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Part IV – Initiating Part IV – Initiating Entrepreneurial Ventures Entrepreneurial Ventures
Chapter 11 – Assessment and Evaluation ofChapter 11 – Assessment and Evaluation of Entrepreneurial Opportunities Entrepreneurial OpportunitiesChapter 12 – Legal Structures for NewChapter 12 – Legal Structures for New Business Ventures Business VenturesChapter 13 – Legal Issues Related to Chapter 13 – Legal Issues Related to Emerging Ventures Emerging VenturesChapter 14 – Sources of Capital for Chapter 14 – Sources of Capital for Entrepreneurs Entrepreneurs
Copyright (c) 2004 by South-Western, a division of Thomson Learning. All rights reserved.
Chapter 14 – Sources of Capital Chapter 14 – Sources of Capital For Entrepreneurs For Entrepreneurs
Debt Versus EquityDebt Versus Equity
The use of The use of debtdebt to finance a new to finance a new venture involves a payback of the venture involves a payback of the
funds plus a fee (interest for the use funds plus a fee (interest for the use of the money. of the money. EquityEquity financing financing involves the sale of some of the involves the sale of some of the
ownership in the venture.ownership in the venture.
Debt FinancingDebt Financing
• Commercial BanksCommercial Banks
• Other Debt-Financing Sources:Other Debt-Financing Sources:– Trade CreditTrade Credit
– Accounts Receivable FinancingAccounts Receivable Financing
– FactoringFactoring
– Finance CompaniesFinance Companies
Source of Finance Throughout the Source of Finance Throughout the Evolution of the Entrepreneurial FirmEvolution of the Entrepreneurial Firm
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HighHigh
LowLowSeedSeed Start-UpStart-Up EarlyEarly
GrowthGrowthEstablishedEstablished
Founder, friends,Founder, friends,and familyand family
Business AngelsBusiness Angels
Venture CapitalistsVenture Capitalists
NonfinancialNonfinancialcorporationscorporations
EquityEquitymarketsmarkets
Commercial banksCommercial banks
Stage of Development of the Entrepreneurial FirmStage of Development of the Entrepreneurial Firm
Equity FinancingEquity Financing
Public OfferingsPublic Offerings““Going public” is a term used to refer to a Going public” is a term used to refer to a
corporation’s raising capital through the sale of corporation’s raising capital through the sale of securities on the public markets. Here are some of securities on the public markets. Here are some of the advantages to this approach:the advantages to this approach:
• Size of capital amountSize of capital amount• LiquidityLiquidity• ValueValue• ImageImage
(new issues, referred to as initial public (new issues, referred to as initial public offerings IPOs)offerings IPOs)
Public OfferingsPublic Offerings
Disadvantages of going public:Disadvantages of going public:
• CostsCosts
• DisclosureDisclosure
• RequirementsRequirements
• Shareholder pressureShareholder pressure
Private PlacementsPrivate PlacementsThe SEC provides Regulation D, which eases the The SEC provides Regulation D, which eases the
regulations for the reports and statements required regulations for the reports and statements required for selling stock to private parties – friends, for selling stock to private parties – friends, employees, customers, relatives, and local employees, customers, relatives, and local professionals. Regulation D defines four separate professionals. Regulation D defines four separate exemptions, which are based on the amount of exemptions, which are based on the amount of money being raised:money being raised:
1.1. Rule 504a – placements of less than $500,000Rule 504a – placements of less than $500,0002.2. Rule 504 – placements up to $1,000,000Rule 504 – placements up to $1,000,0003.3. Rule 505 – placements of up to $5 millionRule 505 – placements of up to $5 million4.4. Rule 506 – placements in excess of $5 millionRule 506 – placements in excess of $5 million
Accredited PurchaserAccredited PurchaserAs noted in Rules 505 and 506, Regulation D uses the As noted in Rules 505 and 506, Regulation D uses the
term “accredited purchaser”. Included in this term “accredited purchaser”. Included in this category are the following:category are the following:
• Institutional investors such as banks, insurance Institutional investors such as banks, insurance companies, venture capital firms.companies, venture capital firms.
• Any person who buys at least $150,000 of the Any person who buys at least $150,000 of the offered security and whose net worth, including offered security and whose net worth, including that of his or her spouse, is at least 5 times the that of his or her spouse, is at least 5 times the purchase price.purchase price.
• Any person who, together with his or her spouse, Any person who, together with his or her spouse, has a net worth in excess of $1 million at the time has a net worth in excess of $1 million at the time of purchase.of purchase.
““Sophisticated” InvestorsSophisticated” Investors
““Sophisticated” investors are wealthy Sophisticated” investors are wealthy individuals who invest more or less individuals who invest more or less regularly in new and early- and late-regularly in new and early- and late-
stage ventures. They are knowledgeable stage ventures. They are knowledgeable about the technical and commercial about the technical and commercial
opportunities and risks of the business in opportunities and risks of the business in which they invest.which they invest.
