Utilium

When you have finished studying this module, you will be able to fulfill the following learning objectives:
• List formal and informal sources of capital.
• Compare the benefits and risks of different forms of financing.
• Explain how financing deals are negotiated and structured.
• Discuss the pros and cons of raising money from friends and family.
• Compare the pros and cons of angel investing.
• Explain why an entrepreneur may or may not seek venture capital for a new venture.
• Demonstrate the venture capital method of computing valuations.
• Discuss the pros and cons of bootstrapping.
• Conduct a risk assessment and valuation for a new venture.

This module opens with a video of venture capitalist Christine Comaford-Lynch. What advice does she have for financing new ventures?

Sources of financial capital for new ventures range from venture capital to debt financing (De Clercq, Fried, Lehtonen, and Sapienza, 2006). Although there is much talk in the media about venture capital, the reality is that comparatively few ventures are funded by venture capitalists. Funding through your own savings and debt, from friends and family, and from angels is more common.

Typically, funding proceeds in a series of rounds. At the first stage of financing, entrepreneurs usually invest their own funds and raise funds from friends and family. The next stage usually includes a round of financing from angel investors. After this angel round, the next round might include what is known as a Series A financing, which includes funding from institutional investors, such as venture capitalists.

Examine the following resources to identify the various sources of financing. Can you think of any additional sources?

Further explore three forms of financing. What are the potential advantages and disadvantages of the three forms that you explored?

Consider some of the more creative approaches to financing. Why would an entrepreneur employ these creative approaches rather than seek financing through more traditional channels?

Raising financial capital from friends and family is a common approach for entrepreneurs launching a new venture (Young, 1997). Friends and family are more likely to invest in your venture because of the personal relationship you have established with them over time. These investors are less likely to scrutinize the details of your plan at the same level as a professional investor. Although it is often easier to raise financial capital from friends and family, there are significant risks associated with mixing business and personal relationships.

Assess your attitudes toward friends and family financing. Why or why not would you use this source of capital for your new venture?

What are the potential risks when raising money from friends and family? Are there certain ways to structure friends and family financing to reduce the likelihood that the financing will be a burden on the personal relationship?

An angel investor includes any individual who invests his or her own money in a new venture, typically in return for equity in the venture. Angels range from professionals, such as doctors and lawyers, to successful entrepreneurs who are now seeking to finance one or more new ventures. A typical angel investment is in the $50,000 to $100,000 range.

Use the resources in this section to answer the following questions. What types of investors fit the categories of affiliated and unaffiliated angels?

What are the pros and cons of seeking angels as sources of capital for your new venture?

Consider your network. Who might be an angel investor for your new venture.

Compare and contrast angel investors and venture capitalists as funders.

Distinct from angel investors, venture capitalists (VCs) raise money from outside investors for investment in new, high-growth ventures. With this investment, a VC typically takes an equity position in the new venture, expecting an annual return of 25 to 35% (Zider, 1998). A typical “VC deal” is in the $2-$10 million range.

What is venture capital, and how does it work?

What would be the benefits and risks of using venture capital to fund your entrepreneurial activities?

Use the following resources to answer these questions and to create a tip sheet on how to attract venture capital. What do venture capitalists look for in an entrepreneur? Develop your tip sheet collaboratively with classmates.

Bootstrapping has two meanings. On the one hand, bootstrapping means self-funding a venture and thus limiting or avoiding outside investment. On the other hand, bootstrapping also implies running a venture on a shoestring budget.

What are different ways to self-fund a new venture?

What are the benefits and risks associated with these self-funding approaches?

What are the benefits and risks associated with starting a venture on a limited budget?

Counterintuitively, there may be risks to having too much financial capital. What might these risks include?

Assess your attitude towards bootstrapping. Is this an approach that would work for you in a new venture?

Valuation is an important task at various stages in a new venture’s evolution and is linked closely to financing the venture. Foremost, valuation is necessary to determine the allocation of equity in return for any outside financial equity investments. This valuation will change at each round of financing. Second, as it comes time to execute an exit strategy, such as a sale or initial public offering (IPO) of the venture, valuation is necessary to determine the sale price or IPO offering price.

What are the common valuation approaches? What are the differences between the approaches?

Why would you select one valuation approach over another?

Although you will often hear that entrepreneurs are risk takers, skilled entrepreneurs are actually quite adept at mitigating and managing risk. Risk analysis is an important step in determining the key sources of risk for your venture and the possible actions you can take to mitigate and manage this risk.

What are the primary sources of risk for a new venture?

What are ways to manage these different forms of risk?

Why is it so important to manage risk during the new venture formation process?