Funding the Venture – Part 2
Ch 8, Pt. 2

Equity and Debt Financing for High Growth

Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

Patterns of Entrepreneurship Management
5 th  Edition, Chapter 8, Part 2

Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Presentation Outline  
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt

•
•
•

•
•
•
•

Important terms used in equity investment
The current status of the venture capital sector
The venture capital process
The private placement process
Bank loans
Valuing an early stage company
General guidelines 

Valuations
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Key Terms For Equity Investments 
­ 1
• Equity Investment occurs when an entrepreneur sells
Ch 8, Pt. 2
part ownership in the company to raise funds
Fundamentals • In Private Equity, shares are illiquid and cannot easily 
be sold until a liquidity event, also known as an Exit, 
VC Status
occurs
VC Process • In doing so the entrepreneur suffers Dilution as they now 
PPM’s
own less of the company
Crowd­Funding• The value of the company prior to the investment is 

termed Pre­money, and after, Post­money
Bank Debt • Investors usually own Preferred Stock, which carries 
certain Preferences over the founders(s)
Valuations
• Convertible Loans are a form on investment that starts
Copyright 2015 Jack M. Kaplan & Anthony C. Warren
out as a loan but can be converted later into ownership


Key Terms For Equity Investments 
­ 2
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

•
•
•
•

Investments occur in Rounds termed seed, A, B, C etc.
If value decreases between rounds it is a Down Round
A Capit(alization) Table lists the % ownership
Investors expect to earn a high Internal Rate of Return,  
IRR of at least 30% for taking a high risk

• Investors may also receive Stock Options or Warrants 
permitting them to buy more ownership at a later date at a 
pre­determined (low) value
• Private Stock rarely pays a Dividend, or if one exits it is 
usually accrued until a liquidity event
• A Stock Option Pool  is part of the future compensation 
for key employees. It is listed in the Cap Table.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Key Terms For Equity Investments 
­ 3
• Investors may also insist certain Covenants:
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

•
•
•
•
•

A board seat
Control of certain management decisions

Right to invest in later rounds
Protection against dilution if milestones are not reached
Right to force an exit after a certain time

• Bridge Financing helps the company get to the next 
financing round. This can be very dilutive.
• Term Sheet is a non­binding agreement to invest
• Due Diligence, a detailed investigation of a company 
performed after a term sheet is agreed. 
• Lead Investors source deals, undertake due diligence, 
negotiate terms, take board seats. 
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Pre­and Post­Money 
Cap Table Example
Ch 8, Pt. 2
Fundamentals

Pre-Money Cap
Table
Ownershi
p

Name
Total=

VC Status
VC Process
PPM’s

Crowd­Funding
Bank Debt
Valuations

Shares
1,000,0
00

45%

Founder A 450,000

45%

Founder B 450,000
Option
Pool
100,000

10%

100.00%

Post-Money Cap Table
Value
$50,00
0
$22,50
0
$22,50

0
$5,000

Share
Price

Owner
ship

$0.05
33.33%
33.33%
6.67%
26.67%
100.00
%

Name
Total=
Founder
A
Founder
B
Option
Pool
Investor

Shares
1,500,0
00

500,00
0
500,00
0
100,00
0
400,00
0

Value
$1,500,0
00
$500,00
0
$500,00
0
$100,00
0
$400,00
0

In this example, the two founders sell part of the company for an
investment of $400,000. Their ownership is diluted, and they
have also allocated part of the ownership of the company in the
form of a Stock Option Plan for future employees.

Copyright 2015 Jack M. Kaplan & Anthony C. Warren

Share
Price

$1.00


Sources of Rounds of 
Equity Finance
Round

Ch 8, Pt. 2

Status

Pre-seed* Barely an idea, rough business plan

Expected IRR

Friends/family, bootstrapping, grants, and 1–40%
microequity funds

Fundamentals
VC Status

Likely Sources of Funds

Seed*

Prototype or proof of principle, no sales Angels, grants, possibly a local VC firm 20–40%

