week 7 discussion

Purpose

Scaling a venture and ensuring its sustainability requires strategic thinking, financial planning, and collaboration. In this discussion, you will revisit the collaborative brainstorming process introduced in Unit 3 as part of the design thinking methodology. By returning to a collaborative space, you will refine your scaling, sustainability, and funding strategies, addressing pain points and leveraging constructive feedback from peers. This process reinforces the iterative nature of design thinking, helping you push through challenges and strengthen your plans for long-term growth and resilience.

Task

This discussion focuses on applying design thinking principles to collaboratively refine your scaling, sustainability, and financial strategies. Building on your work in earlier discussions, you will share key components of your strategies and receive constructive feedback to address challenges and improve your approach.

In your initial post, address the following:

Refer to your Innovation Concept assignments and describe the organization, the idea, and the user group it serves.
Share one key component of your scaling strategy.
Share one key component of your sustainability plan.
Describe one funding strategy you are considering and explain why it aligns with your goals.
Identify one specific challenge you foresee in implementing these strategies and ask for peer feedback or suggestions to address it.

Financing the entrepreneurial
venture

OBJECTIVES

After studying this primer you will be able to:

• Recognize the ‘how, what and when’ of financing an entrepreneurial business: e.g., how to

raise capital, what the funding sources are, when it is most suitable to use each of the

financial sources, how to maximize value in a growing venture, how to forecast financial

performance and cash flow.

• Identify the various financial resources available for entrepreneurial activities and evaluate

their relevance to the business by recognizing their pros and cons for the different stages

of the business.

• Understand the flow in entrepreneurial businesses: i.e., assembling resources, combining

them to build a resource platform that will yield distinctive capabilities, assessing their

longterm and sustainable availability to the business.

• List the business’s needs for the purpose of choosing the best-suited financial resources,

and distinguish between needs for initial financing and venture growth capital.

• Recognize the role of networking for the most valuable financial information and for

locating the relevant, available financial resources.

• Recognize the major processes in managing the business’s financial operations.

• Understand the role of factoring for immediate cash funding while experiencing long

billing cycles that put a strain on cash flow, and understand the actions of factoring.

• Distinguish the key competitive issues facing the entrepreneurial business while buying

and selling a business, including research, due diligence and pricing.

Financing Primer

FINANCING THE ENTREPRENEURIAL VENTURE

THE HOW, WHAT AND WHEN OF FINANCING THE VENTURE

Financing is an important input for every business, especially in its first stages: it enables smooth
running of the daily and long-term operations, as well as asset acquisitions, expert recruitment,
and the development of marketing and distribution channels. In the early stages, businesses are
typically constrained in terms of liquidity, and most entrepreneurs are continually concerned
about their finances, as their businesses are typically not yet profitable. Entrepreneurs in the first
stages of these emerging ventures cover their fear of the demanding capital-raising marathon by
presenting often exciting but sometimes unrealistic business plans to potential investors.
Entrepreneurs therefore need to develop skills that are relevant to financing their ventures.

Some of the initial and basic questions faced by entrepreneurs include: how to raise capital
for the new venture; what the pros and cons are of each of the sources of capital, as well as their
availability and reliability; how to maximize the value in a growing venture in terms of valuation,
structuring investments in the entrepreneurial setting, investment staging; how to forecast
financial performance and cash flow. Entrepreneurs should be well acquainted with the art of
negotiation, and need well-established knowledge on using and managing financial modeling,
working capital, fixed versus variable costs, and cash flow versus accounting, among other
things. Most entrepreneurs, however, are either not experienced or lack the relevant knowledge
to manage their financial or potential financial sources, and they may end up choosing unsuitable
sources of financing, managing incongruous negotiation processes with investors and banks, or
disregarding some critical techniques and tools that may assist them in raising money for their
ventures.

Capital is an umbrella term for the critical and valuable assets for the business such as human,
social and financial capital. Financial capital is defined as an economic asset consisting of personal
and general funds. Personal funds include an entrepreneur’s personal savings, financial assistance
from family and friends, or bank loans based on personal guarantees, whereas general funds
consist of seed funding from a developmental agency, government loans and grants, or funds
from business angels or venture capital firms. Existing research shows that entrepreneurs tend
to rely on personal sources of finance both at the startup stage and as the principal source of
initial capital in the following stages of the business (Sullivan 1991; Kelly and Hay 1996; Mason
and Harrison 1997; Gompers and Lerner 2001;Wang and Sim 2001;Hindle and Lee
2002;Wright,Pruthi and Lockett 2005; De Clercq et al. 2006;Villalonga and Amit 2006; Mason
2009).

One major problem with choosing unsuitable financial sources has to do with risk:
entrepreneurs must understand that any decision they consider has an inherent level of associated
risk. Some of the risks that they face are not unique to entrepreneurial markets but others may
be, particularly those concerning issues such as penetration costs of products and potential
returns, potential buyers, promotional programs, billing, pricing, IT systems, and so on.
Avoiding or mitigating exposure to risks is impossible; however, they may be offset by
acknowledging diverse financing strategies. Moreover, entrepreneurs’ inexperience sometimes
causes them to overemphasize short-term expenses or immediate costs: for example,
entrepreneurs that are renting or buying a plant for their business may take into account only the
rental costs and ignore additional, indirect or attached costs (local and municipal taxes and other

FINANCING THE ENTREPRENEURIAL VENTURE

expenses). In such a case, the financial analysis will be lacking and consequently, their choice of
types of financial sources may be unrealistic (Bruno and Tyebjee 1985; Schwienbacher 2007).

In order to turn risks into opportunities and needs into strengths, entrepreneurs need to be
able to estimate the firm’s financial needs. Two main factors are essential to this estimation: (1)
the net cost of the investments in the long term and (2) the assets in the short term.

Moreover, entrepreneurs should be able to conduct benchmarking research on the costs and
expected expenses, using information from colleagues, suppliers and printed materials.
Validating the financial analysis, as well as enriching it by including a variety of different items –
even those that might be considered marginal or irrelevant may assist in matching financial
sources to the firm’s needs. However, some financial terms need to be understood prior to

searching for financial sources: n Return on investment (ROI). The entrepreneur invests capital in a
particular combination of assets, from which the company generates sales. Those sales cover the
costs of operation and hopefully, will produce a profit.

The return, i.e., the profit from an investment, is divided by the cost of the investment; the
result is dependent upon what is included as returns and costs, and it may vary across
entrepreneurial businesses (Lusch, Harvey and Speier 1998). It is expressed in the following
versatile and simple ratio:

Internal rate of return (IRR). This measure is commonly referred to in the venture capital industry,
and includes a concurrent assessment of actual cash flow (see example in Table 12.1) and
the value of unrealized investments held in a fund portfolio. A fund’s IRR is sometimes
measured after the fund has finally been wound up and no unrealized investments remain.
If the risks are equal, investments with higher IRRs pay better when comparing the net
expected returns over the useful life of a project being reviewed by management to the
funds spent on that decision (or project) (Cohan and Unger 2006).

Assets. Assets are subdivided into current and long-term assets to reflect the ease of liquidating

each asset. From a finance perspective, these assets are the revenue generators.

Current assets. Any assets that can be easily converted into cash within one calendar year (e.g.,

cash money-market accounts, accounts receivable, funds parked in near-term instruments
earning interest, funds tied up in inventory and notes receivable that are due within one
year’s time).

FINANCING THE ENTREPRENEURIAL VENTURE

Table 12.1 The cash flow statement

Jan. Feb. Mar. Apr. May. Jun. Jul. Aug. Sep. Oct. Nov. Dec.

Source of funds

Beginning cash

Sales/income

Sale of assets

Customer deposits

Loans

Contributed capital

Available cash

Salaries

Other operating
expenses

Loan payments

Capital expenditures

Tax payments

Total cash out Net

cash flow

Fixed assets. The long-term base of the business’s operation (e.g., equipment, machinery,
vehicles, facilities, IT infrastructure and long-term contracts), all of which the firm has
invested in to conduct business (George 2005).

Cost of capital. This is the true cost of securing the funds that the business uses to pay for its asset

base. Ando, Hancock and Sawchuk (1997), for example, used the before-tax rate of return
on capital, adjusted for inflation, to estimate the cost of capital; Jog (1997) computed the
weighted average costs of debt and equity on an after-tax basis for 714 Canadian firms
grouped into twenty-two industrial sectors. This ‘financial cost of capital’ constitutes only
part of the ‘user cost of capital’, the latter being a broader and more economically complete
concept.

Weighted average (between debt and equity) cost of capital (WACC). The firm’s true annual cost for
obtaining and holding on to the combination of debt and equity that pays for the fixed asset base.

Risks. Two basic approaches in risk and risk control are accepted in the entrepreneurial realm;

both refer to how the capital market can affect the firm and how the firm can control its
potential risks in this context. One is the principal agent approach, referring to the use of
comprehensive contracts, and the other, the incomplete contract approach, which deals

FINANCING THE ENTREPRENEURIAL VENTURE

with active involvement in venture management (Hart 1995). Entrepreneurs must always
decide whether the risk premium of additional potential return is commensurate with the
additional risk costs that come with choosing that investment project (Jensen and Meckling
1976; Bourgeois and Eisenhardt 1998; Harvey and Lusch 1995; St-Pierre and Bahri 2006).
Due diligence may help in managing potential risks (see example in Table 12.2).

Table 12.2 Due diligence: main topics

Topic Examples

Organization The business’s minute book, including all minutes and resolutions of
and good shareholders and directors, executive committees, and other governing groups
standing The business’s organizational chart

The business’s list of shareholders and number of shares held by each
Financial Audited financial statements for the past three years, together with auditors’
information reports

The most recent unaudited statements, with comparable statements from the
prior year
Auditors’ letters and replies for the past five years
Any projections, capital budgets and strategic plans

Physical A schedule of fixed assets and their locations
assets A schedule of sales and purchases of major capital equipment during the last

three years
Real estate A schedule of the business’s locations

Copies of all real-estate leases, deeds, mortgages, title policies, surveys, zoning

approvals, variances or use

permits

Intellectual A schedule of domestic and foreign patents and patent applications
property A schedule of trademarks and trade names

A schedule of copyrights
A description of important technical know-how
A description of methods used to protect trade secrets and know-how

Employees A list of employees, including positions, current salaries, salaries and bonuses

and employee paid during the past three years, and years of service

benefits Résumés of key employees
The business’s personnel handbook and a schedule of all employee benefits, and

holiday, vacation and sick-leave policies

Licenses and Copies of any governmental licenses, permits or consents

permits

Environmental Environmental audits, if any, for each property leased by the business

issues A listing of hazardous substances used in the business’s operations
A description of the business’s disposal methods
A list of environmental permits and licenses

FINANCING THE ENTREPRENEURIAL VENTURE
Taxes Federal, state, local, and foreign income tax returns for the past three years

State sales tax returns for the past three years
Any audit and revenue agency reports
Any tax-settlement documents for the past three years

Material A schedule of all subsidiary, partnership, or joint-venture relationships and

contracts obligations, with copies of all related agreements
All loan agreements, bank financing arrangements, lines of credit, or
promissory notes to which the business is a party
Any options or stock purchase agreements involving interests in other
companies
The business’s standard quote, purchase order, invoice and warranty forms

Product or A list of all existing products or services as well as those under development

service lines Copies of all correspondence and reports related to any regulatory approvals of
any of the business’s products or services
A summary of all complaints or warranty claims
A summary of results of all tests, evaluations and other data regarding existing

products or services and those that are under development

Customer A schedule of the business’s twelve largest customers in terms of sales and a

information description of those sales for a period of at least two years
Any supply or service agreements
A description or copy of the business’s purchasing policies
A description or copy of the business’s credit policy

Litigation A schedule of all pending litigations
A description of any threatened litigations
Copies of insurance policies that may provide coverage for pending or

threatened litigation

Insurance A schedule and copies of the business’s general liability, insurance claims

coverage history, personal and real-estate property, product liability, errors and

omissions, key man, directors and officers, workers’ compensation, and other

insurance

Professionals A schedule of all law firms, accounting firms, consulting firms, and similar

professionals engaged by the business during the past five years

Articles and Copies of all articles and press releases relating to the business within the past

publicity three years

Source: Modified from FindLaw for small businesses, at http://smallbusiness.findlaw.com/business-
formscontracts/be3_8_1.html; the Kauffman Foundation, at www.kauffman.org/; AllBusiness, at
www.allbusiness.com/business-finance/equity-funding-private-equity-venture/81-1.html.

http://www.allbusiness.com/business-finance/equity-funding-private-equity-venture/81-1.html

FINANCING THE ENTREPRENEURIAL VENTURE

Before entering into the financing process, some general key steps need to be taken, as

illustrated in Figure 12.1.

