Module 7
Informal risk capital and venture capital
Informal risk capital market Venture capital - Nature and overview Venture capital process Locating venture capitalists Approaching venture capitalists
Funding
Entrepreneurship Development
A ventures typical life-cycle
Profit, Productivity, Revenues
New Venture
Start-up Venture Growth
Business stabilisation
Innovation or Decline
Source and type of funding varies
Funding
Entrepreneurship Development
Why new ventures need funding
Cash Flow Challenges Inventory must be purchased Employees must be trained and paid Establishment overheads Advertising must be paid for Capital Investments Lengthy PDLC
Cost of buying real estate, building Purchasing equipment Technology purchases patent filing
Product development can take a long time Funds required during development
Funding
Entrepreneurship Development
Stages of business development funding
Highest risk, Highest return expected
Lowest risk, Lowest return expected
Funding
Entrepreneurship Development
Sources of financing
Personal financing
Informal Capital
Entrepreneurship Development
Sweat Equity Friends and family Bootstrapping
Equity
Business Angels Private placement Venture capital IPO
Debt
Commercial banks Govt. financial agencies
Funding
Formal Capital
Informal risk capital market Business Angels
Invest their personal capital directly in start-ups High net worth ex-entrepreneurs, retired corporate executives, professionals $25K to $150K per start-up Apple received 91K from Mike Markkula (ex-Intel) in 1977. When Apple went public in 1980, this investment was worth $150M Expect hefty 40%+ annual return Sit on the Board sometimes Act as mentors and use their wide personal network Remain anonymous
Funding Entrepreneurship Development 6
Venture capital market
Funds made available for start-up firms and small businesses with exceptional growth potential Also known as venture capital, risk capital is provided to companies in the early stage of development It is a professionally managed pool of equity capital Venture Capital Investments are private equity investments in business ventures from growth stage through expansion of a company already producing and selling a product and through preparation for exit from the investment via buyout or initial public offering They bring equity investment (and debt), financial planning, business skills to the firm
Funding Entrepreneurship Development 7
Public Equity market
Organized markets for trading in equity shares such as common stocks, preferred stocks, and warrants. Includes markets for both regularly traded and nonregularly traded securities This is another source of finance for enterprises Typically available for major expansion after being established in the market Some high potential start-ups also use this route for risk financing (technology, biotech etc)
Funding Entrepreneurship Development 8
Appropriate Source of Funding
Characteristics of venture
Business has high risk with an uncertain return
Weak cash flow Low to moderate growth Unproven management
Source
Personal funds, friends and family, bootstrapping
Business has low risk with predictable return
Strong cash flow Audited financials Good management
Debt financing
Funding
Entrepreneurship Development
Appropriate Source of Funding
Characteristics of venture
Business offers high return
Unique business idea High growth Niche market Proven management
Source
Equity
Funding
Entrepreneurship Development
10
The financing continuum
IPO
$5M and up
Private Placements
$500K and up
Banks and Govt.
$5K and up
Venture Capital
$2M 50M
Business Angels
$100K 2M
Family and Friends
$20K 250K
Owners money
$10K 100K
Funding
Entrepreneurship Development
11
Debt financing
Debt financing Advantages
No relinquishment of ownership More borrowing means greater return on equity When interest rates are low, cost of borrowing is justified
Debt financing Disadvantages
Regular interest payments are reqd. Payback may result in cash flow problems Heavy use of debt can inhibit growth
Funding
Entrepreneurship Development
12
Business Angels vs. Venture Capitalists
Parameter Personal Firms funded Due diligence done Location of investment Contract used Monitoring after invst. Exiting Rate of return Funds
Funding
Business Angels Entrepreneurs Small, Early stage Minimal Of concern Simple Active, hands-on Of lesser concern Of lesser concern Personal
Entrepreneurship Development
Venture Capitalists
Investors Large, Mature Extensive Not important Comprehensive Strategic Very important Very important Manage others
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Venture capital process
Objective of a venture capitalist is to generate long term capital process thru debt and equity investments Objective of entrepreneur is survival or growth Can invest at any stage depending on risk appetite Criteria for commitment
Strong management team Market opportunity must be unique and real Potentially significant capital appreciation
Funding Entrepreneurship Development 14
Venture capital process
Preliminary screening
Business plan Industry economics Ability to evaluate/invest
Agreement on principal terms
Deal terms and conditions
Due diligence
Detailed review of business suppliers, market, finances Management interviews Risk assessment
Final approval
Internal investment memorandum Formal legal documents
Funding Entrepreneurship Development 15