Entrepreneurship Chap 12

Hisrich

Peters

Shepherd

Chapter 12Informal Risk Capital,

Venture Capital, and

Going PublicCopyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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Financing the Business

Criteria for evaluating appropriateness of financing alternatives: Amount and timing of funds required. Projected company sales and growth.

Three types of funding: Early stage financing. Development financing. Acquisition financing.

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Table 12.1 - Stages of Business Development Funding

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Risk capital markets provide debt and equity to nonsecure financing situations.

Types of risk capital markets: Informal risk capital market. Venture-capital market. Public-equity market.

All three can be a source of funds for stage-one financing. However, public-equity market is available only

for high-potential ventures.

Financing the Business (cont.)

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Informal Risk Capital

It consists of a virtually invisible group of wealthy investors (business angels).

Investments range between $10,000 to $500,000.

Provides funding, especially in start-up (first-stage) financing.

Contains the largest pool of risk capital in the United States.

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Table 12.2 - Characteristics of Informal Investors

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Table 12.2 - Characteristics of Informal Investors (cont.)

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Venture Capital

Nature of Venture Capital A long-term investment discipline, usually

occurring over a five-year period. The equity pool is formed from the resources of

wealthy limited partners. Found in:

Creation of early-stage companies. Expansion and revitalization of businesses. Financing of leveraged buyouts of existing divisions of

major corporations or privately owned businesses.

Venture capitalist takes an equity participation in each of the investments.

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Figure 12.1 - Types of Venture-Capital Firms

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Figure 12.3 - Percentage of Venture Dollars Raised by Stage in 2008

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Venture-Capital Process Objective of a venture-capital firm - Generation

of long-term capital appreciation through debt and equity investments.

Criteria for committing to venture: Strong management team. A unique product and/or market opportunity. Business opportunity must show significant capital

appreciation.

Venture Capital (cont.)

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Figure 12.4 - Venture-Capital Financing: Risk and Return Criteria

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Venture-capital process can be broken down into four primary stages: Stage I: Preliminary screening – Initial evaluation

of the deal. Stage II: Agreement on principal terms -

Between entrepreneur and venture capitalist. Stage II: Due diligence - Stage of deal

evaluation. Stage IV: Final approval - Document showing the

final terms of the deal.

Venture Capital (cont.)

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Locating Venture Capitalists Venture capitalists tend to specialize either

geographically by industry or by size and type of investment.

Entrepreneur should approach only those that may have an interest in the investment opportunity.

Most venture capital firms belong to the National Venture Capital Association.

Venture Capital (cont.)

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Table 12.6 - Guidelines for Dealing with Venture Capitalists

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Table 12.6 - Guidelines for Dealing with Venture Capitalists (cont.)

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Valuing Your Company

Factors in Valuation Nature and history of business. Economic outlook- general and industry. Comparative data. Book (net) value. Future earning capacity. Dividend-paying capacity. Assessment of goodwill/intangibles. Previous sale of stock. Market value of similar companies’ stock.

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Ratio Analysis Serves as a measure of financial strengths and

weaknesses of the venture but should be used with caution.

It is typically used on actual financial results. Provides a sense of where problems exist in the

pro forma statements.

Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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General Valuation Approaches Assessment of comparable publicly held

companies and the prices of these companies’ securities.

Present value of future cash flow. Replacement value. Book value. Earnings approach. Factor approach. Liquidation value.

Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Table 12.7 - Steps in Valuing Your Business and Determining Investors’ Share

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Evaluation of an Internet Company

Qualitative portion of due diligence carries more weight.

Focus is more on the market itself. Company's financial projections are

compared with the future market in terms of fit, realism, and opportunity.

Management team is examined. Opportunities available in the investor

market are examined.

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Deal Structure

Terms of the transaction between the entrepreneur and the funding source. Needs of the funding sources:

Rate of return required. Timing and form of return. Amount of control desired. Perception of risks.

Entrepreneur’s needs: Degree and mechanisms of control. Amount of financing needed. Goals for the particular firm.

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Going Public

Selling some part of the company by registering with the Securities and Exchange Commission (SEC). Resulting capital infusion provides the company

with: Financial resources. A relatively liquid investment vehicle.

Company consequently gains: Greater access to capital markets in the future. A more objective picture of the public’s perception of

the value of the business.

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Table 12.8 - Advantages and Disadvantages of Going Public

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Timing of Going Public and Underwriter Selection Timing

Is the company large enough? What is the amount of the company’s earnings,

and how strong is its financial performance? Are the market conditions favorable for an initial

public offering? How urgently is the money needed? What are the needs and desires of the present

owners?

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Underwriter Selection Managing underwriter - Lead financial firm in

selling stock to the public. Underwriting syndicate - A group of firms

involved in selling stock to the public. Factors to consider in selection:

Reputation. Distribution capability. Advisory services. Experience. Cost.

Timing of Going Public and Underwriter Selection (cont.)

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Registration Statement and Timetable “All hands” meeting - Preparing a timetable

for the registration process. First public offering requires six to eight

weeks. The SEC takes six to 12 weeks to declare

the registration effective.

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Reasons for delays: Heavy periods of market activity. Peak seasons. Attorney’s unfamiliarity with federal or state

regulations. Issues arising over requirements of the SEC. When the managing underwriter is

inexperienced.

Registration Statement and Timetable (cont.)

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SEC attempts to ensure that the document makes a full and fair disclosure of the material reported.

Registration statement consists of: Prospectus. Registration statement.

Most initial public offerings will use a Form S-1 registration statement.

Registration Statement and Timetable (cont.)

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Cover page Prospectus summary Description of the

company Risk factors Use of proceeds Dividend policy Capitalization Dilution

Selected financial data

Business, management, and owners

Type of stock Underwriter

information Actual financial

statements.

Registration Statement and Timetable (cont.)

Prospectus

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The Registration Statement Information regarding:

Offering. Past unregistered securities offering of the company. Other undertakings by the company.

Includes exhibits: Articles of incorporation. Underwriting agreement. Company bylaws. Stock option and pension plans. Initial contracts.

Registration Statement and Timetable (cont.)

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Procedure Preliminary prospectus (red herring) can be

distributed to the underwriting group. Deficiencies are communicated through

telephone or a comment letter. Pricing amendment - Additional information on

price and distribution is submitted to the SEC to develop the final prospectus.

Waiting period - Time between the initial filing and its effective date is usually around 2 to 10 months.

Registration Statement and Timetable (cont.)

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Legal Issues and Blue-Sky Qualifications Legal Issues

Quiet period – 90-day period in going public when no new company information can be released.

Blue-Sky Qualifications Blue-sky laws - Laws of each state regulating

public sale of stock. May cause additional delays and costs to the

company. Many states allow their state securities

administrators to prevent an offering from being sold in their state.

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After Going Public

Aftermarket Support Actions of underwriters to help support the price

of stock following the public offering.

Relationship with the Financial Community Has a significant effect on the market interest

and the price of the company’s stock.

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Reporting Requirements The company must file:

Annual reports on Form 10-K. Quarterly reports on Form 10-Q. Specific transaction or event reports on Form 8-K.

Company must follow proxy solicitation requirements.

After Going Public (cont.)