Sources of Equity Financing: © 2009 Pearson Education, Inc. Publishing As Prentice Hall 1 Chapter 14 Equity Financing

Sources of
Equity Financing
Chapter 14 Equity Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 1
The “Secrets” to
Successful Financing
1. Choosing the right sources of capital is a
decision that will influence a company for a
lifetime
2. The money is out there; the key is knowing
where to look
3. Creativity counts. Entrepreneurs have to be
as creative in their searches for capital as
they are in developing their business ideas
The “Secrets” to
Successful Financing
4. The World Wide Web puts at entrepreneur’s
fingertips vast resources of information that
can lead to financing
5. Be thoroughly prepared before approaching
lenders and investors
6. Looking for “smart” money is more
important than looking for “easy” money
Three Types of Capital
 Fixed - used to purchase the the

permanent or fixed assets of the business
(e.g. buildings, land, equipment, etc.)
 Working - used to support the small
company's normal short-term operations
(e.g. buy inventory, pay bills, wages, or
salaries, etc.)
 Growth - used to help the small business
expand or change its primary direction
Start-Up Early Expansion Profitability
Business is in Business is developing Business is selling Company has

conceptual phase one or more products products or services established a
and exists only or services but is not and is generating customer base and is
Characteristics on paper. yet generating sales. revenue and is profitable.
beginning to establish
a customer base.
Possible Sources of Funding Likelihood of using each source: H = Highly likely; P = Possible; U = Unlikely
Personal savings H H H H
Retained earnings U U U H
Friends and relatives H H P P
Angel investors H H P U
Partners H H P U
Corporate venture capital P H H H
Venture capital U P H H
Initial public offering (IPO) U U P H
Regulation S-B Offering U U P H
Small Company Offering U P P H
Registration (SCOR)
Private placements U P P H
Intrastate offerings (Rule 147) U P P H
Regulation A U P P H
Equity Capital
 Represents the personal investment of
the owner(s) in the business
 Is called risk capital because investors
assume the risk of losing their money if
the business fails
 Does not have to be repaid with interest
like a loan does
 Means that an entrepreneur must give up
some ownership in the company to
outside investors
Sources of Equity
Financing
 Personal savings
 Friends and family members
 Angels
 Partners
 Corporations
 Venture capital companies
 Public stock sale
Personal Savings
 The first place an entrepreneur should
look for money
 The most common source of equity
capital for starting a business
 GEM study:
 Average cost to start a business in U.S. is
$70,200
 Typical entrepreneur provides 67.9% of
the initial capital requirement
Friends and Family
Members
 After emptying her own pockets, an
entrepreneur should turn to those most likely
to invest in the business - friends and family
members
 GEM study:
 Across the globe, the average amount family and
friends invest in start-up businesses is $3,000
 In U.S., average amount is $27,715 for a total of
$100 billion per year
 Careful!!! Inherent dangers lurk in
family/friendly business deals, especially
those that flop
Friends and Family
Members
 Guidelines for family and friendship
financing deals:
 Consider the impact of the investment on
everyone involved
 Keep the arrangement “strictly business”
 Educate “naïve” investors
 Settle the details up front
 Never accept more than the investor can
afford to lose
Friends and Family
Members
 Guidelines for family and friendship
financing deals:
 Create a written contract
 Treat the money as “bridge financing”
 Develop a payment schedule that suits
both parties
 Have an exit plan
 Keep everyone informed
Angels
 Private investors who invest in

emerging business start-ups in
exchange for equity stakes in the
company
 Fastest growing segment of the small
business capital market
 Center for Venture Research study:
234,000 angels invest $25.6 billion a
year in 51,000 small companies
Angel Financing
30 60,000
25 50,000
Number of Small Companies

Billions of $ Invested
20 40,000
Amount Invested (in billions)

15 30,000
Number of Firms
10 20,000
5 10,000
0 -
2002 2003 2004 2005 2006
Year
Source: Center for Venture Financing, Whittemore School of Business, University of New Hampshire, www.unh.edu/cvr.
Angels
 Ideal source of financing for

companies that have outgrown the
capacity of friends and family
members but are still too small to
attract the interest of venture capital
companies
Angels
 Most likely to finance deals in the

$10,000 to $2 million range
 Key: finding them!
 Angels almost always invest their
money locally and can be found
through networking
 Another avenue: Angel capital
networks on the World Wide Web
Angels
 Typical angel accepts 12% of the

proposals presented and has
invested an average of $80,000 in
3.5 businesses
 An excellent source of “patient
money” for investors needing
relatively small amounts of capital –
often less than $500,000
Corporate Venture Capital
 About 300 large corporations across
the globe invest in start-up companies
 19% of all venture capital investments
come from corporations
 Average CVC investment = $2.97 million
 Capital infusions are just one benefit;
corporate partners may share
marketing and technical expertise
Corporate Venture Capital
$18,000 2,500
$16,000
Number of Deals with

Millions of $ Invested
2,000
CVC Participation
$14,000
Corporate Venture
$12,000 Capital Invested (in $
1,500
$10,000 millions)
$8,000 Number of Deals with
1,000
$6,000 Corporate Venture
Capital Participation
$4,000 500
$2,000
$- -
1995 2000 2005
Year
Source: PriceWaterhouse Coopers Moneytree Report, 2007.

