Financing Life Cycle: Early Stages & Venture Capital

Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

This lesson will introduce you to a startup business and how it obtains the necessary funding through the early stages of its development. We will go from the idea stage through the need for venture capital.

Idea Stage

Don and Brad have been interested in technology ever since they can remember. They used to meet in Don's parents' garage and build radios and circuit boards, something their parents encouraged since it kept them out of trouble! Then they had their big idea. They came up with a new kind of battery that works in smartphones and lasts twice as long between charges as what is currently out there! Everyone they know complains about how fast their phones run out of juice. They knew they were sitting on a gold mine, but they would need to actually start a business to get the batteries produced and sold, and that was going to take some money.

Friends and Family Round

The first place they went for cash was their parents, who agreed to lend them a few thousand dollars. 'Pay us back when you are actually making money,' they said. 'It will be sooner than you think.' Don and Brad had a bigger problem, though - they didn't have the slightest idea about how to start a business, much less run one. They could use a business incubator. Business incubators are usually government funded entities that exist to encourage new businesses. They provide cash, office space and advice for new businesses. The boys believed in their product and wanted a real office to call their own. They wanted to try something else first.

They decided instead to talk to Brad's aunt Molly, who has a CPA and works for a leading food retailer. What the boys really needed was for Molly to agree to be their business manager and help them get started. They decided to give Molly one third of the business to partner with them. New businesses that don't have any revenue can raise money and get services from others by offering equity, which is just a different word for ownership. Equity partners own part of the business. Molly believed this battery idea had a big future and she agreed to work for the boys for no salary, as long as she had that one third ownership stake.

Bills

She told the boys to let her use that money their parents gave them to get the business registered. They would also need to get the new battery idea patented. 'That would mean lots of paperwork and more money than we have,' she told them. So Don went to his uncle and offered him 5% ownership in the company for $10,000. The boys were excited when he accepted the offer - now they were going to be real businessmen!

The Angel Round

'We are on the road to riches,' the boys thought, 'but now it's time to find a location and set up production.' They found an old warehouse that was just perfect and put down a sizable deposit. Don and Brad had visions of sitting in their offices in the back smoking expensive cigars! Molly told them not to get ahead of themselves; it was going to take a serious round of financing to pay for all of the equipment they were going to need. The bank wasn't interested in lending them money, at least not yet. They were told to come back when they actually had some revenue. Molly and the boys also knew that there was no one in either family that had the kind of money they needed to get to the next level. They were ready to seek outside investors with some real money!

One day Brad decided to go to the university he attended and get some advice on setting up production. One of his former science professors was glad to help. After helping Brad complete the blue prints and equipment list, the professor had a proposition to make. He told Brad that he thought the new battery idea was solid and could go far. He could be interested in investing his own money in the business for a share of ownership. 'I like to act as an angel investor,' he told Brad. 'I give new businesses the money they need to get off the ground, especially if the business is owned by one of my former students!'

A few weeks later, Don, Brad and Molly agreed to give the professor 20% of the business for $100,000. 'We have found our angel,' said Molly. 'Now you guys can get the battery factory set up!'

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