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Essentials of Entrepreneurship and Small

Business Management

Eighth Edition

Section 3: Launching the Business

Chapter 13

Sources of

Financing:

Equity and Debt

Learning Objectives (1 of 2)

13.1 Describe the difference between

equity capital and debt capital.

13.2 Discuss the various sources of

equity capital available to

entrepreneurs.

13.3 Describe the process of “going

public.”

13.4 Describe the various sources of

debt capital.

Learning Objectives (2 of 2)

13.5 Describe the various loan programs available from the

Small Business Administration.

13.6 Identify the various federal and state loan programs

aimed at small businesses.

13.7 Explain other methods of financing a business.

Raising Capital

• Raising capital to launch or expand a business is a

challenge.

• Many entrepreneurs are caught in a “credit crunch.”

• Financing needs in the $100,000 to $3 million

range may be the most challenging to fill.

The “Secrets” to Successful

Financing (1 of 2)

1. Choosing the right sources of capital can be as important

as choosing the right form of ownership or the right

location.

2. The money is out there; the key is knowing where to

look.

3. Raising money takes time and effort.

4. Creativity counts. Entrepreneurs have to be as creative

in their searches for capital as they are in developing

their business ideas.

5. The Internet puts at entrepreneur’s fingertips vast

resources of information that can lead to financing.

The “Secrets” to Successful

Financing (2 of 2)

6. Put social media to work to locate potential investors.

7. Be thoroughly prepared before approaching lenders and

investors.

8. Entrepreneurs cannot overestimate the importance of

making sure that the “chemistry” among themselves,

their companies, and their funding sources is a good

one.

9. Plan an exit strategy.

10. When capital gets tight remember to bootstrap.

Financing a Business

• Entrepreneurs must cast a wide net to capture the

financing they need to launch their businesses.

• Layered financing:

– Piecing together capital from multiple sources.

• Capital:

– Any form of wealth employed to produce more wealth.

– Two types:

▪ Equity

▪ Debt

Equity Capital

• Equity capital:

– Represents the personal investment of the owner(s) in the

business.

– Called risk capital because investors assume the risk of

losing their money if the business fails.

– Does not have to be repaid with interest like a loan does.

– But, the entrepreneur must give up some ownership in the

company to outside investors.

Debt Capital

• Debt capital:

– Must be repaid with interest.

– Is carried as a liability on the company’s balance sheet.

– Can be just as difficult to secure as equity financing, even

though sources of debt financing are more numerous.

– Can be expensive, especially for small companies, because

of the risk/return tradeoff.

Sources of Equity Financing (1 of 8)

• Personal savings

Personal Savings

• The first place an entrepreneur should look for money.

– Bootstrapping

• The most common source of equity capital for starting a

business.

• Outside investors and lenders expect entrepreneurs to put

some of their own capital into the business before

investing theirs.

Figure 13.1 Sources of Financing for

Typical Start-Up Businesses

Source: Donna J. Kelley, Abdul Ali, Candida Brush, Andrew C. Corbett, Mahdi

Majbouri, and Edward G. Rogoff, “2012 United States Report,” Global

Entrepreneurship Monitor, p. 23.

Sources of Equity Financing (2 of 8)

• Personal savings

• Friends and family members

Friends and Family Members

• After emptying their own pockets, entrepreneurs should

turn to those most likely to invest in the business: friends

and family members.

• Be careful! Inherent dangers lurk in family/friendly

business deals, especially those that flop.

Family and Friendship Financing

• Choose your financier carefully.

• Keep the arrangement “strictly business.”

• Prepare a business plan.

• Settle the details up front.

• Create a written contract.

• Treat the money as “bridge financing.”

• Develop a payment schedule that suits both parties.

• Have an exit plan.

Sources of Equity Financing (3 of 8)

• Personal savings

• Friends and family members

• Crowd funding

Crowd Funding

• Crowd funding:

– Taps the power of social networking and allows

entrepreneurs to post their elevator pitches and proposed

investment terms on specialized Web sites and raise money

from ordinary people who invest as little as $100.

– The returns for investment are tokens – discount coupons

and free samples.

– Jumpstart Our Business Startups (JOBS) Act expands the

use of crowd funding.

Sources of Equity Financing (4 of 8)

• Personal savings

• Friends and family members

• Crowd funding

• Accelerators

Accelerators

• Accelerator programs:

– Provide a small amount of seed capital and a wealth of

additional support for start-up companies.

– Offer a structured program that lasts from three months to

one year.

– The most important contribution is the coaching and

mentoring received.

– Examples: Y Contributor and Tech Stars

Sources of Equity Financing (5 of 8)

• Personal savings

• Friends and family members

• Crowd funding

• Accelerators

• Angels

Angels (1 of 4)

• Angels:

• Wealthy individuals who invest in emerging

entrepreneurial companies in exchange for equity

(ownership) stakes.

• An excellent source of “patient money” for investors

needing relatively small amounts of capital typically

ranging from $100,000 (sometimes less) to as much as $5

million.

• Willing to invest in the early stages of a business.

Angels (2 of 4)

• An estimated 299,000 angels across the United States

invest $24.8 billion a year in 70,000 small companies.

• Their investments exceed those of venture capital firms,

providing more capital to 18 times as many small

companies.

• Angels fill a gap in the seed capital market, specifically in

the $10,000 to $2 million range.

Figure 13.2 Angel Financing

Source: Based on data from the Center for Venture Research, Whittemore School

of Business, University of New Hampshire, http://paulcollege.unh.edu/center-

venture-research.

http://paulcollege.unh.edu/research/center-venture-research

Angels (3 of 4)

• Angels accept between 10 and 15% of the deals that are

pitched to them.

