Chapter Eighteen

Technology Ventures: From Idea to OpportunityTechnology Ventures: From Idea to Opportunity

Summary

Chapter 18: Summary

Capital is to the progress of society what gas is to car.

James Truslow Adams

What are the sources of capital that a new venture can use to finance the start and growth of its company?

Entrepreneurs can estimate the capital required for their new business by reviewing the financial projections they prepare using the methods detailed in Chapter 17. Typically, several stages of investment will be required over the life of the business.

Technology Ventures: From Idea to OpportunityChapter 18: Figure 18.1

Cumulative Cash Flow ($millions)

-3

+3

+2

+1

20

10 30 40 50 Time (months)

Cash Breakeven

0

-1

-2

Idealized cash flow diagram for a new enterprise

Technology Ventures: From Idea to Opportunity

Real Option: the right to invest in (or purchase) a real asset (a new start-up firm) at a future date.

V = IV + OV

IV = Intrinsic Value

OV = Option Value

Chapter 18: Real Option

Technology Ventures: From Idea to OpportunityChapter 18: Table 18.2

The Value of A Real Option Based on Four Factors

•Increases with the level of uncertainty measured by the standard deviation σ.

•Increases with the length of time, T, the person holding the option has to decide whether or not to exercise it.

•Increases with the ratio of the current stock price, P, to the exercise price, X. The ratio is P/X.

•Increases with the discount rate, r.


Sources of Capital•Founders•Family•Friends•Small Business Investment Companies (SBIC)•Small Business Innovation Research (SBIR)•Professional Investors — Angels•Venture Capitalists•Banks•Leasing Companies•Established Companies•Public Stock Offering•Government Grants and Credits•Customer Prepayments•Pension Funds•Insurance Companies


1. Founding Stage

The Entrepreneurial Team Begins with a Vision, Business Model and Strategy

2. Seed Stage

Initial Financial Capital

3. Growth Stage

Growth Capital Required

4. Harvest Stage

IPO or Acquisition Provides Return to Investors and Founders

Four financial steps in building a successful firm.

Technology Ventures: From Idea to OpportunityChapter 18: Bootstrap Financing

Bootstrap Financing: to start a firm by one’s own efforts and to rely solely on the resources available from oneself, family, and friends.


Unable to fund growth phase

Lack of funding commitment for future

Loss of advice from professional investors

Low pressure on valuation

Easy terms on ownership

Control by founders

Little time spent on finding investors

•Disadvantages•Advantages

Advantages and disadvantages of bootstrap financing

Technology Ventures: From Idea to OpportunityChapter 18: Angels

Angels are wealthy individuals, usually experienced entrepreneurs, who invest in business start-ups in exchange for equity in the new ventures.


Criteria for Angel Investments

The New Venture is/has:

•Within the industry that the angel has experience.

•Located within a few hours driving distance

•Recommended by trusted business associates

•Entrepreneurs with attractive personal characteristics such as integrity and coach-ability.

•Good market and growth potential for the opportunity.

•Seeking an investment of $100,000 to $1 million and offers minority ownership, less than 40%

Technology Ventures: From Idea to OpportunityChapter 18: Venture Capital

Venture capital is a source of funds for new ventures that is managed by investment professionals on behalf of the investors in the venture capital fund.


50

40

30

20

10

0

Treasury Bonds

Corporate Bonds

Franchises

Imitations, Improvements

Innovations, Technology

Strong Growth Companies

Acquisitions

Money Market Funds

Risk: Low Medium High

Chance of 0 30% 60% Total Loss

E x p e c t e d

A n n u a l

R e t u r n

(%)

The Risk and Reward Profile for Various Investments

0


Characteristics of An Attractive Venture Capital Investment

•Potential to Become a Leading Firm in a High Growth Industry with few competitors.

•Highly Competent and Committed Management Team and High Human Capital (Talent).

•Strong competitive Abilities and a Sustainable Competitive Advantage.

•Viable Exit or Harvest Strategy.

•Reasonable Valuation of the New Venture.

•Outstanding Opportunity.

•Founders Capital Invested in the Venture.

•Recognizes Competitors and Has a Solid Competitive Strategy.

•A sound business plan showing how cash flow turns positive within a few years.

•Demonstrated progress on the product design and good sales potential.

Technology Ventures: From Idea to OpportunityChapter 18:Valuation Rule

The valuation rule is the algorithm by which an investor such as an angel or venture capitalist assigns a monetary value to a new venture.

Capital Return after N years:

CR = M x I

Market Value in Year N:

MV = PE x EN or PS x SN

NG)(1 M where

%100 x MV

CR PO

+=

=

I = investment

EN = earnings in year N

G = expected annual return


Issues to be resolved within the Terms of the Deal

• Percent Ownership for the Investor Group

• Timing of Investment

• Control Exerted by Investor

• Vesting Periods for Ownership by the Entrepreneur Team

• Rights to Require an IPO, Registration Rights

• Type of Security

• Reservation of Ownership for Employees (Stock Option Pool)

• Anti-dilution Provisions

• Milestones of Achievement, if there are multiple tranches (steps) to the investment

• Stock Option Plans

Technology Ventures: From Idea to OpportunityChapter 18: IPO

Initial Public Offering: the first public equity issue of stock made by a company.


Advantages and Disadvantages of Issuing on IPO

Advantages

• Raising new capital with the possibility of later, additional offerings

• Liquidity — Ability to convert ownership to cash, potential of harvest for investors and founders

• Visibility — Build brand and reputation

Disadvantages

• Offering costs and effort required

• Disclosure requirements and scrutiny of operations

• Perceived pressures on achieving short-term results

• Possible loss of control to a majority shareholder

Technology Ventures: From Idea to OpportunityChapter 18: Principle

Principle: Many kinds of sources for investment capital for a new enterprise exist and should be compared and managed carefully.

Technology Ventures: From Idea to OpportunityChapter 18: Exercise

A new firm intends to sell specialized integrated circuits for wireless applications. Its projections show:

Year 1 2 3

Sales ($ millions) 3.0 6.2 9.8

Profit ($ millions) -1.0 1.0 3.2 Use the valuation rule to determine PO required when investors provide $5 million and expect a return of at least 55% per year. Assume the investors use PE = 14 and PS =4.

Technology Ventures: From Idea to OpportunityTechnology Ventures: From Idea to OpportunityChapter 18: Venture Challenge

VENTURE CHALLENGE2) What sources of capital will you use?

3) Why did you select these sources?

4) How much capital is needed now and for what purpose?

5) What percentage of your venture do you plan to offer to outside investors?

Technology Ventures: From Idea to OpportunityTechnology Ventures: From Idea to OpportunityChapter 18: DVD Videos

DVD Videos

“Venture Capital versus Customer Funding”

Vic Verma (Savi Technology)

“The Benefit of Picking the Right Venture Capitalist”

Marc Fleury

Economy & Finance

Chapter Eighteen