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SMALL BUSINESS CAPITAL : WHERE IT IS AND HOW TO GET IT

 

 

 

“ The men who manage men manage the men who manage things but the men who manage money manage the man who manage men?”

 

The pecking order in this universal saying is as it is in the entrepreneurial world.

     1. Money

     2. Men

     3. Things

 

Venture Capital Tips

 

One of the leading investment bankers of New York, David Silver, who is also a columnist for Venture Magazine, claims all financial forecasts look like a hockey stick. That is, they start out flat and suddenly take a sharp steep upward slope one or two years in the future. Silver further claims there are only three crucial ingredients in a business plan. Silver’s perspective is from the eyes of a venture capital investor, and he claims all successful plans contain these three ingredients in the following order.

 

A. Big market

B. Good product

C. Good management team

 

He likes to tell the story of one of the most successful venture capital investments ever, to illustrate his message. This investment wasn’t in some high technology esoteric product but, rather in a service business. The rule of thumb has always been that a service business is not candidate for a venture capital investment. But in this exciting story, a 28 year old up shot known as Freddie Smith proved everybody wrong as he raised $94,000,000 to launch Federal Express. Better yet, according to Silver, Smith was able to maintain 4% of the business while providing less than 1% of the capital. (He invested just about $1,000,000).

    One of the venture capital sources who invested in Federal Express tells an affectionate Freddie Smith story. It goes like this.

     Four people were stranded on an island in the Pacific when a group of leaflets decended from the sky announcing that the island was to be annihilated in five minutes by a nuclear blast. Looking dejected, one of the inhabitants, an older man, walked into the bushes to enjoy his last bottle of wine. Two of the other inhabitants, a young couple, also went into the bushes to spend their last five minutes alone. Freddie Smith was the 4 th person on the island and he immediately dove into the vast pacific ocean. The other 3 people eventually emerged form the bushes as they watched Freddie diving and swimming in the ocean. Finally one of them shouted “What are you doing?” Freddie ignored them but shouted over his shoulder “I’ve got 5 minutes to learn to swim underwater, please don’t bother me now.”

     They say that the original founders of Federal Express so believed in the venture and Freddie Smith that they all hocked their watches just to make payrolls!

     In 1980 there were private (nonSBIC) venture capital firms with an average portfolio of $30 million each. Just 10 years ago there were only 3 venture funds that were private. So, the success of past venture investments, such as Federal Express, has spawned a renewed interest in venture capital investing.

     What does a venture capitalist look for? According to Silver they have several goals. First, they seek a minimum of five times on their money. In practice, they are often able to turn their money four times in three years, which is a 45% annual return on investment (R.O.I). To make an investment, they want to know the five answers to these five questions.

 

1. How much can I make?

2. How much can I lose?

3. How do I get out of the deal?

4. Who is in the deal?

5. Who says the product and the people are any good?

 

     The 400 or so non private small investment companies (SBICs) firmsand the 150 Minority Enterprise Small Business Investment Companies (MESBICs) have an average of about $10 thousand of capital to invest. In 1981, more venture capital was available in more funds than ever in the history of the venture capital industry. A record of $900 million of new capital was committed to the venture industry in 1980. Private venture firms received $657 million of this, a figure four times greater than 1979 and greater than any previous single year. Of the $657 investment Corporations in 1979 and $17 million was raised by Minority Enterprise Small Business investment Corporations. Since 44 SBICs and 31 MESBICs were licensed in 1980, these totals are not surprising. This total of 75 new firms is the highest number of new licenses since 1964. (Incidentally, these new SBICs combined brought a total of $61,372,723 into the venture capital industry.)

     The industry now boasts a total of approximately 4.5 billion in venture capital broken out in following way.

 

     Independent venture firms  $1.8 billion

     SBIC’s, MESBIC’s          $1.4 billion

     Corporations                      $1.3 billion

                                                  --------

                                   Total   $ 4.5 billion

 

     Watch the growth of the venture capital industry as another 30 groups, many headed by experienced venture capitalists, attempt to raise another $600 million in 1982, which would bring the total capital available to over 5 billion dollars in 1982.

     While the philosophy of venture capital is similar throughout the United States, there are several regional differences which might be useful to know before making your final selection. Here is the regional focus of venture capitalists around the United States.

    

     South: (Texas) The emphasis on “who are your people?”

     East: (New York) The emphasis on “who do you know?”

     Midwest: (Chicago) The emphasis is on “who do you work for?”

     West (California)The emphasis is on “What’s your package?”

 

     The only axiom which seems to hold no matter what part of the country you are from is a very simple but very true expression. “Speak Yiddish but dress British, when raising money.”

     For the very reasonable cost of one dollar, you can obtain all the information you ever wanted to know about SBICs (including the names and addresses of those closest to you) by sending for the directory of SBIC.

