Obtaining Venture & Growth Capital Chapter 13

1. Obtaining Venture & Growth CapitalChapter 13 Dowling BA 560 Fall Term 2006

2. Obtaining Venture & Growth Capital • Cover your equity • Balance the need for startup and growth capital with preservation of equity • The earlier the capital enters, regardless of the source, the more $$$ costly it is • Creative bootstrapping strategies can be great preservers of equity

3. Obtaining Venture & Growth Capital • Considerations • Does the venture need outside equity capital? • Do the founders want outside equity capital? • Who should invest? • An equity investment requires that the management team firmly believe that investors can and will add value to the venture.

4. Exhibit 13.1

5. Obtaining Venture & Growth Capital • Timing • It is unwise for a startup to delay looking for capital since it is likely to take six months or more to raise money.

6. Obtaining Venture & Growth Capital • Early-stage entrepreneurs need investors who: • Are considering new financing proposals and can provide the required level of capital • Are interested in companies at the particular growth stage • Understand and have a preference for investments in the particular industry • Can provide good business advice, moral support • Are reputable and ethical and with whom founder can get along • Have successful track records of 10 years or more advising and building smaller companies

7. Angel Investors • Who are angel investors? • Most are self-made entrepreneur millionaires • Many are in their 40s and 50s • Most are well educated • Ninety-five percent have college degrees from four-year colleges • Fifty-one percent have graduate degrees (Forty-four percent are in a technical field and thirty-percent percent are in business or economics) • Ninety-six percent are men

8. Informal Investors • What type of ventures lends themselves to the use of informal investors? • Special situations, such as very early financing of high-technology inventors who have not developed a prototype • Companies that project high levels of free cash flow within three to five years

9. Obtaining Venture & Growth Capital • Angels and informal investors • Who they are • Typical informal investor will invest from $10,000 to $50,000 in any one venture. They’re appropriate for: • Ventures with capital requirements from $50K-$500K • Ventures with sale potential from $2-$20 million in 5-10 years. • Small, established, privately held ventures with sales and profit growth of 10 to 20 percent per year • Special situations

10. Obtaining Venture & Growth Capital • Evaluation process • An informal investor will want to review a business plan, meet the full management team, see any product prototype or design that may exist, etc. • The decision • Agreement with informal investors will most often include a “put,” whereby the investor has the right to require the venture to repurchase his or her stock after a specified number of years at a specified price.

11. Obtaining Venture & Growth Capital • Venture capital: What is it? • “The venture capital industry supplies capital and other resources to entrepreneurs in businesses with high growth potential in hopes of achieving a high rate of return on invested funds.” • Most credit Ralph Flanders, then president of Federal Reserve Bank of Boston, with the idea. • VC investors commonly expect returns of 5 to 10 times initial investment in 5 to 10 years.

12. Exhibit 13.3

13. Exhibit 13.10

14. Obtaining Venture & Growth Capital • Venture capital • Key is to seek investors who will truly add value to the venture, beyond the money • Carefully screen potential investors to determine how specifically they might fill in some gaps in the founders’ know-how and networks • The right investors can open doors to new customers, vendors, and additional investors

15. Obtaining Venture & Growth Capital • Venture capital • No more than 2 to 4 percent of ventures seeking VC actually receive financing from them • An entrepreneur may give up 25 to 75 percent of his or her equity for seed/startup financing • Most VC investors are limited partnerships, with fund managers serving as general partners and investors as limited partners

16. Exhibit 13.6

17. Obtaining Venture & Growth Capital • Sources and guides • A good place to start is Pratt’s Guide to Venture Capital Sources • What to look for: • Entrepreneurs are well advised to screen prospective investors to determine the appetites of such investors for the stage, industry, technology and capital requirements proposed

18. Obtaining Venture & Growth Capital • Dealing with venture capitalists • If possible, obtain a personal introduction from someone the investors know well • Identify several prospects; create a market for your idea by marketing it • Do not stop selling until the money is in the bank. • Let the facts speak for themselves. Be able to deliver on the claims.

