obtaining venture & growth capital chapter 13 dowling ba 560 fall term 2006

Obtaining Obtaining Venture & Venture &

Growth CapitalGrowth Capital

Chapter 13Chapter 13DowlingDowling

BA 560BA 560Fall Term 2006Fall Term 2006

Obtaining Venture & Obtaining Venture & Growth CapitalGrowth Capital

Cover your equityCover your equity Balance the need for Balance the need for

startup and growth capital startup and growth capital

with preservation of equitywith preservation of equity The earlier the capital The earlier the capital

enters, regardless of the source, the more $$$ enters, regardless of the source, the more $$$ costly it iscostly it is

Creative bootstrapping strategies can be great Creative bootstrapping strategies can be great preservers of equitypreservers of equity


Considerations Considerations Does the venture Does the venture needneed outside equity outside equity

capital?capital? Do the founders Do the founders want want outside equity outside equity

capital?capital? WhoWho should invest? should invest?

An equity investment requires that the An equity investment requires that the management team firmly believe that management team firmly believe that investors can and will add value to the investors can and will add value to the venture. venture.

Exhibit 13.1Exhibit 13.1


TimingTiming It is unwise for a startup to delay It is unwise for a startup to delay

looking for capital since it is likely to looking for capital since it is likely to take six months or more to raise money.take six months or more to raise money.


Early-stage entrepreneurs need investors Early-stage entrepreneurs need investors who:who: Are considering new financing proposals and can Are considering new financing proposals and can

provide the required level of capitalprovide the required level of capital Are interested in companies at the particular Are interested in companies at the particular

growth stagegrowth stage Understand and have a preference for investments Understand and have a preference for investments

in the particular industryin the particular industry Can provide good business advice, moral supportCan provide good business advice, moral support Are reputable and ethical and with whom founder Are reputable and ethical and with whom founder

can get alongcan get along Have successful track records of 10 years or more Have successful track records of 10 years or more

advising and building smaller companiesadvising and building smaller companies

Angel InvestorsAngel Investors

Who are angel investors?Who are angel investors? Most are self-made entrepreneur millionairesMost are self-made entrepreneur millionaires Many are in their 40s and 50sMany are in their 40s and 50s Most are well educatedMost are well educated Ninety-five percent have college degrees from Ninety-five percent have college degrees from

four-year collegesfour-year colleges Fifty-one percent have graduate degrees (Forty-Fifty-one percent have graduate degrees (Forty-

four percent are in a technical field and thirty-four percent are in a technical field and thirty-percent percent are in business or economics)percent percent are in business or economics)

Ninety-six percent are menNinety-six percent are men

Informal InvestorsInformal Investors

What type of ventures lends themselves to the What type of ventures lends themselves to the use of informal investors?use of informal investors? Special situations, such as very early financing of Special situations, such as very early financing of

high-technology inventors who have not developed high-technology inventors who have not developed a prototypea prototype

Companies that project high levels of free cash Companies that project high levels of free cash flow within three to five yearsflow within three to five years


Angels and informal investorsAngels and informal investors Who they areWho they are

Typical informal investor will invest from $10,000 to Typical informal investor will invest from $10,000 to $50,000 in any one venture. They’re appropriate for:$50,000 in any one venture. They’re appropriate for:

Ventures with capital requirements from $50K-Ventures with capital requirements from $50K-$500K$500K

Ventures with sale potential from $2-$20 million Ventures with sale potential from $2-$20 million in 5-10 years.in 5-10 years.

Small, established, privately held ventures with Small, established, privately held ventures with sales and profit growth of 10 to 20 percent per sales and profit growth of 10 to 20 percent per yearyear

Special situationsSpecial situations


Evaluation processEvaluation process An informal investor will want to review a An informal investor will want to review a

business plan, meet the full management business plan, meet the full management team, see any product prototype or design team, see any product prototype or design that may exist, etc.that may exist, etc.

The decisionThe decision Agreement with informal investors will most Agreement with informal investors will most

often include a “put,” whereby the investor often include a “put,” whereby the investor has the right to require the venture to has the right to require the venture to repurchase his or her stock after a specified repurchase his or her stock after a specified number of years at a specified price.number of years at a specified price.


Venture capital: What is it?Venture capital: What is it? ““The venture capital industry supplies capital The venture capital industry supplies capital

and other resources to entrepreneurs in and other resources to entrepreneurs in businesses with high growth potential in hopes businesses with high growth potential in hopes of achieving a high rate of return on invested of achieving a high rate of return on invested funds.”funds.”

