Chapter 10: Getting Financing or Funding

Question 1

CH10 Why most new ventures need funding?

Answer 1

1. Cash flow challenges: Inventory must be purchased, employees must be trained and paid, and advertising must be paid for 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 exceed a firm’s ability to fund these activities on its own.

Question 2

CH10 What is “burn rate”?

Answer 2

• A firm’s negative real-time cash flow is called its “burn rate”
• A company’s “burn rate” is the rate at which it is spending its capital until it reaches profitability.
• It can cause severe complications. A firm usually fails if it burns through all its capital before it becomes profitable

Question 3

CH10 What are Sources of Personal Financing?

Answer 3

1. PERSONAL FUNDS: Involves both financial resources and “sweat equity”
2. FRIENDS AND FAMILY (LOVE MONEY): Often comes in the form of loans or investments, but can also involve outright gifts, foregone or delayed compensation, or reduced or free rent.
3. BOOSTRAPPING: Finding ways to avoid the need for external financing through creativity, ingenuity, thriftiness, cost-cutting, obtaining grants, or any other means.

Question 4

CH10 What is “sweat equity”?

Answer 4

• “Sweat equity” represents the value of the time and effort that a founder puts into a new venture.
• It is important because many founders do not have a huge amount of cash to put into their ventures.
• It is often the sweat equity that makes the most difference

Question 5

CH10 What is “bootstrapping”?

Answer 5

• One of the sources of personal financing
• “Bootstrapping” is finding ways to minimize a firm’s expense through creativity, cost-cutting, or money-saving.
• “Bootstrapping” is highly recommended in almost all start-up situations, but overreliance on this can hold a business back from reaching its full potential.

Question 6

CH10 What are 3 steps in preparing to raise debt or equity financing?

Answer 6

1. Determine precisely how much money the company needs.
   Constructing and analyzing documented cash flow statements and projections for needed capital expenditures
2. Determine the most appropriate type of financing or funding.
   Equity financing or debt financing
3. Develop a strategy for engaging potential investors or bankers: 3 steps
   - Preparing an elevator speech (pitch)
   - Developing a strategy for engaging potential investors/bankers (assess the type of financing/funding likely to qualify for -> collect list of potential investors/bankers)
   - Provide a completed business plan to investors/bankers

Question 7

CH10 What is “equity financing”?

Answer 7

• “Equity financing” is a method of rasing fund which exchanges partial ownership of a firm, usually in the form of stock, in return for funding.
• ANGEL INVESTORS, PRIVATE PLACEMENT, VENTURE CAPITAL, and INITIAL PUBLIC OFFERINGS (IPO) are the most common sources of equity funding (gọi chung là EQUITY INVESTORS)
• Equity funding is not a loan—the money that is received is not paid back.

Question 8

CH10 What is “liquidity event”?

Answer 8

• An event in which a company’s stock are converted into cash.
• The three most common liquidity events for a new venture are when it goes public, finds a buyer, or merges with another company.

Question 9

CH10 What is “debt financing”?

Answer 9

• “debt financing” is a method of rasing fund when a firm’s expense exceeds its personal financing.
• The most common sources of “debt financing” are COMERCIAL BANKS and SMALL BUSINESS ADMINISTRATION GUARANTEED LOANS.
• It is a loan- have to pay back (with interest)

Question 10

CH10 What is “elevator speech (pitch)”?

Answer 10

• A brief, carefully constructed statement that outlines the MERITS of a business opportunity.
• It should be 45 seconds to 2minutes long
• N.A.B.C (needs-approach-benefits-competition)

Question 11

CH10 What kind of firm should raise personal funds first?

Answer 11

The business has high risk with an uncertain return:

• Weak cash flow
• high leverage (the relationship between the amount of money that a company owes to banks and the value of the company)
• Low to moderate growth
• Unproven management

Question 12

CH10 What kind of firm is an ideal candidate for equity financing?

