Ch 1: Entrepreneurial Finance: provision of funding to young, innovative, growth-oriented companies. Ch 6: Term Sheets: a set of contractual clauses that govern the rights and obligations of both entrepreneur and investor. Ch 12: Venture Capital. FUEL Framework. 2 phases: 1. Credit rationing: there exist firms that are willing to borrow at the equilibrium interest rate (or at a higher rate) but are unable to do so. Credi
3 fundamental principles: -Gathering and recombining resources, -Uncertainty, -Experimentation. To Roles: 1)govern the rights, obligations, rewards of the parties 2)shape the incentives for all parties (incl. employees) o bring Investment phase and 2. Return (‘exit,’ ‘harvest’) phase. VC is presence of adverse selection or moral hazard, asymmetric information can lead to market failure.
understand: 2 frameworks: the parties to clarify their expectations 3)allocate risk across the two parties 4)specify the rights and duties of the parties therefore a form of financial intermediation: it raises funds Adverse selection: bank should not lend beyond a certain interest rate, because this attracts bad borrower and good borrowers will start to dro
-FIRE Framework: follows the evolving relationship between the Investors & Entrepreneurs, should help towards external parties (employees, future investors)Contingent contracting: TS address highly uncertain prospects, which credit rationed in equilibrium. // Moral hazard: Banks face borrowers with same risk type, but different amounts of ex-ante collateral/ assets.
from third parties (LPs): it invests the funds on their behalf: it
to structure the whole finance framework. compound the natural impossibility to cover all possible future events and situations. This is expressed as contracts being rational for banks not to lend to some firms (those with insufficient pledgeable assets).
gives back any profits to LPs, retaining part of them. Limited
FIT, 2: matching process E & I [E&I Search challenge (networking, info gathering) & Selection challenge ‘incomplete’. It is addressed through ‘Contingent Contracting’, where clauses apply to certain situations only. TS define Asymmetric information creates a key challenge to allocate finance due to moral hazard and adverse selection
(screening & signaling, due-diligence(track record, credibility))] INVEST,3-6,8, 10: process of closing a contingencies through ‘Milestones’ which identify salient events that reveal information on whether the company’s progress Partners (LPs): = institutional Investors which commit
deal - money for ownership: 4 forces -> [E needs, I needs (see also FUEL framework), conforms or not to expectations. Milestones: measure performance in 4 dimensions: 1) financial 2) operational 3) managerial money directly (e.g., Endowments, Family Offices, Corporates) Ch 11: Exit: Investors have three underlying Reasons for Exiting:
expectations(venture’s future), mrkt conditions(bargaining pwr I&E)] RIDE,7-9: path forward, jointly and 4) technical. Positives: 1. align expectations of entrepreneurs and investors. 2. provide a focal point for renegotiation 3. or on behalf of others (e.g., Pension Funds, Insurance 1)Liquidity: private company shares are difficult to sell, unless the whole company is sold (‘liquidity event’). A
grow c, (learning, governance), staged financing – pos for both E&I but power of the purse!! EXIT,11: I facilitate negotiation about valuation, by linking it to performance targets. Negatives: 1. Elusive 2. Under-pivoting 3. Short- for New Owners: as the company matures, different inputs can benefit it (monetary and not) 3)Market Timing
Companies, Sovereign Wealth Funds). They need to make 2
realize ROI: when? Timing – may lead to conflicts! How? [IPO, acq, Fin Sale(buyout, secondary), closing termism. Milestones economic roles: 1)define performance targets 2)align expectations of entrepreneurs and investors market, especially for IPOs
choices: 1. An asset allocation choice (top down): (stocks,
down (with(out) bankruptcy->Ch11: exit)] 3)provide a focal point (reference point) for renegotiation 4)facilitate negotiation about valuation, by linking it to performnce Types of Successful Exits: A)IPO B)Acquisition C)Sale to financial buyers
bonds, commodities, alternative assets) and 2. A choice of Unsuccessful Exit: D)Closing down
