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Getting Financing

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Title: Getting Financing


1
Getting Financing
  • Business 3215

2
Answer the Questions
  • 1. Explain why most new ventures need to raise
    money at some point during their early life.
  • 2. Identify the three sources of personal
    financing available to entrepreneurs.
  • 3. Provide examples of how entrepreneurs
    bootstrap to raise money or cut costs.
  • 4. Identify the three steps involved in properly
    preparing to raise debt or equity financing.
  • 5. Explain the role of an elevator speech in
    attracting financing for a firm.
  • 6. Discuss the difference between equity funding
    and debt financing.
  • 7. Describe the difference between a business
    angel and a venture capitalist.
  • 8. Explain why an initial public offering is an
    important milestone for a firm.
  • 9. Discuss the financing sources including,
    Canadian Youth Business Foundation, Northern
    Ontario Heritage Fund, Thunder Bay Ventures, the
    Business Development Bank.
  • 10.Explain the advantages of leasing for an
    entrepreneurial firm.

3
Key Terms
  • Bootstrapping
  • Burn rate
  • Business angels
  • Venture capital
  • Debt financing
  • Due diligence
  • Elevator speech
  • Equity financing
  • Final prospectus
  • Initial public offering
  • Lease
  • Love money
  • Road show
  • Rounds of financing (tranche)
  • Sweat equity

4
The Importance of Getting Financing or Funding
  • Understanding the Alternatives for Financing or
    Funding
  • Few people deal with the process of raising
    investment capital until they need to raise
    capital for their own firm.
  • As a result, many entrepreneurs go about raising
    capital haphazardly because they lack experience.
  • To be successful in this area, it is important
    for entrepreneurs to understand the role of
    investment capital in the success of a new
    businesses, and the options available to
    entrepreneurial firms for obtaining financing or
    funding.

5
Why Most New Ventures Need Funding
Figure 10.1 Three Reasons Start-Ups Need Funding
6
Sources of Personal Financing (1 of 3)
  • Sources of Personal Financing
  • Typically, the seed (or initial) money that gets
    a company off the ground comes from the founders
    themselvesfrom their personal savings,
    mortgages, and credit cards.
  • All founders contribute sweat equity to their
    ventures, which represents the value of the time
    and effort that a founder puts into a new firm.
  • Love Money
  • Friends and family are the second source of funds
    for many new ventures. This form of contribution
    is often called love money.

7
Sources of Personal Financing (2 of 3)
  • Love Money (continued)
  • Love money can consist of outright gifts, loans,
    or investments, but often comes in the form of
    forgone or delayed compensation or reduced or
    free rent.
  • Bootstrapping
  • Another source of seed money for new ventures is
    bootstrapping.
  • Bootstrapping is the use of creativity,
    ingenuity, and any means possible to obtain
    resources other than borrowing money or raising
    capital from traditional sources.

8
Sources of Personal Financing (3 of 3)
There are many ways entrepreneurs bootstrap to
raise money or cut costs. Some of the most
common examples include the following
  • Minimizing personal expenses and putting all
    profits back into the
  • business
  • Avoiding unnecessary expenses, such as lavish
    office space or furniture
  • Establishing partnerships and sharing expenses
    with partners
  • Leasing equipment rather than buying
  • Sharing office space or employees with other
    businesses
  • Utilizing the services or a university or
    community incubator
  • Buying items cheaply but prudently through
    discount outlets or online
  • auctions, such as eBay, rather than at
    full-price stores

