Friday, April 18, 2008

Notes from mEga 180408 workshop


Workshop 3a – Feasibility 1

Private Equity Investors: Business Angels & Venture Capitalists

Noel J Lindsay, PhD FCPA

Professor of Entrepreneurship Commercialisation and Innovations Centre

Faculty of Engineering, Computer and Mathematical Sciences, University of Adelaide

Who are business angels and venture capitalist?

Developing an Entrepreneurial Business: Key Drivers need to be balanced:

Based on: "Timmons Model of the Entrepreneurial Process.

Jeffry Timmons, Stephen Spinelli, New Venture Creation: Entrepreneurship for the 21st Century, Harvard Business School Press

- Business Opportunity
- Resources
- Team to take business forward – with a ‘lead’ founder

These need to be adequately balanced
Other considerations:
- Business Plan
- Sustainability: for Environment, Community and Society

Types of Finance:
- External Funds – debt (funds obtained for the company that need to be repaid … generally with interest); equity – (funds obtained for the company in exchange for ownership of the company); Grants – (Funds obtained for the company that do not need to be repaid nor which involved ownership; Banks – (will require evidence of good cash flow and some form of ‘security’)
- Internal Funds – Profits, sale or reduction of assets, extended payment terms, accounts receivables
- Sources of Finance: personal funds, family and friends, bootstrap finance, employees, banks, larger corporates, government grants/loans, business angels, venture capitalists, Initial Public Offering on the Stock Exchange (IPOs), other

Venture Financing Life Cycle (and sources of Finance): Concept, Startup (Friends, Family, Fools), Early Growth (Business Angels), High Growth (Venture Capitalists), Maturity (Merchant Banks)

Playford Capital - Playford Capital invests seed capital in early-stage South Australian companies. We provide funding, advice and contacts for technology-based businesses in a broad range of industries

Newness (Invention) & Value Added – where these overlap you have “Innovations”. Innovations is required as there are plenty of inventions registered at Patent offices around the world which have not ‘hit the marketplace’.

Team is of utmost importance – entrepreneurship of team members is very important. Investors invest in ‘people’ and their integrity and entrepreneurship – and not the ‘widgets’ or ‘inventions’ or ‘ideas’.

Sources of Risk Capital: Business Angels
- high net worth individuals, who use their own money
- people who seek equity in an unlisted company in exchange for their own capital
- tend to be middle aged males with business/professional backgrounds
- goal is to grow the company and hence share in the capital gains
- different from institutional investors (venture capitalists, etc) as they often want to take an active role – look for someone who will ‘add value’or increase the ‘credibility’ to your business

How do we find Business Angels? – personal networks, business networks, social networks, accountants and lawyers, introduction registers

OPR – other people’s resources – always try to use other people’s resources or money – even if you have the resources yourself.

Business Angel Deal Focus:
- can invest up to $200,000 of their own money
- often target earlier stage ventures … often high tech, entrepreneurial ventures
- often heave a ‘psychic affinity’ with the deal
- May use a syndicate

Sources of Risk Capital: Venture Capitalists
- Are institutional Investors (they don’t use their own money – ie OPR)
- Investments size: generally > $1m – looking for a high rate of return on investment
- may use syndicates
- manage funds of large financial institutions
- do not want to have management input but want Board representation
- once they invest, typically they are relatively patient
- relatively easy to locate
- they will ‘add value’ to your business through their networks and expertise

How to we find Venture Capitalist?

