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FINANCIAL BACKING FOR ENTREPRENEURS.
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Discusses how entrepreneurs find capital sources.... More...
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Paper Abstract:
Discusses how entrepreneurs find capital sources. The business plan as a capital-generating product. Available sources of capital. Need for an entrepreneur to redo business concepts of a plan in order to obtain financing. Profiles of two leading entrepreneurs: Bill Gates, of Microsoft, and Michael Dell, of Dell Computers. 1 Table. Many quotations.
Paper Introduction:
HOW ENTREPRENEURS RECEIVE FINANCIAL BACKING
Introduction
Grover (1998) writing in Forbes points out that in 1984, 63% of “The Forbes Four Hundred” richest Americans were first-generation entrepreneurs. Last year [1997] that number was 72%. Nearly three in four of those that are extremely wealthy got that way by investing in themselves. According to the National Federation of Independent Business, more than 4 million people every year decide to start their own businesses. Not many of these business owners get superrich but many get very rich. In the process of owning, running and investing in their businesses most of them have experiences that they would never get working for others (Grover 146).
One of the most written-about topics concerning entreprene
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1, 1998) 63-66.Fisher, Daniel. Accordingto the National Federation of Independent Business, more than 4 millionpeople every year decide to start their own businesses. Even if a founder is ultimately demoted as the company grows, he or she can still get rich because the value of the stock will far outweigh the value of any forgone salary (Zider 1 8). SECOND STAGE These funds are required to augment the working capital of a businessthat is successful and expanding at a greater rate than it is generatingits own working capital. (Feb. However, when he was 13 (in 1968) he did write his first computerprogram. Start up funding allows thecompany to function on a bare bones basis. Investors expect these funds tobe used to get an office, hire some employees, and, in general, concentrateon putting the company into a position of relative stability. In addition, Gates was shy,awkward, nervous, stuttered and had little sense of clothes. "Go ahead: Buy the dream." Forbes Magazine. Part 3: Anything for Money? * No prescribed disclosure requirements, no limit on the number of purchasers, and no investor sophistication standards. At this level, banks and institutions sometimesenter the picture, as the risk is substantially reduced, and they know thatthe new money will be used to maintain the momentum of the company. In the process ofowning, running and investing in their businesses most of them haveexperiences that they would never get working for others (Grover 146). Historically, these ventures have createdapproximately hundreds of thousands of jobs and spend more than $5 billionon research and development annually (Long 23). Part 1 willanalyze the business plan as a capital-generating product. (July 1, 1997) 98-1 4."Something old, something new." The Economist,254. Offerings that are exempt under Rule 5 4 are relatively simple toprepare, which reduces cost and delay and can generally be underwritten bythe offering company (the securities being sold by the company's ownofficers, directors and employees). RULE 5 4 * Allows the company to raise a maximum of $1 million, less the total dollar amount of securities sold during the preceding 12 month period, under Rule 5 4, Rule 5 5 or Section 3 of the act. July 6, 1997) 3D.Matthews, Peter. The process of planning forces the entrepreneur to look at the futureoperations of the business and anticipate what is likely to happen. One of the most written-about topics concerning entrepreneurship is 1)finding where the money is to capitalize an entrepreneurial venture, and 2)how to obtain the money. Working from his dorm room, Dell built computers from cheapsurplus parts made to his customer's specifications. (May 3 , 1996) 3 ."Michael Dell Profile." Biography. Rule 5 4 is the most commonly used Regulation D exemption. "[Research has] examined how venture capitalists evaluateentrepreneurs' business plans and their negotiation processes, almost noresearchers have investigated entrepreneurs' and investors' relationshipsafter a venture has been funded" (Cable and Shane 144). Today his business model is almost identical to his first idea. Everybusiness is involved in the tasks of making decisions and recording theresults of business activities. Part 1: The Business Plan as Capital Tool There is little doubt that crafting