Chapter 10: Getting Financing or Funding
bootstrapping is very important for entrepreneurial firms. Because it’s 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. Students should be encouraged to come up
with examples of bootstrapping based on their own or the experiences of
entrepreneurs they know.
10-6.
Describe the three steps involved in properly preparing to raise debt or equity
financing.
Answer: The three steps involved in properly 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.
10-7.
What is 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.
10-8.
What are 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.
10-9.
Describe the most common sources of debt financing.
Answer: The most common sources of debt financing are commercial banks
and the Small Business Administration (Guaranteed Loan Program).
10-10.
What is the purpose of an elevator speech? Why is preparing 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
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.
10-12.
What are 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.
10-13.
What are the three most common sources of equity funding?
Answer: The most common sources of equity funding are business angels,
venture capital, private placement, and initial public offering.
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?
MyLab Question.
10-15.
What is meant by the term 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 start-ups 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. A large share of venture capital money goes into
the following industries: software, telecommunications, networking, computers
10-16.
Describe the purpose of an initial public offering (IPO). 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.
10-17.
What is the purpose of the investment bank in the initial public offering
process?
Answer: The first step in initiating an IPO is for a firm 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 advisor and walks it through the process of
going public. The most important issues the firm and its investment bank must
agree on are the amount of capital needed by the firm, the type of stock to be
issued, the price of stock when it goes public, and the cost to the firm to issue
the securities.
10-18.
In general, why are commercial banks reluctant to loan money to start-ups?
Answer: There are two reasons that banks have historically been reluctant to
lend money to start-ups. First, banks are risk averse. In addition, banks
frequently have internal controls and regulatory restrictions prohibiting them
from making high-risk loans. So, when an entrepreneur approaches a banker
with a request for a $500,000 loan and the only collateral the entrepreneur has
to offer is the recognition of a problem that needs to be solved and a plan to
solve it and perhaps some intellectual property, there is usually no practical way
for the bank to help. The second reason banks have historically been reluctant to
lend money to start-ups is that lending to small firms is not as profitable as
lending to large firms, which have historically been the staple clients of
commercial banks.
10-19.
Briefly describe the SBA’s 7(A) Loan Guaranty Program. Do most start-up
firms qualify for an SBA guaranteed loan? Why or why not?
Answer: The SBA 7(A) Guaranteed Loan Program operates through private-
sector lenders that provide loans that are guaranteed by the SBA. Almost all
small businesses are eligible to apply for an SBA guaranteed loan. Most start-
ups qualify for an SBA guaranteed loan, except those that are distressed
10-20.
What is a Small Business Innovation Research (SBIR) grant? Why would a firm
want to apply for such a grant if it qualifies for it?
Answer: The SBIR Program is a competitive grant program that provides more
than $1 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. Historically, only a small percentage of the firms that apply
for an SBIR grant are successful; however, for those that receive grants, the
payoff is high. The money is essentially free. It is a grant, meaning that it
doesn’t have to be paid back and no equity in the firm is at stake.
APPLICATION QUESTIONS
10-21.
Write a 60-second elevator speech for Faraday Bikes, the focal firm discussed
in the “You Be the VC 10.1” feature.
Answer: This is a good question for an individual or a group assignment.
10-22.
Samantha Smith, a friend of yours, was recently telling you about a company
that her father is starting in the solar power industry. Samantha’s father is using
a technology he developed, which has received favorable write-ups in several
technical publications. He has been approached by two angel investors who are
eager to invest in his proposed venture. He’s also been offered a spot in a
prestigious technology incubator, where he can maintain an office and a lab to
work on his project. Samantha says that her dad has turned away the potential
investors and is opting to work out of a shop on some property he owns, rather
than move into the incubator. He’ll be able to fund the company from personal
savings, at least for the first two years. Do you think Samantha’s dad is making
good decisions? What are the pluses and minuses of his decisions?
