Transcript Chapter 1:The Foundations of Entrepreneurship

Sources of
Equity Financing
Chapter 14 Equity Financing
Copyright 2006 Prentice Hall Publishing Company
1
The “Secrets” to
Successful Financing
1. Choosing the right sources of capital is a
decision that will influence a company for a
lifetime.
2. The money is out there; the key is knowing
where to look.
3. Creativity counts. Entrepreneurs have to be
as creative in their searches for capital as
they are in developing their business ideas.
Chapter 14 Equity Financing
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The “Secrets” to
Successful Financing
4. The World Wide Web puts at entrepreneur’s
fingertips vast resources of information that
can lead to financing.
5. Be thoroughly prepared before approaching
lenders and investors.
6. Entrepreneurs should not underestimate the
importance of making sure that the
“chemistry” between themselves, their
companies, and their funding sources is a
good one.
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Three Types of Capital



Chapter 14 Equity Financing
Fixed - used to purchase the the
permanent or fixed assets of the business
(e.g. buildings, land, equipment, etc.).
Working - used to support the small
company's normal short-term operations
(e.g. buy inventory, pay bills, wages, or
salaries, etc.).
Growth - used to help the small business
expand or change its primary direction.
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Characteristics
Possible Sources of Funding
Start-Up
Early
Expansion
Business is in
conceptual phase
and exists only
on paper.
Business is developing
one or more products
or services but is not
yet generating sales.
Business is selling
products or services
and is generating
revenue and is
beginning to establish
a customer base.
Profitability
Company has
established a
customer base and is
profitable.
Likelihood of using each source: H = Highly likely; P = Possible; U = Unlikely
Personal savings
H
H
H
H
Retained earnings
U
U
U
H
Friends and relatives
H
H
P
P
Angel investors
H
H
P
U
Partners
H
H
P
U
Corporate venture capital
P
H
H
H
Venture capital
U
P
H
H
Initial public offering (IPO)
U
U
P
H
Regulation S-B Offering
U
U
P
H
Small Company Offering
Registration (SCOR)
U
P
P
H
Private placements
U
P
P
H
Intrastate offerings (Rule 147)
U
P
P
H
Regulation A
U
P
P
H
Equity Capital




Represents the personal investment of
the owner(s) in the business.
Is called risk capital because investors
assume the risk of losing their money if
the business fails.
Does not have to be repaid with interest
like a loan does.
Means that an entrepreneur must give up
some ownership in the company to
outside investors.
Chapter 14 Equity Financing
Copyright 2006 Prentice Hall Publishing Company
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Sources of Equity
Financing
Personal savings
 Friends and family members
 Angels
 Partners
 Corporations
 Venture capital companies
 Public stock sale

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Personal Savings



The first place an entrepreneur should
look for money.
The most common source of equity
capital for starting a business.
Outside investors and lenders expect
the entrepreneur to put some of her
own capital into the business before
investing theirs.
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Friends and Family
Members



After emptying her own pockets, an
entrepreneur should turn to those most
likely to invest in the business - friends and
family members.
Global study: Family members and friends
account for more than 70% of all venture
dollars at start-up.
Careful!!! Inherent dangers lurk in
family/friendly business deals, especially
those that flop.
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Friends and Family
Members

Guidelines for family and friendship
financing deals:
 Consider
the impact of the investment on
everyone involved.
 Keep the arrangement “strictly business.”
 Settle the details up front.
 Never accept more than the investor can
afford to lose.
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Copyright 2006 Prentice Hall Publishing Company
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Friends and Family
Members

Guidelines for family and friendship
financing deals:
 Create
a written contract.
 Treat the money as “bridge financing.”
 Develop a payment schedule that suits
both parties.
 Have an exit plan.
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Angels
Private investors who invest in
emerging business start-ups in
exchange for equity stakes in the
company.
 Fastest growing segment of the small
business capital market.
 Some 400,000 angels invest $50
billion a year in 50,000 small
companies.

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Angels

Ideal source of financing for
companies that have outgrown the
capacity of friends and family
members but are still too small to
attract the interest of venture capital
companies.
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Angels
Most likely to finance deals in the
$10,000 to $2 million range.
 Key: finding them!
 Angels almost always invest their
money locally and can be found
through networking.
 Another avenue: Angel capital
networks on the World Wide Web.

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Angels
Typical angel accepts 30% of the
proposals presented to him and has
invested an average of $131,000 in
3.5 businesses.
 An excellent source of “patient
money” for investors needing
relatively small amounts of capital –
often less than $500,000.

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Corporate Venture Capital
About 300 large corporations across
the globe invest in start-up companies.
 20% of all venture capital investments
come from corporations.
 Capital infusions are just one benefit;
corporate partners may share
marketing and technical expertise.

