Getting Financing

1
Getting Financing

• Business 3215

2
Answer the Questions

• 1. Explain why most new ventures need to raise
  money at some point during their early life.
• 2. Identify the three sources of personal
  financing available to entrepreneurs.
• 3. Provide examples of how entrepreneurs
  bootstrap to raise money or cut costs.
• 4. Identify the three steps involved in properly
  preparing to raise debt or equity financing.
• 5. Explain the role of an elevator speech in
  attracting financing for a firm.
• 6. Discuss the difference between equity funding
  and debt financing.
• 7. Describe the difference between a business
  angel and a venture capitalist.
• 8. Explain why an initial public offering is an
  important milestone for a firm.
• 9. Discuss the financing sources including,
  Canadian Youth Business Foundation, Northern
  Ontario Heritage Fund, Thunder Bay Ventures, the
  Business Development Bank.
• 10.Explain the advantages of leasing for an
  entrepreneurial firm.

3
Key Terms

• Bootstrapping
• Burn rate
• Business angels
• Venture capital
• Debt financing
• Due diligence
• Elevator speech
• Equity financing
• Final prospectus

• Initial public offering
• Lease
• Love money
• Road show
• Rounds of financing (tranche)
• Sweat equity

4
The Importance of Getting Financing or Funding

• Understanding the Alternatives for Financing or
  Funding
• Few people deal with the process of raising
  investment capital until they need to raise
  capital for their own firm.
• As a result, many entrepreneurs go about raising
  capital haphazardly because they lack experience.
• To be successful in this area, it is important
  for entrepreneurs to understand the role of
  investment capital in the success of a new
  businesses, and the options available to
  entrepreneurial firms for obtaining financing or
  funding.

5
Why Most New Ventures Need Funding
Figure 10.1 Three Reasons Start-Ups Need Funding
6
Sources of Personal Financing(1 of 3)

• Sources of Personal Financing
• Typically, the seed (or initial) money that gets
  a company off the ground comes from the founders
  themselvesfrom their personal savings,
  mortgages, and credit cards.
• All founders contribute sweat equity to their
  ventures, which represents the value of the time
  and effort that a founder puts into a new firm.
• Love Money
• Friends and family are the second source of funds
  for many new ventures. This form of contribution
  is often called love money.

7
Sources of Personal Financing(2 of 3)

• Love Money (continued)
• Love money can consist of outright gifts, loans,
  or investments, but often comes in the form of
  forgone or delayed compensation or reduced or
  free rent.
• Bootstrapping
• Another source of seed money for new ventures is
  bootstrapping.
• Bootstrapping is the use of creativity,
  ingenuity, and any means possible to obtain
  resources other than borrowing money or raising
  capital from traditional sources.

8
Sources of Personal Financing(3 of 3)
There are many ways entrepreneurs bootstrap to
raise money or cut costs. Some of the most
common examples include the following

• Minimizing personal expenses and putting all
  profits back into the
• business
• Avoiding unnecessary expenses, such as lavish
  office space or furniture
• Establishing partnerships and sharing expenses
  with partners
• Leasing equipment rather than buying
• Sharing office space or employees with other
  businesses
• Utilizing the services or a university or
  community incubator
• Buying items cheaply but prudently through
  discount outlets or online
• auctions, such as eBay, rather than at
  full-price stores

9
Preparing to Raise Debt or Equity Financing(1 of
3)
Figure 10.2 Preparation for Debt or Equity
Financing
10
Preparing to Raise Debt or Equity Financing(2 of
3)
Two most common alternatives for raising money
Alternative
Explanation
Equity funding means exchanging partial ownership
in a firm, usually in the form of stock, for
funding. Angel investors, private placement,
venture capital, and initial public offerings are
the most common sources of equity funding.
Equity funding is not a loanthe money that is
received is not paid back. Instead, equity
investors become partial owners of a firm.
Equity funding
Debt financing is getting a loan. The most
common sources of debt financing are commercial
banks and the Small Business Administration
(through its guaranteed loan program).
Debt financing
11
Preparing to Raise Debt or Equity Financing(3 of
3)
Table 10.1 Matching a New Ventures
Characteristics with the Appropriate Form of
Financing or Funding
12
Preparing An Elevator Speech(1 of 2)

• Elevator Speech
• An elevator speech is a brief, carefully
  constructed statement that outlines the merits of
  a business opportunity.
• Why is it called an elevator speech?
• If an entrepreneur stepped into an elevator on
  the 25th floor of a building and found that by a
  stroke of luck a potential investor was in the
  same elevator, the entrepreneur would have the
  time it takes to get from the 25th floor to the
  ground floor to try to get the investor
  interested in his or her opportunity. This type
  of chance encounter with an investor calls for a
  quick pitch of ones business idea. This quick
  pitch has taken on the name elevator speech.
• Most elevator speeches are 45 seconds to two
  minutes long.

