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Chapter 12: Early-Stage Business Development: Human and Financial Capital. Questions answered in this chapter: What are the key considerations in the business planning process? What are the different sources of human capital that can play a role in a startup business?
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Chapter 12: Early-Stage Business Development: Human and Financial Capital • Questions answered in this chapter: • What are the key considerations in the business planning process? • What are the different sources of human capital that can play a role in a startup business? • What are the typical sources of funding for an early-stage startup business? • What elements are needed for a successful pitch to investors? Chapter 12: Human and Financial Capital
What is a Startup? • A startup is a business that is in the process of developing the underlying infrastructure needed to support future growth • A startup is a business engaging in the the following three basic processes: • Developing and refining the offering and strategy to go to market • Obtaining initial funding to begin operations • Building a capable management team to handle operations Chapter 12: Human and Financial Capital
Relationship between Human and Financial Capital • Human and financial capital resources can influence the business planning process and, in turn, be influenced by the business plan • Human capital resources may include entrepreneurs, management team, strategic advisors and partners, and logistical advisors and partners • Sources for financial capital include debt financing and equity financing Chapter 12: Human and Financial Capital
Elements of a solid business planning process • The major elements of a business planning process include the following: • Defining the value proposition • Framing the market opportunity • Detailing how to reach customers • Developing an implementation plan • Evaluating potential external influences • Articulating the revenue model • Calculating preliminary financial projections • Establishing critical milestones • Summarizing the advantage Chapter 12: Human and Financial Capital
Human Capital • The role of human capital in a startup business is especially critical because, for a time, it is the only resource available • When investors consider funding an early-stage company, they assess its human capital • Who is the entrepreneur? • Does she have the drive to see this business through? • Who is on the management team? • Will they be able to execute? • The human capital attracts the financial capital Chapter 12: Human and Financial Capital
The Trials and Tribulations of the Entrepreneur • From the outset, the entrepreneur is faced with reconciling several difficult paradoxes: • Being visionary vs. being realistic. The entrepreneur is faced with the challenge of coming up with unique ideas that are grounded in reality • Generating quick returns vs. investing in the future. The entrepreneur is challenged with staying the course to build the organization while meeting the demands of the investors who are needed to build the organization in the first place • Optimism vs. pragmatism. While optimism is an essential motivating force, it must be balanced with the pragmatism to evaluate potential weaknesses of the business Chapter 12: Human and Financial Capital
Characteristics of Successful Entrepreneurs • Key characteristics common to successful entrepreneurs include the following: • Natural problem solvers. Entrepreneurs are those who are able to make observations about the needs of industries, markets, and everyday life and find the best way to meet these needs • Willingness to take risks. Entrepreneurs are willing to leave stable jobs and guaranteed salaries for their enterprises • Drive. The entrepreneur’s personal drive is especially important in the early stages, when his enthusiasm spurs the drive of other employees • Flexibility. The ability to adapt and react quickly are especially important in the fast-changing Internet environment • Vision. The most successful entrepreneurs are not driven by money, but by a vision or a passion consistently pursued Chapter 12: Human and Financial Capital
The Entrepreneur and the Idea • Some of the most common types of business ideas include the following: • Introduce a new product (new software—MP3) • Introduce a new service (overnight delivery—FedEx) • Improve an existing model of business (selling books on the Internet—Amazon.com) • Create demand (free one hour delivery service—Kozmo.com) • Build a brand—the first-mover advantage (eToys.com, Pets.com, eParty.com) Chapter 12: Human and Financial Capital
The Management Team • The core team consists of individuals essential to the early formative days of the startup who will fill the following three roles: • Technology specialist: is the person who understands the specific mechanics of how the product works, how it is manufactured, and how it can be utilized • Sales and marketing specialist: is the person with an in-depth understanding of the startup’s customer • Execution specialist: is the person who keeps everything in perspective in the startup’s development making the vision for the business a reality Chapter 12: Human and Financial Capital
The Management Team (cont’d) • Extended management team can be created on an as-needed basis, depending on how quickly the startup is growing • Chief operating officer • Chief financial officer • VP of marketing • VP of sales • VP of business development • Chief people officer • General counsel Chapter 12: Human and Financial Capital
Strategic Advisors and Partners • Strategic advisors and partners provide the startup with strategic direction, advice, and in many instances credibility for the organization as a whole • Advisory board members serve as an outsourced resource to fill a particular need and may receive stock options in exchange for their expertise • The board of directors consists of individuals who will be responsible for the well-being of the company, as well as holding the management team accountable for its actions when the business formalizes operations • A strategic association is the agreement of two entities to work together and exchange expertise in areas where they lack core competencies • A strategic alliance is a legally binding contractual agreement to share resources on a project for a particular timeframe Chapter 12: Human and Financial Capital
