1. Lecture 1 An Overview of New Venture Financing Copyright¸ 2003 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. Instructors may make copies of the PowerPoint Presentations contained herein for classroom distribution only. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

2. Learning Objectives Learn new venture financing terminology. Understand the value of tying financing to performance milestones Recognize the distinguishing characteristics of the various stages of new venture development Identify the financing sources available to a new venture and the factors favoring one over another Learn the basic structures and availability of various financing sources Identify the key elements of deal structure and the functions they serve ©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 2

3. Some Milestones for New Venture Planning Completion of concept and product testing Completion of prototype First financing Completion of initial plant tests Market testing Production start-up First competitive action First redesign or redirection First significant price change ©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 2 Block and Macmillan (1992)

4. Organizational Forms Organizational FormOwnership RulesTax TreatmentLiabilityTransferability of OwnershipFinancial Capacity Sole proprietorshipA single ownerEarnings pass through to owner Owner is liable for business debts Only through sale of the businessLimited by financial capacity of owner PartnershipTwo or more co- owners Earnings pass through, flexibility concerning allocation of gains and losses Each partner is fully liable for business debts Partnership interests may be transferable through sale, subject to approval of other partners Limited by combined financial capacity of the partners. Partners may disagree about borrowing to support the venture. Limited-liability partnership Two or more co- owners Earnings pass through, flexibility concerning allocation of gains and losses Liability of partners is limited to the extent of their investments Partnership interests may be transferable through sale, subject to approval of other partners Limited by combined financial capacity of the partners. Partners may disagree about borrowing to support the venture. Limited partnershipGeneral partner(s) with control and limited partners who are passive investors Earnings pass through, flexibility concerning allocation of gains and losses Each general partner is fully liable for business debts. Limited partners are liable to the extent of their investments. Partnership interests may be transferable through sale, subject to approval of other partners Limited by combined financial capacity of the partners. Limited partners may have substantial financial capacity. S corporationUp to 75 shareholders, one class of stock Earnings pass through to owners Liability of shareholders is limited to the extent of their investments Shares are transferable without approval of other investors as long as guidelines and SEC rules are followed Limited by constraint on maximum number of shareholders C corporationUnlimited numbers of shareholders and classes of stock Taxable to the corporation when earned and to shareholder when realized. Liability of shareholders is limited to the extent of their investments Shares are transferable without approval of other investors as long as guidelines and SEC rules are followed. Registered shares of public corporations are freely transferable. Unlimited, since number of investors is not limited

5. THREE BIG PROBLEMS Unknown Value of Venture –Uniqueness –Incomplete Information Asymmetry of Information –Entrepreneur has more information than investor Risk of Appropriation of information –Investor may ask Entrepreneur for information and then use it

6. Solutions to Problems Unknown Value of Venture –Preference for tangible evidence –Milestones Asymmetry of Information –Staged investment –Covenants Risk of Appropriation of information –Non-Disclosure Agreements (NDA)  imperfect –Due diligence on trustworthiness