1. Venture Capital and Angel
Financing
For Universidad Adolfo Ibañez
John C. Edmunds
February 1, 2006

2. Starting a New Business in the
United States
• The founders develop a business plan.
• Then they create a corporation.
• They do not try to keep 51% of the shares.
• They do not plan on keeping the company
and passing it to their children.
• Many founders are “serial entrepreneurs”
which means they start one new business
after another.

3. Starting a New Business in the
United States, 2
• Many times the founders fail in their first
attempt.
• Some also fail in their second attempt.
• The bankruptcy law in the United States is
intentionally designed to allow founders a
second or a third chance.

4. Starting a New Business in the
United States, 3
• A person who has tried to start a business
and failed is still a respected member of the
community. He or she is not stigmatized
for life and can still be successful later in
another new business or in some other
career.

5. Angel Financing in the United
States
• After the founders of a new business have
sold some shares in their company to family
and friends, they sometimes find an “angel
investor.”
• An angel is a rich person who helps the new
company in its very early stage.
• The angel invests money and also offers
advice.

6. Angel Financing in the United
States, 2
• The angel usually invests an amount in the
$50,000 - $250,000 range and usually gets
around 20% of the shares of the new
company.
• The angel tries to help the new company
achieve enough growth to attract the
attention of other investors.

7. Stages of Venture Financing
1. Friends, Family and Fools
2. Angel Financing
3. Early Stage Venture Capital Financing
4. Additional Round(s) of Venture Capital
Financing
5. Initial Public Offering of Shares OR Sale
of the Entire Company to a Bigger
Company

8. Venture Capital Financing in the
United States
• There are many venture capital firms in the
United States.
• A large number of them are around here –
in Boston or on Route 128 (also known as
the Silicon Necklace).
• Most venture capital firms are small. They
have a small number of officers.

9. Venture Capital Financing in the
United States, 2
• The typical venture capital firm raises an amount
of money in the $100 million - $500 million
range. The money is put in by “backers” who
agree to leave the money in the hands of the
venture capitalists for eight years.
• After eight years the fund is liquidated. The
“backers” recover their investment and their profit
if the investments have been successful.

10. Venture Capital Financing in the
United States, 3
• Most venture capital firms raise money
from backers more than once. They start a
second fund after two or three years, and
then a third one.
• Venture capital firms can be so successful
that they attract more capital than they can
invest. This happened in 1999-2000 and
might be happening now.

11. Venture Capital Financing in the
United States, 4
• The rate of return that backers have earned
from their investments in venture capital
has been HIGH and VIOLENTLY
CYCLICAL.
• This has been true for the entire history of
venture capital in the United States.

12. Obtaining Venture Capital
Financing in the United States
• The founders of the new company try to
“pitch” their company to venture capitalists.
• When they get a chance to make their
presentation to a venture capital firm, they
try to communicate how good their idea is
and how successful their company will be.

13. Obtaining Venture Capital
Financing in the United States, 2
• If the key decision makers at the venture
capital firm are interested, the negotiations
begin.
• The founders of the new business try to get
as much money as they need, while giving
up as few shares as possible.

14. Obtaining Venture Capital
Financing in the United States, 3
• The founders typically give the venture
capitalist 20% - 40% of the shares in
exchange for $2 million to $5 million.
• The terms depend on how promising the
company is, how good the management
team is, and how many other venture capital
firms are likely to be interested in financing
the company.

15. Obtaining Venture Capital
Financing in the United States, 4
• The founders try to give the venture
capitalist as few shares as possible because
later the company might need to seek a
second round of venture capital financing,
or a third round.
• There have been successful companies that
obtained as many as seven rounds of
financing from venture capitalists.

16. Liquidity Events
• After the new company has been operating
for a couple of years, the venture capitalists
want to recover their investment and their
profit.
• The opportunity comes when the new
company makes an initial public offering of
common stock. (IPO)

17. Liquidity Events, 2
• The IPO is the glamour moment in the life
of a U.S. entrepreneur.
• The new company hires an investment bank
to sell some of the shares, usually 15% or
20% of the total, to the public.
• The founders and the investment bankers do
a “road show” to sell the shares that are
being offered.

18. Liquidity Events, 3
• The shares that are offered to the public in
the IPO come from three sources – some
come from the VCs, some come from the
founders, and some are newly issued shares.
• That is so that the VCs recover their cash
and some of their profit, the founders get
rich, and the company gets some cash to
finance its growth.

19. Liquidity Events, 4
• The shares of the new company are listed
on the NASDAQ and the price of the shares
sometimes rises very rapidly.
• The investment bankers set the initial
offering price of the shares and also try to
maintain an orderly market in the shares for
a few months.

20. Liquidity Events, 5
• Sometimes the market price of the new
company’s shares rises to an extreme level
on the first day of trading.
• This happened often during the period
1998-2000.
• The Google IPO (2004) used an auction
process to limit the frenzy. Huge opening-
day price rises are now much less frequent.

21. Liquidity Events, 6
• In reality, not very many new companies
make an initial public offering of shares.
Instead a big company buys them before
they “go public”.
• The venture capital firms make huge profits
whenever there is a liquidity event.
• They need the big profits to compensate for
the (many) failures.

22. Venture Capital in Chile
• Hay, pero no hay.
• For the past few years, my Chilean friends
have been VERY pessimistic about the
possibility of obtaining venture capital
financing in Chile.
• They tell me that the chances were better in
1996 than in 2006. There is some hope for
2007.