-FUEL framework: reflects the investor’s nature and approach to the deal. o 1. Investors are not fungible targets
building a portfolio of specific GPs. Limited Partnership Team is key driver for successes (96%) and failures (92%)
(vervangbaar), money is not green 2. Focuses on the investor’s defining traits. The I Cashflow rights: ‘convertible’ stock: 1. Debt-like Payoff in case of failure → (1)(‘downside protection’) AND 2. Conversion
nature&approach/identity&behaviors to the deal (focus on I’s defining traits), I impact on company -> I into Common Equity if the company succeeds → (2)(profit-sharing in the upside). Convert when into Common Stock (Equity) at Agreements (LPA’s): LPs cannot see (asymmetric The Timing of Exit depends on three main factors: 1)the preferences of investors and entrepreneurs 2)their exp
add value via expertise & network. Fundamental structure: who is the investor? (organ structure – fin Exit when: Their Cash Flow from Common Stock exceeds the Preferred Terms => Conversion threshold (CT) = Preferred terms information) and assess (lack if expertise) what GPs do. To ability to time the market
resources, governance structure - decision making) Underlying motivation: what does he want? / ownership share. Multiple liquidation preferences: Convertible preferred stock may add a (Multiple) Liquidation preserve limited liability, LPs also refrain from intervening in IPO = Initial Public Offering:
((non)fin return, risk tolerance, patience). Expertise and networks: what does I contribute, what Preference to the preferred dividend, so that the investor gets its capital back several times. Participating preferred terms: the fund’s management. The LPA is a contractual solution to Benefits: 1) Liquidity for shareholders (return or diversification) 2) Visibility vis-à-vis banks, workforce, comp
expertise(own knowledge)&network(knowledge accessible), how is I standing with its peers – network combines Debt and Equity features by adding a (Multiple) Liquidation Preference to the preferred dividend (‘Double Dip’). currency’ // Costs: Direct: the process is time-consuming and expensive: 1)Underpricing, which ultimately aris
these problems: it regulates rights and duties of both parties. channels) 2)Costs of investment bankers, auditors, advisors 3)Listing fees (also yearly) 4)Compliance and Disc
centrality? Logic and Style: how do I operate? (how to select and interact w/firms - link to FIT stage of Participating preferred with cap: A Cap may be imposed on the participation in order to preserve incentives for the LPA Fund Rules: a. Investment restrictions: b. Fund
FIRE) entrepreneurs. The drop in the cap is usually smoothed out to avoid providing perverse incentives at the time of exit. 3 Costs Indirect: 1)Opportunity cost of managerial attention 2)Disclosure of sensitive information at IPO 3)Cost o
rationales for using preferred stock: 1. provide incentives to founders. 2. screen out weaker projects. 3. align investor and management rules c. Partner activity restrictions. GP shareholders
Ch 2: Evaluating Business Opportunities: Venture Evaluation Matrix: both E and I perspective: below entrepreneur’s expectations. Compensation and employment: Upon Funding, Founders become Employees, 3 implications: 1. compensation: -Management Fee: 2% of ‘capital’: covers Preparing for the IPO requires:1) Becoming a fully-fledged independent company 2) Complete the managemen
// Role Bus. plan: structured narrative along VEM logic. // Role Fin. projections: verify assump they can be fired. 2. they are subject to non-compete laws. 3. they confer to the company their IP. Two guiding principles:(1) operational costs -Carried Interest: 20% of ‘profits’: aligns LP 3)Structure the board for a public market (independent directors, committees) 4)Satisfy listing requirements,
underlying BP; focus on operational viability&profi; focus on timing&milestones. defer pay as much as possible to save cash (2) provide incentives for long-term value creation. 4 Control Rights: 1. and GP incentives. GP incentives: fees give an incentive to quarterly earnings targets) 5)Retain an investment bank to manage the process 6) Decide when: Market Timin
Sources of info: own data, secondary, learn from others, own experience. Shareholders’ voting rights 2. Board of directors 3. Contractual rights 4. Informal control. Investor liquidity clauses: 1. raise larger fund -> ‘Strategy Drift’ with larger funds list: Home vs. Abroad, Main vs. Niche market