A Round* Development nearly complete, first trials Super-Angels, early-stage VC

VC Process


30%+

with customers

PPM’s
B Round

Customers, first growth phase

C/D

Sufficient to get to cash flow neutrality or Late-stage VCs in syndicate

Bank Debt

Rounds

exit

Valuations

Mezzanine Prepare for sale or IPO, acquisitions

Crowd­Funding

VC or other institutional sources of funds 30%+

Large private equity funds


20%+

15–20%

Note: crowd-funding can be considered at these stages* – see Chapter 5
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Discounted Convertible Debt
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

 This form of investment is often used in early rounds as 
it avoids the difficult issue of valuation in a start­up
 Investors lend money to the company (called a 
debenture)  
 The money earns interest (referred to as coupon) 
between 7­12%.
 Interest is not paid but accrued
 When a defined level of equity is raised later, the first 
investors can choose to convert their total debt at a 
discount of between 20­24% to the new money
 The discount may be time dependent
Copyright 2015 Jack Kaplan and Anthony C. Warren



IRR of VC Funds by Vintage Year
Source: Cambridge Associates LLC, 2012

Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

The dot.com bubble in the late 90’s fundamentally changed the Venture Capital
landscape. At its peek VC firms raised a lot of money, but have been unable to
achieve any reasonable returns in the last decade. In order to invest their large
amounts of cash the focus has moved to later stage companies making it very
hard for entrepreneurs to get early stage venture financing.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Venture Capital Raised by Vintage Year

Ch 8, Pt. 2
Fundamentals

Source: NVCA, 2011

VC Status

VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

This chart shows the impact of the dot.com bubble on the ability of VC’s to
raise large funds. The poor returns over the last decade have reduced the
amount of new money flowing to the fund managers until recently.

Copyright 2015 Jack M. Kaplan & Anthony C. Warren


VC Performance 1990­2008
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

Here are these two sets of data superimposed to show the
high influx of funds while returns plummeted. During the
lean years better returns could be attained by putting
money into a bank account!
Copyright 2015 Jack M. Kaplan & Anthony C. Warren



Signs of Recovery
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

Source: PwC/NVCA MoneyTree™ Report. Data: Thompson Reuters

However there has been a recent recovery in the VC sector with
investments focused on social media and internet scalable
businesses. But we are still well below the over-enthusiasm of the
Copyright 20015 Jack M. Kaplan & Anthony C. Warren
dot-com bubble.


The IPO Dearth Years
Ch 8, Pt. 2

Source, NVCA

Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt

Valuations

Until recently, poor economic conditions have suppressed the Initial
Public Offering market, with exits moving to corporate purchases. This
shift makes building a “virtual” or “essential” company an attractive
strategy.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Summarizing Trends in VC’s
•
Ch 8, Pt. 2 •
•
Fundamentals •
•
VC Status
•

Funds have got larger….
Money must be “put to work” but….
New business models can be more capital efficient….
Resulting partly from the impact of the Internet
So Entrepreneurs are using other sources of funds
Bootstrapping is de rigeur in current environment

VC Process

• New Models have emerged to fill the gap:
• Early Buy-in by VC-funds to “capture” deal - little due diligence
PPM’s

• Micro-equity funds such as YCombinator and DreamIt
Crowd­Funding
Ventures combining networking and seed funding
• “Crowd-Funding*” - Internet sourcing of loans or equity
• Virtual companies – use resources from anywhere only when
Bank Debt
required
Valuations

* See Kevin Lawton’s site: />Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Venture Capital is Focused
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

 VC Firms Specialize: 
•
•
•
•
•
•


By Industry Sector
By Location of the Venture
By Stage of Development of the Venture
By Stage of Their Fund
By Size of Funding Required
By Their Perceived Ability to Add Value

 
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Venture Capitalists Seek:
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

High returns (IRR’s) of 30% or more
Or alternatively 10 times money invested
High growth companies
Deals requiring over $2 million for the 
initial round and possibly > $10million 
overall in multiple rounds
 Company has gained its first customers
 An exit within 3­5 years






Copyright 2015 Jack M. Kaplan & Anthony C. Warren


What VC’s Expect
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

• For a typical start­up ­ Venture Capital 
Fund will invest 2­3 million for 40% 
preferred equity ownership position.
• This gives VC’s a liquidation preference 
over common shares until the 2­3 
million is returned.
• If Venture fails, they have first claim to 
assets including technology.
• Also blocking rights over key decisions 
including sale of the company or IPO.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren



VC’s also ask for: 
• Anti­dilution clauses or “Ratchets” ­ This 
Ch 8, Pt. 2
protects against equity dilution of additional 
rounds of financing in “down­rounds”.
Fundamentals
• This preferential treatment comes at the 
VC Status
expense of all common shareholders.
VC Process
• If company does well, VC enjoys upside 
PPM’s
provision by having right to put additional 
Crowd­Funding
money at a set price using warrants or 
options.
Bank Debt
• Limiting risk by co­investing with other firms 
Valuations
known as “syndicating”.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Profile of the Ideal Entrepreneur from a 
VC Perspective
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s

Crowd­Funding
Bank Debt
Valuations

There are client or customer references
The opportunity is considered a “hot” area
The venture delivers scalable technology and markets
The team is diligent and goal oriented
The entrepreneur is skilled in finance, capital and deal 
structures
 The entrepreneur will accept advice
 The entrepreneur will not resist replacement if they are 
not capable of managing growth
 Realistic expectations are incorporated into goals of 
the company






Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Optimistic Investment Timeline
WEEK

Ch 8, Pt. 2

0


TASK
Entrepreneur identifies VC’s with appropriate match to needs

2­4

Entrepreneur gains personal introduction to a partner(s)

2­6

Entrepreneur has first telephone call, sends executive summary

4­6

Additional telephone calls, and exchange of business plan

VC Process

6­8

Invitation to first presentation

PPM’s

8­12

Invitation to a full partners’ meeting presentation and discussions

Crowd­Funding


10­16

Negotiation of Term Sheet, Signing of a Non­Disclosure Agreement

12­20

Due Diligence

Bank Debt

16­24

Re­negotiation of Term Sheet, preparation of full legal documents

Valuations

18­30

Closing and deposit of first tranche of investment funds

Fundamentals
VC Status

Copyright 2015 Jack M. Kaplan & Anthony C. Warren


The Structure of VC’s
Limited
Partners


Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s

VC General Partnership(s)
General Partners

Syndicate

Crowd­Funding
Bank Debt
Valuations

VC II

Portfolio Companies
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


How the Money Flows IN
Ch 8, Pt. 2
Annual Management Fee = 2- 3%

Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding


Called
Investment
From Limited
Partners
Individual CoInvestments

Bank Debt
Valuations
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


How the Money Flows OUT
Ch 8, Pt. 2
Fundamentals

Money Back “off the top”
+ 80% of the Remaining

VC Status

20% “Carry”

VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

Acquirer or IPO


Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Using a Private Placement 
Memorandum (PPM)
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding

•An alternative to seeking venture capital, is to offer shares in
your company to one or more private investors using a PPM.
•There are a number of federal and state restrictions that must
be met and you will need a securities lawyer to prepare the
documents and make sure all the regulations are followed
•You should only offer shares to “accredited investors” who
must meet certain requirements regarding personal net-worth
and income history. They must certify in writing that they are
able to lose all their investment.
•The PPM must list all the risk factors in the investment

Bank Debt
Valuations

•There are private bankers that have networks of private
investors that they advise. You will need an introduction and
you should check on references. They take a fee for raising

the agreed finance.
Copyright 2015 Jack M. Kaplan & Anthony C. Warren


Examples of PPM Regulation 
Classes
Ch 8, Pt. 2
Fundamentals
VC Status
VC Process
PPM’s
Crowd­Funding
Bank Debt
Valuations

Rule 504
• Up to $1,000,000
• 12  month completion period
• No restrictions on the number of  investors
Rule 505
• Up to $5 million
• 12 month completion period
• No more than 35 non accredited investors and unlimited 
number of accredited investors
Rule 506
• Unlimited amount of raising funds
• No more than 35 unaccredited but sophisticated purchasers.and 
to unlimited number of accredited investors.
• must be able to evaluate merit and risks.


Copyright 2015 Jack M. Kaplan & Anthony C. Warren