VENTURE CAPITAL

IMPORTANT SOURCE OF EQUITY FOR HIGH GROWTH

COMPANIES

• “POOL OF CAPITAL, TYPICALLY ORGANIZED AS A LIMITED PARTNERSHIP, WHICH INVESTS IN COMPANIES THAT REPRESENT AN OPPORTUNITY FOR A HIGH RATE OF RETURN WITHIN 5-7 YEARS.”

Venture Capital Funds

Year number of funds Funds($Bill) New Fundsfunds

1990 82 3.1 131995 155 9.7 442000 494 92.6 162

BACKGROUND

• VENTURE CAPITAL FIRM BACKED FIRMS RESPONSIBLE FOR

– 3.3% OF NATION’S JOBS– 7.4% OF GROSS DOMESTIC PRODUCT– ALL FOR ONLY 1% OF NATION INVEST.– “GAZELLES” (>20% GROWTH) ARE 5% OF

NATION’S FIRMS; 2/3 NEW JOBS

BIG CHANGE IN FINANCING

• GROWING WEALTH/DISPOSABLE INCOME

• VERY VISIBLE HIGH TECH COMPANIES - poster children for feast-or-famine nature of venture capital

• RECENT SURVEY - 6/100 of high tech startups had traditional bank debt as first-round financing

VENTURE CAPITAL ROLES

• PURCHASE EQUITY OR HYBRID SECURITIES

• ASSIST IN NEW PRODUCT DEVELOPMENT

• FOCUS ON HIGHER RISK-RETURN COMPANIES

SAMPLE FIRMS THAT USED VENTURE CAPITAL

• FEDERAL EXPRESS

• COMPAQ

• SUN MICROSYSTEMS

• INTEL

• MICROSOFT

VARIABLE TRAITS OF VENTURE CAPITAL FUND

• RISK

• LENGTH OF COMMITMENT

• INVESTMENT ILLIQUIDITY

• MINIMUM $ COMMITMENT

STRATEGY OF V.C. FIRMP. 283 OF TEXT

• MANAGEMENT ABILITY

• WELL-DEFINED NICHE BUSINESS

• LEADING MARKET POSITION

• STRONG GROWTH POTENTIAL

• CONSOLIDATION

• RISK AVOIDANCE

• REASONABLE SELLING PRICE

EXIT OPTION 1

• MERGER/ACQUISTION

– MOST FREQUENT EXIT– AT LEAST 3-5 YEARS AFTER INITIAL

INVESTMENT

EXIT OPTION 2

• INITIAL PUBLIC OFFERING (IPO)

– MOST GLAMOROUS

– FUND GETS PUBLIC SHARES BUT OFTEN MAY NOT BE TRADED FOR UP TO 2 YEARS

WHAT INDUSTRIES ATTRACT VENTURE CAP.

• Poised for rapid growth/high profit

• Sustainable growth in excess of 5 years

• Niche or emerging markets

• market large enough to support in range of $100 million in company value– health care– information technology (?)

LIFE CYCLE OPTIONS FOR V.C. INVESTMENT

• SEED INVESTING - before the real product or company is organized– $300-3 million

• EARLY STAGE INVESTING - after first product development– $3 million - $20 million

V.C. CYCLE CONT.

• EXPANSION STAGE - beyond critical mass toward more successful firm– $20 MILLION-$100 MILLION– STAGE AT WHICH IPO OR FIRM BUYOUT

EXPECTED

• LATER STAGE - also through exit via stock offering or buyout

EVALUATION APPROACH

• Uniqueness of product

• Will company become profitable?

• How will proceeds be used?

• Management able and willing to meet specific goals?

• Is there an exit strategy for equity investors?

VALUATION APPROACHES

• EARLY STAGE FIRMS - focus on management

• EXPANSION STAGE FIRMS - value = multiple of revenues

• LATE STAGE FIRMS - MULTIPLE OF EARNINGS

CASE STUDY VALUATIONS

• HOP-IN-FOODS - P. 259-260

• BERG ELECTRONICS - P. 281

• Q: COMPARE IPO FIRMS WITH FIRMS IN SAME INDUSTRY