1. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 1 Sources of Equity Financing

2. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 2 The “Secrets” to Successful Financing 1. Choosing the right sources of capital is a decision that will influence a company for a lifetime 2. The money is out there; the key is knowing where to look 3. Creativity counts. Entrepreneurs have to be as creative in their searches for capital as they are in developing their business ideas

3. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 3 The “Secrets” to Successful Financing 4. The World Wide Web puts at entrepreneur’s fingertips vast resources of information that can lead to financing 5. Be thoroughly prepared before approaching lenders and investors 6. Looking for “smart” money is more important than looking for “easy” money

4. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 4 Three Types of Capital Fixed - used to purchase the the permanent or fixed assets of the business (e.g. buildings, land, equipment, etc.) Fixed - used to purchase the the permanent or fixed assets of the business (e.g. buildings, land, equipment, etc.) Working - used to support the small company's normal short-term operations (e.g. buy inventory, pay bills, wages, or salaries, etc.) Working - used to support the small company's normal short-term operations (e.g. buy inventory, pay bills, wages, or salaries, etc.) Growth - used to help the small business expand or change its primary direction Growth - used to help the small business expand or change its primary direction

5. Start-UpEarlyExpansionProfitability Characteristics Business is in conceptual phase and exists only on paper. Business is developing one or more products or services but is not yet generating sales. Business is selling products or services and is generating revenue and is beginning to establish a customer base. Company has established a customer base and is profitable. Possible Sources of FundingLikelihood of using each source: H = Highly likely; P = Possible; U = Unlikely Personal savings HHHH Retained earnings UUUH Friends and relatives HHPP Angel investors HHPU PartnersHHPU Corporate venture capital PHHH Venture capital UPHH Initial public offering (IPO) UUPH Regulation S-B Offering UUPH Small Company Offering Registration (SCOR) UPPH Private placements UPPH Intrastate offerings (Rule 147) UPPH Regulation A UPPH Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 5

6. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 6 Equity Capital Represents the personal investment of the owner(s) in the business Represents the personal investment of the owner(s) in the business Is called risk capital because investors assume the risk of losing their money if the business fails Is called risk capital because investors assume the risk of losing their money if the business fails Does not have to be repaid with interest like a loan does Does not have to be repaid with interest like a loan does Means that an entrepreneur must give up some ownership in the company to outside investors Means that an entrepreneur must give up some ownership in the company to outside investors

7. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 7 Sources of Equity Financing Personal savings Personal savings Friends and family members Friends and family members Angels Angels Partners Partners Corporations Corporations Venture capital companies Venture capital companies Public stock sale Public stock sale

8. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 8 Personal Savings The first place an entrepreneur should look for money The first place an entrepreneur should look for money The most common source of equity capital for starting a business The most common source of equity capital for starting a business GEM study: GEM study:  Average cost to start a business in U.S. is $70,200  Typical entrepreneur provides 67.9% of the initial capital requirement

9. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 9 Friends and Family Members After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business - friends and family members After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business - friends and family members GEM study: GEM study:  Across the globe, the average amount family and friends invest in start-up businesses is $3,000  In U.S., average amount is $27,715 for a total of $100 billion per year Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop

10. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 10 Guidelines for family and friendship financing deals: Guidelines for family and friendship financing deals:  Consider the impact of the investment on everyone involved  Keep the arrangement “strictly business”  Educate “naïve” investors  Settle the details up front  Never accept more than the investor can afford to lose Friends and Family Members

11. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 11 Guidelines for family and friendship financing deals: Guidelines for family and friendship financing deals:  Create a written contract  Treat the money as “bridge financing”  Develop a payment schedule that suits both parties  Have an exit plan  Keep everyone informed Friends and Family Members

12. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 12 Angels Private investors who invest in emerging business start-ups in exchange for equity stakes in the company Private investors who invest in emerging business start-ups in exchange for equity stakes in the company Fastest growing segment of the small business capital market Fastest growing segment of the small business capital market Center for Venture Research study: 234,000 angels invest $25.6 billion a year in 51,000 small companies Center for Venture Research study: 234,000 angels invest $25.6 billion a year in 51,000 small companies