Answer: Most students will say that Samantha’s dad is not making good
decisions. By engaging the angel investors and moving into the incubator,
Samantha’s dad could build a strong network of fellow entrepreneurs and
investors, which could serve him well in the future. By basically isolating
himself, he misses the benefits of being surrounded by other entrepreneurs and
by building a professional network. Entrepreneurs often strengthen their
business ideas by interacting with other entrepreneurs.
10-23.
Jim Carter, a classmate of yours, is preparing to launch an e-commerce
company to sell home repair guidebooks, tools, how-to videos, and related
material for home repair and remodeling projects. He just told you that he
talked to his paternal grandmother over the weekend, and she has agreed to lend
him $25,000 to launch the firm. When you asked Jim what arrangements he has
made with his grandmother to formalize the loan, he looked puzzled and said,
Chapter 10: Getting Financing or Funding
financials, good management, and a healthy balance sheet. Although Ed may be
“She plans to send me a check in a week or so—she just needs to get the money
out of her savings account.” Jim seemed concerned by the worried look on your
face and said, “Tell me what you’re thinking, I really want to do the right thing
here.” What would you say to Jim?
Answer: There are two things to tell Jim. First, he and his grandmother should
have a formal promissory note prepared, and should both sign it. The note
should specify the repayment terms for the loan. Second, Jim should carefully
consider whether his grandmother is in a position to loan him money. It’s not a
good idea to ask a relative, or anyone for that matter, for financial assistance if
losing the money would cripple them financially. He also doesn’t want to
jeopardize his personal relationship with his grandmother.
10-24.
Kathy Baker is in the midst of starting a computer hardware firm and thinks she
has identified a real problem that her company will be able to solve. She needs
investment capital, but doesn’t know much about the process and doesn’t know
where to begin. She’s turned to you for advice. Write Kathy a 250- to 300-word
e-mail message introducing her to the process of raising investment capital.
Answer: This is a good question for an individual or a group assignment.
10-25.
Imagine you invented a new type of car seat for children, which is lighter and
safer than the car seats currently on the market. You have a business plan and
have won two business plan contests based on your idea. You also have a
working prototype. You’d like to find an angel investor to fund the launch of
your firm. Describe how you’d go about finding an angel investor in the area in
which you live. Make a list of the specific steps you’d take, and the specific
people you’d talk to, to try to locate an appropriate angel investor.
Answer: The best way to identify a business angel is to work your network of
acquaintances, including college professors, attorneys, accountants, bankers,
and other people in the entrepreneurship community, such as SBDC counselors
and SCORE advisors. It’s best to get an introduction from one of these people.
10-26.
Ed Sayers just returned from a meeting with his banker with a frustrated look on
his face. He tosses his keys on the kitchen counter and tells his wife, “I just
can’t understand where my banker is coming from. I have a great idea for a new
firm, but the bank isn’t interested in helping me with a loan. Tomorrow, I’m
going to visit a couple of other banks to see if I have better luck.” Do you think
Ed will have any better luck with the second and third bank he visits? Why or
why not?
Answer: Unfortunately, Ed is unlikely to have any better luck with the second
and third bank he visits. As shown in Table 10.2 in the textbook, banks are
interested in firms that have a strong cash flow, low leverage, audited
very creditworthy and have a great idea, his potential new firm, like most
potential new firms, simply doesn’t meet the criteria that bankers are looking
for. This reality isn’t necessarily a knock against banks; it’s just that banks are
risk averse, and financing start-ups is a risky business.
10-27.
Joshua Sherman, who lives near Vancouver, Canada, is preparing to pitch an
idea for a social gaming website to a group of angel investors. The site has
some new and novel aspects to it. He made a practice presentation in front of
his advisory board, and one question that an advisor urged him to prepare for is
“If you’re successful, what’s to prevent Facebook from launching a similar
product?” Joshua frowned, and said he thinks it’s unlikely he’ll be asked that
question. What do you think? If you were Joshua, how would you prepare to
answer that question?
