MGMT 321: Chapter 13

Forms of Equity Financing

- Angel Investors - Venture Capitalists - Initial Public Offering (IPO)

If > $5M

- VC - IPO

So, why use equity capital?

1. You will reduce your own exposure to financial loss 2. Your business will not have increased costs in the form of interest 3. Bringing outside investors into an existing business can often reenergized it by providing new ideas, procedures, and processes

Financial Leverage

A measure of the amount of debt relative to total investment

The business has low risk with a more predictable return: - Strong Cash Flow - Low Leverage - Audited Financials - Good Management - Healthy Balance Sheet

Debt Financing

The business offers a high return: - Unique Business Idea - High Growth - Niche Market - Proven Management

Equity

Dividends

Payments of profits to the owners of corporations

The business has high risk with an uncertain return: - Weak Cash Flow - High Leverage - Low-to-moderate Growth - Unproven management

Personal funds, friends, family, and other forms of bootstrapping

Preparing to Raise Equity (Or Debt)

Step 1: Determine precisely how much money is needed Step 2: Determine the type of financing or funding that is the most appropriate Step 3: Develop a strategy for engaging potential investors or bankers

Weighted Average Cost of Capital (WAC)

The expected average future cost of funds

Risk

The level of probability that an investment will not produce expected gains

Cost of Capital

The percentage cost of obtaining future funds

Optimum Capital Structure

The ratio of debt to equity that provides the maximum level of profits

Coporation

- A legal "artificial" entity that is formed by filing specific documents with a state government - May be subject to double taxation - C corp, S corp

Limited Liability Company (LLC)

- A legal form of business organization that is created by filing required documentation with a state government - Have a choice, under federal tax law, of being taxed as either corporations or partnerships

Limited Partnership

- A legal form of business organization that is created by filing required documentation with a state government - One or more partners may have no liability for the debts and actions of the partnership.

IPO

- An Initial Public Offering is a company's first sale of stock to the public. When a company goes public, it's stock is traded on one of the major stock exchanges - Most entrepreneurial firms that go public trade on the NASADAQ, which is weighted heavily toward technology, biotech, and small-company stocks - An IPO is an important milestone for a firm. Typically, a firm is not able to go public until is had demonstrated that it is viable and has a bright future

Not today, but soon

- Bank Loan - Bank Line - SBA - Friends/Family - Home Equity - Bootstrapping

If $20K - $100K

- Bank Loan - Home Equity Loan - Friends/Family - Bootstrapping - Bank Line of Credit - SBA

If $100K - $1M

- Bank Loans - Bank Line of Credit - Angels - Private Placement - SBA

I need $ now!

- Credit Cards - Existing Line of Credit - Friends/Family

Angel Network

- Ease of Finding Angels: Formal Networks public so easy to find; small private networks hard to find - Legal Form: Formal networks, corporation; informal networks vary - Source of Funds: Each angel invests their own money - Typical Size of Investment: $50-$250K - Geographic Proximity Preferences: Very close proximity is preferred. May invest remotely via syndicate - Why Invest?: Equity Growth and personal interest - Reporting Requirements: Varies, set by investing angels - Involvement Level and Method: Low to extremely high; informal - Angels Exit Expectation: Cash-out when firm brought or VC's invest

Individual Angel

- Ease of Finding Angels: Hard to find - Legal Form: Private Individual - Source of Funds: Invests own money - Typical Size of Investment: $50-100K - Geographic Proximity Preferences: Very close proximity is preferred - Why Invest?: Equity growth and personal interest - Reporting Requirements: Varies by Individual - Involvement Level and Method: Low to extremely high: informal - Angels Exit Expectation: Often Unplanned, Trade Sale

Angel Fund

- Ease of Finding Angels: Publicly known, so easy to find - Legal Form: Corporation - Source of Funds: Funds invests on angels' behalf - Typical Size of Investment: $50-$500K - Geographic Proximity Preferences: Very close proximity is preferred, May invest remotely via syndicate - Why Invest?: Equity growth, sometimes regional development - Reporting Requirements: Forma, set by the fund - Involvement Level and Method: Low to extremely high; more formal - Angels Exit Expectation: Cast-out when firm bought or VC's invest

The Entrepreneur's View

- Financing with equity is (1) expensive and (2) may create problems of control and decision making - Suppose you sell half your business to raise capital. You have just sold half of all your future profits, half of all your future growth, half of all your future wealth

A Hypothetical Startup

- Finding a co-founder - Finding early funding - Registering the company - Finding an angel - Cutting the pie - Seeking venture capital - Going public

Angel Investors

- Individuals who invest their personal capital directly in start-ups - the prototypical business angel is about 50 years old, has high income and wealth, is well educated, has succeeded as an entrepreneur, and is interested in the start-up process - Valuable due to their willingness to make relatively small investments - Generally invest between $10,000 and $500,000 in a single company - Looking for companies that have the potential to grow between 30% to 40% per year - However, angels may be difficult to find due to informality - Angels provide mentoring, monitoring, and guidance - Provide connections and introductions to their widespread network - Teach entrepreneurs valuable business strategies

Equity Financing

- Money contributed to the venture in return for part ownership - Usually in the form of stock

Venture Capitalists

- Money that is invested by venture capital firms in start-ups and small ventures with exceptional growth potential - VC firms are limited partnerships of money managers who raise money in "funds" to invest in start-ups and growing ventures - The funds are raised from wealthy individuals, pension plans, university endowments, foreign investors, and similar sources - Investors who invest in VC are called limited partners. The VC's are called general partners Venture Capital firms fund very few entrepreneurial ventures in comparison to business angels - Invest money in start-ups in "stages" meaning that not all the money that is invested is disbursed at the same time - Typically portfolios of ventures in one or a few industries - Often provide entrepreneurs with valuable non-financial resources as well

Sole Proprietorship

- Most Common - Easiest to Create - Greatest Level of Liability - A business owned by a single individual who is responsible for all debts and claims against the business (same as general partnership) - Can't sell ownership

Legal Form

- Only certain legal forms allow for the entrepreneur to sell equity

If < $20K

- Personal $$ - Home Equity Loan - Credit Card - Friends/Family - Bootstrapping - SBA

Diversify

- Provide capital to ventures of differing risk profiles for the purpose of reducing overall risk - Build portfolios

I need $ the quarter

- SBA - Friends/Family Investment - Strategic Partners - Bootstrapping

Gain on Investment

- The percentage amount that the payout of an investment differs from original cost - Calculated as (payout - investment + dividends)/investment

The Investor's View

- To get money, you must show resource providers that your venture has the potential to provide future financial rewards - Growth potential is a primary concern for equity investors

If > $1M

- VC - Private Placement

I've got Months!

- Venture Capital - Strategic Partners - SBA - IPO - Private Placement

Reasons that ventures go public:

1) Raise equity capital to fund current and future operations 2) Raise a venture's public profile, making it easier to attract high-quality customers, business partners, and employees 3) Liquidity event that provides a way for investors to recoup their initial investments 4) Creates a form of currency that can be used to grow the venture via acquisitions