Getting Financing &

Funding
THE IMPORTANCE OF GETTING FINANCING OR FUNDING
 Why Most New Ventures Need
Funding
1. cash flow challenges,
2. capital investments, and
3. lengthy product development cycles.
• If a firm operates in the red, its negative real-time cash flow, usually
computed monthly, is called its burn rate e-g biotech industry
• A company’s burn rate is the rate at which it is spending its capital
until it reaches profitability.
• A firm usually fails if it burns through all its capital before it becomes
profitable. This is why inadequate financial resources is a primary
reason new firms fail.
Sources of Personal Financing
• The seed money that gets a company off the ground comes from the
founders’ own pockets.
• Sweat equity represents the value of the time and effort that a
founder puts into a new venture. Because many founders do not have
a substantial amount of cash to put into their ventures, it is often the
sweat equity that makes the most difference.
• There are three rules of thumb that entrepreneurs should follow when
asking friends and family members for money.
• First, the request should be presented in a businesslike manner, just like
one would deal with a banker or investor. The potential of the business
along with the risks involved should be carefully and fully described.
• Second, if the help the entrepreneur receives is in the form of a loan, a
promissory note should be prepared, with a repayment schedule, and
the note should be signed by both parties.
• Third, financial help should be requested only from those who are in a
legitimate position to offer assistance.
• Bootstrapping is finding ways to avoid the need for external financing
or funding through creativity, ingenuity, thriftiness, cost-cutting, or
any means necessary.
Preparing to Raise Debt or
Equity Financing
 SOURCES OF EQUITY FUNDING
1. Business angels are individuals who invest their personal capital
directly in start-ups.
• Apple received its initial investment capital from Mike Markkula, who
obtained his wealth as an executive with Intel. In 1977, Markkula
invested $91,000 in Apple and personally guaranteed another $250,000
in credit lines. When Apple went public in 1980, his stock in the
company was worth more than $150 million.
• in 1998, Google received its first investment from Sun Microsystems’
cofounder Andy Bechtolsheim, who gave Larry Page and Sergey Brin
(Google’s cofounders) a check for $100,000 after they showed him an
early version of Google’s search engine.
2. Venture capital is money that is invested by venture capital firms in
start-ups and small businesses with exceptional growth potential.
• The peak year for venture capital investing was 2000, when $98.6
billion was invested at the height of the e-commerce craze.
• A distinct difference between angel investors and venture capital
firms is that angels tend to invest earlier in the life of a company,
whereas venture capitalists come in later.
• The majority of venture capital money goes to follow-on funding for
businesses originally funded by angel investors, government programs
(which are discussed later in the chapter), or by some other means.
• Venture capital firms are limited partnerships of money managers
who raise money in “funds” to invest in start-ups and growing firms.
• The funds, or pools of money, are raised from high net worth
individuals, pension plans, university endowments, foreign investors,
and similar sources.
• The investors who invest in venture capital funds are called limited
partners.
• The venture capitalists, who manage the fund, are called general
partners.
• The percentage of the profits the venture capitalists get is called the
carry. So if a venture capital firm raised a $100 million fund and the
fund grew to $500 million, a 20 percent carry means that the firm
would get, after repaying the original $100 million, 20 percent of the
$400 million in profits, or $80 million.
• Some venture capital “funds” invest in specific areas like IT.
• Venture capitalists know that they are making risky investments and
that some of them will not be successful.
• The home runs must (successful business) be sensational to make up
for the modest-return firms and the failures.
• Once a venture capitalist makes an investment in a firm, subsequent
investments are made in rounds (or stages) and are referred to as
follow-on funding.
• An important part of obtaining venture capital funding is going
through the due diligence process, which refers to the process of
investigating the merits of a potential venture and verifying the key
claims made in the business plan.
3. Initial Public Offering
• Most entrepreneurial firms that go public trade on the NASDAQ,
which is weighted heavily toward technology, biotech, and small-
company stocks
• investment bank
• a preliminary prospectus
• A variation of the IPO is a private placement, which is the direct sale
of an issue of securities to a large institutional investor.
• When a private placement is initiated, there is no public offering, and
no prospectus is prepared.
 Sources of Debt Financing
• A single-purpose loan, in which a specific amount of money is
borrowed that must be repaid in a fixed amount of time with interest.

