entrepreneurial finance

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New Venture Finance: 

New Venture Finance PACE UNIVERSITY LUBIN SCHOOL OF BUSINESS Department of Management and Management Science Bruce Bachenheimer, Clinical Professor E-mail: [email protected] Phone: (212) 618-6580 Fax: (212) 618-6482 Office: 1 Pace Plaza, W-491

Sources of Start-up Financing: 

Sources of Start-up Financing Internally Generated Funds Organic growth from retained earnings Debt: Asset-based financing Cash flow financing Equity: Inside equity Founders, friends & family Outside equity Angel investor Private equity (PE) Venture capital (VC) Public offering (IPO)

Debt-Based Financing: 

Debt-Based Financing Asset-Based Debt: collateralized by a specific asset (type of asset dictates term and borrowing limit - accounts receivable vs. real estate). Cash Flow Financing: unsecured financing based on the firms ability to generate enough cash to cover the debt.

Debt-Based Financing: 

Debt-Based Financing Five Cs of Bank Lending Character: your experience and reputation Capacity: the firm’s ability to pay interest and principal (cash flow, coverage ratio, etc.) Capital: owner’s equity at risk (debt/equity ratio) Conditions: specific firm, industry, and macro-environmental considerations Collateral: specific assets to ensure principal and interest obligations are met.

Debt-Based Financing: 

Debt-Based Financing Five Questions in Bank Lending: What is your ability to repay the loan? What will the money be used for? How much is needed? How and when will the money be paid back? When is the money needed?

Equity-Based Financing: 

Equity-Based Financing Inside Equity Founder Friends & Family Outside Equity Angels Investors Private Equity Venture Capital Public Offering

Seed Capital Funding: 

Seed Capital Funding Are you willing to share control with others? Will you share confidential information with prospective investors? Do your financial statements accurately reflect the operation? Are you willing to give up a large ownership stake in the company? Can your business deliver an investment return of at least 30%? Is there a clear path to exit the investment within three years? Is the total market size at least $1 billion? Can the business become one of the top three competitors? Have the technology and business strategies been validated? Are you willing to accept additional executives in the business?

Profile of an Angel Investor: 

Profile of an Angel Investor Prefers to invest within one day of travel Typically well educated Tends to invest in a group Range of investment: $10,000 - $1,000,000 Average investment - $10,000 - $250,000 Makes one investment every two years

Venture Capital Investments: 

Venture Capital Investments Management teams with successful track records and experience and skills to succeed $500,000 to $5 million in required capital Unique technology or service where the market is huge Can carve out a significant and sustainable market share against existing market leaders Can produce gross margins greater than 50% Annual revenues of $25 million in 3 years and the possibility to reach at least $50 million in 5 years Only 0.1% of all business investment capital comes from established Institutional Venture Capital funds.

A VC’s Scorecard: 

A VC’s Scorecard Management ability, past successes, and broad experience Product or service uniqueness and attractiveness Size and growth rate of industry and competition Investment value proposition of Company Is the market strategy clearly defined? Are financials audited or ready for audit? Is the capital structure clean and well conceived? Are the margins (gross and net) in line with VC goals? What is the status of the current balance sheet? Is current revenue above $1 million? Is potential revenue growth above $100 million? Are capital needs between $500,000 and $5 million? Is there a clear and viable exit strategy with 5 years? Is the use of proceeds clearly defined and supported? Was management’s presentation impressive?


Valuation Assessing comparable, publicly held companies. Asset-Based Valuations Book Value Adjusted Book Value Replacement Value Liquidation Value Earnings-Based Valuations Historical Earnings Future Earnings (historical, or present and future, resource base) Earnings measure (EBITDA, EAT) and capitalization factor or P-E multiple Discounted Cash Flow (NPV, IRR, WACC, Residual Pricing)

Investors’ Share of Business?: 

Investors’ Share of Business? Estimate the Earnings After Taxes (EAT) in year n Determine an appropriate earnings multiple (P/E) Determine the required rate of return i Determine initial funding needed Valuation = EAT * P/E Future Value = Valuation in year n Present Value = Future Value / (1 + i)n Investors’ share = Initial Investment / Present Value

Investors’ Share - an example: 

Investors’ Share - an example Earning after taxes are projected to be $750,000 in year 5 Similar companies are selling at 6 times their earnings Based on current interest rates and the estimated company risk, the required return is determined to be 16% An initial investment of $250,000 is being sought Inv. Share = 250,000 / (($750,000 * 6)/(1 + .16)5) = 12%

Discounted Cash Flow: 

Discounted Cash Flow WACC = 15% P-E Ratio = 10 Terminal Value = $5,000,000 PV of Future Cash Flows = $4,557,720 NPV of Investment = + 3,557,720 [PV = FV/(1+r)n)] IRR = 68.15% [set initial investment equal to the 5-year stream plus terminal value and solve for r]

Break-Even Analysis: 

Break-Even Analysis Break-Even: the volume of sales needed to at least cover all your costs Fixed Costs: remain the same regardless of your level of sales Variable Costs: increase directly in proportion to the level of sales in dollars or units sold BE(Q) = Break-Even Quantity TFC = Total Fixed Costs SP = Selling Price VC/unit = Variable Costs per unit

Lisa's Bakery: 

Lisa's Bakery fixed costs = $49,000 variable costs per unit = $.30 sales revenue per unit = $1.00 Therefore, after the $.30 per loaf variable costs are covered, each loaf sold can contribute $.70 toward covering fixed costs.

Lisa's Bakery: 

Lisa's Bakery TFC = Total Fixed Costs = $49,000 SP = Selling Price = $1.00 VC/unit = Variable Costs per unit = $0.30 BE(Q) = TFC ÷ (SP - VC/unit) BE(Q) = $49,000 ÷ ($1.00 - $0.30) = 70,000 units

Lisa's Bakery: 

Lisa's Bakery Contribution Margin per Unit = Sales Price per Unit - Variable Costs per Unit = $1.00 - $0.30 = $0.70 Contribution Margin Ratio = Contribution Margin per Unit / Sales Price per Unit = $0.70 / $1.00 = .70 Breakeven Sales Revenue = Fixed Costs / Contribution Margin Ratio = $49,000 / .70 = $70,000 As sales exceed $70,000 (70,000 loaves), Lillian's Bakery earns a profit. Sales of less than 70,000 loaves produce a loss. Lillian's Bakery can see that a 10,000 loaf increase in sales over the breakeven point to 80,000 loaves will produce a $7,000 profit

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