Venture Capital

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Entrepreneurial Finance, Private Equity and
Venture Capital
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Admin General

• Office Leslie Commerce 5.37.
• Core Available times
• Mo and Thu from 900 to 1200, otherwise by
  appointment.
• One exam, one assignment.
• Reading pack.
• Numbered slides and notes.

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Times and Dates

• Four Lectures.
• 19, 26 April, 3, 10 May.
• Exam
• 17 May, 1500.
• Venue Jameson Hall (unless otherwise informed).
• Lectures, reading packs and general insights.
• Course Assessment
• 70 Exam, 30 Assignment.

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Course Goals

• Understanding the pros and cons of various
  options for entrepreneurial financing.
• Apply general investment concepts in
  entrepreneurial settings.
• Understanding the workings of V/C and P/E.
• The basics of assessing a proposed equity
  investment in an idea or business.
• Not everybody ends up in the corporate world or
  investment industry.

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Course Structure

• Lecture 1
• Entrepreneurship and funding options.
• Lecture 2
• The V/C and P/E industries.
• Lecture 3
• Looking at the investment.
• Lecture 4
• ?? Plus assignment plus exam discussion

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Assignment (1)

• Topic A basic business plan of a novel business
  idea / concept / product.
• Target Audience A venture capitalist or VC firm.
• Objective To obtain funding from the venture
  capitalist to start the business.
• Format MS Word format. Maximum length of text
  15 A4 pages of (minimum) font 11.
• Should include (at a minimum)
• A description of the concept
• The need and how this idea will satisfy it
• The target market
• Why it would be a good investment for the venture
  capitalist (build an investment case).
• The financial case (attached financial
  projections as an Annexure)
• Competition issues.
• A clear indication of the amount of funding that
  will be required and why.
• Annexures may be added to the above (e.g.
  supporting material, competing products etc.,
  website info, additional research etc.).

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Assignment Practical Arrangements

• To be done in groups of between 3 and 5.
• You are expected to form your own
  groups timeously and will not be required to
  register your groups in advance.
• Assignments handed in by groups of more than 5
  or less than 3 members will automatically be
  marked down 25.
• The key will be to be original, comprehensive and
  concise within the space constraints
• Deadline for hand-in 1200 on 10 August 2007 to
  Tina Petersen (LC 5.28)
• Grading will be on a relative basis therefore
  there is no absolute right or wrong.
• Remember you will be graded on how well you
  achieve your objective, namely to convince the
  venture capitalist of the size of the
  opportunity, the novelty of the idea, the profits
  that can be made from it etc.
• Therefore, you have to achieve a fine balance
  between being creative and being realistic. The
  more realistic your assumptions, idea, financials
  etc,. the better your mark will be. This is an
  exercise in realism, not a license to dream or go
  on a flight of fancy.
• In short You have to come up with an idea that
  can work and that can make money, and you have to
  be able to sell this idea as being realistic and
  profitable in order to get funding from a VC,
  which is your objective.

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Would you invest in these guys?
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This guy did
Dave Marquardt, Technology Venture Investors
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Microsoft as an investment

• 1981
• Revenues 16,000,000
• Employees 128
• TVI buys 5 of Microsoft for 1,000,000
• 2005
• Revenues 39,000,000,000
• Operating Income 4,200,000,000
• Employees 31,000
• Market Value (4/05) 266,000,000,000
• 5 13,000,000,000

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Which is a return of

• per annum over 24 years!

48,4
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Could this happen at UCT?
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Lecture 1EntrepreneurialFinancing
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Lecture Structure

• Entrepreneurship.
• Funding needs and basics.
• Sources of finance.

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What is Entrepreneurship?

• The act of initiating, creating, building
  and expanding an enterprise or organisation,
  building an entrepreneurial team and gathering
  other resources to exploit an opportunity in the
  marketplace for long-term gain.
• Van Aardt, Van Aardt and Bezuidenhout in
  Entrepreneurship and New Venture Management

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Personal Attributes

• Are you considering starting your own business at
  some stage?
• Do you have start-up skills?
• Do you see opportunity?
• Do you know an entrepreneur?

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Personal Attributes
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2006 Entrepreneurship Survey
South Africa
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At least SA ladies rank slightly better
South Africa
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Obstacles to SA Entrepreneurs
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Entrepreneurial Businesses

• Family owned businesses.
• 80-90 of US businesses.
• gt50 globally.
• Franchises.
• 188 registered with FASA. Many more 100s of
  outlets.
• Home-based Businesses
• Over 50 of small businesses.

