Topic 9-FINANCING THE NEW VENTURE(Ui TM) (1)

FINANCING THE NEW VENTURE

Module for Principles of Entrepreneurship (ENT 530)BBA, Faculty of Business Management, UiTM

Fauziah Pawan, Sept 2012 (ENT 530)

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MODULE FOCUSThis module will focus on: Introducing the key sources of finance for a new own business venture

Introducing the financing needs at different business development phases

Introducing debt and equity financing implications for a new own venture


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FINANCING THE OWN NEW VENTURE The discussion in this module focuses on the challenges and options that an own business entrepreneur faces in financing a new venture

and growing it to full growth

The discussion encompasses key sources of finance and how these sources feature at different stages of business development financing.

Forming a background to the discussion is how the different forms of funds impact on the debt or equity profile of the business


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DEBT & EQUITY FINANCING In financing a new venture creation and growing the new business, an entrepreneur can tap into two key financing approaches namely debt financing and equity financing

Equity financing primarily involves funds (cash or asset) from parties who expect to take some form of ownership stake in the new venture to represent the extend of their contribution.

Parties who extend equity financing expect to earn yearly dividends from business profits as well as the possibility of a handsome return on investment upon selling back the shares after a period of business growth


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DEBT & EQUITY FINANCING…CONT.

Debt financing involves the business owners taking on borrowings that have to be paid back over a period of time with additional charges (interest or administrative fee)

Qualifying for the borrowings often requires some form of collateral (e.g. land, buildings) or surety to protect the financier in case of non-payment.


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IMPLICATIONS OF DEBT & EQUITY FINANCING Equity financing from parties other than the founding entrepreneur(s) can dilute the entrepreneur’s control over business direction and strategic decisions as well as return on equity.

On the other hand, debt financing allows the entrepreneur more control of the business but puts a strain on the business to consistently pay on the borrowings or face legal action that can hamper business credibility & growth and even lead to foreclosure or bankruptcy.


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IMPLICATIONS OF DEBT & EQUITY FINANCING…CONT.

A good financing package for a new business normally starts with equity financing that needs to be supplemented with debt financing as the business grows

The entrepreneur who is able to attract debt as well as equity financing can take advantage of how the outside financing reflects confidence in the business potential

On the other hand, failure to balance between debt and equity financing can expose the business to either too much borrowings (debt heavy) or risk of losing too much control over the business (equity loss)


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SOURCES OF FINANCE

Financing for a new own business can come from both internal and external sources

In this module, the key sources of financing discussed are: Personal funds Family & friends Angel financing Bank Term Loans Venture capital financing Government loans & grants Bootstrap financing


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ENTREPRENEUR OWN FUNDS All new ventures start with an initial capital contribution by the entrepreneur(s)

The entrepreneur’s own contribution or personal funds is regarded as equity financing that is reflected in the ownership of the business

Most new ventures however need more capital to operate than what the entrepreneur is able to commit or make available.


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FUNDS FROM FAMILY & FRIENDS It is not uncommon for a new entrepreneur to rely on family and friends to raise more initial capital for a business start-up

The contribution from family and friends are often limited but is more easily obtainable at the early stages of business start-up because : They know the entrepreneur and They want to support his undertaking especially when they think the business has growth potential.

Friends and family capital contribution is likely to be in the form of equity financing that gives them ownership in the business


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Business Angels Business angels or angel investors are normally wealthy or high net worth individuals who provide capital for a business start-up in return for equity in the business

Most angel investors are successful entrepreneurs and retired executives that want to get involved in helping small start-ups succeed by offering private financing and sometimes, valuable expertise & experience as well. They are well educated and often in their 40’s or 50’s and look for investments across a broad range of businesses that offer high growth potential

Angels assume high risks by providing capital at very early stages of business start-up and normally look for a 30-40% desired return on investment (ROI) or 5-7 times ROI

Angels also have to have patience in realizing their ROI since on average an angle investor looks to wait at least 5 years before cashing in.


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BUSINESS ANGEL…CONT. Angel investments are noted as filling a gap in between the often limited funds from family & friends and the more difficult to obtain venture capital funds or bank term loans that are deterred by the newness or smallness of early stage ventures.

Business angels invest their funds and sometimes organize themselves into groups or networks to share information & contacts (e.g. Virtuous Investment Circle & Netrove Asia Sdn.Bhd.)

Angels seek out investment potentials through informal contacts, referrals (e.g. Capital – a Malaysian angel investment introducer company) and investment conferences & seminars (e.g. the Asian Business Angel Forum, a regional gathering of angel investors).


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Venture Capital Financing

Venture capital can be broadly regarded as a pool of equity capital that come from different individuals or groups of individuals who want to invest in high growth businesses for high returns

Unlike angel investors that invest their own funds, venture capitalists are professional managers investing money from a pool of funds (equity capital pool) parked under registered venture capital companies


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VENTURE CAPITAL FINANCING…CONT. While venture capital funds are found in a diverse range of business sectors they do tend to focus on high potential, innovation & technology-centered businesses such as ICT development business and biotechnology companies.

