Transcript [T] Ch. 13

Obtaining Venture &
Growth Capital
Chapter 13
Dowling
BA 560
Fall Term 2006
Obtaining Venture & Growth Capital
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Cover your equity
Balance the need for
startup and growth capital
with preservation of equity
 The earlier the capital
enters, regardless of the source, the more $$$ costly it is
 Creative bootstrapping strategies can be great preservers of
equity
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Obtaining Venture & Growth Capital
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Considerations
Does the venture need outside equity capital?
 Do the founders want outside equity capital?
 Who should invest?
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An equity investment requires that the management
team firmly believe that investors can and will add
value to the venture.
Exhibit 13.1
Obtaining Venture & Growth Capital
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Timing
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It is unwise for a startup to delay looking for capital
since it is likely to take six months or more to raise
money.
Obtaining Venture & Growth Capital
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Early-stage entrepreneurs need investors who:
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Are considering new financing proposals and can provide the
required level of capital
Are interested in companies at the particular growth stage
Understand and have a preference for investments in the
particular industry
Can provide good business advice, moral support
Are reputable and ethical and with whom founder can get
along
Have successful track records of 10 years or more advising
and building smaller companies
Angel Investors
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Who are angel investors?
Most are self-made entrepreneur millionaires
 Many are in their 40s and 50s
 Most are well educated
 Ninety-five percent have college degrees from
four-year colleges
 Fifty-one percent have graduate degrees (Fortyfour percent are in a technical field and thirtypercent percent are in business or economics)
 Ninety-six percent are men
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Informal Investors
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What type of ventures lends themselves to the
use of informal investors?
Special situations, such as very early financing of
high-technology inventors who have not developed
a prototype
 Companies that project high levels of free cash
flow within three to five years
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Obtaining Venture & Growth Capital
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Angels and informal investors
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Who they are
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Typical informal investor will invest from $10,000 to
$50,000 in any one venture. They’re appropriate for:
 Ventures with capital requirements from $50K-$500K
 Ventures with sale potential from $2-$20 million in 510 years.
 Small, established, privately held ventures with sales
and profit growth of 10 to 20 percent per year
 Special situations
Obtaining Venture & Growth Capital
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Evaluation process
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An informal investor will want to review a business
plan, meet the full management team, see any
product prototype or design that may exist, etc.
The decision
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Agreement with informal investors will most often
include a “put,” whereby the investor has the right to
require the venture to repurchase his or her stock
after a specified number of years at a specified price.
Obtaining Venture & Growth Capital
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Venture capital: What is it?
“The venture capital industry supplies capital and
other resources to entrepreneurs in businesses with
high growth potential in hopes of achieving a high
rate of return on invested funds.”
 Most credit Ralph Flanders, then president of
Federal Reserve Bank of Boston, with the idea.
 VC investors commonly expect returns of 5 to 10
times initial investment in 5 to 10 years.
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Exhibit 13.3
Exhibit 13.10
Obtaining Venture & Growth Capital
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Venture capital
Key is to seek investors who will truly add value to
the venture, beyond the money
 Carefully screen potential investors to determine
how specifically they might fill in some gaps in the
founders’ know-how and networks
 The right investors can open doors to new
customers, vendors, and additional investors
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Obtaining Venture & Growth Capital
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Venture capital
No more than 2 to 4 percent of ventures seeking VC
actually receive financing from them
 An entrepreneur may give up 25 to 75 percent of
his or her equity for seed/startup financing
 Most VC investors are limited partnerships, with
fund managers serving as general partners and
investors as limited partners
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Exhibit 13.6
Obtaining Venture & Growth Capital
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Sources and guides
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A good place to start is Pratt’s Guide to Venture
Capital Sources
What to look for:
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Entrepreneurs are well advised to screen prospective
investors to determine the appetites of such
investors for the stage, industry, technology and
capital requirements proposed
Obtaining Venture & Growth Capital
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Dealing with venture capitalists
If possible, obtain a personal introduction from
someone the investors know well
 Identify several prospects; create a market for your
idea by marketing it
 Do not stop selling until the money is in the bank.