a business plan so that it thoroughly and candidly addresses the ingredients of success -- people, opportunity, context, and the risk/reward picture -- is vitally important. In the absence of a crystal ball, in fact, a business plan built of the right information and analysis can only be called indispensable (Sahlman 99). Loan Usage State whether the loan will be used for working capital, bridge financing or so on. START-UP FUNDING This refers to capital that is used to bring the various aspects ofthe potential business together, such as the $5 , loaned by Gates'smother to buy the needed software program. Entrepreneurial Snapshot Two: Michael Dell (This is the edited profile that appeared on "Biography," called themost accurately researched shows on cable TV) In 1984, 19-year-old University of Texas freshman Michael Dell decidedto eliminate the middle man, and sell custom-made computers directly tocustomers. It is apparent from the research presented that there is moneyavailable for venture financing, if the entrepreneur is able to understandthe rules and play by them. A&E. It is not a way to separate unsuspecting investors from their money by hiding the fatal flaw. company. 2 .Marlowe, Gene. 11, 1998) 1 6 - 112. In this analysis, we will discuss the following topics. Corporate and academic training provides many of the technological and business skills necessary for the task while venture capital contributes both the financing and an economic reward structure well beyond what corporations or universities afford. "Banks traditionally are skittish about lending to entrepreneurs: Start-up companies are forced to obtain initial capital from personal savings or loans from family and friends. FIRST STAGE FINANCING These funds (typically equity) are used to enable the company toinitiate full scale operations with manufacturing, marketing, and sales.This capital is usually provided to businesses that have spent theirinitial funds and still have a 'strong' story and probably a number of hardorders. You will besurprised how much easier the plan is after the first time and after arevision or two, just how much you know about your business. Operating without a plan breaks the continuousprocess shown above and as a result you manage by reacting to events ratherthan by anticipating and planning for how to maximize events. Failing with the banks, the entrepreneurcan then turn to the Small Business Administration for a guaranteed loan.(However, the entrepreneur must first show evidence of having been turneddown by banks.) Therefore, the entrepreneur must turn to the realm of "OPM" or otherpeople's money ("Something Old" 12). Is that why they succeeded? SEED CAPITAL This money is loaned for research and development. Zider, 1998, presents a challenging inside look at venture capitalfrom the risk point of view of the VC. In the absence of a crystal ball, in fact, a business plan built of the right information and analysis can only be called indispensable (Sahlman 98). There are accepted formats for business plans, and the standardoutline goes something like this. (Dec. Purpose of the Plan This is a brief statement of why the plan was written, i.e., performance tool, request for financing (including type and amount). Those who lack new ideas, funds, skills, or tolerance for risk to start something alone may be quite willing to be hired into a well-funded and supported venture. Thisprocess better prepares one for the future, or what actually happens, andmakes the entrepreneur more knowledgeable about your business. With great bravado, Gates contacted themanufacturer and said he and his partner could provide a version of BASICfor the Altair. "The Many Lives of a Wall Street Angel." Fast Company. Without a plan there is no meaningful wayto evaluate results, thus future actions are not based on a revised planbut rather revised guessing. He didn't make ituntil his sophomore year. 2 .Long, Mark. 142-177.Dorsey, David. Keep in mind when reading thesesections that the key to achieving each one is a thorough business plan.However, with these plans, the entrepreneur's financials are moremeaningful, since they are based on reality, rather than just serving as anexample of how proficient the entrepreneur is with spreadsheet programs(Evanson and Beroff 72). GOING PUBLIC This is the most expensive capital there is, since the company notonly has to lay out sizable fees (registering its securities with theappropriate authorities, hiring an underwriter, negotiating the aftermarket support) and also has to completely make full disclosure, on acontinuing basis, of all material facts regarding the operations of thebusiness. Ofcourse, they had to race back to Seattle and try to solve the problem ofquickly