Financial planning: Working Capital (WC) = Equity + LT loans – fixed assets (Healthy when WC > 0) Redemption Rights: allows investors to “redeem”(inruilen) his shares after a reasonably long period, at preferred terms. 2. Five main steps: (1) Investment Bank (2) Due Diligence(3) Road Show(4) Pricing (5) Sale & Trading
investing at later stages, where more money is put into a
Working Capital requirement (WCR) = inventories + Customer credit – Supplier credit Tag-along rights: investors can sell their shares along with founders. 3. Drag-along rights: investors can force other 3 pricing methods of IPO: Book-building, Fixed-price, Auction
If WCR > WC, need to rely on ST loans // NWC = Cash, inventory, accounts receivables [CA] – accounts single company. ACQUISITIONS: most common // Benefits: 1)Liquidity for shareholders (Return or Diversification) 2) Simplic
shareholders to sell their stock 4. Registration rights and piggy-back: force listing. // “Founders stock is vested, its main
payables [CL] // CF = Net Income – ΔNWC – Capex + Depreciation purpose is to assure the continued commitment of the founders to the company” Costs: Direct: 1)The process is relatively inexpensive, but may involve Earn-outs and Fees to an investment ba
Ch 7: Structing deals: art. ‘Hard’ elements (valuation, term sheet): summarized in quantitative relationships (e.g., pricing) Indirect: 1)Scrutiny (controle/toezicht) by potential competitors (‘Opening the Kimono’), loss of control over t
and hard legal constraints. ‘Soft’ elements provide a Buffer to sustain the deal and allow the parties to work productively: go Auction theory:how prices are formed in alternative competitive bidding processes: 1)English auction: Ascend
Ch 2: VEM à evaluate the strength of an E idea by assessing how it might generate value, assess main risks into effect when (contingent) contracts are not enough for effective solutions. Nash specifically showed that all we need to
know is three variables: 1. Each party’s outside option of walking out of the deal 2. The joint value that the two parties can
auction: ‘Descending price’ that stops at the first bid 3) Sealed bid auction: Buyers submit private bids
FINANCIAL SALE: A) Buyout: The whole company is sold. This often concerns late stage companies that are w
VEM Market risk Technology risk People risk achieve by cooperating 3. A rule for splitting the surplus between joint value and the sum of the outside options. 5 steps up or a turnaround by a specialized investor. 3 types: 1) MBO = Management BuyOut(managers buy the compa
process: new managers)3)LBO = Leveraged BuyOut (debt-financed transaction)
Attractiveness(rows) Customer (demand) Company (supply) Entrpr. (implem a solution) 1: Fundraising/Pitching: use VEM. The disclosure dilemma: NDAs are a useless tool: information is largely common knowledge B) Secondary Sale: Only the seller’s stake is sold, to secure liquidity or to allow a new investor that can help t
Value propositon NEED (what, strength, SOLUTION (solve need? How wrt TEAM (talent = scarce: skills, (idea execution is key) and Arrow’s information paradox: you only want to pay if you can see the quality of the idea but that Like Buyouts: Buyers are financial investors 2)Unlike Buyouts: The sale is about only some ownership stakes.
requires that this is disclosed! Types of Transactions: A) Funding Round Sale: allowing new investors to buy out old ones B) Stand-alone Tra
(Micro) WTP, B2B or B2C? Can alternatives? protect innovation? experience, motivation, 2: Screening (business opportunities): MATCH tool: represents a way to assess the fit between investor and entrepreneur. ones C) Specialized Marketplace Sale: founders and employees can sell shares to new investors
Ability to create value we learn from early -> experimentation, design thinking – commitment, complementary & 3: Syndicating to have 1. second opinions 2. reduce commitment 3. reciprocate invitations 4. involve investors EXITING INVESTMENTS: Determinants: 1)Market Forces 2)Economic Fundamentals 3)Company Dynamics
adaptors?) lean start-up methodology), iterative cohesive, trustworthy/integer) 4: Deal Negotiating: 3 concepts to make nash bargaining theory operational: Outside options, ZOPA, The actual final agreement.