 Let the facts speak for themselves. Be able to deliver
on the claims.
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Obtaining Venture & Growth Capital
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What to look out for:
Attitude
 Over-commitment
 Inexperience
 Unfavorable reputation
 Predatory Pricing
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Obtaining Venture & Growth Capital
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Due Diligence: A two-way street
DD can take several weeks or months at startup
 Involves a painstaking investigation for investors
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Obtaining Venture & Growth Capital
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Other equity sources
SBA 7(a) Guaranteed Business Loan Program
 Small business investment companies
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Licensed and loan-funded by SBA
 Limited to taking minority shareholder positions
 Can invest only 20% of equity capital in any one firm
 Common options include long-term loans with stock
options, convertible debentures, straight loans, and
preferred stock
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Obtaining Venture & Growth Capital
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Other equity sources
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Mezzanine capital
Capital that is between senior debt financing and common
stock
 Most often, it’s subordinated debt carrying an equity
kicker consisting of warrants or a conversion feature into
common stock
 Generally unsecured, with maturity in 5 to 10 years
 Can be burdensome in its claims on cash
 Subordinated debt often contains covenants relating to
net worth, debt and dividends
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Obtaining Venture & Growth Capital
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Other equity sources
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Private placement investors. Could include:
Dealers, franchisors or wholesalers
 Professional investors always on the lookout for a good,
small company in its formative years
 Others seek opportunities to buy shares of smaller
growth firms in the expectation that the firms will soon
go public
 Attractive to venture capitalists who hope to benefit when
the company goes public or when the company is sold
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Obtaining Venture & Growth Capital
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Other equity sources
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Initial public stock offerings (IPO)
Raises capital through federally registered and
underwritten sales of the company’s shares
 More mature companies get better terms at IPO
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Obtaining Venture & Growth Capital
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Advantages of going public
Raise more capital with less dilution
 Improve balance sheet or reduce/eliminate debt
 Obtain cash for pursuing other opportunities
 Access other capital suppliers and increase
bargaining power
 Improve credibility
 Achieve liquidity for owners and investors
 Create equity incentives for new and existing staff
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Obtaining Venture & Growth Capital
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Disadvantages of going public
Legal, accounting and administrative costs
 Management time, effort and expense is required to
comply with SEC rules and reporting requirements.
 Management can become more interested in
maintaining the price of the company’s stock than in
running the company
 Liquidity of company stock achieved through a
public offering may be more apparent than real
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Obtaining Venture & Growth Capital
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Private placement after going public
Can “tide you over” in the event the public turns
sour
 SEC Regulation D
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Employee stock option plans (ESOPs)
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Used by firms with high confidence in the stability
of their future earnings and cash flow. An ESOP is a
program in which the employees become investors
in the company. Tax-qualified benefit plans.
Presenting Information to Possible
Investors
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A concise presentation should include the
following:
What is the market opportunity?
 Why is it compelling?
 How will/does the business make money?
 Why is this the right team at the right time?
 How does an investor exit the investment?
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Additional Ch. 13
Materials
What to Look Out for in Investors
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Attitude
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Be wary if getting through to a general partner in the
investment firm is an ordeal
Be wary if the investor thinks he or she can run the
business better than the lead entrepreneur or the
management team
Over commitment
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Be wary of lead investors who indicate they will be
active directors but who also sit on the boards of six to
eight other startup and early0stage companies or are in
the midst of raising money for a new fund
What to Look Out for in Investors
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Inexperience
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Be wary of dealing with venture capitalists who
are under 30 years of age and have:
Only worked on Wall Street or as a consultant
 No operating, hands-on experience in new and growing
companies
 A predominantly financial focus
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What to Look Out for in Investors
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Unfavorable reputation
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Be wary of funds that have a reputation for early and
frequent replacement of the founders
Be wary of those where more than one-fourth or the
portfolio companies are in trouble or failing to meet
projections in their business plans
Predatory pricing
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Be wary of investors who unduly exploit conditions
during adverse capital markets by forcing large share
price decreases in the new firms and punishing terms on
prior investors