developing such a software. The venture capitalmarket is divided into certain kinds of funding, and it is absolutelyessential that the entrepreneur understand what these divisions are, andhow they relate to the business plan (Matthews 3 ). The process requires many hours ofassistance by attorneys and accountants, and the SEC review can last from2 to 6 days. (Nov. Planning is a continuous process in business management. Below is the typicalhierarchy of funding, starting from the most basic. THIRD STAGE or MEZZANINE FINANCING These funds are usually slated for big capital expenditures such asbuilding new plants, entering new markets, develop new products, and arealways limited to companies that are break-even or profitable. In Sahlman's view, there are five reasons why an entrepreneur needs anexcellent business plan.1) The thinking involved in answering the questions posed will force theentrepreneur to take a thorough look at your whole business rather thanfocusing on an individual piece of it.2) The completed plan can serve as a feasibility study to help evaluate anew business idea or the continued success of an existing business.3) The completed plan will be a tool to help the entrepreneur moresuccessfully manage the business operations.4) The completed plan will help communicate the business ideas to personsoutside the business and can be a starting point for constructing afinancial proposal.5) Businesses managed from a plan rather than by "the seat-of-the-pants"are more successful. Venture capital-backed start-ups are an importantsource of innovation and technological development and serve as a majorsource of new wealth creation in the United States (Long 14). The process of developing a business plan helps youto anticipate the future and make well-informed decisions because you havethought about alternatives you will be facing. Talk to most budding entrepreneurs andthey are nervous about "getting screwed over" and losing the business thatthey have set up ("Entrepreneurs" 14). In 1982,the SEC adopted Regulation D, which set forth objectives and rules forexemptions from federal registration. (June 15, 1998). 1, 1997). Part 2: Sources of Venture Capital Marlowe (1997) is one of many writers to emphasize that entrepreneurslooking to shake "the money tree" must typically turn to the traditionsources of personal savings, and/or family and friends, since even with asolid business plan and a great idea, banks are typically risk-averse andtend to deny venture financing. REGULATION D OFFERINGS As suggested by the above statements, registration documents includedetailed disclosure, historical financial statements, and third partyaudits that take time to assemble. This side of the coin is seldomexplored, and in the article he presents a table, (Table 1, below) whichshows the stretch and range of a typical VC portfolio. His mother, anxious to get her investment back, knew several people atIBM and Gates and Allen flew to New York, met with five men from IBM, andexplained that their company was going to specialize in software, so therewould be no competition. It is moneytargeted at developing and documenting the business plan, for the creationof prototypes, bench models or other pre-business expenses. Although Fortune 5 companies have shed 5 million jobs in the past 2 years, the overall economy has added almost 3 million. With great luck, they found a computernerd who had developed a program called "Down and Dirty Disc OperatingSystem" which they bought for $5 , (borrowed from mother again) andrenamed the software Microsoft Dos. Capital from Venture Capitalists, Investment Bankers, Private Investors, and Other Sources. However, first stage funderstypically want a longer piece of the action and demand more equity, and arenot as interested in seeing an exit strategy built into the plan. A plan should be revised as needed; but at least once a year. But there is little doubt that crafting a business plan so that it thoroughly and candidly addresses the ingredients of success -- people, opportunity, context, and the risk/reward picture -- is vitally important. Likewise, business planning is aconsistent activity in any business. "Earning curve: entrepreneurship programs at universities nationwide have capital- hungry business owners heading back to school." Entrepreneur Magazine. Objectives can include sales, production, profit margin, market share and/or penetration. 