9
Preparing to Raise Debt or Equity Financing (1 of
3)
Figure 10.2 Preparation for Debt or Equity
Financing
10
Preparing to Raise Debt or Equity Financing (2 of
3)
Two most common alternatives for raising money
Alternative
Explanation
Equity funding means exchanging partial ownership
in a firm, usually in the form of stock, for
funding. Angel investors, private placement,
venture capital, and initial public offerings are
the most common sources of equity funding.
Equity funding is not a loanthe money that is
received is not paid back. Instead, equity
investors become partial owners of a firm.
Equity funding
Debt financing is getting a loan. The most
common sources of debt financing are commercial
banks and the Small Business Administration
(through its guaranteed loan program).
Debt financing
11
Preparing to Raise Debt or Equity Financing (3 of
3)
Table 10.1 Matching a New Ventures
Characteristics with the Appropriate Form of
Financing or Funding
12
Preparing An Elevator Speech (1 of 2)
  • Elevator Speech
  • An elevator speech is a brief, carefully
    constructed statement that outlines the merits of
    a business opportunity.
  • Why is it called an elevator speech?
  • If an entrepreneur stepped into an elevator on
    the 25th floor of a building and found that by a
    stroke of luck a potential investor was in the
    same elevator, the entrepreneur would have the
    time it takes to get from the 25th floor to the
    ground floor to try to get the investor
    interested in his or her opportunity. This type
    of chance encounter with an investor calls for a
    quick pitch of ones business idea. This quick
    pitch has taken on the name elevator speech.
  • Most elevator speeches are 45 seconds to two
    minutes long.

13
Preparing an Elevator Speech (2 of 2)
Table 10.2 Guidelines for Preparing an Elevator
Speech
14
The Cash Flow Cycle
  • Working Capital Management - General Issues

15
Cash and Net Working Capital
  • The cash flow cycle where cash comes fromhow
    it is used to finance the operations of the
    firmand how it is recovered and how it grows
    over time is a crucially-important part of
    understanding how a business functions.

16
Cash and Net Working Capital Activities that
Increase Cash
  • Increasing long-term debt
  • Increasing equity
  • Increasing current liabilities
  • Decreasing current assets other than cash
  • Decreasing fixed assets

17
Cash and Net Working Capital Activities that
Decrease Cash
  • Decreasing long-term debt
  • Decreasing equity
  • Decreasing current liabilities
  • Increasing current assets other than cash
  • Increasing fixed assets
  • Paying dividends

18
Operating Cycle
  • Operating cycle is the time period between the
    acquisition of inventory and when cash is
    collected from receivables.

19
Cash Cycle
  • Cash cycle is the time between cash disbursement
    and cash collection.

20
Example of Exhaustion of the Liquid Resources of
a New Firm
  • A simple example of a 1.0 million equity
    investment in a business levering additional
    financial resources and the need to finance the
    growth of the business leaving it exhausted of
    cash resources.

10 steps to insolvency
21
Cash Flow Cycle Start
The entrepreneur opens a current account in the
name of the business.
Step 1
Cash Account Balance 0
22
Cash Flow Cycle Initial Equity Investment
The entrepreneur invests 1,000,000 in equity.
Step 2
Balance Sheet Cash 1m Common Stock 1
m _____________________________________ T.
Assets 1m T. Claims 1m
23
Cash Flow Cycle Purchase of 500,000 Fixed Assets
The firm purchases fixed assets.
Step 3
Balance Sheet Cash 0.5 F. Assets 0.5 Common
Stock 1 m ___________________________________ T.
Assets 1m T. Claims 1m
24
Cash Flow Cycle Buy 300,000 of inventory on
trade credit
The firm purchases 300,000 inventory from
suppliers.
Step 4
Balance Sheet Cash 0.5 A/P 0.3 Inventory 0.3 F.
Assets 0.5 Common Stock 1 m ____________________
_________________ T. Assets 1.3m T. Claims 1.3m
25
Cash Flow Cycle Further Work-in-process plus
finished goods
Value is added to inventory through labour
(300,000) and equipment (100,000).
Step 5
Balance Sheet Cash 0.5 A/P 0.4 Inventory 0.8 Ac
cruals 0.3 F. Assets 0.4 Common Stock 1
m _____________________________________ T.
Assets 1.7m T. Claims 1.7m
26
Cash Flow Cycle Payment of initial A/P and
Accruals
Labour and suppliers are paid.
Step 6
Balance Sheet Cash 0.1 A/P 0.1 Inventory 0.8 Ac
cruals 0.2 F. Assets 0.4 Common Stock 1
m _____________________________________ T.
Assets 1.3m T. Claims 1.3m
27
Cash Flow Cycle Goods sold on A/R for a profit
Sale of inventory occurs. Accounts receivable
created. Cash resources near exhausted. 30 days
till A/R collected.
Step 7
Balance Sheet Cash 0.1 A/P 0.1 A/R 0.5 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
28
Cash Flow Cycle Inventory Purchased
Firm purchases 400,000 inventory from suppliers.
Step 8
Balance Sheet Cash 0.1 A/P 0.4 A/R 0.5 Inventor
y 0.8 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.8m T. Claims 1.8m
29
Cash Flow Cycle Value Added to W.I.P. Inventory
Value is added to inventory through labour
(300,000) and equipment (100,000).
Step 9
Balance Sheet Cash 0.1 A/P 0.4 A/R 0.5 Invento
ry 1.2 Accruals 0.5 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 2.2m T. Claims 2.2m
30
Cash Flow Cycle Suppliers and Employees Paid
Firm pays suppliers and employees.
Step 10
Balance Sheet Cash 0.1 A/P 0.1 A/R 0.5 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
31
Cash Flow Cycle Collection on A/R
Step 11
Balance Sheet Cash 0.6 A/P 0.1 A/R 0.0 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
32
Cash Conversion Cycle
  • Cash Conversion Cycle Inventory conversion
    period
  • Receivables conversion period -
  • Payables deferral period
  • Management of the cash cycle can make an
    important difference in the amount of financing
    required, assets employed to generate a given
    level of sales...and therefore, can affect ROA
    and ROE.

