Growth Funding  Patterns of Entrepreneurship Chapter 7 Session 6: Financial Alternatives for Debt and Equity Capital
Session Outline  <ul><li>Understand the Venture Capital Process </li></ul><ul><li>Private Placement Process </li></ul><ul>...
<ul><li>Venture capital firms </li></ul><ul><li>Investment banking firms </li></ul><ul><li>Insurance companies </li></ul><...
Understand the Venture Capital Process  <ul><li>Specialized Industries for the venture </li></ul><ul><li>The Location of t...
<ul><li>VC firms want returns of 30% or more </li></ul><ul><li>Only for high-growth companies </li></ul><ul><li>Require de...
The Venture Capital Process Entrepreneurs Venture Capitalists Investment Bankers Private Investors Public Market <ul><li>C...
The Logic of the Deal <ul><li>Typical start-up - Venture Capital Fund will invest 2-3 million for 40% preferred equity own...
<ul><li>Antidilution clauses or “Rachets” - This protects against equity dilution of additional rounds of financing at low...
The VC “LANDSCAPE” in 2000 # of VC Firms in Existence # of Professionals # of First Time VC Funds Raised # of VC Funds Rai...
The Committed Capital Bubble Source:  VentureOne Years Accumulated Capital  Over-commitments ($B)
The Illiquid Bulge <ul><li>From 1995-2000: </li></ul>14,463 978 1,529 1,180 10,776 Companies funded Went public Were acqui...
A Generic Late 90’s Model Million Round Type Date Amount Raised (MM)  Pre-Money Valuation (MM)  IRR Multiple 1 Seed Jan-97...
A Generic Early 90’s Model Million Round Type Date Amount Raised (MM)  Pre-Money Valuation (MM)  IRR Multiple 1 Seed Jan-9...
Why It’s Great To Be An Entrepreneur - TODAY US Venture Capital Partnership Returns Versus Public Market Returns Funds For...
<ul><li>The opportunity is considered “hot” area </li></ul><ul><li>The venture delivers scalable technology </li></ul><ul>...
<ul><li>Two Formal Methods: </li></ul><ul><ul><li>Private placement </li></ul></ul><ul><ul><li>Public stock offering </li>...
<ul><li>Rule 505 </li></ul><ul><ul><li>Up to $5 million </li></ul></ul><ul><ul><li>12 month completion period </li></ul></...
<ul><li>First:  Determine motive for valuing the business </li></ul><ul><ul><ul><li>Selling stock or buying a business  </...
<ul><li>Recent profit history </li></ul><ul><li>General conditions of company </li></ul><ul><li>Market demand and competit...
<ul><li>Valuation:  Select the valuation method </li></ul><ul><ul><ul><li>Apply the methods and compute valuation </li></u...
<ul><li>Asset Valuations </li></ul><ul><li>Earnings Valuations </li></ul><ul><li>Discounted Cash Flow Valuation </li></ul>...
<ul><li>No single valuation captures the real value of the firm.  Value is the perception of  opportunity, risk, and finan...
<ul><li>Asset Valuation </li></ul><ul><ul><ul><li>Book Value </li></ul></ul></ul><ul><ul><ul><li>Adjusted Book Value </li>...
<ul><li>Book value  </li></ul><ul><ul><ul><li>Current assets + property + equipment  </li></ul></ul></ul><ul><ul><ul><li>(...
<ul><li>Current assets + market value of property + equipment + intangible assets </li></ul><ul><li>Adjusts for large disc...
<ul><li>If the business is sold </li></ul><ul><li>Value of assets - quick sale </li></ul><ul><li>Asset valuation does not ...
<ul><li>Historical Earnings </li></ul><ul><li>Future Earnings </li></ul><ul><ul><ul><li>Projected earnings </li></ul></ul>...
<ul><li>Prepare Executive Summary </li></ul><ul><ul><ul><li>Company, market potential, marketing strategy, competitive pos...
<ul><li>Determine P.E. Ratio </li></ul><ul><ul><ul><li>Select similar public companies if available </li></ul></ul></ul><u...
<ul><li>Use Factors for Rating Scale of 1-6  </li></ul><ul><ul><ul><li>Risk assessment </li></ul></ul></ul><ul><ul><ul><li...
<ul><li>Form a corporation  </li></ul><ul><li>Authorize 2 million shares </li></ul><ul><li>Issue 1million shares </li></ul...
<ul><li>Value company at 2.4 million today </li></ul><ul><li>Each share is $2.40 outstanding </li></ul><ul><li>Determine a...
<ul><li>Select adviser(s) </li></ul><ul><li>Complete business plan </li></ul><ul><li>Define use of funds </li></ul><ul><li...