5: Closing: 2 ‘soft’ elements are particularly important as Buffers: (1)Trust & (2)a Long-Term Perspective. Ch 13: Early stage investors
Industry (Macro) MARKET (how big is COMPETITION (current & future NETWORK (access resources, // SV(=surplus) = Joint Value – OutsideOptionE – OOI //BargValueEntrpreneur = OOE + BargStrengthE*SV // BVI = OOE + Why do corporate investors fund startups?1) Startups are a window on the technology landscape and allow cor
Ability to scale up/ the opport: (target) rivals, differentiation from rivals, reputation, form/maintain new BStrengthI*SV // ZOPA= maps the set of admissible deals: for each party, the deal that’s more attractive than OO (Building talents (“acqui-hires”) 2)To establish vertical relationships with innovators (downstream buyers or upstream
better OO, reduces ZOPA // Preparation: use VEM, build financial plan, negotiate share splits among founders, prepare to (“killer acquisitions”)
achieve scale market size/growth nature competition: entry barriers relationships, network centrality negotiate valuation Corporate/Strategic investors: Major differences with VC investors approach: 1)Deal flow driven by strategic
s-curve speed, adaptation?) prod. Differentiation & regulation) (connectednes,diversity, position)) Ch 8: Corporate governance: Set of actions through which investors (try to) ensure to receive a return from their valuations for strategic benefits 3)Expertise and networks focused on technological space 4)Ambivalent effects
investment “competitive threat”
Strategy (Dynamic) SALES (how to reach PRODUCTION (how to capture ORGANIZATION (how to -> Companies’ need for guidance/BoD: Board of Directors Crowdfunding (matching platform for I & E): Reach out to decentralized resources through an online platform
Ability to grow, customers, marketing & value; development strat, scope of develop/maintain company -> Investors’ need to protect their investment startups: lack of verifiable information, Limited size loans (rarely above $50K), Low interest rates but transact
How: 3 control structures (in company charter!) Two major benefits for investors: 1)Reach a much wider deal flow in a cost-efficient way 2)Ease of closing tran
capture value & be distribution strategy, activities – partnering strategy, leadership, governance structure, 1.Voting rights: equal voting power, share class & dual-class shares, non voting Social Impact Venture Investors are a small but growing segment of early stage investing
dynamically pricing strategy, revenue efficient operations? Milestones talent strategy, develop cultural 2.BoD: Fiduciary duty to all shareholders // Roles: Boss, Monitor, Coach, Promotor; 3 categories: I, E & indep Directors
3.Informal control: Decisions are often made outside of framework of formal control rights a. Power of the Purse
sustainable Ch 8 model) /secure key inputs, choice on imprint, talent recruiting/ (Investors) b. Power of Personality (Management) c. Power of Persuasion (I & E) Staging: Option Value of Waiting:
boundaries of firm – outsourcing) retention, founders’ succession) Investor value adding: Differentiate Selection from Treatment: both dimensions matter 1) Selection = The ability to Assumptions:
• Discount rate = 20%
Competitive advantage Gain access customers erect and maintain Entry barriers Developing key competences choose the right company’s 2) Treatment = The ability to help it succeed
How they add value: • Project life = 5 years
(columns) 1. Mentoring & coaching (personal level) 2. Advising (comp level) 3. Networking (industry level) 4. Pressuring (comp lvl) • Capital needed upfront ($2M), after 1 year ($3M), after 2 years ($10M)
VEM for E: identify and assess strenghts&weaknesss of venture, to structure BP (fin projections reflect underlying BP) Where they add value? VEM to Identify Strategic challenges: 1. sales: strategic advice, expertise, contacts 2.production: Strategy 1: Raise $15M upfront
support, connections 3. organization: support + 4. exit challenge: more developed corporate structure // I replacing • Probability of (40% * 50% * 50% =) 10% to realize exit value of $200M • Post-money
VEM for I: 1. a first screening 2. Due diligence (time consuming) – quality of BP always at heart of decision management: THE MATCH TOOL = Tool to help understand to which extent an investor is a good match for a company: valuation = $200M * 10% / (1+20%)^5 = $8.04M
Financial planning: to predict, negotiate, choose, avoid surprises – ST/MT/LT – why FP? for growth&WC managment geography, industry, stage; size, board of directors;customers & markets, leadership & organization ; trust? • Pre-money valuation = $8.04M - $15M = -$6.96M
Strategy 2: Raise $5M upfront, and $10M after two years
Ch 3: The Financial Plan. 2 key questions: 1. How financially attractive is the venture? (=Financial goals: where to get to?) 2. What financial resources does the venture Ch 9: Staged Financing = raising successive rounds
need? (Financial means: how to (financially) get there?) II Financial projections are managerial accounting tools that look forward (rather than financial accounting • Probability of 50% to realize exit value of $200M at the time of the
Motivations for Staged Financing: For the Entrepreneur: -Staging reduces the cost of fundraising and the associated $10M investment
tools that serve the purpose of reporting past facts). II 3 Reflections: 1. Force entrepreneurs to reflect on their business model (analyze, motivate, and discuss strategic dilution For the Investor: - Staging creates option value of waiting - Staging increases control through the ‘power of the • Post-money valuation at the time of the $10M investment = $200M *
choices) 2. Reflection of the businesses plan (set expectations and make BP speak in numbers) 3. Reflect something about entrepreneurs themselves (Reveal their purse’ - Facilitates termination of investing (refusal vs getting back). Staged financing is based on Milestones = ‘salient 50% / (1+20%)^3 = $57.9M
approach to business) 3 Limitations: 1. Always inaccurate 2. Quickly become outdated 3. Financial projections are always optimistic. 3 Main accounts: 1. Income events at which uncertainty about the company is resolved and information is revealed’ Raising capital by issuing shares • Pre-money valuation at the time of the $10M investment = $57.9M - $10M = $47.9M
Statement 2.Balance Sheet 3. Cashflow Statement. How to build? 1. Timeline(GANTT)(milestones=reveals important info & horizon) 2. Revenues (bottom-up: supply-side, leads to ‘Dilution’= Existing shareholder’s ownership fraction mechanically decreases when new shares are issued.