Types of Business Risks which Venture Capitalists will investigate: development risk, production risk, market risk, management risk

How the Enterpreneur Game is Played
- grow the pie – forget about the size of the slices (but make sure that no other invester has > 50%) – you grow your business through either the development of products or markets
- don’t worry about voting control
- focus on maximsing profits and an IPO
- understanding rapidly growing businesses are short of cash
- money that is invested in tbe business stays in the business
- increased value of the business comes from increased profitability & converting from a private to a public company
- raising cash is an ongoing process of capital placements: dilution is continual
- divide and conquer investors

Critical variables affecting finance availability and cost
- milestones achieved to date
- investor’s perceived risk
- industry and technology
- upside potential of venture
- timing of expected exit
- expected growth rate of venture
- venture age and stage of development
- investor’s required ROI
- capital required and valuation of venture
- founder vision – should have a ‘time horizon’ and should be measurable, can have more than 1 ‘founder’, but investors will want to see a ‘lead founder’
- relative bargaining positions

Structuring the Deal
- Use of Equity Hybrids – convertible notes (loan from investor, interest payable – investor may want to convert to ‘shares’ if business starts to do well – if business runs into difficulty then the ‘lendor’ is likely to get some of their money back during the ‘winding up’ of the business), convertible redeemable preference shares
- tranches – subject to performance criteria – milestone payments
- claw-backs – on performance, entrepreneur gains from investor, investor gains from entrepreneur, no ceiling and floors, can be ‘mutual’
- voting – Board – one vote per Director, shareholders – as per shareholding, special resolutions – winding up

Negotiating the Deal
- the entrepreneur’s bargaining position is influenced in part by the venture’s free cash flow determinants: cash burn rate, time to ‘out of cash’, time to close the deal

What are Opportunities?
- entrepreneurs use thei rcreativitiy to turn ideas into opportunities
- opportunities have the qualities of being atrractice, durable, abd timely and are anchored in products or services that create or add value for buyers or end users
- opportunity is like

Risk/Return Relationships – Low, Medium, High Risks affect the rate of return. The higher the risk, the expected higher level of return

Where are opportunities often found?
Opportuntities are spawned when there are:
- adversity/problems being faced
- changing circumstances
- chaos/confusion/uncertainly
- inconsistencies in the market
- time lags or leads in the availability of information
- knowledge or information gaps

Some Underlying Opportunity Cues
- industry and market issues – customer need, large market, growing market, market share attainable, are a price maker, bargaining power of customers are suppliers is low
- financial issues – high Net Profit after Tax (NPAT) and high gross profit margins, breakeven and positive cash flow within two years, high ROI potential, reasonable capital requirements, low asset intensity, rent roll
- harvest issues – value added potential, high potential valuation multiples, planned exit mechanisms and strategy
- strategic differentiation issues – exceptional proprietary technology capable of spawning multiple products, long lead time needed to copy technology, strategic alliances in place, distribution channels in place, sustainable competitive advantage, entry barriers, few or no substitutes, scaleable, endorsements, no fatal flaws

What do Investors Look for in Deals?
Adversity – Size of the Market
What is the opportunity? – not the product – you shouldn’t on the ‘product’ to sell the business idea.
Why are people going to buy your product? What are the financial benefits? Where are the market niches/advantages?
We have an exceptional team….

What is the Business Opportunity underpinning your Business? Why is it an opportunity?
Opportunity Screening Instrument: Copyright Noel Lindsay 2008
- Need/Issue/Challenge
- Target Market
- Product
- Sustainable Competitive Advantage (SCA)
- Financial Performance
- Harvestability
- Strategic Differentiation Issues

Building the Team: Filling the Gaps
Team composition will depend on
- importance of the team
- insights into building winning entrepreneurial teams
- entrepreneurial team philosophies
- common team pitfalls
– technical know-how; all other functional know-how of the business covered ie sales/marketing, finance, legal, clearly defined ‘leader’; psychological make-up/profile of the team – do you ‘complement’ one another – able to deal with conflict, ie are they: doers, thinkers, carers; team egos – can use the model of ‘Enneagram of Personality
- if you have ‘gaps’ or ‘weaknesses’ in your team – identify them and how you might address them

Key Items in the Shareholder Agreement
- scope of the venture’s operations – now and in the future, shareholder restraint provisions
- contributions of each shareholder – job specifications
- how the venture will be managed – who makes what decisions, majority versus unanimous
- exit and introduction of shareholders – valuation, preemptive rights (to other shareholders), exit mechanisms
- intellectual property – now and in the future

1 comment:

Dacks said...

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