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CHAPTER 10
GETTING FINANCING OR FUNDING
LEARNING OBJECTIVES
1.
Describe the importance of financing for entrepreneurial success.
2.
Explain why most entrepreneurial ventures need to raise money during their early
life.
3.
Identify and describe the three sources of personal financing available to
entrepreneurs.
4.
Identify and explain the three steps involved in properly preparing to raise debt or
equity financing.
5.
Explain the three most important sources of equity funding that are available to the
entrepreneurial firm.
6.
Describe common sources of debt financing entrepreneurial firms use.
7.
Describe several creative sources of financing entrepreneurial firms may choose to
use.
CHAPTER OVERVIEW
This chapter focuses on the important topic of getting financing or funding. The chapter
begins by describing why most new ventures need funding. The chapter then transitions
to discuss sources of personal financing, which includes an entrepreneur using his or her
personal funds, bootstrapping, and borrowing from friends and family, which are
common occurrences in start-up firms. Strategies for preparing to raise debt or equity
financing are discussed. The concept of an elevator speech is introduced. An elevator
speech is a brief, carefully constructed statement that outlines the merits of a business
opportunity.
The center portion of the chapter focuses on the primary ways that entrepreneurs raise
money: equity funding or debt financing. The common sources of both equity funding
and debt financing are discussed. The chapter concludes with a discussion of creative
sources of financing and funding, which includes crowdfunding, leasing, SBIR and STTR
government grants, other grant programs, and strategic partners.
CHAPTER OUTLINE
I. The Importance of Getting Financing or Funding
II. Why Most New Ventures Need Funding
A. Cash Flow Challenges
B. Capital Investments
C. Lengthy Product Development Cycles
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III. Sources of Personal Financing
A. Personal Funds
B. Friends and Family
C. Bootstrapping
IV. Preparing to Raise Debt or Equity Financing
V. Sources of Equity Funding
A. Business Angels
B. Venture Capital
C. Initial Public Offering
VI. Sources of Debt Financing
A. Commercial Banks
B. SBA Guaranteed Loans
D. Other Grant Programs
E. Strategic Partners
CHAPTER NOTES
I. The Importance of Getting Financing or Funding
Few people deal with the process of raising capital until they need to raise capital for
their own firm. As a result, many entrepreneurs go about the task of raising capital
haphazardly, because they lack experience in this area and because they don’t know
much about their choices.
II. Why Most New Ventures Need Funding
A. 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.
B. Capital Investments. The cost of buying real estate, building facilities, and
purchasing equipment typically exceeds a firm’s ability to provide funds for these
initial activities on its own.
C. 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.
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III. Sources of Personal Financing
A. Personal Funds. Typically, the seed money that gets a company off the ground
comes from the founders themselves—from their personal savings, mortgages,
and credit cards and by tapping into the cash value of life insurance.
B. Friends and Family. Friends and family are the second source of funds for many
IV. Preparing to Raise Debt or Equity Financing
Once a start-up’s financial needs exceed what personal funds, friends and family,
and bootstrapping can provide, debt and equity are the two most common sources
of funds. The steps involved in properly preparing to raise debt or equity
financing are shown in Figure 10.3 in the textbook and are outlined below.
Step 1: Determine precisely how much money the company needs.
Step 2: Determine the most appropriate type of financing or funding.
V. Sources of Equity Funding
A. Business Angels
1. Business angels are individuals who invest their personal capital directly in
start-ups.
a. 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 start-up process.
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b. The number of angel investors in the United States has increased
dramatically over the past decade, partly because of the high returns some
report.
B. Venture Capital
1. Venture capital is money that is invested by venture capital firms in start-ups
and small businesses with exceptional growth potential.
2. Venture capital firms are limited partnerships of money managers who raise
3. 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 fihome run” and so reject the
majority of the proposals they consider.
C. Initial Public Offering
2. Firms decide to go public for the following reasons: (1) it is a way to raise
3. Although there are many advantages to going public, it is a complicated and
expensive process. The first step is to hire an investment bank. An investment
bank is an institution, such as Credit Suisse First Boston, that acts as an
underwriter or agent for a firm issuing securities. The investment bank acts as
the firm’s advocate and adviser and walks it through the process of going
public.
