Entrepreneurial Financing: Unit 7 Quiz

Unit 7: Getting Funding or Financing

• Funding is crucial for entrepreneurial success.
• Many new ventures need funding during their early stages.
• Funding needs arise due to cash flow challenges, capital investments (real estate, buildings, equipment), and lengthy product development cycles.

Unit Objectives

• Describe the significance of financing for entrepreneurial success.
• Explain why new ventures require funding during their initial phases.
• Identify and describe three sources of personal funding for entrepreneurs.
• Explain the three steps involved in preparing for debt or equity financing.
• Identify three main sources of equity funding for entrepreneurial firms.
• Detail common sources of debt financing used by entrepreneurial firms.
• Describe creative financing options for entrepreneurial firms.

Importance of Getting Financing

• Few people actively consider raising investment capital until needed for their own firm.
• Entrepreneurs often raise capital haphazardly from lack of experience.
• Many funding methods are available, but not all are suitable for every business.
• Choosing the correct funding mix has a significant impact on a venture's success.

Why Most New Ventures Need Financing

• Inventory, employee wages, and advertising must be paid before generating sales.
• Capital investments (real estate, buildings, equipment) often exceed a firm's initial funds.
• Long product development cycles frequently result in upfront costs exceeding funding capabilities.

Alternatives for Raising Money

• Personal Funds
• Equity Capital
• Debt Financing
• Creative Sources

Sources of Personal Financing

• Personal Funds: Founders often contribute personal funds and sweat equity. Sweat equity values the time and effort invested.
• Friends and Family: Friends and family often fund new ventures.
• Bootstrapping: A third source is bootstrapping. This involves finding ways to avoid external funding through creativity, resourcefulness, or cost-cutting. Various bootstrapping methods exist, including using used equipment, coordinating purchases with other businesses, obtaining advance payments, minimizing expenses, and sharing resources with other businesses.

Preparing to Raise Debt or Equity Financing (Steps)

• Step 1: Determine the precise amount of funding needed.
• Step 2: Choose the appropriate funding type (debt or equity).
• Step 3: Develop a strategy to engage potential investors or bankers.

Two Common Financing Alternatives

• Equity Funding: Exchanging partial ownership (typically in the form of stock) for funding.
• Debt Financing: Obtaining a loan for funding.

Matching Venture Characteristics with Appropriate Funding

• High-risk/uncertain return: Personal funds, friends/family, forms of bootstrapping are appropriate
• Low-risk/predictable return: Debt financing is suitable.
• High-return potential: Equity financing is a good option.

Sources of Equity Funding

• Venture Capital
• Business Angels
• Initial Public Offerings (IPOs)

Business Angels

• Individuals who invest personal capital in start-ups.
• Prototypical angel is around 50 years old, high income/wealth, well-educated, experienced entrepreneur.
• Number of angels has grown significantly.
• Generally invest between 10,000and10,000 and 10,000and500,000 per company.
• Seeking high-growth companies (typically 30-40% annual growth).
• Difficult to find.

Venture Capital

• Money invested by venture capital firms in start-ups with growth potential.
• Venture capital firms are limited partnerships managing funds typically from wealthy individuals, pension plans, endowments, and foreign investors.
• Investors are "limited partners," while venture capitalists are "general partners."
• Venture capital firms fund a small percentage of ventures compared to business angels.
• Entrepreneurs often face rejection from venture capitalists despite having an excellent business plan.
• Venture capitalists seek "home run" investments.
• Angels typically invest earlier in a company's lifecycle than venture capitalists.
• Venture capital funding often occurs in stages, not all at once.
• Due diligence is a key part of obtaining venture capital.

Initial Public Offering (IPO)

• A company's first stock sale to the public.

• Publicly traded on major stock exchanges.

• Many technology, biotech, and small-company firms opt for NASDAQ.

• IPOs are an important milestone signifying the viability and positive future potential of the company.

• Reasons for Going Public: Raise equity capital for ongoing operations, increase visibility and attract high-quality customers & partners, and provide liquidity for investors to recoup their investments, facilitate future growth through acquisitions.

Sources of Debt Financing

• Commercial Banks
• Government Loans

Commercial Banks

• Historically not a primary source for start-up funding due to risk aversion.
• Prefers firms with strong cash flow, low leverage, sound financials, good management, and a healthy balance sheet.

Other Debt Financing Sources

• Vendor Credit (Trade Credit): Vendors offer credit allowing businesses to purchase products/services now with payment deferred until later.
• Factoring: Selling accounts receivable to a third party ("factor") for immediate cash at a discounted rate.
• Merchant Cash Advance: Loan where lender gets a portion of future sales to cover loan and fees – usually with high-interest rates.
• Peer-to-Peer Lending: Direct borrowing transactions between individuals.

Creative Sources of Financing

• Crowdfunding (raising capital from a large number of people typically online).
• Leasing (paying for the use of an asset over time).
• Strategic Partnerships (collaborations between entities to benefit one another).
• Other Grant Programs

Crowdfunding

• Rewards-based: Money in exchange for amenities/rewards e.g Kickstarter.
• Equity-based: Individuals provide funding in exchange for shares of the business.

Leasing

• Written agreement allowing the use of assets in exchange for payments.
• Major advantage: minimal or no down payment required.
• Often more expensive than outright purchase.

Strategic Partnerships

• Collaborative funding between ventures for product/service development or resource access.
• Early-stage businesses benefit from partnering with larger firms.
• Established firms benefit by gaining access to new ideas/creative spirit of entrepreneurial firms.

Additional Examples:

• Honest Tea, started by Goldman & Nalebuff, was initially funded by personal investment from associates and friends, using family as a starting point. Later, when sales exceeded a million dollars, the company secured additional financing.

This quiz tests your understanding of financing's role in entrepreneurial success. You'll explore the various sources of funding available to new ventures and learn about preparing for debt or equity financing. Engage with concepts crucial for securing financial support for your business initiatives.