Chapter 12
Informal Risk Capital, Venture
Capital,
and
Going Public
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
• To explain the basic stages of venture funding
• To discuss the informal risk-capital market
• To discuss the nature of the venture-capital
industry and the venture-capital decision
process
• To explain all aspects of valuing a company
• To identify several valuation approaches
• To explain the process of going public
12-2
Financing the Business
• Criteria for evaluating financing alternatives:
• Amount and timing of funds required
• Projected company sales and growth
• Types of funding
• Early stage financing: One of the first financings
obtained by a company
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Financing the Business
• Development financing: Financing to rapidly
expand the business
• Acquisition financing: Financing to buy another
company
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Table 12.1 - Stages of Business
Development Funding
12-5
Financing the Business
• Risk capital markets: Provide debt and equity
to nonsecure financing situations
• Types of risk capital markets
• Informal risk capital market: Consists mainly of
individuals
• Venture-capital market: Consists of formal firms
• Public-equity market: Consists of publicly owned
stocks of companies
12-6
Informal Risk Capital
• Business angels: Individuals investing in the
informal risk-capital market
• Investments range between $10,000 to
$500,000
• Provides first-stage financing
• Referral sources: Ways individual investors
find out about potential deals
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Table 12.2 - Characteristics of Informal
Investors
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Table 12.2 - Characteristics of Informal
Investors
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Venture Capital
• Nature of venture capital
• Long-term investment discipline
• Equity pool: Money raised by venture capitalists
to invest
• Equity participation: Taking an ownership position
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Venture Capital
• 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
12-11
Types of Venture Capital Firms
• SBIC firms: Small companies with some
government money that invest in other
companies
• Private venture-capital firms: Having general
and limited partners
• State-sponsored venture-capital fund
• A fund containing state government money that
invests primarily in companies in the state
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Figure 12.1 - Types of Venture-Capital
Firms
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Venture Capital
• Venture-capital process: Decision procedure
of a venture-capital firm
• 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
• Unique product and/or market opportunity
• Significant capital appreciation: Increase in value of
the organization during a specific period of time
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Figure 12.4 - Venture-Capital Financing:
Risk and Return Criteria
12-15
Venture Capital
• Venture-capital process
• Preliminary screening: Initial evaluation of the
deal
• Agreement on principal terms between
entrepreneur and venture capitalist
• Due diligence: Process of deal evaluation
• Final approval: Document showing the final terms
of the deal
12-16
Valuing Your Company
• Factors in valuation: Nonmonetary aspects
that affect the fund valuation
•
•
•
•
•
Nature and history of business
Economic outlook
Book (net) value
Future earning capacity
Dividend-paying capacity
12-17
Valuing Your Company
• Assessment of goodwill/intangibles
• Previous sale of equity
• Market value of similar companies’ stock
• Financial ratio
• Measure financial strengths and weaknesses of
the venture
• Used on actual financial results
12-18
Valuing Your Company
• Liquidity ratios
C u rren t ratio =
C u rren t assets
C u rren t liab ilities
A cid test ratio =
C u rren t assets  In ven to ry
C u rren t liab ilities
12-19
Valuing Your Company
• Activity ratios
A ctivity collection period =
A ccounts recievable
A verage daily sales
Inventory turnover =
C ost of goods sold
Inventory
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Valuing Your Company
• Leverage ratios
D ebt ratio =
T otal liabilities
T otal assets
D ebt to equity =
T otal liabilities
S tockholder's equity
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Valuing Your Company
• Profitability ratios
N et p ro fit m arg in =
N et p ro fit
N et sales
R etu rn o n in vestm en t =
N et p ro fit
T o tal assets
12-22
Valuing Your Company
• General valuation approaches: Methods for
determining the worth of a company
• Types of approaches
• Assessing comparable publicly held companies
and the prices of these companies’ securities
• Present value of future cash flow
• Valuing a company based on its future sales and profits
• Replacement value
• Cost of replacing all assets of a company
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Valuing Your Company
• Book value
• Indicated worth of the assets of a company
• Earnings approach
• Determining the worth of a company by looking at its
present and future earnings
• Factor approach
• Using the major aspects of a company to determine its
worth
• Liquidation value
• Worth of a company if everything was sold today
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Valuing Your Company
• General valuation method
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Table 12.7 - Steps in Valuing Your Business
and Determining Investors’ Share
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Evaluation of an Internet Company
• Financial projections are compared with the
future market in terms of:
• Fit
• Realism
• Opportunity
• Management team is examined
• Opportunities available in the investor market
are examined
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Deal Structure
• Form of the transaction when money is
obtained by a company
• Needs of the funding sources
•
•
•
•
Rate of return required
Timing and form of return
Amount of control desired
Perception of risks
12-28
Deal Structure
• Entrepreneur’s needs
• Degree and mechanisms of control
• Amount of financing needed
• Goals for the particular firm
12-29
Going Public
• Selling some part of the company by
registering with the Securities and Exchange
Commission (SEC)
• Provides the company with:
• Financial resources
• A relatively liquid investment vehicle
• Initial public offering:The first public
registration and sale of a company’s stock
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Table 12.8 - Advantages and
Disadvantages of Going Public
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Timing of Going Public and
Underwriter Selection
• Timing - Issues to be considered before going
public
• Size of offering
• Amount of the company’s earnings, and financial
performance
• Favorability of the market conditions
• Urgent money requirement
• Needs and desires of the present owners
12-32
Timing of Going Public and
Underwriter Selection
• 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
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Timing of Going Public and
Underwriter Selection
• Factors to consider in selection
•
•
•
•
•
Reputation
Distribution capability
Advisory services
Experience
Cost
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Registration Statement and Timetable
• Reasons for delays in registration process
• Heavy periods of market activity
• Peak seasons
• Attorney’s unfamiliarity with federal or state
regulations
• Issues arising over requirements of the SEC
• Inexperienced managing underwriter
12-35
Registration Statement and Timetable
• Reviewing registration statement includes
ensuring
• Full and fair disclosure: Nature of all material
submitted to SEC for approval
• Registration statement constitutes of:
• Prospectus: Document for distribution to
prospective buyers
• Registration statement: Materials submitted to
the SEC for approval to sell stock
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Registration Statement and Timetable
• Form S- 1: Form for registration for initial
public offerings
• The Registration Statement-Provides
information regarding:
• Offering
• Past unregistered securities offering of the
company
• Other undertakings by the company
12-37
Registration Statement and Timetable
• Includes exhibits:
•
•
•
•
•
Articles of incorporation
Underwriting agreement
Company bylaws
Stock option and pension plans
Initial contracts
12-38
Registration Statement and Timetable
• Procedure
• Red herring: Preliminary prospectus of a potential
public offering
• Deficiencies are communicated through
• Comment letter: Letter indicating corrections that need
to be made in the submitted prospectus
• Pricing amendment
• Additional information on price and distribution is
submitted to the SEC to develop the final prospectus
12-39
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
12-40
After Going Public
• Aftermarket support
• Actions of underwriters to help support the price
of stock following the public offering
• Reporting requirements - File:
• Annual reports on Form 10-K
• Quarterly reports on Form 10-Q
• Specific transaction or event reports on Form 8-K
12-41