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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 markets


Markets providing debt and equity to
non-secure financing situations
Informal risk capital markets
Area of risk-capital markets consisting
mainly of individuals.
Business Angels
are private investors who invest in unquoted
small and medium sized businesses

Venture capital market


One of the risk capital market consisting
of formal firms
Venture capital is a professionally managed
pool 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. for
1. Financing of product development
2. Financing of market penetration
3. Financing of investments
4. Working capital financing to secure
operative continuity
5. 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
companys 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 for
years, a situation that is typical in high-tech
branches.

Operative financing
To bridge the deficit in operative financing, the
company has the following choice of available
measures:
1. To ensure that the liquidity planning has been
appropriate
2. To make the clients pay their invoices on time
by offering, for example, discounts for rapid
payments
3. To intensify the collection of sales receivables
4. To delay the payments to suppliers within their
terms of payment
5. To maximize the sales margins to cut indirect
costs

External financing
Should these measures not be sufficient, the
company 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 Venture


Capital 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 Venture


Capital financing
The central issues considered by the venture
capital investor at this stage are:
Is the company able to conduct profitable and
growing 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 Venture


Capital financing
Besides the company's business plan, the venture
capital investor will assess the compatibility of the
investment request against its own investment
Strategy
The decisive investment strategy criteria may be
company size, development stage, branch or
geographical 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 Venture


Capital financing
Should the investor decide that the
investment request meets his criteria, the
following step is a meeting arranged with the
company management
Experience has shown that about half of the
remaining companies are discarded at the
negotiation stage

The Process of acquiring Venture


Capital 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, weighted
investment 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 the
business at the actual investment stage and the
eventual additional investment needs.

The Process of acquiring venture


capital 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 venture


capital 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. The
parties finally make a shareholder agreement to
establish practical operating rules.
VCs exit could be anything between liquidation and
IPO

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 beyond
proof 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 within
12 to 18 months of an IPO.

VCs 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 VCs expertise and network the
portfolio companies could gain access to:
a) follow-on capital through venture capital ties
b) knowledge of partnership opportunities in
multiple markets
c) in-depth operational and management
experience
d) access to high-quality management teams
e) ties to the investment banking community

Stages of VC financing
Seed 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 one


principal working full time. The search is on
for the other key management team
members and work is being done on testing
and finalizing the prototype for production

Stages of VC financing
First -stage financing

The venture has finally launched and achieved


initial traction. Sales are trending upwards. .A
management 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 financing
Second -stage financing

Sales at this point are starting to snowball. The


company is also rapidly accumulating accounts
receivable 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 stage
funding enter the picture at this point

Stages of VC financing

Mezzanine 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 financing

Initial Public Offering (IPO)


The company finally achieves liquidity by being
allowed to have its stock bought and sold by the
public. Founders sell off stock and often go back
to square one with another start up.
Please note that some companies have more
financing 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.