Most credit Ralph Flanders, then president of Most credit Ralph Flanders, then president of Federal Reserve Bank of Boston, with the idea.Federal Reserve Bank of Boston, with the idea.

VC investors commonly expect returns of VC investors commonly expect returns of 5 to 5 to 10 times initial investment10 times initial investment in 5 to 10 years. in 5 to 10 years.


Venture capitalVenture capital Key is to seek investors who will truly add Key is to seek investors who will truly add

value to the venture, beyond the moneyvalue to the venture, beyond the money Carefully screen potential investors to Carefully screen potential investors to

determine how specifically they might fill determine how specifically they might fill in some gaps in the founders’ know-how in some gaps in the founders’ know-how and networksand networks

The right investors can open doors to new The right investors can open doors to new customers, vendors, and additional customers, vendors, and additional investorsinvestors


Venture capitalVenture capital No more than 2 to 4 percent of ventures No more than 2 to 4 percent of ventures

seeking VC actually receive financing from seeking VC actually receive financing from themthem

An entrepreneur may give up 25 to 75 An entrepreneur may give up 25 to 75 percent of his or her equity for seed/startup percent of his or her equity for seed/startup financingfinancing

Most VC investors are limited partnerships, Most VC investors are limited partnerships, with fund managers serving as general with fund managers serving as general partners and investors as limited partnerspartners and investors as limited partners

Sources and guidesSources and guides A good place to start is Pratt’s Guide to A good place to start is Pratt’s Guide to

Venture Capital SourcesVenture Capital Sources What to look for:What to look for:

Entrepreneurs are well advised to screen Entrepreneurs are well advised to screen prospective investors to determine the prospective investors to determine the appetites of such investors for the stage, appetites of such investors for the stage, industry, technology and capital industry, technology and capital requirements proposedrequirements proposed



Dealing with venture capitalistsDealing with venture capitalists If possible, obtain a personal If possible, obtain a personal

introduction from someone the investors introduction from someone the investors know wellknow well

Identify several prospects; create a Identify several prospects; create a market for your idea by marketing itmarket for your idea by marketing it

Do not stop selling until the money is in Do not stop selling until the money is in the bank. the bank.

Let the facts speak for themselves. Be Let the facts speak for themselves. Be able to deliver on the claims. able to deliver on the claims.


What to look out for:What to look out for:

AttitudeAttitude Over-commitmentOver-commitment InexperienceInexperience Unfavorable reputationUnfavorable reputation Predatory PricingPredatory Pricing


Due Diligence: A two-way streetDue Diligence: A two-way street DD can take several weeks or months at DD can take several weeks or months at

startupstartup Involves a painstaking investigation for Involves a painstaking investigation for

investorsinvestors


Other equity sourcesOther equity sources SBA 7(a) Guaranteed Business Loan SBA 7(a) Guaranteed Business Loan

ProgramProgram Small business investment companiesSmall business investment companies

Licensed and loan-funded by SBALicensed and loan-funded by SBA Limited to taking minority shareholder positions Limited to taking minority shareholder positions Can invest only 20% of equity capital in any one Can invest only 20% of equity capital in any one

firmfirm Common options include long-term loans with Common options include long-term loans with

stock options, convertible debentures, straight stock options, convertible debentures, straight loans, and preferred stockloans, and preferred stock


Other equity sourcesOther equity sources Mezzanine capitalMezzanine capital

Capital that is between senior debt Capital that is between senior debt financing and common stockfinancing and common stock

Most often, it’s subordinated debt carrying Most often, it’s subordinated debt carrying an equity kicker consisting of warrants or a an equity kicker consisting of warrants or a conversion feature into common stockconversion feature into common stock

Generally unsecured, with maturity in 5 to Generally unsecured, with maturity in 5 to 10 years10 years

Can be burdensome in its claims on cashCan be burdensome in its claims on cash Subordinated debt often contains covenants Subordinated debt often contains covenants

relating to net worth, debt and dividendsrelating to net worth, debt and dividends


Other equity sourcesOther equity sources Private placement investors. Could include:Private placement investors. Could include:

Dealers, franchisors or wholesalersDealers, franchisors or wholesalers Professional investors always on the lookout for a Professional investors always on the lookout for a

good, small company in its formative yearsgood, small company in its formative years Others seek opportunities to buy shares of Others seek opportunities to buy shares of

smaller growth firms in the expectation that the smaller growth firms in the expectation that the firms will soon go publicfirms will soon go public

