Vince Bellino ’15 & Paul Buckley ’17, Staff Writers
As a college student, one may have an idea or innovative product that could revolutionize a given industry. Two of the most notable examples are: Facebook with founder Mark Zuckerberg and more recently, Jack Ma and Alibaba Group. So, how does finance relate to a social media or e-commerce enterprise?
Start-up companies are typically not profitable for the first few years. In order to grow the business, there is a demand for seed capital. As a young entrepreneur, one of the best ways to finance the business is through angel or venture capital investors. They will buy an equity stake, and in return, the company will receive cash in order to facilitate growth. Let’s assume the company is doing well. Albeit, it is burning through cash and the angel investors do not want to increase their equity stake for risk purposes. On the other hand, the commercial bank is not willing to lend any money because they are risk averse and it is an early stage company. So, the prudent entrepreneur looks to financial sponsors for growth equity or a potential leverage buyout. Essentially, growth equity is a non-controlling, minority investment that a private equity group with make in order to help a company continue to grow. On the other hand, a leveraged buyout is when a private equity firm will commit a combination of cash (equity) and a substantial amount of leverage (debt) to buyout the company for a controlling interest. Given that this is still an early stage business and the cash flows are fairly uncertain, the entrepreneur decides to accept the growth equity.
A private equity firm will hold a company in its portfolio for three to five years, or however much time it takes to continue building the business. After a couple of years, the company is performing well, but in order to establish a competitive advantage, the entrepreneur decides that it is time for the next step. At this point there are three main options: initial public offering (IPO), strategic buyer, or to be acquired by another financial sponsor. The IPO would provide a significant amount of capital through the financial markets. A strategic buyer will typically acquire the company in hopes to realize synergies. In essence, synergies are when two companies together are more valuable than the sum of them individually. Lastly, this company could be sold to another private equity firm.
Given the recent success of IPO’s, the entrepreneur decides to take the company public. The investment bankers will run a roadshow and pitch the company to institutional investors i.e. pension funds and money managers. The bankers will then price the company on a per share basis, based on valuation methods and what the secondary market’s consensus may be (what investors are willing to pay). The investment bankers play an intermediary role in facilitating the IPO and any potential merger and acquisition deals.
Finance relates to the social media, e-commerce, or any industry given that investors such as venture capital, private equity, and asset managers are willing to invest in the next best emerging entrepreneur