1. Informal Risk Capital, Venture Capital,
Chapter 12
Informal Risk Capital, Venture Capital,
and
Going Public
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Stages of Business Development Funding

3. Financing the Business (cont.)
Risk capital markets provide debt and equity to nonsecure financing situations.
Types of risk capital markets:
Informal risk capital market.
Venture-capital market.
Public-equity market.

4. Informal Risk Capital
It consists of a virtually invisible group of wealthy investors called business angels.
Investments amounts at all dollar levels.
Provides funding, usually in early-stage ventures (seed or first round)
Contains the largest pool of risk capital in the United States. (more than venture capital!)

5. Characteristics of Informal Investors

6. Characteristics of Informal Investors (cont.)

7. Venture Capital Nature of Venture Capital
A long-term investment discipline, usually occurring over a five-year period.
The equity pool is formed from the resources of wealthy limited partners.
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.
Venture capitalist takes an equity participation in each of the investments.

8. Types of Venture-Capital Firms

9. Percentage of Venture Dollars Raised by Stage in 2008

10. Venture Capital (cont.)
Venture-Capital Process
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.
A unique product and/or market opportunity.
Business opportunity must show significant capital appreciation potential.

11. Venture-Capital Financing: Risk and Return Criteria

12. Venture Capital (cont.)
Venture-capital process typically occurs in four primary stages:
Preliminary Screening – Initial evaluation of the deal.
Agreement on Principal Terms - Between entrepreneur and venture capitalist.
Due Diligence - Stage of deal evaluation.
Final Approval - Document showing the final terms of the deal (Terms Sheet).

13. Venture Capital (cont.)
Locating Venture Capitalists
Venture capitalists tend to specialize either
geographically by industry, and/or
by size and type of investment.
Entrepreneur should approach only those VCs that may have an interest in the investment opportunity.
Most venture capital firms belong to the National Venture Capital Association (NVCA).

14. Some Guidelines for Dealing with Venture Capitalists

15. Some More Guidelines for Dealing with Venture Capitalists (cont.)

16. Valuing Your Company Factors in Valuation
Nature and history of business.
Economic outlook- general and industry.
Comparative data.
Market value of assets (less liabilities).
Future earning capacity.
Dividend-paying capacity.
Assessment of goodwill/intangibles.
Previous sale of stock.
Market value of similar companies’ stock. (comparables and earnings/CF multiples)

17. Valuing Your Company (cont.)
Ratio Analysis
Serves as a measure of financial strengths and weaknesses of the venture but should be used with caution.
It is typically used on actual financial results.
Provides a sense of where problems exist in the pro forma statements.

18. Valuing Your Company (cont.)

19. Valuing Your Company (cont.)

20. Valuing Your Company (cont.)

21. Valuing Your Company (cont.)

22. Valuing Your Company – Mechanics (cont.)
General Valuation Approaches
Assessment of comparable publicly held companies’ stock prices
Present value of future cash flow
Earnings Multiples
Factor approach (weighted capitalized value)
Earnings
Dividends
Net Asset Valuations
Liquidation value
Replacement value

23. Valuing Your Company (cont.)

24. Steps in Valuing Your Business and Determining Investors’ Share

25. Valuation / Equity Share Example
Start-up will earn $1,000,000 after taxes in year 5.
VC invests $800,000 in start-up
Comparable companies selling for an average of 15x earnings
50% compound annual required return for VC firm
Question: What % equity share should the VC get in the start-up?

26. Going Public
Selling part or all of the company by registering with the Securities and Exchange Commission (SEC).
Very difficult to do!

27. Advantages and Disadvantages of Going Public

28. Timing the IPO Timing Is the company large enough?
What are the company’s earnings, and how strong is its track record of financial performance?
Are the market conditions favorable for an IPO?
How urgently is the money needed?
What are the needs and desires of the present owners?

29. 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.
Factors to consider in selection:
Reputation
Distribution capability
Experience
Cost
Buy/Sell vs. Best Efforts

30. Registration Statement and Timetable
“All hands” meeting - Preparing a timetable for the registration process.
The SEC takes six to 12 weeks to declare the registration effective.

31. Registration Statement and Timetable (cont.)
6 to 12 weeks for SEC to declare the registration effective – if no issues.
Reasons for delays:
Heavy periods of market activity.
Peak seasons.
Attorney’s unfamiliarity with federal or state regulations.
Inadequately fulfilled SEC requirements.
When the managing underwriter is inexperienced.

32. Registration Statement and Timetable (cont.)
SEC attempts to ensure full and fair disclosure of investment-relevant information.
Registration statement consists of:
Prospectus.
Registration statement.
Most initial public offerings use a Form S-1 registration statement.

33. Registration Statement and Timetable (cont.)
Prospectus
Cover page
Prospectus summary
Description of the company
Risk factors
Use of proceeds
Dividend policy
Capitalization
Dilution
Selected financial data
Business, management and owners
Type of stock
Underwriter information
Actual financial statements

34. Registration Statement and Timetable (cont.)
The Registration Statement
Information regarding:
Offering
Past unregistered securities offerings of the company
Other undertakings by the company
Includes exhibits:
Articles of incorporation.
Underwriting agreement.
Company bylaws.
Stock option and pension plans
Initial contracts

35. Registration Statement and Timetable (cont.)
Procedure
Preliminary prospectus (Red Herring) can be distributed to the underwriting group.
Deficiencies are communicated through an SEC Comment Letter.
Pricing Amendment - Additional information on price, commissions and net proceeds is submitted to the SEC to develop the final prospectus.
Waiting period - Time between the initial filing and its effective date is usually around 2 to 10 months
no publicity of offer during this period.

36. IPO 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.
May cause additional delays and costs to the company.
Many states allow their state securities administrators to prevent an offering from being sold in their state.

37. After Going Public Aftermarket Support
Actions of underwriters to help support the price of stock following the public offering.
Relationship with the Financial Community
Has a significant effect on the market’s interest in and the price of the company’s stock.

38. After Going Public (cont.)
Reporting Requirements
The company must file:
Annual reports on Form 10-K.
Quarterly reports on Form 10-Q.
Specific transaction or event reports on Form 8-K.
Company must follow proxy solicitation requirements.