<ul><li>Prepare a Presentation to Investors </li></ul><ul><ul><ul><li>Non-Disclosure / Non-Compete Agreement </li></ul></u...
<ul><li>Is useful to investors who are attempting to appraise a return on investment and return on time </li></ul><ul><li>...
<ul><li>Terminal value  </li></ul><ul><ul><ul><li>Return of capital via sale </li></ul></ul></ul><ul><li>Tax benefits </li...
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  • 86-94 less volatility in VC 95-00 comes closer and closer to Nasdaq pattern Why would pension mgr allocate to illiquid VC
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    1. 1. Growth Funding Patterns of Entrepreneurship Chapter 7 Session 6: Financial Alternatives for Debt and Equity Capital
    2. 2. Session Outline <ul><li>Understand the Venture Capital Process </li></ul><ul><li>Private Placement Process </li></ul><ul><li>Value the Venture </li></ul><ul><li>Select the Valuation Method </li></ul><ul><li>Prepare a Presentation to Investors </li></ul>
    3. 3. <ul><li>Venture capital firms </li></ul><ul><li>Investment banking firms </li></ul><ul><li>Insurance companies </li></ul><ul><li>Large corporations </li></ul>Growth Equity Investors
    4. 4. Understand the Venture Capital Process <ul><li>Specialized Industries for the venture </li></ul><ul><li>The Location of the Venture </li></ul><ul><li>Stage of Development </li></ul><ul><li>Early Stage Financing </li></ul><ul><li>Expansion Financing </li></ul><ul><li>Acquisioion/Buyout Financing </li></ul>
    5. 5. <ul><li>VC firms want returns of 30% or more </li></ul><ul><li>Only for high-growth companies </li></ul><ul><li>Require deals over $2 million to invest </li></ul><ul><li>Most often, VC is not available until the company is ready for commercialization of the product or services </li></ul><ul><li>Most want a exit strategy in 3-5 years </li></ul>Venture Capitalists
    6. 6. The Venture Capital Process Entrepreneurs Venture Capitalists Investment Bankers Private Investors Public Market <ul><li>Corporations </li></ul><ul><li>Angles </li></ul>Funds Ideas Funds IPO’s Money Stock
    7. 7. The Logic of the Deal <ul><li>Typical start-up - Venture Capital Fund will invest 2-3 million for 40% preferred equity ownership position. </li></ul><ul><li>This gives V.C. a liquidation preference over common shares until the 2-3 million is returned. </li></ul><ul><li>If Venture fails, they have first claim to assets and technology. </li></ul><ul><li>Also blocking rights over key decisions including sale of the company and IPO. </li></ul>
    8. 8. <ul><li>Antidilution clauses or “Rachets” - This protects against equity dilution of additional rounds of financing at lower values take place. </li></ul><ul><li>This preferential treatment comes at the expense of all common shareholders. </li></ul><ul><li>If company does well, V.C. enjoys upside provision by having right to put additional money at a set price. </li></ul><ul><li>Limit risk by co-investing with other firms. </li></ul>
    9. 9. The VC “LANDSCAPE” in 2000 # of VC Firms in Existence # of Professionals # of First Time VC Funds Raised # of VC Funds Raised This Year VC Capital Raised This Year ($B) Avg VC Fund Size Raised This Year ($M) Source: NVCA Yearbook 2001; Venture Economics 1980 87 1035 24 57 2.08 36.5 1990 375 3794 14 82 3.20 39.0 2000 693 8368 164 497 105.05 211.4
    10. 10. The Committed Capital Bubble Source: VentureOne Years Accumulated Capital Over-commitments ($B)
    11. 11. The Illiquid Bulge <ul><li>From 1995-2000: </li></ul>14,463 978 1,529 1,180 10,776 Companies funded Went public Were acquired Went out of business Remaining Source: Venture Economics; Venture Source - - -
    12. 12. A Generic Late 90’s Model Million Round Type Date Amount Raised (MM) Pre-Money Valuation (MM) IRR Multiple 1 Seed Jan-97 $ 5 $ 35 79% 18.37 2 1st Jan-98 $ 10 $ 100 65% 7.35 3 2nd Jan-99 $ 25 $ 200 59% 4.04 4 3rd Jan-00 $ 60 $ 600 52% 1.52 5 IPO Jan-01 $ 1000 $ 100