Answer: Jason is incorrect. He’ll very likely be asked that question. He should
prepare to answer the question by thinking about what makes his site special,
and what he can do that Facebook can’t do. If Facebook tries to copy his site,
his only chance for survival is to highlight what’s “different” about his site
compared to Facebook’s to maintain a competitive advantage.
YOU BE THE VC 10.1
Company: Faraday Bikes (www.faradaybikes.com)
Business Idea: Design and produce a bicycle that is stylish, comfortable to ride, allows
riders to work as much or as little as they want, and enables riders to bike to work
without breaking a sweat.
You Be the VC Scorecard
Faraday Bikes
(www.faradaybikes.com)
Item
Score/Comments
Strength of New-Venture
Team
1 2 3 4 5
Faraday Bikes was founded by Adam Vollmer as a
result of a design contest won by a team at Ideo.
Vollmer formed a team with a head of operations and
finance and a marketing person. Given that they are
producing a physical product that has inventory and
working capital issues, it is hard to emphatically say that
Vollmer and his team are ideal for the venture.
Chapter 10: Getting Financing or Funding
219
Strength of the Opportunity
1 2 3 4 5
The opportunity is consistent with the increased
awareness of environmental pollution. In addition to
alleviating the need for fossil fuel-based gasoline,
Faraday Bikes’ main product helps address traffic
congestion in urban areas As time goes on, an increasing
number of city dwellers will be in need of bicycles.
Strength of the Industry
1 2 3 4 5
The bicycle industry is large and growing as there is an
increased awareness of maintaining one’s health and
living in a way that results in minimal environmental
pollution.
Strength of Business Model
1 2 3 4 5
From their website, it appears that Faraday Bikes’
business model consists of the company sending the
assembly kit for their bike to a local bike shop near the
customer’s home. Say, I live in Apopka, Florida and I
order a bike from Faraday Bikes. The company will
deliver the unassembled bike to a bike shop in Apopka,
which will assemble the bike for me to pick it up from
the store. While this model enlists the support of bike
shops, it is unclear how much cost this adds to the
product.
3.75/5.0
Decision: We would fund this firm. It appears to be well-managed, has a solid business
concept, and is in an industry that is growing. We also like the fact that it addresses both
urban congestion and environmental pollution. We think it could be successful in a big
way. That makes it a very attractive investment opportunity.
Chapter 10: Getting Financing or Funding
220
YOU BE THE VC 10.2
Company: Lumo Bodytech (www.lumobodytech.com)
Business Idea: Design and develop two small, unobtrusive wearable devices. The first
device monitors and improves the user’s posture – which allows the user to sit straighter,
stand taller, and look better. The second device analyzes the user’s running form and
offers personalized coaching to help the user exceed his or her running goals.
You Be the VC Scorecard
Lumo Bodytech
(www.lumobodytech.com)
Item
Score/Comments
Strength of New-Venture
Team
1 2 3 4 5
Three Stanford entrepreneurs – Monisha Perkash, Dr.
Charles Wang, and Andrew Chang – founded Lumo
Bodytech. Perkash is a serial entrepreneur, who had
previously founded and sold TuitionCoah. Wang is a
trained physician, and Chang has extensive technical
background. Together, this appears to be a formidable
team.
Strength of the Opportunity
1 2 3 4 5
The opportunity is quite strong. While fitness trackers
like FitBit help in measuring and keeping track of the
number of steps a person takes a day and related metrics,
the Lumo Lift helps in doing all that AND correcting
body posture. Likewise, Lumo Run is a running coach.
There is an increased awareness toward physical fitness
and Lumo Bodytech taps into that.
Strength of the Industry
1 2 3 4 5
The fitness tracker industry is fairly new, but has grown
tremendously because of being paired with smartphones.
Lumo Bodytech enters an already crowded space, but it
is able to differentiate itself based on the value it
provides.