comp. data, Capacity; top-down: demand-side, secondary data, Market share) –> Combining both: estimated market share: S=Capacity/Market size. 3. Costs (bottom-up: What is the implication for the valuation at t=0?
‘Tranching’ is an intermediate approach to staging. It is a contractual arrangement that specifies a total round amount and • Probability of (40% * 50% =) 20% to realize pre-money valuation of
looking at inputs; top-down: learning from competitors) 4. Build the fin. model (3FS)=(IS: profitability; BS: needs for working capital looking at CA-CL; CF: funding needs
$47.9M at the time of the $10M investment
looking at CF) 5. Formulate financial plan (answer 2 key questions). Behavioural biases: framing, sunk cost fallacy, over-optimism. Behavioural biases can be amplified, the share price but divides this amount into tranches—typically two. The second tranche is conditional on achieving a
• Post-money valuation at t=0 = $47.9M * 20% / (1+20%)^2 = $6.6M
or reduced, by nudging, which is a form of framing. milestone – conditionality can be automatic or at the investor’s discretion// Difference between tranching and staging:
Ch 4: Ownership and returns. The “Capitalization Table” is a spreadsheet table that, for each shareholder, keeps track (at each round) of: The number of shares • Pre-money valuation at t=0 = $6.6M - $5M = $1.6M
Staging: requires negotiation and entails uncertainty about its outcome while tranching: is largely automatic. Retention
owned, The amount invested, The ownership fraction: It is organized in blocks corresponding to funding rounds, with each row reporting data for one owner// The The valuation for the investor has increased from -$6.96M to $1.6M
Stock Options Pool (SOP) is used for: 1. attracting and retaining talent 2. deferring cash payments to key employees and board members -> Stock can be granted rate: Extent to which the investor’s stake is reduced in case of no re-investment = ratio between the final (‘post-deal’) • In the 80% of scenarios in which there is no point in investing another $10M after two
directly or through stock options. II With a 𝐒𝐎𝐏 we express share numbers on a ‘fully diluted’ base. -> Fully diluted = all shares in the pool are assumed to be converted ownership fraction of inside investors and their current ownership. (if you contribute in next round pro rate = retention years, she can opt out!
