Financing New Ventures

Issues with new ventures.

• Where to find investors?

• Why consider friends and family?

• What’s bootstrapping?

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Issues with new ventures.
• Funding Sources.
– From whom should you raise money?
– Most appropriate source of funding.
• Pitching Strategies.
– What are funders looking for?
– How should you structure your business model to
meet investors expectations.
• Financing Tactics.
– How much money a venture raise?
– How is valuation determined?

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Sources of Funds
• Two primary categories:
– Debt: borrow money, which is paid back over time
with interest.
– Equity: money is invested in your business (or
idea) in exchange for part ownership.

• Early-stage companies rarely raise money via

debt (exception, convertible notes which are a
‘hybrid’ more closely related to equity).

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Sources of Funds: Example
• An investor is looking to invest $10,000 and has a
choice of two projects (details given below).
– If invest as debt will get 15% interest
– Otherwise, he can invest as equity

• Safe investment: Certain to return $15,000.

• Risky investment: 10% probability of returning
$500,000 and 90% of failing completely.

• How can equity investors reduce the risk?

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Debt Financing
• Cash flow financing (Bank loans)
– Required earnings history
– Banks impose restrictions: minimum cash flow
balance, limits on the debt/equity ratio

• Asset-based financing
– Accounts Receivables (up to 85%)
– Inventory (up to 50%)
– Equipment
– Real Estate
– Letter-of-Credit Financing
• Purchase of goods, other parts of the world where company
do not have relationships with local banks.

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Sources of Funds : Contacts
• Private investors
– Initial equity funding.
– Angel/VC Investors or Band of Angles
– A rapidly growing part of private equity market.

• Institutional investors
– Traditional venture capital firms (VC’s).
– Pooled funds of LP’s.
– Private Equity Investors/Funds

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Sources of Funds
• Strategic or Corporate VC’s
– Subsidiaries of large corporations (Intel, Google,
ABB, SAP, Siemens, Samsung).

– Invest within their core businesses to achieve

BOTH financial and strategic returns, eg.,
technologies, or acquire critical in-house expertise.

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Sources of Funds
• Overseas Investors
– Foreign investors, banks and leasing companies.
– Particularly for rapidly growing economies like
China, India, Germany and Saudi Arabia.

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Sources of Funds
• Intermediaries
– Growth capital primarily.
– Investment bankers, brokers, merchant bankers or
financial consultants can assist in introductions to
financing sources.
• Must be aware of banking fees associated with such
intermediaries.

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Sources of Funds
• Mergers & Acquisitions
– M&A with companies rich in cash can be a viable
source.
– Triggers many legal, structural and tax issues that
must be evaluated.
– M&A activity reflects the consolidation of
technology and the “make vs. buy” analysis that
companies may go through in evaluating how best
to remain competitive.

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Sources of Funds : Summary
• Understanding the characteristics of the
different sources of capital is critical to
successfully funding your company.

• Every investor generally invests for a different

reason and at a different stage.

• If the stage of your company is not aligned

with the stage of the investor, you will not be
successful.

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Financing From Friends and Family
• Equity or Debt.

• Invest based on the relationship.

• Discuss impact on family dynamics.

• Be and make it very clear about risks and

rewards.

• Always put terms into writing.

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Family Offices (FBO) or Wealthy Investors
• Wealthy families with financial managers.

• Normally operating as a “quasi-venture” fund.

• FBOs may directly invest or co-invest with

angels or local VC’s.
– They have good relationships with local VC’s

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Bootstrapping
• Derived from “pulling oneself up by your
bootstraps”
– Doing more with less.
– Studies show that more than 80% of new startup
operations are funded through the founders' personal
finances. The recorded median in start-up capital is
reported at approximately $10,000.

• Operations of the firm

– Advantages : Better control, more focus on business, if
successful, you have a bigger share of exit value (or a
higher valuation when you raise funds).

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Important Bootstrapping Strategies
• Don’t delay but ‘keep your day job’ if possible.
Focus on customer relationships.

• Focus on cash flow and keep staff focused on

projects that produce income or expand market
share.
– Raising money is not a substitute for making money.

• Be frugal, not cheap –distinguish between

avoidable and necessary costs.
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Important Bootstrapping Strategies
• Leverage your assets –look for way to grow
without cash (licensing, joint ventures,
strategic alliances, exchanging use of your
product for other services).

• Trade equity for services –but stay within the

securities laws.
– Lawyers, accountants, employees, ad agencies,
consultants, and others are candidates.

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Important Bootstrapping Strategies
• Be a junkyard dog –look for equipment and
supplies cast off by others. Seek out someone
else’s underutilized resources.

• Perception vs. reality –high quality

letterhead, business cards, well written web
page, voice mail system, ‘borrowed’
conference rooms for meetings.

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Important Bootstrapping Strategies
• Use others’ resources –find companies not
using resources 24 x 7, partner with more
established companies, use interns.

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Important Bootstrapping Strategies
• Don’t give up –entrepreneurship is a
marathon, not a sprint.
• Rely on yourself, co-founders, friends and
family for support through tough times. There
will be sleepless nights.

• THE DARK SIDE –do not step outside the

bounds of integrity and ethics.

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Bootstrapping –Summary
• Bootstrapping may well be the best way to
finance an early stage company.

• The longer you bootstrap, the higher the likely

valuation you’ll get when you seek external
funding.

