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
13

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