33
Cash Flow Time Line
34
Sources of Personal Financing (1 of 3)
  • Sources of Personal Financing
  • Typically, the seed (or initial) money that gets
    a company off the ground comes from the founders
    themselvesfrom their personal savings,
    mortgages, and credit cards.
  • All founders contribute sweat equity to their
    ventures, which represents the value of the time
    and effort that a founder puts into a new firm.
  • Love Money
  • Friends and family are the second source of funds
    for many new ventures. This form of contribution
    is often called love money.

35
Sources of Personal Financing (2 of 3)
  • Love Money (continued)
  • Love money can consist of outright gifts, loans,
    or investments, but often comes in the form of
    forgone or delayed compensation or reduced or
    free rent.
  • Bootstrapping
  • Another source of seed money for new ventures is
    bootstrapping.
  • Bootstrapping is the use of creativity,
    ingenuity, and any means possible to obtain
    resources other than borrowing money or raising
    capital from traditional sources.

36
Sources of Personal Financing (3 of 3)
There are many ways entrepreneurs bootstrap to
raise money or cut costs. Some of the most
common examples include the following
  • Minimizing personal expenses and putting all
    profits back into the
  • business
  • Avoiding unnecessary expenses, such as lavish
    office space or furniture
  • Establishing partnerships and sharing expenses
    with partners
  • Leasing equipment rather than buying
  • Sharing office space or employees with other
    businesses
  • Utilizing the services or a university or
    community incubator
  • Buying items cheaply but prudently through
    discount outlets or online
  • auctions, such as eBay, rather than at
    full-price stores

37
Preparing to Raise Debt or Equity Financing (1 of
3)
Figure 10.2 Preparation for Debt or Equity
Financing
38
Preparing to Raise Debt or Equity Financing (2 of
3)
Two most common alternatives for raising money
Alternative
Explanation
Equity funding means exchanging partial ownership
in a firm, usually in the form of stock, for
funding. Angel investors, private placement,
venture capital, and initial public offerings are
the most common sources of equity funding.
Equity funding is not a loanthe money that is
received is not paid back. Instead, equity
investors become partial owners of a firm.
Equity funding
Debt financing is getting a loan. The most
common sources of debt financing are commercial
banks and the Small Business Administration
(through its guaranteed loan program).
Debt financing
39
Preparing to Raise Debt or Equity Financing (3 of
3)
Table 10.1 Matching a New Ventures
Characteristics with the Appropriate Form of
Financing or Funding
40
Sources of Equity Funding
Venture Capital
Business Angels
Initial Public Offerings
41
Business Angels (1 of 2)
  • Business Angels
  • Are individuals who invest their personal capital
    directly in start-ups.
  • 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 startup process.
  • The number of angel investors in the U.S. has
    increased dramatically over the past decade.

42
Business Angels (2 of 2)
  • Business Angels (continued)
  • Business angels are valuable because of their
    willingness to make relatively small investments.
  • This gives access to equity funding to a start-up
    that needs just 50,000 rather than the 1
    million minimum investment that most venture
    capitalists require.
  • Business angels are difficult to find. Most
    angels remain fairly anonymous and are matched up
    with entrepreneurs through referrals.

