Venture Capital

Debt Financing • Interest based instrument• Usually a loan• Indirectly related to the sales and profits• Requires collateral security

Short term debt used for• Account receivable• Finance inventory• Operation of the business

Long term debt used for• To purchase assets like machinery,

land, building

Equity financing• Funds in exchange of ownership• No collateral security• Investor shares in the profits of the venture

Internal funds

•Profits•Sale of asset•Reduction in working capital•Extended payment terms•Account receivable

External funds

•Personal funds•Family & friends•Suppliers/trade credit•Commercial banks•Govt. loan programs

Types of bank loans

•Account receivable loans

•Inventory loans

•Equipment loans

•Real estate loans

Cash flow financing

•Installment loans

•Straight commercial loans

•Long term loans

•Character loans

Stages of business development funding

Early stage financing• Seed capital• Start-up

Expansion or development financing• Second stage• Third stage• Fourth stage

Acquisitions and leveraged buyout financing• Traditional acquisitions• Leveraged buyouts• Going private

Risk capital marketsMarkets providing debt and equity tonon-secure financing situations

Informal risk capital marketsArea of risk-capital markets consistingmainly of individuals.

Business Angelsare private investors who invest in

unquoted small and medium sized businesses

Venture capital marketOne of the risk capital market consisting of formal firms

Venture capital is a professionally managedpool of equity capital

Why companies need financing?

•For start-ups or growing companies, as well as those facing a major change, financing is one of the key business issues.

•New capital is needed e.g. for1. Financing of product development2. Financing of market penetration3. Financing of investments4. Working capital financing to secure

operative continuity5. Maintaining liquidity to be able to

cover daily payments

Why companies need financing?

•During their start-up, growth and expansion stages, the companies are often faced with the fact that the incoming cash flow is not sufficient for the operations. The company's cumulative cash flow is negative. The time needed for turning the company‘s cash flow positive varies considerably

•A long product development stage and slow market penetration prolong the negative cash flow period.

•The company can have a negative cash flow foryears, a situation that is typical in high-techbranches.

Operative financing

•To bridge the deficit in operative financing, thecompany has the following choice of availablemeasures:

1. To ensure that the liquidity planning has beenappropriate2. To make the clients pay their invoices on time by offering, for example, discounts for rapid payments3. To intensify the collection of sales receivables4. To delay the payments to suppliers within theirterms of payment5. To maximize the sales margins to cut indirect costs

External financing

•Should these measures not be sufficient, thecompany has the following alternatives:

•To acquire equity capital (e.g. venture capital investors)

•To borrow capital

•To apply for public subsidies

The Process of acquiring VentureCapital financing

•The actual venture capital investment made in a company is preceded by a thorough and selective assessment of potential investment targets made by the venture capital investor. At the first stage, the assessment of the investment request is based on a business plan made by the company.

•The initial assessment is made relatively rapidly and therefore the company should pay attention to two aspects: the business plan should be carefully prepared and the contact targeted to the correct investors. A well-prepared business plan summary is the best means of attracting and convincing the investor.

The Process of acquiring VentureCapital financing

The central issues considered by the venture capital investor at this stage are:

•Is the company able to conduct profitable andgrowing business operations?

•Do the company executives have the necessary qualities to manage the business in the various development stages?

•Will the investor be able to obtain the desired return through an increase in the company's net worth?

The Process of acquiring VentureCapital financing

•Besides the company's business plan, the venturecapital investor will assess the compatibility of theinvestment request against its own investmentStrategy

•The decisive investment strategy criteria may becompany size, development stage, branch orgeographical location.

•Contacts directed to the correct investors at an early stage of the process will save time and diminish the probability of negative answers.

The Process of acquiring VentureCapital financing

•Should the investor decide that theinvestment request meets his criteria, thefollowing step is a meeting arranged with thecompany management

•Experience has shown that about half of theremaining companies are discarded at thenegotiation stage

The Process of acquiring VentureCapital financing•The third stage, or the due diligence stage, involves a thorough study of the target company by the venture capital investor who assesses the company on the basis of his own, weightedinvestment criteria.

•The preparedness of the company management to launch and developed the business in question is generally seen as the most important criterion.