    13. 13. A Generic Early 90’s Model Million Round Type Date Amount Raised (MM) Pre-Money Valuation (MM) IRR Multiple 1 Seed Jan-90 $ 0.50 $ 2 101% 32.53 2 1st Jan-91 $ 3.00 $ 10 70% 8.13 3 2nd Jan-92 $ 8.00 $ 32 50% 3.30 4 3rd Jan-94 $ 13.50 $ 100 32% 1.32 5 IPO Jan-95 $ 150 $ 25
    14. 14. Why It’s Great To Be An Entrepreneur - TODAY US Venture Capital Partnership Returns Versus Public Market Returns Funds Formed 1969-1999 (quarterly returns) Source: Venture Economics/NVCA
    15. 15. <ul><li>The opportunity is considered “hot” area </li></ul><ul><li>The venture delivers scalable technology </li></ul><ul><li>There are client references </li></ul><ul><li>The team is diligent and goal </li></ul><ul><li>The entrepreneur is skilled in finance, capital and deal structures </li></ul><ul><li>Realistic expectations are incorporated into goals of the company </li></ul>Profile of the Ideal Entrepreneur from a VC Perspective
    16. 16. <ul><li>Two Formal Methods: </li></ul><ul><ul><li>Private placement </li></ul></ul><ul><ul><li>Public stock offering </li></ul></ul><ul><ul><li>Private placement controlled by Regulation D of the Federal Securities Act </li></ul></ul><ul><li>Rule 504 </li></ul><ul><ul><li>Up to $1,000,000 </li></ul></ul><ul><ul><li>12 month completion period </li></ul></ul><ul><ul><li>No restrictions on the number of investors </li></ul></ul>Equity Financing
    17. 17. <ul><li>Rule 505 </li></ul><ul><ul><li>Up to $5 million </li></ul></ul><ul><ul><li>12 month completion period </li></ul></ul><ul><ul><li>No more than 35 non accredited investors and unlimited number of accredited investors </li></ul></ul><ul><li>Rule 506 </li></ul><ul><ul><li>Unlimited amount of raising funds </li></ul></ul><ul><ul><li>No more than 35 unaccredited but sophisticated purchasers.and to unlimited number of accredited investors. </li></ul></ul><ul><ul><li>must be able to evaluate merit and risks. </li></ul></ul>Equity Financing
    18. 18. <ul><li>First: Determine motive for valuing the business </li></ul><ul><ul><ul><li>Selling stock or buying a business </li></ul></ul></ul><ul><li>Second: Define what is to be valued </li></ul><ul><ul><ul><li>Entire company, product line or a unit division </li></ul></ul></ul><ul><ul><ul><li>Income stream determination </li></ul></ul></ul><ul><li>Third: Set a point in time for valuation </li></ul>Valuation Process
    19. 19. <ul><li>Recent profit history </li></ul><ul><li>General conditions of company </li></ul><ul><li>Market demand and competition -- at time of offering </li></ul><ul><li>Ability to transfer goodwill </li></ul><ul><li>Future profit potential </li></ul><ul><li>Management team </li></ul>Factors to Assess a Company’s Value
    20. 20. <ul><li>Valuation: Select the valuation method </li></ul><ul><ul><ul><li>Apply the methods and compute valuation </li></ul></ul></ul><ul><li>Weight the Values: Apply a percentage allocation to each value (E.G.: 40% to adjusted book value, 30% price earnings, and 30% to discounted value) </li></ul>Determine Value and Weight
    21. 21. <ul><li>Asset Valuations </li></ul><ul><li>Earnings Valuations </li></ul><ul><li>Discounted Cash Flow Valuation </li></ul>Valuation Techniques
    22. 22. <ul><li>No single valuation captures the real value of the firm. Value is the perception of opportunity, risk, and financing resources available . </li></ul><ul><li>Difference is determined by vision, market analysis, time pressures, and negotiating. </li></ul>Valuation Statement
    23. 23. <ul><li>Asset Valuation </li></ul><ul><ul><ul><li>Book Value </li></ul></ul></ul><ul><ul><ul><li>Adjusted Book Value </li></ul></ul></ul><ul><ul><ul><li>Liquidation Value </li></ul></ul></ul><ul><ul><ul><li>Replacement Value </li></ul></ul></ul>What is the Business Worth?