Answer 12

The business offers a high return:

• Unique business idea
• high growth
• clearly difined niche market
• Proven management

Question 13

CH10 What kind of firm is an ideal candidate for debt financing?

Answer 13

The business has low risk with a more predictable return:

• Strong cash flow
• Low leverage
• Audited financial statements
• good management

Question 14

CH10 What are pros and cons of equity financing?

Answer 14

• Pros: access to capital

- COns: the firm’s owners may lose part of their ownership interest and some control.

Question 15

CH10 What is “business angels”?

Answer 15

• One of the common sources of equity finacing
• Business angels are individuals who invest their personal capital directly in start-ups.
• These investors are looking for companies that have the potential to grow 30 to 40 percent per year before they are acquired or go public and willing to make relatively small investments.
• Usually invest in the early life cycle of a firm

Question 16

CH10 What is “venture capital”?

Answer 16

• One of the common sources of equity finacing
• Venture capital is money that is invested by venture capital firms in start-ups and small businesses with exceptional growth potential.
• The majority of venture capital money goes to follow-on funding for businesses that were originally funded by angel investors, government programs

Question 17

CH10 What are “venture capital firms”?

Answer 17

• “Venture capital firms” are limited partnerships of money managers who raise money in “funds” to invest in start-ups and growing firms.
• The funds are raised from high-net-worth individuals, pension plans, university endowments, foreign investors, and similar sources
• They fund very few entrepreneurial ventures due to theirs high demanding in criteria.
• It help firms connect well to the business world
• The investors who invest in venture capital funds are called “limited partners”
• The venture capitalists, who manage the fund, are called “general partners”
• The venture capitalists receive an annual management fee in addition to 20 to 25 percent of the profits earned by the fund. The percentage of the profits the venture capitalists get is called the “carry”

Question 18

CH10 What are “rounds”?

Answer 18

• Stages of subsequent investments made in a firm by investors
• Including 6 stages: seed funding, start-up funding, first-stage funding, second-stage funding, mezzanine funding, and buyout funding

Question 19

CH10 What is “follow-on funding”?

Answer 19

• Additional funding for a firm following the initial investment made by investors

Question 20

CH10 What is “due diligence”?

Answer 20

• The process of investigating the merits of a potential venture and verifying the key claims made in the business plan.
• Firms should conduct “due diligence” to prove they are qualified for venture capital funding.

Question 21

CH10 What is “corporate venture capital”?

Answer 21

• Similar to traditional venture capital

- The funding comes from corporations that invest in start-ups are related to their areas of interest.

Question 22

CH10 What is “Initial Public Offering”?

Answer 22

• One of the common sources of equity finacing
• It is the first sale of stock by a firm to the public
• Stocks are traded on NASDAQ
• It is an important milestone for a firm beacause it proves that the firms are vitable and has a bright future.

Any later public issuance of shares is referred to as a “secondary market offering”.

Question 23

CH10 What are the reasons firms decide to go public?

Answer 23

• A way to RAISE EQUITY FUNDING/CAPITAL
• An IPO raise a FIRM’S PUBLIC PROFILE -> attracts high-quality customers, partners, employees
• Creating a ANOTHER FORM OF CURRENCY that can be used to grow the company
• An IPO is a liquidity event providing a mechanism for the company stockholders/investors to cash out their investments.

Question 24

CH10 What is “investment bank”?

Answer 24

• An institution that acts as an agent for a firm issuing securities, waliking a firm though going public process.
• Hiring an investment bank is the fisrt step in IPO for a firm.
• Most important issues a firms and its investment bank must agree on are the amount of CAPITAL NEEDED, TYPE OF STOCK, PRICE OF STOCK, and COST TO ISSUE THE SECURITIES.

Question 25

CH10 What is the process of offering approval in IPO?

