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Module 7

Informal risk capital and venture capital

Informal risk capital market

Venture capital - Nature and overview

Venture capital process Locating venture capitalists

Approaching venture capitalists

Funding Entrepreneurship Development 1

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A ventures typical life-cycle

Funding Entrepreneurship Development 2

Profit,Productivity,Revenues

New Venture Start-up Venture Growth Businessstabilisation

Innovation orDecline

Source and type of funding varies

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Why new ventures need funding

Cash Flow Challenges

Inventory must be

purchased

Employees must

be trained and

paid

Establishment

overheads

Advertising mustbe paid for

Funding Entrepreneurship Development 3

Capital Investments

Cost of buying real

estate, building

Purchasing

equipment

Technology

purchases

patent filing

Lengthy PDLC

Product

development can

take a long time

Funds required

during

development

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Stages of business development funding

Funding Entrepreneurship Development 4

Highest risk,Highest returnexpected

Lowest risk,Lowest returnexpected

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Informal risk capital market

Business Angels

Invest their personal capital directly in start-ups

High net worth ex-entrepreneurs, retired corporate

executives, professionals

$25K to $150K per start-up Apple received 91K from Mike Markkula (ex-Intel) in 1977.

When Apple went public in 1980, this investment was worth

$150M

Expect hefty 40%+ annual return Sit on the Board sometimes

Act as mentors and use their wide personal network

Remain anonymous

Funding Entrepreneurship Development 6

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Venture capital market

Funds made available for start-up firms and small businesseswith exceptional growth potential

Also known as venture capital, risk capital is provided to

companies in the early stage of development

It is a professionally managed pool of equity capital

Venture Capital Investments are private equity investments in

business ventures from growth stage through expansion of a

company already producing and selling a product and through

preparation for exit from the investment via buyout or initialpublic offering

They bring equity investment (and debt), financial planning,

business skills to the firm

Entrepreneurship Development 7Funding

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Public Equity market

Organized markets for trading in equity shares such

as common stocks, preferred stocks, and warrants.

Includes markets for both regularly traded and non-

regularly traded securities This is another source of finance for enterprises

Typically available for major expansion after being

established in the market

Some high potential start-ups also use this route for

risk financing (technology, biotech etc)

Entrepreneurship Development 8Funding

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Appropriate Source of Funding

Characteristics of venture

Business has high risk with an

uncertain return

Weak cash flow

Low to moderate growth

Unproven management

Source

Personal funds, friends and family,

bootstrapping

Funding Entrepreneurship Development 9

Business has low risk with

predictable return

Strong cash flow Audited financials

Good management

Debt financing

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Appropriate Source of Funding

Characteristics of venture

Business offers high return

Unique business idea

High growth

Niche market

Proven management

Source

Equity

Funding Entrepreneurship Development 10

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Funding Entrepreneurship Development 11

Owners money

Family and Friends

Business Angels

Venture Capital

Banks and Govt.

Private Placements

IPO

$10K 100K

$20K 250K

$100K 2M

$2M 50M

$5K and up

$500K and up

$5M and up

The financing continuum

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Debt financing

Funding Entrepreneurship Development 12

Debt financing Advantages No relinquishment of ownership More borrowing means greater return on equity When interest rates are low, cost of borrowing is justified

Debt financing Disadvantages Regular interest payments are reqd. Payback may result in cash flow problems Heavy use of debt can inhibit growth

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Business Angels vs. Venture Capitalists

Parameter

Personal

Firms funded

Due diligence done

Location of investment

Contract used

Monitoring after invst.

Exiting

Rate of return

Funds

Business Angels

Entrepreneurs

Small, Early stage

Minimal

Of concern

Simple

Active, hands-on

Of lesser concern

Of lesser concern

Personal

Funding Entrepreneurship Development 13

Venture Capitalists

Investors

Large, Mature

Extensive

Not important

Comprehensive

Strategic

Very important

Very important

Manage others

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Venture capital process

Objective of a venture capitalist is to generate long

term capital process thru debt and equity

investments

Objective of entrepreneur is survival or growth Can invest at any stage depending on risk appetite

Criteria for commitment

Strong management team Market opportunity must be unique and real

Potentially significant capital appreciation

Entrepreneurship Development 14Funding

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Venture capital process

Preliminary screening Business plan

Industry economics

Ability to evaluate/invest

Agreement on principal terms Deal terms and conditions

Due diligence

Detailed review of business suppliers, market, finances

Management interviews

Risk assessment

Final approval

Internal investment memorandum

Formal legal documentsEntrepreneurship Development 15Funding