183 Entrepreneurial Finance

(1)

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Entrepreneurial Finance

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(3)

SAMENVATTING

ENTREPRENEURIAL FINANCE

(BOEK)

(4)

PART I: FUNDING SOURCES

Chapter 1: Introduction to

entrepreneurial finance

1.2 What is entrepreneurial finance?

Entrepreneurial finance = entrepreneurship + finance Entrepreneurship

• Entrepreneurship relates to the discovery of an opportunity and the steps that need to be taken to make it reality.

• Entrepreneurs need resources, with the key resource being money

o Recourse acquisition is one of the main lines of research in entrepreneurship Finance

• = the management of money

• Finance relates to obtaining money, to investing money and to understanding the cost and the best use of money

• Corporate finance = the type of finance that relates to businesses

o Investing = how owners or managers in companies decide where to invest their budgets

▪ Refers to the assets of the company

o Financing = where do you get the money needed to invest in or to run your business? How do you finance your investment plan? How much will that cost you?

▪ Refers to liabilities and equity Entrepreneurial finance

= the art and science of investing and financing entrepreneurial ventures

Entrepreneurial finance involves mainly private funding ( corporate finance: public funding)

1.3 Differences and similarities between corporate finance and

entrepreneurial finance

Focus

Corporate finance focuses on existing business and the challenges they face to grow in order to deliver a healthy return to their investors.

• Goal: increase shareholder value

Entrepreneurial finance relates to an entrepreneur’s first challenge to acquire the funding to be able to test whether there is an actual opportunity that can be made into a business, that has the potential to become financially sustainable.

• Starts way before the generation of value (begins during the opportunity phase, when entrepreneurs start developing their ideas)

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Information

In corporate finance you have historical information that will help you to forecast the future (not always accurate).

In entrepreneurial finance (startup) there is no previous history and the future is unknown. Returns

In corporate finance we assume that projects or investments will have a positive net present value (NPV) – if not, they will not be implemented.

In entrepreneurial finance, losses are part of the game, since in the early years most of the money is ploughed into investments and expenses that, hopefully, at some point in the future, will translate into positive cash flows.

In corporate finance most of the returns come from the existing company.

In entrepreneurial finance investors will make a profit when they divest from the venture. It is the increase in value of the shares in the company that matters.

Rationality

Corporate finance theories are based on the assumption that investors are rational. They will either choose the option with the lower risk given the same expected return or the one with the higher return given the same level of risk.

In entrepreneurial finance, the level of risk and the expected return is very difficult to estimate. And investors may not have the profile of a ‘typical’ investor (more risk-taking). In entrepreneurial finance, rationality is mixed with passion, a bit of fun and a lot of uncertainty.

Topic Entrepreneurial finance Corporate finance Funding sources • Friends and family

• Crowdfunding • Incubators/accelerators • Business angels • Venture capital • Private equity • Banks • Capital markets

Funding process • Deal sourcing and screening

• Financial plan • Valuation • Term sheet

• Standard due diligence • Financial plan

• Collateral to back loan

Growth • Monitoring & key metrics

• Corporate governance • Protecting knowledge • Private equity

• Capital budgeting • Mergers & acquisitions • Private equity

• Initial public offering (IPO)

Harvesting • Existing (selling) initial public

offering (IPO)

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1.4 Stages of venture development and sources of financing

1.4.1 Seed stage

The seed stage begins with the idea for developing a new product or service. In most cases, a company will not yet have been established, but its founders will have identified an opportunity. They will try to validate their idea, produce a first prototype and reach the market. This might be achieved within a short or a very long period of time. It varies according to the activity of the business and its specific characteristics.

