Sources of Capital Disney Productions n n

Sources of Capital

Disney Productions n n n Entrepreneurial endeavors started when 10 “doctoring” German helmets in WW I $250 started Iwerks & Disney 1937 - success of Snow White 1940 - sold 755, 000 shares common stock raising $8 million Sold Mickey Mouse to ABC for $5 million for Disney Land

Funding Stages n Seed or Start-up n n Development n n SBIR, Venture Capital (A) Growth n n Bootstrapping, Angel Investors Debt, Venture Capital (B, C) Competitive or Maturity n Debt, IPO

Bootstrap Financing 75% of start-ups are self-financed Advantages n n Low pressure on valuation Easy terms on ownership Control by founders No time spent on finding investors Disadvantages n n n Unable to fund growth phase Lack of funding commitment for future Loss of advice from professional investors

Angel Investors n n n Wealthy, experienced entrepreneurs who invest in start-ups in exchange for equity in the new ventures Angles invest about $16 billion per year in early-stage U. S. companies Examples n n Jeff Bezos (Amazon) raised $1. 2 million from angels Mike Markkula invested $91, 000 and guaranteed $250, 000 line of credit for Apple Comp. Start-up

Angel Investors Criteria for Investing n n n Within Industry Angel has experience Within geographic vicinity Recommended by trusted Bus. Assoc. Entrepreneur w/right characteristics Good market growth potential Investment of $100, 000 – 1, 000 with 40% ownership

Venture Capital n n Managed by investment professionals on behalf of venture capital fund Stage Funding n n Seed – team formation / business plan (seldom) Series A – product development completed Series B – product test and customer acceptance Series C – Launch product into market

Venture Capital Investment Requirements n n Industry is well known to Venture Fund Investment > $1, 000 Company is in appropriate stage of progress Potential return is 40% or more annually

Venture Capitalist Functions n n Obtain finance capital for start-ups Evaluate projects for other participants in the venture Provide expertise for the development of the firm Central coordinator for participants involved in firm

Venture Capital Firms n n National Venture Capital Assoc. http: //www. nvca. org Silicon Valley Social Venture Fund (SV 2) http: //www. sv 2. org Social Enterprise Alliance http: //see-alliance. org

Venture Capital Deal n n n Determine cash needed & its use Locate venture capital investors Determine risks that can be reduced n n n Team risk Capital risk Technology risk Market risk Agree on valuation & ownership structure Agree on contract

Existing Operations Corporate Venture Capital Advances strategy Allows exploration Tight of current business: of new business: Microsoft Agilent Loose Complements current business: Intel Strategic Provides potential financial returns: Dell Financial Corporate Investment Objective

Valuation (capital return)

Valuation (capital return) Investor invests $1. 1 million in the series A stage, expects an annual return of 45%. If the harvest time is 5 years, then what is the capital return ?

Valuation (market value)

Valuation (market value)

Valuation (market value) Based on average earnings growth and industry, investor estimates PE ratio of 16 and PS ratio of 2. 3 for a 5 year period. Estimate Market Value for firm.

Valuation (market value) Based on average earnings growth and industry, investor estimates PE ratio of 16 and PS ratio of 2. 3 for a 5 year period. Estimate Market Value for firm. MV = 16 x E(5) = 16 x $1, 000 = $16, 000 MV = 2. 3 x S(5) = 2. 3 x $8, 000 = $18, 400, 000

Valuation (Ownership %)

Venture Capital (Terms of Deal) n n n n % ownership of investors Timing of investment Control exerted by investors Rights to require an IPO Type of security Reservation of ownership (stock options) Antidilution provisions Milestones of achievement

Debt/Equity Financing n Debt financing n n n Long term > 1 yr. Short term < 1 yr. Equity Financing n n sale of assets reduction in working capital extended payment terms inventory reductions

Financing Sources n n n Commercial Banks Small Business Administration Research & Development Limited Partnerships Government Grants Private Placement

External Financing n Evaluation Basis n n n length of time funds are available the costs of the funds amount of company control lost

Commercial Banks n Asset Base (Collateral) n n Accounts Receivable - up to 80% of A. R. - factoring Inventory Loans - finished goods up to 50% Equipment - 50 to 80% of equipment value - lease financing or sale-leasback Real estate - 75% of value

Commercial Banks n Cash Flow Financing n n n Line-of-Credit Installment loans - 30 -40 days, need a track record Straight Commercial loans - 30 -90 days Long-term loans Character loan - usually requires personal collateral

The 5 C’s n Character n n n Case Tractors in CA Capacity Capital Collateral Conditions

Small Business Admin. n SBA Guaranty Loan n n SBA guarantees 80% of amount loaned new buildings up to 20 yrs. existing buildings up to 15 yrs. equipment, inventory, working capital up to 10 yrs. (5 yrs. common) See SBA Loan Application Procedure

