In addition they want confirmation that the founders

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Unformatted text preview: vide debt capital, want to be assured that they are taking no more risk than the founding owner(s). In addition, they want confirmation that the founders are confident enough in their vision for the firm that they are willing to risk their own money. The initial nonfounder financing for business startups with attractive growth prospects comes from private equity investors. Then, as the firm establishes the viability of its product or service offering and begins to generate revenues, cash flow, and profits, it will often “go public” by issuing shares of common stock to a much broader group of investors. Before we consider the initial public sales of equity, let’s review some of the key aspects of early-stage equity financing in firms that have attractive growth prospects. Venture Capital The initial external equity financing privately raised by firms, typically earlystage firms with attractive growth prospects, is called venture capital. Those who provide venture capital are known as venture capitalists (VCs). They typically are 1. Most preferred stock is cumulative, because it is difficult to sell noncumulative stock. Common stockholders obviously prefer issuance of noncumulative preferred stock, because it does not place them in quite so risky a position. But it is often in the best interest of the firm to sell cumulative preferred stock because of its lower cost. Most preferred stock has a fixed dividend, but some firms issue adjustable-rate (floating-rate) preferred stock (ARPS) whose dividend rate is tied to interest rates on specific government securities. Rate adjustments are commonly made quarterly. ARPS offers investors protection against sharp rises in interest rates, which means that the issue can be sold at an initially lower dividend rate. CHAPTER 7 angel capitalists (angels) Wealthy individual investors who do not operate as a business but invest in promising earlystage companies in exchange for a portion of the firm’s equity. Stock Valuation 315 formal business entities that maintain strong oversight over the firms they invest in and that have clearly defined exit strategies. Less visible early-stage investors called angel capitalists (or angels) tend to be investors who do not actually operate as a business; they are often wealthy individual investors who are willing to invest in promising early-stage companies in exchange for a portion of the firm’s equity. Although angels play a major role in early-stage equity financing, we will focus on VCs because of their more formal structure and greater public visibility. Organization and Investment Stages Institutional venture capital investors tend to be organized in one of four basic ways, as described in Table 7.2. The VC limited partnership is by far the dominant structure. These funds have as their sole objective to earn high returns, rather than to obtain access to the companies in order to sell or buy other products or services. VCs can invest in early-stage companies, later-stage companies, or buyouts and acquisitions. Generally, about 40 to 50 percent of VC investments are devoted to early-stage companies (for startup funding and expansion) and a similar percentage to later-stage companies (for marketing, production expansion, and preparation for p...
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This document was uploaded on 01/19/2014.

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