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.)