 

     National Association of Small Business

     Investment Companies (NASBIC)

     618 Washington Bldg.

     Washington, DC 20005

     (202-638-3411)

 

Breakeven

 

A breakeven analysis is a critical calculation for every small business. Rather than calculating how much your firm would make if it obtained an estimated sales volume, a more meaningful analysis determines at which sales volume your firm will break even. The other statistic is really pie-in the sky because the estimated sales volume is very questionable. Don’t assume a sales volume and determine your profits; do it in reverse; determine the sales volume necessary for your firm to break even. Above the breakeven, the firm makes money, below it loses money. A breakeven point, then, is a level of sales volume over some period of time. An example would be : “ My firm broke even on $10,000 a week in sales.”

 

T.C = V.C. + F.C.

Total costs = variable costs plus fixed costs

 

T.C. = Total costs = All costs to operate the business over a specified time period.

V.C. = Variable costs = Those costs which vary directly with the number of products

            Manufactured. Sometimes called direct costs, they typically include material and labor

            Costs plus a percentage of the overhead costs.

F.C. = Fixed costs = Costs which do not vary with the number of products produced. Also known

           As indirect costs, these costs typically include executive salaries, rent, insurance, and are

           Considered fixed over a relevant range of production.

B.E. = Breakeven point = Where total costs are equal to total revenues.

 

           Here is an example for a plant which produces only one product.

A. The fixed costs are $100,000 per year. These costs include

      -lights and power and phones (utilities),

      -rent,

      -insurance,

      -administrative salaries.

These costs are fixed over 20,000 – 40,000 units manufactured annually.

 

B. The variable costs over the 20,000 – 40,000 unit range are:

     $2.00 material

     $3.00 labor

     $1.00 overhead (50% of material)

     ---------

     $6.00 per unit

 

C. Sale price per unit is $10.00

     

 

 

 

 

 

 

A BREAKEVEN CHART REVENUE = $10/UNIT FIXED COSTS = $100,000 VARIABLE COSTS =$6/UNIT

 

 

Creation of the Breakeven Chart

 

A breakeven chart (also known in more optimistic circles as a profit graph) translates the three known facts into liner terms. The fixed costs of $100,000, the variable costs of $6 per unit, and the sales price of $10 per unit.

     The fixed costs line is horizontal because the fixed costs are $100,000 regardless of production volumes. To determine the revenue line, calculate that at 10,000 units the revenue is $100,000 (10,000)($10) and that at 40,000 units it will be $400,000, and draw a line through those two points. From the revenue line, you can determine the revenue if you know the number of units or the number of units if you know the revenue.

     The total costs line is determined by calculating what the variable costs would be at any two volumes, adding the $100,000 in fixed costs to each of these numbers, and drawing a line through the two points. The total costs at 10,000 units are $160,000 (10,000 x $6 = $60,000 + $100,000), and at 40,000 units the total costs are $340,000. The total costs line through these two points shows the total costs at different volumes.

     When you have drawn the fixed costs, revenue, and total costs lines, you see the breakeven point is 25,000, which is the intersection of the revenue and total costs lines. At volumes greater than 25,000, there will be profit since revenues will be greater than total costs.

 

The Breakeven Formula

 

Although the breakeven chart is probably the most useful means of visualizing breakeven analysis, the following formula provides the same information.

 

             Breakeven =                       Fixed Costs

                                 ----------------------------------------------

                                 (Revenue/Unit – Variable Costs/Units)

 

   

      Using the figures from the example, there is a breakdown equal to $100,000 ÷ (($10 - $6) = 25,000 units. Being able to determine the specific breakdown point is handy, but the main value of breakeven analysis comes in applying the concept to evaluate a variety of business problems.

 

Pricing Decisions

 

A common business problem is estimating the effects of raising or lowering a product’s price. How many more would need to be sold to maintain the profit level if you lowered the price a dollar? How many fewer would need to be sold to maintain that profit level if you raised the price a dollar? A rough estimate can be quickly made by drawing new revenue lines on the breakeven point drops from 25,000 to 20,000 units. If you lower the price a dollar, the breakeven jumps to 33,333 units. As you change the revenue line you will also see how much the profits rise and fall with other price changes.

     Breakeven is a valuable tool, but only one of many useful tools for analyzing your business. Breakeven oversimplifies decision. While the advantage is that it makes it easier to comprehend difficult small business issues, it also has some disadvantages. The assumptions are its disadvantages and some of them are listed here.

 

1. All fixed costs are not really fixed, even over the relevant unit range. They can and do vary.

2. A changing product mix can change the breakeven. The assumption that one plant produces

    product can be misleading.

3. Costs do not vary directly with production. Material or labor costs often vary even over very

    narrow ranges.

4. Selling price is seldom fixed.

5. Inventory costs are seldom calculated within a breakeven and these costs can be large.

 

As a final tool in understanding pricing decisions, the following formula can also be helpful for determining prices.

 

S.P. = T.C. + P.

S.P. = Selling Price = Per unit selling price

T.C. = Total Costs = Variable costs plus fixed costs per unit.

    P. = Profit = Profit per unit.

 

 

100%

Selling Price
P
V.C
F.C

0%

 

Continue to Part 2

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