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The Venture Capital Financing Process(Part Deux)

Venture capital (VC) funding is typically used by enterprises that are early-stage, high-risk, high-potential growth startup companies.  Many times they are already generating revenue for their product or service, even though they may not be profitable yet.

Round and round we go

In the venture capital game financing rounds typically have names that relate to the class of stock being sold:

    The seed round is where company insiders provide start-up capital.

    The Angel round is where early outside investors can buy common stock.

Under normal circumstances the company will have advanced its cause by the time of the next round.  As a result, each subsequent round of venture capital reflects a different valuation (i.e. if the company is prospering, the Series B round will value company stock higher than Series A, and Series C will have a higher stock price than Series B).

On the other hand, if the company is not prospering, it can still get subsequent Series-rounds of financing, but the valuation will be lower than the previous series: this is referred to as a “down round.”

These “down rounds” may also include “strategic investors” who participate in the round and also offer value in their area of expertise such as marketing or technology assistance.

After a “down round” where the company fails to meet established growth objectives they can essentially re-start under a new group of funders. These rounds are identified as series AA, BB, etc.

After that we get into the ‘Alphabet Soup Rounds’

The first of the Alphabet rounds is known as "A round" or "A round financing".  This is the first round of financing for a new business venture after the seed capital is received.  In most instances this will be the first time that company ownership is offered to outside investors.

By this point in time the company should be generating some revenue but is probably not yet profitable.  The investors at this stage are venture capital funds or angel investors who are willing to accept higher risk for the prospect of higher returns.

As the company grows and requires even more capital, each subsequent round of preferred stock issued to investors takes on the next letter in the alphabet.  This way investors know where they stand in the pecking order of claiming future profits.

At each stage, the company gets revalued.

The second round of financing for a company by private equity investors or venture capitalists is known as Series B.  This round usually takes place once certain milestones have been reached by the organization.

The third round of financing is called, guess what? Series C and usually represents an additional expansion stage for the company.  At this stage the company has proven successful in the market and has the potential for an even larger market.

Series Round D financing (along with series C) represent the final stages in the Early Financing cycle. Usually these are the final steps in the company’s growth cycle before the IPO (Initial Public Offering) or the sale of the company to another group of investors.

During the Series A, B, C, etc. rounds of financing, the company typically receives money from investors in exchange for preferred stock.  As a side note insiders, seed capital investors and angel investors usually receive common stock. Private equity investors generally prefer convertible preferred stock to common stock.

Holders of preferred stock have a greater claim to a company’s assets and earnings. In addition if a company is forced to liquidate in order to pay creditors and bondholders, common stock holders receive no money until after preferred shareholders are paid out.

THE VENTURE CAPITAL STORY

With the media frenzy that Facebook has caused on the way to a possible $100 billion IPO, I thought it might be appropriate to discuss the venture capital process and how it affects both the company and the market.

As a credit professional, I’ve dealt with established Fortune 1000 companies as well as quite of few start-ups.  Along the way I’ve had to come up with a few ways to establish acceptable thresholds of risk depending upon where the companies were in their growth stages and what sort of risk was hanging in the balance.

Venture capital is provided to early-stage companies, with high potential (and high-risk) for growth. They make their money by having equity in the firms in which they invest.  So, to put it mildly, they have “skin in the game.”

All venture capital is private equity, but not all-private equity is venture capital.

If the enterprise is a small venture, then perhaps they can rely on such capital sources as family funding, loans from friends, personal bank loans or crowd funding.

Some ventures have access to rare funding resources called Angel investors. These are private investors who are using their own capital to finance a ventures’ need but they take a passive role regarding company management.

For more ambitious projects, something a bit more substantial is in order.  For these situations often times a pooled investment (often an LLC) will provide funding that is too risky for standard capital markets or bank loans.

THE STAGES OF A START-UP FUNDING

Seed stage funding - Typically used to pay for market research and development. Seed capital is generally provided by those with a connection to the new enterprise although it could come from the founders themselves. It is not unusual for seed funding to come from family, friends or angel investors.  These investment dollars tend to be lower (in quantity) and the risk very high.

