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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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