Answer 25

• During the time the Securities and Exchage Comission (SEC) is investigating the potential offering, the investment bank issues the “preliminary prospectus”( or “red herring”) which DESCRIBE THE OFFERING TO THE PUBLIC.
• After the SEC has approved the offering -> investment bank issues the “final prospectus” which SETS A DATE AND ISSUING PRICE FOR THE OFFERING
• To ensure the firm’s offering get approval, investment bank take the top management of the firm on a “road show”, which is a whirlwind tour that CONSISTS OF MEETING IN KEY CITIES, where the firm preresent its business plan to group of investors. The “road show” presentations are required to be taped and made available to the publuc.

Question 26

CH10 What is “private placement”?

Answer 26

• A variation of the IPO
• It is the direct sale of an issue of securities to a large institutional investor.
• There is no public offering, and no prospectus is prepared.

Question 27

CH10 What are 2 commom types of loans?

Answer 27

1. “single-purpose loan” in which a specific amount of money is borrowed that must be repaid in a FIXED AMOUNT OF TIME WITH INTEREST
2. “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

Question 28

CH10 What are pros and cons of debt funding?

Answer 28

1. Pros:
   - None of the ownership of the firms is surrended/shared
   - Interest payments on a loan are TAX DEDUCTIBLE, (dividend payments to investors in equity funding are not tax deductible)
2. Cons:
   - The money must be repaid
   - Lenders often impose STRICT CONDITION ON LOANS

Question 29

CH10 What is “Commercial banks?

Answer 29

• A common source for a firm to find debt funding
• Banks are RISK AVERSE, so they just give funding to the firms that are RELIABLY REPAID the loan (strong cash flow, low leverage, audited financials, good management, healthy balance sheet)
• Banks are important source of credit for small businesses later in their life cycles.

Question 30

CH10 What are 2 reasons banks are reluctant to lend money to start-up?

Answer 30

1. Banks are RISK AVERSE, frequently having INTERNAL CONTROL and REGULATORY RESTRICTIONS preventing them from making high-risk loans.
2. Lending to small firms is NOT AS PROFITABLE as lending to large firms.

Question 31

CH10 What is “SBA Guaranteed loans?

Answer 31

• A common source for a firm to find debt funding
• The most notable SBA program available to small businesses is the “7(A) Loan Guaranty Program”
• To obtain an SBA guaranteed loan, an application must meet the requirements of both the SBA and the lender

Question 32

CH10 What are other sources of debt financing?

Answer 32

1. “Vendor credit” (or trade credit)
   - It 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.
   - The practice is especially common in RETAIL
2. “Factoring” is a financial transaction whereby a business sells its account receivable to a third party, called a factor, at a discount in exchange for cash
3. “merchant cash advance”:
   - ONLINE FIRMS that offer loans at an ESCALATED INTEREST RATE
   - the lender provides a business a sum of money in exchange for a share of future sales
4. “peer-to-peer loans”
   - A financial transaction that occurs directly between individuals or “peers.”
   - The loans are facilitated by online firms

Question 33

CH10 What are creative sources of financing and funding?

Answer 33

1. “crowfunding”:
   - the practice of funding a project by RAISING MONETARY CONTRIBUTION from a large number of people, typically via Internet.
   - 2 types: “rewards-based crowfunding” (raise money in EXCHANGE FOR AMENITY/REWARDS) and “ equity-based crowfunding” (raise money by in EXCHANGE FOR EQUITY IN THE BUSINESS)
   (“accredited investors: a person who is permitted to invest in higher-risk investments)
2. “Leasing”
   - Owners of a piece of property allows individuals/businesses use the property in a specific period of time in exchange for payments
   - It allows a company to aquire the use of assets with little or no down payment
   - 2 most common types: leases for facilities and leases for equipment

“venture-leasing firms” acts as brokers bringing the parties involved in a lease together; contact facilities/equipment owners and match these owners with the firms are in need; its responsibility is conducting due diligence.

3. SBIR and STTR Grant Program