1. Hisrich Peters Shepherd Chapter 12 Informal Risk Capital, Venture Capital, and Going Public Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. 12-2 Financing the Business  Criteria for evaluating appropriateness of financing alternatives:  Amount and timing of funds required.  Projected company sales and growth.  Three types of funding:  Early stage financing.  Development financing.  Acquisition financing.

3. 12-3 Table 12.1 - Stages of Business Development Funding

4. 12-4  Risk capital markets provide debt and equity to nonsecure financing situations.  Types of risk capital markets:  Informal risk capital market.  Venture-capital market.  Public-equity market.  All three can be a source of funds for stage- one financing.  However, public-equity market is available only for high-potential ventures. Financing the Business (cont.)

5. 12-5 Informal Risk Capital  It consists of a virtually invisible group of wealthy investors (business angels).  Investments range between $10,000 to $500,000.  Provides funding, especially in start-up (first-stage) financing.  Contains the largest pool of risk capital in the United States.

6. 12-6 Table 12.2 - Characteristics of Informal Investors

7. 12-7 Table 12.2 - Characteristics of Informal Investors (cont.)

8. 12-8 Venture Capital  Nature of Venture Capital  A long-term investment discipline, usually occurring over a five-year period.  The equity pool is formed from the resources of wealthy limited partners.  Found in:  Creation of early-stage companies.  Expansion and revitalization of businesses.  Financing of leveraged buyouts of existing divisions of major corporations or privately owned businesses.  Venture capitalist takes an equity participation in each of the investments.

9. 12-9 Figure 12.1 - Types of Venture- Capital Firms

10. 12-10 Figure 12.3 - Percentage of Venture Dollars Raised by Stage in 2008

11. 12-11  Venture-Capital Process  Objective of a venture-capital firm - Generation of long-term capital appreciation through debt and equity investments.  Criteria for committing to venture:  Strong management team.  A unique product and/or market opportunity.  Business opportunity must show significant capital appreciation. Venture Capital (cont.)

12. 12-12 Figure 12.4 - Venture-Capital Financing: Risk and Return Criteria

13. 12-13  Venture-capital process can be broken down into four primary stages:  Stage I: Preliminary screening – Initial evaluation of the deal.  Stage II: Agreement on principal terms - Between entrepreneur and venture capitalist.  Stage II: Due diligence - Stage of deal evaluation.  Stage IV: Final approval - Document showing the final terms of the deal. Venture Capital (cont.)

14. 12-14  Locating Venture Capitalists  Venture capitalists tend to specialize either geographically by industry or by size and type of investment.  Entrepreneur should approach only those that may have an interest in the investment opportunity.  Most venture capital firms belong to the National Venture Capital Association. Venture Capital (cont.)

15. 12-15 Table 12.6 - Guidelines for Dealing with Venture Capitalists

16. 12-16 Table 12.6 - Guidelines for Dealing with Venture Capitalists (cont.)

17. 12-17 Valuing Your Company  Factors in Valuation  Nature and history of business.  Economic outlook- general and industry.  Comparative data.  Book (net) value.  Future earning capacity.  Dividend-paying capacity.  Assessment of goodwill/intangibles.  Previous sale of stock.  Market value of similar companies’ stock.

18. 12-18  Ratio Analysis  Serves as a measure of financial strengths and weaknesses of the venture but should be used with caution.  It is typically used on actual financial results.  Provides a sense of where problems exist in the pro forma statements. Valuing Your Company (cont.)

19. 12-19 Valuing Your Company (cont.)

20. 12-20 Valuing Your Company (cont.)

21. 12-21 Valuing Your Company (cont.)

22. 12-22 Valuing Your Company (cont.)

23. 12-23  General Valuation Approaches  Assessment of comparable publicly held companies and the prices of these companies’ securities.  Present value of future cash flow.  Replacement value.  Book value.  Earnings approach.  Factor approach.  Liquidation value. Valuing Your Company (cont.)

24. 12-24 Valuing Your Company (cont.)

