Management and Organizational Studies 1023A/B Lecture Notes - Venture Capital Financing, Venture Capital, Private Equity Firm
DepartmentManagement and Organizational Studies
Course CodeMOS 1023A/B
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
• 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
• 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
• 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
• 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
• 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 external funding is often the private markets.
• When market conditions are unstable, some smaller firms that were previously able to sell securities in
the public markets may no longer can.
• Bootstrapping and venture capital financing are part of the private market as well.
• Many private companies that are owned by entrepreneurs, families, or family foundations, and are
sizable companies of high credit quality, prefer to sell their securities in the private markets even though
they can access public markets.
• Private placement is the sale of securities to a relatively small number of select investors as a way of
raising capital. Investors involved in this placement are usually large banks, mutual funds, insurance
companies, pension funds, and wealthy individuals.
• Advantages of private placement:
• Private lenders are more willing to negotiate changes to a bond contract,
• If a firm suffers financial distress, the problems are more likely to be resolved without going to a
• Other advantages include the speed of private placement deals and flexibility in issue size,
• The biggest drawback of private placements involves restrictions on the resale of the securities.
• As venture capitalists, private equity firms (firms that aren’t traded publicly) pool money from wealthy
investors, pension funds, insurance companies, and other sources to make investment,
• Private equity firms invest in more mature companies and undervalued or under-appreciated companies,
and they often purchase 100% of a business,
• Private equity firm managers look to increase the value of the firms. Hence, they acquire by closely
monitoring their performance and providing better management,
• Once value is increased, they sell the firms for a profit. Private equity firms generally hold investments
for three to five years.
• Dividend policy is generally used to refer to a firm’s overall policy regarding distributions of value to
• A dividend is something of value that is distributed to a firm’s stockholders proportionally.
• A dividend can involve the distribution of cash, assets, or something else, such as discounts on the
firm’s products that are available only to stockholders.
• When a firm distributes value through a dividend, it reduces the value of the stockholders’ claims
against the firm.
• A dividend reduces the stockholders’ investment in a firm by returning some of that investment to them.
• Types of Dividends;
• The most common form is the regular cash dividend and these dividend are generally paid quarterly,
[the size of a firm’s regular cash dividend is typically set at a level that management expects the
company to be able to maintain in the long-run, if no major change happens in the fortunes of the
• Extra dividend is a dividend that is generally paid at the same time as a regular cash dividend to
distribute additional value.
• Special dividend is a one-time payment to stockholders that is normally used to distribute a large amount
• Liquidating dividend is the final dividend that is paid to stockholders when a firm is liquidated.
• The figure below shows the dividend payment process time line for a public company;
• Clarification for the figure;
• The dividend payment process begins when the board votes to pay a dividend.
• Shortly afterward, the firms publicly announce its intent to pay dividends, which is called declaration
• Ex-dividend is the sale of a security after a dividend has been announced but before it has been
distributes. When a security is sold ex-dividend, the dividend remains with the seller.
• Record date follows the ex-dividend date by two business days, and is the date by which a shareholder
must officially own shares in order to be entitled to a dividend.
• Payable date is the date when dividends or capital gains are paid to shareholders or reinvested in
• Stock repurchase is the purchase of stock by a company from its stockholders and they don’t represent a
proportionally distribution of value to the stockholders because not all stockholders participate,