Chapter 13 Flashcards
(20 cards)
What is Equity Financing
As the company begins to grow/show
potential, entrepreneurs begin to look at
equity financing: the sale of shares of stock
in exchange for cash.
- Way to get capital from investors to start/grow a business
Stages of Equity Financing
- Seed-stage financing
- Startup financing
- Early-stage financing
- Second-stage or later-stage financing –> as the business grows and more revenue
- Going public through Initial Public Offering (IPO) –> seek investment through the third or mezzanine stage
- Bridge financing –> to cover the expenses associated with the IPO
Seed-stage financing
Small or modest amounts of
capital are provided to entrepreneurs to prove a concept.
Startup financing
The money provided to entrepreneurs to enable them to implement their idea by funding product research and development.
Early-stage financing
Larger amounts of funds for companies that have a team and a product or service tested or piloted but show little or no revenue yet.
What does the 3 Fs typically do?
– Invest cash in exchange for equity.
– Provide a loan.
– Provide a loan that can later be converted to equity (convertible debt).
Angel investors
- Anyone who uses personal capital to invest in an entrepreneurial venture. (Not friends or family)
- Typically invest 25k to 100k of personal funds
- Often self-made entrepreneurs themselves, they can add value by providing advice, skills, and expertise and lucrative contacts.
- Many angels go to pool funds to invest and work together, they meet regularly to hear pitches and see if they’re interested to hear more
Venture Capitalist (VC)
A professional investor (or firm that
manages pooled funds from institutions, high-net-worth individuals, and corporations to invest in high-growth companies) who invests in emerging companies because of long-term growth potential.
In other words:
Former or current entrepreneur that are mostly professional money managers.
Earns money through ownership of equity in different companies.
- Typically invest more than 500k; average 7 million.
- VCs take more equity, more control, may even take over the running of the company
- They look mainly for a great team in the company they want to invest in
The Basics of Valuation
Before entrepreneurs seek equity investment,
they must know the value of their company
so they will know how much equity to give up.
How Can Entrepreneurs Value Their Companies?
- Check similar companies in industry to see
how they are being valued. - True valuation falls somewhere between
owners and investors calculations
How Do Investors Value Startups?
How Do Investors Value Startups?
* Knowing the criteria that matter to them, you can better position your company to attract investors.
– Experience and team’s past successes.
– How many people use your product/service.
– Having a distribution channel already set up.
– Whether the industry is popular with investors at the moment.
What’s a Unicorn?
Any tech startup company that has received a $1 billion valuation
Rare, but becoming more common
Convertible Debt
- Short-term loan turned into equity.
– Debt converts to stock shares.
Benefits & Advantages of Convertible Debt
– Valuation becomes easier after the first round of financing when there is more
data and information to work with.
– If your company succeeds, your investors may be entitled to a discount off the
share price or bonus when converting the debt into equity, which can be an
incentive for investors to commit.
Cautions & Disadvantages of Convertible Debt
– Early lenders may not want to take the risk of having their money tied up until the
debt is converted into equity.
– They may be wary of losing money if the conversion event doesn’t happen or if
the company ends up filing for bankruptcy.
– A clause can be added to address this possibility; initial investment could remain
as debt (which the entrepreneur must repay).
Types of Angel Investors
- Entrepreneurial Angels
(Have already successfully started and operated their own businesses) - Corporate Angels
(Usually former business executives, often from big multinationals, looking to use their savings or current income to invest) - Professional Angels
(Doctors, lawyers, accountants… who use their savings and income to invest) - Enthusiast Angels
(Wealthy (semi)retired entrepreneurs who often invest their personal capital in startups as a hobby)
Bank Loan
- Debt financing: Borrowing money to start a
business that is expected to be paid back with
interest at a designated point in the future. - Banks typically don’t give money to startups
because they are too risky. - If they do, banks expect entrepreneurs to have: capital, collateral, capacity, credit rating.
What is Due Diligence
- A rigorous process carried out to evaluate an investment opportunity prior to a deal being finalized.
- Angel investors/groups do not carry out as much due diligence as VCs due to time constraints, resource constraints, and lack of information.
The Due Diligence Process for VCs
- Investing in early-stage companies is risky
- Entrepreneurs, teams, and the company will
undergo a vigorous appraisal, which generally
lasts several weeks or even months - Backgrounds of the entrepreneurial team will be verified; references checked; and corporate compliance, employment and labor, intellectual property rights, and legal issues reviewed.
How is money repaid to VCs?
VCs expect a return when the firm exits the investment within 5–10 years.
Money is repaid through 1 of 3 strategies:
- Initial public offering (IPO): A company’s first opportunity to sell stocks on the stock market to be purchased by members of the general public.
2.Acquisitions: smaller companies are bought by bigger companies.
(increase their profitability and, in some cases, swallows competition)
- Buyback: gives the entrepreneur an opportunity to buy back a venture capital firm’s stock at cost + premium (less common).
