Chapter 9 Flashcards
working capital
short-term operational needs such as paying suppliers or employee salaries
Investment capital
(medium/long) fund the purchase of a one-off physical asset such as a car or machinery or breaking into a new market, marketing and sales development, supporting research and development.
Insider finance
own money, own loan, friends, family etc.
retained earnings
keep money made (profit) in business useful because you don’t rely on other people for money.
External sources of finance
money from outside sources.
Kinds of external sources
Public funders, Banks, Crowdfunders, Asset financiers, Trade creditors, Factors and invoice discounters, Equity funders
Public funders
local, regional and national governments provide grants, ‘soft’ loans, loan guarantees, and equity finance.
Types of crowdfunding
donations, rewards, loans and equity-based funding.
Asset financiers
they pay for assets and you pay them back or lease from them.
Trade creditors
suppliers agree to supply a good or service on account and ask for payment at a specified later date.
Factors and invoice discounters
A third party gives you money for your invoices (facturen) that are not paid yet on condition they have a % of the invoice amount.
2 types of equity funders
- Business angels (own money), 2. Venture capitalists (others money)
What do most small businesses use
bank loans and internally funded loans from their directors or family. Few use equity funders.
the pecking order
people prefer to first use their own and insider money than external debt and then external equity.
Why is there a pecking order
because businesses desire to stay in control of their own business.
what is another reason start ups need to rely on own funds
because alot of info is opac (only available to the company) and not available to the public like public companies so the investors can’t look at what the entrepreneur is doing + has no asset collateral to fall on.
how can a business solve this (assymetry)
give more information so the information is not asymmetrical anymore and once the business is going and shows some revenue it is easier to identify where the business is going.
2 forms of asymmetries
adverse selection and moral hazard
Adverse selection
when one party (the entrepreneur) has more information than another (the financier) before a deal is struck.
Moral hazard
occurs after a deal is struck, usually because the financier (the principal) has failed to anticipate a change in the agent’s (entrepreneur) behaviour.
what do bank and others use to prevent this asymmetry
credit scores to get information about credit history get other hard information from management accounts and business plans
what is soft information and what does it do
you build a relationship → relationship-based lending → reduce the need for collateral, improve the prospects of getting finance and reduce interest rates costs.
permanent non-borrowers
have not sought external finance in the last five years
how to prevent moral hazard
have collateral
skin in the game
putting an x amount of money in your own business
what is the sequence of funding
often start the stamp of self-funding complemented with public funding, crowdfunding, or business angel finance, once revenue starts you can get a bank loan, and post revenue with the potential to fast growth you can use venture capital equity funding
four main consequences of financial constraints
- It prevents talented but poor individuals from becoming entrepreneurs, 2 Start-ups are under-capitalised, 3. Business costs increase, and 4. Business growth is restricted and productivity falls.
difference men and women internal and external capital
women use at start up more internal capital and later on use about half of external capital men use and this remains as business grow.
discouraged borrowers
The fear of being rejected can also be enough to discourage some businesses from applying for finance, even if they are creditworthy.
four main sources of finance
the bank, business angels, venture capitalists and crowdfunders.
CAMPARI screening banks use
Character, Ability, Margin, Purpose, Amount, Repayment, Insurance.
misunderstanding about angels
they also provide debt funding
Angels’ common complaints
Weak team or management, Lack of intellectual property rights, immature working prototypes, limited sales, incomplete financial model, Sluggish market growth, Immature understanding of competitors, Limited plans for marketing.
2 key metrics angels focus on
- Return on Investment (ROI), 2. Internal Rate of Return (IRR) (ROI, but additionally takes account of time).
What are 4 important things for angels
value business now, value when sold, how long it will take to sell, and what the ROI and IRR will be.
what aim angels investors for
25% IRR across the portfolio.
pros and cons after having an angel investment
pro: extra knowledge, expertise, and connections
cons: may want different things (sell business for profit) then owners (grow the business)
What are VCs looking for when screening
Strength of the team, their industry and entrepreneurial experience, the passion, ability and teamwork, as well as business-related factors such as the product, technology, business model and strong revenue growth potential. They also consider financial prospects (expected IRR and ROI), entrepreneurial passion and the business’ fit with the fund, because they typically will only invest in industries or sectors where they believe that they have expertise.
What is the VCs target
IRR is around 30 percent or a 5x multiple
IPO
public stock market
what do VCs make
2% management fee of the fund and 20% of the profit above an agreed target (carried interest)
carried interest
taking a percentage of the extra profit made on top of the agreed profit
Disadvantages of venture capital
they get on board, want to sell the company, get paid when the company is sold before the entrepreneurial team bc preferred shares, can choice to have certain rules set that they pay in stages,anti-dilution clauses → entrepreneur sees their equity share diluted= ,take money out first etc. often only in big cities, similar professional backgrounds needed, entrepreneurs have similar norms, went to the same universities and schools, are male and have shared networks → women and minorities have a smaller chance of getting vc funding
advantages of venture capital
add legitimacy, help leverage other funding sources such as bank finance, offer huge sums, they are patient for a return, have money to repeatedly invest, they help society by making it possible for more start-ups to succeed and create wealth. Their networks can help recruitment and business development, while their expertise supports improved managerial professionalism, speeds product development and supports greater innovation towards a successful exit.
crowdfunding
the efforts by entrepreneurial individuals and groups – cultural, social, and for-profit – to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries.
four basic types of crowdfunding campaigns
- Donations, 2. Preorders, 3. Peer-to-peer (P2P) loan funding, 4. P2P equity funding.
what to be careful about when doing crowdfunding
The crowdfunding platform, Previous successful campaigns, Planning the campaign, The need for a formal pitch deck and business plan, Marketing the campaign.
Problems with crowdfunding
all or nothing, pretty low success rate, last resort, hard sometimes to convince investors for more rounds, need to disclose your product and service to market which may result in copycat.
summary banks
Banks follow a low-risk, low-return business model that seeks to separate out ‘good’ from ‘bad’ borrowers (adverse selection)
summary angels & VCs
Business angels and venture capitalists follow a high-risk, highreturn business model that offers significant amounts of finance, as well as monitoring and value-adding services to fast-growing businesses in the hope of realising a sizeable capital gain.
