1. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. FUNDING A RAPIDLY GROWING VENTURE 16

2. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives  Discuss the cost and process of raising capital.  Explain the role of the venture capital market.  Describe the process associated with the initial public offering.  Discuss how to grow with strategic alliances.  Explain ways to value a business.

3. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Cost and Process of Raising Capital  Raising money takes time. It takes twice as long as expected for money to reach the bank. The chosen financial source may not complete the deal. Entrepreneurs always need backup investors. Second round investors often buy out first round funding sources.  “It takes money to make money.”

4. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Venture Capital Market  Venture capital A pool of money managed by professionals The ability to secure funding depends upon: The status of the venture capital industry What the entrepreneur brings to the table

5. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Total Venture Capital Investing in the U.S. from 1995 - 2009 Figure 16.1 Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report, Data: Thomson Reuters.

6. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Venture Capital Investment by Industry Table 16.1 Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report, Data: Thomson Reuters.

7. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sequence of Events in Securing Venture Capital  Understand the goals/motivations of the venture capitalists Venture capitalists (VCs) are fundamentally risk averse – reduce risk in key areas where VC’s find risk: Management risk Technology risk Business model risk

8. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sequence of Events in Securing Venture Capital (cont’d)  Three major stages during which entrepreneurs receive funding: Idea and proof of concept stage Early growth and transition Rapid growth  Venture capitalists scrutinize new opportunities by evaluating (in order): The market Management Technology

9. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Funding Stages and Risk Figure 16.2

10. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sequence of Events in Securing Venture Capital (cont’d)  Venture capitalists invest in growing businesses through the use of debt and equity instruments to achieve long-term appreciation on the investment in 3 to 5 years.  Entrepreneur should research and select venture capital firm carefully.  After extensive due diligence, term sheets are drawn up.

11. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Getting to a Term Sheet  Does not guarantee a “done deal”  Represents the start of the negotiation process  Term sheet contains: Amount of investment the VC firm is willing to consider Conditions under which VC firm is willing to consider the funding

12. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Capital Structure  Components of an investment deal: Amount of money to be invested Time and use of the investment monies Return on investment to investors Level of risk involved  Provisions of the deal: Equity and debt positions Anti-dilution provision Forfeiture provision

13. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Super Angel Market  Fills the gap between traditional angel market and VCs  Invest their own money and also manage investments of friends and family  Investments normally between $500,000 – $2M  Favor types of businesses where smaller investment is required and success is achieved between 6 months – 1 year  Enjoy a lower rate of failure than VCs

14. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Initial Public Offering (IPO)  Advantages of going public: A big source of interest-free capital Future option of additional stock offerings More prestige and marketplace clout Restricted stock and stock options can be used to attract new employees and reward existing employees Easier for founders to harvest rewards

15. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Initial Public Offering (IPO) (cont’d)  Disadvantages of going public: Dramatic decline in pre-IPO issuer’s financial condition and significant rise in failure rate post-IPO Public offering process is expensive Going public is very time-consuming All company proceedings become public Stringent disclosure rules under Sarbanes-Oxley Act Intense pressure post IPO to perform in the short term

16. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The IPO Process Simplified Figure 16.3

17. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Growing via Strategic Alliances  A close, collaborative relationship between two or more firms with the intent of accomplishing mutually compatible goals that would be difficult for each to accomplish alone  Advantages of alliances with big companies: Excellent course of growth capital Better financial deal for a growing company  Cautions: Investigate the potential partner carefully Consider several partners before selecting one Don’t become too heavily dependent on partner Ensure that benefits will flow in both directions

18. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Valuing the Business  Financial yardsticks: Fair market value Intrinsic value Investment value Going-concern value Liquidation value Book value

19. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Valuing the Business (cont’d)  Non financial yardsticks: The experience level of the management team Firm’s distribution channels level of innovation Nature of the company’s relationships in the industry and with customers Company’s ability to be fast and flexible Amount/kind of the company’s intellectual property

20. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Valuing the Business (cont’d)  Comparables Companies with similar value characteristics (risk, rate of growth, capital structure, size and timing of cash flows)  Multiple of earnings Simple and direct way to value publicly owned companies Figures normal earnings and then capitalizes at some rate of return as a multiple of earnings

21. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Valuing the Business (cont’d)  Discounting cash flows Values business by potential earnings power Capitalization of future cash flows to the present value 4 components to be addressed: 1.The assumptions 2.Forecast period 3.Terminal value 4.Discount rate

22. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Valuing the Business (cont’d)  Real options model Techniques applied to entrepreneur’s options under changing circumstances Includes calculation of probability that specific events will occur  Venture capital model Often used in private equity arena to value investments with negative cash flows and earnings but with future promise

23. ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. New Venture Action Plan Determine how much growth capital will be needed and at what stages. Develop a strategy for seeking growth capital. Consider whether and, if so, when to proceed with an IPO. Establish a value for the business.