Government Grants n Small Business Innovation Research (SBIR) n n n Fed. agencies with > $100 million in R&D award a portion to SBIR grants program typical 700 projects totaling $40 million Three Phases n n n Idea Phase I (SBIR funds up to $50, 000) Product Stage - II (SBIR funds up to $500, 000) Business Stage - III (private sector funds)

Government Grants n Participating Agencies n n n DOD NASA DOE HHS NSF USDA DOT NRC EPA DOI DOED Dept. of Defense Natl. Aeronautics and Space Admin. Dept. of Energy Health & Human Services Natl. Science Foundation Dept. of Agriculture Dept. of Transportation Nuclear Regulatory Commission Environmental Protection Agency Dept. of Interior Dept. of Education

Debt Financing Advantages n n n Can result in lower cost of capital Allows for leverage Retention of ownership Disadvantages n n Decreases firm’s drive to make money Availability of capital increases impulse to spend Can decrease company’s flexibility May cause more disruption & problems than was present without it

Financial Leverage ROA = 18, 000 = 0. 18 100, 000 18, 000 = 0. 18 ROE = 100, 000

Financial Leverage ROA = 14, 000 = 0. 14 100, 000 14, 000 = 0. 28 ROE = 50, 000 Note: ROI = 18, 000/100, 000

Initial Public Offering (IPO) n n n IPO – public issue of stock made by a company Total cost to the firm can be 10 -15% of funds raised Typical offering raising $50 million or >

Initial Public Offering (IPO) Advantages n n n Raises new capital and provides for later, additional offerings Liquidity: converts ownership to cash (potential of harvest) Visibility: builds brand reputation Disadvantages n n Substantial cost & effort Disclosure requirements (scrutiny) Pressure to achieve short-term results Loss of control to a majority shareholder

BCD Company n n Wish to raise 10 million (10, 000) to fund new product line Bond debt; 20 yr, 11. 5% financing 0 -4 yrs $ 0 5 -19 yrs $400, 000 yr 20 $4, 000 n Expected incremental revenue = $2, 000 / yr

Impact of debt n n After tax cost of debt = 1, 150(1 -. 34) = 759 Incremental revenue of 2, 000 sufficient to cover increased debt cost of 759 Immediate loss of 76 cents per share As product sells, increased revenue results in 56 cent (9. 4%) increase in EPS

BCD Company n n n Wish to raise 10 million (10, 000) to fund new product line Preferred Stock 12. 5% Expected incremental revenue = $2, 000 / yr

Impact of Preferred n n n After tax cost of preferred = 1, 250 (vs 759) After tax revenue = 2, 000(1 -. 34) = 1, 320 Little opportunity for growth Immediate impact = 1. 25 decline in EPS As product sells, impact = +. 07 (1. 2%) increase in EPS

BCD Company n n n Wish to raise 10 million (10, 000) to fund new product line Common Stock 275, 000 new shares @ $36. 36 / share Expected incremental revenue = $2, 000 / yr

Impact of Common n Immediate – EPS greatest dilution in 1. 28 (21. 5%) decline in EPS n Long term - still have a dilution in EPS. 25 (4. 3%) decline in EPS

Special Financing n n Lease vs buy Convertible Securities Stock Rights Warrants

Lease n Types n n n Advantages n n n Operating Capital Way to leverage finances Lease cost tax deductible Disadvantages n Lose depreciation

Lease vs Buy

Lease vs Buy

Convertible Securities n Ex: $100 convertible preferred with conversion ratio of 3 Conversion price of $33 > current market price Investors hold looking for market growth Company sells at slightly higher price Call provision protects company

Stock Rights n Ex: BCD has 100, 000 shares outstanding and wishes to sell 50, 000 new shares. Current market price is $50/share. Subscription price is $40/share. 100, 000 rights are issued Investor gives 2 rights + $40 to buy one new share Limits potential for dilution of control Direct appeal for funds to group of investors

Warrants n n n Entitle holder to purchase common shares at a fixed price Often have long or no expiration dates Strong potential for earnings dilution from unexpired warrants

R&D Limited Partnerships n n Funds from Investors looking for Tax Shelters Three major elements n n n contract - company agrees to use funds to develop marketable technology sponsoring company limited partnership - limited liability - income & loss allocated to each partner’s tax return

R&D Limited Partnerships n Three Stages n n Funding stage Development stage Exit Stage n n n Equity partnerships - partners form new co. based on partnership agreement Royalty partnerships - sponsoring co. pays a royalty (6 -10%) on sales of new product Joint ventures

R&D Limited Partnerships n Advantages n n n minimum equity dilution limited risks Disadvantages n n expensive ($50, 000 to set up) typically more expensive than conventional loans giving up a portion of technology developed exit from partnership may be too complex