43
Venture Capital (1 of 4)
  • Venture Capital
  • Is money that is invested by venture-capital
    firms in start-ups and small businesses with
    exceptional growth potential.
  • There are about 650 venture-capital firms in the
    U.S. that provide funding to about 3,000 to 4,000
    firms per year.
  • Venture-capital firms are limited partnerships of
    money managers who raise money in funds to
    invest in start-ups and growing firms. The
    funds, or pool of money, are raised from wealthy
    individuals, pension plans, university
    endowments, foreign investors, and similar
    sources. A typical fund is 75 million to 200
    million and invests in 20 to 30 companies over a
    three- to five-year period.

44
Venture Capital (2 of 4)
  • Venture Capital (continued)
  • The investment preferences of venture-capitalist
    are fairly narrow.
  • For example, in 2002, 20 of all venture-capital
    investments were in the software industry.
    Telecommunications, networking, computers and
    peripherals, semiconductors, medical devices, and
    biotechnology are other industries attracting
    funding from venture capitalists.
  • Many entrepreneurs get discouraged when they are
    repeatedly rejected for venture capital funding,
    even though they may have an excellent business
    plan.
  • Venture capitalists are looking for the home
    run and so reject the majority of the proposals
    they consider.

45
Venture Capital (3 of 4)
  • Venture Capital (continued)
  • An important part of obtaining venture-capital
    funding is going through the due diligence
    process, which refers to the process of
    investigating the merits of a potential venture
    and verifying the key claims made in the business
    plan.
  • Venture capitalists invest money in start-ups in
    stages, meaning that not all the money that is
    invested is disbursed at the same time.
  • Some venture capitalists also specialize in
    certain stages of funding.
  • For example, some venture capital firm specialize
    in seed funding while others specialize in
    first-stage or second-stage funding.

46
Venture Capital (4 of 4)
Table 10.3 Stages (or Rounds) of Venture-Capital
Funding
47
Initial Public Offering (1 of 3)
  • Initial Public Offering
  • An initial public offering (IPO) is a companys
    first sale of stock to the public. When a stock
    goes public, its stock is traded on one of the
    major stock exchanges.
  • Most entrepreneurial firms that go public trade
    on the NASDAQ, which is weighted heavily toward
    technology, biotech, and small-company stocks.
  • 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.

48
Initial Public Offering (2 of 3)
Four reasons that motivate firms to go public
Reason 1
Reason 4
Reason 3
Reason 2
An IPO raises a firms public profile, making it
easier to attract high-quality customers,
alliance partners, and employees
An IPO is a liquidity event that provides a means
for a company shareholders (including its
investors) to cash out their investments
Is a way to raise equity capital to fund current
and future operations
By going public, a firm creates another form of
currency that can be used to grow the company
49
Initial Public Offering (3 of 3)
  • Initial Public Offering (continued)
  • Although there are many advantages to going
    public, it is a complicated and expensive
    process.
  • The first step in initiating a public offering is
    to hire an investment bank. An investment bank
    is an institution, such as Credit Suisse First
    Boston, that acts as an advocate and adviser and
    walks a firm through the process of going public.
  • As part of this process, the investment bank
    typically takes the firms top management team
    wanting to go public on a road show, which is a
    whirlwind tour that consists of meetings in key
    cities where the firm presents its business plan
    to groups of investors (in an effort to drum up
    interest in the IPO).

50
Sources of Debt Financing
Chartered Banks and other deposit-taking
financial institutions
Government-supported lending programs and agencies
51
Chartered Banks
  • Banks
  • Historically, chartered banks have not been
    viewed as practical sources of financing for
    start-up firms.
  • This sentiment is not a knock against banks it
    is just that banks are risk adverse, and
    financing start-ups is a risky business.
  • As shown in Table 10.1 (on a previous slide),
    banks are interested in firms that have a strong
    cash flow, low leverage, audited financials, good
    management, and a healthy balance sheet.
  • Although many new ventures have good management,
    few have the other characteristics, at least
    initially.