23. Venture Capital in Chile, 2
• Let’s discuss why people like you have had
such difficulty obtaining venture capital
financing in Chile.
• The size of the venture capital sector in
Chile is, in proportional terms, about the
same size as the venture capital sector in the
United States.

24. Venture Capital in Chile, 3
• In Chile, venture capital funds have cash,
but they do not place it.
• Instead the venture capitalists sit in their
offices and reject the proposals they
receive.
• Is that true? My Chilean friends think so.
• If that is true, why is it true?

25. The Conventional Explanation
• For 15 years I have been hearing an
explanation why venture capital funds in
Chile have been such a disappointment.
• The explanation has never convinced me
but is has always convinced my Chilean
friends.

26. The Conventional Explanation, 2
• Chileans are self-critical. Chilean venture
capitalists say that they proposal they see
are not worthy of financing.
• The Chilean economy is small, but is it
REALLY too small to support new
companies???

27. My Objection to the
Conventional Explanation
• The conventional explanation assumes that
Chile, as a country, suffers from some
disadvantages that are impossible to
overcome.
• It assumes that a business that starts in
Chile, or operates entirely in Chile, can
never be very exciting or valuable.

28. My Objection, 2
• I ask my Chilean friends if it is really
necessary for Chileans to go to Silicon
Valley or to Boston in order to have a good
idea.
• Many of them think that Chileans become
more creative after they leave Chile.

29. My Explanation for the Lack of
Venture Capital Financing in
Chile
• Venture capitalists make mistakes.
• Two thirds of the ventures they finance fail.
• The key question is how much profit
venture capitalists make on the
investments that succeed.

30. My Explanation, 2
• In Chile, the venture capitalists were
criticized for the mistakes they make in the
Nineties.
• The venture capitalists had some successful
investments.
• But on those successful investments they
didn’t make big enough profits.

31. My Explanation, 3
• The biggest profit I heard about was an
investment where the venture capitalist
made a return equal to six times the
investment.
• That is not a big enough return to
compensate for the failures.

32. My Explanation, 4
• The result has been that the rate of return on
venture capital investments in Chile has
been too low to compensate for the risk.
• This fact has made Chilean venture
capitalists look bad.

33. My Explanation, 5
• Chile’s capital markets were not set up to
finance new ventures.
• The law allowing venture capital funds to
be created was passed in 1989, BUT the
other needed changes in the DESIGN of the
capital markets did not come until a decade
later.

34. My Explanation, 6
• During the Nineties there was no market for
initial public offerings of common stock in
Chile.
• La Ley de OPAS (1999) changed the
treatment of minority shareholders.
• La Ley de Multifondos (2002) is what
finally reactivated the Chilean stock market.

35. My Explanation, 7
• In 2004 and 2005 there were several initial
public offerings in Chile.
• Two of these were oversubscribed in the
ratio of 17 to 1.
• The Chilean stock market is now
functioning better.

36. My Explanation, 8
• The Bolsa Emergente IPOs in the years
2004-2006 have not been Compañías
Emergentes. The IPOs have been done by
companies that are already mature, like
Ripley, and also one semi-bankrupt football
club (Colo Colo).

37. My Explanation, 9
• The Chilean venture capital funds are still
being ultra-cautious because there STILL
has not been an initial public offering of
common shares from a company that
obtained venture capital financing.

38. My Explanation, 10
• The venture capital sector in Chile needs a
BIG success, something like Google.
• A Chilean venture capitalist needs to make
a HUGE return, at least 100 for 1.
• Then the Chilean venture capital sector will
become very vibrant and will give financing
to all of you.

39. Future Prospects for Venture Capital
in Chile 2007 -
• The government assigned US$ 200 million
to CORFO in November 2006.
• The Initial Public Offerings via the Bolsa
Emergente are continuing in 2007.
• Soon there will be an IPO in Chile by a
company that received venture capital
financing.

40. Future Prospects, 2
• Chile has fallen behind Brazil in IPO
financing.
• Brazil, via the Novo Mercado, has done
MANY more IPOs than Chile since 2004.
• Chile will take steps to catch up with Brazil
in the key area of financing new businesses.

41. Conclusion
• In the U.S., the culture, the legal system,
AND the financial system are all very
friendly to entrepreneurs.
• Venture capital firms are profitable and
sometimes very profitable.
• Many young people with ideas get
financing.

42. Conclusion, 2
• In the U.S., there are periods of time when
every start-up company gets financing,
including the ones that so bad they should
not get financing.
• The U.S. is in a period of time like that
now.
• The next boom here has already started.

43. Conclusion, 3
• In Chile, there have been venture capital
funds since 1990. Many start-up companies
have received financing.
• The venture capital funds have performed
poorly, especially since 1997.
• The Ley de Multifondos and the Ley de
Ahorro Previsional have revived the
demand of initial public offerings.

44. Conclusion, 4
• The preconditions are in place for venture
capital in Chile to enter a phase of rapid
growth.
• There have been several encouraging signs
that key people in Chile now consider that
venture capital is a priority.
• One more thing is needed: a big success.

45. Conclusion, 5
• Capital will not flow to new businesses in
Chile until there is a BIG success
• In which the venture capitalist obtains a
return of 100 to 1 on the initial investment.
• This can happen soon in Chile because the
initial public offering market has revived.