EF – Summary
Table of Contents
EF – Summary .......................................................................................................................................... 1
Chapter 1: Introduction to finance for entrepreneurs ........................................................................ 2
Chapter 2: Developing the business idea ............................................................................................ 8
Chapter 3: Organizing and financing a new venture ......................................................................... 13
Chapter 7: Types and costs of financial capital ................................................................................. 18
Chapter 9: Projecting financial statements ....................................................................................... 22
Chapter 10: Valuing early-stage ventures ......................................................................................... 26
Chapter 11: Venture capital valuation methods ............................................................................... 30
Chapter 12: Professional venture capital .......................................................................................... 32
Chapter 13: Other financing alternatives .......................................................................................... 35
Chapter 14: Security structures and determining enterprise value .................................................. 38
Chapter 15: Harvesting the business venture investment ................................................................ 41
Chapter 16: Financially troubled ventures: turnaround opportunities? ........................................... 45
Article 1: A Comparison of Cost of Equity Estimates of Local and Global CAPMs ............................ 49
Article 2: Financial reporting quality and the cost of debt of SMEs .................................................. 52
Article 3: Startup valuation by venture capitalists: an empirical study ............................................ 55
Article 4: Valuing and pricing IPOs .................................................................................................... 59
Article 6: Access to financing and firm growth ................................................................................. 64
Article 7: Making sense of entrepreneurial exit strategies: A typology and test .............................. 68
,Chapter 1: Introduction to finance for entrepreneurs
1.1 The entrepreneurial process
Entrepreneurial process = developing opportunities, gathering resources, and managing and building
operations with the goal of creating value.
1.2 Entrepreneurship fundamentals
Who is an entrepreneur?
The ups and downs of the entrepreneurial lifestyle are difficult for those supporting the entrepreneur
financially and emotionally. Nonetheless, we believe that the tools and techniques we introduce can
help entrepreneurs and others anticipate venture challenges, navigate through shortfalls, and achieve
important milestones. These tools and techniques can help smooth out an inevitably bumpy ride.
Basic definitions
Entrepreneurship = process of changing ideas into commercial opportunities and creating value.
Entrepreneur = individual who thinks, reasons, and acts to convert ideas into commercial opportunities
and create value.
Entrepreneurial traits or characteristics
1. Successful entrepreneurs recognize and seize commercial opportunities, frequently before
others even have an inkling of their potential.
2. Successful entrepreneurs tend to be doggedly optimistic.
3. Successful entrepreneurs are not consumed entirely with the present.
Opportunities exist but not without risks
Nearly half of business failures are due to economic factors such as inadequate sales, insufficient
profits, or industry weakness. Of the remained, almost 40% cite financial causes, such as excessive
debt and insufficient financial capital. Other reasons include insufficient managerial experience,
business conflicts, family problems, fraud, and disasters.
Successful entrepreneurs are able to anticipate and overcome the business risks that cause others to
fail.
1.3 Sources of entrepreneurial opportunities
Entrepreneurial opportunities = ideas with potential to create value through different or new,
repackaged, or repositioned products, markets, processes, or services.
Megatrends = large societal, demographic, or technological trends or changes that are slow in forming,
but once in place, continue for many years.
Fads = not predictable, have short lives, and do not involve macro changes.
Societal changes
To succeed in a competitive environment requires an understanding of current megatrends and the
anticipation of new ones.
Social, economic, and legal changes may occur within pervasive trends.
Demographic changes
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Technological changes
Technological change may be the most important source of entrepreneurial opportunities.
e-commerce = the use of electronic means to conduct business online.
Emerging economies and global changes
One of the most notable changes in recent years is the emergence of substantial demand in emerging
economies.
For the watchful entrepreneur, emerging economy demand provides opportunities for establishing
and expanding a venture’s line of business. Awareness of the shifts and a readiness to exploit new
avenues of demand for a venture’s products and services is an important aspects of being an
entrepreneur in today’s global economy.
Crises and ‘bubbles’
Importantly for aspiring entrepreneurs, these dark and cloudy times almost always come with a silver
lining. For this most recent financial crisis, it appears that one nascent sector that benefitted
dramatically during the time of crisis was alternative and renewable energy. Subsidies abounded with
project credits, production and investment tax credits, and loan guarantees.
Additionally, even in the absence of crisis-related government favoritism for certain sectors, while
many entrepreneurs suffer dearly as their ventures fail, others benefit from consolidation and the
resulting lower level of competition due to the shakeout. Many aspiring entrepreneurs and investor
connections are made during the fallout from major economic crises.
Disruptive innovation
Innovation = introduction of a new idea, product, or process.
Disruptive innovation = an innovation that creates a new market or network that disrupts and displaces
an existing market or network.
1.4 Principles of entrepreneurial finance
Seven principles of entrepreneurial finance:
1. Real, human and financial capital must be rented from owners.
2. Risk and expected reward go hand in hand.
3. While accounting is the language of business, cash is the currency.
4. New venture financing involves search, negotiation, and privacy.
5. A venture’s financial objective is to increase value.
6. It is dangerous to assume that people act against their own self-interests.
7. Venture character and reputation can be assets or liabilities.
Real, human, and financial capital must be rented from owners (principle #1)
When you obtain permission to use someone’s land and building (real capital) you have to compensate
the owner for the loss of its use otherwise.
The time value of money is an important component of the rent one pays for using someone else’s
financial capital.
, When investors are also employees (human capital).
Risk and expected reward go hand in hand (principle #2)
One way humans express their dislike of risk is to expect more when the rent is riskier.
While accounting is the language of business, cash is the currency (principle #3)
Accounting for entrepreneurial firms has two purposes. The first is to provide for checks, balances,
integrity, and accountability in tracking a firm’s conduct. The second purpose, and our emphasis for
the entrepreneurial finance context, is to quantify the future in a recognizable dialect of the official
language.
Cash burn = measures the gap between the cash being spent and that being collected from sales.
Cash build = measures the excess of cash receipts over cash disbursements, including payments for
additional investment.
New venture financing involves search, negotiation, and privacy (principle #4)
Public financial markets = where standardized contracts or securities are traded on organized securities
exchanges.
Private financial markets = where customized contracts or securities are negotiated, created, and held
with restrictions on how they can be transferred.
New ventures usually arrange financing in private financial markets.
A venture’s financial objective is to increase value (principle #5)
Nonetheless, whatever the myriad personal motivations for founders, investors, and employees, there
is really only one overarching financial objective for the venture’s owners: to increase value.
Free cash = cash exceeding that which is needed to operate, pay creditors, and invest in assets.
Free cash flow = change in free cash over time.
When we line up free cash flows and adjust them for risk and the time value of money, we get value –
the best proxy for common owner sentiment regarding a venture’s prospects.
It is dangerous to assume that people act against their own self-interests (principle #6)
When incentives are aligned, the presence of self-interest, even of moral or religious interest, is not at
odds with economic incentives.
There will be many times when financial and operational arrangements have to be renegotiated. This
should be expected. It is unwise to assume that arrangements are durable in the new venture context.
Owners will need to constantly monitor incentive alignments for everyone associated with the venture
and be ready to renegotiate to improve failing alignments.
To keep incentives aligned, it is common to provide contingent increases in the entrepreneur’s
ownership to improve the tie between her self-interest and the majority owners’ interests.
Owner-manager (agency) conflicts = differences between manager’s self-interest and that of the
owners who hired him.
