Wk 8 Flashcards
Entrepreneurship
Why are entrepreneurs worth studying?
Source of Wealth Creation: Entrepreneurs drive innovation and generate substantial wealth, contributing to economic growth and investment opportunities.
Diverse Wealth Pathways: Their varied approaches to capital intensity and fundraising create unique wealth management challenges and strategies.
Investment Opportunities: Entrepreneurial ventures introduce investable asset classes (e.g., venture capital, equity, debt), providing diverse options for asset allocation in wealth management.
Wealth Catalysts Through Exit Events: IPOs, trade sales, and other exit events serve as significant wealth management opportunities, enabling liquidity and reinvestment potential.
Why are entrepreneurs an unusual category for wealth management ?
Liquidity: Entrepreneurs often have wealth tied up in their businesses, limiting liquid assets and making liquidity events (like IPOs or sales) critical for access to cash.
Stake Leverage: They frequently hold concentrated ownership stakes, which increases their exposure to business risks and creates challenges in managing a balanced portfolio.
Cashflow: Cash flow is typically reinvested in the business, leading to less consistent personal income and unique cash management needs.
Tax Planning: Entrepreneurs require specialized tax strategies to manage capital gains, deferred compensation, and succession, making tax planning complex.
Unusual Wealth Products: Entrepreneurs may need tailored financial products (e.g., pre-IPO liquidity solutions, structured equity, bespoke loans) to manage their unique financial situations and maximize their wealth potential.
Business model implications
* What is bootstrapping ?
* How important is asset intensity?
* Impact of working capital ?
* Pace of growth
Bootstrapping:
Bootstrapping is funding a business through personal savings or reinvested profits, rather than external financing. It often promotes lean operations, but can limit growth due to constrained capital.
Asset Intensity:
Asset-intensive businesses require significant investment in assets (e.g., machinery, equipment) to generate revenue, impacting cash flow and capital needs. This can limit flexibility and increase financial risk, especially for growing companies.
Impact of Working Capital:
Working capital is critical for daily operations. Low working capital can strain cash flow and hinder growth, while high working capital improves stability but may tie up funds that could be invested in expansion.
Pace of Growth:
Fast-growing businesses often face cash flow pressures and may require external financing to scale, while slower growth enables sustainable, self-funded expansion. Growth pace impacts funding needs and operational strategy.
What are some sources of funding and what are some types of equity?
Bootstrapping: Self-funding using personal savings or profits; retains control but limits capital.
Seed Funding: Early-stage funds from personal sources, family, friends, or angels; kickstarts development.
Series Funding (A, B, C…): Progressive investment rounds for scaling and market expansion; Series A focuses on product-market fit, B on growth, C+ on large-scale scaling.
Equity: Selling ownership shares in exchange for capital; raises funds without adding debt but dilutes ownership.
Angel Investors vs. Venture Capital (VC):
Angels: Individuals funding early, riskier stages for high returns.
VCs: Institutional investors funding later stages with larger investments and strategic oversight.
Debt: Loans or credit; retains ownership but adds repayment obligations.
Family and Friends: Informal early funds; easy access but can create personal risks.
Strategic Investors: Industry-aligned partners offering capital and market expertise, with a focus on synergies rather than quick exits.
- What ultimately is the ‘cost of equity’ in this sort of startup journey ? Is it similar to CAPM derived metrics ?
Definition: The cost of equity is the return required by investors for their investment in a startup, reflecting the associated risks.
CAPM Similarity: While the Capital Asset Pricing Model (CAPM) is commonly used to estimate cost of equity, startups often face unique risks that may not be fully captured, leading to a potentially higher cost of equity.
Factors Influencing Cost:
Market Conditions: Economic environment and industry trends.
Company Stage: Early-stage startups typically incur higher costs due to increased risks.
Investor Expectations: Investors demand higher returns to compensate for the risks of investing in startups.
Venture Capital:
- What is a LP ?
- What is a GP ?
- Why is this structure used ?
- How significant are typical VC control rights ?
What is a LP (Limited Partner)?
Limited Partners are investors in a venture capital fund who provide capital but have limited involvement in management. Their liability is restricted to their investment in the fund.
What is a GP (General Partner)?
General Partners are the fund managers responsible for making investment decisions, managing the portfolio, and overseeing the operations of the venture capital fund. They have unlimited liability.
Why is this Structure Used?
This structure allows GPs to actively manage investments while limiting LPs’ risks and liabilities. It also facilitates capital pooling from various investors, enabling larger investments and diversification.
How Significant Are Typical VC Control Rights?
VC control rights are significant, as they allow VCs to influence key decisions such as board appointments, funding rounds, and exit strategies. These rights help protect their investments and ensure alignment with the startup’s strategic direction.
- Why are rounds used ? What is the strategy behind the industry’s positioning of rounds ?
- Who ‘leads’ a round ?
Why Are Rounds Used?
Rounds are used to segment funding into phases, allowing startups to raise capital incrementally as they achieve milestones. This strategy helps manage risk for investors, ensures accountability, and aligns funding with the startup’s growth trajectory.