First stage (start-up stage) – A business plan gets presented to the venture capital firms, a management team gets formed to run the venture, if a board of directors exists, a member of the venture capital firm will take a seat on the board of directors. After reading the business plan and the proper consultation, the investor decides whether or not the idea is worth further development.

Second stage – At this stage the idea has now been transformed into a tangible product and is likely being produced and sold.  The venture is striving to reach the break-even point. The management team must prove its’ mettle to the venture capitalists. The VC firm will monitor how management navigates the development process and deals with competitors.

Third stage – The capital that is provided to a company with an established commercial production and a basic marketing set-up, looking for market / plant expansion, acquisitions, and product development. At this stage the company should be enjoying revenue growth but may not yet realize a profit.

Mezzanine stage – This is late-stage venture capital, usually describing a company which is somewhere between startup and IPO. To be even more exact Mezzanine Financing is for a company expecting to go public usually within 6 to 12 months.  The expectation is that the proceeds from a public offering will repay this financing or at least establish an opening price for the IPO.

The further along the process a company goes, less risky the VC-firm’s investment becomes.

                                            

 

OLDER WORKERS…YOUNGER WORKERS…A HUGE RECESSION…COULD A LOGJAM BE BREWING?

 A recent article proclaimed that there would be 32.4 million replacement job openings between 2008 and 2018, as baby-boomers exit the workforce.  The first thought that came to mind was, “Really…how can we be certain that these folks can even afford to retire?”

A completely different article stated that young Americans seemed to be having a much tougher time finding work than older workers. It seems that the overall workforce is getting older. Workforce participation of workers over 55 has risen 11 percent since December 2007.

The consensus seems to point to the fact that many workers will need to remain in the workforce to approximately 70 years of age in order to replenish the losses of recent years.  Think about that. Of course this is assuming that they are able to find someone willing to employ them at that point in their lives.

But even if older workers decide to stick around an additional 5 years, think about the impact that decision will have on the following generations of workers.

Hypothetically speaking, a 65-70 year old worker remaining in the workforce has an impact on the average 45-50 year old worker, who in turn impacts the work life of the average 25-30 year old worker and so it goes.

Through in the greatest economic downturn since the Great Depression and you can see where this is headed.

The truth is a little murkier than what we would think intuitively. No one owns any particular job. The economy is always creating new opportunities. As we know, businesses get created and others go the way of the dinosaurs.  In addition, how often is a younger person in direct competition for the position currently held by an older worker?

Do you think that older workers end up hurting the younger set by sticking around longer?

Millions of iPhones and not many job opportunities for U.S. workers

I was reading an interesting article the other day about American technology and how it has NOT translated into American jobs.

President Obama asked Steven Jobs what would it take to make iPhones in the United States?  In a nutshell, Jobs informed the President that that wasn’t going to happen.  And the thing that really surprised me was that the central issue wasn’t cheap labor.  Rather, it’s the ability of overseas factories to ramp up at a moment’s notice, provide the sort of flexibility, attention to detail and skill level that is unheard of in America.

According to this article Apple earned over $400,000 in profits per employee last year. Back in the day, when American companies were in their heyday they traditionally hired tons of U.S. workers. That doesn’t seem to be the case these days. Profits and efficiency are top patriotism and loyalty to the homeland.

This story explains why the U.S. economy (and its’ corporations) can grow and enjoy huge profits without any substantive gains in employment.

Some of these factories house thousands of workers inside company’s dormitories.  They can get them up in the middle of the night and work them around the clock in 12-hour shifts.

How can the U.S. compete with that?           

Not that long ago, Apple products were made in America. Today, not so much.

Just imagine, 70 million iPods, 30 million iPads and 59 million other Apple products that are being manufactured overseas instead of in the U.S.A.

What happened?

For starters, innovation, leadership and a massive technologically skilled workforce.

Apparently, the cost of labor isn’t a major stumbling block.  The cost of labor is actually dwarfed when compared with the cost of buying parts and managing supply chains from hundreds of companies.  One company, Foxconn Technology, has many facilities in Asia, Eastern Europe, Mexico and Brazil.  It assembles approximately 40% of the world’s consumer electronics. 

