Start Up Funding
by
John Seelinger
SCORE Counselor
John.Seelinger@SCORE114.org
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START UP COSTS
• IF YOU DON’T HAVE ENOUGH CASH TO
START YOUR BUSINESS RIGHT, WAIT
UNTIL YOU CAN.
• BUSINESS PLAN WILL HELP
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Start Up Cost Estimates
• Average Start Up Cost Estimates - $65K
– Construction - $82K
– Retail - $98K
– Manufacturing - $175K
-Babson College survey
START-UP COSTS and CAPITAL
SOURCES
•
START-UP CASH INVESTMENT
FIXED CAPITAL INVESTMENTS
•
•
•
START UP
GROWTH
MAINTENANCE
WORKING CAPITAL INVESTMENTS
•
•
•
START UP
GROWTH
MAINTENANCE
CASH OUTLAYS UNTIL BREAKEVEN
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START-UP COSTS and CAPITAL
SOURCES
• FIXED CAPITAL – How do you calculate how much
your business needs at start-up and to maintain
growth? Do not confuse the justification with how it will
be financed. Justify first, then determine how to
finance the investments.
SALES FORECAST – 24 to 36 months
How much “capacity” investment is required?
How fast will you grow? New products or services?
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START-UP COSTS and CAPITAL
SOURCES
• WORKING CAPITAL INVESTMENTS – The
excess of current assets over current liabilities or
the amount of cash required to fund the
business on a day-to-day basis. An indication of
short-term financial strength. Don’t be undercapitalized.
• No business has ever failed because they had
too much working capital.
Working Capital = CURRENT ASSETS minus
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CURRENT LIABILITIES
START-UP COSTS and CAPITAL
SOURCES
• WORKING CAPITAL INVESTMENTS - How do
you calculate how much your business needs at
start-up and during periods of growth?
SALES FORECAST – 24 to 36 months
Working Capital increases and decreases with
sales. It is a variable investment.
Example: Figure $.20 increase for every
incremental sales dollar increase. 7
CAPITAL SOURCES
Does seed capital effect long-term
profitability or growth rate?
Only 65% of companies that started with more than
$100,000 were in the black after one year compared
with 83% of those businesses that were launched
with $1,000 to $10,000.*
*Inc Magazine
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CAPITAL SOURCES
• 42% of the Inc 500 CEOs surveyed had a formal
business plan before the company was started
• 31% are family owned
• 17% have one or more offices overseas
How start-ups are really funded:
Self Financed
82%
Loans from Family or Friends
22%
Bank Loans
35%
Private Equity, Venture Capital
8%
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CAPITAL SOURCES
• EQUITY FUNDING – Financing your
business by selling a minority equity
interest. This cash is less risky but
more expensive. Valuation issues must
be addressed. Initial and target
valuation calculations must be made.
56% of founders started the company
with a partner.
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CAPITAL SOURCES
Private Equity and Venture Capital Funding
The average angel investor is between 48
and 59 years old, has a postgraduate
degree, has experience in management
and building a company, and typically
invests between $25,000 and $250,000
per deal in one to four deals per year.
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CAPITAL SOURCES
Private Equity and Venture Capital funding
Angel investors tend to like proprietary products and
non-capital intensive businesses. They anticipate future
rounds of financing. Angel investors look for:
1.
Market niches – potential to dominate or be #1 or #2 in the
industry
2.
Advanced technology and a disruptive model (going to change
things)
3.
Compelling and sustainable advantage – not “me too”
4.
Planned exit in 4-6 years
5.
Reasonable valuation
6.
Performance equal to 5 -10 times original investment
7.
ROI equal to 20-40% per year
8.
Sitting on your board but not having control
9.
Higher risk business models
10. Angels spend, on average, 51 hours on due diligence per
investment
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CAPITAL SOURCES
BANK LOANS or DEBT FINANCING
Banks typically will loan 2.5 – 4.0 times Cash Flow –
usually based on EBITDA.
Banks would like to see a 3-5 year track record or a
history of business experience
Debt is less expensive but more risky than equity
Banks will not lend on pure projections: You must
have a history of cash flow or a current personal
guarantee.
Three sources of repayment:
1.
2.
3.
4.
5.
•
•
•
Cash Flow
Liquidation value of assets
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Personal Guarantees of each 25% equity owner
CAPITAL SOURCES
NEGATIVES TO A BANKER
1.
2.
3.
4.
5.
6.
7.
8.
9.
Getting involved with something outside your normal business
model
Absentee management / ownership
Divorce
Burnout
Growing beyond owner’s capacity to operate the business
Parent turns over business to son or daughter
Computer conversions
Relocation and / or expansion of facility
Companies “hit the wall” at:
1.
Manufacturing companies at $2 million in sales
2.
Distribution companies at $4 million in sales
3.
Retailers at 3 stores and distance
4.
Service companies at 12 employees
5.
Contractors at 2 or more big jobs
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CAPITAL SOURCES
A bank would rather see a 640 FICO score with all
payments as agreed (no late payments,
foreclosures, repossessions, charge offs or
collection accounts) than a 740 FICO score with a
past foreclosure, and three previously delinquent
accounts now paid.
Having a stable source of income to meet personal
income requirements can be a significant factor in
reducing business risk for a start-up.
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CAPITAL SOURCES
QUESTIONS A BANKER WILL ASK YOU
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Do you have a Business Plan?
How much experience do you have in this industry?
How is your credit and how much personal debt do you have?
How much is your down payment? Is it at least 25%?
How much collateral do you have?
Who is the competition?
Do you have personal and business insurance?
Do you have services of an accountant and attorney?
Have you ever filed for bankruptcy?
Do you have 2-4 years of tax returns available?
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CAPITAL SOURCES
SMALL BUSINESS ADMINISTRATION (SBA)
The SBA does not loan money. It guarantees (to the bank)
approximately 85% of the loan proceeds to you. Five to ten
year payback terms. Interest rates of prime plus 2 – 4%
depending on the program and terms.
This reduces the banker’s risk, thereby enabling the loan to
be approved. They use basic credit standards:
–
–
–
–
–
–
Character
Management ability
Cash Flow
Equity
Feasible Business Plan
Sufficient collateral
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CAPITAL SOURCES
SBA ELIGIBILITY (There are exceptions)
• Must be “for profit”
• Must be an operating company. SBA does not
allow speculation or investment companies.
• Must be a small business:
– Manufacturing
– Wholesaling
– Services
500 -1,000 employees
less than 100 employees
Receipts test for each
classification
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CAPITAL SOURCES
•
•
•
•
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SBA ELIGIBILITY
Cannot be a business in lending, life insurance,
real estate development or rental property.
Gambling, promoting religion, pyramid sales plans,
consumer marketing cooperatives and persons of
poor character are ineligible.
Individuals must be lawfully in the U.S.
Business cannot be located outside the U.S.
Import businesses may be ineligible
Go to www.SBA.gov for a complete list of ineligible
businesses. Also, a good resource for minority and
micro-loan plans.
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EXIT
Many of the CEO’s plan to cash out.
41% of CEO’s started the company with
at least one exit strategy in mind. Some
had several.
Those strategies included:
Going Public:
47%
Selling to a private buyer:
80%
Leaving the company to heirs:
7%
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CAPITAL SOURCES
MISTAKES ENTREPRENEURS MAKE WHEN RAISING
CAPITAL
Don’t understand share prices or valuations
Confuse broad market with served market
Make unrealistic assumptions about an exit strategy
Don’t understand long term capital needs
Have no clue about competition
Don’t understand that marketing beats technology 9
out of 10 times
7. Write a poor executive summary
1.
2.
3.
4.
5.
6.
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CAPITAL SOURCES
MISTAKES ENTREPRENEURS MAKE WHEN RAISING
CAPITAL
8. Use “off the wall” numbers or pull numbers from
thin air
9. Lack focus; e.g. many products or niches
10. Develop too simplistic of a market plan / analysis
11. Underestimate expenses
12. Rely on financial plans with major inconsistencies;
e.g. numbers don’t match or tie
13. Speak in “techno-jargon”. No one understands
what they are saying
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CAPITAL SOURCES
BEST WAYS TO IRRITATE AN INVESTOR
1.
Lying to investors or not being forthright; omission of
material information
2. Inability to answer direct questions with direct answers
3. Surprises; e.g. problem with credit checks, hidden
liabilities or debts
4. Over hype or exaggerate upside
5. Your story always changes
6. Arguing with investors
7. Late for meetings
8. Excessive secrecy or legalese; expect investor to sign
NDA
9. Investing capital in fancy facility and furniture
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10. Fail to attract top talent
CAPITAL SOURCES
LEASE FINANCING
Many start-ups may want to consider lease
financing for their fixed capital needs. Leasing
sometimes shifts the risk of ownership, such as
technological obsolescence onto the lessor thus
freeing the lessee to finance working capital
needs. There also may be possible tax
advantages in certain cases that makes leasing
less expensive on an after-tax basis.
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Capital Sources
• ROYALTY FINANCING:
• basically loaning money against
the promise of a future sales. The lender collects a portion of the
gross revenue on a monthly or quarterly basis until an agreed to
total amount is paid back, usually 4 times the original
loan amount. This works with companies that are pre-revenue and
are just at the point that they can begin to make sales but need
financing to buy inventory or materials for manufacturing or need
to invest in key marketing expenses to fuel their revenue
machine.
The companies cannot usually borrow from traditional lenders because
they lack a documented means to pay the loan back (historic sales),
may have been in business less than 2 years, and do not have
collateral to secure the note.
Capital Sources
(Royalty Financing cont’d)
• Often the valuation for a company at this stage
is relatively low compared to their potential once fully operational;
therefore any equity investment would take a substantial amount of
equity. Companies that fit this model tend to have high margins
and non-cash transactions.
Example: Terralink Software Systems, of Maine, needed to turbocharge its sales and marketing efforts of its PC based software
products. Terralink was selling their product and having moderate
growth. The founders felt that an infusion of $200K could get them
to their target of $750K in sales and repeat customer sales
transactions. However, they did not want to give
up a substantial part of their equity for that money. A $200K loan
against future sales seemed ideal.
Capital Sources
(Royalty Financing cont’d)
• In exchange for this “advance”, the investors received 3% of
Terralink’s sales for 10 years or until they received payments
totaling $600,000. This amount would represent the original
$200,000 investment plus $400,000 more. If Terralink repaid the
advance over 10 years, investors would earn a compound annual
return of 11.6% or their investment. If however, Terralink’s sales
took off and the $600,000 was paid to the investors in five years,
the compound annual return would be a juicy 24.5%.
Capital Sources
• Asset Based Lending
• Factoring
Good To Know Websites
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SBA.Gov
Score.org
Score114.org
Rjbradley.com/blog
Business.gov
Grants.gov
Prosper.com
Boefly.com
More Websites
“Crowd Funding”
– Profounder.com
– Peerbackers.com
– Kickstarter.com
– Indiegogo.com
– Rockethub.com
QUESTIONS
?
SCORE
JOHN SEELINGER
John.Seelinger@SCORE114.org
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