13
Preparing an Elevator Speech(2 of 2)
Table 10.2 Guidelines for Preparing an Elevator
Speech
14
The Cash Flow Cycle

• Working Capital Management - General Issues

15
Cash and Net Working Capital

• The cash flow cycle where cash comes fromhow
  it is used to finance the operations of the
  firmand how it is recovered and how it grows
  over time is a crucially-important part of
  understanding how a business functions.

16
Cash and Net Working CapitalActivities that
Increase Cash

• Increasing long-term debt
• Increasing equity
• Increasing current liabilities
• Decreasing current assets other than cash
• Decreasing fixed assets

17
Cash and Net Working CapitalActivities that
Decrease Cash

• Decreasing long-term debt
• Decreasing equity
• Decreasing current liabilities
• Increasing current assets other than cash
• Increasing fixed assets
• Paying dividends

18
Operating Cycle

• Operating cycle is the time period between the
  acquisition of inventory and when cash is
  collected from receivables.

19
Cash Cycle

• Cash cycle is the time between cash disbursement
  and cash collection.

20
Example of Exhaustion of the Liquid Resources of
a New Firm

• A simple example of a 1.0 million equity
  investment in a business levering additional
  financial resources and the need to finance the
  growth of the business leaving it exhausted of
  cash resources.

10 steps to insolvency
21
Cash Flow CycleStart
The entrepreneur opens a current account in the
name of the business.
Step 1
Cash Account Balance 0
22
Cash Flow CycleInitial Equity Investment
The entrepreneur invests 1,000,000 in equity.
Step 2
Balance Sheet Cash 1m Common Stock 1
m _____________________________________ T.
Assets 1m T. Claims 1m
23
Cash Flow CyclePurchase of 500,000 Fixed Assets
The firm purchases fixed assets.
Step 3
Balance Sheet Cash 0.5 F. Assets 0.5 Common
Stock 1 m ___________________________________ T.
Assets 1m T. Claims 1m
24
Cash Flow CycleBuy 300,000 of inventory on
trade credit
The firm purchases 300,000 inventory from
suppliers.
Step 4
Balance Sheet Cash 0.5 A/P 0.3 Inventory 0.3 F.
Assets 0.5 Common Stock 1 m ____________________
_________________ T. Assets 1.3m T. Claims 1.3m
25
Cash Flow CycleFurther Work-in-process plus
finished goods
Value is added to inventory through labour
(300,000) and equipment (100,000).
Step 5
Balance Sheet Cash 0.5 A/P 0.4 Inventory 0.8 Ac
cruals 0.3 F. Assets 0.4 Common Stock 1
m _____________________________________ T.
Assets 1.7m T. Claims 1.7m
26
Cash Flow CyclePayment of initial A/P and
Accruals
Labour and suppliers are paid.
Step 6
Balance Sheet Cash 0.1 A/P 0.1 Inventory 0.8 Ac
cruals 0.2 F. Assets 0.4 Common Stock 1
m _____________________________________ T.
Assets 1.3m T. Claims 1.3m
27
Cash Flow CycleGoods sold on A/R for a profit
Sale of inventory occurs. Accounts receivable
created. Cash resources near exhausted. 30 days
till A/R collected.
Step 7
Balance Sheet Cash 0.1 A/P 0.1 A/R 0.5 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
28
Cash Flow CycleInventory Purchased
Firm purchases 400,000 inventory from suppliers.
Step 8
Balance Sheet Cash 0.1 A/P 0.4 A/R 0.5 Inventor
y 0.8 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.8m T. Claims 1.8m
29
Cash Flow CycleValue Added to W.I.P. Inventory
Value is added to inventory through labour
(300,000) and equipment (100,000).
Step 9
Balance Sheet Cash 0.1 A/P 0.4 A/R 0.5 Invento
ry 1.2 Accruals 0.5 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 2.2m T. Claims 2.2m
30
Cash Flow CycleSuppliers and Employees Paid
Firm pays suppliers and employees.
Step 10
Balance Sheet Cash 0.1 A/P 0.1 A/R 0.5 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
31
Cash Flow CycleCollection on A/R
Step 11
Balance Sheet Cash 0.6 A/P 0.1 A/R 0.0 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ____________________________________ T
. Assets 1.4m T. Claims 1.4m
32
Cash Conversion Cycle