12.Zider, Bob. Aspreviously mentioned, planning is a continuous process. For in the final analysis, the only one being fooled is the entrepreneur (Sahlman 1 ). The European. The two got the contract, and moved to New Mexico wherethey filed a DBA as Micro-Soft. While still in high school, Gates and Allen formed a companycalled Traf-O-Data which analyzed city traffic data. Minneapolis Star Tribune. Cable and Shane (1997) discuss the fact that the importance of thesecompanies on the economy has led to a large body of literature that seeksto deal with the relationship of the entrepreneur-venture capitalistrelationships. It is fitting to start off this section with another quote bySahlman. Entrepreneurial Snapshot One: Bill Gates (This is the edited profile that appeared on "Biography," called themost accurately researched shows on cable television). 26, 2 ). Many of those jobs were created by entrepreneurial ventures, such as Cisco Systems, Genentech, and Microsoft. "Startup City." Forbes Magazine (Oct. Type of Business In this section is found the company name, brief statements about your business structure (i.e., sole proprietorship, partnership, LLC, Sub S); the industry (retail, service, agriculture, etc.) in which it will operate; the product/service being offered; and whether it is a start- up, expansion, or the purchase of an operating business. Further, the company must maintain certain minimum requirementsin order to keep its 'public' status. Not many of thesebusiness owners get superrich but many get very rich. Andsince he started the company with $2, of his own savings, he didn't haveto approach venture capitalists for First Stage funding -- they approachedhim. Research suggests that venture capital-backed IPOs have accounted forone third of the market value of all initial public offerings in the UnitedStates each year (Lacy 23). Each of theseparts will be separated by profiles of two leading entrepreneurs -- BillGates, founder of Microsoft, and Michael Dell, founder of Dell Computers. (Nov. Dorsey (1998) writing extensively about the nature ofventure capitalists points out that "More great corporations will be formedin the next decade than have been formed in any previous 1 -year span. (An accredited investor is any one investor with a certain net worth and or experience in the purchase of stocks.) * The company can determine the sophistication of its investorswith a questionnaire subscription agreement.) * Very specific disclosure rules, generally related to the size of the offering. Introduction/Summary This states the facts of the business, and should also summarize the more important points of the plan. Online at http://www.biography.com.Sahlman, William A. Previously in this paper, in thesection on business planning, the statement was made that it is importantto mention both the "type" and amount of financing. Table 1: Typical breakout of VC portfolio performance per $1, |Item |Bad |Alive |Okay |Good |Great |Total || | | | | | | ||$ invested |2 |4 |2 |1 |1 |1, ; || | | | | | | ||Payout year |5 | |1x |5x |1 x |2 x || | | | | | | ||Gross Return | |4 |1, |1, |2, |4,4 ; || | | | | | | ||Net Return |(2 ) | |8 |9 |1,9 |3,4 ; || | | | | | | | He comments on this sample spread thusly: For all these reasons, venture capital is an attractive deal for entrepreneurs. 1, 1998) 23 ."Entrepreneurs: Envy versus enterprise." The Economist,352. Nearly three in four of those thatare extremely wealthy got that way by investing in themselves. (July 1, 1999) 14.Evanson, David R., Art Beroff. Each of those companies started with a business plan. Curiously, however, Sahlman, who has taught the preparation ofbusiness plans at Harvard for several years, is vague about one aspect ofrisk/reward. Works Cited"Bill Gates Profile." Biography. Online at http://www.biography.com.Cable, Daniel M., Scott Shane. Such situations do happen, but they tend to be the exception ratherthan the rule. These provisions are broad andinclude civil and criminal penalties for the misstatement or omission offacts that are relevant to making a fully informed investment decision. He then explained that they had a program thatcould work on any computer, called DOS (for Disc Operating System). This is why many entrepreneurs turn to a Reg D offering. The purpose of this was to makeraising money more efficient and cost effective for entrepreneurs.Offerings that are exempt under Rules 5 4, 5 5 and 5 6 have become the mostcommon cost and time saving methods for small and growing businesses toraise capital from private investors. There is no knowing for sure. A plan must demonstrate mastery of the entire entrepreneurial process, from identification of opportunity to harvest. Part 3 will analyze towhat extent an entrepreneur must be willing to redo business conceptsinherent in a plan, in order to obtain the needed financing. Specifically, how much is an entrepreneur willing to give upin return for the money he seeks? * A business can raise only $5 , by the sale of securities to persons residing in the states of Montana and Alaska, which