Part IV – Initiating Entrepreneurial Ventures Chapter 11 – Assessment and Evaluation of Entrepreneurial Opportunities Chapter 12 – Legal Structures for New Business Ventures Chapter 13 – Legal Issues Related to Emerging Ventures Chapter 14 – Sources of Capital for Entrepreneurs Copyright (c) 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Chapter 14 – Sources of Capital For Entrepreneurs

Debt Versus Equity The use of debt to finance a new venture involves a payback of the funds plus a fee (interest for the use of the money. Equity financing involves the sale of some of the ownership in the venture.

Debt Financing Commercial BanksCommercial Banks Other Debt-Financing Sources:Other Debt-Financing Sources: –Trade Credit –Accounts Receivable Financing –Factoring –Finance Companies

Source of Finance Throughout the Evolution of the Entrepreneurial Firm Level of Investment Risk Assumed by Investor High Low SeedStart-Up Early Growth Established Founder, friends, and family Business Angels Venture Capitalists Nonfinancial corporations Equity markets Commercial banks Stage of Development of the Entrepreneurial Firm

Equity Financing

Public Offerings “Going public” is a term used to refer to a corporation’s raising capital through the sale of securities on the public markets. Here are some of the advantages to this approach: Size of capital amountSize of capital amount LiquidityLiquidity ValueValue Image (new issues, referred to as initial public offerings IPOs)Image (new issues, referred to as initial public offerings IPOs)

Public Offerings Disadvantages of going public: CostsCosts DisclosureDisclosure RequirementsRequirements Shareholder pressureShareholder pressure

Private Placements The SEC provides Regulation D, which eases the regulations for the reports and statements required for selling stock to private parties – friends, employees, customers, relatives, and local professionals. Regulation D defines four separate exemptions, which are based on the amount of money being raised: 1.Rule 504a – placements of less than $500,000 2.Rule 504 – placements up to $1,000,000 3.Rule 505 – placements of up to $5 million 4.Rule 506 – placements in excess of $5 million

Accredited Purchaser As noted in Rules 505 and 506, Regulation D uses the term “accredited purchaser”. Included in this category are the following: Institutional investors such as banks, insurance companies, venture capital firms.Institutional investors such as banks, insurance companies, venture capital firms. Any person who buys at least $150,000 of the offered security and whose net worth, including that of his or her spouse, is at least 5 times the purchase price.Any person who buys at least $150,000 of the offered security and whose net worth, including that of his or her spouse, is at least 5 times the purchase price. Any person who, together with his or her spouse, has a net worth in excess of $1 million at the time of purchase.Any person who, together with his or her spouse, has a net worth in excess of $1 million at the time of purchase.

“Sophisticated” Investors “Sophisticated” investors are wealthy individuals who invest more or less regularly in new and early- and late- stage ventures. They are knowledgeable about the technical and commercial opportunities and risks of the business in which they invest.

The Venture Capital Market

Venture Capital Investments Year Number of Companies Amount Invested (in billions) , , , , ,

Venture Capital Investments by Stages of Development Stage of Development Start-up/Seed Early Stage Expansion Later Stage Amount (in billions) Companies Companies , , , , , ,

Dispelling Venture Capital Myths Myth 1: Venture capital firms want to own control of your company and tell you how to run the business. Myth 2: Venture capitalists are satisfied with a reasonable return on investment. Myth 3: Venture capitalists are quick to invest Myth 4: Venture capitalists are interested in backing new ideas or high-technology inventions – management is a secondary consideration. Myth 5: Venture capitalists need only basic summary information before they make an investment.

Criteria for Evaluating New-Venture Proposals

Returns on Investment Typically South by Venture Capitalists Stage of Business Expected Annual Return on Investment Expected Increase on Initial Investment Start-up business (idea stage) 60% x investment First-stage financing (new business) 40%-60% Second-stage financing (development stage) 30%-50% Third-stage financing (expansion stage) 25%-40% Turnaround situation 50% 6-12 x investment 4-8 x investment 3-6 x investment 8-15 x investment

Venture Capitalist Screening Criteria Venture Capital Firm RequirementsVenture Capital Firm Requirements Nature of the Proposed BusinessNature of the Proposed Business Economic Environment of Proposed IndustryEconomic Environment of Proposed Industry Proposed Business StrategyProposed Business Strategy Financial Information on the Proposed BusinessFinancial Information on the Proposed Business Proposal CharacteristicsProposal Characteristics Entrepreneur/Team CharacteristicsEntrepreneur/Team Characteristics

Informal Risk Capital – “Angel” Financing Many wealthy people in the United States are looking for investment opportunities. They are referred to as “business angels” or informal risk capitalists.

Informal Risk Capital – “Angel” Financing One newly created source is the Angel Capital Electronic Network (ACE-Net). This Internet-based service provides information to institutional and individual accredited investors about small, dynamic, growing businesses seeking $250,000 to $5 million in equity financing.

Types of Angel Investors Corporate AngelsCorporate Angels Entrepreneurial AngelsEntrepreneurial Angels Enthusiast AnglesEnthusiast Angles Micromanagement AngelsMicromanagement Angels Professional AngelsProfessional Angels

Angel Stats Typical deal size: $250,000Typical deal size: $250,000 Typical recipient: Start-up firmsTypical recipient: Start-up firms Cash-out time frame: 5 to 7 yearsCash-out time frame: 5 to 7 years Expected return: 35 to 50%Expected return: 35 to 50%

The Pros and Cons of Business Angel Investments Angels’ Characteristics Value-adding Geographically dispersed More permissive investors Investment Characteristics Seek Smaller Deals Prefer start-up & early stage Invest in all industry sectors Like high-tech firms Added Bonuses Leveraging effect Give loan guarantees No high fees Advantages Business Angels Disadvantages Little follow-on money Want a say in firm Could turn out to be “devils” No national reputation to leverage