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Module 4 The Search for Capital Module 4 Topics 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) Perspective on Raising Capital http://edcorner.stanford.edu/authorMaterialIn fo.html?mid=1374 (3 minutes) General Sources of Capital Equity Personal Sources Profits Angel Capital Venture Capital Debt Financial Institutions Credit Cards Other (Home Equity Loan, Life Insurance) Other Local Community Grants and Loans Government Programs Other (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 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 Angels “Gatekeepers” (Initial introduction) Venture Capital Clubs Regional-Based Groups of Investors Matching Networks Venture Capital: Background Professionally Managed Investment Funds $29.4 billion into 3,800 U.S. start-ups 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 > $441 billion > 57,000 companies ½ of IPOs have VC investment Europe (2006) 71 billion invested in 2006 8.3% Seed 21% Expansion 70% Buyout financing US (2007) $1.4 billion in China $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 technology 55 new venture capital funds Identifying a Venture Capitalist Needs Of Firm Characteristics of 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% 18% 15% 9% manufacturing services IT retail Going 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?