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VI. Sources of Debt Financing
A. Commercial Banks
1. Historically, commercial banks have not been viewed as practical sources of
2. There are two reasons that banks have historically been reluctant to lend
money to start-ups.
a. First, as mentioned previously, banks are risk averse. In addition, banks
frequently have internal controls and regulatory restrictions prohibiting
them from making high-risk loans.
b. Second, lending to small firms is not as profitable as lending to large
firms. In many instances, it is simply not worth a banker’s time to do the
due diligence necessary to determine the entrepreneur’s risk profile.
B. SBA Guaranteed Loans
1. Many different types of banks in the United States participate in the SBA
Guaranteed Loan Program. Although these loans typically aren’t available to
start-ups, they are an important source of funding for small businesses in
general.
2. The most notable SBA program available to small businesses is the 7(A) Loan
3. The SBA can guarantee as much as 75 percent (debt to equity) on loans up to
$5 million and 85 percent on loans up to $150,000.
C. Other Sources of Debt Financing
1. Peer-to-peer lending is a financial transaction that occurs directly between
2. Vendor credit (also known as trade credit) is when a vendor extends credit to
3. Factoring is a hybrid method for obtaining cash. Not really debt financing
per se, factoring is a financial transaction whereby a business sells its
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accounts receivable to a third party, called a factor, at a discount in exchange
for cash.
VII. Creative Sources of Financing and Funding
A. Crowdfunding
1. Crowdfunding is the practice of funding a project or new venture by raising
2. Rewards-based crowdfunding allows entrepreneurs to raise money in
3. Equity-based crowdfunding helps businesses raise money by tapping
individuals who provide funding in exchange for equity in the business. Three
B. Leasing
1. A lease is a written agreement in which the owner of a piece of property
2. The major advantage of leasing is that it enables a company to acquire the use
of assets with very little or no down payment.
3. The two most common types of leases that new ventures enter into are leases
for facilities and leases for equipment.
C. SBIR and STTR Grant Programs
1. The Small Business Innovation Research (SBIR) and the Small Business
2. The SBIR Program is a competitive grant program that provides more than
$2.5 billion per year to small businesses for early-stage and development
projects. Each year, 11 federal departments and agencies are required by the
SBIR to reserve a portion of their research and development funds for awards
to small businesses.
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a. The SBIR is a three-phase program, meaning that firms that qualify have
the potential to receive more than one grant to fund a particular proposal.
b. Historically, less than 15 percent of all Phase I proposals are funded, and
about 30 percent of all Phase II proposals are funded. The payoff for
3. The STTR Program is a variation of the SBIR for collaborative research
projects that involves small businesses and research organizations, such as
universities and federal laboratories.
D. Other Grant Programs
1. There are a limited number of other grant programs available to entrepreneurs.
2. The federal government has grant programs beyond the SBIR and STTR
3. One thing to be careful of is grant-related scams.
E. Strategic Partners
1. Strategic partners are another source of capital for new ventures. Indeed,
2. Biotechnology, for example, relies heavily on partners for financial support.
Biotech firms, which are typically fairly small, often partner with larger drug
companies to conduct clinical trials and bring products to market.
BOXED FEATURES: QUESTIONS FOR CRITICAL THINKING
Failed
1.
Examine the problems that DrawQuest encountered. How could the company
have avoided or navigated around each problem?
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Answer: DrawQuest may have benefited from a comprehensive feasibility
analysis. The feasibility analysis may have brought to light that only a small
percentage of users would pay for the enhanced features. DrawQuest may also
have benefited from developing a minimal viable product and testing it in the
marketplace (with a small set of enhanced features included) to see if people
would buy the enhanced features. Again, this approach may have alerted
DrawQuest to the fact that only a small percentage of people would buy the
enhanced features.
2.
What alternatives did DrawQuest have for generating income for its app? Why do
you think the company didn’t try any of these alternatives before shutting down?
Answer: DrawQuest could have (1) charged a download fee for the app, (2)
included advertising on the app, (3) gave away a basic version of the app and
charged from a more advanced version, or (4) any combination of the first three
along with selling upgrades. It’s unclear why DrawQuest did not try any of these
alternatives.
3.
Based on what you learned in Chapter 4, complete a Barringer/Ireland Business
Model template for DrawQuest. Is there anything that is noticeable in the business
model template that may have forecast that DrawQuest would have a hard time
surviving?
Answer: This is a good question for an individual or group assignment. Most
students will conclude that the major flaw in DrawQuest’s business model was
that it relied on a single source of revenue. The company simply didn’t bring in
enough money. DrawQuest clearly had a strong basis of differentiation, important
core competencies, sound operations, and a viable target market. It just wasn’t
able to monetize these advantages via the single revenue stream that it had.
