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sold to another company, the investment is repaid at an agreed upon formula containing profit . If the company merges with another company, the investor may cash out their investment or carry their equity interest over to the new company – or a little of both.
IPO – The Ultimate Exit Strategy Venture capitalists hope that a startup is so successful it eventually can be converted from a private company to a publicly traded company . The conversion is referred to as “ going public ” and it happens by a process called an Initial Public Offering (“IPO”) . Students will learn more about IPOs in a later lesson, but understand that when a company “goes public,” it’s a pretty big deal. Its shares are listed for sale in a public equities market called the stock market . To qualify for an IPO, a company must have annual revenue of several million dollars. An IPO has a huge impact on a company’s ability to raise capital because the company can sell shares to anyone in the world. That has the potential to raise vast sums of capital for growth . The IPO is supervised, managed, and funded (underwritten) by an investment bank. If a startup is successful enough to qualify for an IPO, the venture capitalists who funded the startup and the investment bank that underwrote the IPO, often realize a very large return on their investment (ROI) . How big? The venture capitalists who invested in such companies as Google, Facebook, Airbnb, Twitter, Dropbox, and eBay had returns of over 1000 x their investment. That’s right, an investment of $1 million returned $1 billion after going public. That makes the IPO the Holy Grail of the venture capital world. Of course, there are companies whose IPOs did not return anywhere near those numbers, but generally the VC firm and investment bank make a very healthy return on their investments. Once a corporation goes public, it is subject to all sorts of government-mandated annual financial disclosures . Its shares and financial affairs are public . Students will learn more about the government agency responsible for maintaining a fair and orderly stock market in a later lesson. How about a bank loan to fund a startup? Commercial banks provide business loans which can be used to pay for things or services needed to expand a business. However, there are limitations on how much and to whom a bank can lend. Generally, commercial banks may loan only to profitable businesses with a stable, established operating history, and proof of the ability to repay the loan. Commercial banks do not fund startup business ventures. Engage students in a discussion: Can anyone recall why a commercial bank is not able to invest in a startup, no matter how promising the product? Answer: Recall Chapter 6 The World Goes for Wealth. Students learned about the Glass-Steagall Act (GSA) which barred commercial banks from engaging in risky ventures. The GSA was repealed, but parts were reinstated under the Dodd-Frank Act of 2010. Banks are not permitted to risk depositors’ money investing in startups, and may not take equity (shareholder) positions in companies. There being exceptions to every rule, commercial banks are permitted to make loans to startups through the federal govenrment’s Small Business Administration (”SBA”) programs . The SBA does not make loans directly to a startup or invest in startups. Instead, it guarantees to a bank that the loan the bank makes PRODUCT PREVIEW
247 THE 21st CENTURY STUDENT’S GUIDE TO FINANCIAL LITERACY
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