Informal Risk Capital, Venture Capital,

and Going Public

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.
Stages of Business Development Funding
Financing the Business (cont.)

}  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.
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.
Characteristics of Informal Investors
Characteristics of Informal Investors (cont.)
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.
Types of Venture-Capital Firms
Percentage of Venture Dollars Raised by
Stage in 2008
Venture Capital (cont.)

}  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 Financing: Risk and
Return Criteria
Venture Capital (cont.)

}  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.)
}  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.
Guidelines for Dealing with Venture Capitalists
Guidelines for Dealing with Venture
Capitalists (cont.)
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.
Valuing Your Company (cont.)

}  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.)
Valuing Your Company (cont.)
Valuing Your Company (cont.)
Valuing Your Company (cont.)
Valuing Your Company (cont.)

}  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.)
Steps in Valuing Your Business and
Determining Investors’ Share
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.
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.
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.
Advantages and Disadvantages of Going
Public
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?
Timing of Going Public and
Underwriter Selection (cont.)
}  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.
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.
Registration Statement and
Timetable (cont.)
}  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.)
}  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.)
§ Prospectus
}  Cover page }  Selected financial data
}  Prospectus summary }  Business, management, and
}  Description of the company owners
}  Risk factors }  Type of stock
}  Use of proceeds }  Underwriter information
}  Dividend policy }  Actual financial statements.
}  Capitalization
}  Dilution
Registration Statement and
Timetable (cont.)
}  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.)
}  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.
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.
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.
After Going Public (cont.)
}  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.