25. 12-25 Table 12.7 - Steps in Valuing Your Business and Determining Investors’ Share

26. 12-26 Evaluation of an Internet Company  Qualitative portion of due diligence carries more weight.  Focus is more on the market itself.  Company's financial projections are compared with the future market in terms of fit, realism, and opportunity.  Management team is examined.  Opportunities available in the investor market are examined.

27. 12-27 Deal Structure  Terms of the transaction between the entrepreneur and the funding source.  Needs of the funding sources:  Rate of return required.  Timing and form of return.  Amount of control desired.  Perception of risks.  Entrepreneur’s needs:  Degree and mechanisms of control.  Amount of financing needed.  Goals for the particular firm.

28. 12-28 Going Public  Selling some part of the company by registering with the Securities and Exchange Commission (SEC).  Resulting capital infusion provides the company with:  Financial resources.  A relatively liquid investment vehicle.  Company consequently gains:  Greater access to capital markets in the future.  A more objective picture of the public’s perception of the value of the business.

29. 12-29 Table 12.8 - Advantages and Disadvantages of Going Public

30. 12-30 Timing of Going Public and Underwriter Selection  Timing  Is the company large enough?  What is the amount of the company’s earnings, and how strong is its financial performance?  Are the market conditions favorable for an initial public offering?  How urgently is the money needed?  What are the needs and desires of the present owners?

31. 12-31  Underwriter Selection  Managing underwriter - Lead financial firm in selling stock to the public.  Underwriting syndicate - A group of firms involved in selling stock to the public.  Factors to consider in selection:  Reputation.  Distribution capability.  Advisory services.  Experience.  Cost. Timing of Going Public and Underwriter Selection (cont.)

32. 12-32 Registration Statement and Timetable  “All hands” meeting - Preparing a timetable for the registration process.  First public offering requires six to eight weeks.  The SEC takes six to 12 weeks to declare the registration effective.

33. 12-33  Reasons for delays:  Heavy periods of market activity.  Peak seasons.  Attorney’s unfamiliarity with federal or state regulations.  Issues arising over requirements of the SEC.  When the managing underwriter is inexperienced. Registration Statement and Timetable (cont.)

34. 12-34  SEC attempts to ensure that the document makes a full and fair disclosure of the material reported.  Registration statement consists of:  Prospectus.  Registration statement.  Most initial public offerings will use a Form S-1 registration statement. Registration Statement and Timetable (cont.)

35. 12-35  Cover page  Prospectus summary  Description of the company  Risk factors  Use of proceeds  Dividend policy  Capitalization  Dilution  Selected financial data  Business, management, and owners  Type of stock  Underwriter information  Actual financial statements. Registration Statement and Timetable (cont.)  Prospectus

36. 12-36  The Registration Statement  Information regarding:  Offering.  Past unregistered securities offering of the company.  Other undertakings by the company.  Includes exhibits:  Articles of incorporation.  Underwriting agreement.  Company bylaws.  Stock option and pension plans.  Initial contracts. Registration Statement and Timetable (cont.)

37. 12-37  Procedure  Preliminary prospectus (red herring) can be distributed to the underwriting group.  Deficiencies are communicated through telephone or a comment letter.  Pricing amendment - Additional information on price and distribution is submitted to the SEC to develop the final prospectus.  Waiting period - Time between the initial filing and its effective date is usually around 2 to 10 months. Registration Statement and Timetable (cont.)

38. 12-38 Legal Issues and Blue-Sky Qualifications  Legal Issues  Quiet period – 90-day period in going public when no new company information can be released.  Blue-Sky Qualifications  Blue-sky laws - Laws of each state regulating public sale of stock.  May cause additional delays and costs to the company.  Many states allow their state securities administrators to prevent an offering from being sold in their state.

39. 12-39 After Going Public  Aftermarket Support  Actions of underwriters to help support the price of stock following the public offering.  Relationship with the Financial Community  Has a significant effect on the market interest and the price of the company’s stock.

40. 12-40  Reporting Requirements  The company must file:  Annual reports on Form 10-K.  Quarterly reports on Form 10-Q.  Specific transaction or event reports on Form 8-K.  Company must follow proxy solicitation requirements. After Going Public (cont.)