    24. 24. <ul><li>Book value </li></ul><ul><ul><ul><li>Current assets + property + equipment </li></ul></ul></ul><ul><ul><ul><li>(net of depreciation) </li></ul></ul></ul><ul><ul><ul><li>Total net worth </li></ul></ul></ul><ul><li>Used primarily for accounting purposes </li></ul>Asset Valuation
    25. 25. <ul><li>Current assets + market value of property + equipment + intangible assets </li></ul><ul><li>Adjusts for large discrepancies (land, equipment) </li></ul><ul><li>Better reflects actual market value </li></ul>Adjusted Book Value
    26. 26. <ul><li>If the business is sold </li></ul><ul><li>Value of assets - quick sale </li></ul><ul><li>Asset valuation does not consider intangible factors such as reputation, talent, or goodwill </li></ul>Liquidation Value
    27. 27. <ul><li>Historical Earnings </li></ul><ul><li>Future Earnings </li></ul><ul><ul><ul><li>Projected earnings </li></ul></ul></ul><ul><ul><ul><li>Nature of industries and similar companies </li></ul></ul></ul><ul><ul><ul><li>Anticipated economic conditions </li></ul></ul></ul>Earnings Valuation
    28. 28. <ul><li>Prepare Executive Summary </li></ul><ul><ul><ul><li>Company, market potential, marketing strategy, competitive position, milestones, product position, financial summary </li></ul></ul></ul><ul><li>Prepare Forecast: 1-3 Years </li></ul><ul><ul><ul><li>Monthly: year 1 </li></ul></ul></ul><ul><ul><ul><li>Quarterly: year 2 and 3 </li></ul></ul></ul><ul><li>Choose Valuation Process </li></ul>Earning Valuation for Start-Up Companies
    29. 29. <ul><li>Determine P.E. Ratio </li></ul><ul><ul><ul><li>Select similar public companies if available </li></ul></ul></ul><ul><ul><ul><li>Use S&P quarterly industry analysis handbook for your P.E. ratio </li></ul></ul></ul><ul><ul><ul><li>Reduce P.E. by 50%, if your size is smaller and illiquidity factor (holder may not be able to sell shares without considerable effort). </li></ul></ul></ul>Earning Valuation
    30. 30. <ul><li>Use Factors for Rating Scale of 1-6 </li></ul><ul><ul><ul><li>Risk assessment </li></ul></ul></ul><ul><ul><ul><li>Competitive position </li></ul></ul></ul><ul><ul><ul><li>Industry and company </li></ul></ul></ul><ul><ul><ul><li>Growth opportunity </li></ul></ul></ul><ul><ul><ul><li>Desirability </li></ul></ul></ul><ul><ul><ul><li>Total and average </li></ul></ul></ul>How to Calculate P.E. Multiple
    31. 31. <ul><li>Form a corporation </li></ul><ul><li>Authorize 2 million shares </li></ul><ul><li>Issue 1million shares </li></ul><ul><li>Projected P&L is $200,000 </li></ul><ul><li>Profit after 3 years (EBIT) </li></ul><ul><li>Projected P.E. is 12 for your industry (after careful analysis) </li></ul>Guidelines Using Earning Valuation
    32. 32. <ul><li>Value company at 2.4 million today </li></ul><ul><li>Each share is $2.40 outstanding </li></ul><ul><li>Determine amount you require to raise </li></ul><ul><ul><ul><li>Sell 100,000 shares @ $2.40 </li></ul></ul></ul><ul><ul><ul><li>You are offering 10% of the company for $240,000 </li></ul></ul></ul>Value Guidelines
    33. 33. <ul><li>Select adviser(s) </li></ul><ul><li>Complete business plan </li></ul><ul><li>Define use of funds </li></ul><ul><li>Seek qualified advise from lawyer </li></ul><ul><li>Select a mentor to advise you </li></ul><ul><li>Target investor group </li></ul><ul><ul><ul><li>Personal, family, angels, professional </li></ul></ul></ul>Guidelines
    34. 34. <ul><li>Prepare a Presentation to Investors </li></ul><ul><ul><ul><li>Non-Disclosure / Non-Compete Agreement </li></ul></ul></ul><ul><ul><ul><li>Demo of product </li></ul></ul></ul><ul><ul><ul><li>Hand-outs </li></ul></ul></ul><ul><ul><ul><li>PowerPoint presentation </li></ul></ul></ul><ul><ul><ul><li>Determine if you want qualified or determine if you want qualified or non-qualified investors </li></ul></ul></ul><ul><ul><ul><li>Subscription Agreements </li></ul></ul></ul>Guidelines
    35. 35. <ul><li>Is useful to investors who are attempting to appraise a return on investment and return on time </li></ul><ul><li>Forecasts cash flows and discounts them back to the business </li></ul><ul><li>Must have positive cash flow - Calculate </li></ul>Discounted Cash Flow Valuation
    36. 36. <ul><li>Terminal value </li></ul><ul><ul><ul><li>Return of capital via sale </li></ul></ul></ul><ul><li>Tax benefits </li></ul><ul><li>Operating cash flows </li></ul><ul><ul><ul><li>Business related expenses (car, club membership) </li></ul></ul></ul><ul><ul><ul><li>Salary and dividends </li></ul></ul></ul>Discounted Cash Flow Valuation
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