52
Government-supported Loan Programs and Lending
Agencies
  • Canadian Youth Business Foundation
  • Northern Ontario Heritage Fund
  • Business Development Bank
  • FedNor (Industry Canada)
  • Small Business Loans Act
  • Thunder Bay Ventures (Community Futures)
  • PARO (Community Futures)
  • Nishnawbe Aski Development Fund Youth Business
    Fund (Community Futures)
  • Aboriginal Financial Institutions
  • Small Business Canada - advice

53
Creative Sources of Financing or Funding
Leasing
Strategic Partners
University-Business Innovation Research Grants
54
Leasing (Slide 1 of 2)
  • Leasing
  • A lease is a written agreement in which the owner
    of a piece of property allows an individual or
    business to use the property for a specified
    period of time in exchange for payments.
  • The major advantage of leasing is that it enables
    a company to acquire the use of assets with very
    little or no down payment.
  • The two most common types of leases that new
    ventures enter into are leases for facilities and
    leases for equipment.
  • For example, many new businesses lease computers
    from Dell. The advantage for the new business is
    that it can gain access to the computers it needs
    with very little money invested up front.

55
Leasing (Slide 2 of 2)
  • Leasing (continued)
  • Most leases involve a modest down payment and
    monthly payments during the duration of the
    lease.
  • At the end of an equipment lease, the new venture
    typically has the option to stop using the
    equipment, purchase it for fair market value, or
    renew 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.

56
Strategic Partners
  • Strategic Partners
  • Strategic partners are another source of capital
    for new ventures.
  • Biotechnology, for example, relies heavily on
    partners for financial support. Biotech firms,
    which are typically small, often partner with
    larger drug companies to conduct clinical trials
    and bring products to market.
  • Alliances also help firms round out their
    business models and conserve resources.
  • As we discussed in Chapter 5, Dell can focus on
    its core competency of assembling computers
    because it has assembled a network of strategic
    partners that provides it critical support.

57
Review Question 10 - 1
  • What are the three most common reasons most new
    firms need to raise money in their early life?
  • Answer
  • Cash flow challenges, capital investments, and
    lengthy product development cycles.

58
Review Question 10 - 2
  • What is meant by the term burn rate? What are
    the consequences of experiencing a negative burn
    rate for a prolonged period of time?
  • Answer
  • A companys burn rate is the rate at which it is
    spending its capital until it reaches
    profitability. Although a negative cash flow is
    sometimes justified early in a firms lifeto
    build plant and equipment, train employees, and
    establish a brandit can cause severe
    complications.
  • A firm usually fails if it burns through all of
    its capital before it becomes profitable.

59
Review Question 10 - 3
  • What is meant by sweat equity?
  • Answer
  • Sweat equity represents the value and time that
    the founders of a firm put into their firm, prior
    to the time that actual equity (or money) is
    involved.

60
Review Question 10 - 4
  • To what extent do entrepreneurs rely on their
    personal funds and funds from friends and
    families to finance their ventures? What
    different forms do funds from friends and family
    take?
  • Answer
  • Friends and family are a common source of funds
    for many new ventures. This form of contribution
    is often called love money, which can consist
    of outright gifts, loans, or investments, but
    often comes in the form of forgone or delayed
    compensation or reduced or free rent.

61
Review Question 10 - 5
  • What is bootstrapping? Provide several examples
    of how entrepreneurs bootstrap to raise money or
    cut costs. In your judgment, how important is
    the art of bootstrapping for an entrepreneurial
    firm?
  • Answer
  • An important source of seed money for many new
    ventures is referred to as bootstrapping.
  • Bootstrapping is the use of creativity,
    ingenuity, and any means possible to obtain
    resources other than borrowing money or raising
    capital from traditional sources.
  • Most people will say that the art of
    bootstrapping is very important for
    entrepreneurial firms. Because its hard for new
    firms to get financing or funding early on, many
    entrepreneurs bootstrap out of necessity. As a
    result, a firm may never get off the ground
    unless its founders are good at bootstrapping.

62
Review Question 10 - 6
  • Describe the three steps involved in properly
    preparing to raise debt or equity financing.
  • Answer
  • The three steps involved in property preparing to
    raise debt or equity financing are as follows
  • Step 1 Determine precisely how much money is
    needed.
  • Step 2 Determine the type of financing or
    funding that is the most appropriate.
  • Step 3 Develop a strategy for engaging potential
    investors or bankers.