• Cash Conversion Cycle Inventory conversion
  period
• Receivables conversion period -
• Payables deferral period
• Management of the cash cycle can make an
  important difference in the amount of financing
  required, assets employed to generate a given
  level of sales...and therefore, can affect ROA
  and ROE.

33
Cash Flow Time Line
34
Sources of Personal Financing(1 of 3)

• Sources of Personal Financing
• Typically, the seed (or initial) money that gets
  a company off the ground comes from the founders
  themselvesfrom their personal savings,
  mortgages, and credit cards.
• All founders contribute sweat equity to their
  ventures, which represents the value of the time
  and effort that a founder puts into a new firm.
• Love Money
• Friends and family are the second source of funds
  for many new ventures. This form of contribution
  is often called love money.

35
Sources of Personal Financing(2 of 3)

• Love Money (continued)
• Love money can consist of outright gifts, loans,
  or investments, but often comes in the form of
  forgone or delayed compensation or reduced or
  free rent.
• Bootstrapping
• Another source of seed money for new ventures is
  bootstrapping.
• Bootstrapping is the use of creativity,
  ingenuity, and any means possible to obtain
  resources other than borrowing money or raising
  capital from traditional sources.

36
Sources of Personal Financing(3 of 3)
There are many ways entrepreneurs bootstrap to
raise money or cut costs. Some of the most
common examples include the following

• Minimizing personal expenses and putting all
  profits back into the
• business
• Avoiding unnecessary expenses, such as lavish
  office space or furniture
• Establishing partnerships and sharing expenses
  with partners
• Leasing equipment rather than buying
• Sharing office space or employees with other
  businesses
• Utilizing the services or a university or
  community incubator
• Buying items cheaply but prudently through
  discount outlets or online
• auctions, such as eBay, rather than at
  full-price stores

37
Preparing to Raise Debt or Equity Financing(1 of
3)
Figure 10.2 Preparation for Debt or Equity
Financing
38
Preparing to Raise Debt or Equity Financing(2 of
3)
Two most common alternatives for raising money
Alternative
Explanation
Equity funding means exchanging partial ownership
in a firm, usually in the form of stock, for
funding. Angel investors, private placement,
venture capital, and initial public offerings are
the most common sources of equity funding.
Equity funding is not a loanthe money that is
received is not paid back. Instead, equity
investors become partial owners of a firm.
Equity funding
Debt financing is getting a loan. The most
common sources of debt financing are commercial
banks and the Small Business Administration
(through its guaranteed loan program).
Debt financing
39
Preparing to Raise Debt or Equity Financing(3 of
3)
Table 10.1 Matching a New Ventures
Characteristics with the Appropriate Form of
Financing or Funding
40
Sources of Equity Funding
Venture Capital
Business Angels
Initial Public Offerings
41
Business Angels(1 of 2)

• Business Angels
• Are individuals who invest their personal capital
  directly in start-ups.
• The prototypical business angel is about 50 years
  old, has high income and wealth, is well
  educated, has succeeded as an entrepreneur, and
  is interested in the startup process.
• The number of angel investors in the U.S. has
  increased dramatically over the past decade.

42
Business Angels(2 of 2)

• Business Angels (continued)
• Business angels are valuable because of their
  willingness to make relatively small investments.
  
• This gives access to equity funding to a start-up
  that needs just 50,000 rather than the 1
  million minimum investment that most venture
  capitalists require.
• Business angels are difficult to find. Most
  angels remain fairly anonymous and are matched up
  with entrepreneurs through referrals.

