Financing the Business

Enterprise & Business Development

Session 10 - Financing the Business

  • University of West London

Session Objectives

  • Understand the sources and types of financial investment.
  • Learn about venture life cycle financing.
  • Discuss bank lending principles.
  • Explore business angels and venture capital sources.
  • Review creative sources of finance.
  • Engage with guest speakers for practical insights.
  • Participate in a discussion on the topics covered.

Financial Viability and Management

  • The ability to pursue opportunities is heavily influenced by availability of funds.
  • Financial viability is emphasized as the key factor for any business.
  • Financial management encompasses:
    • Raising money to support the business.
    • Managing company finances to ensure the highest possible rate of return.
  • Importance of achieving a balance between finance and control within financial management.

Sources of Finance

Types of Financial Sources

  • Personal Investment: Capital invested by the entrepreneur, which demonstrates commitment.
  • Friends and Family: Support through loans or investments from personal networks.
  • Investors: Various forms of external investment, such as venture capitalists or business angels.
  • Crowdfunding: An emerging way to raise small amounts of money from many people via internet platforms.
  • Bank Finance: Loans and credit facilities provided by banks.
  • Small Business Grants: Funds provided by government or organizations that do not require repayment.
  • Leasing: Acquiring the use of assets without ownership liability.
  • Hire Purchase: Paying in installments with eventual ownership rights.
  • Debt Factoring: Selling invoices to receive immediate cash.
  • Bootstrapping: Using personal savings and reinvesting income from the business.

Differences in Financial Sources

  • Debt vs. Equity Financing: Debt involves loans that must be repaid, while equity involves selling shares of the company.
  • Short-term vs. Long-term: Refers to the duration for which the funds are needed.
  • Formal vs. Informal: Formal finance includes established financial institutions, while informal can be personal contacts or smaller investors.

Advantages and Disadvantages of Different Sources of Finance

Personal Finance

Advantages
  • Strong incentive to succeed, as the entrepreneur retains full control.
  • Demonstrates personal commitment, potentially attracting additional finance.
  • No interest payable can enhance profit margins.
  • Suitable for higher risk scenarios where returns are uncertain.
Disadvantages
  • Risk of losing personal funds if the business fails.
  • Limited amount of money typically available.

Friends and Family

Advantages
  • Flexibility in repayment terms.
  • Ability to tap into personal relationships that provide both financial support and time/expertise.
  • Helpful when management is inexperienced.
Disadvantages
  • Potential strain on personal relationships due to financial dealings.
  • Limited capital is usually available.

Debt Finance

Advantages
  • Suitable for businesses with predictable income, allowing retention of business control.
  • Interest on loan payments is typically tax-deductible.
Disadvantages
  • Fulfills obligation to repay loans irrespective of business performance.
  • Loans usually require assets as collateral.

Equity Finance

Advantages
  • Access to expert knowledge and a wider network of investors.
  • Significant investment can be acquired without repayment obligations.
Disadvantages
  • Equity financing leads to a dilution of ownership and control.
  • Usually available only to businesses that meet specific growth criteria.

Sequence of Venture Financing

  • Bootstrapping: Initial funding by personal savings or profits.
  • Seed Financing: Early funds to develop ideas and start business activities.
  • R&D Financing: Financial support for research and development activities.
  • Start-up Financing: Funding for launching the product/service but not yet profitable.
  • First-stage Financing: Funding to support initial sales and operations.
  • Second-stage Financing: Capital for expansions or new product lines.
  • Third-stage Financing: Further capital infusion as the business grows.
  • Mezzanine Financing: Intermediate debt/equity financing to bridge gaps.
  • Bridge Financing: Short-term financial support until more permanent solutions are found.
  • LBO, MBO, MBI, IPO: Various exit strategies or acquisition structures.

The Financing Lifecycle

  • Essential stages described: Seed Capital to IPO
  • Seed/Start-up stage focuses on market research and product development.
  • Early Stage funding emphasizes full-scale operation establishment.
  • Later Stage finance aims for expansion and introduction of new products.

Financial Access by Stage

  • Breakdown of finance needed by funding stage:
    • Amounts varying from under $50K to over $100M.
    • Sources such as side jobs, credit cards, friends & family, angel investors, offered based on the required funds.

Bank Considerations for Lending

  • Loan Factors: Purpose, amount needed, and repayment terms.
  • Financial Assessment: Analyzing cash flow, break-even points, and debt gearing.
  • Personal Insights: Considering borrower character and ability to repay.

