This document provides an overview of different financing options for businesses at various stages, including informal risk capital (investments from business angels), venture capital, and going public. It discusses the criteria for different financing alternatives, characteristics of informal investors and venture capital firms, the venture capital process, valuing a company, and the registration process and requirements for going public.

1. Hisrich
Peters
Shepherd
Chapter 12
Informal Risk Capital,
Venture Capital,
and
Going Public
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. 12-2
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.

3. 12-3
Table 12.1 - Stages of Business
Development Funding

4. 12-4
 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.
Financing the Business (cont.)

5. 12-5
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.

6. 12-6
Table 12.2 - Characteristics of
Informal Investors

7. 12-7
Table 12.2 - Characteristics of
Informal Investors (cont.)

8. 12-8
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.

9. 12-9
Figure 12.1 - Types of Venture-
Capital Firms

10. 12-10
Figure 12.3 - Percentage of Venture
Dollars Raised by Stage in 2008

11. 12-11
 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 (cont.)

12. 12-12
Figure 12.4 - Venture-Capital
Financing: Risk and Return Criteria

13. 12-13
 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.)

14. 12-14
 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.
Venture Capital (cont.)

15. 12-15
Table 12.6 - Guidelines for Dealing
with Venture Capitalists

16. 12-16
Table 12.6 - Guidelines for Dealing
with Venture Capitalists (cont.)

17. 12-17
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.

18. 12-18
 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.)

19. 12-19
Valuing Your Company (cont.)

20. 12-20
Valuing Your Company (cont.)

21. 12-21
Valuing Your Company (cont.)

22. 12-22
Valuing Your Company (cont.)

23. 12-23
 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.)

24. 12-24
Valuing Your Company (cont.)

25. 12-25
Table 12.7 - Steps in Valuing Your
Business and Determining Investors’
Share

26. 12-26
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.

27. 12-27
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.

28. 12-28
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.

29. 12-29
Table 12.8 - Advantages and
Disadvantages of Going Public

30. 12-30
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?

31. 12-31
 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.
Timing of Going Public and
Underwriter Selection (cont.)

32. 12-32
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.

33. 12-33
 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.)

34. 12-34
 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.)

35. 12-35
 Cover page
 Prospectus summary
 Description of the
company
 Risk factors
 Use of proceeds
 Dividend policy
 Capitalization
 Dilution
 Selected financial
data
 Business,
management, and
owners
 Type of stock
 Underwriter
information
 Actual financial
statements.
Registration Statement and
Timetable (cont.)
Prospectus

36. 12-36
 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.)

37. 12-37
 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.
Registration Statement and
Timetable (cont.)

38. 12-38
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.

39. 12-39
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.

40. 12-40
 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.
After Going Public (cont.)