Financing Entrepreneurial Ventures - Techomepage.cem.itesm.mx/maria.fonseca/master/documents/Investors.pdf · and Development Corporation (ARD) ... • SBIC firms – combination

Financing Entrepreneurial Ventures

Professor Andrew Zacharakis

Babson College

Zacharakis 2

Almost always start with equity…

• Identify potential investors– List and prioritize

– develop funding strategy

• Can investors add value beyond $?

• What ROR requirements do they expect?

• How do you Value and price the deal?

Zacharakis 3

Sources of Seed Capital, Inc 500, 2001

Zacharakis 4

Zacharakis 5

Zacharakis 6

Staged Capital Commitments

• Seed financing

• Start-up

• First-stage financing

• Second-stage financing

• Third-stage financing

• Bridge financing

• Management / leveraged buy-out

• Secondary purchase of public shares

Zacharakis 7

What Rates of Return Do VC Investors Seek?

Expected

Annual Holding

Stage ROR% Period

Seed and Start-up 50-100+ ~10+years

1st Stage 40-60 5-10

2nd Stage 30-40 4-7

Expansion and Bridge 20-30 3-5

LBOs 30-50 3-5

Turnarounds 50+ 3-5

Zacharakis 8

WE ALMOST ALWAYS START WITH...

• THE ENTREPENEUR

– Personal savings account

– Credit cards

– Personal assets• mortgaged property

• computers

• in-home offices

• phone/fax machine

• furniture

• vehicles

Zacharakis 9

THE “NEST EGG PHENOMENON”

The need to feed yourself and family...and a recognition of risk. Six Months?

Zacharakis 10

SOME PERSONAL RISK

• Income from the job you are leaving or could have had.

• The foregone interest/opportunity on the initial investment.

• Difficulty in being re-hired or finding a job.

• Credit rating issues.

• Self-Confidence.

Zacharakis 11

FAMILY AND FRIENDS

• There is often a lack of a formal repayment schedule.

• But the funds are not free:

– family pressure

– unsophisticated input and monitoring

– unsophisticated & unpredictable repayment expectations

Zacharakis 12

Other Sources

• Professional advisors and acquaintances• “Angels” - private investors and business assocs.• Private placement finders/packagers• Present or potential customers, suppliers• Past employers• Prospective team members• SBIR program• Strategic alliances and partnerships• State and Federal programs

Zacharakis 13

VESTED INTEREST IN YOUR SUCCESS?

• Suppliers: spontaneous source of financing

– enhanced terms on payables

– use of assets

– $$$$$$$$$$

– sales• Customers= cash or receivables

Zacharakis 14

Valuation

Future Value = Present Value X (1 + IRR)n

Zacharakis 15

Valuation Example

AssumptionsCompany:

PAT in Year 5 $2.5MP/E 15 times PAT

Investor:Investment $2.0MROR 50%Holding Period 5years

Zacharakis 16

Valuation Example

FUTURE VALUE (FV) (Year 5)

PAT X P/E = ($2.5M X 15) = $37.5M

Zacharakis 17

VALUATION EXAMPLE(CONT.)

FV = PV (1 + IRR)n

= 2(1 + .50)5 = $15.1875M

OWNERSHIP REQUIREDinvestment $2Mfuture value to investor: $15.1875MFV of the company: $37.5M

Ownership to fulfill the investors return req’d

41%

Zacharakis 18

What is Venture Capital?

• Pool of equity capital used to invest in new ventures

• Patient money

• Originated in 1946 with American Research and Development Corporation (ARD)

Zacharakis 19

Types of Venture Capital

• Private venture capital firms – limited partners contribute to pool of equity that is managed by general partner

• SBIC firms – combination of private and government funds (created with 1958 act)

• Corporate venture capital – venture capital divisions of larger corporations, banks, etc.