Long-term

• Land and construction, including local improvements

• Equipment and machinery n Working materials

• Transferable material and furniture

• Startup costs (incorporation, judicial costs, marketing research, credits, and

more)Short-term Startup cash and stock

• Preservation of capital and assets

Figure 12.1 General key steps in the financing process

Prospect

When and how much money is needed?

Meeting criteria

Planning the costs properly

Current needs versus interests

Setting realist goals

Financial process

Assessing financing sources

Closure

FINANCING THE ENTREPRENEURIAL VENTURE
The prospect addresses questions regarding when and how much money is needed for the firm,

what it will be used for, and how long the entrepreneur thinks the financial assistance will
be needed.

Meeting criteria means planning the costs properly: rather than either overestimating or
underestimating the financial requirements needed to properly capitalize the business, the
preparation of financial projections in the business plan is essential.

Current needs versus interests are the realistic goals that should be set; this is the first step in financing

management that entrepreneurs should determine – the scope and size of their business.
Rather than simply jumping into the idea of starting a business without understanding what
the business really entails, goals need to be set with respect to the financial requirements of
multiple issues – i.e., management know-how and technological skills, HR requirements,
among others – in the short and long term.

Financial process. Financing a small business is not a lock, stock and barrel proposition. For many
entrepreneurs, no single source will finance their entire operation and they need to look at
financing as the sum of their business’s parts.The ideal financing source is one that provides
the longest payback period, carries the lowest interest rates, requires little or no collateral
and demands no personal liability, but such sources are very difficult to find.Thus a financial
process is needed that emphasizes assessment of the different sources of financing and their
pros and cons.

Closure is the stage at which the sources of financing are chosen.This should be decided upon
with full knowledge of what the financing sources entail, what the entrepreneurs’
obligations to and participation in such financing sources and processes are, and how to
best manage such sources.

By obtaining detailed information on operations and finances, entrepreneurs may better
understand their business’s needs and make them more attractive to investors. The due-diligence
checklist (Table 12.2) addresses some major topics that should be assessed and documented.

FINANCIAL SOURCES

Family and friends. At the very early stages of any startup, entrepreneurs tend to raise money from
relatives, colleagues and other people they know well.

Banks. The bank loans money based on the business’s ability to pay back: banks are more likely

to finance businesses that have greater value to minimize their risks. From the bank’s point
of view, lending to entrepreneurial businesses is a complex and challenging task since
entrepreneurs (i.e., the borrowers) have more information about their firms than the banks
have, as entrepreneurs usually do not disclose all important information related to their
firm’s business transactions. Furthermore, many entrepreneurs lack the skills to prepare
financial statements and business plans, and this amplifies the risk of loaning to
entrepreneurial businesses. However, when professional management practices are run in

FINANCING THE ENTREPRENEURIAL VENTURE

an entrepreneurial business, the bank will be more willing to loan money to that business
(Colombo and Grilli 2007; Beck, Demirgüç-Kunt and Maksimovic 2008; Le and Nguyen
2009).

Grants. Federally funded programs mandate that certain agencies set aside part of their budgets
to fund fledgling high-tech companies with interesting inventions they want to
commercialize (e.g., Small Business Innovation Research grant (SBIR); government grants
for women and minority-owned businesses). Competition for this money is steep, and as
such, if such a grant is received, it is helpful in attracting funding from other investors
(Holger, Henry and Strobl 2008).

Angels. Angel investors enable the business to acquire venture capital from individual investors

who are looking for companies that exhibit high growth prospects, have a synergy with their
own business or compete in an industry in which they have succeeded. Early-stage
companies with no revenues or established companies with sales and earnings can use this
source, but they must be ready to relinquish some control of their business. Most important,
to successfully accommodate angel investors, the entrepreneurs should be ready to provide
them with an ‘exit’ through an initial public offering (IPO) or buyout by a larger firm (Steier
2000; Bruton, Chahine and Filatotchev 2009; Wiltbank et al. 2009).

Bootstrapping. Bootstrapping market entry is a viable model involving launching a business on a
low budget, including outsourcing the work, renting rather than buying equipment and
bartering for services; this is when entrepreneurs have great faith in their idea and they want
to give up any equity, or when they have taken on a small amount of seed financing, just
enough to get them into the market. The benefits of bootstrapping are in the speed of raising
capital and generating revenue, flexibility in ‘taking the time’ to learn the entrepreneurial
process and modify the business’s operations accordingly, efficiency and capital
preservation, by using money in a more disciplined manner, tracking expenses carefully,
and spending only on the most efficient tactics.

Venture capital. This is a type of private equity capital typically provided by professional, outside

investors to new, high-potential-growth companies in the interest of taking the company to
an IPO. Venture capitalists pool their money with additional funds from institutional
investors (e.g., pension funds, endowments and foundations), and these investors become
‘limited partners’ in the firm’s funds. Typically, venture funds have a life span of
approximately ten years: during the first several years, they invest in promising new
companies that then become part of the firm’s portfolio; over the course of the fund’s
life,these companies are treated for acquisition or to go public at a premium of the total
amount invested (‘exit’) (Sahlman 1990; Gompers and Lerner 1999; Jeng and Wells 1998).

Initial public offering (IPO) and sellout. When private firms move to public ownership, they can
either do so through an IPO or a sellout. In an IPO, a private firm generally sells off a portion
of its outstanding equity, but the previous owners retain significant ownership and control
of the public corporation. IPO investors, on the other hand, take a significant risk when they

FINANCING THE ENTREPRENEURIAL VENTURE
invest in a business whose worth has yet to be revealed in the marketplace. Sellout is a
transaction in which a public company generally buys all of the outstanding shares of a
privately held business. Both sellout and IPO firms benefit from access to public debt and
equity markets, from liquidity of ownership for managers and investors, and from the
possibility of linking management and employee compensation to traded securities (Deeds,
Decarolis and Coombs 1997; Mulherin and Boone 2000; Certo, Daily and Dalton 2001;
Brau, Francis and Kohers 2003; Certo 2003; Certo et al. 2003).

Crowdfunding. Crowdfuning is a form of raising money that takes place, usually via the Internet,
where people pool their money to support a start-up or other initiative, usually in return
for some sort of amenity rather than loan. Can be equity based, and many other alternative
variants. Kickstarter is a popular online crowdfunding platform.

OBTAINING VENTURE AND GROWTH CAPITAL

Several sources of funding and financial alternatives are pertinent for entrepreneurs; they vary
in their content, suitability and uses, as well as in their supply process. All businesses know that
financing is vital to their present and future success; however, some entrepreneurs –
inexperienced ones or those lacking knowledge on the benefits and shortcomings of the different
options – may obtain less than optimal forms of financing.

FINANCING THE ENTREPRENEURIAL VENTURE

Every venture fund has a net asset value or the value of an investor’s holdings in that fund at

any given time; therefore, evaluating which financial option best suits the business is difficult.

This decision takes considerable investment knowledge and time on the part of the

entrepreneur and on the part of the investors, as each company is given a valuation that is

agreed upon between the venture firms when invested in by the venture fund(s).In subsequent

quarters, the venture investor will usually keep this valuation intact until a material event

occurs to change the value (Fiet 1996; Mullins 2004; Cumming 2005; de Bettignies and

Brander 2007).

Some entrepreneurs may therefore seek to delegate this decision to an investment advisor or
so-called ‘gatekeeper’. This advisor will pool the assets of its various clients and join together
entrepreneurs and the best options for them with the shorter funding-process cycles. Some
websites can facilitate these decisions.1

NETWORKING AND FINANCIAL INFORMATION

The success of a new venture often depends on an entrepreneur’s ability to establish a network
for the mobilization of financial resources. One of the most important key benefits of networks
for the entrepreneurial process is the access they provide to information and advice, which may
lead to better financial resources for the business.

In the uncertain and dynamic environments under which entrepreneurial activity occurs,
resource holders, such as potential investors, ‘angels’, etc., are likely to seek information that
helps gauge the underlying potential of a venture, while entrepreneurs seek ways to reduce risks
associated with their business process by associating with investors. Access through a network to
venture capitalists and professional service organizations, for example, is an important means of
tapping into key market information and establishing financial ties (Freeman 1999). Moreover,
when an entrepreneurial business is recognized and appreciated by more well-regarded
individuals and organizations associated with that entrepreneur in the same networks, it will lead
this business to effective and subsequently beneficial financial resource exchanges; in support,
there is some empirical evidence that high-tech businesses with prominent strategic alliance
partners are able to go public faster and at higher market valuation (Stuart, Hoang and Hybels
1999; Calabrese, Baum and Silverman 2000).

Studies in entrepreneurship have also documented that entrepreneurs consistently use
networks to get ideas and gather information that will facilitate their search for financial
resources, entrepreneurial opportunities, or a niche (Birley 1985;Smeltzer,Van Hook and Hutt
1991;Singh et al. 1999; Hoang and Young 2000), for example, in organizing and managing a
supportive angel or informal investor networks.

The reliance on networks is not constrained to the startup stage. Entrepreneurs continue to
rely on networks for business information, advice, and problem-solving, with some contacts
providing multiple resources (Johannisson et al. 1994); effective networks have also been found
to affect both survival and financial performance of entrepreneurial businesses (Gimeno et al.
1997; Bruderl and Preisendorfer 1998; Honig and Davidsson 2000). Trustworthy ties with
suppliers, competitors, distributors, customers, or financial organizations can be important as

FINANCING THE ENTREPRENEURIAL VENTURE

conduits of information and know-how and can lead to reliable information flow, advice and
beneficial business exchange (Brown and Butler 1995; Deeds, Mang and Frandsen 1997; Stuart,
Hoang and Hybels 1999; Higgins and Gulati 2000; Shane and Cable 2001).

MANAGING THE FINANCIAL PROCESS

Once the source of financing has been decided upon and the selection has been made,
entrepreneurs need to maintain it and manage it. Six major tips for managing the business’s
financial operations are provided (Shepherd, Armstrong and Levesque 2005; Sørheim 2005).

Follow up on the financial operations of the business. Entrepreneurs should have control over their
financing by following up on their business’s financial operations daily – costs, sales,
turnover, and more. In the computerized era, such follow-up is simple and attainable. Once
a month, a larger follow-up should be performed for the other financial elements, such as
loans, long run payments, unfixed payments, long-run sales, and more.

Always leave a margin for financial tactics. The margin for financial tactics has two purposes –

security, in case there are unexpected costs, and as a reserve, when a feasible opportunity
becomes available and the ongoing cash flow may not be enough to exploit it. For example,
the initial purchase of a particular raw material might be at the bottom of an entrepreneur’s
priority list but then unexpectedly, this raw material becomes available for sale at a reduced
price. Such a margin may assist the entrepreneur in purchasing it.

Proceed step by step. It is recommended that the business be launched step by step, and that the

sources of financing be used over several months rather than all at once. This has several
advantages: first, it decreases the financial risk; second, it allows the gradual establishment
of credibility; and third, if the first steps are well managed, better conditions will exist for
subsequent steps.

Prevention is better than recovery. Entrepreneurs should proactively gather information on potential

financial funding. Acknowledging the nature of the potential problems connected to each
financial source means envisaging how to plan operations accordingly and preparing a plan
that may prevent some of the potential problems. This is much more highly recommended
than preparing a plan for recovery because things have gone wrong.

Sign an agreement with the stockholders. Confidence is the key factor in deciding which funds to

select for the business. In order to ensure such confidence, a set of rules should be established
and signed by the players. Topics such as the engagement of both sides for the business’s
interests, rules regulating how to ‘go public’ or sell the business, partitioning of profits,
among others, should be discussed and regulated in a contract (Brown 1992).

Insurance policy. The secret of an entrepreneurial business’s success relies for the most part on a

very limited number of team members who are the business’s ‘key people’. Insurance
companies offer policies for these ‘key people’; the business is generally designated as the
recipient of these policies and, when needed, the insurance company covers the business.