13. Source: Center for Venture Financing, Whittemore School of Business, University of New Hampshire, www.unh.edu/cvr.

14. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 14 Angels Ideal source of financing for companies that have outgrown the capacity of friends and family members but are still too small to attract the interest of venture capital companies Ideal source of financing for companies that have outgrown the capacity of friends and family members but are still too small to attract the interest of venture capital companies

15. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 15 Most likely to finance deals in the $10,000 to $2 million range Most likely to finance deals in the $10,000 to $2 million range Key: finding them! Key: finding them! Angels almost always invest their money locally and can be found through networking Angels almost always invest their money locally and can be found through networking Another avenue: Angel capital networks on the World Wide Web Another avenue: Angel capital networks on the World Wide Web Angels

16. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 16 Typical angel accepts 12% of the proposals presented and has invested an average of $80,000 in 3.5 businesses Typical angel accepts 12% of the proposals presented and has invested an average of $80,000 in 3.5 businesses An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000 An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000 Angels

17. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 17 Corporate Venture Capital About 300 large corporations across the globe invest in start-up companies About 300 large corporations across the globe invest in start-up companies 19% of all venture capital investments come from corporations 19% of all venture capital investments come from corporations  Average CVC investment = $2.97 million Capital infusions are just one benefit; corporate partners may share marketing and technical expertise Capital infusions are just one benefit; corporate partners may share marketing and technical expertise

18. Source: PriceWaterhouse Coopers Moneytree Report, 2007.

19. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 19 Venture Capital Companies More than 1,300 venture capital firms operate across the U.S. More than 1,300 venture capital firms operate across the U.S. Most venture capitalists seek investments in the $3,000,000 to $10,00,000 range in companies with high-growth and high-profit potential Most venture capitalists seek investments in the $3,000,000 to $10,00,000 range in companies with high-growth and high-profit potential  Average VC investment = $7.4 million

20. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 20 Venture Capital Companies Business plans are subjected to an extremely rigorous review - less than 1% accepted Business plans are subjected to an extremely rigorous review - less than 1% accepted GEM study: Only 1 in 10,000 entrepreneurs worldwide receives VS funding at start-up GEM study: Only 1 in 10,000 entrepreneurs worldwide receives VS funding at start-up

21. Source: PriceWaterhouse Coopers Moneytree Report, http://www.pwc.moneytree.com

22. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 22 Venture Capital Companies Usually take an active role in managing the companies in which they invest Usually take an active role in managing the companies in which they invest Focus their investments in specific industries with which they are familiar Focus their investments in specific industries with which they are familiar Invest in a company across several stages Most common stages: Invest in a company across several stages Most common stages:  Expansion  Later-stage  Early-stage

23. Start-up/Seed – This is the initial stage in which companies are just beginning to develop their ideas into products or services. Typically, these businesses have been in existence less than 18 months and are not yet fully operational. Early stage – These companies are refining their initial products or services in pilot tests or in the market. Even though the product or service is available commercially, it typically generates little or no revenue. These companies have been in business less than three years. 1% to 2 % 18% to 20 % 28% to 30 % 48% to 50 % Expansion stage – These companies’ products or services are commercially available and are producing strong revenue growth. Businesses at this stage may not be generating a profit yet, however. Later stage – These companies’ products or services are widely available and are producing ongoing revenue and, in most cases, positive cash flow. Businesses at this stage are more likely to be generating a profit. Sometimes these businesses are spin-offs of already established successful private companies. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 23

24. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 24 What Do Venture Capital Companies Look For? Competent management Competent management Competitive edge Competitive edge Growth industry Growth industry Viable exit strategy Viable exit strategy “Intangibles” “Intangibles”

25. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 25 Going Public Initial public offering (IPO) - when a company raises capital by selling shares of its stock to the public for the first time Initial public offering (IPO) - when a company raises capital by selling shares of its stock to the public for the first time Since 2000, average number of companies making IPOs is 211 Since 2000, average number of companies making IPOs is 211 Few companies with annual sales below $25 million make IPOs Few companies with annual sales below $25 million make IPOs

