Spisni, Massimo

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Almae Matris Studiorum Campus

Tanega2_mod2

23/04/20091Understanding Entrepreneurial FinanceAnd Venture CapitalIn the Corporate Life CycleA Risk Symmetric Perspective23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 1byJoseph TanegaReader International Financial LawUniversity of WestminsterVisiting Professor, University of BolognaRequired return line forAny given level of riskAverageReturnRisk and Return TheoryIncreasingReward23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 2Volatility (Standard Deviation)IncreasingRiskSee:  Moles and Terry (1999) The Handbook of International Financial Terms, p xxi.ReturnBond-likeEquity-like54 Preference SharesCommon StockOptionsConvertible BondsAsset Classes• Capital marketsdeterminesreference rate ofall financialinstruments, and23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 30      1     2     4     5     6    7     8     9     10     Ris k3210US TreasuriesGov’t BondsCorporate Bonds • CM enables participantsto appreciate marketvalue of particulartypes of financingrelative to benchmarkinstruments23/04/20092Capital MarketsDebt EquityBank Commercial Preferred USCapital Markets are Composed of Asset Classes23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 4loans Bonds paper Leases Common Preference UK WarrantsAdapted from Grinblatt & Titman (2002) p. 5Capital MarketsDebt EquityMajorFinancialInstrumentsDeep Legal Principles are Building Blocks of Capital Markets23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 5BilateralRights& DutiesDeepLegalPrinciplesOffer Acceptance Conditions ContingencyEnforceability Void VoidableExecutoryRemediesNational Venture Capital AssociationModel Venture Capital Financing Documents1. Term Sheet2. Stock Purchase Agreement3. Certificate of Incorporation4. Investor Rights Agreement5 V ti A t23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 6. o ng greemen6. Right of First Refusal and Co-Sale Agreement7. Management Rights Letter8. Indemnification AgreementSource:  http://www.nvca.org/index.php?option=com_content&view=article&id=108&Itemid=136Note:  these documents will be discussed in greater detail in the Second Year Course onMerchant Banking & Private Equity – Private Equity & Structured Finance by Prof. Simona Zambelli23/04/20093• Product risk• Market acceptance• Market shareLarge group of risks are gradually eliminated over the cycle if the entrepreneurial company is to thrive. • Market shareRisks Over the Entrepreneurial Life Cycle23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 7Launch Growth Maturity Decline• Size of market at maturity• Length of maturity period• Maintain market share• Rate of decline• Size of market at maturity• Length of maturity period• Maintain market share• Rate of decline• Length of maturity period• Maintain market share• Rate of decline• Maintain market share• Rate of declineSource: Ward (2004) “Developing Financial Strategies – A Comprehensive Model” in Strategic Business Finance edited by Tony Grundy and Keith Ward. Kogan Page. p. 43.Risk = Volatility in future expected returnsFinancial Risk =Volatility of fulfilling financial obligationBusiness Risk = volatility of business industry• Distinguish high volatility in start ups23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 8• Depends on capital structure and  financial policies • E.g. high level of debt = high perception of financial risk (since principal balance plusinterest must be paid despite profitabilityof the firm)• E.g. High level equity  Æ lower level of financial risk    -to low volatility in mature companiesBusinessRiskHIVery high riskof total failureOrVery high returnsafter debt is paidHigh business riskfirm should useequity financingAs company matures Raider introduces large debt23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 9Financial RiskLOLO HICompany becomes“fat and happy” (doesn’t Borrow), then becomes a takeover target;good business but hasa bad financial strategy   to increase the value of the equity.  No change incompetitive strategy, justadded value by repositioningfinancial strategy with businessprofile of company23/04/20094LaunchGrowthCorporate Life Cycle23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 10Maturity DeclineLaunchGrowthVirtuous Cycle of Corporate Funding23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 11Maturity DeclineLaunchGrowthBusiness RiskVery Highe.g. product not workingOr market demand too smallHighe.g. hi growth not apparentto competitors. Must focus on market sharedevelopment, otherwisemarket developmentexpense is unjustified sinceIt b fit l tit23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 12Maturity Decline ene s on y compe orsMedium• Very high relative market shareof a large total market.