Creative people @ creative venue

Building a venture business is a creative process. Either getting into a new market or competing with large gorilla, you get to be creative. You have to know where to nail. You have to turn things fast and furious. You have to creatively engage with people and partners. If you don’t enjoy starting something from scratch, you may not be a right entrepreneur material.

Creative work often starts at a creative space. It can be your small den or garage. It can be a corner side bakery where you can find high dose of caffeine. Wherever you get to find productive is a good place to start with. Though, finding a creative venue keeps your creative energy arousing. It can be a MIT Media Lab or IDEO-ish business incubation center. It can be a place where lots of entrepreneur socialize and gather and talk. I won’t urge you to pick on their brain but if you come across with those people in and out and you have a small talk. Eventually small talks can be a more serious talk just like you spot somebody and eventually date.

Sitting in a small cubicle or small rent-out office is a great idea to organize your thoughts and develop business plan. Though, getting to know people with full of creativeness and sharing entrepreneurial passion will make your move a lot smoother. If you feel like hitting on the wall, get out and talk to people.

Creative people @ creative venue
Creative people @ creative venue

Cost of equity financing for start-up business

Entrepreneurs face a dilemma when it comes to raising capital for their ventures. Startups are all about product development and sales, but at the same time, corporate development such as financing and structuring are equally important. Determining whether to take on debt and repay or give up a portion of a company to raise sufficient capital is no easy answer. Deciding on the sources of venture financing requires a clear understanding of the trade-offs.

By and large, the cost of equity is more expensive than the cost of debt. There are several reasons behind this notion.

The debt holder enjoys extra safety while the equity holder enjoys potential upside. Debt is secured by assets so it is typically safe. Debt holder receives interests as agreed until pay-back time. In case of default, the debt holders would be able to seize assets such as real estate, account receivables, inventories or intellectual properties. Though, when debt is paid back, debt holder does not have any further right. They are protected to secure their assets and, in exchange of risks, they receive interests. They have no voting rights and no upsides.

On the other hand, equity holders who buy shares of the company do not have the as strong right as debt holders to claim the asset when the company goes bankrupt. The equity holders have the right to vote at the shareholder’s meeting to influence management team, hire (or fire) executives, set annual budget, and make significant decision such as M&A or spin-off because they are partial owners of the company. Equity holders enjoy upsides with the founders if the company prospers. However, they don’t go anywhere until somebody else buys their portions of the ownership. Selling equity is like marriage. If everything goes well, you have happy married life, but if relationship breaks, every single board (or shareholder) meeting can be troublesome.

Debt holders are compensated with a scheduled interest payment, regardless of the financial health of the company. If companies fail to make interest payments that debt holders are entitled to receive, they would inadvertently be forced to liquidate. It requires lots of commitments for most of start-up business, but it has its end. Once all obligations for the debt holders are satisfied, you’re free to go. Contrarily, the equity holders are paid dividends in regards to the earnings of the company while their ownership stays as is until there is ownership change.

Both strategies come down to a trade-off between risk and reward. Debt holders are usually risk-averse and are compensated accordingly, while equity holders are rewarded in terms of the profitability of the company and upsides of business. In other words, the higher the risk, the higher the expected return or in this case rewards.

To share you typical venture financing formula, angel investors often pursue 5 to 10% of equity and series A investors take roughly 20 to 30% equity shares of the startup. Numerous sequential financing rounds may dilute the founder’s shares of the company significantly, which can lead to losing control of the company, thereby lowering motivation of the founding members. This also denotes the idea of what the ideal percentage the company should provide for its equity holders. If the market were to be sour, the entrepreneurs will have to suck up the bitterness and sell the shares at a low price. On the other hand, debt can be in the form of promissory notes, convertible notes or line-or-credits with interest rates that can be troublesome if a company does not generate cash quickly enough to pay its debt holders. However, debt is still cheaper than equity if you see long-term implication to your business.

Heavy burden on debt may thwart the entrepreneurs from receiving further equity financing; so entrepreneurs and management teams have to keep an eye on the company’s fiscal management under their belt. Therefore, entrepreneurs should be able to discern the advantages and disadvantages of both financing methods and determining the company’s feasibility accordingly.

(This article was developed with H.G. Byun, a publicist at KingsBay Capital.)

Why asking your exit strategy from beginning?

It’s quite odd to press this topic whenever I sit down with entrepreneur for the first time. Though, as an investor, knowing where your entrepreneurial goal is heading to is very important before we commit anything. No matter what happens, professional venture capital firm needs to take an exit route someday. Main motivation is how to maximize our investment return even if our top priority is to build a great company along with founders. VC loves J-curve. VC loves to chip into “a start-up company that has potential to become a large cap blue-chip business in a few years.” If your business is expected to generate $20~30 million in revenue and you’re happy with the result collecting dividends, you’re not really fitting into VC investment. IPO and M&A’s are still major exit routes for all venture investors. If you don’t want to make any change in control or no plan to sell your business or invite new investors to expand your business, VC is not a really good fit, either. That’s why major VC firms from the Silicon Valley wants to hear from founders who have identified $1B+ market and have a clear plan to capture that market. If you just want to prove your concept or continue product research even if you don’t know anything about market, you’d better talk to different type of investors, not VC.