VENTURE CAPITAL FINANCING : AN INTRODUCTION

Prof.Stephen OngBSc(Hons)Econs (LSE), MBA (Bradford)

Visiting Professor, Shenzhen University

Academic Fellow, Entrepreneurship & Innovation,

The Lord Ashcroft International Business School, Anglia Ruskin University Cambridge UK

MSC TECHNOPRENEURSHIP

• Getting Funding for Technology Start-Ups

1

• Sources of Venture Capital Financing2

• Case Discussion : APPLE iPOD3

Today’s Overview

LEARNING OBJECTIVES1. To explore funding options for

financing technology start-ups.

2. To understand the business cycle and conditions to qualify for equity financing.

3. To discuss success factors required to secure venture capital funding.

4. To discuss issues and challenges faced by entrepreneurs and business founders funded by venture capital.

Are you a

Venture Capitalist?

A27 year old graduate in Electrical & Electronic Engineering from local

Technical College, with 7 years working

experience. With a partner, started up a

computer repairs shop to make Chinese

language computers in Chinatown.

B26 year old drop-out from local university,

working with a company making

calculators. With a partner, started

making computer parts at home for a

newly opened computer shop.

C20 year old drop-out from local university, working with a local software company. With two partners,

started up data processing service

for local government using computers at the school library.

ENTREPRENEURS

A6,000

(from combined savings)

B1,300

(from sale of car)

C25,000

(from Family)

START-UP CAPITAL

A27 year old

classmate from local Technical College,

holder of Diploma in Electrical & Electronic

Engineering. He holds strong beliefs in living life without regrets and making the world a better

place.

B26 year old high school leaver, from average family, whose step-father is a mechanic and carpenter. He has been a drug user, a follower of Eastern religions like Hinduism and Buddhism, and always short of money. He believes in changing the world.

C17 year old drop-out from local university, working with a local software company.

He comes from a middle-class family

and strongly believes in intellectual

property rights.

CO-FOUNDERS

A• Copied 2

patents from US Competitor and had to buy Company.

• Owned 1 patent copied by US Company and wins damages.

B• Copied 1 patent

from US Company

• Copied 1 patent from foreign Company and legally forced to pay damages for licence.

CBuys 1

exclusive licence from US Competitor and

sells non-exclusive

licences to customers.

INTELLECTUAL PROPERTY

AA 60-year old

company with a

network of 3,000

computer stores

BA new local computer store and friends.

CA 70-year old

company with its own sales

force, own stores and

reseller agents

MARKETING PARTNERS

A232m

Customers in USA

B0.3m

Customers in USA

C6m

Customers worldwide

INITIAL MARKET SIZE

Is your FACE,your FORTUNE?

A B26 year old drop-out from local university, working with a local company making calculators. With a partner, started up small manufacturing of computer parts at home for local newly opened computer shop.

C20 year old drop-out from local university, working with a local software company. With two partners,

started up data processing service

for local government using computers at his parent’s school.

A B C

B

GETTINGSTART-UPFUNDING

Raising Capital

Raising capital to launch or expand a business is a challenge.

Many entrepreneurs are caught in a

“credit crunch.”

Financing needs in the RM100,000 to RM2 million range may be the most challenging to fill.

Why Most New Ventures Need Financing or Funding

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. Raising money takes time and effort.

4. 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

5. The Internet puts at entrepreneur’s fingertips vast resources of information that can lead to financing.

6. Be thoroughly prepared before approaching lenders and investors.

7. Entrepreneurs should not underestimate the importance of making sure that the “chemistry” among themselves, their companies, and their funding sources is good.

(continued)

Options for Raising Money for a New Venture

Personal Funds Equity Capital

Debt Financing Creative Sources

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

Venture

Capital

Business

Angels

Initial Public

Offerings

Preparing to Raise Equity Financing

Matching a New Venture’s Characteristics with Funding

SOURCES OF VENTURECAPITAL

FIGURE 13.4 Angel Investing and Venture Capital Investing

Source: Robert Wiltbank and Warren Bocker, Returns to Angel Investors in Groups, Angel

Capital Education Foundation, http://www.kauffman.org/Details.aspx?id=1032, and PWC Moneytree

Report, Pricewaterhouse Coopers, https://www.pwcmonnneytree.com/MTPublic/nc/indes.jsp.

Business Angels

An estimated 258,000 angels across the U.S. invest $26 billion a year in 57,000 small companies.

Their investments exceed those of venture capital firms, providing more capital to 15 times as many small companies.

Angels fill a gap in the seed capital market, specifically in the $10,000 to $2 million range.

Business Angels

Average angel investment = $50,000.

Typical angel invests in 1 company per year, and the average time to close a deal is 67 days.

52% of angels’ investments lose money, but 7% produce a return more than 10 times their original investment.

Angels can be an excellent source of “patient” money.

FIGURE 13.1 Angel Financing Source: Center for Venture Financing, Whittemore School of

Business,

University of New Hampshire, www.unh.edu/cvr.

Venture Capital Companies

Around 800 venture capital firms operate across the USA. (vs 25 in Malaysia).

Most venture capitalists seekinvestments in the $2m to 10m range

(vs Rm0.5m to RM5m)

Target companies with high-growth and high-profit potential.

Business plans are subjected to an extremely

rigorous review - less than 1% accepted.