Venture capital prefer to invest at early stage to full growth & expansion stage of business growth

The amount of capital available for investment can start at RM 1 million for early growth financing and extend to RM20 million at later stages of growth financing


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VENTURE CAPITAL FINANCING…CONT. The venture capitalist look to providing managerial and technical expertise alongside the capital investment

In July 2012,the Securities Commission noted that Malaysia has 60 registered venture capital companies

Venture capital companies are both private entities (e.g. Teak Capital, Mayban Venture Capital Company Sdn.Bhd) as well as government investment agencies (e.g. Malaysian Venture Capital Management Bhd or Mavcap, Mavcap Biotech, Mavcap ICT)

The total venture capital investment in Malaysia as of February 2012 stands at RM5.4 billion with 54% of the investments coming from government venture capital agencies


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Bank Term Loans Commercial banks offer an important source of financing primarily in the form of term loans (short & long-term loans)

Bank term loans are a form of debt financing that requires the business to repay the loan in progressive (usually monthly) payments with additional interest or administration fees over a stipulated period of time

Banks are generally cautious about approving loans particularly to new ventures because of the high risk of non-payment of monthly payments

Once the business has progressed to a more stable stage with definite financial records to show repayment capabilities, banks will be a more viable source of finance.


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BANK TERM LOANS…CONT. Entrepreneurs wanting to access bank loans need to have some sort of tangible collateral or surety (guarantor)

Collateral can be in the form of: assets of the business (e.g. land, equipment, business premise or building)

entrepreneur’s personal assets ( own house, landed property)

guarantor assets

In case of non-payment of any loans, the bank holds the right to forfeit the collateral to cover outstanding amounts

©Fauziah Pawan, Sept 2012 (ENT 530)

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Government loans & grants Government offers financial assistance in the form of loans & grants at all level of business development

Government assistance is meant to supplement other sources of financing and not in anyway compete or take over the primary role played by the other sources discussed earlier.

Government financial assistance serve more an economic or social development purpose than a profitable return on investment objective.

For that reason, financing from government sources normally incur a comparatively lower interest rate or fee (for loans) or are in the form of one-time cash payouts with no repayment necessary (grants)


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GOVERNMENT LOANS & GRANTS…CONT. Government financial assistance are primarily channeled through public agencies established to serve specific purposes or sectors

For instance, Cradle Fund Sdn Bhd (Cradle) is an agency under the Ministry of Finance responsible to manage a RM100 million fund dedicated to funding innovation & technology commercialization towards building a strong pool of technology ventures in the country


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GOVERNMENT LOANS & GRANTS…CONT. Government also tap into the wide spread distribution network and easy accessibility of established financial institutions like commercial banks to manage and distribute specific financial assistance.

For example, government special loan schemes like the ‘Skim Usahawan Siswazah (SUS)’ for graduate entrepreneurs or ‘Skim PROSPER’ for entrepreneurs in the retail service sector through commercial banks like Maybank, CIMB Bank & Affin Bank.

Apart from loans and grants, government financial assistance also extends into venture capital funds (through Mavcap) as well as various guarantee schemes (through the Credit Guarantee Corporation Malaysia Bhd. or CGC)


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Bootstrap financing Bootstrap financing is an internal financing approach that is derived from conserving cash in the business operations by utilizing various facilities offered by suppliers & vendors

Bootstrapping is particularly important at the start-up & early stages of the business when debt financing is difficult to qualify for and too much equity financing can erode entrepreneur control over the business

This form of financing requires the entrepreneur to: understand what facilities are available and be able to convince the various supplier & financing parties to extend the facility.

A key element in convincing & accessing the financing facilities is through a well prepared financial plan that highlight the business cash flow planning & potential to meet financing requirements.


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BOOTSTRAP FINANCING…CONT.Some of the common facilities include: Trade credit

Obtain goods from suppliers and only pay in 30, 60 or 90 days hence allowing the business to trade with the goods without expanding valuable cash upfront

Supplier discounts Saving cash by taking advantage of discounts given for buying in large amounts (bulk purchase), buying promotion items and for being a frequent buyer

Consignment financing Facility to make an order for goods required over a period of time but only receive and pay for what is delivered as it is needed over that period. Can obtain bulk purchase price but save cost on storage and paying up front


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TABLE 1: SUMMARY OF SOURCES OF FINANCINGSources of Financing

Description Category

Personal Funds

Entrepreneur(s) own contribution in cash or assets.

Internal equity financing

Family & Friends

Contribution by individuals who know the founding entrepreneur and invest mainly because of their relationship with the entrepreneur

Internal equity financing

Business Angels

Wealthy individuals who invest their own funds in businesses that are not yet attractive to conventional bank financing but display attractive prospects for growth and significant success

External debt financing with equity participation

Venture Capital

Capital investments made by professional fund managers from an equity pool lodged with a registered venture capital company. VC investments are repaid when the VC exits the business with a healthy profit at the end of the specified time.

