6. Sources of Capital Flashcards
a) Describe the most common sources of equity funding.
b) Describe the most common sources of debt financing.
(8 marks) 2011
a)
The most common sources of equity funding are:
-friends and family: Often when starting out, entrepreneurs will ask this group to invest. This money is easy to access as trust has already been built up. A US study found that 95% of funding for start-ups comes from family and friends.
Your own money: most investors want to see that the entrepreneur has put some of their own money into the venture as sgin of commitment.
-business angels: These are professional investors who will give advice and money in return for equity.
venture capital. These are funds raised and managed by professionals. These investors are highly demanding and will only invest in enterprises with a very large potential win.
-initial public offering. Going to the market for equity is a worthwhile strategy but needs to be done once the business is established as otherwise credibility will be lacking
b)
The most common sources of debt financing are:
The entrepreneur’s own loans: eg bootstrap finance in the form of credit card loans, personal loans etc.
-friends and family: Often when starting out, entrepreneurs will ask this group to invest. Some friends and family who are risk-averse may not want equity and will prefer to give debt financing with a clear repayment plan.
-commercial banks lend short term and long term money to small enterprises but at present there are significant problems in persuading them to part with their money! Secured loans on property etc are easier to get.
-convertible loans from banks which begin as debt but then if the company succeeds they turn into equity
Fred has started a new business. His loving Auntie Hilda wants to invest Elm.
What are the advantages and disadvantages of taking
the money from Auntie Hilda versus using funds offered by a Venture Capitalist?
(8 marks) 2011
a) ‘In late August 2004, Peter Thiel … became the company’s first major investor with a $500,000 cash infusion into Facebook.
“A few other people have invested a few thousand dollars hereand there, but I’m sort of the main investor, pre-venture,” said Thiel.’ (pp7-S).
Discuss the role of FFF and business angels in new venture’s development.
b) ‘By late May 2005, Facebook had attracted 2.S million
registered users . . . “I think we had 30 VCs who had expressed an interest in the deal’’’. (p9)
How should a start-up choose a VC?
Define Equity Funding
Equity financing takes the form of money obtained from investors in exchange for an ownership share in the business. Such funds may come from friends and family members of the business owner, wealthy “angel” investors, or venture capital firms.
+
- The main advantage to equity financing is that the business is not obligated to repay the money. Instead, the investors hope to reclaim their investment out of future profits.
- The involvement of high-profile investors may also help increase the credibility of a new business.
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- The main disadvantage to equity financing is that the investors become part-owners of the business, and thus gain a say in business decisions.
- You lose part of the business, give up the future value of that share
- Investors want a high return
- To obtain equity, you need a convincing argument and forecasted return
Define Debt Financing
When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors.
In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid.
+ cheap
+ Retain control of the business
- Very hard to obtain now (due to tightening of regulation after the economic downturn)
- Interest payments must be a priority!
- Default can cause bancrupcy
Seed/ start up capital
seed capital funds a start up phase
Outline the growth process of a start up
- Founding stage
- vision, business model, strategy - Seed stage
- initial financial capital - Growth stage
- growth capital required - Harvest stage
- IPO or acquisition provides return for investors and founders
Define working capital
working capital is the capital used to support a firm’s normal operations and is defined as current assets minus current liabilities
Define IPO
Initial Public Offering
The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.
- Risk that no funding will be secured
- It is costly to conduct the IPO (accounting, legal, marketing)
- Competitiors will have access to all information
Advantages and disadvantages of grants
+
- Doesn’t have to be repaid
- May come with advice too
- Useful for businesses that are for the greater good i.e. social enterprises
- For example in April, Santander awarded nearly £100,000 to three social enterprises in London and access to mentoring from the bank
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- Opportunity cost of time required to apply and secure grants
- Timing can be slow
- Project has to fit criteria
- Stricy conditions
What are the options for funding a venture?
Debt
Equity
Grants
Personal Investment
Crowdfunding
Explain crowdfunding
Thanks to social media and other forms of modern technology, entrepreneurs are able to build networks of friends, colleagues, and like-minded individuals more easily and effectively than ever before. Crowdfunding websites allow entrepreneurs to leverage these networks to gain funding. Typically, entrepreneurs post a request for funding on a crowdfunding site with a detailed project description
- may be difficult administratively to have so many shareholders
- Legally complicated
What is bootstrapping?
Up to 75% of start-ups are bootstrapped
Launching a start-up with modest funds from the entrepreneurial team, friends and family.
To start a firm by one’s own efforts and to rely soley on resources available from oneself, family and friends.
Bootstrappers start with a modest business plan and build on it as they go
They look for quick routes to breakeven and positive cashflow
e.g. the firm Eeve, at the time of lecture, were bootstrapping and abiding by a ‘lean start-up’ model - continually testing their app on the market and with consumers
Ways to bootstrap:
- second jobs
- sweat equity
- mortgage
- personal investment
+ No pressure from investors, bootstrappers are able to make mistakes
- Risk
What are VCs?
Venture Capitalists
High net-worth individuals that provide start ups with equity financing
Can offer experience, guidance, contacts
Want to invest in companies with profitable potential, scalability, sound business plan, competitive advantage
Exit route! - Trade sale, MBO, MBI, IPO,
What is NPV?
Net Present Value
- NPV is a mathematical concept used to measure the viability of an investment project.
- It is the difference between the present value of the future revenues of the project and the present value of its future costs
- Present values being calculated by discounting the future revenue and costs by the cost of capital or discount factor
