MOS 1023A / Finance Lecture #2.pdf

4 Pages
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Department
Management and Organizational Studies
Course Code
Management and Organizational Studies 1023A/B
Professor
Maria Ferraro

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Nov 7, 2012 / Wednesday • Bootstrapping is the process by which many entrepreneurs raise “seed” money and obtain other resources that are necessary to start their business. As in short terms, it is the initial funding of the firm. • Most of the time, initial “seed” money comes from the entrepreneur or other founders. • An individual is said to be boot strapping when he or she tries to found and build a company from personal finances or from the operating revenues of the new company. • Venture capital is the money provided by investors to startup firms and small businesses with realized long-term growth potential. • “Venture capitalists” or “angel investors” are individuals or firms that help new businesses get started and provide much of their early-stage financing. These individuals are, most of the time, wealthy businessmen and they invest their own money in emerging businesses. • Venture capital is considered a very significant source of funding for startups that do not have access to capital markets. • There are also three things to keep in mind about the disadvantages of venture capital; • Firstly, venture capital typically entails high risk for the investor. Hence, they are typically more sophisticated and may drive a harder bargain. • Due to this risk, secondly, venture capitalists are more likely to influence the strategic direction of the company. • Thirdly, venture capitalists are more likely to be interested in taking control of the company if the management is unable to drive the business. This actually means that the actual owner of the company loses complete control somehow. • Venture capitalists’ investments give them an equity interest (proportion of ownership) in the company, • Often in the form of preferred stock that is also convertible into common stock at the inclination of the venture capitalist. • Preferred stock is a class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends of the common stockholders and the shares usually don’t have voting rights. • Security is a financial instrument that represents an ownership position in a publicly-traded corporation, a creditor relationship with governmental body or a corporation, or rights to ownership as represented by an option. Negotiable financial instrument that represents a financial value. • Common stock is a security that represents ownership in a corporation. These stockholders exercise control by electing a board of directors and voting on corporate policy. These types of stockholders are on the bottom priority ladder for ownership structure. • Additionally, venture capitalists provide more than just financing. However, the extent of the venture capitalists’ involvement depends on the experience of the management team. • Advice can be said to carrying one of the most important roles of venture capitalists. • Advice from these people is important because they know the general knowledge regarding what it takes for a business to succeed. Therefore, they also provide counseling for entrepreneurs from when a business is just started to early stages of operation and so forth. • Venture capitalists are not “foolish” with their money. They actually know that only a few companies will survive to become successful. So, they have tactics to reduce their risk of investment; • Funding the ventures (money) in stages, • Requiring entrepreneurs to make personal investments, • Syndicating investments, • Maintaining in-depth knowledge regarding the industry in which they specialize. • Syndication occurs when originating venture capitalists sells a percentage of a deal to other venture capitalists. It reduces risk in two ways; • It increases the diversification of the originating venture capitalist’s investment portfolio, • The willingness of other venture capitalists to share in the investment provides independent corroboration that the investment is a reasonable decision. • 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 terms identifying who has the authority to make critical decisions concerning the exit process. • There are three principal ways in which venture capital firms exit venture-backed companies; • Selling the part of the firm’s equity to a strategic buyer in the private market, • Selling the part of the firm’s equity to a financial buyer, • Initial public offering (a.k.a IPO). • Initial public offering (IPO) is the first sale of stock by a private company to the public. • IPO of the company’s common stock is a way to raise larger sums of cash or to facilitate the exit of a venture capitalist. • First-time stock issues are given a special name as IPO because the marketing and pricing of these issues are distinctly different from those of seasoned offerings. • Seasoned offering is when a company that is already publicly traded issues new shares. In other words, these are all share issues after the IPO. • There are advantages for going public; • 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, • Once an IPO has been completed, additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost, • Going public can enable an entrepreneur to fund a growing business without giving up control, • After IPO, there is an active secondary market in which stockholders can buy and sell its shares, • Publicly traded firms find it easier to attract top management talent and to better motivate current manager if a firm’s stock is publicly traded. • There are also disadvantages for going public; • High cost of the IPO itself, • The cost of complying with ongoing Securities and Exchange Commission (SEC) disclosure requirements, • The transparency that results from the compliance to SEC can be costly for some firms, • Managers may focus on short-term profits rather than long-term wealth maximization. • Many smaller firms and firms of lower credit standing have limited access, or no access to the public markets, the cheapest source of exte
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