Logistical Advisors and Partners • Logistical advisors and partners differ from the strategic advisors and partners in that they are more involved in the day-to-day operations of the business • Necessary logistical advisors and partners include certified public accountants (CPA) and legal counsel • Supporting logistical advisors and partners serve as outsourced, human-capital leverage for the startup and may include intermediaries, consultants, and incubators Chapter 12: Human and Financial Capital
Financial Capital • Sources of debt financing (commercial banks, trade credit) • Sources of equity financing (owner’s equity, “angels”, venture-capital) • Strategic investors are concerned how a certain business compliments their current activities (exposure to cutting-edge technology or business model, collaboration in research and development for a product, etc.) • Financial investors are concerned with return on investment (ROI), internal rate of return, cost of capital, and return on equity Chapter 12: Human and Financial Capital
Debt Financing • Trade credit is credit extended to a business by its suppliers. It is an interest-free loan covering the time period from when supplies are delivered to when the invoice is due • Suppliers typically offer trade credit to buyers with an established track record of making prompt payments • Hidden interest rate cost • Commercial bank loan is, typically, an installment loan in which the business borrows a certain amount of money for a specified period with either a fixed or variable interest rate • Commercial banks evaluate a business’ loan application by assessing the likelihood of loan repayment • Bank loans can be relatively difficult to obtain, especially for early-stage businesses with little collateral and no positive cash flow Chapter 12: Human and Financial Capital
Equity Financing: Bootstrapping • Bootstrapping is the art of using personal resources to finance the early stages of a startup • Bootstrapping may include taking a personal loan, mortgaging a home, using credit cards or savings accounts • Bootstrapping provides the most viable option for the entrepreneur when the startup is in the earliest stages of business, especially during the stages that involve proving the business concept • Bootstrapping allows the entrepreneur to control the company and refine his business strategy without pressure from outside investors • The disadvantage of bootstrapping is that it is unlikely to provide sufficient cash for a good business concept to grow quickly beyond the earliest stages Chapter 12: Human and Financial Capital
Equity Financing: “Angels” • “Angels” are wealthy individuals who invest personal capital in startups in exchange for equity or sometimes a seat on the board of directors • Its critical for the entrepreneur to develop a network of individuals within the industry to gain introductions to potential financiers because “angels” seldom look at unsolicited business plans • Business plans are evaluated based on the quality of the management team, market potential for the business idea, and the track record of the entrepreneur • Typically, “angels” are more flexible in accepting changes in the original business plan if it is necessary • “Angels” tend to be more involved in the day-to-day” operations of startups Chapter 12: Human and Financial Capital
Equity Financing: Venture Capital • Venture-capital firms are usually private partnerships or closely held corporations that raise money from a group of private investors • A venture-capital firm typically invests $250,000 to $10 million in a business in exchange for a 30 to 40 percent equity stake and a seat on the board of directors • In addition to receiving cash, the entrepreneur receives guidance for building the startup • Venture capitalists, typically, charge management fees on the order of 1 to 5 percent of the capital investment in a startup • A venture-capital firm seeks opportunities that will return 10 times the original investment within five years, but realizes that each investment is a gamble and that only 10 percent are likely to succeed • The biggest disadvantage of venture capital funding is the source’s concern with the bottom line Chapter 12: Human and Financial Capital
Equity Financing: Corporate Ventures • Large corporations sometimes set up venture funds as a subsidiary that can make investments on behalf of the parent company, referred to as either corporate venture or “direct investors” • Corporate-venture funds invest in complimentary business for primarily strategic reasons • In exchange for cash, capital ventures seek an equity stake in the company and access to the company’s technology or product • Established corporations can offer the operational expertise as well as the credibility and visibility that come from associating with an established high-profile parent • Because the investments are strategic rather than financial, the pricing of deals with corporations tends to favor the entrepreneur more than deals with venture-capital firms Chapter 12: Human and Financial Capital
The Business Plan • A business plan should provide the following information to a potential investor • Description of the product or service that will be offered and the value proposition for the customer • Summary of the size and nature of the market opportunity • Explanation of the revenue model • Profiles of the management team, advisory board, and board of director members describing specific relevant skills and expertise • Clear articulation of the startup’s core competencies and sustainable competitive advantage • Summary of financials and financing needs Chapter 12: Human and Financial Capital
