Venture Capital and Private Equity

FIN ZG 528

Session 1
(Contact Hours 1, 2)
Introduction/ Overview
Krishnamurthy Bindumadhavan, CFA, FRM
Associate Professor, Management - Finance
Email: k.bindumadhavan@pilani.bits-pilani.ac.in

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Agenda

 Need/Importance of pursuing this course

 Describe entrepreneurship & characteristics
of entrepreneurs
 Sources of entrepreneurial opportunities
 Describe an entrepreneurial venture’s
financial goal

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Agenda-Contd.

 Discuss entrepreneurial finance & role of

the financial Manager
 Describe the stages of a venture’s life cycle
 Identify types of financing & major suppliers
by life cycle stage
 Understand the life cycle approach-a
complete overview for venture operating
and financial decisions

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Need / Importance of Course

• Tremendous Rise in Entrepreneurship and New Firms all over

the world

• People in search of business/commercial ideas which can be

converted into marketable products/services

• Funding is most critical aspect of a new venture. Market

based funding is gaining traction.

• Understanding venture capital and private equity is interesting

following recent growth in this source of funding also because
of startup movement. However, complexities abound and
critics view needed.

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Entrepreneurship Fundamentals

 Entrepreneurship
>process of changing ideas into commercial
opportunities & creating value

 Entrepreneur
>individual who thinks, reasons, and acts to
convert ideas into commercial opportunities
& to create value

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Entrepreneurial Traits or
Characteristics
A successful Entrepreneur:
 Sees and seizes a commercial opportunity
 Tends to be doggedly optimistic (perhaps
even to a fault)
 Plans and construct paths to obtain the
physical, financial, and human resources
needed for the venture to succeed

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Non-Entrepreneurial Traits
or Characteristics

Success is unlikely if you:

 “Are seldom able to see an opportunity,
until it ceases to be the one” (Mark Twain)
 “View the glass as being half-empty or
half-full instead of full” (unknown)
 “Fail to plan which may be viewed as
planning to fail” (unknown)

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Opportunities Exist but
Not Without Risks
• Risk and return go together. Business ventures are
exposed to high risks

• Common causes of venture failure are: inadequate

sales, insufficient profits, industry weakness, excessive
debt, insufficient financial capital, insufficient managerial
experience, business conflicts, family problems, frauds,
disasters, etc

• Essential to manage business risks

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Sources of Entrepreneurial
Opportunities
• Societal Changes – social preferences like food,
clothing, travel or leisure, housing and so on

• Demographic Changes- age and composition of

population

• Technological Changes- information boom and

development of ecommerce and mobile technologies

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Entrepreneurial Venture’s
Financial Goal
 Maximizing the Venture’s Value (to the
entrepreneur, management team & venture
equity investors)
 Cash is King! Cash Build vs Cash Burn
>Value depends on the venture’s
generation of free cash flow over time
 Risk must be Considered >The timing &
riskiness (variability) of cash flows
ultimately determine the present (today’s)
value of the cash flows

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Public markets vs Private
markets
• New venture financing involves search, negotiation and
privacy

• Public markets are efficient and liquid, however, private

markets lack in efficiency (price discovery) and rather,
illiquid (difficult to sell)

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Business Ethics & Social
Responsibility
 Business ethics reflect the entrepreneur’s
attitude and conduct towards the venture’s
customers, employees, creditors, venture
investors, & the community as a whole
 Following laws, regulations, & practicing
high ethical management, marketing, and
finance standards builds confidence &
support for the entrepreneur and the
venture

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Life Cycle Stages of
Successful Venture

Source: Entrepreneurial Finance by Leach and Melicher

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Early Stage Firms vs
Seasoned Firms
• Early Stage Firms are new/young firms with little
operating histories

• Development, Startup or Survival life stages fall under

early stage firms

• Seasoned Firms are in rapid growth or maturity stages,

therefore, they have track record of operating histories

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Development Stage

• Venture progresses from an idea to a promising

business opportunity

• Comments, reactions and feedback sought from various

experts

• The feasibility of idea is tested, development of

prototypes and trial run of idea

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Startup Stage

• Venture is organized, developed and an initial revenue

model is put to place

• Need all resources to be organized including physical

and intellectual, streamlining production and delivery
processes

• Revenue generation also begins

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Survival Stage

• Revenue grows, however, not enough

• Financing sought through debt or equity

• Need financing to put it to growth trajectory

• Serious financial planning/formal financial statements

begin

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Rapid Growth Stage

• Revenues and cash flows grow very rapidly; hence,

large appreciation in venture’s value

• Substantial gaining of market share

• Benefits of economies of scale in production and

distribution

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Maturity Stage

• Growth in revenues and cash flows continues but at a

slower rate

• Saturation in increasing more value as most of it is

already realized

• Characterized by sale or merger by entrepreneur or

investors willing to exit

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Types and Sources of
Financing by Life Cycle Stage

Source: Entrepreneurial Finance by Leach and Melicher

BITS Pilani, Deemed to be University under Section 3, UGC Act

Seed Financing-Development
Stage
• Entrepreneur’s own assets/financial bootstrapping

• Family and friends – an important secondary source

• A few angel investors may invest

• Also available through incubators under govt. schemes

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Startup Financing-Startup
Stage
• Entrepreneur’s assets/family and friends continue to provide
financial support

• Angel investors/Venture Capital can be tapped/requirement of

funds quite larger/extraordinary returns for high risk

• Business Angels- informal investors, not uninformed

investors. Invests in technologies, products with personal
interest and previous experience

• Venture Capital is formal and organized funding to new and

fast growing ventures

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First Round Financing-
Survival Stage
• Expenses and investments exceeds revenues, hence
cash shortfalls and need for external equity

• Venture Capital brings firm to full operations

• Suppliers credit/ early recovery from debtors ease

financial woes

• Government Schemes/Commercial banks may provide

some financing

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Second Round Financing-
Rapid Growth Stage
• Funding rapid growth requires more investment in
inventories and accounts receivables/working capital
expansion

• Business operations, venture capital, suppliers and

customers, commercial bank and investment bankers
provide most of the funding

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Mezzanine Financing-Rapid
Growth Stage
• Ventures usually gets break even before rapid growth
stage

• Funds for plant expansion, marketing expenditures,

working capital and product/service improvements

• Mezzanine financing provides debt, often includes an

equity ‘kicker’ or ‘sweetener’ in the form of
warrants/rights/stock options to purchase equity at a
specific price and within the set time.

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Liquidity Stage Financing-
Rapid Growth Stage
• Access to public markets (stock markets)/ private equity

• Temporary or bridge financing for financing gap till the

IPO offering

• Characterized for exits by venture capital through IPO

proceeds/sale or merger/acquisition of firm

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Seasoned Financing-Maturity
Stage
• Retained earnings from business operations – a major
source

• Loan from commercial banks, issue of shares/bonds

• Seasoned financing to cut taxes, fine tune returns and

provide capital for mergers/acquisition or extraordinary
expansion

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Life Cycle Approach: Venture
Operating and Financial Decisions

Source: Entrepreneurial Finance by Leach

and Melicher

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Homework

• Review the Chapter 1 from textbook

• Review discussion questions given at the end of Chapter 1

• Attempt Exercises/Problems given at the end of Chapter 1

• Email me your expectations from this course:

k.bindumadhavan@pilani.bits-pilani.ac.in

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Source

Entrepreneurial Finance, 5th Edition

Authors: Leach and Melicher
Publisher: Cengage Learning

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