Informal Risk Capital & Venture Capital

Financing the Business Stages for Financing Stages for Financing Early-stage financing Early-stage financing Seed capital Seed capital Start-up financing Start-up financing Development-stage financing Development-stage financing Second stage Second stage Third stage Third stage Fourth stage Fourth stage Acquisition-financing Acquisition-financing Traditional acquisitions Traditional acquisitions Leveraged buyouts Leveraged buyouts Public-equity Public-equity

Risk-Capital Markets Informal risk capital Informal risk capital Venture-capital market Venture-capital market Public equity Public equity

Informal Risk & Capital Markets Business angels Business angels Usually start-up Usually start-up Hard to calculate exact size Hard to calculate exact size Characteristics Characteristics Industries Industries Investment size Investment size Time frame Time frame Finding them Finding them

Venture Capital Nature of Venture Capital Nature of Venture Capital Definition Definition General partners General partners Limited partners Limited partners Length of investment Length of investment

Overview of Venture Capital American Research and Development Corporation American Research and Development Corporation Small Business Investment Act Small Business Investment Act 1960s= 585 SBICs Today= s= 585 SBICs Today= 360 Late 1960s- Private Venture Capital Firms Late 1960s- Private Venture Capital Firms Today=980 Today=980

Overview of Venture Capital Corporations Corporations State-sponsored Venture Capital State-sponsored Venture Capital University-sponsored Venture Capital University-sponsored Venture Capital Characteristics Characteristics Size Size Industries Industries Stages of business being funded Stages of business being funded Geographic location Geographic location

VC Process What do venture capitalists want? What do venture capitalists want? Basic Goal Basic Goal Trusting relationship with entrepreneur Trusting relationship with entrepreneur Business criteria Business criteria Strong management team Strong management team Unique Product/MKT Opportunity Unique Product/MKT Opportunity Good ROI Good ROI Early-stage v. late-stage Early-stage v. late-stage

VC Process Portfolio establishment Portfolio establishment Four stages Four stages Preliminary Preliminary Evaluate business plan Evaluate business plan Background information Background information Agreement on principal terms Agreement on principal terms Due diligence Due diligence Longest stage Longest stage Detail-oriented Detail-oriented Final approval Final approval

VC Process Where to find venture capitalists? Where to find venture capitalists? Member lists Member lists Referrals Referrals Approaching venture capitalists Approaching venture capitalists Call to check specialization Call to check specialization Send plan and short letter Send plan and short letter General rules General rules

Valuing the Company Eight Factors Eight Factors Nature and History of Venture Nature and History of Venture Economy and Finances from Business Economy and Finances from Business Book Value and Overall Financial Conditions Book Value and Overall Financial Conditions Future Earnings Capacity Future Earnings Capacity Dividend-paying Capacity Dividend-paying Capacity Goodwill and Intangible Assets Goodwill and Intangible Assets Any Previous Stock Sales Any Previous Stock Sales Market Price of Stocks in Same Industry Market Price of Stocks in Same Industry

Ratio Analysis Liquidity Ratios Liquidity Ratios Current Ratio Current Ratio Current Assets/ Current Liabilities Current Assets/ Current Liabilities Acid Test Ratio Acid Test Ratio (Current Assets-Inventory)/ Current Liabilities (Current Assets-Inventory)/ Current Liabilities Activity Ratios Activity Ratios Average Collection Period Average Collection Period Accounts Receivable/ Average Daily Sales Accounts Receivable/ Average Daily Sales Inventory Turnover Inventory Turnover Net Profit/ Total Assets Net Profit/ Total Assets

Ratio Analysis Leverage Ratios Leverage Ratios Debt Ratio Debt Ratio Total Liability/ Total Assets Total Liability/ Total Assets Debt-to-Equity Ratio Debt-to-Equity Ratio Total Debt/ Total Equity Total Debt/ Total Equity Profitability Ratios Profitability Ratios Net Profit Margins Net Profit Margins Net Profit/ Net Sales Net Profit/ Net Sales Return on Investment Return on Investment Net Profit/ Total Assets Net Profit/ Total Assets

General Valuation Approaches Comparable Publicly-Held Companies Comparable Publicly-Held Companies Present Value of Future Cash Flows Present Value of Future Cash Flows Replacement Value Replacement Value Book Value Book Value Adjust book value (depreciation, unsellable intangible assets, fair market value) Adjust book value (depreciation, unsellable intangible assets, fair market value)

General Valuation Approaches Earnings Approach Earnings Approach Weighing recent years’ earnings after adjusting for extraordinary Weighing recent years’ earnings after adjusting for extraordinary Factor Approach Factor Approach Similar to Earnings Approach Similar to Earnings Approach Weight earnings, dividend-paying capacity, book value Weight earnings, dividend-paying capacity, book value Liquidation Value Liquidation Value Lowest value Lowest value

General Valuation Method ($ of VC Investment) * (VC investment multiple) ($ of VC Investment) * (VC investment multiple) VC Ownership % = (Projected Profits in 5 years)* (P/E multiple of comparable company) (Earnings) * (Earnings Multiple) Present Value= (1+i)^n Initial Funding Initial Funding Investor’s share= Present Value

Valuation Internet Companies Internet Companies Due Diligence Due Diligence Market Market Finances Finances Management Team Management Team

Deal Structure Venture Capitalist needs: Venture Capitalist needs: Rate of return Rate of return Timing and form of return Timing and form of return Amount of control Amount of control Perception of risk Perception of risk Entrepreneur needs: Entrepreneur needs: Control Amount of funding Goals