FINANCIAL SOURCES

OBTAINING VENTURE AND GROWTH CAPITAL

NETWORKING AND FINANCIAL INFORMATION

MANAGING THE FINANCIAL PROCESS

Building New

Venture
Financials
* Financial Management knowledge + historicals

reference +

*Proforma building knowledge

Financial Management
1 of 2

• Financial Management
• Financial management deals with two things: raising money

and managing a company’s finances in a way that achieves
the highest rate of return

• Chapter 10 focuses on raising money. This chapter focuses
primarily on:
• How a new venture tracks its financial progress through preparing,

analyzing, and maintaining past financial statements.

• How a new venture forecasts future income and expenses by
preparing pro forma (or projected) financial statements.

Financial Management
2 of 2

The financial management of a firm deals with questions
such as the following on an ongoing basis:

• How are we doing? Are we making or losing money?

• How much cash do we have on hand?

• Do we have enough cash to meet our short-term obligations?

• How efficiently are we utilizing our assets?

• How do our growth and net profits compare to those of our industry peers?

• Where will the funds we need for capital improvements come from?

• Are there ways we can partner with other firms to share risk and reduce the

amount of cash we need?

• Overall, are we in good shape financially?

Financial Objectives of a Firm
1 of 3

Financial Objectives of a Firm
2 of 3

• Profitability
• Is the ability to earn a profit.

• Many start-ups are not profitable during their first one to three years while they are
training employees and building their brands.

• However, a firm must become profitable to remain viable and provide a return to
its owners.

• Liquidity
• Is a company’s ability to meet its short-term financial obligations.

• Even if a firm is profitable, it is often a challenge to keep enough money in the bank
to meet its routine obligations in a timely manner.

Financial Objectives of a Firm
3 of 3

• Efficiency
• Is how productively a firm utilizes its assets relative to its revenue and

its profits.
• Southwest Airlines, the classic example, uses its assets very productively. Its

turnaround time, or the time its airplanes sit on the ground while they are being
unloaded and reloaded, is the lowest in the airline industry.

• Stability
• Is the strength and vigor of the firm’s overall financial posture.

• For a firm to be stable, it must not only earn a profit and remain liquid but also
keep its debt in check.

The Process of Financial Management
1 of 4

• Importance of

Financial Statements

• To assess whether its financial objectives are being met, firms rely

heavily on analysis of financial statements.
• A financial statement is a written report that quantitatively describes a firm’s

financial health.

• The income statement, the balance sheet, and the statement of cash flows are the
financial statements entrepreneurs use most commonly.

• Forecasts
• Are an estimate of a firm’s future income and expenses, based on past

performance, its current circumstances, and its future plans.

The Process of Financial Management
2 of 4

• Forecasts (continued)
• New ventures typically base their forecasts on an estimate of sales and

then on industry averages or the experiences of similar start-ups
regarding the cost of goods sold and other expenses.

• Budgets
• Are itemized forecasts of a company’s income, expenses, and capital

needs and are also an important tool for financial planning and control.

The Process of Financial Management
3 of 4

• Financial Ratios
• Depict relationships between items on a firm’s financial statements.

• An analysis of its financial ratios helps a firm determine whether it is
meeting its financial objectives and how it stacks up against industry
peers.

• Importance of Financial Management
• Many experienced entrepreneurs stress the importance of keeping on

top of the financial management of the firm.

The Process of Financial Management
4 of 4

Financial Statements

• Historical Financial Statements
• Reflect past performance and are usually prepared on a quarterly and

annual basis.
• Publicly traded firms are required by the SEC to prepare financial statements and

make them available to the public.

•

Pro Forma Financial Statements

• Are projections for future periods based on forecasts and are typically

completed for two to three years in the future.
• Pro forma financial statements are strictly planning tools and are not required by

the SEC.

Historical Financial Statements (study slides 12-22 for reference)
New Ventures focus on proformas starting on slide

Three types of historical financial statements

Financial Statement Purpose

Income Statement

Balance Sheet

Statement of cash flows

Reflects the results of the operations of a firm over a
specified period of time. It records all the revenues and

expenses for the given period and shows whether the
firm is making a profit or is experiencing a loss.

Is a snapshot of a company’s assets, liabilities, and
owner’s equity at a specific point in time.

Summarizes the changes in a firm’s cash position for a
specified period of time and details why the changes

occurred.

Historical Income Statements

Historical Balance Sheets
1 of 2

Assets

Historical Balance Sheets
2 of 2

Liabilities and Shareholders’ Equity

Historical Statement of Cash Flows

Ratio Analysis

• Ratio Analysis
• The most practical way to interpret or make sense of a firm’s

historical financial statements is through ratio analysis, as
shown in the next slide.

• Comparing a Firm’s Financial Results to Industry Norms
• Comparing a firm’s financial results to industry norms helps a

firm determine how it stacks up against its competitors and if
there are any financial “red flags” requiring attention.

Historical Ratio Analysis

Forecasts
1 of 4

• Forecasts
• The analysis of a firm’s historical financial statements are followed by

the preparation of forecasts.

• Forecasts are predictions of a firm’s future sales, expenses, income, and
capital expenditures.
• A firm’s forecasts provide the basis for its pro forma financial statements.

• A well-developed set of pro forma financial statements helps a firm create
accurate budgets, build financial plans, and manage its finances in a proactive
rather than a reactive manner.

Forecasts
2 of 4

• Sales Forecast
• A sales forecast is a projection of a firm’s sales for a

specified period (such as a year).

• It is the first forecast developed and is the basis for
most of the other forecasts.
• A sales forecast for a new firm is based on a good-faith

estimate of sales and on industry averages or the experiences
of similar start-ups.

• A sales forecast for an existing firm is based on (1) its record
of past sales, (2) its current production capacity and product
demand, and (3) any factors that will affect its future product
capacity and product demand.

Forecasts
3 of 4

Historical and Forecasted Annual Sales for New Venture

Forecasts
4 of 4

• Forecast of Costs of Sales and Other Items
• Once a firm has completed its sales forecast, it must

forecast its cost of sales (or cost of goods sold) and
the other items on its income statement.

• The most common way to do this is to use the
percentage-of-sales method, which is a method for
expressing each expense item as a percentage of
sales.
• If a firm determines that it can use the percent-of-sales

method and it follows the procedures described in the
textbook, then the net result is that each expense item on its
income statement will grow at the same rate as sales (with
the exception of items that can be individually forecast, such
as depreciation).

Pro Forma Financial Statements

• Pro Forma Financial Statements
• A firm’s pro forma financial statements are similar to its

historical financial statements except that they look forward
rather than track the past.

• The preparation of pro form financial statements helps a firm
rethink its strategies and make adjustments if necessary.

• The preparation of pro forma financials is also necessary if a
firm is seeking funding or financing.

Types of Pro Forma Financial Statements

Financial Statement Purpose

Pro Forma Income
Statement

Pro Forma Balance
Sheet

Pro Forma Statement of
Cash flows

Shows the projected results of the operations of a firm
over a specific period.

Shows a projected snapshot of a company’s
assets, liabilities, and owner’s equity at a specific

point in time.

Shows the projected flow of cash into and out of a
company for a specific period.

Pro Forma Income Statements

Pro Forma Balance Sheets
1 of 2

Assets

Pro Forma Balance Sheets
2 of 2

Liabilities and Shareholders’ Equity

Pro Forma Statement of Cash Flows
1 of 2

Operating Activities

Pro Forma Statement of Cash Flows
2 of 2

Investing Activities and Financing Activities

Ratio Analysis

• Ratio Analysis
• The same financial ratios used to evaluate a firm’s historical

financial statements should be used to evaluate the pro forma
financial statements.

• This work is completed so the firm can get a sense of how its
projected financial performance compares to its past
performance and how its projected activities will affect its
cash position and its overall financial soundness.

Ratio Analysis Based on Historical and Pro-
Forma Financial Statements

Slide 1: Building New Venture Financials
Slide 2: Financial Management 1 of 2
Slide 3: Financial Management 2 of 2
Slide 4: Financial Objectives of a Firm 1 of 3
Slide 5: Financial Objectives of a Firm 2 of 3
Slide 6: Financial Objectives of a Firm 3 of 3
Slide 7: The Process of Financial Management 1 of 4
Slide 8: The Process of Financial Management 2 of 4
Slide 9: The Process of Financial Management 3 of 4
Slide 10: The Process of Financial Management 4 of 4
Slide 11: Financial Statements
Slide 12: Historical Financial Statements (study slides 12-22 for reference) New Ventures focus on proformas starting on slide 23
Slide 13: Historical Income Statements
Slide 14: Historical Balance Sheets 1 of 2
Slide 15: Historical Balance Sheets 2 of 2
Slide 16: Historical Statement of Cash Flows
Slide 17: Ratio Analysis
Slide 18: Historical Ratio Analysis
Slide 19: Forecasts 1 of 4
Slide 20: Forecasts 2 of 4
Slide 21: Forecasts 3 of 4
Slide 22: Forecasts 4 of 4
Slide 23: Pro Forma Financial Statements
Slide 24: Types of Pro Forma Financial Statements
Slide 25: Pro Forma Income Statements
Slide 26: Pro Forma Balance Sheets 1 of 2
Slide 27: Pro Forma Balance Sheets 2 of 2
Slide 28: Pro Forma Statement of Cash Flows 1 of 2
Slide 29: Pro Forma Statement of Cash Flows 2 of 2
Slide 30: Ratio Analysis
Slide 31: Ratio Analysis Based on Historical and Pro-Forma Financial Statements

Getting New

Venture Funding

or Financing

* Every company needs to raise
funds
* Most investors don’t invest alone

The Importance of Getting Financing or
Funding

• The Nature of the Funding and Financing Process
• 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 the task of raising capital

haphazardly because they lack experience in this area.

• Why Most New Ventures Need Funding
• There are three reasons most new ventures need to raise

money during their early life.
• The three reasons are shown on the following slide.

Why Most New Ventures Need Financing
or Funding

Alternatives for Raising Money for a
New Venture

Personal Funds
(or friends and family)

Equity Capital
– Angels, Venture,

Private Equity

Debt Financing
(mostly impossible

for new venture)

Creative Sources
(Crowd-Funding now
massive, but amounts

per company are
small at about $28,000)

Sources of Personal Financing
1 of 2

•Personal Funds
• The vast majority of founders contribute

personal funds, along with sweat equity,
to their ventures.
• Sweat equity represents the value of the time

and effort that a founder puts into a new
venture.

•Friends and Family
• Friends and family are the second source

of funds for many new ventures.

Sources of Personal Financing
2 of 2

•Bootstrapping
• A third source of seed money for a new

venture is referred to as bootstrapping.
• Bootstrapping is finding ways to avoid the

need for external financing or funding
through creativity, ingenuity, thriftiness,
cost cutting, or any means necessary.

• Many entrepreneurs bootstrap out of
necessity.

Examples of Bootstrapping Methods

Buying used instead of
new equipment

Coordinating purchases
with other businesses

Leasing equipment
instead of buying

Obtaining payments in
advance from

customers

Minimizing personal
expenses

Avoiding unnecessary
expenses

Buying items cheaply but
prudently via options

such as eBay

Sharing office space or
employees with other

businesses
Hiring interns

Preparing to Raise Debt or Equity Financing
1 of 3

Equity Funding Debt Financing

Means exchanging
partial ownership in a

firm, usually in the
form of stock, for

funding

Getting a loan (almost
impossible without

substantial collateral,
even then unlikely)

Preparing to Raise Debt or Equity Financing
2 of 3

Two Most Common Alternatives

Preparing to Raise Debt or Equity Financing
3 of 3

Matching a New Venture’s Characteristics with the Appropriate Form of
Financing or Funding

Sources of Equity Funding

Venture Capital

Private Equity

Business Angels

Initial Public Offerings (never
available for new startup. Must

go through several rounds of
investment before this

Crowd Funding

Alternative
Finance

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
start-up process.

• The number of angel investors is significant, though
remained steady over the past few decades.

Business Angels
2 of 2

•Business Angels (continued)
• Business angels are valuable because of their

willingness to make relatively small investments.
• These investors generally invest between $10,000 and

$500,000 in a single company.

• Are looking for companies that have the potential to grow
between 30% to 40% per year.

• Business angels are difficult to find.

Venture Capital
1 of 3

• Venture Capital
• Is money that is invested by venture capital firms in start-ups and small

businesses with exceptional growth potential.