The founders will need funding to finance this period of time: • Founders’ own savings (= bootstrapping)

• 3F’s (friends, family and fools) • Research grants or public funding

o Only if the business meets certain criteria or has an important research base or innovation component

• Crowdfunding, incubator/accelerator (C2) • Business angels

o Only businesses with high-growth potential, that have the potential to provide a healthy return in the long term (C3)

• Venture capitalists

o Usually invest during the start-up stage, but there are some venture funds that focus on seed investing

o They look for the same types of companies as business angels, but they will take a more objective approach to investing. This means that they will ask for a great deal more information, undertaking a deeper level of analysis and due diligence before becoming shareholders

Seed

- from idea to first customer (sales)- prototyping, testing to validate, reformulate - from few months to many years

Startup

- from sales to breakeven(profit) - improving the product or service - growing the customer base - being efficient and scaling up

Growth

expansion

- launching new lines or entering new markets - new initiatives might be losing money but core business is profitable

- growth is the key driver of the business

Maturity

- company's growth slows down

- not many new initiatives for high growth - market and competition have reached maturity - risk of new disruptive players

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1.4.2 Start-up stage

The company is already selling its products or services, or has some customers. It will remain in the startup stage until it reaches break-even, which is the stage at which the startup is able to cover all its costs. The company will then no longer need additional external financing, and will be sustainable.

Having first customers is very important, because it is proof that there is initial demand for the product or service. However, the first customers are often friends or people who are close to the entrepreneur, so there is still much to learn about the potential customer base.

Understanding the cost of acquiring a customer is a key metric (CAC = Customer Acquisition Cost), as it is very important that the value of a customer to the business (LTV = LifeTime Value) is higher than the cost of acquiring it. If that is the case, the business could potentially reach profitability if it keeps on growing.

At this stage in the company’s life cycle, it is still consuming cash, as its income is not yet sufficient to cover its expenses. Depending on the financial needs of the company, the most suitable source of financing will be business angels (less than 1 million) or venture capitalists (more than 1 million; “series A”).

In a few cases, startups will achieve stock exchange listing for an initial public offering (IPO).

1.4.3 Growth stage

The growth stage starts once the company has reached break-even and is becoming profitable. Most of the cash generated will go to finance growth. Additional financing can be raised, but now banks may come into play, as the company will, most likely, meet the credit control requirements of traditional financial institutions.

1.4.4 Maturity stage

The maturity stage begins once the growth of the market or the company stabilizes at normal rates. The company will not make large investments at this stage, will be carrying out ‘business as usual’ and will try to maintain its current market share.

Finance for mature companies: corporate finance. (or entrepreneurship by acquisition)

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In summary, there are different types of financing available according to the size and timing of the new venture’s financial needs, as well as the milestones achieved.

Seed

The sources relied upon in the very early phase of a venture are the entrepreneurs themselves and the people closest to them. First to invest anything is typically the entrepreneur. They see an opportunity and feel the urge to pursue it. The funding comes from their own savings account or they approach their family and close relations. The benefit of obtaining the funds through these means it that the entrepreneur is not yet required to issue equity. A support in these very early stages with restricted access is a business incubator. Although not directly providing capital, this source enables the entrepreneur to speed-up the development process through peer entrepreneur contact and obtaining valuable external contacts.

Start-up

Sources of funding in the start-up phase are: • Accelerator (largely support)

• Crowdfunding

• Angel investors (= former successful entrepreneurs that have money, time and experience) • Government programs

o Grants, subsidies, tax benefits or loans that governments provide

o To support and stimulate entrepreneurship and to incentivize initiatives aimed at particular societal needs

These sources require the venture to be slightly more developed from the start and extent their support into the phase where the venture is revenue generating. Both accelerators and angel investors require the venture to give out part of its equity as compensation.

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The corporate strategic partner seems to have the broadest application area when related to the venture development.

• Entrepreneur: seeking support from and partnering with established companies helps to build credibility and get access to a corporate network

• Corporate: bonding with young innovative ventures is a means to build understanding of new trends and have a first-row seat to seeing the venture grow, appreciating their impact and developing a new supplier or buyer relation

Venture capital (VC) = professionals that invest large amounts of capital in high-risk-high-return early-stage ventures.

Venture debt and asset-based lending are forms of loans available to entrepreneurs in the start-up phase.

