VENTURE CAPITAL
IMPORTANT SOURCE OF
EQUITY FOR HIGH GROWTH
COMPANIES
• “POOL OF CAPITAL, TYPICALLY
ORGANIZED AS A LIMITED
PARTNERSHIP, WHICH INVESTS IN
COMPANIES THAT REPRESENT AN
OPPORTUNITY FOR A HIGH RATE OF
RETURN WITHIN 5-7 YEARS.”
Venture Capital Funds
Year number of funds Funds($Bill) New Funds
funds
1990 82 3.1 13
1995 155 9.7 44
2000 494 92.6 162
BACKGROUND
• VENTURE CAPITAL FIRM BACKED
FIRMS RESPONSIBLE FOR
– 3.3% OF NATION’S JOBS
– 7.4% OF GROSS DOMESTIC PRODUCT
– ALL FOR ONLY 1% OF NATION INVEST.
– “GAZELLES” (>20% GROWTH) ARE 5%
OF NATION’S FIRMS; 2/3 NEW JOBS
BIG CHANGE IN FINANCING
• GROWING WEALTH/DISPOSABLE
INCOME
• VERY VISIBLE HIGH TECH
COMPANIES - poster children for feast-or-
famine nature of venture capital
• RECENT SURVEY - 6/100 of high tech
startups had traditional bank debt as first-
round financing
VENTURE CAPITAL ROLES
• PURCHASE EQUITY OR HYBRID
SECURITIES
• ASSIST IN NEW PRODUCT
DEVELOPMENT
• FOCUS ON HIGHER RISK-RETURN
COMPANIES
SAMPLE FIRMS THAT USED
VENTURE CAPITAL
• FEDERAL EXPRESS
• COMPAQ
• SUN MICROSYSTEMS
• INTEL
• MICROSOFT
VARIABLE TRAITS OF
VENTURE CAPITAL FUND
• RISK
• LENGTH OF COMMITMENT
• INVESTMENT ILLIQUIDITY
• MINIMUM $ COMMITMENT
STRATEGY OF V.C. FIRM
P. 283 OF TEXT
• MANAGEMENT ABILITY
• WELL-DEFINED NICHE BUSINESS
• LEADING MARKET POSITION
• STRONG GROWTH POTENTIAL
• CONSOLIDATION
• RISK AVOIDANCE
• REASONABLE SELLING PRICE
EXIT OPTION 1
• MERGER/ACQUISTION
– MOST FREQUENT EXIT
– AT LEAST 3-5 YEARS AFTER INITIAL
INVESTMENT
EXIT OPTION 2
• INITIAL PUBLIC OFFERING (IPO)
– MOST GLAMOROUS
– FUND GETS PUBLIC SHARES BUT OFTEN
MAY NOT BE TRADED FOR UP TO 2
YEARS
WHAT INDUSTRIES
ATTRACT VENTURE CAP.
• Poised for rapid growth/high profit
• Sustainable growth in excess of 5 years
• Niche or emerging markets
• market large enough to support in range of
$100 million in company value
– health care
– information technology (?)
LIFE CYCLE OPTIONS FOR
V.C. INVESTMENT
• SEED INVESTING - before the real
product or company is organized
– $300-3 million
• EARLY STAGE INVESTING - after first
product development
– $3 million - $20 million
V.C. CYCLE CONT.
• EXPANSION STAGE - beyond critical
mass toward more successful firm
– $20 MILLION-$100 MILLION
– STAGE AT WHICH IPO OR FIRM BUYOUT
EXPECTED
• LATER STAGE - also through exit via
stock offering or buyout
EVALUATION APPROACH
• Uniqueness of product
• Will company become profitable?
• How will proceeds be used?
• Management able and willing to meet
specific goals?
• Is there an exit strategy for equity investors?
VALUATION APPROACHES
• EARLY STAGE FIRMS - focus on
management
• EXPANSION STAGE FIRMS - value =
multiple of revenues
• LATE STAGE FIRMS - MULTIPLE OF
EARNINGS
CASE STUDY VALUATIONS
• HOP-IN-FOODS - P. 259-260
• BERG ELECTRONICS - P. 281
• Q: COMPARE IPO FIRMS WITH FIRMS
IN SAME INDUSTRY