• There are about 800 venture capital firms in the U.S.
• 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.

• The investors who invest in venture capital funds are called limited partners. The
venture capitalists are called general partners.

Venture Capital
2 of 3

•Venture Capital (continued)
• Venture capital firms fund very few entrepreneurial

firms in comparison to business angels.
• 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.

• Venture capitalists fund a massive amount of money for
startups – $345 billion in 2021 in the US alone.

Venture Capital
3 of 3

•Venture Capital (continued)
• An important part of obtaining venture capital funding

is going through the due diligence process.
• 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 (commonly referred to as series A,
series B, etc..)

Initial Public Offering
1 of 3

• Initial Public Offering
• An initial public offering (IPO) is a company’s first sale of stock to the

public. When a company 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.

Reason 1 Reason 2

Is a way to raise equity

capital to fund current

and future operations.

Raises a firm’s public

profile, making it easier

to attract high-quality

customers and business

partners.

Initial Public Offering
2 of 3

Reasons that Motivate Firms to Go Public

Reason 3 Reason 4

Is a liquidity event that
provides a means for a
company’s investors to

recoup their
investments.

Creates a form of
currency that can be

used to grow the
company via
acquisitions.

Initial Public Offering
3 of 3

Reasons that Motivate Firms to Go Public

Sources of Debt Financing

Commercial
Banks

Goverment
Guaranteed

Loans

Other Sources of Debt Financing
1 of 2

• Vendor Credit
• Also known as trade credit, is when a vendor extends credit to

a business in order to allow the business to buy its products
and/or services up front but defer payment until later.

• Factoring
• Is a financial transaction whereby a business sells its accounts

receivable to a third party, called a factor, at a discount in exchange for
cash.

Other Sources of Debt Financing
2 of 2

• Peer-to-Peer Lending
• Is a financial transaction that occurs directly between individuals or

peers.

• Prosper is the best know peer-to-peer lending network.

• Crowdfunding
• A form of raising money that takes place, usually via the Internet, where

people pool their money to support a start-up or other initiative, usually
in return for some sort of amenity rather than loan. Can be equity based,
and many other alternative variants.

• Kickstarter is a popular online crowdfunding platform.

Creative Sources of Financing or Funding

SBIR and STTR
Grant Programs

Leasing

Strategic PartnersOther Grant Programs

Slide 1: Getting New Venture Funding or Financing
Slide 2: The Importance of Getting Financing or Funding
Slide 3: Why Most New Ventures Need Financing or Funding
Slide 4: Alternatives for Raising Money for a New Venture
Slide 5: Sources of Personal Financing 1 of 2
Slide 6: Sources of Personal Financing 2 of 2
Slide 7: Examples of Bootstrapping Methods
Slide 8: Preparing to Raise Debt or Equity Financing 1 of 3
Slide 9: Preparing to Raise Debt or Equity Financing 2 of 3
Slide 10: Preparing to Raise Debt or Equity Financing 3 of 3
Slide 11: Sources of Equity Funding
Slide 12: Business Angels 1 of 2
Slide 13: Business Angels 2 of 2
Slide 14: Venture Capital 1 of 3
Slide 15: Venture Capital 2 of 3
Slide 16: Venture Capital 3 of 3
Slide 17: Initial Public Offering 1 of 3
Slide 18: Initial Public Offering 2 of 3
Slide 19: Initial Public Offering 3 of 3
Slide 20: Sources of Debt Financing
Slide 21: Other Sources of Debt Financing 1 of 2
Slide 22: Other Sources of Debt Financing 2 of 2
Slide 23: Creative Sources of Financing or Funding

Performance
Measurement
Forecasting
Budgeting
Metrics

Measurement and

Control

Measurement

• Forecasts of future sales and costs,

• Budgets allocating financial resources,

• Schedules identifying the timing of marketing tasks, and

• Metrics to gauge progress toward achieving objectives.

Control

• Identify

• Analyze

• Correct

Overview of Measurement Tools

Professor Mark Rendon

Forecasts

• Are future projections of what sales and costs are likely
to be in the months and years covered in the plan.

• Can never be more than good estimates.

• However, still should be as accurate as possible.

• Need to be reviewed often.

• Must account for the effect that marketing activities
will have on the direction and velocity of sales.

Forecasts of Sales and Costs

• External factors to consider:
• Demand

• Threats

• Opportunities

• Internal factors to consider:
• Goals

• Capabilities

• Constraints

Types of Forecasts

• Market and segment sales

• Company product sales

• Cost of sales

• Sales and costs by channel

Creating the forecasts is only part of the task. Next,

month-to-month and year-to-year changes must be

estimated in order to examine trends and rates of

change.

Sources of Information
For Forecasting

• Value-chain partners

• Primary research:
• Studies of buying patterns and buying intentions.

• Secondary research:
• Trade associations.

• Government statistics.

• Industry analyst reports.

• Judgment is typically used to fine-tune the estimates.

Judgment-based Forecasting
Professor Mark Rendon

Forecasting New Products
• Forecasting for new products is even more challenging than

for existing products.

• Bass model appropriate when:
• The company has been able to collect sales data for even a

brief period , and
• The product is similar to an existing product or technology

with a known sales history.

• When the product is so innovative that it establishes a new
product category, companies will:
• Use simulated test markets.
• Look at sales patterns of products with similar market

behavior.

Budgets
• Budgets are time-defined allocations of financial

outlays for specific functions, programs,
customer segments or geographic regions.

• Enable marketing managers to:
• Allocate expenses, and

• Compare estimates with actual expenses.

Examples of Budgeting Policies

• Insist that budget preparation follow internal financial
calendars.

• Specify profit hurdles.

• Specify particular assumptions about expenses and
allocations.

• Mandate particular formats or supporting
documentation.

• Based upon best-case, worst-case and most-likely
scenarios.

• Adjusting budgets monthly instead of annually.

Budgeting Methods

• Affordability budgeting

• Percentage-of-sales budgeting

• Comparative-parity budgeting

• Objective-and-task budgeting

Affordability Budgeting

• Budgeting what you believe you can afford.

• May work for start-ups.

• Generally, not a good way to budget.
• Doesn’t allow for the kinds of significant, ongoing

investments often needed to launch major new
products or enter intensely competitive markets.

• Ignores profit payback calculation.

Percentage-of-sales Budgeting

• Management sets aside a certain percentage of dollar
sales to fund marketing programs.

• Based on internal budgeting guidelines or previous
marketing experience.

• Advantage: Simple to implement.

• Disadvantages:
• Sales are seen as the source of marketing funding, rather

than as the result of budget investments.

• Difficult to justify the % set aside for marketing.

• Self-defeating: lower sales may lead to a lower marketing
budget.

Comparative-parity Budgeting

• Funding marketing by matching what competitors
spend.

• Advantage: Simple to implement.

• Disadvantages:
• Ignores differences between companies.

• Doesn’t allow for adjustments to meet specific
marketing objectives.

Objective-and-task Budgeting

• Adding up the cost of completing all of the
marketing tasks needed to achieve marketing plan
objectives.

• Advantage: A reasonable build-up method.

• Disadvantage: May add up to more than the firm
can afford. Priorities may have to be established.

Budgets Within the Marketing Budget

• Budgets for each marketing mix program.

• Budgets for each brand, segment or market.

• Budgets for each region or geographic division.

• Budgets for each division or product manager.

• Budget summarizing all marketing expenses.

Schedules

• Schedules are time-defined plans for completing a
series of tasks or activities related to a specific
program or objective.
• Timing should be as concrete as possible.

• Help avoid conflicts.

• Help measure progress toward completion.

The Scheduling Process

• List the main tasks and activities.

• Assign each a projected start and end date.
• Through research or experience.

• Determine who is responsible for each task.

• Develop an overall summary schedule.

• Develop detailed schedules for each sub-program.
• Gantt charts.

• Critical path schedules.

Metrics

Metrics:

• Focus employees on activities that make a
difference.

• Set up performance expectations that can be
objectively measured.

• Lay a foundation for internal accountability and
pride in accomplishments.

Main Categories of Metrics
Professor Mark Rendon

Marketing Dashboard

• A marketing dashboard is a computerized,
graphical presentation that helps management
track important metrics over time and spot
patterns that signal deviations from the marketing
plan.

• Helps managers see the situation at a glance,
based upon a limited number of data inputs.

• Varying levels of dashboards: Corporate, divisional
or functional.

Identifying Metrics

Methods of identifying appropriate metrics include:

• Working backward from mission, goals and objectives.

• Looking for key components or activities related to
customer buying behavior.

• This would include metrics for each of the three key
areas:
• Marketing objectives,

• Financial objectives, and

• Societal objectives

Sample Marketing Metrics

Objective Metric

To acquire new
customers.

Measure number or percentage

of new customers acquired by

month,

quarter, year.

To retain current
customers.

Measure number or percentage

of customers who continue

purchasing

during a set period.

To increase market
share.

Measure dollar or unit sales

divided by total industry sales

during a set period.

To accelerate product
development

Measure the time needed to

bring a new product to market.

Sample Financial Metrics

Objective Metric

To increase sales
revenue by product.

Measure product sales in

dollars per week, month,

quarter, or year.

To improve profitability. Measure gross or net margin for

a set period byproduct, line,

channel, marketing program or

customer.

To reach break-even. Measure the number of weeks

or months until a product’s

revenue equals and begins to

exceed costs.

Sample Societal Metrics

Objective Metric

To make products more
environmentally friendly.

Measure the proportion of each

product’s parts that are

recyclable or have been recycled

during a set period.

To build awareness of a
social issue.

Measure awareness among the

target audience after the

program or a set period.

To conserve electricity or
fuel.

Measure amount used by month,

quarter, year.

Metrics Based on Customer Behavior
Professor Mark Rendon

Using Metrics

Metrics are most valuable to the marketer when
viewed in the context of:

• Expected outcomes.

• Historical results.

• Competitive or industry outcomes.

• Environmental influences.

Keys to Success in Implementing a Marketing
Plan

Professor Mark Rendon

Controlling Marketing Plan Implementation

Four types of marketing control help marketers gauge the
effectiveness of the plan implementation:

• Annual Plan,

• Profitability,

• Productivity, and

• Strategic Control

Four Forms of Control

Professor Mark Rendon

Applying Control

1. Set objectives.

2. Determine metrics.

3. Determine measurement intervals.

4. Measure.

5. Take corrective action, if necessary.
• Or modify standards and/or objectives.

Untitled Section

Slide 1: Performance Measurement Forecasting Budgeting Metrics

Slide 2: Measurement and Control

Slide 3: Overview of Measurement Tools

Slide 4: Forecasts

Slide 5: Forecasts of Sales and Costs

Slide 6: Types of Forecasts

Slide 7: Sources of Information For Forecasting

Slide 8: Judgment-based Forecasting

Slide 9: Forecasting New Products

Slide 10: Budgets

Slide 11: Examples of Budgeting Policies

Slide 12: Budgeting Methods

Slide 13: Affordability Budgeting

Slide 14: Percentage-of-sales Budgeting

Slide 15: Comparative-parity Budgeting

Slide 16: Objective-and-task Budgeting

Slide 17: Budgets Within the Marketing Budget

Slide 18: Schedules

Slide 19: The Scheduling Process

Slide 20: Metrics

Slide 21: Main Categories of Metrics

Slide 22: Marketing Dashboard

Slide 23: Identifying Metrics

Slide 24: Sample Marketing Metrics

Slide 25: Sample Financial Metrics

Slide 26: Sample Societal Metrics

Slide 27: Metrics Based on Customer Behavior

Slide 28: Using Metrics

Slide 29: Keys to Success in Implementing a Marketing Plan

Slide 30: Controlling Marketing Plan Implementation

Slide 31: Four Forms of Control

Slide 32: Applying Control

The Importance of Intellectual Property

• Intellectual Property
• Is any product of human intellect that is intangible but has value in the

marketplace.

• It is called “intellectual” property because it is the product of human
imagination, creativity, and inventiveness.

• Importance
• Traditionally, businesses have thought of their physical assets, such as land,

buildings, and equipment as the most important.

• Increasingly, however, a company’s intellectual assets are the most important.

Intellectual Property legal

issues – relevant to

startups, but especially

innovation initiatives

Determining What Intellectual
Property to Protect

Criteria 1 Criteria 2

Determine whether the

intellectual property in

question is directly

related to the firm’s

competitive advantage.

