1	Venture Capital Entrepreneurship Dr. Jeff Shay
2	Venture Capital Venture capital became a very popular topic during the 1990’s After all venture capital helped fuel much of the growth in the United States during that decade However, most people really don’t understand what venture capital is and what types of businesses are most likely to attract it In this module we’ll try to provide you with some insights into venture capital
3	Venture Capital in our Region An interesting issue surfaced during recent elections Some individuals in the political debates were claiming that they wanted to bring venture capital to the region The reality is that most of the businesses in this region do not have the characteristics necessary to attract venture capital As such, we believe it is critical for entrepreneurs to understand this source of funding in greater detail
4	Characteristics of Classic Venture Capital Requires early-stage equity or equity-linked financing Involves high risk Lack of liquidity or marketability Returns are primarily from capital gains that come through selling stock later Provided by patient investors equipped to offer value-added advice
5	Classic venture investors These individuals are in the business of financing and building businesses that will be worth five to ten or more times the capital invested in five to ten years Seek long-term capital gains Invest financial and managerial know-how as well as capital
6	Why venture capital is expensive Extreme uncertainty surrounding investment outcomes Absence of investment liquidity As a result, there is a limited number of attractive investment opportunities
7	When not to look for venture capital Before you are convinced that the venture will generate significant wealth for you and your investors If your goal is self-employment If your business venture is not in a high growth potential market
8	Practical goals to attract VC Minimum in five years: $10 million in revenues 20 percent growth per year 15 percent pretax profit No problem if in five years: $50 million in revenues 30 – 50 percent growth per year 20+ percent pretax profit
9	VC’s see three types of ventures Life-style Under $10 million in revenues in five years Account for 90 percent of all ventures Middle-market $10 – 50 million in revenues in five years May need venture financing High-potential $50+ million in five years Require several rounds of 6 or 7 figure financing Publicly traded or acquired within five years
10	Visible sources of venture capital Venture capital funds 500 funds $40 billion managed $4 billion invested annually in new ventures 1,000 companies bankrolled Roughly 66% of this money is for ventures already in the portfolio Odds are against getting this type of financing
11	Invisible sources of financing There are some “invisible” sources of financing The most common group is “Angel” investors Characteristics of this group are: 2 million individuals in this group, each worth more than $1 million Most are self-made millionaires Typical deal in early stage is $100-500k raised from six or eight investors Usually trusted friends and business associates Keep low profiles, hard to find
12	Finding prospective angels The appropriate angel investor for your business will most likely be: Located close to you company’s headquarters Familiar with your markets or technology Active in charitable and civic affairs Risk takers in avocations and profession Individuals who rely on gatekeepers (lawyers, accountants, VC’s, bankers, etc.) who let them know about opportunities
13	Angel Characteristics Demographic patterns and relationships Well-educated, many hold graduate degrees Finance businesses within a day’s drive Expect to play an active role in venture Clustered with 9-12 other investors Investment record Range of investment: $10,000 - $500,000 Average investment: $175,000 One to two deals per year
14	Angel Characteristics Venture preference Start-ups or ventures less than 5 years old Most interested in: Manufacturing: industrial or consumer Energy/natural resources Services Retail/wholesale trade Risk/reward expectations Start-up: 10 times Under one year old: 6 times 1-5 years old: 5 times Over 5 years old: 3 times
15	Angel Characteristics Reasons for rejecting proposals: Risk/return ratio inadequate Inadequate management team Not interested in business area Unable to agree on price Principals not sufficiently committed Unfamiliar with business area
16	Obtaining financing Stage 1 1.75 months between decision to obtain funds and first meeting with Angel or VC partner Persistence – may take several calls Stage 2 2.5 months between first meeting and receiving funds from an Angel 4.5 months between first meeting and receiving funds from venture capitalist It should be clear that turning to these sources for investment takes a significant amount of time…therefore you need to plan ahead
17	Reasons why business plan is critical Discipline of process forces you to articulate your vision and how and when you expect to achieve it. Raises the odds of gaining the attention of serious investors. “The Executive Summary is the most critical section in a business plan. It is your bait.”
18	What to look for in advisors Attorneys – experienced in negotiating, pricing, and structuring venture financing Bankers – commercial loan officer who has been through the financing of emerging companies more than once is key Accountants – respected CPA firm that specializes in the design of accounting and management information systems for emerging companies. Other entrepreneurs
19	Factors influencing choice of sources Investors’ exit expectations Availability of future financing Quality of management assistance Investors’ experience in dealing with illiquid, high-risk investments GOAL: Complementary resources and Shared Goals
20	Investigate investors’ past Ask founders from other ventures: Are your investors trustworthy and predictable? Do you consider them fair and reasonable? Were they difficult to deal with? How long did it take to get your money? What are they like to work with on a consistent basis? How active are they in your business? Do you consider them meddlesome or helpful? What have they done for you besides invest money? How have they been helpful? Do they act like your partners or adversaries? How did your investors behave during periods of difficulty?
21	Early-stage financing There are several stages of financing, let’s explore some of them: Seed financing Small amount to prove concept Market research, product development Startup financing Product development and initial marketing complete Business plan and management team in place First-stage financing Expended initial capital Funds needed to go full-scale in manufacturing and sales
22	Expansion financing Second-stage financing Provides working capital for expansion of company that is producing and shipping and has growing accounts receivable and inventories Third-stage financing Major expansion for firm that has increasing sales and is at breakeven or profitable Funds used for marketing, working capital, plant expansion, or development of improved product Bridge financing Between stages, plans to go public in next 6 months
23	Expected returns from financing Seed 80% Startup 60% First-stage 50% Second-stage 40% Third-stage 30% Bridge 25% Thus, going too early for external sources can cost a new venture significantly more!
24	Nonfinancial payoffs for VC’s Generate jobs in areas of high unemployment Develop socially useful technology (e.g., medical) Assist in economic revival of urban areas Support female or minority entrepreneurs Personal satisfaction from assisting entrepreneurs who build successful ventures
25	Pricing the deal The division of ownership determined by expected future value and share required to compensate investors at competitive rates The longer the track record of a new venture, lower the risk to investor, lower the cost of capital, lower the share of equity required to purchase any given amount of capital The more a venture is expected to be worth in the future, the lower the share of equity required to purchase any given amount of capital The shorter the waiting period to harvest, the lower the share of equity required to purchase any given amount of capital
26	Pricing the Deal Based on our experience, we highly recommend that you hire an experienced financial consultant when pricing the deal All too many new ventures give up too much of the business in order to get it started The results can be a loss of control over the business or reduced opportunities for attracting additional capital if the business takes off
27	Common reasons for rejection Lack of confidence in management Unsatisfactory risk/reward ratios Absence of well-defined business plan Investors’ unfamiliarity with products, processes, or markets Angels – unattractiveness to investor
28	Guidelines for dealing with VC’s Carefully select a VC who is appropriate for the deal Don’t speak with multiple VC’s Approach VC through intermediary, but entrepreneur should run meetings Be careful about what is projected or promised Disclose any significant problems or negative situations in the initial meeting Reach a flexible, reasonable agreement on timeline Do not sell the deal based on commitments from other VC’s Be careful about glib remarks (i.e., there is no competition) Do not ask for inordinate salaries, benefits, etc. Eliminate the use of funds to handle past problems (i.e., back salaries for managers)
29	Next Module As we indicated early on in the present module, venture capital is not appropriate for many businesses In the next module we’ll discuss the various forms of debt and other means of financing your new business