• Many think that bootstrapping equates to

“small” companies which have low valuations.

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The Financial Plan
• Entrepreneurs should raise only what is actually
needed.
• Too often financing may be costly both in time
and money.
• Growth Stage Identification
– Emergence, Transition, Rapid Growth
• The Unique Funding Issues of High-tech Ventures
– Failure rate is very high
– Require more time for product development, but
business cycle is very short

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The Financial Plan
• Entrepreneurs should raise only what is
actually needed
• Funding a Social Ventures
– Not attractive to the traditional type of investors
– How to scale the venture?
– Creativity and Innovation is the key.
• Business in a Bag
– Impact investing.

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Returns on Funds

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Returns on Funds

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A mapping of funding sources

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Funding Sources and Business Models
• Location decisions for startups

• Change in the risk and uncertainty profile of a project

can jeopardize its financing.
– TA Energy – Turkey (1998)

• Past financing decisions, especially with respect to

equity investors have lasting implications on
subsequent business model decisions.
– Mixing unsophisticated angel and VC investors

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Tactical Strategies for Financing Ventures
• Pitch right for your type
– Entrepreneur’s pitch should reflect the interests of the
financiers.
• VC vs. bank lenders
• Upside potential of the business

• Understand that valuation is in the context of a financing

negotiation
– There is no “true” value of a new business

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Tactical Strategies for Financing Ventures
• Deal terms have value
– Sometimes it is easier to negotiate on certain deal terms
rather than directly on valuation
• Low valuation exit
• A down round of financing

• Raise appropriate amounts of money to reach the next

milestones
– Too much money is also not good
– Do not run out of cash!

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Valuing Pre-revenue Companies

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Valuing Pre-revenue Companies…Cont’d

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Valuing Pre-revenue Companies…Cont’d

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Valuing Pre-revenue Companies…Cont’d

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Median Pre-Money Valuation by Round Class ($ Millions)

Ratio 17.9 12.57 9.60 10.21 17.05 17.78 14.75

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Median Pre-Money Valuation by Development Stage ($ Millions)

Ratio 17.9 12.57 9.60 10.21 17.05 17.78 14.75

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VC Method: Valuation Q1
– Roger Harkel, CEO of Bestafer Inc., sought to raise $5 million in a
private placement of equity in his early stage dairy products company.
– Harkel conservatively projected net income of $5 million in year five,
and knew that comparable companies traded at a price earnings ratio of
20x.
– What share of the company would a VC require today if her required
rate of return was 50%?
– If the company had 1 million shares outstanding before the private
placement, how many shares should the venture capitalist purchase?

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VC Method: Valuation…Cont’d
– Roger Harkel, CEO of Bestafer Inc., sought to raise $5 million in a
private placement of equity in his early stage daily products company.
– Harkel conservatively projected net income of $5 million in year five,
and knew that comparable companies traded at a price earnings ration
of 20x.
– What price per share should she agree to pay if her required rate of
return was 50%? (Assume investment is in standard preferred stock
with no dividends and a conversion rate of common of 1:1)
– What is the pre-money valuation?
– What is the post-money valuation?
– Roger feels that he may need as much as $12 million in total outside
financing to launch his new product. If he sought to raise the full
amount in this round, how much of his company would he have to give
up? What would be the share price?

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Valuation Gap
– Entrepreneurs is looking for pre-money $4 million valuation
– For an investment of $1 million investment
– Angel Investor agreed on $3 million only

– Deal will not happen, what to do? Bridge the gap.

– Warrants: The angles can agree to the $4m pre-money but ask for
additional long-term warrants to purchase shares at the same time.
– Liquidity Preference: Increase the liquidity preference (1 x non
participating)
– Dividends: 8% dividends that accrue and are payable upon a liquidity
event.
– Preferential Shares: Convertible preferential shares
convertible/redeemable at the liquidity event.

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Valuation Gap
– Preferential Shares:

– Suppose the angels agree to take 20% preferential shares for $1m
investment (pre-money valuation $4 million)
– Immediately after the investment, due to some good job offer,
entrepreneur want to quit.
– Company has $2 million cash and no other assets
– The angles agree to liquidate

– Due to the preferential shares they will get their all money back.
– If the angles had common shares they would get only $0.40 million

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Valuation Gap
– Warrants:

– Suppose pre-first round of financing 10 million shares outstanding.

– Suppose the angels agree to take 20% common shares (2.5 m) plus
warrants (5%) convertible after 10 years at current price for $1m
investment (pre-money valuation $4 million)
– After 10 years, if company sustains the angles will get shares
corresponding to their 5% warrants.

– Advantage: entrepreneur’s equity will not dilute immediately after the

funding.
– The angels will get the value after 10 years by getting more shares.

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Valuation Gap
– Liquidity Preference:

– A liquidity preference determines the relative distribution between the

preferred shareholders and the common shareholders.
– Non-participating simple preference (1x, 3x or 5x): At exit investors
may choose between a return of capital and participation with the
common shares in proportion to their ownership.

– Angles invest $1 m for 25 percent of a company without a liquidation

preference.
– In case of if a company is sold for $ 2m, Angles would get 0.5 m only
– With a liquidity preference of 1x simple preference, angels would get
their money back i.e. 1 million first and then rest money i.e. 1m will be
distributed among the common shareholders. The angles will get 1m
plus 25k.

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Thank You!

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