chapter 13 Notes ENT

Equity Financing

  • Definition: Sale of shares of stock in exchange for cash as businesses grow.

  • General Rule: Avoid seeking investment too early to allow time for the enterprise to grow and build value.

  • Note: Some businesses require more capital than others.

Splitting the Ownership Pie

  • Concept: Initially owning 100% of a small pie.

  • Impact of Equity: As equity is given away, ownership diminishes but if the company grows, the value of the smaller ownership stake can exceed initial ownership.

Stages of Equity Financing

  • Seed-stage financing: Small funds to prove the concept.

  • Startup financing: Supports implementation of ideas through product R&D.

  • Early-stage financing: Pre-revenue funding for tested products/services.

Forms of Equity Financing

  • 3 F's: Family, Friends, and Fools.

  • Angel Investors: Individuals using personal funds to support startups.

  • Venture Capitalists (VC): Professional investors funding emerging companies for growth.

Differences Between Angel Investors and Venture Capitalists

  • Angel Investors:

    • Individual investors with a net worth > $1 million.

    • Invest $25,000 to $100,000.

    • Fund seed or early-stage companies.

    • Conduct informal due diligence.

    • Provide advice but not heavily involved.

    • Exit via personal investment returns.

  • Venture Capitalists:

    • Part of companies managing funds.

    • Invest $500,000 or more, avg. $7 million.

    • Fund early to late-stage companies.

    • Conduct formal due diligence.

    • Offer strategic support and often occupy board seats.

    • Decisions made by committee.

    • Exit via fund's returns.

Basics of Valuation

  • Entrepreneurs must know their company value to negotiate equity offers.

  • Investors expect a business valuation to define equity percentages during negotiations.

How Entrepreneurs Value a Company

  • Determine worth based on market potential and compare with peer companies in the same industry.

Factors Influencing Investors' Valuation

  • Team's experience and past successes, market demand, product usage, established distribution channels, and industry popularity.

Valuation Metrics

  • Premoney Valuation: Value before external investment.

  • Postmoney Valuation: Value after investment.

    • Example: $150,000 for 10% results in pre=$1.35M, post=$1.5M.

    • Alternative: $150K for 30% results in pre=$350K, post=$500K.

The Age of the Unicorn

  • Definition: A tech startup with a $1 billion valuation.

  • Notable: Unicorn startups are rare but increasing in prevalence.

Angel Investors

  • Defined as individuals using personal capital for entrepreneurial ventures, must be accredited (earn > $200,000 or net worth > $1 million).

  • Typically experienced self-made entrepreneurs.

Finding an Angel Investor

  • Resources: AngelList, Angel Capital Association, tapping personal networks for introductions.

Types of Angels

  • Entrepreneurial Angels: Self-made entrepreneurs.

  • Corporate Angels: Former corporate executives.

  • Professional Angels: Professionals like doctors and lawyers.

  • Enthusiast Angels: Wealthy retirees investing for interest.

Angel Groups

  • Angel investors may pool funds, meet regularly to hear pitches, and often specialize in certain sectors.

Timing for Seeking Angel Funds

  • Necessary conditions: Product developed, customer interest, utilized personal funds, and a strong business model.

Role of Venture Capitalists

  • Mostly professional fund managers seeking significant returns (10x in 5 years) through equity ownership.

  • Typically represent investments through a 10-year fund cycle.

Venture Capital Characteristics

  • Look for firms with seed funding and are willing to take more equity.

  • Favor teams with strong talent and reputable support.

Bank Loans vs. Equity Financing

  • Debt Financing: Borrowing with the obligation of paying back with interests.

  • Typically too risky for banks to lend to startups.

Due Diligence

  • A thorough evaluation process for investment opportunities, more informal for angels but rigorous for VCs to identify risks.

Exit Strategies

  • VCs expect returns via:

    • Initial Public Offering (IPO)

    • Acquisitions

    • Buybacks

Y Combinator Case Study

  • Overview: Accelerator founded in 2005, supporting multiple companies with $125K in funds over a 3-month program.

  • Has invested in over 3,500 companies with a near $1 trillion valuation.

Critical Questions to Consider

  • Connection to financing stages, entrepreneurial mindset promotion, importance of financing vs. social capital in startups.

Financial vs. Social Capital

  • Reflect on aspects of financial and social capital, understanding their values in entrepreneurship.

Self-Understanding for Entrepreneurship

  • Exercise focusing on personal accomplishments to identify skills and capabilities for venture ideas.

  • Goals: List significant accomplishments, identify knowledge and skills used, and enhance self-awareness in entrepreneurship.