43
Venture Capital(1 of 4)

• Venture Capital
• Is money that is invested by venture-capital
  firms in start-ups and small businesses with
  exceptional growth potential.
• There are about 650 venture-capital firms in the
  U.S. that provide funding to about 3,000 to 4,000
  firms per year.
• Venture-capital firms are limited partnerships of
  money managers who raise money in funds to
  invest in start-ups and growing firms. The
  funds, or pool of money, are raised from wealthy
  individuals, pension plans, university
  endowments, foreign investors, and similar
  sources. A typical fund is 75 million to 200
  million and invests in 20 to 30 companies over a
  three- to five-year period.

44
Venture Capital(2 of 4)

• Venture Capital (continued)
• The investment preferences of venture-capitalist
  are fairly narrow.
• For example, in 2002, 20 of all venture-capital
  investments were in the software industry.
  Telecommunications, networking, computers and
  peripherals, semiconductors, medical devices, and
  biotechnology are other industries attracting
  funding from venture capitalists.
• Many entrepreneurs get discouraged when they are
  repeatedly rejected for venture capital funding,
  even though they may have an excellent business
  plan.
• Venture capitalists are looking for the home
  run and so reject the majority of the proposals
  they consider.

45
Venture Capital(3 of 4)

• Venture Capital (continued)
• An important part of obtaining venture-capital
  funding is going through the due diligence
  process, which refers to the process of
  investigating the merits of a potential venture
  and verifying the key claims made in the business
  plan.
• Venture capitalists invest money in start-ups in
  stages, meaning that not all the money that is
  invested is disbursed at the same time.
• Some venture capitalists also specialize in
  certain stages of funding.
• For example, some venture capital firm specialize
  in seed funding while others specialize in
  first-stage or second-stage funding.

46
Venture Capital(4 of 4)
Table 10.3 Stages (or Rounds) of Venture-Capital
Funding
47
Initial Public Offering(1 of 3)

• Initial Public Offering
• An initial public offering (IPO) is a companys
  first sale of stock to the public. When a stock
  goes public, its stock is traded on one of the
  major stock exchanges.
• Most entrepreneurial firms that go public trade
  on the NASDAQ, which is weighted heavily toward
  technology, biotech, and small-company stocks.
• An IPO is an important milestone for a firm.
  Typically, a firm is not able to go public until
  it has demonstrated that it is viable and has a
  bright future.

48
Initial Public Offering(2 of 3)
Four reasons that motivate firms to go public
Reason 1
Reason 4
Reason 3
Reason 2
An IPO raises a firms public profile, making it
easier to attract high-quality customers,
alliance partners, and employees
An IPO is a liquidity event that provides a means
for a company shareholders (including its
investors) to cash out their investments
Is a way to raise equity capital to fund current
and future operations
By going public, a firm creates another form of
currency that can be used to grow the company
49
Initial Public Offering(3 of 3)

• Initial Public Offering (continued)
• Although there are many advantages to going
  public, it is a complicated and expensive
  process.
• The first step in initiating a public offering is
  to hire an investment bank. An investment bank
  is an institution, such as Credit Suisse First
  Boston, that acts as an advocate and adviser and
  walks a firm through the process of going public.
  
• As part of this process, the investment bank
  typically takes the firms top management team
  wanting to go public on a road show, which is a
  whirlwind tour that consists of meetings in key
  cities where the firm presents its business plan
  to groups of investors (in an effort to drum up
  interest in the IPO).

50
Sources of Debt Financing
Chartered Banks and other deposit-taking
financial institutions
Government-supported lending programs and agencies
51
Chartered Banks

• Banks
• Historically, chartered banks have not been
  viewed as practical sources of financing for
  start-up firms.
• This sentiment is not a knock against banks it
  is just that banks are risk adverse, and
  financing start-ups is a risky business.
• As shown in Table 10.1 (on a previous slide),
  banks are interested in firms that have a strong
  cash flow, low leverage, audited financials, good
  management, and a healthy balance sheet.
• Although many new ventures have good management,
  few have the other characteristics, at least
  initially.