Venture Capital Companies
 More than 1,300 venture capital firms

operate across the U.S.
 Most venture capitalists seek
investments in the $3,000,000 to
$10,00,000 range in companies with
high-growth and high-profit potential
 Average VC investment = $7.4 million
 Business plans are subjected to an

extremely rigorous review - less than
1% accepted
 GEM study: Only 1 in 10,000
entrepreneurs worldwide receives VS
funding at start-up
Venture Capital Financing
$35.0 2,500
Amount Financed (in
$30.0
2,000
Number of Deals
$25.0
Billions of $)
$20.0 1,500
$15.0 1,000
$10.0
500
$5.0
$- -
Q1
Q3
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Billions of $ Number of Deals
Source: PriceWaterhouse Coopers Moneytree Report, http://www.pwc.moneytree.com

 Usually take an active role in managing the

companies in which they invest
 Focus their investments in specific
industries with which they are familiar
 Invest in a company across several stages
Most common stages:
 Expansion
 Later-stage
 Early-stage
Venture Capital Funding by Stage
60%
48% to 50 %
50%
Percent of Funding
40%
28% to 30 %
30%
20% 18% to 20 %
10%
1% to 2 %
0%
Start-up/Seed Early-stage Expansion Later-stage
Stage
Start-up/Seed – This is the initial stage in which Expansion stage – These companies’ products or services
companies are just beginning to develop their ideas into are commercially available and are producing strong
products or services. Typically, these businesses have revenue growth. Businesses at this stage may not be
been in existence less than 18 months and are not yet fully generating a profit yet, however.
operational.
Later stage – These companies’ products or services are
Early stage – These companies are refining their initial widely available and are producing ongoing revenue and,
products or services in pilot tests or in the market. Even in most cases, positive cash flow. Businesses at this stage
though the product or service is available commercially, it are more likely to be generating a profit. Sometimes these
typically generates little or no revenue. These companies businesses are spin-offs of already established successful
have been in business less than three years. private companies.
What Do Venture Capital
Companies Look For?
 Competent management
 Competitive edge
 Growth industry
 Viable exit strategy
 “Intangibles”
Going Public
 Initial public offering (IPO) - when a

company raises capital by selling shares
of its stock to the public for the first
time
 Since 2000, average number of
companies making IPOs is 211
 Few companies with annual sales below
$25 million make IPOs
Initial Public Offerings
$100.0 600
Number of IPOs
$80.0 500
Billions of $
400
Raised
$60.0 $ Raised (Billions)

300
$40.0 Number
200
$20.0 100
$0.0 0
9 85 9 90 9 95 0 00 0 01 0 02 0 03 0 04 0 05 0 06 0 07
1 1 1 2 2 2 2 2 2 2 2
Year
Source: PriceWaterhouseCoopers, US IPO Watch 2006 Analysis and Trends, p.2.

Advantages of "Going
Public"
 Ability to raise large amounts of
capital
 Improved corporate image
 Improved access to future financing
 Attracting and retaining key
employees
 Using stock for acquisitions
 Listing on a stock exchange
Disadvantages of "Going
Public"
 Dilution of founder's
ownership
 Loss of control
 Loss of privacy
 Regulatory requirements and
reporting to the SEC
 Filing expenses
Disadvantages of "Going
Public"
 Accountability to shareholders
 Pressure for short-term
performance
 Loss of focus
 Timing
The Registration
Process
 Choose the underwriter
 Negotiate a letter of intent
Letter of Intent
 Two types of underwriting agreements:
 Firm commitment
 Best efforts
 Minimum number of shares offered is usually
400,000 to 500,000
 Total offering is usually at least $8 to $15
million
 Initial share price is usually between $10 and
$20 per share
The Registration
Process
 Choose the underwriter
 Negotiate a letter of intent
 Prepare the registration statement
 File with the SEC
 Wait to “go effective” and road show
 Meet state requirements
Simplified Registrations
and Exemptions
 Regulation S-B
 S-B-1: Transitional registration for
companies making offerings of less
than $10 million over 12 months
 S-B-2: Registration for companies
making offerings of more than $10
million over 12 months
 Regulation D: Rule 504 - Small
Company Offering Registration
(SCOR)
SCOR Offerings
 Ceiling is $1 million
 Share price must be at least $5 per share
 Must file Form U-7, a standardized
disclosure statement
 Can issue almost any kind of security
through SCOR
 Cost is usually less than $25,000
and Exemptions
 Regulation D: Rule 505 and 506
 Private placements
 Section 4 (6)
 Rule 147 (Intrastate offerings)
 Regulation A
 Offerings up to $5 million over 12
months
 Typical cost: $80,000 to $120,000
and Exemptions
 Direct Stock Offerings
 Go straight to Main Street instead of
through underwriters on Wall Street
 World Wide Web (usually either
Regulation A or Regulation D offerings)
 Typically generate between $300,000 and
$4 million for company
 Foreign Stock Markets
Web Sites
 PriceWaterhouseCoopers Money Tree
Survey
http://www.pwcmoneytree.com/
 Hoover’s Online IPO Central
http://www.hoovers.com/global/ipoc/ind
ex.xhtml
 Active Capital
http://activecapital.org/
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Sources of

 Fixed - used to purchase the the

Business is in Business is developing Business is selling Company has

 Private investors who invest in

Number of Small Companies

Amount Invested (in billions)

 Ideal source of financing for

 Most likely to finance deals in the

 Typical angel accepts 12% of the

Number of Deals with

Source: PriceWaterhouse Coopers Moneytree Report, 2007.

 More than 1,300 venture capital firms

 Business plans are subjected to an

Billions of $ Number of Deals

Source: PriceWaterhouse Coopers Moneytree Report, http://www.pwc.moneytree.com

 Usually take an active role in managing the

 Initial public offering (IPO) - when a

$60.0 $ Raised (Billions)

Source: PriceWaterhouseCoopers, US IPO Watch 2006 Analysis and Trends, p.2.

Copyright ©2009 Pearson Education, Inc.

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