Sources of Finance for New Ventures
Madhura Kodithuwakku
Department of Management and Entrepreneurship
Learning objectives
• To explain the why most new ventures need financing or
funding
• To discuss alternatives for raising money for a new
venture
• To discuss matching a new venture’s characteristics with
the appropriate form of financing or funding
The successful venture life cycle
• The venture life cycle begins in the development stage, has various
growth stages, and “ends” in a maturity stage. The five life cycle stages
are:
The successful venture life cycle
• The venture life cycle begins in the development stage, has various
growth stages, and “ends” in a maturity stage. The five life cycle stages
are:
–
–
–
–
–
Development stage
Start-up stage
Survival stage
Rapid-growth stage
Early-maturity stage
• For the typical venture, operating losses usually occur during the startup
and survival stages, with profits beginning and growing during the
rapid-growth stage.
•
Free cash flows generally lag operating profits because of the heavy
investment in assets usually required during the first part of the rapidgrowth stage.
Development Stage
• During the development stage, the venture progresses from an idea to a
promising business opportunity.
• Most new ventures begin with an idea for a potential product, service, or
process. The feasibility of an idea is first put on trial during the
development stage.
• Ventures determine core strengths and capabilities. The purpose of this
stage is to lay the foundation to the business.
Startup Stage
• The second stage of a successful venture’s life cycle is the start-up stage,
when the venture is organized, developed, and an initial revenue
model is put in place.
• In some instances, the process of acquiring necessary resources can
take less than one year.
For example, a business venture requiring little physical and
intellectual capital
and having simple production and delivery
processes might progress from the initial idea to actual start-up in one
year or less.
Survival Stage
• During the survival stage, revenues start to grow and help pay some,
but typically not all, of the expenses.
• The gap is covered by borrowing or by allowing others to own a part
of the venture.
• However, lenders and investors will provide financing only if they
expect the venture’s cash flows from operations to be large enough to
repay their investments and provide for additional returns.
• Formal financial statements and planning begin to have useful
external purposes.
• Formalization happens..
Rapid-Growth Stage
• The fourth stage of a successful venture’s life cycle is the rapid-growth
stage, when revenues and cash inflows grow very rapidly. Cash flows
from operations grow much more quickly than do cash outflows,
resulting in a large appreciation in the venture’s value.
• The successful venture reaps the benefits of economies of scale in
production and distribution.
• At this stage ventures attempt to make partnerships.
Early-Maturity Stage
• The fifth stage in a successful venture’s life cycle is the early-maturity stage,
when the growth of revenue and cash flow continues, but at much slower
rates than in the rapid growth stage. Well managed firms acquire small firms.
• The early-maturity stage often happens with decisions by the entrepreneur
and other investors to exit the venture through a sale or merger.
Why Most New Ventures Need Financing or Funding?
Why Most New Ventures Need Financing or Funding?
1. Cash Flow Challenges
Inventory must be purchased, employees must be trained and paid
and advertising must be paid before cash is generated from sales.
2. Capital Investments
The cost of buying real estate, building facilities and purchasing
equipment typically exceeds a firm’s ability to provide funds for
these needs on its own.
3. Lengthy Product
Development Cycles
Some Products are under development for years before they
generate earnings. The up-front costs often exceeds a firm’s ability
to fund these activities on its own.
Alternatives for Raising Money for a New Venture
Sources
Personal Financing
Debt
Financing
Equity
Financing
Creative
Sources
Sources of Raising Funds for a New Venture
Personal Financing
1. Personal Funding
The vast majority of founders contribute personal funds, along with
sweat equity, to their ventures.
(Sweat equity represents the value of the time and effort that a founder puts into a new
venture.)
2. Friends and Family
3. Bootstrapping
Friends and family are the second source of funds for many new
ventures .
Bootstrapping is finding ways to avoid the need for external financing or
funding through creativity, ingenuity, thriftiness, cost cutting, or any
means necessary.
Examples of Bootstrapping Methods
Buy used instead of
new equipment.
Coordinate
purchases
with other
businesses.
Lease equipment
instead of buying.
Obtain payments in
advance from
customers.
Minimize personal
expenses.
Avoid unnecessary
expenses.
Buy items cheaply
but
prudently via
options
such as eBay.
Share office space or
employees with
other
businesses.
Hire interns.
Preparing to Raise Debt or Equity Financing
Two Most Common Alternatives
Equity Funding
Debt Financing
Means exchanging
partial ownership
in a firm, usually in
the form of stock,
for funding.
Is getting a loan.