Who ‘Leads’ a Round?
A lead investor is typically a venture capital firm or an angel investor who contributes the largest portion of the capital in a funding round. The lead investor often sets the terms of the round and plays a significant role in negotiating and influencing the startup’s strategy and direction.
What about valuation ?
* What is “liquidation preference” and how does it work ?
* How does this tie into vanity valuations?
* What are the mechanics
Liquidation Preference:
A provision that ensures preferred shareholders are paid back their investment (or a multiple) before common shareholders in a liquidation event (e.g., company sale).
Ties to Vanity Valuations:
Vanity valuations are inflated company valuations. Liquidation preferences provide a safety net for investors, making them more comfortable with higher valuations despite potential risks.
Mechanics:
During a liquidation event, investors with liquidation preferences receive their payouts first, influencing negotiations around the company’s overall valuation.
Strategic investors
* Why ?
* Why run a fund
* Why not ‘intrapreneurship’ ?
* Why not R&D ?
Why?
Strategic investors bring industry expertise, operational support, and long-term alignment with a business’s goals. They invest in companies that complement their own, enabling synergies and competitive advantages.
Why Run a Fund?
Running a dedicated fund allows strategic investors to diversify investments, access high-growth companies outside their core business, and maintain financial returns alongside strategic goals.
Why Not ‘Intrapreneurship’?
Intrapreneurship can be limited by existing corporate structures and risk tolerance, while investing externally enables faster, innovative growth without disrupting internal operations.
Why Not R&D?
Traditional R&D may not capture market-ready innovations as effectively or swiftly. Investing externally through strategic stakes offers access to developed, market-tested technologies and solutions.
What are some investor conflicts?
* Pathways
* Bootstrapping, clean capital tables
* VC
* Strategic
* Do these mix ?
Why These Are Common: Convertible stock offers flexibility for investors to convert their shares into common stock at a later date, often benefiting from future company growth. It’s attractive because it combines debt-like security with equity upside potential.
How Preferred Equity Works: Holders of preferred equity receive priority over common shareholders for dividends and liquidation payouts. They often have fixed returns and conversion options, offering more stability and control.
Wealth Management Opportunities: Convertible stock provides opportunities for strategic growth, risk management, and exit planning. Wealth managers can advise on timing conversions, leveraging liquidity events, or balancing portfolios with high-growth, convertible investments.
Convertible stock
* Why are these common ?
* How does preferred equity work ?
* What wealth management opportunities arise here?
Why Are These Common?
Convertible stock combines the security of debt with the potential for equity upside, making it attractive to investors. It allows holders to convert to common stock if the company grows, offering both safety and growth potential.
How Does Preferred Equity Work?
Preferred equity holders have priority over common shareholders for dividends and liquidation, often with fixed returns. They may have conversion options, providing stability and an opportunity for equity participation.
Wealth Management Opportunities:
Convertible stock offers flexibility for growth-focused strategies, allowing wealth managers to advise on optimal conversion timing, cash flow planning, and portfolio diversification with high-potential equity-linked investments.
IPO
* Listing venues
* Primary or secondary ?
* Liquidity implications
* Escrow
* Lock-ups
* Pathway to listing
* ‘Equity overhang’
* Founder selldown over time (10-b5-1 or equivalent programs)
IPO Overview
Listing Venues:
Stock exchanges (e.g., NYSE, NASDAQ, LSE) where a company’s shares are publicly listed and traded.
Primary or Secondary Offering:
Primary Offering: New shares are issued to raise capital for the company.
Secondary Offering: Existing shareholders sell their shares, providing liquidity without new share issuance.
Liquidity Implications:
An IPO increases liquidity for shareholders by allowing public trading, though initial lock-ups may temporarily restrict it.
Escrow:
Funds or shares may be held in escrow for a period to manage distribution and provide security for investors.
Lock-Ups:
Period (usually 6-12 months) during which insiders cannot sell shares, reducing market volatility post-IPO.
Pathway to Listing:
Includes financial audits, regulatory approvals, prospectus preparation, and setting an offering price before the public listing.
Equity Overhang:
The potential dilution risk from a large number of shares that could enter the market post-lock-up or through future offerings.
Founder Selldown Over Time:
Programs like 10b5-1 (in the U.S.) allow founders to sell shares gradually over time, helping reduce market impact and maintain price stability.
Trade sale exits
* Full or partial exit ?
* Liquidity considerations
* Approvals and deal risk
* Scrip transactions
Full or Partial Exit: Trade sales can involve selling the entire company (full exit) or only part of it, allowing original owners to retain some stake.
Liquidity Considerations: Provides significant liquidity, especially in a full exit, which can be critical for investors looking to cash out.
Approvals and Deal Risk: Often requires regulatory, board, or shareholder approvals, adding complexity and potential deal risk.
Scrip Transactions: Instead of cash, the buyer might offer shares (scrip) in their own company as payment, giving sellers ongoing ownership in the buyer’s business.
