Entrepreneurial finance Flashcards
session 9
Cash burn rate
The rate at which cash is consumed is called the cash burn rate
* Cash burn rate: If beginning cash is EUR 100’000 and cash at end of year is EUR
40’000, then the cash burn rate is 60’000/12 = EUR 5,000 per month
Cash runway
Cash runway: You have now EUR 40’000 left in cash left. With a burn rate of EUR
5,000 per month, it will take 8 months until you run out of cash
Sources of new venture finance
- bootstrapping
- External money
-Equity financing/Investment
-Debt financing
Valley of death
The Valley of Death for startups is a well-known concept in the startup ecosystem, representing the critical phase where a startup begins operations but has yet to generate meaningful revenue.
Cash flow negative on graph
Bootstrapping
Financing the venture without outside capital, only with own money and the startup‘s cash
flow
Bootstrapping Benefits
Ownership and control remain with
founder(s) for a long time
Higher financial reward in a potential later
exit/ IPO
Bootstrapping Disadvantages
Need to generate cash flow soon
Hard to develop the best possible
(complex) product
Growth can be slower
More difficult to pay an own salary
Investors often add value
Equity financing
Equity financing
An investor provides capital to the new
venture and receives an ownership
share in return
Particular important for R&D-intensive, high growth ventures
Examples: family and friends, venture
capitalists, angel investors
Debt financing
Debt financing
The new venture gets a loan that has to
be repaid (including the corresponding
interest)
Particular important for ventures that can offer securities
Examples: bank loans, loans from
friends, family members, colleagues, or
other lenders
Equity financing benefits
No forcible repayments, therefore no
bankruptcy risks from equity financing.
More equity financing can increase the
creditworthiness for future debt financing.
Equity financing cons
The investor takes a stake in the company
(dilution of control).
The entrepreneur has less freedom in
decision-making.
Buying out their stake at a later stage will
cost more in comparison with what was
originally invested
Debt financing benefits
Creditor has no control over the business
Debt can be cheaper than equity (the
interest is tax deductible, lower required
return due to different risk pattern, etc.)
Financial planning is easier due to fixed
and finite payment structures
Return on equity may be positively
influenced by financial leverage (‘leverage
effect’)
Debt financing downsides
It’s difficult to get a bank loan without having
assets to pledge, a good credit history, and/or
a track record
Obligation to pay amount back at fixed
schedule
3 Fs: Family, Friends, & Fools
Advantages of family as a source of financing:
Altruistic ties between borrower and lender, leading to:
* Easier access
* Longer time frame
* More flexibility in terms of contract form
* Lower cost
* Renegotiation opportunity
The downsides:
* Limited amount of funds
* Reciprocity
* Increased risk aversion to keep family
assets safe
* Intervening family members
* Potential relational conflicts
Government subsidies (grants)
- Targeted toward very early stage ventures
- Often linked to technology transfer
- Regional development
- Industry-specific programs
- Typically „free money“ – no ownership or interest loans
Business angels
- Wealthy individuals often with expertise to add value to the new
venture - Usually invest in products related to personal interest
- Early stage, typical investment 50,000 to 500,000 €
- More flexible to invest in ventures that may grow at a slower rate or
have a lower rate of return than demanded by VCs - Individual or collaborative investors (Business Angel Network - BAN)
VC
- Equity capital for young ventures, typically combined with management support
- Seed, early stage, or expansion financing (often specialized)
- Risk reduction strategies:
− Portfolio of investees
− Specialization (phases, industry)
− Staged financing in several rounds (Seed, A, B, C …)
− Lead investor or co-investor in VC investment syndicates - Explicit goal to sell the business within a certain timeframe (through an IPO, trade sale, etc.)
- Venture capitalists typically invest in exchange for at least 20-30% share of equity
- Investment horizon 3 to 5 years
- Targeted investors’ expected return (internal rate of return, IRR) > 20% p.a.
- Out of 10 investments: 1 star, 2-3 moderate, rest write-offs
- VCs are compensated by fund management fee and profit share
New ways of venture finance
- Business incubators/accelerators
* Public or private organization that provides new
ventures with offices, networks, advice for up to 3-6
month
* Entrepreneurs provide an equity share (1-10%) in
return - Peer-to-peer lending
* Uncollateralized loans from other individuals (equity or
other ownership relations are generally not included)
* Screening process involves credit history of the
borrower and other criteria
* Risk that entrepreneurs use money to finance
consumption - Crowd-funding
* Collection of (small amounts) of capital from a large a
number of people through online platform/social media
* Entrepreneurs present their projects on platform
* Investors get a compensation in form of “tokens of
appreciation” (e.g., personalized products) or equity
stake
4, Microfinance
* Provides uncollateralized loans to people living in
poverty without access to finance (especially women)
* Loan is provided to an individual or a group (a group
decreases the risk of loss and increases probability of
repayment)
* Entrepreneurs need to repay the loan and the interest
Exit
= exit of investors or the founders from the company with the highest possible profit.
What do you need for an successful exit?
- fast growth & multiplication of start-up value
- high valuation of the start-up
What happens during an exit?
Investors or founders sell their shares in the company and leave the company as shareholders
Why should one do this?
Investors: generally they don‘t plan to invest their capital in the long term. After an exit they can reinvest the
capital in new start-ups (and earn even more money)
Founders: an exit means financial and legal independence
Exit strategy
Trade Sale = selling the start-up to a corporation or private equity investor
Leveraged Buyout = selling the start-up to an investor that already invested in the company
before
IPO = Initial Public Offering, probably ideal way of an exit, only possible for very successful
start-ups
Merger = merging the start-up with a competitor
