15.

431:
Entrepreneurial Finance

Spring 2002

Antoinette Schoar
1

Sloan School of Management MIT

Course Overview:
The World of Entrepreneurial
Finance

Large increase in supply of and demand for venture capital/private equity.

Record amounts raised in every year 1995-2000.
Even with drop in fundraising in 2001 it is about what it was in 1998 and 17x the level in 1990. Likely to continue at relatively high rates, i.e. probably not just boom part of cycle.

Does this reflect a structural shift in the way new businesses/projects are organized and financed?

Unprecedented Flow of Funds into

Start-up Companies

120 100

$ billion

80
60
40
20
0
1980

1985

1990

1995

2000

Investment

Fundraising

Data Source: Venture Economics

What Is Special About

Entrepreneurial Finance?

Valuing New Ventures

Large uncertainties
Massive option values

Financing new ventures:

Large financing needs Severe information problems

Severe agency problems

These issues are common to all new projects, but here we focus on how investors and entrepreneurs deal with them.

Course Perspectives and Goals

Understand the broader issues of investing in entrepreneurial ventures Understand the more detailed issues of how to evaluate and finance entrepreneurial investments Apply tools developed in 15.401 and 15.402, and go beyond them:
Issues here are more complex
Finance most important in birth and death of firms

Study interaction of finance and strategy

Course Perspectives and Goals

Ultimately

our goal is to give you some of the tools you need to:
Start a company and finance it Be a venture capitalist or private equity partner
Invest in private equity partnerships

Course Overview

Module 1: Business Valuation

Framework for qualitative and quantitative evaluation of new business opportunities
DCF Method Venture Capital Method Real Options Method

Course Overview

Module 2: Structuring Investments/Financing

Terms of the initial investment/financing

Understanding deal terms

Evaluating deal terms
Negotiating deal terms

Follow-on investments
Later Stage Deals

Course Overview

Module 3: Venture Capital Funds

Structure of partnership compensation

Structure of partnership covenants Partnership strategies

Corporate Venture Capital Funds International Venture Capital Funds

Course Overview

Module 4: Employment Issues

Joining start-ups Valuing alternative compensation plans

Module 5: Exit
IPO Sale Liquidation

10

Course Mechanics

Cases (16), Lectures (6), Guests (2) Guideline questions for each case available
Work in study groups of no more than 4
Expect to grope around
Not meant to be easy, but you'll learn more Do not use outside sources (library, web) to find out what happened

11

Memos

Memos are 10% of grade

Hand in memos for 12 out of 16 cases. Must do first case, Technical Data Corporation Be ready to discuss cases even if youre not handing in memo Memos should answer two questions:

What is going on?

What would you do?

Write to major decision-maker

Up to two pages of text

Attach exhibits / calculations

12

Class Participation

30% of final grade

Individual Based on quality and quantity Good chance for to practice in low-risk environment Isn't class participation grade subjective?
Not after 20 cases TA will be taking notes in class

Mid-term participation grades

13

Class Participation Process

You know the basic rules

Listen to others and build

Try not to change the subject

Ask questions

Sometimes whole class is lost

I may cold call

Please don't come late!

14

Final Exam

60% of your grade Case based Take home exam I grade the exams, not T.A.

15

This Course Is Not For Everyone

Requires Tolerance for Ambiguity:

Entrepreneurial ventures involve massive uncertainty Not always a formula or right answer
Please do not take the course if you are looking for cookbook answers

Requires Work:
One Case/Memo Per Week Class Attendance

16

Scheduling: Guests

John Chory (Hale and Dorr)

Thursday, April 4th

Alan Spoon (Polaris Venture Partners)

Tuesday, April 9th

17

Exciting Time for Entrepreneurship

Large

increase in supply and demand for private equity

Massive inflows of funds in to VC partnerships
Record number of firms in the industry

Huge opportunities
New technologies Regulatory changes Organizational changes

18

Unprecedented Flow of Funds into

Start-up Companies

120 100

$ billion

80
60
40
20
0
1980

1985

1990

1995

2000

Investment

Fundraising

Data Source: Venture Economics

19

World wide rise in New Venture Financing

Fund Flows into Companies - Europe 1989-1999
30000
EUR in billions

30000 25000 20000 15000 10000 5000 0

25000 20000 15000 10000 5000 0

19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99

New Funds Raised

Investments

Year
Data Source: European Venture Capital Association

20

Unprecedented Number of IPOs

VC backed IPOs
300 250 200 150 100 50 0
VC backed IPOs

8 19

8 19

8 19

8 19

8 19

9 19

9 19

9 19

9 19

9 19

0 20

Data Source: SDC

21

But there are Differences ...

IRR (%) For US Venture Capital Firms 1992-1998

150 100 50
Max imum IRR Median IRR

0 92
-50

93

94

95

96

97

98

Minimum IRR

-100 -150
Year
Data Source: Venture Economics

22

Why is Entrepreneurship Important?

Central to Growth and Job Creation

Small companies earn 50% of GDP

Small companies provide 50% of jobs in the US

Important for Knowledge Creation

Young firms patent groundbreaking innovations

Entrepreneurs have Higher Upward Mobility

23

Small Firms are Increasing in

Importance in the Economy

US Small Business Firms 1988 - 1998

6 300 250 200 150 100 50 0 88 89 90 91 92 93 94 95 96 97 98

5.8 5.6 5.4 5.2

5

$ in million

in million

# of Start-up Firms Tax Revenues

4.8 4.6 4.4 Year

24
Data Source: U.S. Census Bureau

But Uncertainty is High

Business Turnover 1990 - 1998

700000 600000 500000 400000 300000 200000 100000 0
90 91 92 93 94 Year 95 96 97 98

Firm Terminat ion

Firm Birth

25

Data Source: U.S. Census Bureau