(eventually) into common stock. II Two important differences with how the Trade-off Risk and Return plays in Entrepreneurial vs. Standard Corporate finance: 1. Risk rate 100%) TERM SHEETS: Liquidation stack: order of seniority of different investors (organized by Series). Anti-dilution Strategy 3: Raise $2M upfront, $3M after 1 year, $10M after 2 years
is often ‘extreme’ (‘skewed’ in statistical terms): Venture investors are not risk lovers, they are risk tolerant investors who work towards reducing the risk of their protects investors in case of a ‘down round.’ Down round: round where the share price falls below that of the previous • Pre-money valuation of $47.9M at the time of the $10M investment
companies. 2. Liquidity Risk: selling company shares takes time and one may find a buyer only at a very low price. This contrasts with the liquidity of traded stocks. 3 round. It compensates investors for having paid a share price that turns out to have been too high. It offers investors • Probability of 50% to realize pre-money valuation of $47.9M at the time of the $3M
measures of investor returns: 1. NPV: +allows comparing investments with different horizons -one needs to estimate an appropriate discount rate, which is difficult protection complementary to the downside protection offered by convertible preferred stock. - Convertible preferred: investment
to find because of lack of benchmark companies 2. Cash on cash multiple (CCM): +simplicity -CCM does not account for the time value of money, nor for the • Pre-money valuation at the time of the $3M investment = $47.9M * 50% / (1+20%) - $3M
protects against disappointing exits - Anti-dilution: protects against disappointing future rounds. They are complementary = $16.9M
investment risk 3. IRR:+IRR takes into account the time value of money, and so the timing of cash flows -IRR does not take into account the level of risk taken. to pre-emption rights, which preserve percentage ownership. Weighted-average protection: the first round is re-priced at:
Comparing Comparing two projects with the same IRR but two different horizons (41% in the table) is difficult!! CCM: does NOT vary with the time horizon! IRR: does • Probability of 40% to realize pre-money valuation of $16.9M at the time of the $3M
vary with the time horizon! NPV for decision making; CCM and IRR for reporting purposes. II FAST Tool: Founder Allocation of Shares Tool: 1) define team members and // Pre-emption rights = right to participate in future rounds purchasing new shares up to ‘pro rata’ amount. Right of first investment
their roles 2) define time period and their weights 3) allocation points to founders for their contributions 4) Identify net transfers across founders 5) recommend refusal: allows the company to purchase shares sold by an investor or founder on the same terms as offered by a third • Pre-money valuation at t=0 = $16.9M * 40% / (1+20%) - $2M = $3.6M
ownership stakes and contingencies // Four main determinants of a venture valuation: The opportunity itself, The market context, Deal competition, Investor party with goal to preserve insiders ownership. FINANCING DIFFICULT SITUATIONS Structuring a Down Round can be The valuation for the investor has increased even further to $3.6M
quality//Founder agreements address five main issues: 1.Who are the founders? 2.Salaries and other forms of compensations 3.Obligations and rights of the company challenging because it requires several difficult steps: - the consent of inside shareholders, who may be diluted -the need to • She can avoid investing $13M in the 60% of scenarios in which proceeding after 1 year is
towards founders 4.Ownership allocation 5.Contingencies under which some founders obtain stronger or weaker rights keep founders motivated, due to dilution -the need to deal with stock-option washing out -the need to find willing outside pointless.
Ch 5: Valuation Methods. Challenges: high degree of uncertainty, asymmetric information, lack of value-relevant objective information, inadequate accounting for • In half of the 40% of scenarios in which proceeding after 1 year is worthwhile, she can
investors who believe in the company’s potential. DYNAMIC INVESTMENT STRATEGIES Staged Financing Process: avoid investing $10M when proceeding after 2 years is pointless.
intangible assets (incl. human capital) –> Standard valuation models cannot be simply applied. Trade-off simplicity vs. complexity: uncertainty calls for a simple, Investors and Entrepreneurs each have to make 4 important Choices: Investors: 4 important Choices to make: 1)When to
reasonable approach uncertainty may also require a precise, complex methodology. -> Different people have different views on this. 4 valuation methods: The investor attaches higher value to the shares she buys if she provides the $15M in a
make their first investment in a company (Timing: financial resources, expertise and ability to add value, risk attitude) staggered fashion.
1) Venture Capital Model (VCM): from practice, simple, consistent. 4 inputs: Investment amount I, Time to exit T, Xe Exit value, P required rate of return (Fin: Riskless
2)Whether to Reinvest, and if so how much (drivers: portfolio strategy, investor’s confidence in the potential, extent to In the example, this is reflected in the entrepreneur maintaining ownership stakes of
rate of return: Time value of money; Financial risk premium: Measures the return investors require to bear Systematic Risk= Systematic risk – CAPM: Investors CAN
eliminate the Risk that is specific to each company (= ‘Idiosyncratic Risk’) → By investing in many companies the gain of one compensates the loss of another. Investors which the investor can/wants to share. 3)Whom to Co-invest with (and how to split the investment) 4)How to structure 45.4% under Strategy 3 and of 20.5% under Strategy 2.