Common Worries From Banks

  • Frequent excesses in borrowing and lending markets.
  • Development of core borrowing with insufficient financial records.
  • Repeated profit losses, declining margins, and erratic sales figures.

Term Loans: Advantages & Disadvantages

Advantages

  • Typically secured against business or personal assets.
  • Funds can be refused due to lack of collateral security.
  • Fixed terms with known capital repayments.
Disadvantages
  • Set repayment schedules; inflexible terms.
  • Interest rates can vary and are generally lower than rates on overdrafts.

Asset Security Values for Loans

  • The percentage of collateral value:
    • Freehold land & buildings: 70%.
    • Long leasehold: 60%.
    • Non-specialist machinery: 100% through leasing.
    • Debtors/receivables: 30%.
    • Stock/inventory: % value depends on asset type.

What Investors Look For

  • Risk & Return: Expecting 30-60% annual returns as capital gain.
  • Exit Route: Plan for liquidating investments within 5-10 years.
  • Typical factors investors consider:
    • Market growth and attractiveness, competition, market entry ease, and uniqueness of products.

Business Angels

  • Characteristics considered by investors:
    • Size of investment, business attributes, systematic approach, geographic footprint, holding periods, and investor motives.

Angel Finance: Advantages vs Disadvantages

Advantages
  • Suitable mainly for growth-oriented businesses.
  • Part of profits shares with investors.
  • Less interference in the business from angels.
Disadvantages
  • Often hinders strategic plans due to investor expectations (exit strategies).
  • Generally, small amounts of equity are available, and finance duration varies.

Finding a Business Angel

  • Exploration strategies:
    • Search locally; look among successful entrepreneurs.
    • Network through clubs, alumni associations, and civic forums.
    • Leverage connections with gatekeepers (lawyers, accountants).
    • Platforms such as British Business Angels Association and AngelList.

Venture Capital Overview

  • Defined as a financial intermediary focusing on private company investments.
  • Active role in portfolio management to maximize returns via exits like IPOs.
  • VCs usually fund internal growth in companies.

Structure of Venture Capital Funds

  • Investors (limited partners) include:
    • Governments, wealthy individuals, pension funds, foundations, etc.
  • Managed by a venture capital firm (general partners) that handles capital and seeks returns for investors.

Key Factors Venture Capitalists Assess

  • Product-Market Factors: Market fit, growth rates.
  • Management Team Factors: Skills, expertise, and experience levels.
  • Financial Assessment: Profitability timelines, ROI, and cost structures.
  • Deal Factors: Proposed structures, competitive landscape, and unique offerings.

Financial Odds Expectation by Stage

  • Expected annual returns by venture stages:
    • Seed: 80%.
    • Start-up: 60%.
    • First-stage: 50%.
    • Second-stage: 40%.
    • Third-stage/Mezzanine: 30%.
    • Bridge: 25%.

Understanding Investor Questions

  • Key inquiries from potential investors include:
    • Type of venture, investment required, anticipated returns, growth stages, project specifics, and risks involved.
  • Important considerations also include the exit strategy and investor control mechanisms.

Venture Finance Overview

Advantages and Disadvantages

Advantages
  • Focused on businesses with significant growth potential.
  • Profit and capital opportunities shared with investors.
  • Investors may offer strategic advice and support.
Disadvantages
  • Generally, no daily operational involvement; only strategic foresight.
  • Financing duration varies typically around 5-10 years.

AirBnB Case Study: Financing Journey

  • Overview of two entrepreneurs starting with renting air mattresses in San Francisco.
  • Initial small funding led to development growth with a unique business model.
  • Notable milestones include reaching a $10 billion valuation through diverse funding strategies and growth adaptations.

Creative Sources of Finance

Options Explored

  • Leasing: Accessing assets for regular payments without ownership.
  • Factoring: Immediate cash through selling invoices.
  • Crowdfunding: Emerging popularity for seed and startup funding via the internet.
Crowdfunding Insights
  • Explosive growth in crowdfunding reflects a new avenue for financing, gaining popularity particularly in creative sectors.
  • Examples of successful campaigns showcasing potential.
  • Increasing legislative and regulatory frameworks governing equity crowdfunding effectively.

Peer-to-Peer Lending

  • Platforms bringing together borrowers and investors sans traditional banks, often yielding favorable terms for both parties.

Bootstrapping Techniques

  • Practical tips include:
    • Purchase used items instead of new.
    • Lease equipment if possible rather than buy.
    • Focus on minimizing expenses and maximizing early revenue through strategic planning.

Closing Notes / Evaluation

  • Reminders to provide feedback through the module evaluation survey, ensuring anonymity and improving future learning experiences.