•Other vital issues include the size and development of the company's target market, the competitiveness of the company's product and technology as well as the capital required by thebusiness at the actual investment stage and the eventual additional investment needs.

The Process of acquiring venturecapital financing

•During the second and third stage of the assessment process, the investor determines the value of the company. Once the entrepreneur and the investor have agreed on the value, the investor's future share of the company is determined.

•The entry valuation of investor will depend on factors such as investors return expectations, proportion of the company that the management will give up to attract the investments and the view of the opportunity for new concept, product or service

The Process of acquiring venturecapital financing

•The intention is to liquidate the shareholding in early phase companies after 4-8 years and in companies with follow-on funding after 1-3 years

•In the end, the investment is made in about 3 to 4 % cases of all received investment requests. Theparties finally make a shareholder agreement toestablish practical operating rules.

•VC’s exit could be anything between liquidation andIPO

Stages of Investments

•Early stage companies may have proprietary technology or intellectual property that has the potential to be exploited on a global scale. The technology or lead product is usually beyondproof of principle stage

•Mid-stage companies may have strong pipeline of technologies and products, which has been developed by research and management teams with scientific and commercial credibility

•Later stage companies have operational and corporate finance skills ideally positioned and company may need investments to precipitate consolidations. Companies at this stage are within12 to 18 months of an IPO.

VC’s contribution to entrepreneur

•In addition to money, professional VC as a shareholder bring strong industry, operational, financial and investment banking skills to the partnership with the target company•Through the VC’s expertise and network the portfolio companies could gain access to:

a) follow-on capital through venture capital tiesb) knowledge of partnership opportunities in multiple marketsc) in-depth operational and management experience’d) access to high-quality management teamse) ties to the investment banking community

Stages of VC financingSeed stage financing

•The venture is still in the idea formation stage and its product or service is not fully developed. The usually lone founder/inventor is given a small amount of capital to come up with a working prototype. Money may also be spent on marketing research,patent application, incorporation, and legal structuring for investors.

•It's rare for a venture capital firm to fund this stage. In most cases, the money must come from the founder's own pocket, from the "3 Fs" (Family, Friends, and Fools), and occasionally from angel investors.

Stages of VC financing Start up financing

•The venture at this point has at least oneprincipal working full time. The search is onfor the other key management teammembers and work is being done on testingand finalizing the prototype for production

Stages of VC financingFirst -stage financing

•The venture has finally launched and achieved initial traction. Sales are trending upwards. .Amanagement team is in place along with employees

•The funding from this stage is used to fuel sales, reach the breakeven point., increase productivity, cut unit costs, as well as build the corporate infrastructure and distribution system. At this point the company is two to three years old

Stages of VC financingSecond -stage financing

•Sales at this point are starting to snowball. Thecompany is also rapidly accumulating accountsreceivable and inventory. Capital from this stage is used for funding expansion in all its forms from meeting increasing marketing expenses to entering new markets to financing rapidly increasing accounts receivable.

•Venture capital firms specializing in later stagefunding enter the picture at this point

Stages of VC financingMezzanine or Bridge financing•At this point the company is a proven winner and investment bankers have agreed to take it public within 6 months.Mezzanine or bridge financing is a short term form of financing used to prepare a company for its IPO. This includes cleaning up the balance sheet to remove debt that may have accumulated, buy out early investors and founders deemed not strong enough to run a public company, and pay for various other costs stemming from going public.

•The funding may come from a venture capital firm or bridge financing specialist. They are usually paid back from the proceeds of the IPO.

Stages of VC financingInitial Public Offering (IPO)

•The company finally achieves liquidity by beingallowed to have its stock bought and sold by thepublic. Founders sell off stock and often go back to square one with another start up.

•Please note that some companies have morefinancing stages than shown above and others may have fewer. Very few reach the bridge and IPO stages. It all depends on the individual company.

Informal risk capital-Business Angels

Definition•Business Angels are private investors who invest in unquoted small and medium sized businesses. •They are often businessmen and women who have sold their business.• They provide not only finance but experience and business skills. •Business Angels invest in the early stage of business development filling, in part, the equity gap.