ED31&32 ENP 2763

Entrepreneurship Development

Financing Options II

Dr. Sudipta Sen Gupta

 Dispelling Venture Capital Myths
• Myth 1: Venture capital firms want to own control of your
company and tell you how to run the business.
• Myth 2: Venture capitalists are satisfied with a
reasonable return on investment.
• Myth 3: Venture capitalists are quick to invest.
• Myth 4: Venture capitalists are interested in backing new
ideas or high-technology inventions—
management is a secondary consideration.
• Myth 5: Venture capitalists need only basic summary
information before they make an investment.

© 2012 Cengage Learning. All rights reserved.

 Venture Capitalists and Business Plans
Proposal
Size

Financial Investment
Projections Recovery

Competitive Company
Advantage Management

© 2012 Cengage Learning. All rights reserved.

 Factors in Successful Funding of Ventures
Characteristics of
the Entrepreneurs

Characteristics Success in Seeking

Sources of
of the Funding
Advice
Request (Demand Side)

Characteristics of
the Enterprise

© 2012 Cengage Learning. All rights reserved.

 Figure
8.2 Venture Capitalist System of Evaluating Product/Service and
Management

Level 4
Fully developed product/service
Established market
4/1 4/2 4/3 4/4
Satisfied users
Level 3
Status of Product/Service

Fully developed product/service

Few users as of yet 3/1 3/2 3/3 3/4
Market assumed

Level 2
Riskiest Operable pilot or prototype
Not yet developed for production 2/1 2/2 2/3 2/4
Market assumed

Level 1
Product/service idea
Not yet operable 1/1 1/2 1/3 1/4
Market assumed

Level 1 Level 2 Level 3 Level 4

Individual founder/ Two founders Partial management Fully staffed,
entrepreneur Other personnel not team—members experienced
yet identified identified to join management team
company when funding
received

Riskiest
Status of Management

Source: Stanley Rich and David Gumpert, Business Plans That Win $$$ (New York: Harper & Row, 1985), 169.
Reprinted by permission of Sterling Lord Literistic, Inc. Copyright © 1985 by Stanley Rich and David Gumpert.
© 2012 Cengage Learning. All rights reserved.
 Table
8.3 Returns on Investment Typically Sought by Venture
Capitalists

Stage Of Expected Annual Return on Expected Increase

Business Investment on Initial Investment

Start-up business 60% + 10–15 × investment

(idea stage)

First-stage financing 40%–60% 6–12 × investment

(new business)

Second-stage financing 30%–50% 4–8 × investment

(development stage)

Third-stage financing 25%–40% 3–6 × investment

(expansion stage)

Turnaround situation 50% + 8–15 × investment

Source: W. Keith Schilit, “How to Obtain Venture Capital,” Business

Horizons (May/June 1987): 78. Copyright © 1987 by the Foundation for the
School of Business at Indiana University. Reprinted by permission.
© 2012 Cengage Learning. All rights reserved.
 Table
8.4 Factors in Venture Capitalists’ Evaluation Process

Attribute Level Definition

Timing of entry Pioneer Enters a new industry first
Late Enters an industry late in the industry’s stage of development
follower
Key success factor High Requirements necessary for success will not change radically during
stability industry development
Low Requirements necessary for success will change radically during industry
development
Educational High Considerable resources and skills available to overcome market
capability ignorance through education
Low Few resources or skills available to overcome market ignorance through
education
Lead time Long An extended period of monopoly for the first entrant prior to competitors
entering the industry
Short A minimal period of monopoly for the first entrant prior to competitors
entering this industry

Source: Dean A. Shepherd, “Venture Capitalists’ Introspection: A Comparison of ‘In Use’ and ‘Espoused’ Decision Policies,” Journal of Small Business Management
(April 1999): 76–87; and “Venture Capitalists’ Assessment of New Venture Survival,” Management Science (May 1999): 621–632. Reprinted by permission. Copyright
1999, the Institute for Operation Research and the Management Sciences (INFORMS), 7240 Parkway Drive, Suite 310, Hanover MD 21076 USA.
© 2012 Cengage Learning. All rights reserved.
 Table
8.4 Factors in Venture Capitalists’ Evaluation Process