• State-sponsored venture capital – states creates funds that foster business within state

Zacharakis 20©2000, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Organizational Structure of Venture Capital Investment

Portfolio Companies–Value creation

– Generate deal flow – Screen opportunities– Harvest investments

– Negotiate deals– Monitor and advise

General Partners

Venture Capital Fund

– Pension plan– Endowments– Life insurance companies

– Corporations– Individuals

Limited Partners

Effort and 1% of capital

Annual Management

Fee 2-3%

Carried Interest 20-

30% of Gain

99% of Investment Capital

Capital Appreciation 70-80% of Gain

Investment Capital and

Effort

Financial Claims

Zacharakis 21

The Venture Capital Investment Process

Development of Fund Concept

Secure Commitments from Investors

Generate Deal Flow

Closing of FundFirst Capital Call

Screen Business

Plans

Evaluate and Conduct Due

Diligence

Negotiate Deals and

Staging

Additional Capital Calls

Invest Funds

Distributing Proceeds– Cash – Public Shares

– OtherHarvesting Investment– IPO– Acquisition

– LBO – Liquidation

Value Creation and Monitoring– Board service– Performance evaluation and review– Recruitment management

– Assist with external relationships– Help arrange additional financing

Year 0

2-3 years

4-5 years

2-3 years or more

7-10 years plus extensions

Zacharakis 22

Inside the VC Firm

Partner

Proposal

Associate

Screen

Pitch

Weekly Meeting

Associate

Screen

Zacharakis 23

VC Capital Flow

Pension

Individuals

Corporations

VCs$50B

Angels$110B Early Stage

Expansion Stage

Later Stage

TradeSale

IPO

60%

11%

11%

29%

45%

25%

OtherEndowments, Foreign, etc.

18%

Zacharakis 24

VC Portfolio Returns

• Homeruns – 10X or 60% ROR

• Singles and Doubles – 5x or 30% ROR

• Living Dead – 0x or 5% ROR

• Failures – complete loss

Zacharakis 25

Key Events: 1999-2000

Zacharakis 26

VC Investments

0

5

10

15

20

25

30

35

40

45

50

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999Year

Early S tage Expans ion Stage Later S tagea Wicks Business Information company

1995 1996 1997 1998 1999 2000 YTD01

$6.8 $9.8 $12.7$17.5

$46.9

$90.5

$25.4

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

1-3Q Investment Annual Investment

YTD Investment Pace at ’99 LevelsEquity into Venture-Backed Companies

Am

ount

Inve

sted

($B

)

Source: VentureOne/PwC

Zacharakis 27a Wicks Business Information company

$4.6 $4.8 $5.9

$10.2 $11.4

$19.5

$26.4

$6.5$8.4

$24.1$22.1

$17.8

$10.6600

717790

11281289

15531656

1430

11081056

743658620

$0

$5

$10

$15

$20

$25

$30

$35

3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q010

400

800

1,200

1,600

Amount Invested ($B) Number of Deals

But Declining Every Quarter Equity into Venture-Backed Companies, Quarterly

Am

ount

Inve

ste d

($ B

)N

umber of D

eals



$5.0$4.6

$5.0$5.6

$6.0

$8.0

$10.0$9.5

$10.0 $10.1

$8.5$8.0

$6.6

$0

$2

$4

$6

$8

$10

3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01

Median Round Size Continues DeclineMedian Amount Invested Per Round

Med

ian

Am

ount

Inve

ste d

($ M

)



Especially Affecting Later-Stage RoundsMedian Amount Invested by Round Class

$9.5$6

$22

$7

$15

$10

$5 $5

$8

$1 $0.5$1.7

$0

$5

$10

$15

$20

$25

3Q98 1Q99 3Q99 1Q00 3Q00 1Q01 3Q01

Later Round

Second Round

First Round

Seed Round

Source: VentureOne/PWC

Med

ian

Am

o un t

Inve

sted

($M

)


