Foundations of New Venture Finance 267established by the Central Intelligence Agency (CIA) to tap into high-tech firms and
security-related ventures. The Federal Bureau of Investigation (FBI) and Defense
Intelligence Agency (DIA) participate in In-Q-Tel, and the Army and the National
Aeronautical and Space Administration (NASA) plan similar venture capital opportuni-
ties. Hundreds of millions of dollars have been invested since 1999 and more since
9/11/2001. “Through In-Q-Tel, the FBI has been able to review new, cutting-edge tech-
nologies that have not yet been fully developed for the commercial market,” says Jack
Israel, the FBI’s chief technology officer.^18
We will return to the subject of venture capital in the next chapter, when we discuss
how investors evaluate proposals, structure deals, and negotiate.
Public offerings are the ultimate source of outside equity and wealth creation. When
you own 100 percent of a company that earns $500,000 per year, you make a very good
living. When you own 50 percent of a company that makes $500,000 per year, is pub-
licly traded, and is valued at 25 times earnings (25 x $500,000 = $12.5 million x .50 =
$6.25 million), you are a multimillionaire. Often, in order to go from well-off to rich,
the founders of the venture must take their firm public. This type of financing creates
significant wealth because it capitalizes earnings at a multiple (the price-earnings ratio).
“Going public” is done with the aid of an investment banker through an investment
vehicle known as the initial public offering (IPO).
The IPO enables a firm to raise much more equity capital than was previously possi-
ble. It also allows the entrepreneur, the top management team, and the earlier investors
who still own shares of the firm to sell some shares. This event, often eagerly anticipat-
ed by founders and early investors, represents one of the most lucrative financial oppor-
tunities in a businessperson’s career. The value of the firm increases by an estimated 30
percent at the completion of a public offering.^19 The appendix to Chapter 7 offers a
detailed look at the process of going public.
For entrepreneurs and their top managers, going public is the culmination of years of
hard work, public recognition of their success, and the delivery of long-delayed financial
rewards. On the downside there are disadvantages and real costs to going public, costs
that entrepreneurs should weigh against the benefits of going public. The pros and cons
are detailed in Street Story 7.2. Street Story 7.3 deals with the important factors that
must be considered in deciding whether to go public.
Debt-Based Financing
Debt is borrowed capital. It represents an agreement for repayment under a schedule at
an interest rate. Both the repayment schedule and the interest rate may be fixed or vari-
able or have both fixed and variable components. In most cases, debt costs the company
less than equity. Interest rates on debt are historically less than rates of return on equity.
Why would entrepreneurs ever seek anything but debt? Because debt often requires col-
lateral and its repayment always requires discipline to meet the regular interest and prin-
cipal payments. Failure to meet those payments puts the company in default and in jeop-
ardy of forced bankruptcy. If the loan is collateralized (i.e., has encumbered a specific
physical asset as assurance of repayment of principal), default may cause the loss of that
asset. Therefore, entrepreneurs often seek higher-cost equity because share-owners have
no legal right to the dividends of the company, and the equity holder is the owner of last