52
Government-supported Loan Programs and Lending
Agencies

• Canadian Youth Business Foundation
• Northern Ontario Heritage Fund
• Business Development Bank
• FedNor (Industry Canada)
• Small Business Loans Act
• Thunder Bay Ventures (Community Futures)
• PARO (Community Futures)
• Nishnawbe Aski Development Fund Youth Business
  Fund (Community Futures)
• Aboriginal Financial Institutions
• Small Business Canada - advice

53
Creative Sources of Financing or Funding
Leasing
Strategic Partners
University-Business Innovation Research Grants
54
Leasing(Slide 1 of 2)

• Leasing
• A lease is a written agreement in which the owner
  of a piece of property allows an individual or
  business to use the property for a specified
  period of time in exchange for payments.
• The major advantage of leasing is that it enables
  a company to acquire the use of assets with very
  little or no down payment.
• The two most common types of leases that new
  ventures enter into are leases for facilities and
  leases for equipment.
• For example, many new businesses lease computers
  from Dell. The advantage for the new business is
  that it can gain access to the computers it needs
  with very little money invested up front.

55
Leasing(Slide 2 of 2)

• Leasing (continued)
• Most leases involve a modest down payment and
  monthly payments during the duration of the
  lease.
• At the end of an equipment lease, the new venture
  typically has the option to stop using the
  equipment, purchase it for fair market value, or
  renew the lease.
• Leasing is almost always more expensive than
  paying cash for an item, so most entrepreneurs
  think of leasing as an alternative to equity or
  debt financing.

56
Strategic Partners

• Strategic Partners
• Strategic partners are another source of capital
  for new ventures.
• Biotechnology, for example, relies heavily on
  partners for financial support. Biotech firms,
  which are typically small, often partner with
  larger drug companies to conduct clinical trials
  and bring products to market.
• Alliances also help firms round out their
  business models and conserve resources.
• As we discussed in Chapter 5, Dell can focus on
  its core competency of assembling computers
  because it has assembled a network of strategic
  partners that provides it critical support.

57
Review Question 10 - 1

• What are the three most common reasons most new
  firms need to raise money in their early life?
• Answer
• Cash flow challenges, capital investments, and
  lengthy product development cycles.

58
Review Question 10 - 2

• What is meant by the term burn rate? What are
  the consequences of experiencing a negative burn
  rate for a prolonged period of time?
• Answer
• A companys burn rate is the rate at which it is
  spending its capital until it reaches
  profitability. Although a negative cash flow is
  sometimes justified early in a firms lifeto
  build plant and equipment, train employees, and
  establish a brandit can cause severe
  complications.
• A firm usually fails if it burns through all of
  its capital before it becomes profitable.

59
Review Question 10 - 3

• What is meant by sweat equity?
• Answer
• Sweat equity represents the value and time that
  the founders of a firm put into their firm, prior
  to the time that actual equity (or money) is
  involved.

60
Review Question 10 - 4

• To what extent do entrepreneurs rely on their
  personal funds and funds from friends and
  families to finance their ventures? What
  different forms do funds from friends and family
  take?
• Answer
• Friends and family are a common source of funds
  for many new ventures. This form of contribution
  is often called love money, which can consist
  of outright gifts, loans, or investments, but
  often comes in the form of forgone or delayed
  compensation or reduced or free rent.

61
Review Question 10 - 5

• What is bootstrapping? Provide several examples
  of how entrepreneurs bootstrap to raise money or
  cut costs. In your judgment, how important is
  the art of bootstrapping for an entrepreneurial
  firm?
• Answer
• An important source of seed money for many new
  ventures is referred to as bootstrapping.
• Bootstrapping is the use of creativity,
  ingenuity, and any means possible to obtain
  resources other than borrowing money or raising
  capital from traditional sources.
• Most people will say that the art of
  bootstrapping is very important for
  entrepreneurial firms. Because its hard for new
  firms to get financing or funding early on, many
  entrepreneurs bootstrap out of necessity. As a
  result, a firm may never get off the ground
  unless its founders are good at bootstrapping.

62
Review Question 10 - 6

• Describe the three steps involved in properly
  preparing to raise debt or equity financing.
• Answer
• The three steps involved in property preparing to
  raise debt or equity financing are as follows
• Step 1 Determine precisely how much money is
  needed.
• Step 2 Determine the type of financing or
  funding that is the most appropriate.
• Step 3 Develop a strategy for engaging potential
  investors or bankers.

63
Review Question 10 - 7

• Briefly describe the difference between equity
  funding and debt financing.
• Answer
• Equity funding means exchanging partial
  ownership in a firm, usually in the form of
  stock, for funding.
• Debt financing is getting a loan.

