Corporate Finance: Private Equity

Corporate Finance Lecture 1: Private Equity

Learning Outcomes

• Understand various equity financing options available for private companies and their implications on company control and growth.

• Identify potential sources of funding, including specific characteristics and roles of each source.

Equity Financing for Private Companies

Initial Capital

• Definition: Initial capital refers to the funds provided by the entrepreneur and immediate family members to kickstart a business.

• Importance: This capital is essential for covering initial business setup costs, which have seen a significant decrease, making it more accessible to aspiring entrepreneurs.

Outside Sources

• Need: As businesses grow, external funding sources become crucial to sustain and accelerate growth, often impacting the control and governance structure of the firm.

• Considerations: Entrepreneurs should weigh the trade-offs between acquiring necessary funding and maintaining control over their companies.

Potential Sources of Funding

1. Angel Investors:

   • Definition: Wealthy individuals who provide capital for startups, often in exchange for equity ownership.

   • Community Growth: The angel investing community has grown exponentially, with over 400 groups listed by the Angel Capital Association, consisting of approximately 42 members per group and a total investment of about $2.42 million annually.

   • Investment Dynamics: Typically, more than 300,000 individual angel investors participate each year, leveraging their wealth to back emerging businesses.

   • Valuation Challenges: Angel investors frequently use convertible notes or SAFE instruments to postpone company valuations until later funding rounds, enhancing flexibility.

2. Crowdfunding:

   • Definition: A method of raising capital through small contributions from a large number of people, often via online platforms.

   • Types:

     • Equity Crowdfunding: Regulated in certain jurisdictions (like the UK), allowing investors to directly buy shares in a company.

     • Donation and Reward-Based: Generally less regulated and often entail non-equity contributions.

   • Benefits: Provides alternative financing avenues without the stringent requirements of bank loans, and fosters community involvement.

   • Risks: High potential for loss, particularly in donation-based systems, and investors should conduct due diligence before investing.

3. Venture Capital Firms:

   • Structure: Typically structured as limited partnerships, where General Partners (GP) manage the fund and make investment decisions, while Limited Partners (LP) provide capital with a more passive role.

   • Advantages: Offers diversification benefits and access to expert advice and mentorship from seasoned investors, though it comes with high management fees.

   • Funding Characteristics: Preferred stock, commonly issued, provides investors with preferential treatment regarding dividends and liquidation rights.

   • Ownership Dilution: In successive funding rounds, ownership percentages may change based on new valuations and share structures, necessitating careful calculations of ownership stakes.

4. Private Equity Firms:

   • Role: Firms that invest directly in private companies, often acquiring a significant amount of control and influencing operational decisions.

   • Investment Focus: These firms typically target established businesses looking to expand or restructure.

5. Institutional Investors:

   • Definition: Large organizations, including pension funds and insurance companies, that invest in various asset classes, including private equity.

   • Impact: Their involvement often signifies a high level of due diligence and increases the legitimacy of investment opportunities.

6. Corporate Investors:

   • Definition: Established companies which invest in emerging firms to foster innovation and gain strategic advantages.

   • Strategic Implications: These investments often come with a focus on synergies or technological advancements that benefit both the investor and the invested company.

Sources of Funding for Private Companies

Utilizing professional platforms such as AngelList and Crunchbase allows startups to connect with potential investors and analyze market trends. Prominent global angel investors are often profiled in lists published by Forbes, CB Insights, and TechCrunch, providing valuable insights into investor activities and market dynamics.

Key Networks for Angel Investors:

• Keiretsu Forum: A structured network of angel investors across various industries.

• Golden Seeds: Focused on empowering women entrepreneurs.

• Techstars Investment Network: A platform connecting startups with investors for backing and mentorship.

Conclusion

Understanding the diverse funding sources available for private companies is critical for aspiring entrepreneurs and business leaders navigating the complexities of corporate finance and private equity. Each funding option comes with its unique benefits, risks, and implications for ownership and control that need careful consideration as businesses grow and evolve.