F317 – Venture Capital & Entrepreneurial Finance Why Venture Capital Exists

All successful businesses get paid to: 1) Solve a problem; or 2) Meet an unmet need. 10,000 FT View

Example #1

Example #2

and the greater the problem or unmet need, the greater the opportunity to make a lot of… $$MONEY$$ 10,000 FT View

Here’s the problem The greater the Business Opportunity…….. 1) The more competitive it will be to capitalize on the business opportunity

Here’s the problem The greater the Business Opportunity…….. 2) The higher the risk of failure (Too Early) (Too Late) (Miss on Product)

Here’s the problem The greater the Business Opportunity……..and 3) The more money it will take to succeed > $17 Billion> $4 Billion> $5.5 Billion

So where does an aspiring young entrepreneur find the necessary capital to go out and solve big problems?

Venture Capitalist Defined A Venture Capitalist is a professional investor who deploys third-party funds into relatively early-stage companies with both high potential and a relatively high degree of risk.

Let’s see how Venture Capital gets injected into a startup (using a bathtub example)

Initial Capitalization of the Business Revenue Expenses Cash in the Business Venture Capital

The Start-up immediately invests the capital in product, management, and initiating some revenue. Incurs a sizable “Burn Rate” Revenue Expenses Cash in the Business

At this point, the company will either have to: 1) Raise More Capital; 2) Dramatically cut expenses; or 3) Shut Down Revenue Cash in the Business Venture Capital

Expenses The process will continue until the company can generate enough revenue to cover the costs to grow at an optimal level Revenue Cash in the Business

The ultimate goal is that the revenue pipe is much bigger than the drain pipe and lots of $$$ is returned to the Venture Capital Investors. Revenue Venture Capital Revenue Expenses Cash in the Business Return Cash to VC with big profit

When do VCs invest? TIME RISK Company Launch Venture Capital Sale or IPO

Why don’t banks invest in high potential ventures?

4 Reasons Banks don’t invest in start-ups 1)Banks are not in the business of losing money (4 out 5 start-up companies fail within the first 5 years); 1)Start-ups have limited assets to pledge to the bank. 2)Banks are not set up to take equity in companies; 3)Usury laws prevent Banks from charging a high enough interest rate to compensate for loans that go bad.

What’s the difference between Debt & Equity Capital? Debt Capital: Capital that is borrowed and repaid within a specified period of time. Debt comes with a fee (in the form of interest) and is usually secured by the assets of the company. Equity Capital: Capital used to acquire ownership in the company. Investors hope to sell their ownership in the future at a price much higher than what they originally paid.

Why Banks cannot invest (Example) $1,000,000 $5,000,000 Investment Suppose a Bank invests $1MM in 5 high potential Mobile App Start-ups in the form of a 5-Year Term loan at 10% Interest (Estimated income of $132,000 Per Loan) Failed after 12 months Failed after 24 months Failed after 36 months Acquired for $200MM in Yr 5 Outcome $254,964 $509,928 $764,892 $1,132,000 $3,171,712 Returned

Why VC’s will invest $1,000,000 $5,000,000 Investment Suppose a VC invests $1MM in 5 Mobile App Startups and receives 25% Equity in each of the investments Outcome $0 $50,000,000 Returned Failed after 12 months Failed after 24 months Failed after 36 months Acquired for $200MM in Yr 5

So what has to be the #1 criteria for a Venture Capitalist Investment? Every investment MUST have grand slam potential!!!

Example #1 $250, $78 MM 2012

Example #2 $12.5MM 1999 $3.7 Billion 2004

Example #3 $6.7MM 1997 $5 Billion 1999

Example #3 (In Perspective) $25, $18.7 MM 1999 IF YOUR PARENTS HAD INVESTED

What doesn’t get funded by Venture Capital? Restaurants & Bars Real Estate Developments Financial Services Commodity Food Products

This Semester, you’re going to learn: -What types of companies raise Venture Capital; -How Venture Capital Funds are formed; -How Venture Capital deals are structured; and then…. Spend 6 weeks playing the:

Questions?