64
Review Question 10 - 8

• Describe the most common sources of equity
  funding.
• Answer
• The most common sources of equity funding include
  angel investors, private placement, venture
  capital, and initial public offerings.

65
Review Question 10 - 9

• Describe the most common sources of debt
  financing.
• Answer
• The most common sources of debt financing are
  chartered banks and other deposit-taking
  financial institutions (sometimes credit unions)
• The Business Development Bank
• Other government agencies such as Export
  Development Canada, FedNor, Thunder Bay Ventures.

66
Review Question 10 - 10

• What is the purpose of an elevator speech? Why
  is the preparation of an elevator speech one of
  the first things an entrepreneur should do in the
  process of raising money?
• Answer
• An elevator speech is a brief, carefully
  constructed statement that outlines the merits of
  a business opportunity.
• There are many occasions when a carefully
  constructed elevator speech might come in handy.
  For example, many university-sponsored centers
  for entrepreneurship hold events that bring
  investors and entrepreneurs together. Often,
  these events include social hours and refreshment
  breaks designed specifically for the purpose of
  allowing entrepreneurs looking for funding to
  mingle with potential investors.
• Having an elevator speech prepared equips an
  entrepreneur to be ready to quickly explain his
  or her business idea to a potential investor.

67
Review Question 10 - 11

• Why is it so important to get a personal
  introduction before approaching a potential
  investor or banker?
• Answer
• Bankers and investors receive many business
  plans, and most of them end up in a pile in their
  offices. As a result, to have your business plan
  noticed, it is necessary to find someone who
  knows the banker or the investor and ask for an
  introduction.

68
Review Question 10 - 12

• Describe the three steps required to effectively
  engage potential investors or bankers.
• Answer
• The three steps required to effectively engage a
  potential investor or a banker are as follows
• Step 1 Prepare an elevator speech.
• Step 2 Identify and contact the best prospects
  (preferably with an introduction).
• Step 3 Be prepared to provide the investor or
  banker a completed business plan
• and make a presentation of the plan
  if requested.

69
Review Question 10 - 13

• Identify the three most common forms of equity
  funding.
• The most common sources of equity funding are
  private investment, business angels, venture
  capital, private placement, and initial public
  offering.

70
Review Question 10 - 14

• Describe the nature of business angel funding.
  What types of people typically become business
  angels, and what is the unique role that business
  angels play in the process of funding
  entrepreneurial firms?
• Answer
• Business angels are individuals who invest their
  personal capital directly in start-ups.
• The prototypical business angel is about 50
  years old, has high income and wealth, is well
  educated, has succeeded as an entrepreneur, and
  is interested in the startup process.
• These investors typically invest between 25,000
  and 150,000 in a single company. The number of
  angels in Canada has increased dramatically over
  the past decade. Business angels are valuable
  because of their willingness to make relatively
  small investments. This gives access to equity
  funding to a start-up that needs just 50,000
  rather than the 1 million minimum investment
  that most venture capitalists require.

71
Review Question 10 - 15

• Describe what is meant by venture capital.
  Where do venture capital firms get their money?
  What types of firms do venture capitalists
  commonly want to fund? Why?
• Answer
• Venture capital is money that is invested by
  venture-capital firms in start-ups and small
  businesses with exceptional growth potential.
  Venture-capital firms are limited partnerships of
  money managers who raise money in funds to
  invest in startups and growing firms. The funds,
  or pools of money, are raised from wealthy
  individuals, pension plans, university
  endowments, foreign investors, and similar
  sources. The investment preferences of venture
  capitalists are fairly narrow. For example, in
  2002, 20 of all venture-capital investments were
  in the software industry. Telecommunications,
  networking, computers and peripherals,
  semiconductors, medical devices, and
  biotechnology are other industries attracting
  funding from venture capitalists.

72
Review Question 10 - 16

• Describe the purpose of an initial public
  offering. Why is an initial public offering
  considered to be an important milestone for an
  entrepreneurial firm?
• Answer
• An initial public offering (IPO) is the first
  sale of stock by a firm to the public. When a
  company goes public, its stock is typically
  traded on one of the major stock exchanges.
• An IPO is an important milestone for a firm.
  Typically, a firm is not able to go public until
  it has demonstrated that it is viable and has a
  bright future.

