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Sources of Equity Financing

  • Personal savings
    • The first place an entrepreneur should look for money
    • The most common source of equity capital for starting a business
    • Outside investors and lenders expect entrepreneurs to put some of their own capital into the business before investing theirs
  • Friends and family members
    • After emptying their own pockets, entrepreneurs should turn to those most likely to invest in the business: friends and family members
    • Be careful! Inherent dangers lurk in family/friendly business deals, especially those that flop.
    • Guidelines for family and friendship financing:
      • Choose your financier carefully
      • Keep the arrangement “strictly business.”
      • Prepare a business plan
      • Settle the details up front
      • Create a written contract
      • Treat the money as “bridge financing.”
      • Develop a payment schedule that suits both parties
      • Have an exit plan
  • Crowd funding
    • Crowdfunding taps the power of social networking and allows entrepreneurs to post their elevator pitches and proposed investment terms on specialized websites and raise money from ordinary people who invest as little as $100
    • Two typesofcrowdfunding
  • Angel investors
    • Wealthy individuals who invest in emerging entrepreneurial companies in exchange for equity (ownership) stakes
    • An excellent source of “patient money” for investors needing relatively small amounts of capital typically ranging from $100,000 (sometimes less) to as much as $5 million
    • Willing to invest in the early stages of a business
    • An estimated 318,000 angels across the U.S. invest $22.5 billion a year in 66,000 small companies
    • Their investments exceed those of venture capital firms, providing more capital to 18 times as many small companies
    • Angels fill a gap in the seed capital market, specifically in the $10,000 to $2 million range
    • Average angel investment = $50,000 in a company that is in the seed or start-up growth stage
    • Typical angel invests in 1 company per year, and the average time to close a deal is 67 days
    • 52% of angels’ investments lose money, but 7% produce a return more than 10 times their original investment
    • Angels can be an excellent source of “patient” money
  • Partners
    • Giving up personal control
    • Diluting ownership
    • Sharing profits
    • “For every penny you get in the door, you have to give something up.”
  • Venture capital companies
    • More than 400 venture capital firms operate across the U.S.
    • Most venture capitalists seek investments in the $5 million to $25 million range
    • Target companies with high-growth and high-profit potential
    • Business plans are subjected to an extremely rigorous review – less than 1% accepted
    • Most often, venture capitalists invest in a company across several stages
    • Only about 2% of venture capital goes to businesses in the start-up or seed phase
    • What do venturecapitalcompanies look for?
      • Competent management
      • Competitive edge
      • Growth industry
      • Viable exit strategy
      • Intangibles factors
    • On average, 96-98% of venture capital goes to:
      • Early stage investments (companies in the early stages of development)
      • Expansion stage investments (companies in the rapid growth phase)
  • Corporate venture capital
    • About 300 large corporations across the globe invest in start-up companies
    • Approximately 14% of all venture capital invested is from corporations
    • Capital infusions are just one benefit; corporate partners may share marketing and technical expertise
  • Public stock sale – “going public”
    • Initial public offering (IPO) – when a company raises capital by selling shares of its stock to the public for the first time
    • Since 2001, the average number of companies making IPOs each year is 134
    • Few companies with less than $25 million in annual sales make IPOs
    • Successful IPO candidates have…
      • Consistently high growth rates
      • Scalability
      • Strong record of earnings
      • 3 to 5 years of audited financial statements that meet or exceed SEC standards
      • Solid position in a rapidly-growing industry: Average company age is 10 years
      • Sound management team with experience and a strong board of directors
    • Advantages of “Going Public”
      • Ability to raise large amounts of capital
      • Improved corporate image
      • Improved access to future financing
      • Attracting and retaining key employees
      • Using stock for acquisitions
      • Listing on a stock exchange
    • Disadvantages of “Going Public”
      • Dilution of founder’s ownership
      • Loss of control
      • Loss of privacy
      • Reporting to the stock exchange
      • Filing expenses
      • Accountability to shareholders
      • Pressure for short-term performance

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