BUSM4716 – Topic 2
The Start-Up Funding Process
Professor Ian Eddie,
VinaCapital Professor of Private Equity
Introduction
• Why start-up companies raise money?
• Sources of funding to start-up a business
• Sources of funding for growth stage of a business
• VC Funding Process
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Start-up Funding Process
VC Series A / B Funding
Rounds
VC Seed Funding Round
Bootstrapping / Angel
Investors / Crowdsourced
Equity Funding/ Debt
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The Objective of Raising Finance
• The business owner’s objective is to source investment
capital at the ‘best possible terms’ to grow the company.
• What are the terms and conditions attached to different
sources of finance?
• The goal for the business owner is to be able to compare
and assess a number of alternative finance proposals
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Key Finance Questions
• How much finance is required?
• What is the financial planning time horizon?
• What is the project cash inflow and outflow over the time horizon?
• What is the contingency allowance for additional finance?
• What cost is associated with each potential source of finance – both
direct and indirect costs?
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Start-up Financing Stages
• Pre-revenue, seed stage funding: capital for creating and developing
new products or services primarily from entrepreneurs own sources
• First revenue, early growth stage funding: Once a company has
products or services on the market it can source alternative finance.
• Revenue growth and accelerator / elevator stage funding:
Companies with revenue track record can attract funding on better
terms and conditions to sustain growth from diverse sources.
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Bootstrapping
• Bootstrapping is the process entrepreneurs use to find funding and
resources to launch their business – it is a mind-set attitude toward
starting a business. (Cornwall, 2009)
• Bootstrap finance comprises the entrepreneur’s own financial
resources plus family, friends, founding employees and service
providers – to ensure cash flow and credit to start-up the business and
finding ways to minimize costs and cash outflows.
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Bootstrapping Finance
• Cash inflows from entrepreneur’s own savings or source income from a
‘second’ job while growing the business
• Cost minimization such as home-based business start-ups to minimize
rent costs – ‘garage business model’.
• Source incubator / activator hub space and low cost corporate identity
providers that minimize costs and maximize profile
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Bootstrapping Employees
• Employees are costly (wages, benefits and taxes) but essential to grow
the business team and set the organizational culture.
• In the start-up phase only employ people with critical founding skills
and outsource all routine tasks.
• Founding employees can be offered stock in the business to minimize
cash flows and incentivize their performance – Employee Stock
Ownership Plan (ESOP).
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Benefits of Bootstrapping
• Entrepreneurs money is invested creating pressure to succeed.
• Focus on lean business start-up and responsive decision making
• Focus on early revenue generation to create positive cash flow
• Maximizes entrepreneurial control of operation in early stage
• Signals to future investors entrepreneurial commitment
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Angel Investors
• Angel investors invest in small startups or entrepreneurs. Often, angel investors are
among an entrepreneur's family and friends. The capital angel investors provide may be
a one-time investment to help the business propel or an ongoing injection of money to
support and carry the company through its difficult early stages.
• Angel investors must meet the Securities Exchange Commission's (SEC) standards
for accredited investors. To become an angel investor, one must have a minimum net
worth of $1 million and an annual income of $200,000.
• Reference: [Link]
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Accredited Investor
• An accredited investor is a person or entity that can deal with securities not registered
with financial authorities by satisfying one of the requirements regarding income, net
worth, asset size, governance status or professional experience. The term is used by
the Securities and Exchange Commission (SEC) under Regulation D to refer to investors
who are financially sophisticated and have a reduced need for the protection provided by
regulatory disclosure filings. Accredited investors include natural individuals, banks,
insurance companies, brokers and trusts.
• Reference: [Link]
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Benefits of Angel Investors
• Focus of angel investing is early stage and seed capital finance.
• Angel investors provide a non-financial benefit by contributing
management and investment skills, knowledge and networks to
support the business growth in exchange for equity instruments in the
company
• Angel investment horizon is normally from 5 – 7 years before exit
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Facebook’s Angel
• Peter Thiel in August 2004 made a US$500,000 angel
investment in Facebook for a 10.2% equity stake and a
board seat and was the first external investor.
• At Facebook’s IPO, PT’s equity in Facebook had been
diluted to 3% but with an IPO valuation of more than
US$100billion, PT had a return of more than 6,000%.
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Crowd Sourced Funding
• Crowd sourced funding has evolved as an innovative way for
entrepreneurs to attract investment funds without diluting ownership.
• Crowd funders are normally provided access to the business products
or services and are often referred to as ‘backers’ not ‘investors’
because there is no financial return offered.
• Entrepreneurs pitch directly to backers on the internet to provide
financial support for their ideas – [Link] and [Link]
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Crowd Sourced Reward Funding
• Entrepreneurs offers crowd funders merchandise, exclusive access,
can’t buy experiences, samples or first use rights for funders providing
donations to the start-up business.
• CSRF does not dilute ownership or control in the business or create a
future debt obligation
• CSRF provides an instant market of consumers to test the product or
service and create viral marketing of the business concept
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Crowd Sourced Debt Funding
• CSDF raises money for entrepreneurs via a loan structure where both
principal and interest are repaid to the lender over the term of the loan.
• The entrepreneur does not dilute equity or loose control and interest
rates paid are usually competitive with other sources of debt finance.
• [Link] [Link] [Link] [Link]
[Link] are websites focused on CSDF
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Crowd Sourced Equity Funding
• CSEF is regulated in most countries because it circumvents the
traditional laws governing prospectus disclosure requirements and
capital raising from public sources.
• [Link] [Link] (USA); [Link] (UK) and
[Link] (Sweden, Norway and Finland) are CSEF websites.
• A risk of CSEF is that it may limit a companies ability to raise future
capital from other sources such as Venture Capital Funds or Angels.
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Venture Capital Finance
• VC finance represents only a small percentage of the total investment
in start-up businesses in any economy and is a sub-set of the much
larger private equity investment market.
• The objective of a VC fund is to build a portfolio of successful
businesses in exchange for an equity interest in the company.
• A group of companies invested in by a VC fund are referred to as the
portfolio companies.
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Structure of a VC Fund
• A VC fund is normally structure as a limited partnership with the
founding partners comprising the board of directors.
• The VC fund may comprise several management layers including non-
director principals and associates responsible for analytics, industry
research and decision support roles.
• An additional structure will include advisers and consultants to bring
expertise, networks and technical skills on an ‘as needed basis’.
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Understanding the VC Fund
• An entrepreneur seeking VC funding needs to conduct due diligence
on the VC funds being targeted.
• In particular the entrepreneur needs to be able to work with the
managing director / partner as well as other principals in the firm.
• The relationship between the entrepreneur and the VC fund is
negotiated in the TERM SHEET.
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VC Fund Management
• A VC principal is managing a fund of investor money and therefore
needs to generate a high rate of return to meet the expectations of the
investors.
• A VC fund priority is earnings growth and the exit strategy to maximize
the ROI for the fund investors.
• VC funds normally specialize in a range of industries and geographic
locations.
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References
• Cornwall, J. (2009). Bootstrapping, Upper Saddle River,
NJ: Prentice Hall.
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