Hisrich Peters Shepherd Chapter 12 Informal Risk Capital, Venture Capital, and Going Public Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights.

Hisrich

Peters

Shepherd

Chapter 12Informal Risk Capital,

Venture Capital, and

Going PublicCopyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

12-2

Stages of Business Development Funding

12-3

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.

Financing the Business (cont.)

12-4

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!)

12-5

Characteristics of Informal Investors

12-6

Characteristics of Informal Investors (cont.)

12-7

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.

12-8

Types of Venture-Capital Firms

12-9

Percentage of Venture Dollars Raised by Stage in 2008

12-10

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.

Venture Capital (cont.)

12-11

Venture-Capital Financing: Risk and Return Criteria

12-12

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).

Venture Capital (cont.)

12-13

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).

Venture Capital (cont.)

12-14

Some Guidelines for Dealing with Venture Capitalists

12-15

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

12-16

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)

12-17

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.

Valuing Your Company (cont.)

12-18

Valuing Your Company (cont.)

12-19

Valuing Your Company (cont.)

12-20

Valuing Your Company (cont.)

12-21

Valuing Your Company (cont.)

12-22

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

Valuing Your Company – Mechanics (cont.)

12-23

Valuing Your Company (cont.)

12-24

Steps in Valuing Your Business and Determining Investors’ Share

12-25

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?

12-26

Going Public

Selling part or all of the company by registering with the Securities and Exchange Commission (SEC).

Very difficult to do!

12-27

Advantages and Disadvantages of Going Public

12-28

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?

12-29

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

Underwriter Selection

12-30

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.

12-31

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.

Registration Statement and Timetable (cont.)

12-32

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.

Registration Statement and Timetable (cont.)

12-33

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

Registration Statement and Timetable (cont.)

Prospectus

12-34

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

Registration Statement and Timetable (cont.)

12-35

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.

Registration Statement and Timetable (cont.)

12-36

IPO Legal Issues and Blue-Sky Qualifications Legal Issues

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.

12-37

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.

12-38

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.

After Going Public (cont.)