Financing and Distribution
Bootstrapping (ie. puling them up by themselves)
- Initial Funding of the Firm
- The process by which many entrepreneurs raise “seed” money and obtain
other resources necessary to start their businesses
- The initial “seed” money usually comes from the entrepreneur or other
- Other cash may come from personal savings, the sale of personal assets, loans
from family and friends, use of credit cards.
- The seed money, in most cases, is spent on developing a prototype of the
product or service and a business plan.
- Usually lasts 1 to 2 years
Venture Capital (move company from bootstrapping period – ex. Dragons)
Venture capitalists are individuals or firms that help new businesses get
started and provide much of their early-stage financing.
Individual venture capitalists or angel investors, are typically wealthy
individuals who invest their own money in emerging businesses at the very
early stages in small deals.
Three reasons exist as to why traditional sources of funding do not work for
new or emerging businesses:
1. The high degree of risk (most suppliers like banks are not
interested- therefore need venture capitalists)
2. Types of productive assets.
3. Informational asymmetry problems
The venture capitalists’ investments give them an equity interest in the
Often in the form of preferred stock that is convertible into common stock at
the discretion of the venture capitalist. – because CS will go up if company
does well - preferred stock doesn’t move up like this
Venture Capitalists Provide More Than Financing
- The extent of the venture capitalists’ involvement depends on the
experience of the management team. Ex. Pharmaceutical industry
- One of their most important roles is to provide advice.
- Because of their industry and general knowledge about what it takes
for a business to succeed, they provide counsel for entrepreneurs
when a business is being started and during early stages of operation.
How Venture Capitalists Reduce Their Risk
Venture capitalists know that only a handful of new companies will survive
to become successful firms.
Tactics to reduce risk: 1. funding the ventures in stages (stage funding)
2. requiring entrepreneurs to make personal investments
3. syndicating investments
4. in-depth knowledge about the industry
Venture Capital Syndication (selling your ownership to others)
It is a common practice to syndicate seed- and early-stage venture capital
Syndication occurs when the originating venture capitalist sells a percentage
of a deal to other venture capitalists.
Syndication reduces risk in two ways:
1. it increases the diversification of the originating venture
capitalist’s investment portfolio.
2. the willingness of other venture capitalists to share in the
investment provides independent corroboration that the
investment is a reasonable decision.
The Venture Capital Exit Strategy
Venture capitalists are not long-term investors in the companies, but usually
exit over a period of three to seven years.
Every venture capital agreement includes provisions identifying who has the
authority to make critical decisions concerning the exit process.
1. Timing (when to exit)
2. The method of exit
3. What price is acceptable
There are three principal ways in which venture capital firms exit venture-
1. Sell to a strategic buyer in the private market. (ex. Coke & Smart
Water- company will compliment business in future)
2. Sell to financial buyer in the private market (looking at it as an
3. Initial Public Offering: selling common stock in an initial public
offering (IPO). (taking company from private to public stocks)
Initial Public Offering (IPO)
One way to raise larger sums of cash or to facilitate the exit of a venture
capitalist is through an initial public offering, or IPO, of the company’s
First-time stock issues are given a special name because the marketing and
pricing of these issues are distinctly different from those of seasoned
Advantages Going Public:
o The amount of equity capital that can be raised in the public equity
markets is typically larger than the amount that can be raised through
private sources. o Once an IPO has been completed, additional equity capital can usually
be raised through follow-on seasoned public offerings at a low cost.
o Going public can enable an entrepreneur to fund a growing business
without giving up control.
o After the IPO, there is an active secondary market in which
stockholders can buy and sell its shares.
o Publicly traded firms find it easier to attract top management talent
and to better motivate current managers if a firm’s stock is publicly
Disadvantages to Going Public.
o High cost of the IPO itself.
o The costs of complying with ongoing SEC disclosure requirements
o The transparency that results from this compliance can be costly for
o To complete an IPO, a firm will need the services of investment
bankers, who are experts in bringing new securities to the market.
o Investment bankers provide three basic services when bringing
securities to market–
Includes giving the firm financial advice and getting the
issue ready to sell. – thorough due diligence
The investment banker helps the firm determine
whether it is ready for an IPO.
Once the decision to sell stock is made, the firm’s
management must obtain a number of approvals.
File a registration statement with the Securities
The risk-bearing part of investment banking- who owns
the risk of not selling shares or getting the price
The securities can be underwritten in two ways:
1. Firm-Commitment Underwriting
o the investment banker guarantees the issuer a
fixed amount of money from the stock sale.
o Investment banker’s compensation –
underwriter’s spread (what’s left over)
o The underwriter bears the risk -price risk. If
sells high its good worse if it sells less
2. Best-Effort Underwriting
o the investment banking firm makes no
guarantee to sell the securities at a particular
o does not bear the price risk o compensation is based on the number of shares
Underwriting Syndicates (spread the risk through a
group of people=syndicate)
o To share the underwriting risk and to sell a new
security issue more efficiently, underwriters may
combine to form a group called an underwriting
o Participating in the syndicate entitles each
underwriter to receive a portion of the
underwriting fee as well as an allocation of the
securities to sell to its own customers.
Determining the Offer Price
o One of the investment banker’s most difficult
tasks is to determine the highest price at which
the bankers will be able to quickly sell all of the
shares being offered and that will result in a
stable secondary market for the shares.
Due Diligence Meeting (about protection)
o Before the shares are sold, representatives from
the underwriting syndicate hold a due-diligence
meeting with representatives of the issuer.
o Investment bankers hold due-diligence meetings
to protect their reputations and to reduce the
risk of investors’ lawsuits in the event the
investment goes sour later on.