Attractive to venture capitalists who hope to Attractive to venture capitalists who hope to benefit when the company goes public or when benefit when the company goes public or when the company is soldthe company is sold


Other equity sourcesOther equity sources Initial public stock offerings (IPO)Initial public stock offerings (IPO)

Raises capital through federally registered Raises capital through federally registered and underwritten sales of the company’s and underwritten sales of the company’s shares shares

More mature companies get better terms at More mature companies get better terms at IPOIPO


Advantages of going publicAdvantages of going public Raise more capital with less dilutionRaise more capital with less dilution Improve balance sheet or reduce/eliminate Improve balance sheet or reduce/eliminate

debtdebt Obtain cash for pursuing other opportunitiesObtain cash for pursuing other opportunities Access other capital suppliers and increase Access other capital suppliers and increase

bargaining powerbargaining power Improve credibilityImprove credibility Achieve liquidity for owners and investorsAchieve liquidity for owners and investors Create equity incentives for new and Create equity incentives for new and

existing staffexisting staff


Disadvantages of going publicDisadvantages of going public Legal, accounting and administrative costs Legal, accounting and administrative costs Management time, effort and expense is Management time, effort and expense is

required to comply with SEC rules and required to comply with SEC rules and reporting requirements.reporting requirements.

Management can become more interested in Management can become more interested in maintaining the price of the company’s stock maintaining the price of the company’s stock than in running the companythan in running the company

Liquidity of company stock achieved through Liquidity of company stock achieved through a public offering may be more apparent than a public offering may be more apparent than realreal


Private placement after going publicPrivate placement after going public Can “tide you over” in the event the public Can “tide you over” in the event the public

turns sourturns sour SEC Regulation DSEC Regulation D

Employee stock option plans (ESOPs)Employee stock option plans (ESOPs) Used by firms with high confidence in the Used by firms with high confidence in the

stability of their future earnings and cash stability of their future earnings and cash flow. An ESOP is a program in which the flow. An ESOP is a program in which the employees become investors in the employees become investors in the company. Tax-qualified benefit plans. company. Tax-qualified benefit plans.

Presenting Information to Presenting Information to Possible InvestorsPossible Investors

A concise presentation should include the A concise presentation should include the following:following: What is the market opportunity?What is the market opportunity? Why is it compelling?Why is it compelling? How will/does the business make money?How will/does the business make money? Why is this the right team at the right time?Why is this the right team at the right time? How does an investor exit the investment?How does an investor exit the investment?

Additional Ch. 13 Additional Ch. 13 MaterialsMaterials

What to Look Out for in What to Look Out for in InvestorsInvestors

AttitudeAttitude Be wary if getting through to a general partner in the Be wary if getting through to a general partner in the

investment firm is an ordealinvestment firm is an ordeal Be wary if the investor thinks he or she can run the Be wary if the investor thinks he or she can run the

business better than the lead entrepreneur or the business better than the lead entrepreneur or the management teammanagement team

Over commitmentOver commitment Be wary of lead investors who indicate they will be Be wary of lead investors who indicate they will be

active directors but who also sit on the boards of six to active directors but who also sit on the boards of six to eight other startup and early0stage companies or are in eight other startup and early0stage companies or are in the midst of raising money for a new fundthe midst of raising money for a new fund


InexperienceInexperience Be wary of dealing with venture capitalists who Be wary of dealing with venture capitalists who

are under 30 years of age and have:are under 30 years of age and have:

Only worked on Wall Street or as a consultantOnly worked on Wall Street or as a consultant No operating, hands-on experience in new and growing No operating, hands-on experience in new and growing

companiescompanies A predominantly financial focusA predominantly financial focus


Unfavorable reputationUnfavorable reputation Be wary of funds that have a reputation for early and Be wary of funds that have a reputation for early and

frequent replacement of the founders frequent replacement of the founders Be wary of those where more than one-fourth or the Be wary of those where more than one-fourth or the

portfolio companies are in trouble or failing to meet portfolio companies are in trouble or failing to meet projections in their business plansprojections in their business plans

Predatory pricingPredatory pricing Be wary of investors who unduly exploit conditions Be wary of investors who unduly exploit conditions

during adverse capital markets by forcing large share during adverse capital markets by forcing large share price decreases in the new firms and punishing terms on price decreases in the new firms and punishing terms on prior investorsprior investors

obtaining venture & growth capital chapter 13 dowling ba 560 fall term 2006

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