18 Summary Sources of Capital Capital is to the progress of society what gas is to a car. James Truslow Adams Summary What are the sources of capital that a new venture can use to finance the start and growth of its company? Entrepreneurs can estimate the capital required for their new business by reviewing the financial projections they prepare using the methods detailed in Chapter 17. Typically, several stages of investment will be required over the life of the business. Chapter 18: Summary Technology Ventures: From Idea to Enterprise

18 Sources of Capital Idealized cash flow diagram for a new enterprise *Burn rate of $100K per month for the first 20 month. Chapter 18: Figure 18.1 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Professional investors of the think of an opportunity as OPTIONS. OPTIONS may be defined as rights but not obligations to take some actions in the future. Mathematical model of venture investment. Real Option: the right to invest in (or purchase) a real asset (a new start-up firm) at a future date. V = IV + OV IV = Intrinsic Value (Economic Capital) OV = Option Value (Strategic Capital) Chapter 18: Real Option Technology Ventures: From Idea to Enterprise

The Value of A Real Option Based on Four Factors Sources of Capital 18 The Value of A Real Option Based on Four Factors Increases with the level of uncertainty measured by the standard deviation σ. Increases with the length of time, T, the person holding the option has to decide whether or not to exercise it. Increases with the ratio of the current stock price, P, to the exercise price, X. The ratio is P/X. Increases with the discount rate, r. Chapter 18: Table 18.2 – value of a real option Technology Ventures: From Idea to Enterprise

18 Sources of Capital Sources of Capital Founders Family Friends Small Business Investment Companies (SBIC) Small Business Innovation Research (SBIR) Professional Investors — Angels Venture Capitalists Banks Leasing Companies Established Companies Public Stock Offering Government Grants and Credits Customer Prepayments Pension Funds Insurance Companies Chapter 18: Table 18.3 – Sources of capital Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Comparison of major selected sources of growth capital Chapter 18: Table 18.4 – sources of growth capital Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Four financial steps in building a successful firm. Chapter 18: Figure 18.2 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Bootstrap Financing: to start a firm by one’s own efforts and to rely solely on the resources available from oneself, family, and friends. Chapter 18: Bootstrap Financing Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Advantages and disadvantages of bootstrap financing Advantages Disadvantages Low pressure on valuation Easy terms on ownership Control by founders Little time spent on finding investors Unable to fund growth phase Lack of funding commitment for future Loss of advice from professional investors Chapter 18: Table 18.4 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Grants from such organizations as SBIR and STTR can be used to support small businesses, especially in industries in which the technical challenge is the primary risk. Chapter 18: Bootstrap Financing Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Angels are wealthy individuals, usually experienced entrepreneurs, who invest in business start-ups in exchange for equity in the new ventures. Chapter 18: Angels Technology Ventures: From Idea to Enterprise

18 Sources of Capital Criteria for Angel Investments The New Venture is/has: Within the industry that the angel has experience. Located within a few hours driving distance Recommended by trusted business associates Entrepreneurs with attractive personal characteristics such as integrity and coach-ability. Good market and growth potential for the opportunity. Seeking an investment of $100,000 to $1 million and offers minority ownership, less than 40% Chapter 18: Table 18.5 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Venture capital is a source of funds for new ventures that is managed by investment professionals on behalf of the investors in the venture capital fund. Chapter 18: Venture Capital Technology Ventures: From Idea to Enterprise

The Risk and Reward Profile for Various Investments Sources of Capital 18 The Risk and Reward Profile for Various Investments Chapter 18: Figure 18.3 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Characteristics of An Attractive Venture Capital Investment Potential to Become a Leading Firm in a High Growth Industry with few competitors. Highly Competent and Committed Management Team and High Human Capital (Talent). Strong competitive Abilities and a Sustainable Competitive Advantage. Viable Exit or Harvest Strategy. Reasonable Valuation of the New Venture. Outstanding Opportunity. Founders Capital Invested in the Venture. Recognizes Competitors and Has a Solid Competitive Strategy. A sound business plan showing how cash flow turns positive within a few years. Demonstrated progress on the product design and good sales potential. Chapter 18: Table 18.9 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 The valuation rule is the algorithm by which an investor such as an angel or venture capitalist assigns a monetary value to a new venture. Capital Return after N years: CR = M x I Market Value in Year N: MV = PE x EN or PS x SN I = investment EN = earnings in year N G = expected annual return Chapter 18:Valuation Rule Technology Ventures: From Idea to Enterprise

18 Sources of Capital Chapter 18: Table 18.15 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Initial Public Offering: the first public equity issue of stock made by a company. Chapter 18: IPO Technology Ventures: From Idea to Enterprise

18 Sources of Capital Chapter 18: Table 18.17 Technology Ventures: From Idea to Enterprise

Sources of Capital 18 Principle: Many kinds of sources for investment capital for a new enterprise exist and should be compared and managed carefully. Chapter 18: Principle Technology Ventures: From Idea to Enterprise

Sources of Capital 18 A new firm intends to sell specialized integrated circuits for wireless applications. Its projections show: Year 1 2 3 Sales ($ millions) 3.0 6.2 9.8 Profit ($ millions) -1.0 1.0 3.2 Use the valuation rule to determine PO required when investors provide $5 million and expect a return of at least 55% per year. Assume the investors use PE = 14 and PS =4. Chapter 18: Exercise Technology Ventures: From Idea to Enterprise

VENTURE CHALLENGE 18 What sources of capital will you use? Why did you select these sources? How much capital is needed now and for what purpose? What percentage of your venture do you plan to offer to outside investors? Chapter 18: Venture Challenge Technology Ventures: From Idea to Enterprise

DVD Videos 18 “Venture Capital versus Customer Funding” Sources of Capital 18 DVD Videos “Venture Capital versus Customer Funding” Vic Verma (Savi Technology) “The Benefit of Picking the Right Venture Capitalist” Marc Fleury (Jboss) Chapter 18: DVD Videos Technology Ventures: From Idea to Enterprise