4.
A common start-up idea on college and university campuses is to build a
smartphone app. What lessons can students building apps learn from
DrawQuest’s experience?
Answer: The main lesson students should learn from the DrawQuest experience is
this: that regardless of how well the app is developed and how many people are
using the app, there has to be sufficient revenue generated to make the app an
attractive business.
Savvy Entrepreneurial Firm
Working Together: How Biotech Firms and Large Drug Companies Bring
Pharmaceutical Products to Market
1.
In your opinion, what factors in the business environment encourage firms to
partner to compete?
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Answer: Small firms partner with large firms for a number of reasons. The reasons
include: gaining access to a particular resource (such as a large drug company’s
distribution network), risk and cost sharing (the large drug companies will often
share the risk of developing a new pharmaceutical product with smaller
companies), and speed to market (the financial resources provided by large firms
often help smaller biotech firms get to market sooner).
2.
What risks do small firms face when partnering with large, successful companies?
What risks do large companies take when they rely on small firms as a source of
innovation?
Answer: Small firms face many risks when partnering with larger companies.
These risks include: loss of proprietary information (by working with a large firm,
the large firm may get access to some of the small firm’s proprietary information
that it wasn’t entitled to), risk becoming dependent on a partner (by working with
large firms, small firms risk becoming overly reliant on their advice and financial
clout), and partners’ cultures may clash (a larger firm may simply be a hassle to
deal with). Large firms take on similar risks in working with small firms.
3.
How might government policies affect partnering actions between small and large
firms in the pharmaceutical industry?
Answer: There may be antitrust implications. If a small firm and a large firm
partner in a way that monopolized a market, the government might intervene. In
addition, it might be more complicated to show that procedures were followed
according to FDA regulations in testing a new drug if the responsibilities were
split between two companies.
4.
If you worked for an entrepreneurial venture, what would you want to know about
a large company before recommending that your firm form a partnership with it?
Answer: Whether that firm had worked with entrepreneurial ventures before, and
how successful the partnerships were. There is nothing wrong with asking for
references when contemplating entering into a partnership with another firm. If the
large firm is unwilling to give references, that is a fired flag” pertaining to the
potential partnership.
Partnering for Success
Startup Weekend: A Fertile Place to Meet Business Cofounders
1.
In referring to Startup Weekend, someone made the comment fiIt’s not a start-up
factory, it’s an entrepreneur factory.” What do you think the person meant by that
comment?
Chapter 10: Getting Financing or Funding
Answer: Most students will say that what the person meant is that more people
will become excited about the entrepreneurial process as a result of attending a
Startup Weekend than actual start-ups will be launched. So, the real benefit of
hosting a start-up weekend is to produce entrepreneurs rather than producing start-
ups.
2.
To what degree do you agree with the basic premise of the feature that Startup
Weekends represent a fertile place to meet business cofounders?
Answer: Most students will say that the premise is accurate. According to the case,
about 55 percent of Startup Weekend participants continue working on their idea
with their team intact after the Startup Weekend ends. That’s a fairly high
percentage. As a result, attending a Startup Weekend may be an excellent place to
become part of a start-up team and to meet potential business co-founders.
3.
What can people learn by attending a Startup Weekend, even if they ultimately do
not stay together with their team after the weekend ends?
Answer: They can learn a host of things, including:
How to pitch business ideas.
How to quickly assess whether a business idea is feasible.
How to quickly iterate on a business idea based on feedback from team
members, mentors, and potential customers.
How to work on a business start-up team.
How to work with mentors and advisors in the context of thinking
through a business start-up idea.
How to polish a presentation to present to a panel of potential investors.
4.
Spend some time looking at the Web site for 3 Day Startup. How do Startup
Weekend and 3 Day Startup compare? Are both equally suited for college student
entrepreneurs?
Answer: The two organizations vary on the following dimensions:
3 Day Startup is strictly for college students. Startup Weekend is for
anyone interested in the business start-up process.
3 Day Startup involves paying the 3 Day Startup organization a fee. In
exchange, 3 Day Startup will send a trained facilitator to your location
to lead the event. Startup Weekend is strictly organized and staffed at
the local level. The Startup Weekend organization provides a kit of
support, but not a facilitator.
3 Day Startup is more structured than Startup Weekend.
There is typically no prize money available to the winning pitches that