63
Review Question 10 - 7
  • Briefly describe the difference between equity
    funding and debt financing.
  • Answer
  • Equity funding means exchanging partial
    ownership in a firm, usually in the form of
    stock, for funding.
  • Debt financing is getting a loan.

64
Review Question 10 - 8
  • Describe the most common sources of equity
    funding.
  • Answer
  • The most common sources of equity funding include
    angel investors, private placement, venture
    capital, and initial public offerings.

65
Review Question 10 - 9
  • Describe the most common sources of debt
    financing.
  • Answer
  • The most common sources of debt financing are
    chartered banks and other deposit-taking
    financial institutions (sometimes credit unions)
  • The Business Development Bank
  • Other government agencies such as Export
    Development Canada, FedNor, Thunder Bay Ventures.

66
Review Question 10 - 10
  • What is the purpose of an elevator speech? Why
    is the preparation of an elevator speech one of
    the first things an entrepreneur should do in the
    process of raising money?
  • Answer
  • An elevator speech is a brief, carefully
    constructed statement that outlines the merits of
    a business opportunity.
  • There are many occasions when a carefully
    constructed elevator speech might come in handy.
    For example, many university-sponsored centers
    for entrepreneurship hold events that bring
    investors and entrepreneurs together. Often,
    these events include social hours and refreshment
    breaks designed specifically for the purpose of
    allowing entrepreneurs looking for funding to
    mingle with potential investors.
  • Having an elevator speech prepared equips an
    entrepreneur to be ready to quickly explain his
    or her business idea to a potential investor.

67
Review Question 10 - 11
  • Why is it so important to get a personal
    introduction before approaching a potential
    investor or banker?
  • Answer
  • Bankers and investors receive many business
    plans, and most of them end up in a pile in their
    offices. As a result, to have your business plan
    noticed, it is necessary to find someone who
    knows the banker or the investor and ask for an
    introduction.

68
Review Question 10 - 12
  • Describe the three steps required to effectively
    engage potential investors or bankers.
  • Answer
  • The three steps required to effectively engage a
    potential investor or a banker are as follows
  • Step 1 Prepare an elevator speech.
  • Step 2 Identify and contact the best prospects
    (preferably with an introduction).
  • Step 3 Be prepared to provide the investor or
    banker a completed business plan
  • and make a presentation of the plan
    if requested.

69
Review Question 10 - 13
  • Identify the three most common forms of equity
    funding.
  • The most common sources of equity funding are
    private investment, business angels, venture
    capital, private placement, and initial public
    offering.

70
Review Question 10 - 14
  • Describe the nature of business angel funding.
    What types of people typically become business
    angels, and what is the unique role that business
    angels play in the process of funding
    entrepreneurial firms?
  • Answer
  • Business angels are individuals who invest their
    personal capital directly in start-ups.
  • 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 startup process.
  • These investors typically invest between 25,000
    and 150,000 in a single company. The number of
    angels in Canada has increased dramatically over
    the past decade. Business angels are valuable
    because of their willingness to make relatively
    small investments. This gives access to equity
    funding to a start-up that needs just 50,000
    rather than the 1 million minimum investment
    that most venture capitalists require.

71
Review Question 10 - 15
  • Describe what is meant by venture capital.
    Where do venture capital firms get their money?
    What types of firms do venture capitalists
    commonly want to fund? Why?
  • Answer
  • 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 startups and growing firms. The funds,
    or pools of money, are raised from wealthy
    individuals, pension plans, university
    endowments, foreign investors, and similar
    sources. The investment preferences of venture
    capitalists are fairly narrow. For example, in
    2002, 20 of all venture-capital investments were
    in the software industry. Telecommunications,
    networking, computers and peripherals,
    semiconductors, medical devices, and
    biotechnology are other industries attracting
    funding from venture capitalists.

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Review Question 10 - 16
  • Describe the purpose of an initial public
    offering. Why is an initial public offering
    considered to be an important milestone for an
    entrepreneurial firm?
  • Answer
  • An initial public offering (IPO) is the first
    sale of stock by a firm to the public. When a
    company goes public, its stock is typically
    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.

73
Application Question 10 - 1
  • Write a 60-second elevator speech for
    PrintDreams, which is the You Be the VC 1
    feature at the end of the chapter.
  • Answer
  • Lets here some of your speeches.

