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Chapter

13

Obtaining Venture and Growth Capital

McGraw-Hill/IrwinNew Venture Creation, 7/e © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Exhibit 13.1

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Obtaining Risk Capital

• Three central issues to be considered• Does the venture need outside equity capital?• Do the founders want outside equity capital?• Who should invest?

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Angel Investors

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

colleges• Fifty-one percent have graduate degrees (Forty-four percent

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

• Ninety-six percent are men

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Informal Investors

• What type of ventures lend themselves to the use of informal investors?• Ventures with capital requirements of between $50,000 and

$500,000• Ventures with sales potential of between $2 million and $20

million within 5 to 10 years• Small, established, privately held ventures with sales and

profit growth of 10% to 20% per year

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Informal Investors

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

technology inventors who have not developed a prototype• Companies that project high levels of free cash flow within

three to five years

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Exhibit 13.3

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Exhibit 13.6

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Exhibit 13.8

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Exhibit 13.9

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What to Look for in Investors

• Seek investors who:• Are considering new financing proposals and can provide the

required level of capital• Are interested in companies at the particular stage of growth• Understand and have a preference for investments in the

particular industry

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What to Look for in Investors

• Seek investors who:• Can provide good business advice, moral support, and has

contacts in the business and financial community• Are reputable, fair, and ethical and with whom the

entrepreneur gets along• Have successful track records of 10 years or more advising

and building smaller companies

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What to Look Out for in Investors

• Attitude• Be wary if getting through to a general partner in the

investment firm is an ordeal

• Be wary if the investor thinks he or she can run the business better than the lead entrepreneur or the management team

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

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

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What to Look Out for in Investors

• Inexperience• Be wary of dealing with venture capitalists who are under 30

years of age and have:• An MBA

• Only worked on Wall Street or as a consultant

• No operating, hands-on experience in new and growing companies

• A predominantly financial focus

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What to Look Out for in Investors

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

frequent replacement of the founders

• Be wary of those where more than one-fourth or the portfolio companies are in trouble or failing to meet projections in their business plans

• Predatory pricing• Be wary of investors who unduly exploit conditions during

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

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Presenting Information to Possible Investors

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

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Chapter

14

The Deal: Valuation, Structure, and

Negotiation

McGraw-Hill/IrwinNew Venture Creation, 7/e © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Exhibit 14.1

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Exhibit 14.3

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Exhibit 14.5

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Valuation Methods

• The Venture Capital Method• Appropriate for investments in a company with negative cash

flow at the time of the investment, but which in a number of years is projected to generate significant earnings

• The Fundamental Method• Simply the present value of the future earnings stream

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Valuation Methods

• The First Chicago Method• Employs a lower discount rate, but applies it to an expected

cash flow

• Discounted Cash Flow• Three time periods are defined (1) Years 1-5, (2) Years 6-10,

(3) Year 11 to infinity• Operating assumptions include initial sales, growth rates,

EBIAT/sales, and (net fixed assets + operating working capital)/sales; also note relationships and trade-offs

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What is a Deal in Entrepreneurial Finance?

• Deals—economic agreements between at least two parties that involves the allocation of cash flow streams (with respect to both amount and timing), the allocation of risk, and hence the allocation of value between different groups

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Deal Characteristics

• Characteristics of successful deals• They are simple• They are robust• They are organic• They take into account the incentives of each party to the deal

under a variety of circumstances• They provide mechanisms for communications and

interpretation

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Deal Characteristics

• Characteristics of successful deals• They are based primarily on trust rather than on legalese• They are not patently unfair• They do not make it too difficult to raise additional capital• They match the needs of the user of capital with the needs of

the supplier• They reveal information about each party

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Deal Characteristics

• Characteristics of successful deals• They allow for the arrival of new information before

financing is required• They do not preserve discontinuities• They consider the fact that it takes time to raise money• They improve the chances of success for the venture

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Minimizing Surprises

• Tips to consider when raising capital:• Raise money when you do not need it• Learn as much about the process and how to manage it as you

can• Know your relative bargaining position• If all you get is money, you are not getting much• Assume the deal will never close• Always have a backup source of capital• The legal and other experts can blow it -- sweat the details

yourself

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Negotiation

• Steps of principled negotiation• Separate the people from the problem• Focus on interests, not positions• Generate a variety of possibilities before deciding what to do• Insist that the result be based on some objective standard

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Burdensome Issues for Entrepreneurs

• Co-sale provisions

• Ratchet anti-dilution protection

• Washout financing

• Forced buyout

• Demand registration rights

• Piggyback registration rights

• Key-person insurance

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Kawasaki, Chapter 3

• The Art of Pitching

• You have one minute• Don’t make it overly autobiographical• Answer the unspoken questions from the “little man” by

using the “For instance…” statements• Not everyone will be shocked, awed or inspired

• So…

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Kawasaki, Chapter 3

• The Art of Pitching

• Decide what is MOST important about:• Your idea

• The business model

• Most likely questions to be answered

• You

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Kawasaki, Chapter 3

• The Art of Pitching

• Know your audience

• 10/20/30 or 10 slides, twenty minutes, thirty-point font

• Excuse me, thirty-point font

• Slides should contain talking points not text

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Kawasaki, Chapter 3

• The Art of Pitching

• Remember, you only want to spark interest, this isn’t the making or closing of a deal

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Kawasaki, Chapter 3

• The Art of Pitching

• CEO/Founder should do the talking

• Team management during presentation (no interrupting)

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Kawasaki, Chapter 3

• The Art of Pitching

• Focus on your total addressable market (TAM)

• Just enough detail…not too much, not too little

• Take notes