Attribute Level Definition

Timing of entry Pioneer Enters a new industry first
Late Enters an industry late in the industry’s stage of development
follower
Key success factor High Requirements necessary for success will not change radically during
stability industry development
Low Requirements necessary for success will change radically during industry
development
Educational High Considerable resources and skills available to overcome market
capability ignorance through education
Low Few resources or skills available to overcome market ignorance through
education
Lead time Long An extended period of monopoly for the first entrant prior to competitors
entering the industry
Short A minimal period of monopoly for the first entrant prior to competitors
entering this industry

Source: Dean A. Shepherd, “Venture Capitalists’ Introspection: A Comparison of ‘In Use’ and ‘Espoused’ Decision Policies,” Journal of Small Business Management
(April 1999): 76–87; and “Venture Capitalists’ Assessment of New Venture Survival,” Management Science (May 1999): 621–632. Reprinted by permission. Copyright
1999, the Institute for Operation Research and the Management Sciences (INFORMS), 7240 Parkway Drive, Suite 310, Hanover MD 21076 USA.
© 2012 Cengage Learning. All rights reserved.
 Table
8.4 Factors in Venture Capitalists’ Evaluation Process (cont’d)

Attribute Level Definition

Competitive rivalry High Intense competition among industry members during industry
development
Low Little competition among industry members during industry
development
Entry wedge mimicry High Considerable imitation of the mechanisms used by other firms to enter
this, or any other, industry—for example, a franchisee
Low Minimal imitation of the mechanisms used by other firms to enter this,
or any other, industry—for example, introducing a new product
Scope Broad A firm that spreads its resources across a wide spectrum of the
market—for example, many segments of the market
Narrow A firm that concentrates on intensively exploiting a small segment of
the market—for example, targeting a niche
Industry-related High Venturer has considerable experience and knowledge with the
competence industry being entered or a related industry
Low Venturer has minimal experience and knowledge with the industry
being entered or related industry

Source: Dean A. Shepherd, “Venture Capitalists’ Introspection: A Comparison of ‘In Use’ and ‘Espoused’ Decision Policies,” Journal of Small Business Management
(April 1999): 76–87; and “Venture Capitalists’ Assessment of New Venture Survival,” Management Science (May 1999): 621–632. Reprinted by permission. Copyright
1999, the Institute for Operation Research and the Management Sciences (INFORMS), 7240 Parkway Drive, Suite 310, Hanover MD 21076 USA.
© 2012 Cengage Learning. All rights reserved.
 Criteria for Evaluating
New-Venture Proposals

• Major Categories of Venture Capitalist Screening

Criteria:
➢ Entrepreneur’s personality
➢ Entrepreneur’s experience
➢ Product or service characteristics
➢ Market characteristics
➢ Financial considerations
➢ Nature of the venture team

© 2012 Cengage Learning. All rights reserved.

 Table
8.5 Ten Criteria Most Frequently Rated Essential in New-Venture

Criterion Percentage
Capable of sustained intense effort 64

Thoroughly familiar with market 62

At least ten times return in five to ten years 50

Demonstrated leadership in past 50

Evaluates and reacts to risk well 48

Investment can be made liquid 44

Significant market growth 43

Track record relevant to venture 37

Articulates venture well 31

Proprietary protection 29

Source: Reprinted by permission of the publisher from “Criteria Used by Venture Capitalists to Evaluate New Venture Proposals,” by Ian C. MacMillan,
Robin Siegel, and P. N. Subba Narasimha, Journal of Business Venturing (winter 1985): 123. Copyright © 1985 by Elsevier Science Publishing Co., Inc.
© 2012 Cengage Learning. All rights reserved.
 Table
8.6 Venture Capitalists’ Screening Criteria

Venture Capital Firm Requirements Financial Information on the Proposed Business

• Must fit within lending guidelines of venture firm for • Financial projections should be realistic
stage and size of investment Proposal Characteristics
• Proposed business must be within geographic area • Must have full information
of interest
• Should be a reasonable length, be easy to scan,
• Prefer proposals recommended by someone known have an executive summary, and be professionally
to venture capitalist presented
• Proposed industry must be kind of industry invested • Proposal must contain a balanced presentation
in by venture firm
• Use graphics and large print to emphasize key
Nature of the Proposed Business points
• Projected growth should be relatively large within Entrepreneur/Team Characteristics
five years of investment
• Must have relevant experience
Economic Environment of Proposed Industry
• Should have a balanced management team in place
• Industry must be capable of long-term growth and
• Management must be willing to work with venture
profitability
partners
• Economic environment should be favorable to a
• Entrepreneur who has successfully started previous
new entrant
business given special consideration
Proposed Business Strategy
• Selection of distribution channel(s) must be feasible
• Product must demonstrate defendable competitive
position