26. Source: PriceWaterhouseCoopers, US IPO Watch 2006 Analysis and Trends, p.2.

27. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 27 Advantages of "Going Public" Ability to raise large amounts of capital Ability to raise large amounts of capital Improved corporate image Improved corporate image Improved access to future financing Improved access to future financing Attracting and retaining key employees Attracting and retaining key employees Using stock for acquisitions Using stock for acquisitions Listing on a stock exchange Listing on a stock exchange

28. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 28 Disadvantages of "Going Public" Dilution of founder's ownership Dilution of founder's ownership Loss of control Loss of control Loss of privacy Loss of privacy Regulatory requirements and reporting to the SEC Regulatory requirements and reporting to the SEC Filing expenses Filing expenses

29. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 29 Disadvantages of "Going Public" Accountability to shareholders Accountability to shareholders Pressure for short-term performance Pressure for short-term performance Loss of focus Loss of focus Timing Timing

30. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 30 The Registration Process Choose the underwriter Choose the underwriter Negotiate a letter of intent Negotiate a letter of intent

31. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 31 Letter of Intent Two types of underwriting agreements: Two types of underwriting agreements:  Firm commitment  Best efforts Minimum number of shares offered is usually 400,000 to 500,000 Minimum number of shares offered is usually 400,000 to 500,000 Total offering is usually at least $8 to $15 million Total offering is usually at least $8 to $15 million Initial share price is usually between $10 and $20 per share Initial share price is usually between $10 and $20 per share

32. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 32 The Registration Process Choose the underwriter Choose the underwriter Negotiate a letter of intent Negotiate a letter of intent Prepare the registration statement Prepare the registration statement File with the SEC File with the SEC Wait to “go effective” and road show Wait to “go effective” and road show Meet state requirements Meet state requirements

33. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 33 Simplified Registrations and Exemptions Regulation S-B Regulation S-B  S-B-1: Transitional registration for companies making offerings of less than $10 million over 12 months  S-B-2: Registration for companies making offerings of more than $10 million over 12 months Regulation D: Rule 504 - Small Company Offering Registration (SCOR) Regulation D: Rule 504 - Small Company Offering Registration (SCOR)

34. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 34 SCOR Offerings Ceiling is $1 million Ceiling is $1 million Share price must be at least $5 per share Share price must be at least $5 per share Must file Form U-7, a standardized disclosure statement Must file Form U-7, a standardized disclosure statement Can issue almost any kind of security through SCOR Can issue almost any kind of security through SCOR Cost is usually less than $25,000 Cost is usually less than $25,000 (http://www.sec.gov/info/smallbus/qasbsec.htm for more information) (http://www.sec.gov/info/smallbus/qasbsec.htm for more information)http://www.sec.gov/info/smallbus/qasbsec.htm

35. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 35 Regulation D: Rule 505 and 506 Regulation D: Rule 505 and 506  Private placements Section 4 (6) Section 4 (6) Rule 147 (Intrastate offerings) Rule 147 (Intrastate offerings) Regulation A Regulation A  Offerings up to $5 million over 12 months  Typical cost: $80,000 to $120,000 Simplified Registrations and Exemptions

36. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 36 Direct Stock Offerings Direct Stock Offerings  Go straight to Main Street instead of through underwriters on Wall Street  World Wide Web (usually either Regulation A or Regulation D offerings)  Typically generate between $300,000 and $4 million for company Foreign Stock Markets Foreign Stock Markets Simplified Registrations and Exemptions

37. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 37 Web Sites PriceWaterhouseCoopers Money Tree Survey http://www.pwcmoneytree.com/ PriceWaterhouseCoopers Money Tree Survey http://www.pwcmoneytree.com/ http://www.pwcmoneytree.com/ Hoover’s Online IPO Central Hoover’s Online IPO Central http://www.hoovers.com/global/ipoc/i ndex.xhtml http://www.hoovers.com/global/ipoc/i ndex.xhtml Active Capital http://activecapital.org/ Active Capital http://activecapital.org/ http://activecapital.org/

38. Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 38 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall