Raising Entrepreneurial Capital

EXAMPLE 3.1 NEW TECH (F): WHERE WILL THE

MONEY COME FROM?

The New Tech case introduced in previous chapters will be used here and in

the next section to illustrate some financing issues covered in Chapters 2 and 3.

THE CHALLENGE:WHERE WILL THE MONEY COME FROM?

How much from:

. Cash flow and other internal sources?

. The bank?

. Risk capital sources?

What They Need to Raise

New Tech now has to consider possible sources of financing. Stuart Chip,

New Tech’s owner, and Elizabeth Smart, his in-house accountant, have a

good handle on how much financing they need—$1,575,000.

Equipment to produce new line (fixed assets) $1,100,000

One-time marketing costs (selling expense) $225,000

Ongoing operations (working capital) $200,000

Financial cushion $50,000

Total financial needs $1,575,000

They feel they have a strong case to present to investors, with a compre-

hensive set of financial forecasts and well-documented assumptions.

Where Will the Money Come From?

Their challenge is to determine how much of the $1,575,000 will be

financed by:

. the company’s internal sources (cash flow from operations, supplier

credit, etc.)

. external conventional financing sources (bank operating line or term

debt), and

. risk capital or unconventional sources (subordinated debt or equity)

Key Tasks

In order to answer these questions, they have got to:

. meet with their bank to determine how much funding they may provide

102 Alternatives in Venture Financing—Early Stage Equity Capital

. examine the company’s own operations for possible internal sources of

funding

. consult with an investment advisor and legal counsel on unconven-

tional, external funding sources

. consider how much they want to fund with debt (borrowing money)

and how much with equity (sale of shares)

THE CHALLENGE:CONVENTIONAL FUNDING

What conventional external and internal sources of funding can New Tech

tap?

The Bank

Stuart and Elizabeth meet with New Tech’s banker, Ted Mooney. He

clearly states that the expansion program contemplated by New Tech is too

risky and that the bank cannot cover the entire financing package. New

Tech’s bank will lend only a very small amount to the company on its

accounts receivable and inventories. Mooney explains that the bank does

not finance high-risk projects.

Mooney tells them that the bank will finance only part of the capital

assets and working capital accounts, but not the marketing costs and the

cushion. The bank would be prepared to provide a loan of $200,000 to

finance part of the cost of the pro duction line (i.e., long-term credit). This

would be a 5-year term loan, with annual payments bearing an annual 10%

interest charge. The bank is also prepared to increase the existing operating

line by $25,000.

Mooney indicates that the company’s track record has not been proven

enough, and he is not convinced of the validity of the information contained

in the forecast. Mooney’s main concern is the lack of experience in managing

a fast-growth business. He emphasizes that Stuart’s prior experience was

managing a division of a larger company.

Internal Sources

Elizabeth’s forecasts indica te that $275,000 will be financed by internal

sources (this would cover the one-time marketing costs and a financial

cushion). Another $200,000 for working capital will be covered by internal

cash flow and supplier credit.

Looking Elsewhere

Elizabeth’s calculations show that internal sources and the amount the

bank is willing to lend will help financ e about half of the required funds.

Alternatives in Venture Financing—Early Stage Equity Capital 103