Notesale: Turn your study into money

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Financial Strategy Week 3
Corporate Financial Strategy Chapter 7- Start-up Businesses and Venture Capital
Start up businesses hold the highest level of business risk, therefore meaning the associated
financial risk should be kept as low as possible through equity funding
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The term ‘venture capital’ is restricted to high-risk situations
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Launch of the product depends on successful R&D and demand in the market/ market share

If CAPM applied, the increase in return would only be related to level of market risk incurred by the
company (degree to which their total return is affected by changes in return of the market)
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The implication of CAPM is that a start-up business does not need to offer enhanced rates of
return to investors to compensate for high business risk as this is unique, diversifiable risk
o However, in reality, returns demanded by investors in new business start-ups are
significantly higher than mature companies
High volatility of cash flows due to unique/unsystematic risk- does not lead to expected
return
The value of a company represents the value of its assets-in-place plus the NPV of its future
activities

Multi-stage projects: if a project can be split into stages rather than investing in the whole thing up
front, then it can be assessed at each stage to see if it is worth proceeding
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Timing flexibility: if an investment can safely be delayed without handing strategic advantage to
competitor, there can be an advantage in delaying to learn more about the potential market and
pitfalls
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Alternative uses: an investment in assets becomes more valuable if those assets have more than one
possible use (tangible and intangibles)
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Growth potential: undertaking a small project with no profit potential to gain entry into potentially
larger market
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Venture capitalist investors need each investment to promise the potential of very high
returns to compensate for those that fail completely
The very high business risk associated with new start ups is taken into account in the return
expected by investors applying CAPM
o However not through directly increasing DF to include unique risk
o Much lower beta-driven rates of return must be applied to future CF’s which have
been adjusted to reflect probability weightings of successful outcome
In a perfect market there is no added value from different capital structures, but the effects
of taxation & costs of financial distress indicate capital structure is important
If having any level of debt in a company increases the risk of default, investors will reduce
the value of the investment by the expected value of associated costs
The current investment value is created by the present value of the expected future CF’s
resulting from the successful development, launch & growth of product
The assets underlying the business are intangible, without any easily established discrete
realisable values- costs of financial distress likely to be high
For a start-up, risk can be high even if small proportion of debt used
A high probability of occurrence combined with high cost if it occurs makes risk premium for
potential financial distress very high
Start up companies have a large and growing demand for cash flow- taking on debt involves
making regular cash outgoings to service interest and repayments

In theory, investors should be indifferent as to whether they receive dividends or achieve their
return through capital gains; the recommended dividend policy for a start-up is to pay no dividends
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Angels’ decision criteria for investment
include having a favourable impression of the management team, a familiarity with the sector,
projected financial rewards and a synergy with their own skills
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These companies invest in promising
new ventures to exploit their ideas, obtain the benefit of their new technologies and gain an edge on
the market
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Positives- provides useful financial support & access to wide range of business contacts
o May also be synergies between the different businesses if industry is related
o Having a significant investor can add to a company’s profile in the business &
investment communities
Negativeso Does each party understand other’s motivation?
o Is a reciprocal arrangement planned where the venture will provide business
advice/contacts? Does venture have a good track record?
o How important is investee business to the venture?
Companies raising venture capital can expect to have to give special protection to their
investors via the share agreement
The terms of venture capital ensure VC’s can exit investment when opportunity presents
itself, and ensures they do not suffer too much if investee company does not perform as
originally expected
‘drag-along rights’ apply is an offer is made for a company- they give majority SH who wishes
to sell, the right to force minority to join in the sale on the same terms

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