$0.2$0.3$0.5$1.4

$6.6

$3.5

$7.4$7.4

$5.3$5.3

$1.5

$0.4$1.1

17

445

70

42

69777575

21

7

18

$0

$2

$4

$6

$8

3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01

0

20

40

60

Amount Raised ($B) Venture-Backed IPOs

IPO Liquidity Evaporates...Deals and Amount Raised Through IPOs

Source: VentureOne

Am

ount

Inve

sted

($B

) Num

ber of Deals


$2.9$4.9

$8.7

$4.6 $3.7

$19.4 $18.8

$113

198

248

68

119

216

142

121

$0

$5

$10

$15

$20

$25

1994 1995 1996 1997 1998 1999 2000 YTD'010

50

100

150

200

250

Amount Raised ($B) Venture-Backed IPOs

… and is the Worst in Many YearsDeals and Amount Raised Through IPOs

Source: VentureOne

Am

ount

Inve

s te d

($B

) Num

ber of Deals


$16

$101

$43

$14$12

$26

$10

153186

217238

298

441

249

$0

$30

$60

$90

$120

1995 1996 1997 1998 1999 2000 YTD2001

0

100

200

300

400

Amount Paid ($B) Number of Transactions

2001 M&As still Exceed 1998Transactions and Amount Paid in M&As

Source: VentureOne

Am

ount

Inve

sted

($B

) Num

ber of Deals


$4.0$4.9$7.1

$11.7

$20.2$23.7

$45.4

$15.5

$8.5$13.1

$5.4$4.2$3.7

71

8494

99

114107

121

8377

85

53

6959

$0

$10

$20

$30

$40

$50

3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01

0

25

50

75

100

Amount Paid ($B) Number of Transactions

M&A Booms Slows, Prices Drop Transactions and Amount Paid in M&As

Source: VentureOne

Am

ount

Inve

sted

($B

) Num

ber of Deals


$11.5$9.8$10.7

$8.5$8.1

$13.0$15.7

$22.7

$27.2

$18.9

$0

$5

$10

$15

$20

$25

$30

1992 1993 1994 1995 1996 1997 1998 1999 2000 YTD01

Median Premoney Valuations Fall Below 1999 Levels

Median Premoney Valuation by Year

Source: VentureOne

Med

ian

P rem

oney

Val

uati

on (

$M)


$16 $17 $18

$23$25 $24

$30

$26

$29

$25

$20 $20

$15

$0

$5

$10

$15

$20

$25

$30

3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01

After 2Q Plateau, Valuations Drop AgainMedian Premoney Valuation

Source: VentureOne

Med

ian

P rem

oney

Val

uati

on (

$M)


Valuations Have Diminished Across All Financing Stages

Median Premoney Valuations by Round Class

$101

$29$30

$44

$15$21

$7$8

$14

$2 $2

$6$0

$20

$40

$60

$80

$100

3Q98 1Q99 3Q99 1Q00 3Q00 1Q01 3Q01

LaterRounds

SecondRound

First Round

Seed

Source: VentureOne

Med

ian

P rem

oney

Val

uati

on (

$M)


Silicon Valley Is 1/3 of US Venture IndustryRegional Investment in the US

DC Metroplex5%

Southeast4%

Midwest5%

Northwest2%

All Other US18%

Silicon Valley34%

New England10%

Southern California8%New York Metro

7%

Texas7%

Source: VentureOne/PWC

Zacharakis 38

It’s a New Ballgame…

January 2000 Today

Cost of CapitalNearly zero:

raise as much asyou can get

Nearly infinite:make the most of what you’ve got

Wall Street Values

Growth, brandand share

Profits and cash

Capital Budgets Loose Tight (airtight)

Business Risk Boil the ocean Make a nickel

Employee Strategy

Recruit like crazy

Motivate, screen, cut

Documents

Financing Entrepreneurial Ventures - Techomepage.cem.itesm.mx/maria.fonseca/master/documents/Investors.pdf · and Development Corporation (ARD) ... • SBIC firms – combination