74
Application Question 10 - 2
  • Doug Malone is a computer programmer at
    Activision, a maker of electronic games. In a
    year or so, Doug plans to leave Activision to
    launch his own firm. A colleague of Dougs
    recently asked him, Where do you plan to get the
    money to fund your new venture? Doug replied, I
    really dont think Ill need to raise any money.
    I have 35,000 in the bank, and think I can fund
    the startup and growth of the firm myself. Do
    you think Doug is being realistic? If not, what
    steps will Doug have to take to properly fund his
    firm?
  • Answer
  • Doug is not being realistic. According to
    figures cited in the chapter, it takes about two
    years and 4 million to develop an electronic
    game. In regard to funding the growth of the
    firm itself, in time, Doug may be able to do
    that. However, most entrepreneurs need
    investment funds to help launch their firms, to
    cope with cash flow challenges, make capital
    investments, and deal with lengthy product
    development cycles.

75
Application Question 10 - 3
  • Tina Russell is in the early stages of launching
    a new firm and has been attending seminars to get
    information about funding. Several of the
    seminars have had business angels and venture
    capitalists on the program. Tina has casually
    spoken with several of these individuals, but has
    only made small talk. A friend of Tina suggested
    that she develop an elevator speech to use when
    she runs into potential investors. If Tina asked
    you, What in the world is an elevator speech,
    and why would I need one? What would you tell
    her?
  • Answer
  • An elevator speech is a brief, carefully
    constructed statement that outlines the merits of
    a business opportunity. There are many occasions
    when a carefully constructed elevator speech
    might come in handy.
  • For example, in the seminars that Tina has been
    attending, if one of the investors she casually
    spoke to had asked her for more information about
    her venture, Tina would have been better prepared
    to give a short and persuasive answer if she had
    prepared an elevator speech in advance.

76
Application Question 10 - 4
  • John Baker is in the midst of starting a computer
    hardware firm, and thinks he has identified a
    real problem that his company will be able to
    solve. He has put together a management team and
    has invested 250,000 of his own money in the
    project. John feels that time is of the essence,
    and has decided to go after venture capital
    funding. How should he go about it?
  • Answer
  • There are three steps that John should take, in
    regard to developing a strategy to appeal to
    venture capitalists
  • Step 1 Prepare an elevator speech.
  • Step 2 Identify the venture funds that are
    interested in the industry that John is
    participating in, and try to arrange an
    introduction to one or more of the venture firms.
  • Step 3 Prepare a business plan and be ready to
    present the business plan to a venture capital
    firm or another group of investors.

77
Application Question 10 - 7
  • YouTube (www.youtube) is a Web site that allows
    users to upload, view, and share video clips. In
    the short time since it was founded (February
    2005), it has become one of the most popular
    sites on the Internet, and now streams more than
    100 million videos per day. As of mid-2006,
    YouTube had obtained more than 11.5 million in
    venture capital funding. Many observers are
    skeptical that YouTube has a viable business
    model and wonder if the VCs involved got caught
    up in the hype surrounding YouTubes rapid
    success.
  • Study YouTube and describe the companys business
    model. Do you think the venture capitalists that
    funded YouTube made prudent investments? How does
    Googles late decision to acquire YouTube
    influence your judgment about the venture
    capitalists investments? Explain your answers.

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Application Question 10 7
  • Answer
  • The secret behind YouTube is that the company was
    able to generate huge traffic, and has become
    somewhat of a cult phenomenon.
  • The idea behind YouTubes business model is that
    while its advertising is fairly limited today,
    the possibility of integrating advertising
    directly into videos is a significant
    opportunity.
  • For example, one potential approach is to display
    ads that match what people are talking about in a
    video. So, if two people were discussing a
    particular kind of car (or driving a particular
    kind of car), an ad for the car could appear at
    the bottom of the screen. Viewers could then
    click on the ad, at their discretion, which would
    pause the video and show a short commercial for
    the car.
  • Google bought YouTube to develop and capitalize
    on this type of potential.

