1. Informal Risk Capital, Venture Capital, and Going Public
Chapter 12
Informal Risk Capital, Venture Capital,
and
Going Public
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives To explain the basic stages of venture funding
To discuss the informal risk-capital market
To discuss the nature of the venture-capital industry and the venture-capital decision process
To explain all aspects of valuing a company
To identify several valuation approaches
To explain the process of going public

3. Financing the Business
Criteria for evaluating financing alternatives:
Amount and timing of funds required
Projected company sales and growth
Types of funding
Early stage financing: One of the first financings obtained by a company

4. Financing the Business
Development financing: Financing to rapidly expand the business
Acquisition financing: Financing to buy another company

5. Table 12.1 - Stages of Business Development Funding

6. Financing the Business
Risk capital markets: Provide debt and equity to nonsecure financing situations
Types of risk capital markets
Informal risk capital market: Consists mainly of individuals
Venture-capital market: Consists of formal firms
Public-equity market: Consists of publicly owned stocks of companies

7. Informal Risk Capital
Business angels: Individuals investing in the informal risk-capital market
Investments range between $10,000 to $500,000
Provides first-stage financing
Referral sources: Ways individual investors find out about potential deals

8. Table 12.2 - Characteristics of Informal Investors

9. Table 12.2 - Characteristics of Informal Investors

10. Venture Capital Nature of venture capital
Long-term investment discipline
Equity pool: Money raised by venture capitalists to invest
Equity participation: Taking an ownership position

11. Venture Capital 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

12. Types of Venture Capital Firms
SBIC firms: Small companies with some government money that invest in other companies
Private venture-capital firms: Having general and limited partners
State-sponsored venture-capital fund
A fund containing state government money that invests primarily in companies in the state

13. Figure 12.1 - Types of Venture-Capital Firms

14. Venture Capital
Venture-capital process: Decision procedure of a venture-capital firm
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
Unique product and/or market opportunity
Significant capital appreciation: Increase in value of the organization during a specific period of time

15. Figure 12.4 - Venture-Capital Financing: Risk and Return Criteria

16. Venture Capital Venture-capital process
Preliminary screening: Initial evaluation of the deal
Agreement on principal terms between entrepreneur and venture capitalist
Due diligence: Process of deal evaluation
Final approval: Document showing the final terms of the deal

17. Valuing Your Company
Factors in valuation: Nonmonetary aspects that affect the fund valuation
Nature and history of business
Economic outlook
Book (net) value
Future earning capacity
Dividend-paying capacity

18. Valuing Your Company Financial ratio
Assessment of goodwill/intangibles
Previous sale of equity
Market value of similar companies’ stock
Financial ratio
Measure financial strengths and weaknesses of the venture
Used on actual financial results

19. Valuing Your Company
Liquidity ratios

20. Valuing Your Company
Activity ratios

21. Valuing Your Company
Leverage ratios

22. Valuing Your Company
Profitability ratios

23. Valuing Your Company
General valuation approaches: Methods for determining the worth of a company
Types of approaches
Assessing comparable publicly held companies and the prices of these companies’ securities
Present value of future cash flow
Valuing a company based on its future sales and profits
Replacement value
Cost of replacing all assets of a company

24. Valuing Your Company Book value Earnings approach Factor approach
Indicated worth of the assets of a company
Earnings approach
Determining the worth of a company by looking at its present and future earnings
Factor approach
Using the major aspects of a company to determine its worth
Liquidation value
Worth of a company if everything was sold today

25. Valuing Your Company
General valuation method

26. Table 12.7 - Steps in Valuing Your Business and Determining Investors’ Share

27. Evaluation of an Internet Company
Financial projections are compared with the future market in terms of:
Fit
Realism
Opportunity
Management team is examined
Opportunities available in the investor market are examined

28. Deal Structure
Form of the transaction when money is obtained by a company
Needs of the funding sources
Rate of return required
Timing and form of return
Amount of control desired
Perception of risks

29. Deal Structure Entrepreneur’s needs Degree and mechanisms of control
Amount of financing needed
Goals for the particular firm

30. Going Public
Selling some part of the company by registering with the Securities and Exchange Commission (SEC)
Provides the company with:
Financial resources
A relatively liquid investment vehicle
Initial public offering:The first public registration and sale of a company’s stock

31. Table 12.8 - Advantages and Disadvantages of Going Public

32. Timing of Going Public and Underwriter Selection
Timing - Issues to be considered before going public
Size of offering
Amount of the company’s earnings, and financial performance
Favorability of the market conditions
Urgent money requirement
Needs and desires of the present owners

33. Timing of Going Public and 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

34. Timing of Going Public and Underwriter Selection
Factors to consider in selection
Reputation
Distribution capability
Advisory services
Experience
Cost

35. Registration Statement and Timetable
Reasons for delays in registration process
Heavy periods of market activity
Peak seasons
Attorney’s unfamiliarity with federal or state regulations
Issues arising over requirements of the SEC
Inexperienced managing underwriter

36. Registration Statement and Timetable
Reviewing registration statement includes ensuring
Full and fair disclosure: Nature of all material submitted to SEC for approval
Registration statement constitutes of:
Prospectus: Document for distribution to prospective buyers
Registration statement: Materials submitted to the SEC for approval to sell stock

37. Registration Statement and Timetable
Form S- 1: Form for registration for initial public offerings
The Registration Statement-Provides information regarding:
Offering
Past unregistered securities offering of the company
Other undertakings by the company

38. Registration Statement and Timetable
Includes exhibits:
Articles of incorporation
Underwriting agreement
Company bylaws
Stock option and pension plans
Initial contracts

39. Registration Statement and Timetable
Procedure
Red herring: Preliminary prospectus of a potential public offering
Deficiencies are communicated through
Comment letter: Letter indicating corrections that need to be made in the submitted prospectus
Pricing amendment
Additional information on price and distribution is submitted to the SEC to develop the final prospectus

40. Legal Issues and Blue-Sky Qualifications
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

41. After Going Public Aftermarket support Reporting requirements - File:
Actions of underwriters to help support the price of stock following the public offering
Reporting requirements - File:
Annual reports on Form 10-K
Quarterly reports on Form 10-Q
Specific transaction or event reports on Form 8-K