73
Application Question 10 - 1

• Write a 60-second elevator speech for
  PrintDreams, which is the You Be the VC 1
  feature at the end of the chapter.
• Answer
• Lets here some of your speeches.

74
Application Question 10 - 2

• Doug Malone is a computer programmer at
  Activision, a maker of electronic games. In a
  year or so, Doug plans to leave Activision to
  launch his own firm. A colleague of Dougs
  recently asked him, Where do you plan to get the
  money to fund your new venture? Doug replied, I
  really dont think Ill need to raise any money.
  I have 35,000 in the bank, and think I can fund
  the startup and growth of the firm myself. Do
  you think Doug is being realistic? If not, what
  steps will Doug have to take to properly fund his
  firm?
• Answer
• Doug is not being realistic. According to
  figures cited in the chapter, it takes about two
  years and 4 million to develop an electronic
  game. In regard to funding the growth of the
  firm itself, in time, Doug may be able to do
  that. However, most entrepreneurs need
  investment funds to help launch their firms, to
  cope with cash flow challenges, make capital
  investments, and deal with lengthy product
  development cycles.

75
Application Question 10 - 3

• Tina Russell is in the early stages of launching
  a new firm and has been attending seminars to get
  information about funding. Several of the
  seminars have had business angels and venture
  capitalists on the program. Tina has casually
  spoken with several of these individuals, but has
  only made small talk. A friend of Tina suggested
  that she develop an elevator speech to use when
  she runs into potential investors. If Tina asked
  you, What in the world is an elevator speech,
  and why would I need one? What would you tell
  her?
• Answer
• An elevator speech is a brief, carefully
  constructed statement that outlines the merits of
  a business opportunity. There are many occasions
  when a carefully constructed elevator speech
  might come in handy.
• For example, in the seminars that Tina has been
  attending, if one of the investors she casually
  spoke to had asked her for more information about
  her venture, Tina would have been better prepared
  to give a short and persuasive answer if she had
  prepared an elevator speech in advance.

76
Application Question 10 - 4

• John Baker is in the midst of starting a computer
  hardware firm, and thinks he has identified a
  real problem that his company will be able to
  solve. He has put together a management team and
  has invested 250,000 of his own money in the
  project. John feels that time is of the essence,
  and has decided to go after venture capital
  funding. How should he go about it?
• Answer
• There are three steps that John should take, in
  regard to developing a strategy to appeal to
  venture capitalists
• Step 1 Prepare an elevator speech.
• Step 2 Identify the venture funds that are
  interested in the industry that John is
  participating in, and try to arrange an
  introduction to one or more of the venture firms.
• Step 3 Prepare a business plan and be ready to
  present the business plan to a venture capital
  firm or another group of investors.

77
Application Question 10 - 7

• YouTube (www.youtube) is a Web site that allows
  users to upload, view, and share video clips. In
  the short time since it was founded (February
  2005), it has become one of the most popular
  sites on the Internet, and now streams more than
  100 million videos per day. As of mid-2006,
  YouTube had obtained more than 11.5 million in
  venture capital funding. Many observers are
  skeptical that YouTube has a viable business
  model and wonder if the VCs involved got caught
  up in the hype surrounding YouTubes rapid
  success.
• Study YouTube and describe the companys business
  model. Do you think the venture capitalists that
  funded YouTube made prudent investments? How does
  Googles late decision to acquire YouTube
  influence your judgment about the venture
  capitalists investments? Explain your answers.

78
Application Question 10 7

• Answer
• The secret behind YouTube is that the company was
  able to generate huge traffic, and has become
  somewhat of a cult phenomenon.
• The idea behind YouTubes business model is that
  while its advertising is fairly limited today,
  the possibility of integrating advertising
  directly into videos is a significant
  opportunity.
• For example, one potential approach is to display
  ads that match what people are talking about in a
  video. So, if two people were discussing a
  particular kind of car (or driving a particular
  kind of car), an ad for the car could appear at
  the bottom of the screen. Viewers could then
  click on the ad, at their discretion, which would
  pause the video and show a short commercial for
  the car.
• Google bought YouTube to develop and capitalize
  on this type of potential.

