Funding a Rapidly Growing Venture Chapter 17 Funding a Rapidly Growing Venture

Learning Objectives 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

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 many 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”

The Venture Capital Market 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

Figure 17.1: Total U.S. Investment in Billions

Figure 17.2: Venture Capital Investment by Industry for 2006

Sequence of Events - Securing Venture Capital Understand the goals/motivations of the venture capitalists VCs are fundamentally risk averse Three major stages during which entrepreneurs receive funding Idea and proof of concept stage Early growth and transition Rapid growth

Figure 17.3: Funding Stages and Risk

Funding Stages and Risk Venture capitalists scrutinize new opportunities by evaluating: The market Management Technology Venture capitalists also look at potential for significant growth, risk of failure and the quality of the business plan Perform due diligence on the venture activity Venture capitalists invest in growing businesses through the use of debt and equity instruments to achieve long-term appreciation on the investment in 3 - 5 years

Getting to a Term Sheet Does not guarantee a “done deal” Lays out the amount of investment the VC firm is willing to consider and the conditions under which it is willing to consider the funding Entrepreneur not required to accept the term sheet as is

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

The Initial Public Offering-IPO Advantages-disadvantages of going public Advantages 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

The Initial Public Offering-IPO (continued) Disadvantages 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

Figure 17.4: The IPO Process Simplified

Growing Via Strategic Alliances Collaborative relationship between two or more firms Intent is to accomplish 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 Investigate best business practices Ensure that benefits will flow in both directions

Valuing The Business Financial yardsticks Fair market value Intrinsic value Investment value Going-concern value Liquidation value Book value

Calculating the Value of a Business (continued) 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

Methods for Valuing a Business Financial measures Multiple earnings Discounting cash flows Real options model Venture capital model $