Are you beginning to see a pattern here? Products manufactured abroad but sold in massive quantities in the good ol’ U.S. of A.

Has the manufacturing industry here completely missed the boat or is this just an unavoidable turn of events? After all, every empire has its’ rise and fall.

If we can’t compete in America what does this mean for our middle class employment options?

MAKING SERIOUS PLANS IN A CHAOTIC ENVIRONMENT

The financial world can be a volatile place. These days major changes that have far reaching impact your finances can take place in the twinkling of an eye.

When I think about the speed with which conditions change I’m always reminded of March 6, 2008.  Shares of the nation’s fifth largest investment bank had dropped nearly 20% in the previous ten days.

Ten days later Bear Stearns was swallowed up by former competitor J.P. Morgan Chase.

The period immediately following World War II up until at least 1980 was probably the most continuously prosperous period United States history. Chances are, those whose working careers spanned that period firmly believe that future generations will never have it as good as they had it.  And I'd be inclined to agree with that opinion. 

Think about it. Back then there were no economic challenges coming from India, China, or Brazil let alone Lithuania, Egypt, Nigeria, Qatar and others.  Industries that the U.S. once dominated are now largely outsourced to other countries.

The Crash of 1987

The Dow hit a new high on August 25, 1987 at a record 2722.44 points. Then, it started to head down. On October 19, 1987, the stock market crashed. To be exact, the Dow dropped 508 points or 22.6% in a single trading day.

During this crash, 1/2 trillion dollars of wealth were erased.

The Crash of 2000

During the dot-com boom period from 1992-2000, the markets and the economy experienced a period of record expansion.  The NASDAQ peaked at 5132.52. Conversely, the end of the dot-com prosperity boom led to many dot-coms running out of capital and were eventually acquired or liquidated.

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

The Great Recession (late-2000s financial crisis) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.  As a result, national governments had to bailout major banks, large financial institutions collapsed, and stock markets around the world endured severe downturns. In many areas, the “mortgage meltdown” all but destroyed housing market, leading to numerous evictions, foreclosures and prolonged unemployment.

Since peaking in the second quarter of 2007, household wealth is down $14 to $16 trillion.

It has been stated that the housing market (especially new home construction) is a major contributor to the health of the U.S. economy. 

With this being the case my question is simply, “How can any sane individual commit to a 30 year financial obligation when the U.S. economy tends to undergo major dislocations every 5-15 years?”

HARD CHOICES IN THE TECH WORLD

I’ve always loved Apple products.  I mean for quite a few years. I’ve been an admirer of their ability to provide products that are way ahead of the curve.  They’ve always been able to bring items to the market even before customers knew that they needed or desired them.

In the last five or so years we, as a nation have become addicted to our iphones, MacBooks, ipads, etc. These products have become a way of life.

For the first time ever Apple has released a list of their suppliers.  In addition, they also graded each one. Many of them did not receive a favorable grade.

One, in particular Foxconn appears to be especially egregious. Just imagine 12 to 14 year old kids working 70 hours per week in massive factories.  They don’t even go home after work. They go back to their dorms on the company campus. 

These kids contemplate suicide on a regular basis. In 2010 ten Foxconn factory workers committed suicide by jumping off of factory rooftops due to the unbearable working conditions. 

These companies also test their employees for STD’s.  They also give the females pregnancy tests. They don’t want their employees to have any relationships or sex because that could affect productivity.

The company’s response? They installed nets to prevent future jumpers.

As an Apple consumer would you feel like an accomplice in allowing human rights violations to take place worldwide?  Would this information make you think about this when you’re using your Apple products?

Hearing stories of children being separated from their families and being forced to work long hours has to impact your feelings.  But will it affect you enough to alter your purchasing decisions?  As an Apple devotee that’s a really hard choice.

The way I see it we as consumers have two choices: Demand a change regarding the working conditions where these items are manufactured or start purchasing our high-tech products from other companies. 

I know this is really hard but what does your moral compass tell you to do?  As for me, I’m going to have to think long and hard about making future purchases from the company that I’ve always admired.