FUNDING A RAPIDLY GROWING VENTURE

1. 16 FUNDING A RAPIDLY GROWING VENTURE

2. Learning Objectives • Discuss the cost and process of raising capital. • Explain the role of the venture capital market. • Describe the process associated with the initial public offering. • Discuss how to grow with strategic alliances. • Explain ways to value a business.

3. The Cost and Process of Raising Capital • Raising money takes time. • It takes twice as long as expected for money to reach the bank. • The chosen financial source may not complete the deal. • Entrepreneurs always need backup investors. • Second round investors often buy out first round funding sources. • “It takes money to make money.”

4. The Venture Capital Market • Venture capital • A pool of money managed by professionals • The ability to secure funding depends upon: • The status of the venture capital industry • What the entrepreneur brings to the table

5. Total Venture Capital Investing in the U.S. from 1995 - 2009 Figure 16.1 Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report, Data: Thomson Reuters.

6. Venture Capital Investment by Industry Table 16.1 Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report, Data: Thomson Reuters.

7. Sequence of Events in Securing Venture Capital • Understand the goals/motivations of the venture capitalists • Venture capitalists (VCs) are fundamentally risk averse – reduce risk in key areas where VC’s find risk: • Management risk • Technology risk • Business model risk

8. Sequence of Events in Securing Venture Capital (cont’d) • Three major stages during which entrepreneurs receive funding: • Idea and proof of concept stage • Early growth and transition • Rapid growth • Venture capitalists scrutinize new opportunities by evaluating (in order): • The market • Management • Technology

9. Funding Stages and Risk Figure 16.2

10. Sequence of Events in Securing Venture Capital (cont’d) • Venture capitalists invest in growing businesses through the use of debt and equity instruments to achieve long-term appreciation on the investment in 3 to 5 years. • Entrepreneur should research and select venture capital firm carefully. • After extensive due diligence, term sheets are drawn up.

11. Getting to a Term Sheet • Does not guarantee a “done deal” • Represents the start of the negotiation process • Term sheet contains: • Amount of investment the VC firm is willing to consider • Conditions under which VC firm is willing to consider the funding

12. Capital Structure • Components of an investment deal: • Amount of money to be invested • Time and use of the investment monies • Return on investment to investors • Level of risk involved • Provisions of the deal: • Equity and debt positions • Anti-dilution provision • Forfeiture provision

13. Super Angel Market • Fills the gap between traditional angel market and VCs • Invest their own money and also manage investments of friends and family • Investments normally between $500,000 – $2M • Favor types of businesses where smaller investment is required and success is achieved between 6 months – 1 year • Enjoy a lower rate of failure than VCs

14. The Initial Public Offering (IPO) • Advantages of going public: • A big source of interest-free capital • Future option of additional stock offerings • More prestige and marketplace clout • Restricted stock and stock options can be used to attract new employees and reward existing employees • Easier for founders to harvest rewards

15. The Initial Public Offering (IPO) (cont’d) • Disadvantages of going public: • Dramatic decline in pre-IPO issuer’s financial condition and significant rise in failure rate post-IPO • Public offering process is expensive • Going public is very time-consuming • All company proceedings become public • Stringent disclosure rules under Sarbanes-Oxley Act • Intense pressure post IPO to perform in the short term

16. The IPO Process Simplified Figure 16.3

17. Growing via Strategic Alliances • A close, collaborative relationship between two or more firms with the intent of accomplishing mutually compatible goals that would be difficult for each to accomplish alone • Advantages of alliances with big companies: • Excellent course of growth capital • Better financial deal for a growing company • Cautions: • Investigate the potential partner carefully • Consider several partners before selecting one • Don’t become too heavily dependent on partner • Ensure that benefits will flow in both directions

18. Valuing the Business • Financial yardsticks: • Fair market value • Intrinsic value • Investment value • Going-concern value • Liquidation value • Book value

19. Valuing the Business (cont’d) • Non financial yardsticks: • The experience level of the management team • Firm’s distribution channels level of innovation • Nature of the company’s relationships in the industry and with customers • Company’s ability to be fast and flexible • Amount/kind of the company’s intellectual property

20. Valuing the Business (cont’d) • Comparables • Companies with similar value characteristics (risk, rate of growth, capital structure, size and timing of cash flows) • Multiple of earnings • Simple and direct way to value publicly owned companies • Figures normal earnings and then capitalizes at some rate of return as a multiple of earnings

21. Valuing the Business (cont’d) • Discounting cash flows • Values business by potential earnings power • Capitalization of future cash flows to the present value • 4 components to be addressed: • The assumptions • Forecast period • Terminal value • Discount rate

22. Valuing the Business (cont’d) • Real options model • Techniques applied to entrepreneur’s options under changing circumstances • Includes calculation of probability that specific events will occur • Venture capital model • Often used in private equity arena to value investments with negative cash flows and earnings but with future promise

23. New Venture Action Plan • Determine how much growth capital will be needed and at what stages. • Develop a strategy for seeking growth capital. • Consider whether and, if so, when to proceed with an IPO. • Establish a value for the business.