79
Case 10.1 - Zazzle

• DISCUSSION QUESTION 1
• So what do you think? Do you think Kleiner
  Perkins and Sherpalo Ventures made a wise
  decision investing 16 million in Zazzle? Three
  years from now, do you think that Zazzle will
  have disappointed or dazzled its investors? Why?
• Answer
• . The VCs apparently think that Zazzles
  business model is scaleable, meaning that sales
  will quickly grow, and that as more sales are
  spread out over the same technological
  infrastructure, profits will rise. They may also
  feel that Zazzle is a platform for the sale of
  customized on-demand products, and that t-shirts,
  stamps, and posters are only the start. On the
  con side, its hard to image that Zazzle will
  create as much interest as the VCs project. With
  all due respect to John Doerr, he is the VC who
  said that Segway would be the fastest company in
  American history to reach 1 billion in sales
  (see the What Went Wrong feature in Chapter 1).
  Segway has never gained traction, and may not
  survive. In addition, although Zazzle says that
  it has proprietary technology, its hard to
  believe that what theyre doing cant be fairly
  easily copied. Look at the Web site of Café
  Press, one of Zazzles main competitors. Its
  hard to see what Zazzle can do that Café Press
  cant match. It also seems like Zazzles cut of
  the revenues generated by the freelance artists
  that post material on its site is very generous.
  An artist gets only a 10 percent royalty (17
  percent if the sale is made through a referral).
  That means that Zazzle keeps 83 to 90 percent of
  the sale. By comparison, although eBays fee
  schedule is complex, in general, it charges .25
  to 80 per listing and two to eight percent of
  the final price. That means that compared to
  eBay, Zazzle keeps approximately 90 percent of
  the profits of the sellers that list items on its
  site, while eBay returns more than 90 percent of
  the profits. It makes one wonder how sustainable
  Zazzles business model is.

80
Case 10.1 Zazzle

• DISCUSSION QUESTION 2
• Look at Table 10.1 in the chapter. At the time
  that Zazzle raised venture capital funding, to
  what extent did it resemble the ideal candidate
  for venture-capital funding as stipulated by the
  materials in the table?
• Answer
• It isnt clear from the chart that Zazzle was a
  candidate for venture capital funding. Zazzles
  ability to print shirts and posters on-demand
  is unique, but the idea of printing logos and
  images on apparel products is hundreds of years
  old. Its not clear whether Zazzle will
  experience high growth. To fully appreciate what
  this means, contrast Zazzle with Nektar
  Therapeutics, the company featured in Case 9.1.
  Nektar solves a real problemit will permit Type
  2 diabetics to receive insulin through an inhaler
  (similar to the type that asthma patient use)
  instead of through needles and syringes. Its
  almost a sure bet that Nektar (whose product will
  be distributed by Pfizer) has high growth
  potential. Is Zazzle an equally sure bet? Zazzle
  market niche is also not clearly defined.
  Finally, in regard to proven management, Zazzles
  lead entrepreneurs, Bobby and Jeff Beaver, are to
  be admired for what they have accomplished, but
  they have no previous business experience. The
  Beavers father, who is involved with the firm,
  is a serial entrepreneur, and apparently has
  substantial experience.

81
Case 10.1 Zazzle

• DISCUSSION QUESTION 3
• Evaluate Jason Balls (the blogger) criticism of
  Kleiner Perkins investment in Zazzle. Do you
  think Ball makes some good points, or do you
  think his arguments are off-base? Explain your
  answer.
• Answer
• It does seem like the criticism has merit. The
  basic point that Ball makes is that 16 million
  seems like a lot for a company that is unproven,
  and he questions whether Zazzle will deliver
  value to people by allowing them to print
  on-demand t-shirts and similar items. Recall
  from Chapter 1 that value means utility or worth.
  Ball is having a hard time equating Zazzles
  value with the size of the investment. Ask your
  students what they think.

82
Case 10.2 Zazzle

• DISCUSSION QUESTION 4
• What do you think is Zazzles exit strategy? How
  will Kleiner Perkins and Sherpalo Ventures recoup
  their investment?
• Answer
• The two possible exit strategies are to be
  acquired or to go public. If either of these
  options becomes a reality, Kleiner Perkins and
  Sherpalo Ventures will recoup their investment by
  liquidating their Zazzle stock. The more
  realistic of the options is to be acquired. Ask
  your students who a likely acquirer might be.