Venture Capital Funds Venture capital firms are limited partnerships

of money managers who raise money in“funds” to invest in start-ups and growingfirms.

The funds, or pool of money, are raised fromwealthy individuals, pension plans,university endowments, foreign investors,and similar sources.

The investors who invest in venture capitalfunds are called limited partners. Theventure capitalists are called generalpartners.

Venture Capital Companies

Most often, venture capitalists invest in a company across several stages.

On average, 98% of venture capital goes to:

Early stage investments (companies in the early stages of development).

Expansion stage investments (companies in the rapid growth phase).

Only 2% of venture capital goes to

businesses in the startup or seed phase.

FIGURE 13.2 Venture Capital Funding

Source: Based on PriceWaterhouseCoopers http:/www.pwcmoneytree.com.

Venture Capital Focus Venture capital firms fund very

few entrepreneurial firms in comparison to business angels.

Venture capitalists are looking for the “home run” and so reject the majority of the proposals they consider.

Venture capitalists fund between 3,000 and 4,000 companies per year, compared to about 62,000 per year for business angels.

Venture Capital Process

An important part of obtaining venture capital funding is going through the due diligence process.

Venture capitalists invest money in start-ups in “stages,” meaning that not all the money that is invested is disbursed at the same time.

Some venture capitalists also specialize in certain “stages” of funding.

Corporate Venture Capital

About 300 large corporations across the globe invest in start-up companies.

Approximately 6 to 8% of all venture capital invested is from corporations.

Capital infusions are just one benefit; corporate partners may share marketing and technical expertise.

What Do Venture CapitalCompanies Look For?

Competent management

Competitive edge

Growth industry

Viable exit strategy

Intangibles factors

SO WHO GETS

FUNDED ?

FIGURE 13.5 Which Factors Are Most Important to Venture Capitalists?

Source: Dee Powers and Brian E. Hill, Venture Capital Survey, The Capital

Connection, http//www.capital-connection.com/survey-value.html.

X-Factor Test for Venture Capital Investor

1. Quality of Management Team

2. Size of market

3. Product qualities (uniqueness, brands, patents)

4. Intensity of competition

5. Market growth rate

6. Barriers to entry

7. Company’s stage of development

8. Industry where company is

Casestudy : Apple iPod►Background“The success of the iPod raises the licensing question for Apple … again”

Trott,P. (2008). Innovation management and new product development,

(4th edition). FT Prentice Hall.

Group Discussion 30 mins discussion in Groups of 7

5 mins presentation by Group representative

► Individual Assignment

Individual coursework (contributes to 15% overall mark of course)

2 pages written in English in WORD format

►Summary

► Issues discussed

►Solutions proposed

SPOT the DIFFERENCE

Patent Litigation

44Source: bbc.co.uk 30th August 2005

Creative wins MP3 player patent

One of Apple's main rivals, Creative Technology, hasbeen awarded a patent in the US for the interface

used on many digital music players.

"The first portable media player based upon the user interface covered in our Zen Patent was our Nomad Jukebox MP3 player," said Creative CEO Sim Wong Hoo."The Apple iPod was only announced in October 2001, 13 months after we had

been shipping the Nomad Jukebox based upon the user interface covered by our Zen Patent."

In its press release, Creative said Apple had filed for a patent for a user interface in a multimedia player in late 2002, but its application had been recently rejected.

On 24 August 2006, Apple and Creative announced a broad settlement to end their legal disputes. Apple will pay Creative US$100 million for a paid-up license, to use

Creative's awarded patent in all Apple products. As part of the agreement, Apple will recoup part of its payment, if Creative is successful in licensing the patent.

Apple pays US$100m for use of Patent

45

Automatic hierarchical categorization of music by metadata

Patent number: 6928433Filing date: Jan 5, 2001Issue date: Aug 9, 2005

Application number: 9/755,723

A method, performed by software executing on the processor of a portable music playback device, that automatically files tracks according to hierarchical structure of categories to organize tracks in a logical order. A user interface is

utilized to change the hierarchy, view track names, and...Inventors: Ron Goodman, Howard N. Egan

Assignee: Creative Technology LTD

Source: bbc.co.uk 30th August 2005

SPOT the DIFFERENCE

NASDAQ AAPLMarket Cap : US$308.8 B

PINK CREAFMarket Cap : US$0.150 B

CREATIVE vs APPLE

“…IF WE DON’T INVENT THE RIGHT

THING, SOMEONE WILL INVENT THE

RIGHT THING.

SO LET’S GO INVENT THAT THING”

Reid Hoffman, founder of LinkedIn with four friends, starting with 6,000 customers, 10 years ago. Today, a US$20B company with 225m customers.

CONCLUSION

Further Reading

Scarborough, Norman, M. (2011) Essentials of Entrepreneurship and Small Business Management.6th edition. Pearson.

Brooks, Arthur C. (2006) Social Entrepreneurship : A Modern Approach to Social Value Creation. Pearson

Barringer, Bruce R. & Ireland, R. Duane (2011) Entrepreneurship –Successfully launching new ventures 4th edition, Pearson.

Schaper, M., Volery, T., Weber, P. & Lewis, K. (2011) Entrepreneurship and Small Business. 3rd Asia Pacific edition. John Wiley.

QUESTIONS?