Decide whether the

intellectual property in

question has value in

the marketplace.

Common Mistakes Firms Make in Regard to
Protecting Their Intellectual Property

Not properly identifying

all of their

intellectual property.

Not legally protecting the

intellectual property

that needs protecting.

Not fully recognizing

the value of their

intellectual property.

Not using their

intellectual property as

part of their overall

plan for success.

The Four Key Forms of Intellectual
Property

Patents

Copyrights

Trademarks

Trade Secrets

Patents

• Patents
• A patent is a grant from the federal government conferring

the rights to exclude others from making, selling, or using
an invention for the term of the patent. (See the next slide
for a full explanation.)

• Increasing Interest in Patents

• There is increasing interest in patents.
• Since Patent #1 was granted in 1790, the U.S. Patent & Trademark

Office has granted over six million patents.

• The patent office is strained. It now takes an average of 35.3
months from the date of first filing to receive a U.S. patent.

Proper Understanding for What a
Patent Means

A patent does not give its owner the right to make, use, or sell an invention;

rather, the right granted is only to exclude others from doing so.

As a result, if an inventor obtains a patent for a new kind of computer chip,

and the chip would infringe on a prior patent owned by Intel, the inventor has

no right to make, use, or sell the chip.

To do so, the inventor would need to obtain permission from Intel. Intel may

refuse permission, or ask that a licensing fee be paid for the rights to infringe

on its

patent.

While this system may seem odd, it is really the only way the system could

work. Many inventions are improvements on existing inventions, and the

system allows the improvements to be (patented) and sold, but only with the

permission of the original inventors, who usually benefit by obtaining

licensing income in exchange for their consent.

Three Basic Requirements for Obtaining a
Patent

Types of Patents

Type Type of Invention Covered

Duration

Utility

Design

Plant

20 years from

the date of the

original

application.

20 years from

the date of the

original

application.

14 years from

the date of the

original

application.

New or useful process, machine,

manufacturer, or composition of material or

any new and useful improvement thereof.

Invention of new, original, and ornamental

design for manufactured products.

Any new varieties of plants that can be

reproduced asexually.

Business Method Patents
(Special Utility Patent)

• Business Method Patent
• A business method patent is a patent that protects an invention that is or

facilitates a method of doing business.

• The most notable business method patents that have been awarded:

• Amazon.com’s one-click ordering system.

• Priceline.com’s “name-your-price” business model.

• Netflix’s method for allowing customers to set up a rental list of movies to be mailed to
them.

The Process of Obtaining a Patent

Patent Infringement

• Patent Infringement
• Takes place when one party engages in the unauthorized use of another party’s

patent.

• The tough part (particularly from a small entrepreneurial firm’s point of view)
is that patent infringement cases are costly to litigate.

• A typical patent infringement case costs each side at least $500,000 to litigate.

Trademarks

•

Trade

mark

• A trademark is any word, name, symbol, or device used to identify the source

or origin of products or services and to distinguish those product or services
from others.

• Trademarks also provide consumers with useful information.

• For example, consumers know what to expect when they see a Macy’s store.

• Think how confusing it would be if any retail store could use the name Macy’s.

Types of Trademarks
1 of 2

Type Types of Marks Covered

Trademark

Duration

Renewable every

10 years, as long

as the mark

remains in use.

Service mark
Renewable every

10 years, as long

as the mark

remains in use.

Any word, name, symbol, or device

used to identify and distinguish one

company’s goods from another.

Examples: Apple, d.light, Dry Soda,

ModCloth, and Zeo.

Similar to trademarks; are used to

identify the services or intangible

activities of a business, rather than a

business’s physical products.

Examples: 1-800-FLOWERS,

Amazon.com, Mint.com, and Zipcar.

Types of Trademarks
2 of 2

Type Types of Marks Covered

Collective

mark

Duration

Renewable every

10 years, as long

as the mark

remains in use.

Certification

mark

Renewable every

10 years, as long

as the mark

remains in use.

Trademarks or service marks used by

the members of a cooperative,

association, or other collective group.

Examples: Rotary International and

International Franchise Association

Marks, words, names, symbols, or

devices used by a person other than

the owner to certify a particular

quality about a good or service.

Examples: 100% Napa Valley and

Underwriters Laboratories

What is Protected Under Trademark Law
1 of 2

Item Example(s)

Words

Numbers

and letters

Designs

and logos

Sounds

Crock-Pot, Magic Marker, Baggies

3M, MSNBA, 1-800-FLOWERS

Nike swoosh logo

MGM’s lion’s roar

What is Protected Under Trademark Law
2 of 2

Item Example

Fragrances

Shapes

Colors

Trade dress

Stationery treated with a special fragrance

Unique shape of the Apple iPhone

Barbie Pink, Target Stores Red

The layout and décor of a restaurant

Exclusions From Trademark Protection

Item Example

Immoral or

scandalous matter

Deceptive matter

Descriptive marks

Surnames

Profane words

Labeling oranges “Fresh Florida

Oranges” that aren’t grown in Florida

Phrases like “golf ball” and “fried chicken”

are descriptive and can’t be trademarked

Common surnames like “Anderson” or

“Smith” can’t be trademarked

The Process of Obtaining a Trademark

Copyrights

• Copyrights
• A copyright is a form of intellectual property protection that grants to the

owner of a work of authorship the legal right to determine how the work is
used and to obtain the economic benefits from the work.

• A work does not have to have artistic merit to be eligible for copyright
protection.

• As a result, things such as operating manuals and sales brochures are eligible for
copyright protection.

What is Protected By a Copyright?

Literary works Musical compositions

Computer software Dramatic works

Pantomimes and

choreographic works

Pictorial, graphic, and

sculptural works

Exclusions From Copyright Protection

• The Idea-Expression Dichotomy
• The main exclusion is that copyright laws cannot protect ideas.

• For example, an entrepreneur may have the idea to open a soccer-themed restaurant. The
idea itself is not eligible for copyright protection. However, if the entrepreneur writes
down specifically what his or her soccer-themed restaurant will look like and how it will
operate, that description is copyrightable.

• The legal principle describing this concept is called the idea-expression dichotomy.

• An idea is not copyrightable, but the specific expression of an idea is.

Obtaining a Copyright

• How to Obtain a Copyright
• Copyright law protects any work of authorship the moment

it assumes a tangible form.

• Technically, it is not necessary to provide a copyright notice
or register work with the U.S. Copyright Office.

• The following steps can be taken, however, to enhance
copyright protection.

• Copyright protection can be enhanced by attaching the copyright
notice, or “copyright bug” to something.

• Further protection can be obtained by registering the work with the
U.S. Copyright Office.

http://images.google.com/imgres?imgurl=www.aarstiderne.com/upload/2001120413421001-copyright &imgrefurl=http://www.aarstiderne.com/Copyright&h=154&w=150&prev=/images%3Fq%3Dcopyright%26svnum%3D10%26hl%3Den%26lr%3D%26ie%3DUTF-8

• Copyright Infringement
• Copyright infringement occurs when one work derives from

another or is an exact copy or shows substantial similarity
to the original work.

• To prove infringement, a copyright owner is required to
show that the alleged infringer had prior access to the
copyrighted work and that the work is substantially similar
to the owner’s.

• The illegal downloading of

movies is an example of

• Copyright infringement costs

the owners of copyrighted

material an estimated $

billion per year in the U.S.

alone.

Trade Secrets

• Trade Secrets
• A trade secret is any formula, pattern, physical device, idea, process, or other

information that provides the owner of the information with a competitive
advantage in the marketplace.

• Trade secrets include marketing plans, product formulas, financial forecasts,
employee rosters, logs of sales calls, and similar types of proprietary
information.

• The Federal Economic Espionage Act, passed in 1996, criminalizes the theft of
trade secrets.

What Qualifies for Trade Secret Protection?
1 of 2

• Trade Secret Protection
• Not all information qualifies for trade secret protection.

• In general, information that is know to the public or that competitors can
discover through legal means doesn’t qualify for trade secret protection.

• Companies protect trade secrets through physical

measures

and written
documents.

What Qualifies for Trade Secret Protection?
2 of 2

The strongest case for trade secret protection is

information that is characterized by the following.

• Is not known outside the company.

• Is known only inside the company on a “need-to-know” basis.

• Is safeguarded by stringent efforts to keep the information

confidential.

• Is valuable and provides the company a competitive advantage

• Was developed at great cost, time, and effort.

• Cannot be easily duplicated, reverse engineered, or discovered.

Physical Measures for Protecting Trade
Secrets

Restricting access Labeling documents

Password protecting

confidential computer

files

Maintaining logbooks

for visitors

Maintaining logbooks for

access to sensitive

material

Maintaining adequate

overall security

measures

Conducting an Intellectual Property Audit
1 of 2

• Intellectual Property Audit
• The first step a firm should take to protect its intellectual property is to

complete an intellectual property audit on any new innovation, product, or
service.

• An intellectual property audit is conducted to determine the intellectual
property a firm owns.

• There are two reasons for conducting an intellectual property audit:

• First, it is prudent for a company to periodically determine whether its intellectual
property is being properly protected.

• Second, it is important for a firm to remain prepared to justify its valuation in the event of
a merger or acquisition.

Conducting an Intellectual Property Audit
2 of 2

• The Process of Conducting an Intellectual Property Audit
• The first step is to develop an inventory of a firm’s existing intellectual

property. The inventory should include the firm’s present registrations of
patents, trademarks, and copyrights.

• The second step is to identify works in progress to ensure that they are being
documented and protected in a systematic, orderly manner.

Slide 1: The Importance of Intellectual Property
Slide 2
Slide 3: Determining What Intellectual Property to Protect
Slide 4: Common Mistakes Firms Make in Regard to Protecting Their Intellectual Property
Slide 5: The Four Key Forms of Intellectual Property
Slide 6: Patents
Slide 7: Proper Understanding for What a Patent Means
Slide 8: Three Basic Requirements for Obtaining a Patent
Slide 9: Types of Patents
Slide 10: Business Method Patents (Special Utility Patent)
Slide 11: The Process of Obtaining a Patent
Slide 12: Patent Infringement
Slide 13: Trademarks
Slide 14: Types of Trademarks 1 of 2
Slide 15: Types of Trademarks 2 of 2
Slide 16: What is Protected Under Trademark Law 1 of 2
Slide 17: What is Protected Under Trademark Law 2 of 2
Slide 18: Exclusions From Trademark Protection
Slide 19: The Process of Obtaining a Trademark
Slide 20: Copyrights
Slide 21: What is Protected By a Copyright?
Slide 22: Exclusions From Copyright Protection
Slide 23: Obtaining a Copyright
Slide 24: Copyright Infringement 1 of 2
Slide 25: Copyright Infringement 2 of 2
Slide 26: Trade Secrets
Slide 27: What Qualifies for Trade Secret Protection? 1 of 2
Slide 28: What Qualifies for Trade Secret Protection? 2 of 2
Slide 29: Physical Measures for Protecting Trade Secrets
Slide 30: Conducting an Intellectual Property Audit 1 of 2
Slide 31: Conducting an Intellectual Property Audit 2 of 2

Preparing a Solid Legal

Foundation &

legal issues facing both startups and

new innovation initiatives

7-1

Initial Ethical and Legal Issues Facing a
New Firm

Establishing a strong

ethical culture
Choosing an attorney

Avoiding legal

disputes

Obtaining business

licenses and permits

Choosing a form of

business organization

Drafting a founder’s

agreement

Establishing a Strong Ethical Culture
1 of 2

• Lead by Example
• The most important thing that any entrepreneur, or team of entrepreneurs, can

do to build a strong ethical culture in their organization is to lead by example.

• Establish a Code of Conduct

• A code of conduct (or code of ethics) is a formal statement of an organization’s
values on certain ethical and social issues. This should be developed alongside
the Mission, Vision & Values statements for the company in the business plan.

7-3

Establishing a Strong Ethical Culture
2 of 2

• Implement an Ethics Training Program
• Ethics training programs teach business ethics to help employees deal with

ethical dilemmas and improve their overall ethical conduct.

• An ethical dilemma is a situation that involves doing something that is
beneficial to oneself or the organization, but may be unethical.

Potential Payoffs for Establishing a Strong
Ethical Culture

Choosing an Attorney for a Firm

• Select an Attorney Early
• It is important for an entrepreneur to select an attorney as early as possible

when developing a business venture.