• Asset-based lending: requires assets as security for the loan • Venture debt: for ventures lacking assets and a steady cash flow Growth

Ventures in the growth phase and able to prove a steady cash flow can opt for a traditional commercial bank loan.

In the growth stage, more funding forms become available: • Trade credit

o Form of spontaneous funding by allowing the entrepreneur to pay later for the goods that he already obtained

o Vendor loan, typically without interest but coming at the expense of foregoing a discount that would be obtained when paying earlier

• Factoring

o Selling accounts receivable to a factoring company for a discount on the face-value of the money that should be received in due time (f.e. selling its accounts receivable of 100 000 euros to a factoring company for 80 000 euros)

o The venture has the benefit of receiving its money directly and without debtor risk, but this comes at the expense of selling it at a discount

• Mezzanine capital

o Hybrid form of debt and equity funding used by ventures that have built an established reputation and track record of positive cash flows

o Often to fund an expansion plan

o Provides a relatively high interest rate and allows the capital providers to convert their loan into an equity stake in the venture

Maturity

Private equity provides very large amounts of capital into ventures in return for a controlling stake and involves itself actively in the operations and streamlining of the venture.

Public debt refers to ventures attracting debt from public markets by issuing bonds.

The Initial Public Offering (IPO) refers to the first time that a stock is offered to the public. After the IPO the equity of the company is freely tradeable. This is the point in time that private companies become public companies.

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Chapter 2: Early sources of funding (1):

incubators, accelerators and

crowdfunding

2.1 Definition and origination of the early funding sources

2.1.1 Pre-market funding

Bootstrapping = the activity of obtaining capital from one’s own savings, personal loans and from close relatives

• Not provided in the market

• Generates only small amounts of money • 3F’s: friends, family and fools

• Obtaining the capital is rarely related to the business concept, but is provided because of the entrepreneur’s personal means and relationship with the funder

• Usually undertaken at the stage when the entrepreneur has perceived an opportunity and is still developing the business concept

• Advantages

o Retain complete control over the venture

o Focus on the customer instead of having the burden of searching for and being accountable to outside investors

2.1.2 Definition of the early market sources

Incubator = an organization that provides startups with a shared operation space and also provides young businesses with networking opportunities, mentoring resources and access to shared equipment

Accelerator = an organization that offers startups support services and funding opportunities, in intense programmes lasting several months that include mentorship, office space and access to capital and investment in return for startup equity

Crowdfunding = an emerging alternative form of financing that connects those who can give, lend or invest money directly with those who need financing for a specific project

Three key elements:

• Primary orientation (source or support) • Venture development phase

• Existence of another form of accelerator that may support later-stage ventures

Incubators and (later-stage) accelerators have a support orientation and are primarily focused internally. Their primary orientation is on the development of the venture itself and they support that development with various tools, templates and networks. By optimizing the processes internally, investors are attracted and market success attained.



Crowdfunding has a source orientation and is primarily directed towards the (external) user/buyer and is used to generate market proof for the venture.

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Of the three sources of early funding, incubators are the only one that supports the search for funding as of the start of the seed phase. They typically provide support while the entrepreneur is developing the initial opportunity or concept.



Accelerators and crowdfunding support in the development of a venture require a more developed concept to generate funding.

Another type of accelerator exists, the later-stage accelerator. This accelerator may be used in a later stage of the venture development. It applies in the case of a revenue-generating company that is not attaining the levels of growth that had been envisioned. The later-stage accelerator assesses the main cause(s) for underperformance and addresses that in a time-bound programme.

2.1.3 Distinct differences

Differences between an incubator and accelerator:

Incubator Accelerator

Specialization Horizontal Vertical(s) / Theme(s)

Target Individuals Teams

Entrance Restricted Open

Support Organic growth Boost growth

Programme None Generic

Duration Months – years – no limit 3-6 months

Financial contribution None – small amount Larger amount (10 000 or more)

Compensation None – small fee (e.g. rent) Equity stake (5-10%)

2.1.4 Key drivers in development

Entrepreneurship is recognized as a key determinant to ensure economic growth, innovation and job creation. Policymakers therefore promote entrepreneurship and actively facilitate it.

