Module 4The Search for Capital

Module 4Topics

Sources of Capital

Background

Start-up

Ongoing Operations

Growth

Review

The Search for Capital

We Know That Small Firms

need capital

don’t have access to capital markets

have limited choices

owners are often inexperienced

The Search for Capital

Finance Theories: Common Themes

(CAPM, Agency theory, Signaling theory, Pecking order theory)

Applicable to large firms, but less applicable to small firms

Most firms have a preferred target capital structure

Preferred target capital structure may vary by firm

Capital structure may affect value

Appropriate capital structure affected by many factors (taxes, cost, collateral, uncertainty, owner preferences)cost, collateral, uncertainty, owner preferences)

Perspective on Raising Capital

http://edcorner.stanford.edu/authorMaterialInfo.html?mid=1374

(3 minutes)

General Sources of Capital

EquityEquity Personal SourcesPersonal SourcesProfitsProfitsAngel Capital Angel Capital Venture CapitalVenture Capital

Debt Financial InstitutionsCredit CardsOther (Home Equity Loan, Life Insurance)

OtherOther Local Community Grants and LoansLocal Community Grants and LoansGovernment ProgramsOther (customer, suppliers)

Common Sources of Start-Up Capital

Personal Equity

Friends and Family

Loans from Financial Institutions

Bootstrap Financing

Common Sources of Growth Capital

“Angel” Investors

Venture Capital

Sale of Stock

Profits

Angel InvestorsAngel Investors

Local Wealthy Individuals

234,000 active investors in US

Work in informal groups

Pool investments

300 informal “angel” groups in US

Angel Investors

Invest < $1 million dollars

Average = $500,000

Annual Angel Investment = VC Investment

(2006: 25.6 billion vs $26.1 billion)

Invest in 10 times number of firms as VCs

(2006: 51,000 firms vs 3522 firms)

Angel Investor Expectations

Return of > 10 times investment

Exit within 5 years

Defined exit strategy

Finding Angel Investors

Not Easy

Cluster

Personal Network

Referrals: attorneys, accountants, bankers

Local Associations

Angel Investors: Due Diligence

Business Plan

Product

Nature of Opportunity

ROI

Cashflow

Management Team (Background Checks)

Exit Opportunity

“ “ Portals” to AngelsPortals” to Angels

“Gatekeepers” (Initial introduction)

Venture Capital Clubs

Regional-Based Groups of Investors

Matching Networks

Venture Capital: BackgroundVenture Capital: Background

Professionally Managed Investment Funds

$29.4 billion into 3,800 U.S. start-ups in 2007 in 2007

$6.6 billion in 800 deals in U.S. – 3rd quarter, 2006

1300 Venture Capital Firms in US

Invest in 1 of 400 proposals

Venture Capital

35 years VCs 35 years VCs > $441 billion> $441 billion> 57,000 companies> 57,000 companies

½ of IPOs have VC investment

Europe (2006) 71 billion invested in 20068.3% Seed 21%

Expansion 70% Buyout financing

US (2007)US (2007) $1.4 billion in China $1.4 billion in China $1.0 billion in India$1.0 billion in India

US Venture Capital

VC investment down 8.5% - 1st quarter 2008 vs 4th quarter 2007 (consistent with slowdown of US economy)

VCs and angel investors more cautious, pursued later stage investments

Shortage of money for seed and early stage ventures

US Investment (California, Massachusetts, Texas, Washington, NY)

Invested in >1,400 companies

Life sciences, clean technology and information technologyLife sciences, clean technology and information technology

55 new venture capital funds

Identifying a Venture Capitalist

NeedsNeedsOf Of

FirmFirmCharacteristics Characteristics

of VC Firmof VC Firm

Identifying a Venture Capitalist

Stage of Development

Amount of Investment

Industry

Services Offered

Reputation

Successful Record

VC Investment Criteria

Entrepreneur

Rate of Potential (50%/year)

Board of Directors

Management Team

Intellectual Property

Exit Opportunity

Venture Capital in Portugal

VC sector is one of smallest in OECD relative to size of economy

1999-2002 0.09% of GDP vs

0.29% of GDP for OECD

Dominated by banks and public VC companies

Venture Capital Process

Screening

Due Diligence

Deal Structure and Negotiation

Post Investment Monitoring

VC Due Diligence

Management Team

Competitive Advantage

Growth Potential

Exit Opportunity

Financial Projections

Intellectual Property

Venture Capital in Portugal

Most investment in Lisbon and Porto

2002 50% of investments in Lisbon

16% in Porto

23% rest of country

10% other European countries

Venture Capital in Portugal

Favor expansion stage projects

Average deal = 1.2 million Euros (2001)

Investments 40% manufacturing

18% services

15% IT

9% retail

Going PublicGoing Public

Process

– Underwriter

– Security and Exchange Commission

– Road Show

Very Expensive (~ $3,000,000 in US)

Discussion

Assignment

How much money to start your proposed business?

Where will money come from?