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Case 10.1 - Zazzle
  • DISCUSSION QUESTION 1
  • So what do you think? Do you think Kleiner
    Perkins and Sherpalo Ventures made a wise
    decision investing 16 million in Zazzle? Three
    years from now, do you think that Zazzle will
    have disappointed or dazzled its investors? Why?
  • Answer
  • . The VCs apparently think that Zazzles
    business model is scaleable, meaning that sales
    will quickly grow, and that as more sales are
    spread out over the same technological
    infrastructure, profits will rise. They may also
    feel that Zazzle is a platform for the sale of
    customized on-demand products, and that t-shirts,
    stamps, and posters are only the start. On the
    con side, its hard to image that Zazzle will
    create as much interest as the VCs project. With
    all due respect to John Doerr, he is the VC who
    said that Segway would be the fastest company in
    American history to reach 1 billion in sales
    (see the What Went Wrong feature in Chapter 1).
    Segway has never gained traction, and may not
    survive. In addition, although Zazzle says that
    it has proprietary technology, its hard to
    believe that what theyre doing cant be fairly
    easily copied. Look at the Web site of Café
    Press, one of Zazzles main competitors. Its
    hard to see what Zazzle can do that Café Press
    cant match. It also seems like Zazzles cut of
    the revenues generated by the freelance artists
    that post material on its site is very generous.
    An artist gets only a 10 percent royalty (17
    percent if the sale is made through a referral).
    That means that Zazzle keeps 83 to 90 percent of
    the sale. By comparison, although eBays fee
    schedule is complex, in general, it charges .25
    to 80 per listing and two to eight percent of
    the final price. That means that compared to
    eBay, Zazzle keeps approximately 90 percent of
    the profits of the sellers that list items on its
    site, while eBay returns more than 90 percent of
    the profits. It makes one wonder how sustainable
    Zazzles business model is.

80
Case 10.1 Zazzle
  • DISCUSSION QUESTION 2
  • Look at Table 10.1 in the chapter. At the time
    that Zazzle raised venture capital funding, to
    what extent did it resemble the ideal candidate
    for venture-capital funding as stipulated by the
    materials in the table?
  • Answer
  • It isnt clear from the chart that Zazzle was a
    candidate for venture capital funding. Zazzles
    ability to print shirts and posters on-demand
    is unique, but the idea of printing logos and
    images on apparel products is hundreds of years
    old. Its not clear whether Zazzle will
    experience high growth. To fully appreciate what
    this means, contrast Zazzle with Nektar
    Therapeutics, the company featured in Case 9.1.
    Nektar solves a real problemit will permit Type
    2 diabetics to receive insulin through an inhaler
    (similar to the type that asthma patient use)
    instead of through needles and syringes. Its
    almost a sure bet that Nektar (whose product will
    be distributed by Pfizer) has high growth
    potential. Is Zazzle an equally sure bet? Zazzle
    market niche is also not clearly defined.
    Finally, in regard to proven management, Zazzles
    lead entrepreneurs, Bobby and Jeff Beaver, are to
    be admired for what they have accomplished, but
    they have no previous business experience. The
    Beavers father, who is involved with the firm,
    is a serial entrepreneur, and apparently has
    substantial experience.

81
Case 10.1 Zazzle
  • DISCUSSION QUESTION 3
  • Evaluate Jason Balls (the blogger) criticism of
    Kleiner Perkins investment in Zazzle. Do you
    think Ball makes some good points, or do you
    think his arguments are off-base? Explain your
    answer.
  • Answer
  • It does seem like the criticism has merit. The
    basic point that Ball makes is that 16 million
    seems like a lot for a company that is unproven,
    and he questions whether Zazzle will deliver
    value to people by allowing them to print
    on-demand t-shirts and similar items. Recall
    from Chapter 1 that value means utility or worth.
    Ball is having a hard time equating Zazzles
    value with the size of the investment. Ask your
    students what they think.

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Case 10.2 Zazzle
  • DISCUSSION QUESTION 4
  • What do you think is Zazzles exit strategy? How
    will Kleiner Perkins and Sherpalo Ventures recoup
    their investment?
  • Answer
  • The two possible exit strategies are to be
    acquired or to go public. If either of these
    options becomes a reality, Kleiner Perkins and
    Sherpalo Ventures will recoup their investment by
    liquidating their Zazzle stock. The more
    realistic of the options is to be acquired. Ask
    your students who a likely acquirer might be.
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