CANNOT diversify away the Risk common to all companies (= ‘Systematic Risk’) → think of the risk of recession; Illiquidity premium: Long-term investments with staging to achieve a good Exit. Entrepreneurs: 4 important Choices to make:1)What Investors to choose 2)How much
almost no secondary market) (Non-Financial: Failure rate premium: Reflects the high mortality of new ventures; ‘Service’ premium: Reflects services provided by the Money to raise and when 3)What Valuation Profile to build 4)What kind of Exit to seek
investor) (= all these premiums lead to a high discount rate) (Perspective of the investor CF) Exercise : non dilution clause
2) Discounted Cash Flow (DCF): from theory and practice, can become complicated and relies on demanding assumptions. It generates ‘intrinsic,’ ‘absolute’ valuation. V_post(r) = I(r) (Investment amount) / F_r(r) (Shares)
Ch 10: Debt Financing. 3 important distinctions: 1. Installment credit is the standard fixed-term (’term’) loan VS Revolving credit (e.g., credit lines) is more
Main model used in corporate finance. It is Theoretically grounded but less popular in practice. It models company cash flows, which require detailed assumptions and flexible and allows to ‘draw’ money up to the agreed ceiling, which cannot be surpassed (‘revolving’ = roterend). 2. Secured credit has collateral that guarantees it
knowledge of the business. The uncertainty of entrepreneurial ventures makes it less applicable, Except at later stages, when historical information about the company
and reassures the lender VS Unsecured credit is granted when the lender can trust the venture to generate enough cashflow to repay the loan. 3. Personal vs.
becomes available. (Perspective of the company CF)
Corporate debt: Founders often can (or need to) tap personal borrowing capacity (Personal debt) to obtain resources before their company becomes ‘bankable’
3) Comparables Method: from practice, uses market information to generate ‘extrinsic,’ ‘relative’ valuation. It is short on modelling, and long on using market
(Corporate debt). 4 key elements: 1. Maturity: How long is the contract 2. Cost: Interest rate and fees 3. Collateral: How is the principal guaranteed: Asset that is
valuations as an indication of potential valuation. Simple logic: Estimate valuations by comparing it to what the market values ‘comparable’ companies. Two
seized by the lender in case of defaul 4. Covenants: How is the lender protected: 2 types: a) Affirmative covenants: used to induce virtuous behavior and avoid Diluted stake: F_(r-1)(r) = F_(r-1)(r-1) * (1 – F_r(r))
approaches: (A) Investment: Compare directly the venture’s valuation with that of similar deals done by investors & (B) Exit Comparables: Look at how markets value repayment problems by setting limits/targets to financial ratios, such as interest coverage or return on equity (ROA) b)Negative covenants: prohibitions: Punish the
comparable mature companies. Comparing the Logic of Investment and Exit Comparables: 1. Different Reference (Public markets vs Private deals) 2. Different Valuation
borrower for taking actions that may make repayment more difficult → Actions cannot be prevented..., but if they occur, the loan can be recalled. Debt vs Equity: e.g., F_2(3) = F_2(2) * (1 – F_3(3)) = 12.50% * (1 – 16.00%)
Ale
criteria (Expected performance vs Actual present valuation) 3. Different Treatment of valuation (Derivative vs Direct)
common fallacy that debt is cheaper than equity! Moral Hazard: The idea that individuals will change their behaviour if they are not fully exposed to its
4) Probabilistic approaches which model uncertainty: It addresses a shortcoming of VCM and DCF: the lack of explicit modelling of the Probability of different events. 3 = 10.50%
consequences3 main criteria in bank’s credit decisions: 1) The probability of default: high for ventures: survival depends on stable revenues, stable costs, and
approaches: A) Scenario analysis B) Simulation C) PROFEX: PRobability OF Exit: extends logic of VCM by modelling the uncertainty about exit outcomes /// Three
experienced management, none found at a start-up 2) The recovery rate in case of default: low for ventures: there are few tangible assets, capital is largely human,
caveats on using multiples 1. Need to measure the multiple consistently across comparable companies (and the focal one). 2. Need to look at the whole distribution, not and ideas are often not embodied into IP. 3) The interest rate they can charge: cannot rise to the point of compensating for the high risk and volatile return.
Founder stake: the residual: so 100%- …
only its average. 3. Need to consider that multiples reflect market valuations, and are thus prone to herding. Value of non dilution clause:
Alternatives type of debt: Personal debt; Trade credit; Discounting and profit; Venture leasing; Venture debt.