have no disclosure laws applicable to the offering. Seattle, WA: Made Ez Products. New York: Adams Media Corporation. A&E. Inthis transitional period...entirely new pockets of wealth will be generated-- in record time -- by virtue of three revolutionary forces: an increasingreliance on the Internet for industry and commerce; the death of inflationand the dawn of price stability; and the astounding growth potential of newventure fundings" (Dorsey 23 ). Although thesefunds aren't usuallyvery large they are the most difficult to get. Venture Capital Made Easy. The two men had nobusiness plan, were unable to predict what kind of market there was fortheir product (since they didn't have a product) and both men were collegedropouts, finding academia a bit too boring. Planning is appropriate for any organization that wants to approachthe future with a strategy for action. RULE 5 5 Highlights of this include: * Offerings may not exceed $5 million, less the total dollar amount of securities sold during the preceding 12 month period under Rule 5 4, Rule 5 5 or Section 3 of the act. 19, 1998) 1 8-112.Grover, Mary Beth. Given the sometimes difficult task, however,of raising money, the entrepreneur is well advised to think through his orher business very clearly, and always keep in mind that a business plan isnothing more than a plan of action. Business Objectives This section is best illustrated by using one sentence "bullets" that start with the word "to" that itemize what the entrepreneur wishes to accomplish in the first year (start-ups) or the next two years: These statements should be measurable and within clear time frames. The major attraction, to the investors, at this stage is that therehas been some positive operational information generated and based on thisthe investment seems more reasonable. Last year [1997] that number was 72%. The future comes whether you areprepared for it or not. Some well-known examplesof these ventures include America Online, Apple Computer, Oracle, Intel,Federal Express, Lotus Development, Compaq, Digital Equipment Corporation,and Microsoft (Fisher 1 9). Ownership This includes a list of the owners, their percent of ownership, and a brief statement of their experience in the business. Studies show that failure rates among new businesses which are basedon a business plan are significantly lower than for new businesses withouta plan. HOW ENTREPRENEURS RECEIVE FINANCIAL BACKING Introduction Grover (1998) writing in Forbes points out that in 1984, 63% of "TheForbes Four Hundred" richest Americans were first-generation entrepreneurs. Funded at less than$6 , the company made a profit in the neighborhood of $2, . When Bill Gates and his partner Paul Allen started Microsoft, it wasdoomed, according to entrepreneurial theorists. Sahman (1997) emphasizes that honesty and efficiency are the keys tosuccess for any business plan. Part 2 willdiscern what sources of capital are available for the entrepreneur once hehas a business plan for an entreprenurial venture. * Number of nonaccredited investors is 35 but there are no investor sophistication stipulations. Almost facing bankruptcy, Gates and Allenmoved back to Seattle and took a loan from Gates' mother. "Beta Group, How Venture Capital Works." Harvard Business Review. "Venture forth for a boost to your business: acquiring venture capital. THE OTHER SIDE OF REG D OFFERINGS The exemptions from registration provided by Regulation D do notinclude exemptions from the anti-fraud or civil liability provisions of anyof the federal or state securities laws. "A Prisoner's Dilemma approach to entrepreneur-venture capitalist relationships." Academy of Management Review 22 (Jan. FOURTH STAGE or BRIDGE FINANCING These funds are used to provide interim financing for a company thatis preparing to go "public" or is in the final phases of planning a"private placement." The business plan for this funding can become quitecomplex, since it could involve restructuring the company's capitalstructure and the issue of various types and categories of securities. "How to Write a Great Business Plan." Harvard Business Review. This is the earliest andhighest risk investment that can be made. 146-152.Lacy, Harold R. We live today in the golden age of entrepreneurship. RULE 5 6 The highlights of this include: * No dollar amount cap on the offering * No limit on the number of accredited investors, but the number of nonaccredited investors may not exceed 35 investors. In December 1974, the two friends saw a Popular Mechanics magazinethat was featuring the new Altair 88 , a "build-it-yourself" kit thatcould be built for $397. Start upfunding is usually a combination of debt and equity.
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