• Recoups investments of earlierstagesLow• Cash flow reduced23/04/20095LaunchGrowthCash Flow AnalysisCash Inflow• from sales                      LowCash Outflow• R&D marketing              HighNet Cash Flow           NegativeCash Inflow• from sales                      HighCash Outflow• Marketing, fixedassets, working cap       HighNet Cash Flow           Negative23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 13Maturity DeclineCash Inflow• from sales                      HighCash Outflow                    LowNet Cash Flow            PositiveCash Inflow• from sales                       LowCash Outflow                    LowNet Cash Flow              NeutralLaunchGrowthFinancial RiskVery LowLow23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 14Maturity DeclineMedium HighLaunchGrowthSource of FundingEquity: Angel FundingOr Venture CapitalEquity: Growth Investors23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 15Maturity DeclineDebt and Equity(Retained Earnings)Debt23/04/20096LaunchGrowthDividend Policy: Pay-out RatioNoneNominal23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 16Maturity DeclineHigh TotalLaunchGrowthFuture Growth ProspectsVery HighHigh23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 17Maturity DeclineMedium/Low NegativeLaunchGrowthPrice/Earnings MultipleVery HighHigh23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 18Maturity DeclineMedium/Low Low23/04/20097LaunchGrowthEarnings Per ShareNominalLow23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 19Maturity DeclineLow DecliningLaunchGrowthShare Price/ VolatilityNone/Very HighGrowing/High23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 20Maturity DeclineStable/Stable Declining/VolatileUK FSA Risk GroupsBusiness Risk Control Risk• Strategy• Market, Credit and Operational Risk• Financial Soundness • Organisation• Internal Systems and Controls• Board, Management and Staff23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 21• Nature of Customers, Users and Products, Services • Business and Compliance CultureSource: FSA (Feb 2003) The Firm Risk Assessment Framework. Available at: www.fsa.gov.uk/pubs/policy/bnr_firm-framework.pdf 23/04/20098FSA Risk Elements1. Quality of strategy2. Nature of business3. Credit Risk4. Insurance underwriting risk5. Market risk6. Operational risk7 Litigation/legal riskBusiness Risks23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 22.  8. Adequacy of capital9. Liquidity10. Earnings11. Type of customer and/or user/member12. Sources of business and distribution mechanisms13. Types of products/services14. Market efficiency15. Proper marketsFSA Risk Elements16. Sales force training and recruitment17. Basis of remuneration of sales force18. Financial promotion19. Accepting, advising and reporting to to customers and/or users/members20. Dealing and managing21 S it f t d/ / b t32. Compliance33. Internal audit34. Outsourcing/third party providers35. Professional advisers36. Business continuity37. Money laundering controls38 Market cleanlinessControl Risk23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 23. ecur y o  cus omer an or users mem ers asse s22. Disclosure/adequacy of product literature23. Membership arrangements24. Clarity of legal/ownership structure25. Jurisdictions/characteristics of controllers/group entities27. Risk management28. Policies, procedures & controls29. Management information30. IT systems31. Financial and regulatory reporting and accounting policies.  39. Clearing and settlement arrangements40. Corporate governance41. Allocation and definition of managementresponsibilities42. Quality of management43. Human resources44. Relationship with regulators45. Cultural issues and business ethicsProblems1. How would you rank the following instruments on the risk and return graph?(1) Mezannine debt(2) Convertible bonds(3) Subordinated debt(4) Senior debt(5) Mortgage-backed debt(6) Government debt(7) Preferred stocksMeanReturns23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 24(8) Common stock(9) Warrants and optionsVolatility23/04/20099Answers1. How would you rank the following instruments on the risk and return graph?(1) Mezannine debt(2) Convertible bonds(3) Subordinated debt(4) Senior debt(5) Mortgage-backed debt(6) Government debt(7) Preferred stocks(8) Common stockIncreasingMeanReturns(2) Convertible bonds(7) Preferred stocks(8) Common stock(9) Warrants & options23/04/2009 Joseph Tanega: Understanding Entrepreneurial Finance & Venture Capital 25(9) Warrants and options(10) Asset backed debtIncreasing Volatility(6) Government debt(5) Mortgage-backed debt(10) Asset backed debt(4) Senior debt(3) Subordinated debt(1) Mezannine debt

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Tanega2_mod2

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