(BUS511) Venture Capital, Valuation, and Debt Capital


In this lesson, we begin with an exploration of the sources of venture capital. Appreciating the capital markets as a food chain looking for companies to invest in is key to understanding motivations and requirements. Entrepreneurs must determine the need for outside investors, whether they want outside investors, and if so whom. America's unique capital markets include a wide array of private investors, from "angels" to venture capitalists. The search for capital can be very time-consuming, and whom you obtain money from is more important than how much.

It is said that the only thing that is harder to get from a venture capitalist than a "yes" is a "no." Fortunately for entrepreneurs, the modest revival of the venture capital industry has raised the valuations and the sources available. Entrepreneurs who know what and whom to look for—and look out for—increase their odds for success.

Next, we examine valuation of organizations and the structuring of deals and negotiations. There is rarely a "fair fight" between users (entrepreneurs) and suppliers of capital (investors). Entrepreneurs need to be prepared by learning how the capital markets determine valuation risk. Several valuation methods are used to arrive at value for a company, the venture capital method being the most common. Investors prefer to stage their capital commitments, thereby managing and containing the risk and preserving their options to invest further or cease. Numerous potential conflicts exist between users and suppliers of capital, and these require appreciation and managing. The economic consequences can be worth millions to founders. Successful deals are characterized by careful thought and sensitive balance among a range of important issues. Deal structure can make or break an otherwise sound venture, and the devil is always in the details. Negotiating the deal is both art and science and can make or break the relationship. The entrepreneur encounters numerous strategic, legal, and other "sand traps" during the fund-raising cycle and needs awareness and skill in coping with them.

Finally, we’ll look at debt capital. Business cycles impact lending cycles, with more or less restrictive behavior. Start-ups are generally not candidates for bank credit, but numerous sources of debt capital are available once profitability and a decent balance sheet are established. Managing and orchestrating the banking relationship before and after the loan decision is a key task for entrepreneurs. Knowing the key steps in obtaining a loan and selecting a banker—not a bank—who can add value can improve your odds. Loan covenants can have a profound impact on how you can and cannot run the business. The devil is in the details of the loan agreement. For the vast majority of small companies, leverage works only during the most favorable economic booms of credit availability. Leverage is a disaster if business turns sour. The IRS also places a time bomb for personal disaster with every entrepreneur who borrows money: If your bank debt is forgiven in a restructuring, it becomes taxable income to the borrower! When the bank says no to a loan request, several key questions need to be addressed in an effort to reverse the decision; or you need to seek sources of credit other than banks.

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Lesson Learning Objectives

By the conclusion of this lesson you should be able to:

  • Explain the capital markets food chain and its implications.
  • Identify informal and formal investment sources of equity capital and describe how venture capital investors make decisions.
  • Locate, contact, and deal with equity investors.
  • Describe methodologies used by venture capitalists and professional investors to estimate the value of a company.
  • Describe how deals are structured, including critical terms, conditions, and covenants.
  • Characterize good versus bad deals and identify some of the sand traps entrepreneurs face in venture financing.
  • Identify sources of debt and explain how to access them in today’s capital markets.
  • Describe the lender’s perspective and criteria in making loans, how to prepare a loan proposal, and how to negotiate a loan.


Study Chapters 14, 15, and 16 of the text.

View the Power Points for Chapters 14, 15, and 16.

Web Resources

Chapter 14

http://www.businesspartners.com - Business Partners is a global Internet-based service that connects entrepreneurs, early-stage companies, and established corporations with angel investors, venture capital, corporate investors, potential partners, and target data on mergers and acquisitions.

http://www.nvca.org - The National Venture Capital Association

http://www.sba.gov/index.html Small business resources and funding information from the Small Business Administration (SBA)

http://www.vcjnews.com/ - The online version of the Venture Capital Journal.

http://www.nasdaq.com/markets/ipos/ - Information relating to initial public offerings, SEC filings, and upcoming IPO’s.

Chapter 15

http://www.nacva.com/ - The National Association of Certified Valuation Analysts.

http://www.valuationresources.com/ - Valuation Resources is a free resource guide to business valuation resources, industry and company information, economic data, and more.

Chapter 16

http://federalreserve.gov/ - Board of Governors of the Federal Reserve System.

http://research.kauffman.org - The research portal of the Ewing Marion Kauffman Foundation.

http://www.aba.com/default.htm - American Bankers Association.


The following Assignments should be completed and submitted to the course faculty via the learning platform for evaluation and grading. Submit your responses to these questions in one WORD document. List the question first, and then your response.

Your response must adequately cover the question without being wordy or relying on “yes” or “no” responses.

Short Answer Questions

  1. What does one look for in an investor, and why?
  2. How can the founders prepare for the due diligence and evaluation process?
  3. Describe the venture capital investing process and its implications for fund-raising.
  4. Explain the capital markets food chain and its implications for entrepreneurs and investors.
  5. Why can there be such wide variations in the valuations investors and founders place on the companies?
  6. Explain five prevalent methods used in valuing a company and their strengths and weaknesses, given their underlying assumptions.
  7. What are the most important questions and issues to consider in structuring a deal? Why?
  8. What security can be used for a loan, and what percentages of its value do banks typically lend?
  9. Why do entrepreneurs in smaller companies need to be especially wary of leverage?
  10. What criteria do lenders use to evaluate a loan application and what can be done before and after the loan decision to facilitate a loan request?

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