Source: John Hall and Charles W. Hofer, “Venture Capitalists’ Decision Criteria
in New Venture Evaluation,” Journal of Business Venturing (January 1993): 37.
© 2012 Cengage Learning. All rights reserved.
 Venture Capitalist Evaluation Process
• Stage 1: Initial Screening
➢ This is a quick review of the basic venture to see if it meets the
venture capitalist’s particular interests.
• Stage 2: Evaluation of the Business Plan
➢ This is where a detailed reading of the plan is done in order to
evaluate the factors mentioned earlier.
• Stage 3: Oral Presentation
➢ The entrepreneur verbally presents the plan to the venture
capitalist.
• Stage 4: Final Evaluation
➢ After analyzing the plan and visiting with suppliers, customers,
consultants, and others, the venture capitalist makes a final
decision.

© 2012 Cengage Learning. All rights reserved.

 Table
8.7 Essential Elements for a Successful Presentation to a Venture
Capitalist

TEAM MUST: MARKET MUST:

• Be able to adapt • Have current customers and the potential for many more
• Know the competition • Grow rapidly (25% to 45% per year)
• Be able to manage rapid growth • Have a potential market size in excess of $250 million
• Be able to manage an industry leader • Show where and how you are competing in the
• Have relevant background and industry experience marketplace
• Show financial commitment to firm, not just sweat equity • Have potential to become a market leader
• Be strong with a proven track record in the industry • Outline any barriers to entry
unless the company is a start-up or seed investment

PRODUCT MUST: BUSINESS PLAN MUST:

• Be real and work • Tell the full story, not just one chapter
• Be unique • Promote a company, not just a product
• Be proprietary • Be compelling
• Meet a well-defined need in the marketplace • Show the potential for rapid growth and knowledge of
• Demonstrate potential for product expansion, to avoid your industry, especially competition and market vision
being a one-product company • Include milestones for measuring performance
• Emphasize usability • Show how you plan to beat or exceed those milestones
• Solve a problem or improve a process significantly • Address all of the key areas
• Be for mass production with potential for cost reduction • Detail projections and assumptions; be realistic
• Serve as a sales document
• Include a strong and well-written executive summary
• Show excitement and color
• Show superior rate of return (a minimum of 30% to 40%
per year) with a clear exit strategy

Source: Andrew J. Sherman, Raising Capital, 2nd ed. AMACOM Books, 2005; p.175.
© 2012 Cengage Learning. All rights reserved.
 Informal Risk Capital
• Business Angel Financing
➢ Wealthy individuals looking for investment
opportunities.
• They are referred to as “business angels” or informal
risk capitalists.
• Types of Angel Investors
➢ Corporate angels
➢ Entrepreneurial angels
➢ Enthusiast angels
➢ Micromanagement angels
➢ Professional angels

© 2012 Cengage Learning. All rights reserved.

 Table
8.8 Main Differences Between Business Angels and Venture
Capitalists

Main Differences Business Angels Venture Capitalists

Personal Entrepreneurs Investors

Firms funded Small, early-stage Large, mature

Due diligence done Minimal Extensive

Location of investment Of concern Not important

Contract used Simple Comprehensive

Monitoring after investment Active, hands-on Strategic

Exiting the firm Of lesser concern Highly important

Rate of return Of lesser concern Highly important

Source: Mark Van Osnabrugge and Robert J. Robinson, Angel Investing (San Francisco:
Jossey-Bass, 2000), 111. This material is used by permission of John Wiley & Sons, Inc.
© 2012 Cengage Learning. All rights reserved.
 Table
8.9 “Angel Stats”

Typical deal size $250,000

Typical recipient Start-up firms
Cash-out time frame 5 to 7 years
Expected return 35 to 50% a year
Ownership stake Less than 50%

Source: William E. Wetzel, University of New Hampshire’s Center for Venture Research, and the Indiana Venture Center, 2008.
© 2012 Cengage Learning. All rights reserved.
 Figure
8.3 The Pros and Cons of Business Angel Investments

Source: Mark Van Osnabrugge and Robert J. Robinson, Angel Investing (San Francisco:
Jossey-Bass, 2000), 64. This material is used by permission of John Wiley & Sons, Inc.
© 2012 Cengage Learning. All rights reserved.
Thank You