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.
 Entrepreneur’s 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 public’s 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 company’s 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.
 Attorney’s 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.

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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 company’s 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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