External debt financing with equity participation


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TABLE 1: SUMMARY OF SOURCES OF FINANCING…CONT.Sources of Financing

Description Category

Bank Loans

Time-based borrowings that need to be repaid with interest or administrative fees. Often involves having collateral or sureties.

External debt financing

Government Financing Schemes

Developmental loans and grants. Loans have to be repaid with or without interest or administrative fees. Grants are one-time cash payouts that do not need to be repaid.

External debt financing or outright payout

Bootstrap Financing

Financing that comes in the form of internal savings and conserving cash through supplier discounts and deals

Internal financing in the form of savings & cash conservation


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BUSINESS DEVELOPMENT PHASES While financing can come from several sources, at each phase of business development different sources feature more prominently than another

In this course, the focus will be financing for the following business phases: Pre-startup & start-up Early growth Full growth & expansion

The financing source at each phase of development is often influenced by the relative balance between risk and potential return on investment at a particular phase


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START-UP PHASES FINANCING The pre start-up phase is just before the business is officially launched and funds are needed to create the business entity (e.g. register the business, apply for licenses & permits) and prepare basic resources (e.g. rent or purchase business premises, hire & train staff , procure raw materials)

The start-up phase is the point of time when the business formally opens its doors for business & begins operations

The start-up phase requires funds to jump start the business operations including managing initial marketing & production process

The pre start-up and start-up phases are normally periods of high expenditures, low sales, if any and no profits. This make this early stages of new venture birth very risky for not only the founding entrepreneur but more so for outside investors.


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START-UP PHASES & FINANCING…CONT. Financing at these phases are categorized as seed financing & start-up or 1st level financial respectively

The main source of seed and start-up financing is primarily from the entrepreneurs own funds and supplemented with funds from family & friends

In some cases, new ventures may be able to attract angel investments but this more likely at the start-up stage and only after the founding entrepreneur and/or family and friends have put in the initial investments as a show of commitment to the business potential.

Government financing assistance will feature consistently throughout the different stages of growth while bootstrap financing will start to play an important role from the start-up phase onwards.


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EARLY GROWTH FINANCING This is the phase where marketing efforts are intensified to produce sales that can at least cover costs

Financing at this stage is referred to as 2nd level financing and it is the first point where total strangers are likely consider financing or investing in the business

A key 2nd level financing source is the business angel

Angel investors are valuable at this stage not only for the funds but also for the business expertise and contacts & credibility their involvement offers to the new venture

Venture capital financing may come in at this point but are likely to focus on high growth potential technology ventures where VC funds and management involvement can do much to tap into the technology venture first mover advantages.


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FULL GROWTH & EXPANSION FINANCING At this stage, the business is poised to take off and is showing profits from established operations and growing market acceptance.

With a much better capability to service loan payments from growing sales & profits, the entrepreneur may now go for 3rd level financing primarily in the form of bank term loans

Debt financing through bank loans will allow the entrepreneur to finance growth without having to sacrifice anymore control in the business through equity financing


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Business Angels Financing

Own, Family & Friends Funds

Government Financing Schemes (loan, grants & govt. venture capital funds)

Banks Term Loans

Venture Capital Financing

START-UP EARLY GROWTH FULL GROWTH &EXPANSION

Seed financing

Start-up or 1st level

financing

2nd level financing 3rd level financing

Fig. 1: Summary of Sources & Stages of Financing for New Venture

PRE-STARTUP


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Bootstrap Financing

Adapted from ENT600 Teaching Slides, FBM, UiTM, 2009

REFERENCES Hisrich, Robert D., Peters, Michael P. & Shepherd, D., (2006). Entrepreneurship, New York: McGraw-Hill / Irwin, 7th Edition, International Edition, 2006.

Entrepreneurship Dept., Faculty of Business Management, (2009), Teaching Notes for Technology Entrepreneurship (ENT 600).

UiTM Entrepreneurship Study Group (MEDEC), (2004). Fundamentals of Entrepreneurship, Petaling Jaya: Pearson-Prentice Hall Sdn. Bhd. 2004

http://www.malaysia.gov.my, Loans, Special Grants & Guarantees

http://www.mavcap.com

http://biz.thestar.com, Malaysia Venture Capital Industry Poised to Bounce Back

http://www.sc.com.my/eng/htlm.../RVCC.pdf, Securities Commission 2012 List of Registered VC Companies in Malaysia

http://www.cradle.com.my


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http://www.malaysia.gov.my/

http://www.mavcap.com/

http://biz.thestar.com/

http://www.sc.com.my/eng/htlm.../RVCC.pdf

Topic 9-FINANCING THE NEW VENTURE(Ui TM) (1)

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