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

Chapter 12Informal Risk Capital, Venture Capital,

and Going Public

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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Financing the Business

• Criteria for evaluating financing alternatives:• Amount and timing of funds required• Projected company sales and growth

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Table 12.1 - Stages of Business Development Funding

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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 (business angels)• Venture-capital market: Consists of formal firms• Public-equity market: Consists of publicly owned stocks

of companies

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Informal Risk Capital

• Business angels• Individuals: educated, experienced in startups,

expect to play an active role in your venture• Investments range: $10,000 to $500,000• Provides first-stage financing (<5 year old firms)

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Table 12.2 - Characteristics of Informal Investors

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Venture Capital Market

• Venture capital firms• Invest in:• Long-term capital appreciation via debt and equity• Early-stage, expansion/revitalization, leveraged buyouts

• Decision criteria:• Strong management team• Unique product and/or market opportunity• Significant capital appreciation

• Process:• Preliminary screening, principal terms, due diligence,

final deal

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

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Valuing Your Company

• General valuation approaches• 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• Book value: 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

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Valuing Your Company

• General valuation method

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Valuing Your Company

• Nonmonetary aspects that affect valuation• Nature and history of business• Economic outlook• Dividend-paying capacity• Assessment of goodwill/intangibles• Previous sale of equity• Market value of similar companies’ stock• Financial ratio: measure financial strengths and

weaknesses of the venture

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Valuing Your Company

• Liquidity ratios

• Activity ratios

Current assetsCurrent ratio =

Current liabilities

Current assets InventoryAcid test ratio =

Current liabilities

Accounts recievableActivity collection period =

Average daily sales

Cost of goods soldInventory turnover =

Inventory

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Valuing Your Company

• Leverage ratios

• Profitability ratios

Total liabilitiesDebt ratio =

Total assets

Total liabilitiesDebt to equity =

Stockholder's equity

Net profitNet profit margin =

Net sales

Net profitReturn on investment =

Total assets

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Deal Structure

• Investors care about:• Rate of return• Timing and form of return• Amount of control desired• Perception of risks

• Entrepreneurs care about:• Degree and mechanisms of control• Amount of financing needed• Goals for the particular firm

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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

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Table 12.8 - Advantages and Disadvantages of Going Public