Preparing to raise Debt or Equity Financing
Determine precisely how
much money is needed
Determine the type of financing
or funding that is the most
appropriate
Develop a strategy for engaging
potential investors or bankers
Sources of Equity Funding
Venture
Capital
Business
Angels
Initial Public
Offerings
Business Angels
• Business Angels
– Are individuals who invest their personal capital directly in startups.
– The prototypical business angel is about 50 years old, has high
income and wealth, is well educated, has succeeded as an
entrepreneur, and is interested in the start-up process.
– These investors generally invest between $10,000 and $500,000 in a
single company.
– Are looking for companies that have the potential to grow between
30% to 40% per year.
Venture Capital
• Venture Capital
– Is money that is invested by venture capital firms in start-ups and
small businesses with exceptional growth potential.
– Venture capital firms are limited partnerships of money managers
who raise money in “funds” to invest in start-ups and growing firms
– Management Fund
– Angel investors tend to invest earlier in the life of a company,
whereas venture capitalists come in later.
Initial Public Offering
• Initial Public Offering
– An initial public offering (IPO) is a company’s first sale of stock to
the public. When a company goes public, its stock is traded on one
of the major stock exchanges.
– An IPO is an important milestone for a firm. Typically, a firm is not
able to go public until it has demonstrated that it is viable and has a
bright future.
Sources of Debt Financing
• Banks
– Historically, commercial banks have not been viewed as a practical
source of financing for start-up firms.
• Banks are interested in firms that have a strong cash flow, low leverage,
audited financials, good management, and a healthy balance sheet.
• Government grants for start-ups
• Small business loans (private funds)
Other Sources of Debt Financing
• Vendor Credit
– Also known as trade credit, is when a 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.
• 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.
Creative Sources of Financing or Funding
Crowdfundin
g
Strategic Partners
Leasing
Crowdfunding
• Crowdfunding (Crowdsourcing)
– Crowdfunding is the practice of funding a project or new venture by
raising monetary contributions from a large number of people (the
“crowd”) typically via the Internet.
• Two Types of Crowdfunding Programs
– Rewards-based crowdfunding allows entrepreneurs to raise
money in exchange for some type of amenity or reward.
– Equity-based crowdfunding helps businesses raise money by
tapping individuals who provide funding in exchange for equity in
the business.
• OnMarket Crowd
–
–
https://www.onmarket.com.au/crowdfunding-investment/
https://www.onmarket.com.au/equity-crowdfunding/
Leasing
• Leasing
– Most leases involve a modest down payment and monthly
payments during the duration of the lease.
– Leasing is almost always more expensive than paying cash for an
item, so most entrepreneurs think of leasing as an alternative to
equity or debt financing.
Strategic Partners
• Strategic Partners
– Many partnerships are formed to share the costs of product or
service development, to gain access to particular resources, or to
facilitate speed to market.
– Older established firms benefit by partnering with young
entrepreneurial firms by gaining access to their creative ideas
and entrepreneurial spirit.
Strategic Partners
•
Biotech firms often partner with large
drug companies to conduct clinical
trials and bring new products to
market.
•
The biotech firms benefit by obtaining
funding from their partners, and the
partners
benefit by having additional products
to sell.
Matching a New Venture’s Characteristics with the appropriate form of
Financing or Funding
Sources
Personal Financing
The Business has high risk with an
uncertain return:
• Weak cash Flow
• High Leverage
• Low to Moderate Growth
• Unproven management
Debt Financing
The Business has low risk with a
more predictable return:
• Strong cash flow
• Low leverage
• Audited financials
• Good Management
Equity Financing
The business offers a high return:
•
•
•
•
Unique business idea
High Growth
Niche Market
Proven Management
Financing through the venture cycle.
Life cycle stage
Types of financing
Major sources/ players
Development stage
Seed financing
Entrepreneur’s assets, family and friends
Startup stage
Startup financing
Entrepreneur’s assets, family and friends,
business angles, venture capitalists
Survival stage
First-round financing
Business operations, venture capitalists,
Suppliers and customers, Government
assistance programs and commercial
banks
Rapid-growth stage
Second round financing
Mezzanine financing
Liquidity stage financing
Business operations, suppliers and
customers, commercial banks and
investment banks.
Early maturity stage
Obtaining bank loans
Issuing bonds
Issuing stocks
Business operations, Commercial banks,
Investment banks.
Class Activities
• Draw a plan for financing your venture
–
–
–
–
–
–
How much do you need? (Target)
Identify sources of funding
Decide on methods to be used to raise the fund
How to proceed?
What are the key issues and challenges?
How to deal with them?