Entrepreneurial Finance of Onset Ventures - Case Study Example

?Onset Ventures Table of Contents I.Background of the Case 3 II.Facts of the Case 4 A d Facts 4 B.Implied Facts 5 III.Problem Definition 5 A.Source Problem 5 B.Secondary Problem 5 IV.Alternative Options 5 V.Criteria 6 VI.Solutions 7 VII.Implementation & Follow-up 8 References 9 Appendices 10 I. Background of the Case Entrepreneurs start ventures for various economic and altruistic motives but their ultimate objective is to create value. A venture goes through different stages of growth: development, startup, survival, rapid-growth, as well as early-maturity stages. Early-stage ventures are very young firms with limited operational resources and are usually in the development, startup or survival stages. The seasoned firms are usually in rapid-growth or maturity stages (Leach & Melicher, p.21-22). Seed financing is represented by the funds required to determine if an idea can be a viable business opportunity. This is usually necessary at the development stage of a venture. Other sources of financing are startup financing, first-round, second-round, liquidity stage, mezzanine and seasoned financing, depending upon the ventures life cycle stage. Onset Ventures is a top-tier seed investor which has raised three funds till now. The partners at Onset have analyzed and set six principles, based on which they provide seed financing to a startup venture. The principles address the skill set and experience of the entrepreneur, continuously evolving business model, validation of business model followed by hiring the CEO, the funds spent only to add value perceived by the capital providers, product’s Unique Selling Proposition and the skills of personnel hired. These principles have been refined over time and lead to the development of incubation process through which the company develops, refines and pursues or rejects business ideas. During the first phase, pre-seed phase of incubation process, Onset analyzes if the business concept can be an attractive investment. Based on the outcome of the pre-seed phase, it proceeds to the seed phase and provides seed financing to the business. Onset analyzes the possible risks and tries to address those risks during this phase. The five risks are market, technical, operating, pricing risks, as well as the risk related to the operational capability of the business team. Onset has a comprehensive process of screening the ideas and identifying profitable ventures but it has lost the opportunities of making more profits due to tight funding of the ventures and by being too careful and risk-averse. II. Facts of the Case A. Stated Facts Onset Ventures was set-up with an initial $5 million fund in 1984 and subsequently raised $30m (Onset I) and $67m funds (Onset II). Out of these funds, two-thirds have been invested in seed and follow-on investments, and the rest is kept as reserves in Onset II. In 1996-97, the size of an average VC fund increased by 40% to $71 billion. The company plans to raise $80m-$95m fund, it’s the largest fund till now. Onset has provided seed financing of $1m for the company TallyUp to develop a viable software product. Onset operates on a model of five business principles and a specific incubation process of pre-seed phase and seed phase to screen the business ideas. The company’s minimum target IRR of a fund is 30% over 12 year cycle. Onset puts in a company around $1m in seed round, $1.5m in the next round, and $2m in the third round. Onset I gave positive IRR within 4 years of its inception (appendix 1) and Onset II took only three years to give positive IRR (appendix 2). The average number of investment has increased in subsequent funds, i.e. $2.5m in Onset I, $3.5m to $4m in Onset II and expected $4.5m to $5m in Onset III. B. Implied Facts Over the last 13 years, Onset has invested mainly in seed-stage and early-stage financing. Onset II has performed better than Onset I (appendix 3). III. Problem Definition A. Source Problem How many funds must be raised for Onset III? Whether Onset should invest an additional $1m into TallyUp for development of beta version of the product or TallyUp should seek funding of $3m-$4m for product development and launch from the VC community. B. Secondary Problem How the funds raised for Onset III should be utilized? How the problems faced in either of the decisions of investment in TallyUp are dealing with? IV. Alternative Options The options available to Onset Ventures regarding the fund size and TallyUp investment are: 1. Proceed with the present four partners and decision of investing $5m per partner per year. This will lead to the required funds of $80m, excluding fees and miscellaneous expenses. 2. Anticipating the changing VC industry, the number of partners or sectors can increase, other than the technology sector might evolve with potential start-up funds seeking entrepreneurs. Therefore, additional funds to the already decided funds of $95m can be raised because the limited partners have already made commitments for $140m. 3. Provide $1m to TallyUp to develop beta version of the product. 4. Provide partial funds to TallyUp and assist it to raise remaining funds of the total $4m from other venture capitalists and launch its product in the market. This way Onset could increase its stake in the company and let the other venture firms take 15-20% ownership. V. Criteria 1. Continue the investment focus of the Onset II in Onset III. 2. Remain with the market trends in VC industry. 3. Achieve the remaining objectives of the first-round financing of TallyUp, i.e. bring product to trial stage. 4. Achieve the engineering, marketing, sales, financial and operations objectives for TallyUp which have already crossed the deadline. 5. Limit the valuation of the company. The company is presently valued at $2,625,000, including $1m of investment by Onset. Furthermore, TallyUp wants to keep $750,000 as stock options for newly hired employees. This would increase its valuation. 6. Need for balance between beta version development and market launch, as well as ownership in TallyUp. VI. Solutions Keeping in view the criteria for decision-making, Onset should choose the following options regarding the two major issues: 1. Based on the calculations in appendix 4, $105m can be raised for Onset III. This amount considers the underlying assumptions of investment per deal, number of partners and the period taken from seed to liquidity. In addition, it includes the amount required for the fees and other expenses. The remaining amount is for any anticipated changes in VC industry in the future 5-10 years, when technology industry becomes less attractive for possible seed investments and other capital intensive industries might grow exponentially. Sometimes the entrepreneurial opportunities are commercial reflections of the societal changes and, therefore, must not be ignored. 2. In case of TallyUp, Onset should provide the 50% of the $4m of the funds for product development and market launch, while the remaining 50% can be sought from other venture capital firms in the market. The terms of this arrangement can be set by Onset in the form of assurance from venture capitalists for later-stage financing of TallyUp if the product’s beta version has a market success. This solution addresses the need for maintaining the momentum of team to develop the product and TallyUp will not have to wait in the long process of VC financing for its development. Also, Onset will not be the sole investor of the company. VII. Implementation & Follow-up As Onset has already generated $140m of commitments from its limited partners, therefore, it should immediately obtain funds for Onset III. Onset should continuously analyze the industry to anticipate future trends. The earlier changing trends are anticipated, the higher the profits it will be able to mop-up through seed financing. The TallyUp product development process should be started as soon as possible to avoid any further delay in the product launch. References Leach, J.C. & Melicher, R.W. Entrepreneurial Finance 2nd ed. Cengage Learning. 2011. Print. Appendices Appendix 1: Annualized Cumulative IRR of Onset I Appendix 2: Annualized Cumulative IRR of Onset II Appendix 3: Comparative Performance of Onset I & Onset II Appendix 4: Required Funds for Onset III Read More