2.2 Incubators

Incubators provide the earliest type of formal support that entrepreneurs can typically access. • Support ventures very early on in the process of developing their business idea

(pre-revenue)

• Incubators are typically attached to either non-profit institutions such as universities or directly to corporates

2.2.1 Forms

Incubators guide the entrepreneur through the early development phases (assessing the opportunity, researching the potential and building the business plan).

• Purpose: support the entrepreneur in this process

Most basic incubator: physical location that provides a general infrastructure and network for its participants.

• Meeting point for entrepreneurs • Benefit:

o Network

o Obtain feedback

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Variations exist according to specialization, type of programme and duration. Some incubators have a specialization, tied in with their origin.

For universities, an incubator is a means of encouraging its students to engage in entrepreneurship. It stimulates them to apply their learning by developing a product or service and gaining experience in commercializing it.

Incubators attached to corporates focus on initiatives that produce innovative offerings and expand the corporate’s existing business. It is a means by which these companies generate new business, retain employees with entrepreneurial aspiration and signal to the market their engagement with innovation. The programme may be extended by including employee training and by linking with the local network.

2.2.2 Process

Most incubators have restricted membership, requiring the entrepreneur to be part of a certain institute or company. They only allow applications from individuals who are directly associated with the founding institution. When making a selection of the applications, attention is mainly given to the qualities of the individuals, as a key determinant of their potential success. In some cases, applicants will pitch their idea.

The incubator is the location (unless virtual) for infrastructure and support, and is dedicated to networking and to limiting distractions for the entrepreneurs. A mentor will be appointed to the entrepreneurs, to support their development and to bridge any questions or challenges that they may experience. The selection of a mentor is key in the success of the entrepreneur and the incubator, as these mentors will maintain ongoing personal contact with the entrepreneurs and coach them as they develop their venture.

The incubator’s network and invited experts are another factor driving the success of the incubator. Typically, well-known entrepreneurs or business leaders from the incubator’s network (co-sponsors or alumni) will be invited to give presentations that inspire the participants as well as advice to avoid common pitfalls.

2.2.3 Benefits and concerns

Success of the incubator is determined by: • Quality of its mentors

• Strong network of peer participants, alumni, partners and experts

• The extent to which the incubator actively maintains contact with the local network

The primary role of the mentor is to build a relationship with the entrepreneur(s) and to challenge them, while maintaining momentum (success). The mentor should provide the entrepreneur with guidelines, allowing them to develop their own approach.

The key benefit of an incubator is the process of learning about entrepreneurship in a confined environment. By building on the experience of their predecessors and the incubator’s (corporate) partners, the participants become more effective in their approach to building a venture. The managed and protective office space allows the entrepreneurs to focus on their venture and feel supported at the same time. The peer network proves to be useful for feedback and support, meaning that ideas are challenged and validated early on, allowing for higher success rates.

183 Entrepreneurial Finance

www.quickprinter.be

Q

Master TEW

Smvt boek

uickprinter

Koningstraat 13

2000 Antwerpen

Entrepreneurial Finance

Online samenvattingen kopen via

SAMENVATTING

ENTREPRENEURIAL FINANCE

(BOEK)

Contents

PART I: FUNDING SOURCES

Chapter 1: Introduction to

entrepreneurial finance

1.2 What is entrepreneurial finance?

1.3 Differences and similarities between corporate finance and

entrepreneurial finance

1.4 Stages of venture development and sources of financing

1.4.1 Seed stage

Seed

Startup

Growth

expansion

Maturity

1.4.2 Start-up stage

1.4.3 Growth stage

1.4.4 Maturity stage

Chapter 2: Early sources of funding (1):

incubators, accelerators and

crowdfunding

2.1 Definition and origination of the early funding sources

2.1.1 Pre-market funding

2.1.2 Definition of the early market sources

2.1.3 Distinct differences

2.1.4 Key drivers in development

2.2 Incubators

2.2.1 Forms

2.2.2 Process

2.2.3 Benefits and concerns