Finance, Private Equity
Admin & General
1. Office: Leslie Commerce 5.37.
2. Core Available times:
• Mo and Thu from 9:00 to 12:00, otherwise
3. One exam, one assignment.
4. Reading pack.
5. Numbered slides and notes.
Times and Dates
1. Four Lectures.
• 19, 26 April, 3, 10 May.
• 17 May, 15:00.
• Venue: Jameson Hall (unless otherwise
• Lectures, reading packs and general
3. Course Assessment
• 70% Exam, 30% Assignment.
• Understanding the pros and cons of various options
for entrepreneurial financing.
• Apply general investment concepts in entrepreneurial
• Understanding the workings of V/C and P/E.
• The basics of assessing a proposed equity
investment in an idea or business.
• Not everybody ends up in the corporate world or
Entrepreneurship and funding options.
The V/C and P/E industries.
Looking at the investment.
?? Plus assignment plus exam discussion
• Topic: A basic business plan of a novel business idea / concept / product.
• Target Audience: A venture capitalist or VC firm.
• Objective: To obtain funding from the venture capitalist to start the business.
• Format: MS Word format. Maximum length of text: 15 A4 pages of (minimum)
• Should include (at a minimum):
• A description of the concept
• The need and how this idea will satisfy it
• The target market
• Why it would be a good investment for the venture capitalist (build an investment
• The financial case (attached financial projections as an Annexure)
• Competition issues.
• A clear indication of the amount of funding that will be required and why.
• Annexures may be added to the above (e.g. supporting material, competing
products etc., website info, additional research etc.).
Assignment: Practical Arrangements
• To be done in groups of between 3 and 5.
You are expected to form your own groups timeously and will not be required
to register your groups in advance.
Assignments handed in by groups of more than 5 or less than 3 members will
automatically be marked down 25%.
• The key will be to be original, comprehensive and concise within the space
• Deadline for hand-in: 12:00 on 10 August 2007 to Tina Petersen (LC 5.28)
• Grading will be on a relative basis – therefore there is no absolute right or
• Remember you will be graded on how well you achieve your objective, namely
to convince the venture capitalist of the size of the opportunity, the novelty of
the idea, the profits that can be made from it etc.
• Therefore, you have to achieve a fine balance between being creative and
being realistic. The more realistic your assumptions, idea, financials etc,. the
better your mark will be. This is an exercise in realism, not a license to dream
or go on a flight of fancy.
• In short: You have to come up with an idea that can work and that can make
money, and you have to be able to sell this idea as being realistic and
profitable in order to get funding from a VC, which is your objective.
Would you invest in these guys?
This guy did…
Technology Venture Investors
Microsoft as an investment
TVI buys 5% of Microsoft for $ 1,000,000
Operating Income: $4,200,000,000
Market Value (4/05): $266,000,000,000
5% = $13,000,000,000
Which is a return of…
per annum over 24 years!
Could this happen at UCT?
2. Funding needs and basics.
3. Sources of finance.
What is Entrepreneurship?
“The act of initiating, creating, building
and expanding an enterprise or
organisation, building an entrepreneurial
team and gathering other resources to
exploit an opportunity in the marketplace
for long-term gain.”
Van Aardt, Van Aardt and Bezuidenhout in “Entrepreneurship and New Venture Management”
1. Are you considering starting your
own business at some stage?
2. Do you have start-up skills?
3. Do you see opportunity?
4. Do you know an entrepreneur?
2006 Entrepreneurship Survey
At least SA ladies rank slightly better…
Obstacles to SA Entrepreneurs
• Family owned businesses.
• 80-90% of US businesses.
• >50% globally.
• 188 registered with FASA. Many
more 100’s of outlets.
• Home-based Businesses
• Over 50% of small businesses.
Cash Flow of a Business Venture
(equity and debt)
Expenditures (to retained earnings)
Employees Materials Fixed Assets
Inventory Credit Sales
Cash sales Accounts
Ending Cash Collections
Equity Returns Debt Service Taxes
2000, Entrepreneurial Finance, Smith and Kiholm Smith 22
Cash Flow Profile of a Business
Even Net Cash
Factors Increasing Cash Needs
1. Capital investment needs.
2. High rates of sales growth – investment.
in working capital.
3. Protection of intellectual property (IP).
4. Marketing and brand building costs.
6. Large established competitors (“deep
7. Low profit margins.
And then there is Tax…
Option1: Raise as much as possible.
• Available for emergencies (a “rainy day”).
• Ability to benefit from unforeseen
• Good for morale / feeling of security.
• Improves credit rating from banks and
suppliers (reduces cost of further capital).
Option 2: Raise as little as possible.
• Cost of capital (interest or equity).
• Excess liquidity promotes wastage /
bad financial discipline.