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Cash Flow of a Business Venture
Capital (equity and debt)
Infusions
Beginning cash
Reinvestment (to retained earnings)
Expenditures
Fixed Assets
Employees
Materials
Production
Inventory
Credit Sales
Cash sales
Accounts Receivable
Collections
Ending Cash
Equity Returns
Debt Service
Taxes
2000, Entrepreneurial Finance, Smith and Kiholm
Smith
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Cash Flow Profile of a Business
Cash Break Even
Cash Burn
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Factors Increasing Cash Needs

• Capital investment needs.
• High rates of sales growth investment. in
  working capital.
• Protection of intellectual property (IP).
• Marketing and brand building costs.
• Research.
• Large established competitors (deep pockets).
• Low profit margins.

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And then there is Tax
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Option1 Raise as much as possible.

• Available for emergencies (a rainy day).
• Ability to benefit from unforeseen opportunities.
• Good for morale / feeling of security.
• Improves credit rating from banks and suppliers
  (reduces cost of further capital).

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Option 2 Raise as little as possible.

• Cost of capital (interest or equity).
• Excess liquidity promotes wastage / bad financial
  discipline.
• Reduces risk in case of failure.
• Promotes a focus on cash flow.

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Financing Option Determinants

• Firms economic potential
• Life cycle stage of company
• Assets
• Owner preferences

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Returns Debt vs. Equity
For 40 share
60 of profit
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Financial Cost of Debt
Assume a successful business
Net cash flow before debt
Net cash flow after cost of debt
Cost of Debt
Cash flow deficit
Time
Term of Debt
Debt capital amount
Cash Break-even after debt
Cash Break-even before debt
Fin. cost of debt PV (interest and capital
repayments loan proceeds)
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Financial Cost of Equity
Assume a successful business
Net attributable cash flow
FV of Equity sacrifice
Cash flow deficit
Time
Cash Break-even
Investment
Financial cost of equity PV (future cash
flow sacrifice investment)
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Financial Choice Debt vs. Equity
Assume a successful business
Net attributable cash flow
Net cash flow after cost of debt
FV of Equity sacrifice
Cash flow deficit
Cost of Debt
Time
Term of Debt
Equity
Debt
PV of Capital amount of loan / investment
Cash Break-even
Cost Difference PVs of (interest and capital
repayments loan proceeds) - (future cash flow
sacrifice investment)
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Other Considerations Equity

• Irreversible (-).
• Skills and experience ().
• Networks and contacts ().
• Personality issues (-/).
• Recapitalisation (-/).

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Sources of Funding

• Own Funds.
• Family and Friends.
• Bank Finance (Loans).
• Government Funding.
• Community Based.
• Angel Financing.
• Venture Capital.

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The Main Considerations.

• Involvement of the financier (good / bad).
• Risk if things go wrong.
• Sacrifice of upside.

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Own Funds
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Family and Friends
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Downside to Family Funding
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Bank Financing
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Four Cs of Credit Granting

• Character.
• Cash Flow.
• Collateral.
• Contribution.

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Bank Financing
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Barriers of Debt Financing (1)

• Applicants lack of collateral.
• Financial institutions lack capacity, skills and
  knowledge to assess risk (especially in
  specialised markets).
• Determining risk vs. potential returns is
  expensive and difficult.

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Barriers of Debt Financing (2)

• Often no track records and history to go on
  (company, management and/or financial histories).
• High transaction costs on smaller deals.
• Banks look at current CASH FLOW , not potential
  future cash flow and growth.

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Bank Financing
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Government Financing

• Based on government objectives, e.g.
• economic growth.
• job creation.
• technological innovation.
• Ownership transfer - black empowerment.
• Tax money.
• Generally not grants can be soft loans,
  equity participation or partial subsidisation.
• Examples Umsobomvu, IDC, Khula.

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Government Funding
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Angel Financing

• Local networks of investors (friends, business
  associates etc).
• Invest close to home.
• In familiar markets technologies.
• Required investment returns lower than venture
  capital funds.
• Fairly informal terms conditions.
• Example Ellerine brothers.

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Angel Financing
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Venture Capital

• Similar investment principles to angel investors.
• Structured investment businesses.
• Equity for money.
• Examples Brait (listed), Ethos (part of RMB),
  HBD etc.

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Venture Capital
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Benefits of V/C Involvement

• Sounding board for management team.
• Access to further equity funding.
• Interfacing with investor group.
• Monitoring financial performance.
• Monitoring operational performance.
• Obtaining alternative debt financing.

Source Iwisi D.S., Kitindi E.G.,
Tesfayohannes, M. 2003. Venture Capital
Overlooked Financing Source for SA Small
Businesses
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Other Forms of Finance

• Barter.
• Supplier financing.
• Factoring.
• Leasing.
• Credit cards.
• Community, e.g. Stokvels.