Chapter 12

Informal Risk Capital,

Venture Capital,
and Hisrich

Going Public Peters

McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Shepherd
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.

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Table 12.1 - Stages of Business
Development Funding

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Financing the Business (cont.)

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.

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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.

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Table 12.2 - Characteristics of
Informal Investors

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Table 12.2 - Characteristics of
Informal Investors (cont.)

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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.
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Figure 12.1 - Types of Venture-
Capital Firms

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

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Venture Capital (cont.)

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.

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

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Venture Capital (cont.)

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.

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Venture Capital (cont.)

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.

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Table 12.6 - Guidelines for Dealing
with Venture Capitalists

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

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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.

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Valuing Your Company (cont.)

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.

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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Valuing Your Company (cont.)

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.

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Valuing Your Company (cont.)

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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

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.

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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.
Entrepreneurs needs:
Degree and mechanisms of control.
Amount of financing needed.
Goals for the particular firm.

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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 publics perception of
the value of the business.

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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
Is the company large enough?
What is the amount of the companys 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?

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Timing of Going Public and
Underwriter Selection (cont.)
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.

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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.

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

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Registration Statement and
Timetable (cont.)
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.

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

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Registration Statement and
Timetable (cont.)
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.

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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. 12-38
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 companys stock.

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After Going Public (cont.)

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.

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