• Average angel investment is $50,000 in a company that is

in the seed or start-up growth stage.

• 52% of angels’ investments lose money, but 7% produce a

return more than 10 times their original investment.

• Angels can be an excellent source of “patient” money.

Angels (4 of 4)

• The Challenge: Finding angels!

– Network

– Look nearby: within a 50- to 100-mile radius

▪ 7 out of 10 angels invest in companies that are

within 50 miles of their homes or offices.

– Informal angel “clusters” and networks

▪ 300 angel groups across the United States

▪ Internet

Sources of Equity Financing (6 of 8)

• Personal savings

• Friends and family members

• Crowd funding

• Accelerators

• Angels

• Venture capital companies

Venture Capital Companies (1 of 2)

• Venture capital companies:

– Private, for-profit companies that purchase equity positions

in young businesses that they believe have high-growth and

high-profit potential.

– More than 400 operate across the United States

– Most venture capitalists seek investments in the $5 million

to $25 million range

– Target companies with high-growth and high-profit potential.

– Business plans are subjected to an extremely rigorous

review - less than 1% accepted.

Figure 13.3 Venture Capital Funding

Source: Price Waterhouse Coopers,

https://www.pwcmoneytree.com/MTPublic/ns/nav.jsp?page=historical.

https://www.pwc.com/us/en/technology/moneytree.html

Figure 13.4 The Business Plan Funnel

Venture Capital Companies (2 of 2)

• Most often, venture capitalists invest in a company across

several stages.

• On average, 96-98% of venture capital goes to:

– Early stage investments (companies in the early stages

of development).

– Expansion stage investments (companies in the rapid

growth phase).

• Only about 2% of venture capital goes to businesses in the

startup or seed phase.

Figure 13.5 Angel vs. Vc Investments

Sources: Based on data from Jeffrey Sohl, “The Angel Investor Market in 2013: A Return to Seed Investing,”

Center for Venture Research,April 30, 2014,http:// paulcollege.unh.edu/sites/paulcollege.unh.edu/files/2013%

20Analysis%20 Report%20FINAL.pdf; https://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/

displays/notice-D.html “MoneyTree Report,PriceWaterhouseCooper and National Venture Capital 0%

Association, April 18, 2014.

https://www.google.co.in/search?q=http://+paulcollege.unh.edu/sites/paulcollege.unh.edu/files/2013%+20Analysis +Report FINAL.pdf&ie=utf-8&oe=utf-8&client=firefox-b-ab&gfe_rd=cr&ei=-f5UWajVOu3t8Aeqn6DgAQ

https://www.pwc.com/us/en/technology/moneytree.html

What Do Venture Capital Companies

Look For?

• Competent management

• Competitive edge

• Growth industry

• Viable exit strategy

• Intangibles factors

Sources of Equity Financing (7 of 8)

• Personal savings

• Friends and family members

• Crowd funding

• Accelerators

• Angels

• Venture capital companies

• Corporate venture capital

Corporate Venture Capital

• About 300 large corporations across the globe invest in

start-up companies.

• More than 17% of all VC deals involve corporate venture

capital.

• Capital infusions are just one benefit; corporate partners

may share marketing and technical expertise.

Sources of Equity Financing (8 of 8)

• Personal savings

• Friends and family members

• Crowd funding

• Accelerators

• Angels

• Venture capital companies

• Corporate venture capital

• Public stock sale

Going Public

• Initial public offering (IPO):

– When a company raises capital by selling shares of its

stock to the public for the first time.

• Since 2001, the average number of companies making

IPOs each year is 120.

• Few companies with less than $25 million in annual sales

make IPOs.

Figure 13.6 Initial Public Offerings

Source: Based on data from 2014 IPO Report, WilmerHale, 2014, p. 2.

Characteristics of Successful IPO

Candidates

• Consistently high growth rates

• Scalability

• Strong record of earnings

• 3 to 5 years of audited financial statements that meet or

exceed SEC standards

• Solid position in a rapidly-growing industry:

– Average company age is 10 years

• Sound management team with experience and a strong

board of directors

Steps to Take a Company Public

• Choose the underwriter

• Negotiate a letter of intent

• Prepare the registration statement

• File with the SEC

• Wait to “go effective”

• Road show

• Sign underwriting agreement

• Meet all state requirements

Nonpublic Registrations and

Exemptions

• Regulation D

– Goal: To give small companies easy access to capital

markets with simplified registration requirements.

▪ Rule 504

▪ Rule 505

▪ Rule 506

The Nature of Debt Financing

• Debt financing is a popular tool used by entrepreneurs to

acquire capital.

• Borrowed capital allows entrepreneurs to maintain

complete ownership of their businesses, but must be

repaid with interest.

• Small businesses are considered more risky than

corporate customers.

– Prime rate

Figure 13.7 Small Business Financing

Strategies

Source: National Small Business Association, 2013 Mid-Year Report, p.11.

Sources of Debt Capital

• Commercial banks

– Lenders of first resort for small businesses

– Average micro-business loan = $6,377

– Average small business loan = $240,428

Sources of Debt Capital from

Commercial Banks

• Short-term loans

– Home Equity Loans

– Commercial Loans

– Lines of Credit

– Floor planning

• Immediate and Long-Term Loans

– Installment Loans

– Term Loans

SBA Loan Guarantee Programs

• The SBA guarantees more than 52,000 small business loans

totaling more than $19 billion each year.

– Aimed at entrepreneurs who can’t get conventional funding.

– Average duration of an SBA loan is 12 years.

• 7(A) Loan Guaranty Program

– Average 7(a) loan = $344,520