19. Obtaining Venture & Growth Capital • What to look out for: • Attitude • Over-commitment • Inexperience • Unfavorable reputation • Predatory Pricing

20. Obtaining Venture & Growth Capital • Due Diligence: A two-way street • DD can take several weeks or months at startup • Involves a painstaking investigation for investors

21. Obtaining Venture & Growth Capital • Other equity sources • SBA 7(a) Guaranteed Business Loan Program • Small business investment companies • Licensed and loan-funded by SBA • Limited to taking minority shareholder positions • Can invest only 20% of equity capital in any one firm • Common options include long-term loans with stock options, convertible debentures, straight loans, and preferred stock

22. Obtaining Venture & Growth Capital • Other equity sources • Mezzanine capital • Capital that is between senior debt financing and common stock • Most often, it’s subordinated debt carrying an equity kicker consisting of warrants or a conversion feature into common stock • Generally unsecured, with maturity in 5 to 10 years • Can be burdensome in its claims on cash • Subordinated debt often contains covenants relating to net worth, debt and dividends

23. Obtaining Venture & Growth Capital • Other equity sources • Private placement investors. Could include: • Dealers, franchisors or wholesalers • Professional investors always on the lookout for a good, small company in its formative years • Others seek opportunities to buy shares of smaller growth firms in the expectation that the firms will soon go public • Attractive to venture capitalists who hope to benefit when the company goes public or when the company is sold

24. Obtaining Venture & Growth Capital • Other equity sources • Initial public stock offerings (IPO) • Raises capital through federally registered and underwritten sales of the company’s shares • More mature companies get better terms at IPO

25. Obtaining Venture & Growth Capital • Advantages of going public • Raise more capital with less dilution • Improve balance sheet or reduce/eliminate debt • Obtain cash for pursuing other opportunities • Access other capital suppliers and increase bargaining power • Improve credibility • Achieve liquidity for owners and investors • Create equity incentives for new and existing staff

26. Obtaining Venture & Growth Capital • Disadvantages of going public • Legal, accounting and administrative costs • Management time, effort and expense is required to comply with SEC rules and reporting requirements. • Management can become more interested in maintaining the price of the company’s stock than in running the company • Liquidity of company stock achieved through a public offering may be more apparent than real

27. Obtaining Venture & Growth Capital • Private placement after going public • Can “tide you over” in the event the public turns sour • SEC Regulation D • Employee stock option plans (ESOPs) • Used by firms with high confidence in the stability of their future earnings and cash flow. An ESOP is a program in which the employees become investors in the company. Tax-qualified benefit plans.

28. Presenting Information to Possible Investors • A concise presentation should include the following: • What is the market opportunity? • Why is it compelling? • How will/does the business make money? • Why is this the right team at the right time? • How does an investor exit the investment?

29. Additional Ch. 13 Materials

30. What to Look Out for in Investors • Attitude • Be wary if getting through to a general partner in the investment firm is an ordeal • Be wary if the investor thinks he or she can run the business better than the lead entrepreneur or the management team • Over commitment • Be wary of lead investors who indicate they will be active directors but who also sit on the boards of six to eight other startup and early0stage companies or are in the midst of raising money for a new fund

31. What to Look Out for in Investors • Inexperience • Be wary of dealing with venture capitalists who are under 30 years of age and have: • Only worked on Wall Street or as a consultant • No operating, hands-on experience in new and growing companies • A predominantly financial focus

32. What to Look Out for in Investors • Unfavorable reputation • Be wary of funds that have a reputation for early and frequent replacement of the founders • Be wary of those where more than one-fourth or the portfolio companies are in trouble or failing to meet projections in their business plans • Predatory pricing • Be wary of investors who unduly exploit conditions during adverse capital markets by forcing large share price decreases in the new firms and punishing terms on prior investors