• The second is a line of credit, in which a borrowing “cap” is

established and borrowers can use the credit at their discretion. Lines
of credit require periodic interest payments.
 Disadvantages
• Strict conditions on loans
• It must be repaid

Advantages

• Interest payments on a loan are tax deductible

• Ownership of the firm is not surrendered
 Sources
1. Commercial Banks
Banks have historically been reluctant to lend money to start-ups
because:
• Banks are risk averse
• Not as profitable
2. SBA Guaranteed Loans

• Individuals must pledge all of their assets to secure the loan

• Utilized more heavily by existing small businesses than start-ups
• The maximum length of the loans are 10 years for working capital,
• 10 years for equipment (or useful life of equipment), and 25 years for
real estate purchase.
2. Vendor credit (also known as trade credit): vendor extends credit to
a business in order to allow the business to buy its products and/or
services up front but defer payment until later.
• Consumed particularly during economic downturns when it’s harder
for businesses to obtain bank financing
3. Factoring is a financial transaction whereby a business sells its
accounts receivable to a third party, called a factor, at a discount in
exchange for cash
4. Peer-to-peer lending is a financial transaction that occurs directly
between individuals or “peers.”

• The loans are unsecured loans that are fully amortized over a period
of one, three, or five years.
5. Crowd funding sites allow entrepreneurs to create a profile,
• list their fund-raising goals, and provide an explanation of how the funds will
be used.
• Individuals can then pledge money, in exchange for some type of amenity,
like being one of the first 100 people to try the company’s product, instead of
equity or a promissory note.
• The site typically takes a small percentage of the funds raised by the
individual for its service.
• There are also organizations that lend money to specific demographic groups
(female).
• Some lenders specialize in microfinance
6. A lease is a written agreement in which the owner of a piece of
property allows an individual or business to use the property for a
specified period of time in exchange for payments.
• venture-leasing firms that act as brokers, bringing the parties involved
in a lease together. These firms are acquainted with the producers of
specialized equipment and match these producers with new ventures
that are in need of the equipment.
• Most leases involve a modest down payment and monthly payments
during the duration of the lease. At the end of an equipment lease, the
new venture typically has the option to stop using the equipment,
purchase it at fair market value, or renew the lease.
7. The Small Business Innovation Research (SBIR) and the Small Business
Technology Transfer (STTR) programs are two important sources of early stage
funding for technology firms.
• These programs provide cash grants to entrepreneurs who are working on
projects in specific areas.
• The main difference between the SBIR and the STTR programs is that the
STTR program requires the participation of researchers working at
universities or other research institutions.
• For the purpose of the program, the term small business is defined as an
American-owned for-profit business with fewer than 500 employees.
• The principle researcher must also be employed by the business.
• The SBIR Program is a competitive grant program that provides over
$1 billion per year to small businesses for early stage and
development projects.
• Each year, 11 federal departments and agencies are required by the
SBIR to reserve a portion of their research and development funds for
awards to small businesses.
It involves three phases
8. Strategic Partners
• Biotech firms, which are typically fairly small, often partner with larger drug companies to conduct clinical
trials and bring products to market.
• Most of these arrangements involve a licensing agreement. A typical agreement works like this: A biotech
firm licenses a product that is under development to a pharmaceutical company in exchange for financial
support during the development of the product and beyond. This type of arrangement gives the biotech
firm money to operate while the drug is being developed.
• The downside to this approach is that the larger firm ultimately markets the drug and retains a large share
of the income for itself. Sometimes strategic partnerships take on a different role in helping biotech firms
take products to market and allow them to keep a larger share of the income than licensing arrangements
permit.
• Finally, many partnerships are formed to share the costs of product or service development, to gain access
to a particular resource, or to facilitate speed to market.
• In exchange for access to plant and equipment and established distribution channels, new ventures bring
an entrepreneurial spirit and new ideas to these partnerships. These types of arrangements can help new
ventures lessen the need for financing or funding.