The Venture Capital The Venture Capital MarketMarket
Venture Capital InvestmentsVenture Capital Investments
YearYearNumber ofNumber ofCompaniesCompanies
Amount InvestedAmount Invested(in billions)(in billions)
20012001 4,9324,932 42.942.920002000 8,4048,404 108.8108.819991999 5,8245,824 56.556.519981998 4,3454,345 22.222.219971997 3,3363,336 16.716.7
Venture Capital InvestmentsVenture Capital Investmentsby Stages of Developmentby Stages of Development
Stage ofStage ofDevelopmentDevelopment
Start-up/SeedStart-up/Seed
Early StageEarly Stage
ExpansionExpansion
Later StageLater Stage
AmountAmount(in billions)(in billions) CompaniesCompanies
AmountAmount(in billions)(in billions) CompaniesCompanies
20012001 20022002
540.6540.6
4,682.94,682.9
1,911.11,911.1
229.4229.4
193193
642642
291291
4141
2,311.62,311.6
16,499.516,499.5
9,654.79,654.7
718.5718.5
537537
1,8721,872
853853
7777
Dispelling Venture Capital MythsDispelling Venture Capital MythsMyth 1:Myth 1: Venture capital firms want to own control of Venture capital firms want to own control of
your company and tell you how to run the business.your company and tell you how to run the business.
Myth 2:Myth 2: Venture capitalists are satisfied with a Venture capitalists are satisfied with a reasonable return on investment.reasonable return on investment.
Myth 3:Myth 3: Venture capitalists are quick to invest Venture capitalists are quick to invest
Myth 4:Myth 4: Venture capitalists are interested in backing Venture capitalists are interested in backing new ideas or high-technology inventions – new ideas or high-technology inventions – management is a secondary consideration.management is a secondary consideration.
Myth 5:Myth 5: Venture capitalists need only basic summary Venture capitalists need only basic summary information before they make an investment.information before they make an investment.
Criteria for Evaluating Criteria for Evaluating New-Venture ProposalsNew-Venture Proposals
Returns on Investment Typically South by Returns on Investment Typically South by Venture CapitalistsVenture Capitalists
Stage ofStage ofBusinessBusiness
ExpectedExpectedAnnual ReturnAnnual Returnon Investmenton Investment
ExpectedExpectedIncrease onIncrease on
Initial InvestmentInitial Investment
Start-up businessStart-up business (idea stage) (idea stage)
60%60% 10-15 x investment10-15 x investment
First-stage financingFirst-stage financing (new business) (new business)
40%-60%40%-60%
Second-stage financingSecond-stage financing (development stage) (development stage)
30%-50%30%-50%
Third-stage financingThird-stage financing (expansion stage) (expansion stage)
25%-40%25%-40%
Turnaround situationTurnaround situation 50%50%
6-12 x investment6-12 x investment
4-8 x investment4-8 x investment
3-6 x investment3-6 x investment
8-15 x investment8-15 x investment
Venture Capitalist Screening CriteriaVenture Capitalist Screening Criteria
• Venture Capital Firm RequirementsVenture Capital Firm Requirements• Nature of the Proposed BusinessNature of the Proposed Business• Economic Environment of Proposed IndustryEconomic Environment of Proposed Industry• Proposed Business StrategyProposed Business Strategy• Financial Information on the Proposed Financial Information on the Proposed
BusinessBusiness• Proposal CharacteristicsProposal Characteristics• Entrepreneur/Team CharacteristicsEntrepreneur/Team Characteristics
Informal Risk Capital – Informal Risk Capital – “Angel” Financing“Angel” Financing
Many wealthy people in the United Many wealthy people in the United States are looking for investment States are looking for investment
opportunities. They are referred to opportunities. They are referred to as “business angels” or informal as “business angels” or informal
risk capitalists.risk capitalists.
Informal Risk Capital – Informal Risk Capital – “Angel” Financing“Angel” Financing
One newly created source is the Angel Capital One newly created source is the Angel Capital Electronic Network (ACE-Net). This Electronic Network (ACE-Net). This
Internet-based service provides information Internet-based service provides information to institutional and individual accredited to institutional and individual accredited investors about small, dynamic, growing investors about small, dynamic, growing
businesses seeking $250,000 to $5 million in businesses seeking $250,000 to $5 million in equity financing.equity financing.
Types of Angel InvestorsTypes of Angel Investors
• Corporate AngelsCorporate Angels
• Entrepreneurial AngelsEntrepreneurial Angels
• Enthusiast AnglesEnthusiast Angles
• Micromanagement AngelsMicromanagement Angels
• Professional AngelsProfessional Angels
Angel StatsAngel Stats
• Typical deal size: Typical deal size: $250,000$250,000
• Typical recipient: Typical recipient: Start-up firmsStart-up firms
• Cash-out time frame: Cash-out time frame: 5 to 7 years5 to 7 years
• Expected return: Expected return: 35 to 50%35 to 50%
The Pros and Cons of Business The Pros and Cons of Business Angel InvestmentsAngel Investments
Angels’ CharacteristicsAngels’ CharacteristicsValue-addingValue-adding
Geographically dispersedGeographically dispersedMore permissive investorsMore permissive investors
Investment CharacteristicsInvestment CharacteristicsSeek Smaller DealsSeek Smaller Deals
Prefer start-up & early stagePrefer start-up & early stageInvest in all industry sectorsInvest in all industry sectors
Like high-tech firmsLike high-tech firms
Added BonusesAdded BonusesLeveraging effectLeveraging effect
Give loan guaranteesGive loan guaranteesNo high feesNo high fees
AdvantagesAdvantages
Business AngelsBusiness Angels
DisadvantagesDisadvantages
LittleLittlefollow-onfollow-on
moneymoney
Want a sayWant a sayin firmin firm
Could turnCould turnout to beout to be“devils”“devils”
No nationalNo nationalreputationreputationto leverageto leverage