MGT 340 - Chapter 13 Financing for Startups PDF

Chapter 13: Financing for Startups Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship What is Equity Financing? • Equity financing is the sale of shares and stock in exchange for cash • One of the most difficult parts of being an entrepreneur is raising funds for startups • Bala...

Chapter 13: Financing for Startups Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship What is Equity Financing? • Equity financing is the sale of shares and stock in exchange for cash • One of the most difficult parts of being an entrepreneur is raising funds for startups • Balancing growth while preserving equity is a challenge – • General rule, avoid investment as long as possible to have more negotiation leverage The idea behind equity is like splitting a pie – When you are the only owner of the company, you own 100% of a small pie – When someone invests in your company to enhance growth, then your pie becomes bigger but you share part of the pie The Entrepreneur’s Dilemma • Type of financing depends on entrepreneur’s tolerance of risk • Financing from family and friends - risks ruining meaningful relationships • Financing from investors - risk of eroding entrepreneur’s vision, company culture, and decision-making autonomy • Entrepreneurs, risk much more than financial investments • – Risk personal relationships – Emotional well-being Do you want to be Rich or King/Queen? Rich or King/Queen? The Trade-off Rich or King/Queen? The Trade-off • Entrepreneurs who give up a bigger slice of equity to investors tend to build more valuable companies than those who give up less equity (or none at all) • Parting with equity means less control over decisions and may lose position of CEO – A study of 212 U.S. startups showed 50% of founders no longer CEO after 3 years • Steve Jobs was fired by Apple’s board of directors <10 years after cofounding Apple • Rob Kalin, founder of Etsy • Travis Kalanick, founder of Uber • Jack Dorsey, founder of Twitter Equity Financing • Seed-Stage Financing: modest amounts of capital to prove a concept • Startup Stage Financing: money to enable implementation of idea by funding product research & development • Early-Stage Financing: larger amounts of funds for companies with a product or services piloted • Entrepreneurs have several equity financing options available to them – The 3 Fs (family, friends and fools) – Angel investors: Fund young startups (seed-stage and startups) – Venture Capitalists (VC): Fund long-term growth potential (early to third-stage) How do entrepreneurs value their companies? • Most investors will expect to see an approximate value of your business – • Needed for negotiation of equity percentage and division of ownership Typically, entrepreneurs value their companies based on the firm's potential in their chosen market – Book suggests sites such as BizBuySell and BizQuest (be cautious) – Just because a similar company appears to be worth millions doesn’t mean your company is worth the same • Overvaluing your startup is dangerous—not only does it put investors off, but it puts the company and the entrepreneur’s reputation at risk • Use a professional (view a valuation as an “investment” not a “cost”) How do investors value startups? Factors Important to Investors 1. Investors will want to know your experience and your team’s past successes 2. They will want to see how many people use your product or service 3. Scalability of your venture (growth potential) Valuation can be complicated when a business is new – Convertible debt which is a short-term loan that can be turned into equity when future financing is issued. Unicorn: Tech startup receiving a $1-billion-dollar valuation (rare, but becoming common) Types of Angel Investors • An “angel” uses personal capital to invest in an entrepreneurial venture – Apple, Google, and Netscape are just a few well-known companies that have benefited from angel funding in the early stages. Venture Capitalists • Professional money managers • Look for opportunities for return on their investments (10x in 5 years) • Earn through ownership of equity • The fund goes through a 10-year cycle • Look for ventures that have received seed funding • Difficult, but not impossible for startups to receive venture capital • Prefer larger businesses, smaller quantity in their funds as it is easier to manage How Venture Capital Works • Look for great teams, big markets, and innovative ideas • Investments typically range from $1m to $100m • VC firms work within a specific investment portfolio – Defined list of types of businesses in which they would like to invest (fit) • Take an interest in entrepreneurs who surround themselves with talented supporters • Ensure that your goals are aligned What about Debt Financing? • Bank financing likely not an option due to high risk • If they do, then entrepreneur must have: – Capital – Collateral – personal assets – Capacity (track record in business to make money and make loan payments) – Credit rating Due Diligence • Due diligence - rigorous process evaluating opportunity prior to deal being finalized • Both angels and VCs conduct due diligence • Angel investors typically complete less due diligence – Time, resource constraints, and lack of information • VCs look for red flags over weeks or even months • Verify things like: – Reference checks – Corporate compliance – Employment and labor – IP rights – Legal issues Due Diligence Checklist Exits / Harvesting • Part of the due diligence process involves the discussion of exit options • VCs and business angels invest to receive a return when firm exits the investment – • Certain time period, usually in 5-10 years Typically, this money is repaid through: – IPO – Mergers and acquisitions – Buyback 3 Key Points • Decide if you want to be Rich or King/Queen? This will shape many of your financing decisions. • Being able to hold onto equity longer without needing to use it to receive capital puts you in a better negotiation position when you need capital later. • Before approaching investors, make sure there is “fit.” You want your goals to be aligned and you are in essence marrying one another. Use the level of selection that you would in your personal life. Questions? Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship