Ventures: ( new projects/ ideas that make it extremely difficult to attract financing since it’s a new product by eutreprenures with no data and history to back up that they will return or make profit or even successfully launch the product) It is an alternative asset! Lack of tangible assets, expecting negative earnings and have uncertain prospects.
Traditional assets: publically traded shares, bonds, foreign exchanges, commodities, real estate.
Alternative asset: investments that have limited investment history, differentiated features from tradition assets (i.e. its not liquid) and it requires specialist skills to mange. Eg:
Venture Capital: provides finance for start up firms that require capital but cant seek it out from other sources. Intensely monitors management and sometimes through representation on the board. Funds are dispensed in stages. Less successful investments are either liquidated or remain in operation at a modest level of activity. Private Equity: Also invests in these high risk, high reward firms. (Not only do they use their own funds but they raise the bulk of their funds from financial institutions and high net worth individuals who want to invest but have no idea on what to invest on) examples of a private equity = university endowments and pension funds. Buy out Funds
Venture Capitalist “raise a fund” on a periodic basis (every 3-5 years) Funds are structure as “Limited Partnerships” – 10 years eventually funds are returned to investors and a new fund is raised 20% of investments will be winders 60% living and the other 20% ceases to exist
key problems in private firm financing:
agency problems (moral hazard) : when a party is unable to observe/verify a counter part’s behvious AFTER a contract is put in place. They also cant observe the effort but they can only observe the final output..
Even higher risk for entrepreneurial firms as its even harder to observe their actions after financing: subject to high information asymmetry
The Capital Gap: when there are insufficient capital for the new firms. These firms are usually too small to be financed by the capital markets, but they require too much capital to be financed by indicidual savings and are too risky to be financed by banks. Due to information asymmetry and perceived agency problem.
Who can help with the capital gap:
Banks could but: in many countries bansk are not permitted to h9old equity or a limited in their ownership stake. Banks may not have enough skills and experience to help firms with a lot of intangibles.
Venture capitalist help by:
Intense scrutiny before capital is provided
screening of investments
the use of covertable securities
staging of investments
provision of oversight and inform coaching
Venture caplist share your ideas, and you share your power with them. They fund you in mile stones not all of it straight away.
Sources of finance:
Problems with obtaining external funds too early:
Incentives to spend, expand and squander
Slower starts = safer
Bootstrapping- when an entrepreneur attempts to found and build a company from personal finances or from the operating revenues of the new company. smaller initial investments can bring very high returns.
2. Angel Investors/ Seed capitalist- professional investors investing with their own funds, wealthy individuals with lot of experience(lawyers bankers, retired CEO). Why they angels invest : initial high returns by getting in early, returns from value adding activities, to help them prepare the company for venture capital funding. Size of initial investment: 50,000-100,000
investment horizon: minimum of 7 years : average of 12
portfolio: less than 5 firms
Investment philosophies: involvement, formal screening and selectivity, maintaining strong financial resources. Deeper pockets = diversification and continuous funding avoids...