• It is critically important that the attorney be familiar with start-up issues,
especially with investment contracts, term sheets and other specialized
contracts and dealings.

• Intellectual Property
• For issues dealing with intellectual property (patents, trademarks, copyrights,

and trade secrets) it is essential to use an attorney who specializes in this field.
This is especially important in innovation initiatives or high-tech startups.

How to Select an Attorney

• Contact the local bar association and ask for a list of attorneys who

specialize in start-ups in your area.

• Interview several attorneys.

• Select an attorney who is familiar with the start-up process.

• Select an attorney who can assist you in raising money for your new

venture.

• Make sure your attorney has a track record of completing his or her work

on time.

• Talk about fees.

• Select an attorney that you think understands your business.

• Learn as much about the process of starting a business yourself as

possible.

Drafting a Founders’ Agreement

• Founders’ Agreement
• A founders’ agreement (or shareholders’ agreement) is a written document that

deals with issues such as the relative split of the equity among the founders of
the firm, how individual founders will be compensated for the cash or the
“sweat equity” they put into the firm, and how long the founders will have to
remain with the firm for their shares to fully vest.

• The items to include in the founders’ agreement are shown on the following
slide.

Items to Include in a Founders’ Agreement

• Nature of the prospective business.

• Identity and proposed titles of the founders.

• Legal form of business ownership.

• Apportionment of stock (or division of ownership).

• Consideration paid for stock or ownership share of each of the founders.

• Identification of any intellectual property signed over to the business.

• Description of the initial operating capital.

• Buyback clause.

Avoiding Legal Disputes
1 of 2

• Avoiding Legal Disputes
• Most early legal disputes are the result of misunderstandings, sloppiness, or a

simple lack of knowledge of the law. Getting bogged down in legal disputes is
something an entrepreneur should work hard to avoid.

• There are several steps that an entrepreneur can take to avoid legal disputes:

• Meet all contractual

obligations.

• Avoid undercapitalization.

• Get everything in writing.

• Set standards.

Avoiding Legal Disputes
2 of 2

• Although it’s tempting to try

to show people you trust

them by not insisting on

written agreements, it’s not a

good practice. This is especially an

issue with friends, family and angel

investors.

• One of the simplest ways to

avoid misunderstandings

and ultimately legal disputes

is to get everything in

writing.

Obtaining Business Licenses and Permits
1 of 2

• Business Licenses
• In most communities, a business needs a license to operate.

• If the business will be run out of the founder’s home, a separate home
occupation business license is often required.

• If a business has employees, or is a corporation, limited liability company, or
limited partnership, it will usually need a state business license in addition to
its local one.

• A narrow group of companies are required to have a federal business license,
including investment advising, drug manufacturing, and interstate trucking.

Obtaining Business Licenses and Permits
2 of 2

• Business Permits
• Along with obtaining the appropriate licenses, some businesses may need to

obtain one or more permits.

• The need to obtain a permit depends on the nature and location of the business.

• If you plan to sell food, you’ll need a city or county health permit.

• If your business is open to the public, you may need a fire permit.

• Some communities require businesses to obtain a license to put up a sign.

• All businesses that plan to use a fictitious name need a fictitious business name permit.

Choosing a Form of Business Ownership

When a business is launched, a form of legal entity must be

chosen. The most common legal entities are…

Sole Proprietorship Partnership

Corporation

Limited Liability

Company

Issues to Consider in Choosing a Legal
Form of Business Ownership

Sole Proprietorship

• Sole Proprietorship
• The simplest form of business entity is the sole proprietorship.

• A sole proprietorship is a form of business organization involving one person,
and the person and the business are essentially the same.

• A sole proprietorship is not a separate legal entity. The sole proprietor is
responsible for all the liabilities of the business, and this is a significant
drawback.

Advantages and Disadvantages of a
Sole Proprietorship
1 of 2

Advantages of a Sole Proprietorship

▪ Creating one is easy and inexpensive.

▪ The owner maintains complete control of the business and retains all of the

profits.

▪ Business losses can be deducted against the sole proprietor’s other sources of

income.

▪ It is not subject to double taxation (explained later).

▪ The business is easy to dissolve.

Advantages and Disadvantages of a
Sole Proprietorship
2 of 2

Disadvantages of a Sole Proprietorship

▪ Liability on the owner’s part is unlimited.

▪ The business relies on the skills and abilities of a single owner to be successful.

Of course, the owner can hire employees who have additional skills and abilities.

▪ Raising capital can be difficult to impossible.

▪ The business ends at the owner’s death or loss of interest in the business.

▪ The liquidity of the owner’s investment is low.

Partnerships
1 of 3

• Partnerships
• If two or more people start a business, they must organize as a partnership,

corporation, or limited liability company.

• Partnerships are organized as either general or limited liability partnerships.

Partnerships
2 of 3

General Partnership

A form of business organization

where two or more people pool

their skills, abilities, and

resources to run a business. The

primary disadvantage is that all

partners are liable for all the

partnership’s debts and

obligations.

Partnerships
3 of 3

Limited Partnership

• A modified form of general

partnership.

• The major difference between the

two is that a limited partnership

includes two classes of owners:

general partners and limited

partners.

• The general partners are liable for

the debts and obligations of the

partnership, but the limited partners

are only liable up to the amount of

their investment.

Advantages and Disadvantages of a
General Partnership
1 of 2

Advantages of a General Partnership

▪ Creating one is relatively easy and inexpensive compared to a corporation or

limited liability company.

▪ The skills and abilities of more than one individual are available to the firm.

▪ Having more than one owner may make it easier to raise funds.

▪ Business losses can be deducted against the partners’ other sources of income.

▪ It is not subject to double taxation (explained later).

Advantages and Disadvantages of a
General Partnership
2 of 2

Disadvantages of a Partnership

▪ Liability on the part of each general partner is unlimited.

▪ The business relies on the skills and abilities of a fixed number of partners. Of

course, the owners can hire employees who have additional skills and abilities.

▪ Raising capital can be difficult.

▪ Because decision making among the partners is shared, disagreements can occur.

▪ The business ends with the death or withdrawal of one partner unless otherwise

stated in the partnership agreement.

▪ The liquidity of each partner’s investment is low.

Corporations

• Corporations
• A corporation is a separate legal entity organized under the authority of a state.

• Corporations are organized as either C corporations or subchapter S
corporations.

• C corporations are what most people think of when they hear the word
“corporation.” However, business startups are often organized as subchapter S
corporations.

C Corporation

1 of 2

C Corporation

• Is a separate legal entity that, in the

eyes of the law, is separate from its

owners.

• In most cases a corporation shields

its owners, who are called shareholders,

from personal liability for the debts of

the corporation.

• A corporation is governed by a board

of directors, which is elected by the

shareholders.

• A corporation is formed by filing

articles of incorporation.

C Corporation
2 of 2

C Corporation

• A corporation is taxed as a separate

legal entity.

• A disadvantage of a C corporation is

that it is subject to double taxation.

This means that a corporation is taxed

on its net income, and when the same

income is distributed to shareholders

in the form of dividends, the income is

taxed again on the shareholders’

personal tax returns.

Advantages and Disadvantages of a
C Corporation
1 of 2

Advantages of a C Corporation

▪ Owners are liable only for the debts and obligations of the corporation up to

the amount of their investment.

▪ The mechanics of raising capital is easier.

▪ No restrictions exist on the number of shareholders, which differs from

subchapter S corporations.

▪ Stock is liquid if traded on a major stock exchange.

▪ The ability to share stock with employees through stock options or other

incentive plans can be a powerful form of employee motivation.

Advantages and Disadvantages of a
C Corporation
2 of 2

Disadvantages of a C Corporation

▪ Setting up and maintaining one is more difficult than for a sole proprietorship

or a partnership.

▪ Business losses cannot be deducted against the shareholder’s other sources of

income.

▪ Income is subject to double taxation, meaning that it is taxed at the corporate

and the shareholder levels.

▪ Small shareholders typically have little voice in the management of the firm.

Subchapter S Corporation
1 of 2

Subchapter S

Corporation

• Combines the advantages of a

partnership and a C corporation.

• Is similar to a partnership in that the

income of the business is not subject

to double taxation.

• Is similar to a corporation in that the

owners are not subject to personal

liability for the debts or behavior of

the business.

• A Subchapter S Corporation does not

pay taxes. Profits and losses are passed

through to the tax returns of the owners.

Subchapter S Corporation
2 of 2

▪ The business cannot be a subsidiary of another corporation.

▪ The shareholders must be U.S. citizens. Partnerships and C corporations may

not own shares in a subchapter S corporation. Certain types of trusts and estates

are eligible to own shares in a subchapter S corporation.

▪ It can only have one class of stock issued and outstanding (either preferred

stock or common stock).

▪ It can have no more than 100 members. Husbands and wives count as one

member, even if they own separate shares of stock.

▪ All shareholders must agree to have the corporation formed as a subchapter

S corporation.

There are strict standards that a business must meet to qualify for status as a

subchapter S corporation. The standards are shown below:

Limited Liability

Company

Limited Liability

Company

• Is a form of business ownership that

is among the most popular now in the US.

• Along with the Subchapter S, it is a

popular choice for start-up firms.

• The limited liability company combines

the limited liability advantage of the

corporation with the tax advantages of

a partnership.

• A limited liability company does not

pay taxes. Profits and losses are passed

through to the tax returns of the owners.

Advantages and Disadvantages of a Limited
Liability Company
1 of 2

Advantages of a Limited Liability Company

▪ Members are liable for the debts and obligations of the business only up to the

amount of their investment.

▪ The number of shareholders is unlimited.

▪ An LLC can elect to be taxed as a sole proprietor, partnership, S corporation,

or corporation, providing much flexibility.

▪ Because profits are taxed only at the shareholder level, there is no double

taxation.

Advantages and Disadvantages of a Limited
Liability Company
2 of 2

Disadvantages of a Limited Liability Company

▪ Setting up and maintaining one is more difficult and expensive.

▪ Tax accounting can be complicated.

▪ Some of the regulations governing LLCs vary by state.

▪ Because LLCs are a relatively new type of business entity, there is not as

much legal precedent available for owners to anticipate how legal disputes

might affect their business.

▪ Some states levy a franchise tax on LLCs—which is essentially a fee the LLC

pays the state for the benefit of limited liability.

Slide 1
Slide 2: Initial Ethical and Legal Issues Facing a New Firm
Slide 3: Establishing a Strong Ethical Culture 1 of 2
Slide 4: Establishing a Strong Ethical Culture 2 of 2
Slide 5: Potential Payoffs for Establishing a Strong Ethical Culture
Slide 6: Choosing an Attorney for a Firm
Slide 7: How to Select an Attorney
Slide 8: Drafting a Founders’ Agreement
Slide 9: Items to Include in a Founders’ Agreement
Slide 10: Avoiding Legal Disputes 1 of 2
Slide 11: Avoiding Legal Disputes 2 of 2
Slide 12: Obtaining Business Licenses and Permits 1 of 2
Slide 13: Obtaining Business Licenses and Permits 2 of 2
Slide 14: Choosing a Form of Business Ownership
Slide 15: Issues to Consider in Choosing a Legal Form of Business Ownership
Slide 16: Sole Proprietorship
Slide 17: Advantages and Disadvantages of a Sole Proprietorship 1 of 2
Slide 18: Advantages and Disadvantages of a Sole Proprietorship 2 of 2
Slide 19: Partnerships 1 of 3
Slide 20: Partnerships 2 of 3
Slide 21: Partnerships 3 of 3
Slide 22: Advantages and Disadvantages of a General Partnership 1 of 2
Slide 23: Advantages and Disadvantages of a General Partnership 2 of 2
Slide 24: Corporations
Slide 25: C Corporation 1 of 2
Slide 26: C Corporation 2 of 2
Slide 27: Advantages and Disadvantages of a C Corporation 1 of 2
Slide 28: Advantages and Disadvantages of a C Corporation 2 of 2
Slide 29: Subchapter S Corporation 1 of 2
Slide 30: Subchapter S Corporation 2 of 2
Slide 31: Limited Liability Company
Slide 32: Advantages and Disadvantages of a Limited Liability Company 1 of 2
Slide 33: Advantages and Disadvantages of a Limited Liability Company 2 of 2

FINANCING THE ENTREPRENEURIAL VENTURE

Documentation package
(some examples) of investor
funding of startups

ENCLOSURES

In this packet you will find examples of:

• A typical NDA (non-disclosure agreement), which is a contract almost always signed by

the startup seeking funds and a potential investor, in which legal confidentiality is ensured.

