Sources of Financing

WHAT

A module of New Venture Financing. New ventures need money to operate and grow. The sources of startup funding have never been greater in number; ease of getting funding is another matter, and so is knowing which sources are appropriate for the type of business you're operating and the stage of your business's development. This module provides a high-level overview of the common sources of financing for new ventures.

LEARNING OBJECTIVES

Upon completing this module, students will be able to:

• relate the types of businesses and their stages of development to appropriate sources of financing.

• explain the benefits and misconceptions about SBA loans

• explain the benefits and downfalls of using credit cards to finance businesses

• position and orient their business to make it as attractive as possible to the targeted source of financing

• know what resources they need to turn to for additional and deeper information about desired sources of financing.

Instructions

• Watch the assigned videos and presentations; 

• Read the assigned readings; 

• Complete the practice quiz or other assigned practice activity

• Complete the assessment;

• Complete the "Mark as Complete" checklist.

READ

Overview of sources of venture financing

The general categories of new venture financing include:

• Personal funds: show others you believe in what you're doing by using your own funds first; but don't max out those credit cards!

• Friends and family: usually the next source of informal financing after personal funds; these people believe in you probably much more than they believe in your product or service, so you will want to reward them if and when you can.

• Business incubators: a growing and increasingly important source of financing, coaching, expertise, and potential partners for your venture. Business incubators often run pitching and business plan competitions with cash prizes, many of which are straight cash awards instead of one-sided equity buys...

• Crowdfunding: Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives and venture capitalists (Investopedia.com). NOT to be mistaken for crowdfunding sites like Kickstarter and IndieGoGo where people sell products and offer rewards for different pledged backing levels to a campaign. 

• Angel investors: they use their own money and are often successful entrepreneurs who have sold their own startups and want to help new entrepreneurs. They can be sources to networks of potential partners, seasoned advice, and future investments. 

• Venture capital: professional investors who serve as the general partners of what are usually limited liability partnerships (LLPs) and invest the money of limited partners such as family trusts, endowments, and other investors who need a high-risk, high-potential-reward asset in their portfolios. 

• Bank loans: less difficult to get if you have an established track record with audited financial statements of at least three fiscal years; otherwise you'll need to provide collateral and possibly co-signers to back your startup loan. Banks want principal and interest payments; you should establish a relationship with a local one for checking, credit card, and a line of credit at a minimum.

• Government grants and subsidies: the US government's Small Business Administration oversees several lending and grant programs that can get you government-backed loans (see SBA "guaranteed loan" and SBIC below). A bank is more likely to approve your loan if it knows the government is essentially a co-signatory. 

Supplemental

Novoa, J. 2017. Understanding differences in startup financing stages

• View - Slides for this Topic

US Small Business Association (SBA.gov): Investment Capital from Small Business Investment Companies (SBICs)

An SBIC is a privately owned company that’s licensed and regulated by the SBA. SBICs invest in small businesses in the form of debt and equity. The SBA doesn’t invest directly into small businesses, but it does provide funding to qualified SBICs with expertise in certain sectors or industries. Those SBICs then use their private funds, along with SBA-guaranteed funding, to invest in small businesses.

SBICs invest in small businesses through debt, equity, or a combination of both (see below). Debt is a loan an SBIC gives to a business, which the business must pay back, along with any interest. Equity is a share of ownership an SBIC gets in a business in exchange for providing funding. Sometimes, an SBIC invests in a business through both debt and equity. Such an investment includes both loans and shares of ownership. A typical SBIC investment is made over a 3-year period.

Debt

A typical SBIC loan ranges from $250,000 to $10 million, with an interest rate between 9% and 16%.

Equity

SBICs will invest in your business in exchange for a share of ownership in your company. Typical investments range from $100,000 to $5 million.

Debt with equity

Financing includes loans and ownership shares. Loan interest rates are typically between 10% and 14%. Investments range from $250,000 to $10 million.

Eligibility

Your business must have at least 51% of its employees and assets in the US. Your business must qualify as a small business according to SBA size standards (usually less than 500 employees). Your business must be in an approved industry (examples that don't qualify include farmland, real estate, and financing). 

To get financing from an SBIC you'll need to do research on the different types of SBICs (e.g., region, size, industry, level of investing activity) to determine if your business fits their investment profile; write a business plan; and try to get a "warm introduction" to an SBIC through your network of friends, accountants, attorneys, etc.

Source: SBA.gov Small Business Funding Programs - Investment Capital accessed June 25, 2020

Resources

US Small Business Association (SBA.gov): Financing Options for Small Businesses (45-minute course). 

This self-paced training exercise is an introduction to financing options for your business. Topics include; determining your financial needs, loans, grants, venture capital, angel investors, crowd funding and other financial options available to small businesses. 

Content

• Course

• Course Transcript

• Worksheets

Y Combinator Resources

1. A Fundraising Survival Guide, Paul Graham
   Techniques for surviving and succeeding at fundraising

2. How To Raise Money, Paul Graham
   Detailed thoughts on fundraising. A must read.

3. The Equity Equation, Paul Graham
   How to decide if you should accept an offer from an investor

4. The Future of Startup Funding, Paul Graham
   How startup funding is evolving

5. How to Convince Investors, Paul Graham
   How to convince investors to invest in you

6. Investor Herd Dynamics, Paul Graham
   How investors think about investing in early stage companies

7. “Venture Deals”, Feld and Mendelson
   Essential elements of a venture deal (book)

8. Raising Money for a Startup, Sal Khan
   Startup Fundraising from Sal Khan

9. Venture Hacks: Debt or Equity, Babak Nivi
   Discussion on debt vs. equity

10. Venture Hacks: First Time, Babak Nivi
    Advice for first time fundraisers.

11. How Much Money To Raise, Fred Wilson
    Advice on how much money to raise.

12. “Startup = Growth”, Paul Graham
    Description of a startup.

13. Venture Hacks / Babk Nivi: Should I Raise Debt or Equity
    Discussion of whether raising debt or equity is the best answer.

14. Fred Wilson: Financing Options
    Another discussion of debt vs. equity

15. Mark Suster on Convertible Debt
    An analysis of problems with convertible debt

16. Clerky Guide
    Clerky docs and guides. A great place to start.

17. Announcing the Safe, Paul Graham
    The simple agreement for future equity. A replacement for convertible notes.

18. The Safe Primer, Carolynn Levy
    Lots of detailed information on the safe and examples as to how it works in various cases.

19. The Handshake Deal Protocol, Paul Graham
    A standard protocol to help ensure that verbal commitments turn into transactions.

PRACTICE

ASSESSMENT - Raise a Friends and Family Round for Autoshop

You have joined the Autoshop team and convinced them not to go in front of an investor audience seeking $1.6M in funding before they run an actual simulation of a weekend's worth of sales near the target mall location. You need to figure out how much money you'll need to run the experiment at a level that will convince you this is a sound business opportunity. You'll read the details in the spreadsheet below and enter answers ONLY into the yellow highlighted fields. When you are done editing the sheet, send your final version to MGT481BAMA@gmail.com.

Mark as Complete