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Finance summary deel 2:Chapter 1: introduction to entrepreneurial Finance.
- Entrepreneurial Finance: an inter-galactic collision (between corporate finance and
entrepreneurship, Provision of funding to young, innovative, growth-oriented
companies. Combining left and right sight of the brain.
Young: typically less than 10 years
Innovative: technology or business model
Growth-oriented: different from SMEs (small medium sized enterprises)
- Investors: great variety that we need to understand
Venture capital: partnerships of professional investors who manage investment
funds on behalf of institutional investors such as pension funds, insurance companies
and banks.
Established corporations invest for strategic reasons.
Crowdfunding platforms: to reach out to general public
- Entrepreneurial finance process: ideas into businesses, long and risky. Need to
understand both actors and steps.
Process starts with a decision to become an entrepreneur in order to develop a
business idea. Founders pursue their vison by structuring their intuition into a
business plan and implementing its initial steps, convincing customers, suppliers,
employees, and investors of the merits of the opportunity. When assembling
resources, they learn about opportunity and challenges of implementing it. They
adjust to changing circumstances. Start-up hires employees, builds prototypes,
acquires initial customers, gains market share, strikes strategic alliances, develops
further products and enters additional markets.
- Three fundamental principles:
1) Gathering and recombining resources (J. Schumpeter)
2) Uncertainty (F. Knight)
3) Experimentation (J. March)
1. Entrepreneurship as a recombination of existing resources to create new
sources of value.
-Entrepreneurs need to gathering resources from owners.
-financing fundraising is a key resource because money allows the
entrepreneurs to acquire other resources
, 2. the entrepreneurial process is inherently uncertain
-risk: we know the potential outcomes
-uncertainty: we don’t know what might happen
-you may know the risk distribution of investing in stocks, but you have no
idea of whether your intuition of building a room-sharing platform will
flop or become a great success. (Airbnb)
-entrepreneurial: uncertainty.
-managerial: no uncertainty anymore, outcomes well understood.
3, entrepreneurship consists of experimentation and dynamic flexibility.
-‘exploration’ by entrepreneurial (start-up’s) companies vs ‘exploitation’
(doing better) by established companies.
-organizational structure matters for incentives and the ability to ‘pivot’ (=
adapt dynamically to market feedback)
- Entrepreneurial finance is challenging because:
1. Entrepreneur perspective:
- getting funded often considered difficult.
-confusing diversity of investors with different characteristics.(different
types of investors with their own decision processes and objectives)
> difficult to reach out to
2. Investor perspective:
-swamped with proposals: most of them are bad or a poor fit.
-long and costly investment process to get their money back.
3. managing a successful inter-galactic collision is not easy. Investors can
stop financing if they don’t make progress.
- importance EF:
-entrepreneur perspective:
> money is a key resource
>investors impact company: money is not green.
-investors perspective:
> search for returns, portfolio diversification, or strategic objectives.
> pass on knowledge and expertise
- Economic and societal perspective:
> market-driven selection system
> create jobs, innovation, economic growth, social welfare
- fundamental economic insights are very important for practical business, including
entrepreneurial finance.
- Bob solow: what drives economic growth?
-once labor and capital are fully employed, key driver is technological progress. (tfp=
total factor productivity)
-several economists have been investigating the links of innovation and
entrepreneurship with TFP, total factor productivity.
,- drivers of long-term growth:
-start-ups that have received VC (venture capital) funding have higher TFP than a control
group of start-ups without VC.
-VC generates more innovative outputs (measured by patent) than corporate R&D
spending.
-Increases in local VC funding increase the local start-up rate, employment, and aggregate
income (all income GDP, consumption expenditure plus net profits).
>>> conclusion: entrepreneurial finance does contribute to economic growth.
- Net job creation: jobs created – jobs destroyed over a period of time. This matters for
economy.
- Young firms make a very significant contribution to net job creation, but the same
cannot be said for small firms.
- Gazelles: fast growing start-ups. Only few become large companies.
- Ventures: start-ups that aim at growing fast into large companies.
A key fact of entrepreneurship is that ‘death is the rule’:
- Few start-ups survive.
- After 10 years (from founding), the failure rate of U.S VC-backed start-up is about
32%, about half the failure rate of comparable non- VC backed start-ups.
In the long-run:
- VC backed companies account for only 0.1% of US start-ups, yet they account for
5.5% of US employment.
- GDP: gross domestic product, total market value of all the finished goods and
services produced within a country’s borders in a period of time.
- VC investment as percentage GDP: Israel, US, Canada, Korea, Ireland. (highest
investment)
Frameworks: simplified models of reality that help understanding it. Longlived tools to
understand the world.
- FIRE framework:
FIT: matching process between entrepreneurs and investors.
Entrepreneur and investor face a search challenge:
Who are potentially relevant partners?
Networking, information gathering, processing.
, Entrepreneur and investor face a selection challenge:
Screening and signalling by both parties
Deep due diligence: track records, credibility, ‘clicking’
Invest: process of closing deal, money for ownership
Entrepreneur needs: company requirements and own preferences
Investor needs: own preferences: FUEL framework
Expectations: on the venture’s future.
Market conditions: parties’ relative bargaining power.
Ride: the path forward, with all the surprises and pivots that are endemic to the
entrepreneurial process.
Entrepreneur and investor both help grow the company:
-learning: discover about the company, the market and each other.
-adjust (pivot) strategy, build/destroy trust.
Governance: who choses when there is disagreement?
-role of board of directors.
Exit: the process by which the investors sell some or all of their shares to obtaina
return on their investment.
Crucial moment: returns are realized.
Exit when timing constraints of different parties. Conflicts?
How to exit?
-success (sale) option: IPO, acquisition, sale to financial buyer (secondary/buyout)
-Failure: Closing down, with or without bankruptcy.
Staged financing:
- money is provided over several rounds every 12/18 months, milestone-based, staged
vs. tranche investment
- entrepreneur and investor both face costs and benefits, but often staging is positive.
- For the entrepreneur:
Staging reduces fundraising cost and dilution
Staging introduces refinancing risk (internal and external)
- For the investor:
Staging creates option value of waiting
Staging increases control through the ‘power of the purse’ (congress, The ability
to tax and spend public money for the national government.
Terminology:
- Rounds (equity fundraising event) are consecutive and numbered
- Each round corresponds to a set of securities, called Series (=process of growing a
business through outside investment) and in alphabetical sequence (abc)
- Pre-VC rounds are called seed (=first official equity funding stage, start kapitaal), but
some VCs call so their own first rounds, this is one confusing bit
- Stages reflect venture developments, from seed to late.
Investors:
- Venture Capitals
- Founders, and their family and friends
- Angel investors: Corporations
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