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Venture Capital Companies



More than 3,000 venture capital firms
operate across the U.S.
Most venture capitalists seek investments
in the $3,000,000 to $10,00,000 range in
companies with high-growth and highprofit potential.
Business plans are subjected to an
extremely rigorous review - less than 1%
accepted.
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2,500
$30.0
2,000
$25.0
$20.0
1,500
$15.0
1,000
$10.0
500
$5.0
$-
1995
1996
Billions of $
1997
1998
1999
Number of Deals
2000
2001
2002
2003
Number of Deals
$35.0
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Amount Financed (in Billions
of $)
Venture Capital Financing
Venture Capital Companies



Usually take an active role in managing the
companies in which they invest.
Focus their investments in specific
industries with which they are familiar.
Invest in a company across several stages.
Most common stages:



Chapter 14 Equity Financing
Expansion
Later-stage
Early stage
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Venture Capital Funding by Stage
60%
48% to 50 %
Percent of Funding
50%
40%
28% to 30 %
30%
18% to 20 %
20%
10%
1% to 2 %
0%
Start-up/Seed
Early-stage
Expansion
Later-stage
Stage
Start-up/Seed – This is the initial stage in which
companies are just beginning to develop their ideas into
products or services. Typically, these businesses have
been in existence less than 18 months and are not yet fully
operational.
Early stage – These companies are refining their initial
products or services in pilot tests or in the market. Even
though the product or service is available commercially, it
typically generates little or no revenue. These companies
have been in business less than three years.
Expansion stage – These companies’ products or services
are commercially available and are producing strong
revenue growth. Businesses at this stage may not be
generating a profit yet, however.
Later stage – These companies’ products or services are
widely available and are producing ongoing revenue and,
in most cases, positive cash flow. Businesses at this stage
are more likely to be generating a profit. Sometimes these
businesses are spin-offs of already established successful
private companies.
What Do Venture Capital
Companies Look For?
Competent management
 Competitive edge
 Growth industry
 Viable exit strategy
 “Intangibles”

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Going Public
Initial public offering (IPO) - when a
company raises capital by selling
shares of its stock to the public for the
first time.
 Typical year: about 550 companies
make IPOs.
 Few companies with sales below $10
million in annual sales make IPOs.

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1000
800
600
400
200
0
Year
$ Raised (Billions)
Number
Numbr of
IPOs
$120.0
$100.0
$80.0
$60.0
$40.0
$20.0
$0.0
19
8
19 1
83
19
85
19
87
19
89
19
9
19 1
93
19
95
19
97
19
99
20
01
20
03
Amount
Raised
(Billions of $)
Initial Public Offerings (IPOs)
Advantages of "Going
Public"






Ability to raise large amounts of
capital
Improved corporate image
Improved access to future financing
Attracting and retaining key
employees
Using stock for acquisitions
Listing on a stock exchange
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Disadvantages of "Going
Public"
Dilution of founder's
ownership
 Loss of control
 Loss of privacy
 Reporting to the SEC
 Filing expenses

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The Cost of Going Public
Typical Costs of a $20 Million IPO
Directors' and officers'
insurance
21.7%
Road show expenses
2.9%
Underwriter's fee
40.5%
Transfer-agent fees
0.4%
State, SEC, and NASD
filing fees
0.3%
Nasdaq initial listing fee
3.9%
Printing expenses
7.2%
Accounting fees
11.6%
Legal fees
11.6%
Disadvantages of "Going
Public"
Accountability to shareholders
 Pressure for short-term
performance
 Loss of focus
 Timing

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The Registration
Process
Choose the underwriter
 Negotiate a letter of intent

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Letter of Intent

Two types of underwriting agreements:





Firm commitment
Best efforts
Minimum number of shares offered is usually
400,000 to 500,000.
Total offering is usually at least $8 to $15
million.
Initial share price is usually between $10 and
$20 per share.
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The Registration
Process
Choose the underwriter
 Negotiate a letter of intent
 Prepare the registration statement
 File with the SEC
 Wait to “go effective” and road show
 Meet state requirements

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Simplified Registrations
and Exemptions

Regulation S-B



S-B-1: Transitional registration for
companies making offerings of less
than $10 million over 12 months.
S-B-2: Registration for companies
making offerings of more than $10
million over 12 months.
Regulation D: Rule 504 - Small
Company Offering Registration
(SCOR)
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SCOR Offerings
Ceiling is $1 million
 Share price must be at least $5 per
share
 Must file Form U-7, a standardized
disclosure statement
 Can issue almost any kind of security
through SCOR
 Cost is usually less than $25,000

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Simplified Registrations
and Exemptions

Regulation D: Rule 505 and 506
 Private
placements
Section 4 (6)
 Rule 147 (Intrastate offerings)
 Regulation A

 Offerings
up to $5 million over 12
months
 Typical cost: $80,000 to $120,000
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Simplified Registrations
and Exemptions

Direct Stock Offerings
 Go
straight to Main Street instead of
through underwriters on Wall Street
 World Wide Web (usually either
Regulation A or Regulation D offerings)
 Typically generate between $300,000 and
$4 million for company

Foreign Stock Markets
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Web Sites
PriceWaterhouseCoopers Money Tree
Survey
http://www.pwcmoneytree.com/
 Hoover’s Online IPO Central
http://www.hoovers.com/global/ipoc/i
ndex.xhtml
 ACE-Net
http://activecapital.org/

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