Finance: Review of Ch.1

• 1.1 What is Finance?• 1.2 The Role of the Financial Manager• 1.3 Who is the Financial Manager• 1.4 Goal of the Firm ?• 1.5 Agency Problem

1.1 What is Finance?

1.2 The Role of the Financial Manager

Two Basic Questions1 Investment Decision

2 Financing Decision

1.3 Who is the Financial Manager

Financial

ManagerFirm's

Operations

Financial

Markets

(1) Cash raised from investors(2) Cash invested in firm(3) Cash generated by operations(4a) Cash reinvested(4b) Cash returned to investors

(1)(2)

(3)

(4a)

(4b)

Overview of Venture Capital

LimitedPartners

VentureFund

Entrepreneurs

IPO/AcquisitionMarket

$

$ and

time

stock

stock

$

$

The Ideal VC Investment

• Large, demonstrated market

• Proven technology

• No competition

• Experienced entrepreneurial team

• Early exit opportunities

Huge Return, No Risk

Is the product a vitamin or a painkiller?

• Vitamins are nice to have

• Painkillers are essential

• What are your insights into the problem?

• How does your technology provide a compelling solution?

• How big is the market?

• Will customers seek you out for your solution?

Silicon Valley Ventures’ Investment Criteria--General

• Differentiated product/technology

• Huge market

• Strong competitive position

• Experienced management

• Multiple exit opportunities

Example: Mayfield--Specific

• Founded in 1969• Mayfield XI raised $1B in March 2000• 11 GPs, 4 venture partners, 2 associates• 30% communications--voice & data• 30% e-commerce infrastructure• 30% B2B, B2G, and I2I• 10% healthcare--biotech, devices• http://www.mayfield.com

“Typical” VC Deal

• The Company– eighteen months old– initial product in beta– ten employees

• eight technical (including CEO and two other founders)• one marketing• one administration

– funded to date with $750K from friends and family

“Typical” VC Deal

• $4 million needed for product launch and continued development

• $4 million “pre money” valuation

• Equity split:– 33% to venture investors (Preferred B)– 25% employee stock option pool (Common)– 20% to founders (Common)– 22% to original investors (Preferred A)

“Typical” VC Deal

• New CEO with industry experience

• Board of Directors:– One founder– New CEO– Two VC representatives– Two industry experts

• All employee/founder shares subject to four year vesting

Market Capitalization

Risk & Returns

PotentialReturns: 0

- 10

X

5 -

10X

3 -

5X

2- 3

X

2 -

3X 2X

2 -

5X 2X

Con

cept

$0 -

250

K

Seed

$50K

- $

500K

!st R

ound

- S

tart

-up

$2M

- 5

M

2nd

Rou

nd -

Exp

ansi

on$5

M -

25M

3rd

Rou

nd I

nt’l

Exp

ansi

on$1

0 M

- 3

0M

Mez

zani

ne R

ound

$10M

- 5

0M

IPO

(In

itial

Pub

lic

Off

erin

g)$2

0M -

100

M

Foll

ow-o

n O

ffer

ings

up tp

$10

BStage ofInvestment:

Time6-9 mos.intervals

Potential returns and related risks

Potential returns and related risks

1.4 Goal of the Firm ?

B. How to Maximize Shareholders’ Wealth?

Do all positive NPV project!

A. Maximization of Shareholders’ Wealth

MV of common stock

All financial decisions

1

2

1.5 Agency Problem

Monitoring by board of directors1

Compensation package2

Active outside takeover market5

Efficient outside managerial labor market4

Monitoring by outside large blockholders

(Bank, insurance Co., pension, mutual fund)

3

B. How to solve agency problem?

A. Separation between Ownership and Management