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| In financing a business, the entrepreneur determines the amount and timing of funds needed. Seed or start-up capital is the most difficult to obtain, with the most likely source being the informal risk-capital market (angels). These investors, who are wealthy individuals, average one or two deals per year, ranging from $10,000 to $500,000, and generally find their deals through referrals.
Although venture capital may be used in the first stage, it is primarily used in the second or third stage to provide working capital for growth or expansion. Venture capital is broadly defined as a professionally managed pool of equity capital. Since 1958, small business investment companies (SBICs) have combined private capital and government funds to finance the growth and start-up of small businesses. Private venture-capital firms have developed since the 1960s, with limited partners supplying the funding. At the same time, venture-capital divisions operating within major corporations began appearing. States also sponsor venture-capital funds to foster economic development. In order to achieve the venture capitalist's primary goal of generating long-term capital appreciation through investments in business, three criteria are used: The company must have strong management; the product/marketing opportunity must be unique; and the capital appreciation must be significant, offering a 40 to 60 percent return on investment. The process of obtaining venture capital includes a preliminary screening, agreement on principal terms, due diligence, and final approval. Through a referral, entrepreneurs need to approach a potential venture capitalist with a professional business plan and a good oral presentation. After a successful initial presentation, the entrepreneur and investor agree on principal terms before the due diligence process is begun. Due diligence involves a detailed analysis of the markets, industry, and finances and can take up to three months. The final stage requires comprehensive documentation of the details of the transaction.Valuing the company is of concern to the entrepreneur. Eight factors can be used as a basis for valuation: the nature and history of the business, the economic outlook, book value, future earnings, dividend-paying capacity, intangible assets, sales of stock, and market price of stocks of similar companies. Numerous valuation approaches can be used and include an assessment of comparable publicly held companies, present value of future cash flow, replacement value, book value, earnings approach, factor approach, and liquidation value. In the end, the entrepreneur and investor must agree on the terms of the transaction, known as the deal. When care is taken in structuring the deal, both the entrepreneur and investor will maintain a good relationship while achieving their goals through the growth and profitability of the business. |