Strength of Business Model
1 2 3 4 5
10-34.
Do you think Revolights will need to raise additional capital? If so, why? Using
In late October 2017, the two main products of Lumo
Bodytech were selling on Amazon. The Lumo Lift
retails at $79.93 and the Lumo Run at $99.48. Since it is
privately owned, we don’t know what the company’s
margins are and its sales. It appears that they have a
traditional retail model.
Average Score
4.00/5.0
Decision: We would fund Lumo Bodytech. We like the management team. Not only does
the team have technical expertise both in IT and in medicine, it is also led by a successful
entrepreneur. We believe they have two solid products, both of which meet specific
needs, enabling the company to differentiate itself from the competition.
CASES
Case 10.1
Revolights: Using Multiple Sources of Funding to Bring Its Innovative Bicycle Lighting
System to Life
DISCUSSION QUESTIONS
10-32.
The following sentence appears early in this chapter: “There are threee reasons
that most entrepreneurial ventures need to raise money during their early life:
cash flow challenges, capital investments, and lengthy product development
cycles.” Evaluate Revolight’s need to raise money in each of these areas.
Answer: (1) Cash flow challenges. Because the Revolights system is a physical
product, inventory must be bought and paid for before the product is sold. As a
result, the gap between when Revolights has to pay its suppliers (for the raw
ingredients needed to built its product) and when it gets paid by its customers
causes cash flow challenges. (2) Capital investments. Revolights has less of a
need for funding for capital investments. There is no indication that the
company is investing money in manufacturing facilities, buildings, or property.
(3) Lengthy product development cycles. Revolights does need money for this
purpose. Prior to launching a new iteration of its bike lights, Revolights builds
prototypes and tests them in the marketplace.
10-33.
In response to a request from Kent Frankovich and Adam Pettler, write a 60-
second elevator pitch about Revolights’ current product.
Answer: This is a good question for an individual or a group assignment.
Table 10.2 in the chapter as a guide, if Revolights raises additional capital, what
would be the most appropriate source of financing or funding? Explain your
answer.
Answer: From the table in the case, Revolights has raised a total of around $2
million, without including the undisclosed amount from VA Angels in 2015.
Given that they sell a physical product that requires investing in inventory and
waiting to collect on accounts receivable, working capital may be needed. From
Table 10.2 in the book, Revolights best fits the third profile – unique business
idea, etc. This suggests that equity financing is the best path forward.
10-35.
To what degree do you think Revolights will be able to reach mainstream
markets and sustain its growth? How successful do you believe the firm will
be? Justify your answer based on criteria introduced in earlier chapters of this
book and your own intuition.
Answer: Most students will argue that Revolights is a very successful start-up
venture. It has produced a string of successfully attractive products, has
garnered positive publicity (along with winning awards), and has attracted the
attention of high-profile investors. It is also producing a product that makes
people safer and could potentially save lives. As the case indicates, however,
their $149 price point appears to be a growth hurdle. Although they have
brought the price down from $399, $149 is still a high price that may slow
down Revolights’ access to the mainstream market.
Case 10.2
Kickstarter: An Increasingly Important Forum for Raising Seed Capital
DISCUSSION QUESTIONS
10-36.
Do you think Kickstarter is a viable alternative to raising equity funding or debt
financing? If so, under what circumstances?
Answer: Most students will say yes—Kickstarter is a viable alternative to raising
equity funding or debt financing in most cases. It certaintly helped raise a
substantial amount of money for the companies highlighted in the table in the case
labeled “Five Most Successful Kickstarter Projects to Date.” In fact, according to
the case, since Kickstarter was started in 2009, it has reportedly helped raise more
than $3 billion in pledges from 12.7 million donors to fund 123,387 projects. Some
of the companies that raise money on Kickstarter will need additional rounds of
equity funding or debt financing to further prove their concepts or to scale their
business. But there are a growing number of businesses that are entirely funded by