Startups often have unique value propositions, business models, ideas business processes or

products and IP that must be protected.

• A Deal Termsheet This is signed when the parties have agreed in principle to do the

business, the investor will invest, and the startup will share the equity. The example you

have in this packet is for the 2nd round of finance of an actual startup company. This

termsheet forms the financial and primary terms of the investment agreement, which is not

included in this packet as these can be typically 50 pages or so and must be drafted by

experienced attorneys in corporate and startup law.

• A Spreadsheet of the agreed valuation and termsheet ownership which shows the final

equity holdings according to the investment agreement and terms of the termsheet deal.

This is always incorporated by reference and made part of the investment agreement as it

details precisely what percentage of the company the various parties (investors, founders,

and other parties) own at various steps.

Financing Examples

FINANCING THE ENTREPRENEURIAL VENTURE

Complete the Business Plan
Must have to seek investment

Undertake Investor Search
Major Undertaking

Negotiate with Interested

Investors
NDA, Valuation, Term Sheets

Sign Deal & get
to work

Always Milestone conditions

Get ready
for next
round

Initial: _____________ _____________ Page 1 of

MUTUAL NON-DISCLOSURE AGREEMENT

THIS MUTUAL NON-DISCLOSURE AGREEMENT (“Agreement”) is made the

day of 20xx BETWEEN:-

(1) THE STARTUP, a THE INVESTOR incorporated in the state of Maryland having its

address at

(2) a THE INVESTOR

incorporated in and having its

address at

(“Investor”).

WHEREAS:-

(A) THE STARTUP and the THE INVESTOR hereto have entered, or intend to enter, into

discussions concerning

(the “Purpose”).

(B) Pursuant to the Purpose the parties have agreed to exchange certain Confidential

Information (hereinafter defined) concerning the Purpose and have agreed to provide

and to accept such Confidential Information on a strictly confidential basis and on the

terms and conditions set out below.

Party” and the party receiving such information shall be referred to as the “Receiving

Party.”

IT IS HEREBY AGREED between the parties as follows:-

1. CONFIDENTIAL

INFORMATION

1.1 The term “Confidential Information” for the purpose of this Agreement shall mean any

and all information disclosed, furnished or communicated (if in writing, machine

readable form, text, drawings, schematics, designs, or any other tangible form

whatsoever to be marked or otherwise designated as being “Confidential” or

“Proprietary” or if disclosed orally, to be stated at the time of disclosure as being

Confidential, reduced into writing and delivered to the Receiving Party within thirty

(30) days of disclosure) including but not limited to, research, product plans, trade

secrets, algorithms, know-how, formulae, schematics, products, pricing, services,

customers, markets, developments, inventions, processes, product development,

Initial: _____________ _____________ Page 2 of 5

forecasts, marketing or finances by or on behalf of the Disclosing Party to the Receiving

Party in connection with the Purpose.

1.2 Notwithstanding any other provision of this Agreement, the parties hereto acknowledge

that Confidential Information shall not include any information that:

a) is in the public domain at the time of disclosure hereunder, or subsequently comes

into the public domain other than by breach of this Agreement;

b) was previously in the possession of the Receiving Party without obligation of

confidentiality as evidenced by written records;

c) is independently developed by the Receiving Party without use of the Confidential

Information as evidenced by written records;

d) a party hereto lawfully receives without any restriction on disclosure from a third

party; and

e) is in response to a valid order of a court or other governmental body or is otherwise

required by law to be disclosed, provided the responding party gives sufficient

notice to the other party to enable it to take protective measures.

2. OBLIGATIONS OF CONFIDENTIALITY

2.1 In consideration of the disclosure and release of the Confidential Information by or on

behalf of the Disclosing Party to the Receiving Party, the Receiving Party hereby agrees

to hold and keep in strictest confidence any and all such Confidential Information. The

Receiving Party shall use the same degree of care to avoid disclosure or use of the

Confidential Information as it uses in respect of its own information of like importance

but in no case less than a reasonable degree of care.

2.2 The Receiving Party undertakes that it shall make use of the Confidential Information

solely for the Purpose.

2.3 The Receiving Party shall take all steps and measures to minimise the risk of disclosure

of the Confidential Information by ensuring that only such employees whose duties

require them to possess the Confidential Information for the Purpose shall have access

to the Confidential Information on a need-to-know basis and such disclosure shall be on

terms not less restrictive than those herein contained. In any event, the Receiving Party

shall be responsible for any breach of the terms of this Agreement by any of its

employees and shall take all measures (including but not limited to court proceedings)

to restrain such employees from prohibited or unauthorised disclosure or use of the

Confidential Information.

Initial: _____________ _____________ Page 3 of 5

2.4 The Receiving Party shall ensure that the Confidential Information will not be copied

or reproduced in any form whatsoever by the Receiving Party, its employees or any

other third parties without the express written permission of the Disclosing Party.

2.5 The Receiving Party hereby agrees that it shall promptly return to the Disclosing Party

any or all such Confidential Information upon request by the Disclosing Party at any

time, or at the Disclosing Party’s request, destroy all such Confidential Information and

issue a written document signed by an officer confirming such destruction.

2.6 Obligations of confidentiality under this Agreement shall not be construed to limit either

party’s right to independently develop products without use of the Confidential

Information. The unintentional use of Confidential Information in non-tangible and

non-recorded form which may be incidentally retained by persons who have had access

to Confidential Information may not be limited

3. NO LICENSE GRANTED

3.1 Nothing in this Agreement shall be construed as granting expressly or by implication

during the duration of this Agreement or thereafter, any transfer, assignment, license on

any other rights in respect of any license, patent, copyright or any other industrial or

intellectual property right in force and belonging to the Disclosing Party which rights

shall remain vested in and the absolute property of the Disclosing Party.

4. REPORTING MISUSE OR MISAPPROPRIATION OF CONFIDENTIAL

INFORMATION

Each party agrees to promptly notify the other party in writing of any misuse or

misappropriation of such Confidential Information of the other party which may come

to its attention.

5. DURATION OF AGREEMENT

This Agreement shall be effective upon its execution, and shall, unless otherwise agreed

between the parties in writing, continue for a period of three (3) years from the date this

Agreement is executed, provided that the obligations undertaken herein with respect to

Confidential Information received prior to the termination of this Agreement shall

survive and continue for three (3) years after disclosure of Confidential Information

notwithstanding the expiration or termination of this Agreement.

6. REMEDIES

Initial: _____________ _____________ Page 4 of 5

Nothing herein shall be construed as limiting any party’s rights to those expressly set

out herein, to the exclusion of such other rights as may be available under common law

or equity. The Receiving Party acknowledges and agrees that due to the importance of

the Disclosing Party’s Confidential Information, there may be no adequate remedy at

law for any breach of its obligations hereunder, which breach may result in irreparable

harm to the Disclosing Party, and therefore, that upon any such breach or any threat

thereof, the Disclosing Party shall be entitled to seek appropriate equitable relief in

addition to whatever remedies it might have at law.

7. RIGHTS CUMULATIVE

The rights and remedies of each of the parties provided herein are cumulative and not

exclusive of any rights and remedies provided by law to such party.

8. GOVERNING LAW

This Agreement shall be governed by and construed in accordance with the laws of the

state of Maryland, USA.

9. JURISDICTION

The parties irrevocably submit to the non-exclusive jurisdiction of the courts Maryland.

Initial: _____________ _____________ Page 5 of 5

IN WITNESS WHEREOF the parties hereto have caused their duly authorised representatives

to set their hands the day and year first abovewritten.

For and on behalf of

THE STARTUP PTE LTD

Name :

Title :

For and on behalf of

[ ]

Name:

Title:

SIGNATURE PAGE TO THE NON-DISCLOSURE AGREEMENT BETWEEN THE STARTUP PTE

LTD AND [ ] DATED [ ]

STARTUP COMPANY

Term Sheet

June 7, 20xx

Co-lead Investor 1: Venturebank Infrastructure Fund

(“VB” or “Investor 1”)

Co-lead Investor 2: Golden Socks Private Equity Fund

(“GS” or “Investor 2”)

Co-lead Investor 3: VC International Group Consortium

(“VC” or “Investor 3,” comprised of the VC group

Managing Director of

The co-lead investing group

And of the investment: VC International Group Consortium

Lead Vendor Financier

And Managing Director Crisco Capital

of Vendor Finance: (“Crisco” or “Lead VF”)

____________________________________________________________________________________

co-lead Amount: US$ 60-70 million to be invested in STARTUP Company (“STARTUP ”

or “the Company”), of which VB will contribute US$ 30 million, GS will

contribute US$20 million, and VC will contribute US$20 million.

Non-lead investors

Amount to be

Obtained: US$5-20 million, resulting in a fully-funded business plan for the

company. Non-lead co-investors to be confirmed subsequent to

execution of this document.

Co-lead total

Shares Purchased: A number of shares of Series B Convertible Preferred Stock, such that

the total number of shares on a fully diluted “as converted basis”

multiplied by the Purchase Price is equal to US$ xxx million post-

money. Fully diluted “as converted basis” means the sum of: 1) all

Common Stock shares; 2) all Series Preferred Stock shares; and 3) all

allocated options (whether issued or not-yet issued) on “as converted

basis”.

Upon completion of the Investment, 3 co-leads will own x%, other

shareholders will own y%, and the Options will comprise z% of the

Company’s fully diluted shares.

Divbursements: The funds will be disbursed according to the following schedule, with the

following specific milestones:

Tranche 1: US$30 million on 30 June 2001, with 15 million Series B

Convertible Preferred Stock issued, of which 3 co-leads will contribute

US$x million for x(a) million Series B Convertible Preferred Stock.

Tranche 2: US$ 35 million on January 30, 2002, with y million Series B

Convertible Preferred Stock, , of which 3 co-leads will contribute US$y

million for y(b) million Series B Convertible Preferred Stock.

Milestones: To achieve two of the three targets as follows:

(a) To generate a target number of Subscribers (to be agreed)

(b) To meet its CAPEX target (to be agreed)

(hereinafter referred to as the “Target” or collectively the “Targets”)

For the purposes of certainty, a Target is deemed to be achieved if the

Company is able to achieve a performance figure which is +20% or -20%

of the number for a given Target.

Tranche 3: US$ 30 million on July 30, 2002, with z million Series B

Convertible Preferred Stock, , of which 3 co-leads will contribute US$15

million for z(c) million Series B Convertible Preferred Stock.

Milestones: To achieve two of the three targets as follows:

(d) To generate a target number of Subscribers (to be agreed)

(e) To meet its CAPEX target (to be agreed)

(f) To meet its OPEX target (to be agreed)

(hereinafter referred to as the “Target” or collectively the “Targets”)

For the purposes of certainty, a Target is deemed to be achieved if the

Company is able to achieve a performance figure which is +20% or –

20% of the number for a given Target.

Conversion: Each share of Series B Convertible Preferred Stock is convertible into

one share of Common Stock at any time, at the option of the holder. The

conversion ratio is subject to adjustments for stock splits and for stock

issued at less than the current conversion price, excluding approved

employee stock options.

Mandatory Conversion: Upon a public sale of Common Stock resulting in at least US$50 million

of proceeds to STARTUP. (hereinafter defined as an “IPO”).

Voting Rights: The Series B Convertible Preferred Stock will vote, together with the

common stock, on an “as if converted” basis.

Debt Financing: Crisco, which has already approved Startup for vendor finance, and

according to the term sheet negotiated, shall provide The Company with

vendor finance in an amount not to exceed X$. For non-Crisco vendor

finance up to an amount of US$50M, Crisco shall act as lead Vendor

Financier. Such debt financing shall include entering into vendor finance

arrangements and the issuance of debt instruments.

Affirmative Covenants: STARTUP shall furnish Series B Preferred shareholders who hold 10%

or more of the outstanding shares (whether Preferred or Common) with

certain information and permit access to certain data including the

following:

1. Monthly financial statements prepared in accordance with U.S.

GAAP (including an income statement, a cash flow statement, a

balance sheet, and comparisons to budget) within 30 days of month-

end.

2. Annual audited financial statements prepared in accordance with

U.S. GAAP within 60 days of year-end.

