why are you doing it that way and not another way? Why should I lend or invest money in your business? Be ready for the how questions: How will this money help grow the business? How will you pay back the money? How and when will you make money? How are you different than XYZ company?

4 Financing Keys To Success Meeting your commitments Deliver on your promises Do things when you say you will do them Over-communicate Go to investors early with bad news; avoid surprises Your credibility is your most valuable asset Valuing your business Be realistic, and not overly optimistic Understand your weaknesses Show humility and flexibility Do not be greedy

5 Financing Keys To Success Be prepared Have your entity formed Have your team in place Have financial information ready Have references available Know your business inside and out, so that there is no question asked that you have not anticipated Try to raise money before you really need it Terms will be better (all else being equal) Rule of thumb: It will take you three times as long as you think and you will raise 1/3 as much as you are seeking Do not run out of money before you run out of time Cash is King

6 Financial Information for Investors Financial Statements Balance Sheet Income Statement Statement of Cash Flows Audited vs. Unaudited Distinguish Financial Statements from: Tax Returns (different rules) Projections (future looking) Business Valuations (fair market value)

7 Types of Financing Two Basic Types: Debt and Equity Debt Must be repaid, with interest Highest priority of payment in the balance sheet Is often secured by assets of the business, or by guarantees of business owners Often includes restrictions on business (covenants) If business succeeds, will be repaid; if business fails, may not be repaid (in whole or part) Expected investment return is less than equity, because debt is generally less risky than equity

8 Types of Financing Equity Need not be repaid; no interest generally (but may pay dividend) Lowest priority in the balance sheet Is usually not secured by assets of business Does not usually include covenants; exception is preferred stock If business succeeds, may be worth a lot; if business fails, will likely be worth nothing Expected investment return is higher than debt, because equity generally is more risky than debt

9 Types of Financing Sources of Funds Bootstrapping (including own funds) Trading Equity for Services (employees/consultants) Friends and Family Angel Investors Commercial Banks Research Grants/Other Public Funding Sources Venture Capital Funds Other Strategic Sources of Investment Initial Public Offering (IPO)

10 Stages of Financing Venture Capital Funds Formal Angel Groups High Net Worth Individuals Friends & Family STAGE Seed Start-Up Early (First) Second Later (Third) Source: Center for Venture Research (U. of New Hampshire), MIT Entrepreneurship Center

11 Bootstrapping Entrepreneur funds the business Building business from the ground up without resorting to significant outside resources ( pulling oneself up by your bootstraps ) Self-sustaining from a cash flow perspective Controlled growth and low overhead Often involves personal resources (credit cards) If you can make it and survive, will provide flexibility for later financing Good read: Bootstrapping Your Business - Start And Grow a Successful Company With Almost No Money," by Greg Gianforte and Marcus Gibson

12 Trading Equity for Services Partially compensate founders, employees and consultants with equity, instead of cash Sometimes issue stock; sometimes use stock options or similar plans Need to keep good records of stock and options issued, to avoid disputes later Need to be able to get stock back when someone leaves, on favorable terms There are tax compliance issues relating to issuance of stock and options

13 Friends and Family In addition to own funds, entrepreneur s raises money from friends and family Advantage: they know you/you know them Potential problem: mixing business and personal ( money changes everything ) Not sophisticated investors, and need to make certain disclosures of risks Limited amount of funds does not make this a good financing source longer term

14 Angel Investors What is an Angel investor? Often an entrepreneur who has sold his or her business Can access the angel s knowledge and network Usually focus on a particular industry or geography Typical investments range between $50,000 and $1 million What are the negatives? Limitation of available funds Sometimes interfere with business High return expectations Cannot count on angels for long-term funding

15 Commercial Banks Local commercial banks include Bank of America, Charter One, Chase, Comerica, National City, Fifth Third and others Most commercial banks do not fund start-up businesses without personal guarantees and collateral from the entrepreneur Emphasize certainty of repayment, fee generation and asset management Often require pledge of all assets of the company, in addition to personal guarantees and collateral from the entrepreneur

16 Research Grants/ Other Public Funding Sources Small Business Innovation Research (SBIR) is a federally funded program which provides financial support to certain qualified small businesses Small Business Technology Transfer (STTR) grants are awarded to public/private R&D partnerships between small businesses and certain nonprofit research institutions Michigan businesses should explore potential state and local funding sources and incentives as well (e.g. MEDC, DEGC, etc.)

17 Research Grants/ Other Public Funding Sources Small Business Administration Loan Programs Section 7(a) Loan Guaranty SBA 504 Loan SBA Section 7(m) Microloan

18 Venture Capital Funds Only available to a very small percentage of early-stage to mid-stage companies A venture capital firm funds only 1 out of a 100 companies that seek investment Some funds are focused on seed (early stage) investing, sometimes with a specific industry focus Usually larger investment amounts than angel investors Advantages include industry knowledge, contacts and assistance with fundraising

19 Other Strategic Sources of Investment Investment by a larger company in the industry May bring access to knowledge and expertise in the industry May provide revenue/your first customer May pave the way for future acquisition by the strategic investor Negatives may include necessity of granting exclusive rights to investor or otherwise tying up assets and limiting value of company

20 Initial Public Offering (IPO) IPO is a process for going public For companies that have larger financing needs and need access to market liquidity Expensive to file an IPO, and substantial ongoing costs of being a public company Sarbanes-Oxley and other reporting requirements Even in best of times, IPO route is not available to most start-up or early stage companies In current stock market, few IPOs are getting done

21 Financing Mistakes To Avoid Waiting too late to start looking for money (and running out of options) Not being prepared/ due diligence mistakes Giving up too much control too early Unrealistic valuations that hamper later financing rounds Getting stuck in continual fundraising mode (taking multiple small bites of financing), and losing focus on business operations