• Reduces risk in case of failure.
• Promotes a focus on cash flow.
Financing Option Determinants
1. Firm’s economic potential
2. Life cycle stage of company
4. Owner preferences
Returns: Debt vs. Equity
Owners’ Equity 100 100 For 40% share
External Equity 100
Assets 200 200
Pre-Interest Profit 50 50
Interest at 10% 10
Net Profit 50
Profit Attributable to Founder 40 30
60% of profit
Return on Equity 40% 30%
Financial Cost of Debt
Assume a successful business: Net cash flow
Net cash flow
Cost of after cost of debt
Term of Debt
Debt capital Cash Break-even
Cash Break-even after debt
amount before debt
Fin. cost of debt = PV (interest and capital repayments – loan proceeds)
Financial Cost of Equity
Assume a successful business: Net attributable
Cash flow FV of Equity
Financial cost of equity = PV (future cash flow sacrifice – investment)
Financial Choice: Debt vs. Equity
Assume a successful business: Net attributable
Net cash flow
after cost of debt
FV of Equity
Cash flow sacrifice
- Term of Debt
PV of Capital Cash Break-even
amount of loan /
Cost Difference: PVs of
(interest and capital repayments – loan proceeds)
- (future cash flow sacrifice – investment) 32
Other Considerations: Equity
• Irreversible (-).
• Skills and experience (+).
• Networks and contacts (+).
• Personality issues (-/+).
• Recapitalisation (-/+).
Sources of Funding
• Own Funds.
• Family and Friends.
• Bank Finance (Loans).
• Government Funding.
• Community Based.
• Angel Financing.
• Venture Capital.
The Main Considerations.
• Involvement of the financier
(good / bad).
• Risk if things go wrong.
• Sacrifice of upside.
Retain all equity. Own capital / at risk.
Least amount of business
Remain in control.
Easiest method. Can be lonely.
Least outside Increased investment can
involvement. be tricky.
Family and Friends
Can be cost effective. Most emotional option.
If venture fails – easy Outside involvement
exit plan. when not needed.
Usually little business Not always familiar with
structure needed. risks.
Downside to Family Funding…
Four “C”s of Credit Granting
• Cash Flow.
Barriers of Debt Financing (1)
• Applicant’s lack of collateral.
• Financial institutions lack capacity,
skills and knowledge to assess risk
(especially in specialised markets).
• Determining risk vs. potential
returns is expensive and difficult.
Barriers of Debt Financing (2)
• Often no track records and history
to go on (company, management
and/or financial histories).
• High transaction costs on smaller
• Banks look at current CASH FLOW ,
not potential future cash flow and
No sharing of upside. Surety or collateral required.
Zero involvement in Inflexible if venture takes
management as long longer than expected (always
as interest paid. the case).
Establishment of a If venture unsuccessful - bad
credit history. credit record immediately.
• Based on government objectives, e.g.
• economic growth.
• job creation.
• technological innovation.
• Ownership transfer - “black empowerment”.
• Tax money.
• Generally not grants – can be “soft loans”,
equity participation or partial subsidisation.
• Examples: Umsobomvu, IDC, Khula.
Low risk to Bureaucracy & red tape –
entrepreneur. slow decisions.
Funder may accept
Lack of guidance and
lower returns as often
involvement can be
not commercial criteria
Funder does not have
direct / personal interest.
Terms and conditions
can be inflexible.
• Local networks of investors
(friends, business associates etc).
• Invest close to home.
• In familiar markets & technologies.
• Required investment returns lower
than venture capital funds.
• Fairly informal terms & conditions.
• Example: Ellerine brothers.
Very effective and Can be restrictive due
flexible: quick decisions. to investor involvement.
Sophisticated investors -
Difficult to find in South
excellent business plan
Can bring on much Decision making can be
needed expertise. emotional.
Access to future capital
• Similar investment principles to
• Structured investment businesses.
• Equity for money.
• Examples: Brait (listed), Ethos
(part of RMB), HBD etc.
Comprehensive Expensive – may have to
selection process. give up too much equity.
Strong likelihood of a
Secondary funding Reduced control and
usually easier to restrictions on ability to
access (at a price). take actions.
No regular cash VC’s usually require very
outflows (e.g., high project returns.
Benefits of V/C Involvement
• Sounding board for management
• Access to further equity funding.
• Interfacing with investor group.
• Monitoring financial performance.
• Monitoring operational performance.
• Obtaining alternative debt financing.
Source: Iwisi D.S., Kitindi E.G., & Tesfayohannes, M. 2003. “Venture Capital: Overlooked Financing Source for SA Small Businesses”
Other Forms of Finance
• Supplier financing.
• Credit cards.
• Community, e.g. “Stokvels”.