Introduction to Corporate Finance

20: Entrepreneurial Finance and Venture Capital

finance in practice

Limited partnerships dominate the venture capital industry, partly because they make their investment

decisions free from outside influences. The financial and corporate funds tend to suffer because their

ultimate loyalty rests with their corporate parents rather than the companies in which they invest. Finally,

corporate funds have histories of only intermittent commitment to venture capital investing. Corporate

funds tend to scale back dramatically when business conditions sour. For all these reasons, limited

partnerships now control the majority of total industry resources, and their influence on fund raising

seems to be increasing.

20-2b INVESTMENT PATTERNS OF VENTURE CAPITAL AND

PRIVATE EQUITY COMPANIES

Given the media attention lavished on venture capital in the United States, most people are surprised

to learn that the industry invested only a few billion dollars each year before 1996. Of course, annual

disbursements naturally differ from total fund raising. The total amount of money available for investment

is the sum of realised investment returns (from IPOs and mergers of companies owned by VCs) as well

as new fund inflows from investors. After 1996, total investment spending surged to an astonishing

A company is considering

establishing a corporate

venture capital fund in order

to gain access to emerging

technologies. Why might

this strategy be preferred

over expanding existing R&D

operations?

thinking cap

question

HOW DO I FINANCE MY BUSINESS STARTUP?

Many business students plan to start their own

business one day, and all who do struggle with

the same question: how can I obtain the funding

needed to start my own business?

Almost all new companies are financed

informally, with investments of cash and effort

(sweat equity) by the entrepreneur, and perhaps

supplemental investments from the entrepreneur’s

friends and family. Although every prospective

entrepreneur can, and should, develop a

detailed business plan, this alone will not allow

the entrepreneur to borrow money successfully

from a bank or obtain arm’s-length equity capital

from investors. The entrepreneur instead should

concentrate on getting the business up and running

and – most vitally – generating the positive cash

flow that must be reinvested in the new business.

Such internally generated funds are usually the only

source of growth capital during a new business’s

very early stage of development.

Once the business has been operating

successfully for many months (or years), the new

entrepreneur is in a position to approach one or

more angel investors for external equity capital.

Angels are typically wealthy businesspeople who

can invest from $50,000 to over $200,000 in a new

business, and can also offer practical advice and

monitoring to the entrepreneur. Angels are looking

for an attractive financial return of 20–40% per year

from investments made in functioning, profitable

businesses with real customers, products and

cash flow.

So if you are dreaming of starting your own

business, keep the following advice in mind. First,

start small, using only money that you, your friends

and your family can provide. Second, reinvest

all your profits in the business, and employ any

reasonably priced debt financing that may be

provided by banks, suppliers or customers (but try

to avoid credit card advances). Finally, approach

business angels for your first round of external

funding once you have your business established –

then present your business plan to them as an

opportunity to invest in a growth business. Good

luck and happy entrepreneuring!