3. Monthly Board meetings to review STARTUP’ progress.

4. Annual Business Plan, approved by STARTUP’ Board (including

monthly budget) no later than 30 days prior to the beginning of the

fiscal year.

Negative Covenants: Without the approval of a majority of the holders of Series B Convertible

Preferred stock, STARTUP will not take certain actions including the

following:

1. Sell or issue any equity or debt securities in the company, with the

exception of Board-approved options to employees.

2. Declare or pay any dividend or distribution or otherwise repurchase

or redeem any equity securities.

3. Make any acquisitions or enter into any mergers.

4. Engage in any business other than that described in the currently

approved Business Plan.

5. Amend the currently approved Business Plan.

6. Appoint, remove, or change the terms of employment (including

compensation) of its CEO, CFO, COO and its other senior

executives.

7. Other mutually agreed covenants.

Executive

Management: The Company intends to make an offer of employment to Mr. Big

Cheese as Chief Executive Officer of the Startup Group, who is prepared

to come on board immediately. Upon Mr. Big Cheese’s acceptance of

the position, Messrs. (Founders 1 & 2) shall move to the positions of

Executive Vice-Chairmen and shall continue in executive capacity and

form the Executive Committee together with Mr. Big Cheese, and the to-

be-named CFO.

Board Seats: VB will have one (1) seat out of eight on the Board of Directors. GS will

have one (1) seat out of eight on the Board of Directors. The other six are

or will be held by (to be named), and two outside directors to be

nominated). There will be an optional ninth board seat to be allocated to

(potential additional investor) in the event of their confirmed investment.

Right of First Refusal: Until an IPO, in the event that any shareholder desires to sell or transfer

all or a portion of its shares, the other shareholders will have the pro-rata

right to purchase such shares on the same terms and conditions as those

offered by prospective buyers.

Pre-emptive Rights: If the Company issues additional equity securities prior to an IPO, all

shareholders will be provided the opportunity to purchase their pro rata

share so as to maintain their fully-diluted equity ownership position.

Registration Rights: In the event of an IPO, the Investor will have rights to three (3) demand

registrations and unlimited “piggyback” registrations of their securities, if

applicable. Expenses for these registrations shall be borne by the

Company.

Expenses: In the event this transaction does not complete, the Investor and the

Company will each bear its own expenses associated with this

transaction.

Termination: If a definitive agreement is not reached on or before June 30, 20xx, or

such other date as the Company, its shareholders and the Investor may

agree in writing, this Term Sheet shall be automatically terminated on

such date.

Disclosure: From and after the date hereof, STARTUP, all its shareholders and

Investor agree that they shall make no written or other public disclosures

regarding this transaction to any individual or organization without the

prior written consent of the other party save to their respective advisers

or as required by law or any regulatory authority.

Binding Effect The parties understand and acknowledge that, except for the

and Liability: obligations of the Company, its shareholders and the Investor in the

sections on “Expenses”, “Termination”, “Disclosure,” and this “Binding

Effect and Liability,” this Term Sheet, or any attachment hereto, is not a

legally binding agreement and that the failure to execute and deliver a

definitive agreement shall impose no liability on the Company, its

shareholders and/or the Investor.

Should the terms of this Term Sheet be acceptable to the Company, please so indicate on the

enclosed copy of this letter and return it to the undersigned.

Signature blocks to be prepared…

By: ___________________________

Accepted and Agreed on behalf of STARTUP, Inc., and all its Shareholders

By: __________________________

Founder 1

Chief Executive Officer, Startup.

Date: _________________________

FINAL EQUITY HOLDINGS INVESTMENT AGREEMENT
Shares Outstanding Shares Issued Value Per Share Value Ownership

Post Money Series A 57,968,750$ after inclusion of employee stock option plan at same per share value
Shares owned Founders 10,500,000 45.28%
Shares owned Employees SOP 4,637,500 20.00%
Shares owned Investor 1 5,950,000 25.66%
Shares owned Investor 2 700,000 3.02%
Shares owned Investor 3 1,400,000 6.04%

23,187,500 2.50 100.00%

Series B Stage – 1 June 2001 – USD20M Drawdown
Premium relative to previous round 1.00
Pre Money Series B Stage 1 57,968,750$ 2.5
Shares owned Founders 10,500,000 0 33.67%
Shares owned Employees SOP 4,637,500 0 14.87%
Shares owned Investor 1 5,000,000 5,950,000 2,000,000 25.49%
Lead New Investor 10,000,000 4,000,000 12.83%

0 0.00%
Shares owned Followers 0 0.00%
Shares owned Investor 2 700,000 0 2.24%
Shares owned Investor 3 5,000,000 1,400,000 2,000,000 10.90%

23,187,500 8,000,000 2.50
Total number of shares 31,187,500 2.50
Post Money Series B Stage 1 77,968,750.00 100.00%

Series B Stage 2 – January 2002 – USD40M Drawdown
Premium relative to previous round 2.00
Pre Money Series B Stage 2 155,937,500$ 5
Shares owned Founders 10,500,000 0 26.79%
Shares owned Employees SOP 4,637,500 0 11.83%
Shares owned Investor 1 7,950,000 0 20.29%
Lead New Investor $30,000,000 4,000,000 6,000,000 25.52%
Shares owned Followers $10,000,000 – 2,000,000 5.10%
Shares owned Investor 2 700,000 0 1.79%
Shares owned Investor 3 3,400,000 0 8.68%

31,187,500 8,000,000 5.00
Total number of shares 39,187,500 5.00
Post Money Series B Stage 2 195,937,500.00 100.00%

Series B Stage 3 – June 2002 – USD40M Drawdown
Premium relative to previous round 2.00
Pre Money Series B Stage 2 391,875,000$ 10
Shares owned Founders 10,500,000 0 24.31%
Shares owned Employees SOP 4,637,500 0 10.74%
Shares owned Investor 1 7,950,000 0 18.41%
Lead New Investor $30,000,000 10,000,000 3,000,000 30.10%
Shares owned Followers $10,000,000 2,000,000 1,000,000 6.95%
Shares owned Investor 2 700,000 0 1.62%
Shares owned Investor 3 3,400,000 0 7.87%

39,187,500 4,000,000 10.00
Total number of shares 43,187,500 10.00
Post Money Series B Stage 3 431,875,000.00 100.00%

Investment per Investor Shares per Investor Average Price Paid
Shares owned Founders 10,500,000 24.31%
Shares owned Employees SOP 4,637,500 10.74%
Shares owned Investor 1 $5,000,000 7,950,000 0.63 18.41%
Lead New Investor $70,000,000 13,000,000 5.38 30.10%
Shares owned Followers $20,000,000 3,000,000 6.67 6.95%
Shares owned Investor 2 $0 700,000 0.00 1.62%
Shares owned Investor 3 $5,000,000 3,400,000 1.47 7.87%

$100,000,000 43,187,500 – 5.00
Total number of shares 43,187,500 5.00
Post Money Series B Stage 2 215,937,500.00 100.00%
Notes :

Start-up
businesses and
venture capital

Start-up businesses and venture capital:
contents

•

Financial strategy for a start-up business

•

Stages in a start-up

• Two ways of accounting for the risk

• Real options

• Venture capital and business angels

• Example of corporate venturing

• Deal terms will include…

•

Pre- and post-money

• Pre- and post-money example

•

Anti-dilution clauses, used in a ‘down’ round

• Liquidation preference reduces risk and boosts return

Financial strategy for a start-up business

Business risk Very high

Financial risk Very low

Source of outside funding Venture capital

Dividend policy Nil pay-out ratio

Future growth prospects Very high

Price/earnings multiple Very high

Current profitability (eps) Nominal or negative

Share price Rapidly growing but highly volatile

Stages in a start-up

Business
making R&D

spend

Prototype and market
testing

Production &
commercialization

Chance to become
valuable

The length of each stage depends on the industry and business model

The number of successful entities decreases at each stage

Time

Two ways of accounting for the risk
Probability-adjust cash flows

• Probability-adjust the cash
flows to allow for the
changes in probability of
success as each stage is
reached

• This is more complex
mathematically, but has the
advantage that certain cash
outflows are not discounted
at a high rate

• It is theoretically more
appropriate

Use a higher discount rate

• A high discount rate is
applied to the whole
project to allow for the
overall risk taken on

• This is more commonly
used, because it is
simpler, but can be
misleading

Real options
• Multi-stage projects

• Timing flexibility

• Alternative uses

• Growth potential

• Exit options

Real options take account of the

value inherent in flexibility

Venture capital investors and business angels

Venture Capital

• Professional investment firms,
generally investing funds they
have raised as intermediaries
rather than their own money

• Have a portfolio of high-risk
investments, often
specializing in a particular
sector or a specific
technology

Business Angels

• Individuals, often investing their
own money

• Often more informal than
professional firms

• Investment criteria include:
favourable impression of the
management team, familiarity
with the sector, geographical
proximity, synergy with own
skills

Both venture capital firms and business
angels are investing with the aim of a high
financial return

Pre- and post-money

Pre-money
value

+ Investment = Post-
money value

Pre- and post-money example
• Entrepreneur seeks $100,000 in exchange for 10% of the

business.
• This implies that the business as it stands is worth $900,000 (pre-

money)
• And after the investment, it will be worth $1,000,000 (post-money)

$100,000 = 10% (Pre-money value + $ 100,000)

$ 100,000 = (10% x Pre-money value) + $ 10,000

10% x Pre-money value = $ 90,000

Pre-money value = $ 900,000

Post-money value = $ 900,000 + $ 100,000 = $ 1,000,000

Anti-dilution clauses, used in a ‘down’ round

If someone else buys more cheaply, you get a refund.

Example

▪ Original VC investors bought ‘A’ shares at $100 per share. The ‘A’ shares will
convert into ordinary shares on a disposal, on a 1:1 basis

▪ Next stage investors will buy ‘B’ shares at $ 50 each

▪ Because the ‘A‘ shares are being diluted, the holders of the ‘A’ shares are
issued with new free(ish) shares, to bring their overall cost down to $ 50 per
share. This dilutes the founder’s stake. Or, conversion terms may alter to
achieve same effect.

Liquidation preference reduces risk and
boosts return

PE company makes sure that on a disposal it gets its money back, or a multiple of its money. Surplus proceeds are then split between
parties

Example, where VC has put in $200,000 for 50% of the equity. Sales proceeds for equity of $100k, $300k and $1m.

$100,000

proceeds

$300,000

proceeds

$1 million

proceeds

No liquid’n pref $50,000 $150,000 $500,000

1x LP $100,000 $250,000
($200k plus half of

$100k)

$600,000
($200k plus half of

$800k)

2x LP $100,000 $300,000 $700,000
($400k plus half of

$600k)

OR – the other shareholders may be credited with their own amounts paid for their shares, in a
catch-up exercise before the net proceeds are divided

Funding Process steps (1)
• Complete Business Plan and form Founding Team1

• Undertake Investor Search2

• After finding interested investor, execute NDA (Non-disclosure
Agreement)3

• Negotiate Valuation with Investor(s)4

• Negotiate Term Sheet with Investors5

• Negotiate & Sign Investment Agreement with Investors6

• Plan process again for next round of finance, according to
business plan

Funding Process steps (1)
• 1 Complete Business Plan (your course capstone gives you this knowledge)

• 2 Undertake Investor Search (beyond the scope of this course and is an extensive
exercise in itself)

• 3 After finding interested investor, execute NDA (there is an example in
your course learning resources)

• 4 Negotiate Valuation with Investors (there is an example in your course
learning resources)

• 5 Negotiate Term Sheet with Investors (there is an example in your course
learning resources)

• 6 Sign Investment Agreement with Investors (beyond the scope of this course –
these typically can run 50 pages and need to be prepared by an experienced attorney at startup
contractual matters)

• Start process again for next round of finance

Slide 1: Start-up businesses and venture capital
Slide 2: Start-up businesses and venture capital: contents
Slide 3: Financial strategy for a start-up business
Slide 4: Stages in a start-up
Slide 5: Two ways of accounting for the risk
Slide 6: Real options
Slide 7: Venture capital investors and business angels
Slide 8: Pre- and post-money
Slide 9: Pre- and post-money example
Slide 10: Anti-dilution clauses, used in a ‘down’ round
Slide 11: Liquidation preference reduces risk and boosts return
Slide 12: Funding Process steps (1)
Slide 13: Funding Process steps (1)

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