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Chapter 1
INTRODUCTION TO
ENTREPRENEURIAL FINANCE
Material from ENTREPRENEURIAL FINANCE: STRATEGY, VALUATION, AND DEAL STRUCTURE, by Janet Kiholm Smith, Richard L. Smith, and Richard T. Bliss, © by Stanford University, all rights
reserved. Instructors may make copies of PowerPoint Presentation contained herein for classroom distribution only. Any further reproduction, distribution, or use of this material, in any way or
by any means, is strictly prohibited without the prior written permission of the publisher.
Learning Objectives
• Describe the evolution of thinking about entrepreneurship
• Recognize that studying entrepreneurial finance leads to
better investment and financing decisions
• Understand why maximizing value for the entrepreneur is
central to the study of entrepreneurial finance
• Describe the process of new venture formation from
inception to harvesting
• Distinguish the various stages of new venture development
• Understand the value of tying new venture financing to
milestones that mark a venture’s progress
• Understand how the business plan is related to strategic
planning and implementation
2
Entrepreneurship and the Entrepreneur
• What is an Entrepreneur?
– R. Cantillon – bearer of risk in provision of capital
– J. B. Say – shifter of resources to higher productivity
– J. Schumpeter – innovation as disturbing status quo
– Knight – directs resources in the presence of uncertainty
– P. Drucker – creating something new, transmuting value
• Modern view
– pursuit of opportunities to combine and redeploy
resources without regard to current ownership or control
of the resources
3
Entrepreneurship is Multidimensional
• The entrepreneur must:
1. perceive an opportunity to create value by
redeploying society’s resources
2. devise a strategy for marshaling control of
necessary resources
3. implement a plan of action to bring about the
change
4. harvest the rewards that accrue from the
innovation
4
Figure 1.1
5
New Venture Survival Rates
• 50% of new ventures survive at least four
years and 30% at least ten years
• “High growth” firms have a better survival
record; 72% survive at least four years
• One-third of non-surviving entrepreneurs still
considered their venture a success
6
Economic Downturns and
Entrepreneurship
• Benefits of starting a venture in a downturn
– lower opportunity cost
– competition may be less intense
– easy to hire high quality employees
• Famous companies started during economic
downturns
7
Globalization of Entrepreneurship
• Entrepreneurship now comes from all over the
world and is driven by
– increased competition for ideas and for financing
– technological advances: communications and
computers
– government policies and subsidies
8
Figure 1.2
9
Types of Entrepreneurship
• Replicative versus innovative
• Opportunity-based versus necessity-based
• Corporate Venturing
• Social Venturing
10
Replicative vs. Innovative Entrepreneur
• Replicative entrepreneurs function as efficient
coordinators of resources
– start and maintain businesses that mimic
predecessors
– provide more of existing goods and services
• Innovative entrepreneurship reshapes
industries and has the potential to add huge
value to economies
– e.g. Google, Intel, Facebook, and e-Bay
11
Necessity-based vs. Opportunity-based
Entrepreneurship
• Necessity-based entrepreneurs start businesses due
to a lack of alternatives
– small, low-capital ventures
– almost always replicative
– common in emerging economies
• Opportunity-based entrepreneurs are motivated by
the idea
– accounts for virtually all innovative entrepreneurship
– most frequently found in developed economies
12
Figure 1.3
13
Corporate Venturing
• Corporate venturing is common for projects
requiring
– large and complex research teams
– generic testing equipment
– lengthy development times
• Incentives to encourage entrepreneurship are
difficult to implement in large organizations
– motivating people to work on the right projects
– rewarding success
– perceived inequities
14
Social Venturing
• Primary objective of the venture’s product or
service is to address a social issue
• Financial returns are traded off against social
objectives
• Includes efforts by non-profit entities to
create for-profit subsidiaries, e.g. museum
shops
• Recent trend in “green-tech” or “clean-tech”
15
The Finance Paradigm
1. More of a good is preferred to less.
2. Present wealth is preferred to future wealth.
3. Safe assets are preferred to risky assets.
We use these guidelines to make:
– investment decisions, i.e., what assets to acquire
– financing decisions, i.e., the types and mix of
funding sources
16
The Importance of Real Options
• A real option is a right, but not an obligation,
to undertake a decision about a non-financial
(i.e., “real”) asset.
• Examples: abandon a poorly performing
venture or expand a venture doing well
• Values of real options depend importantly on
the degree of uncertainty surrounding the
investment.
17
Objective: Maximizing Value
for the Entrepreneur
• Corporate managers often focus on
maximizing shareholder value
• We focus decision making on maximizing the
value for the entrepreneur
• May be different from maximizing the value of
the venture
• All investors may benefit from knowing the
entrepreneur’s objective
18
Stages of New Venture Development
19
Stages
Opportunity
Research and
Development
Start-up Early Growth Rapid Growth Exit
Description
Real
Options
Actions
Assess/Update Business Plan
Assess/Update Business Plan
Assess Opportunity
Continue to Next Stage
Test Market/Market Research
Initiate Revenue Generation
Determine Organizational Structure
Conduct R&D Activities, e.g.: Expand Team as Needed Expand Team as Needed Acquisition
Determine Organizational Form
Secure Patent
Initiate Production
Expand Facilities as Needed Expand Facilities as Needed Buy-Out
Prepare Business Plan
Develop Prototype
Build Starting Inventory
Abandon
Extend Stage/Financing Modify Production/Financing Extend Stage/Financing Extend Stage/Financing
Modify R&D Strategy Modify Marketing/Financing Abandon
Abandon Abandon
All research and development
activity that must be completed
before revenue generation can
commence.
All activities related to start of
production and marketing and
initiation of revenue-generating
activities.
All activities during the period
before the venture reaches a level
of sales sufficient for cash-flow
breakeven.
All activities during the period
after break-even and before
sustainable viability is
established.
All activities related to
establishing continuing financing
and enabling early investors to
harvest.
All activities through preparation of
business plan and before incurring
significant expense.
IPO
Modify Concept
Continue to Next Stage Continue to Next Stage Continue to Next Stage Continue to Next Stage Choose Form of Exit
Assess/Update Business Plan Build Track Record for Harvest Early Investors Harvest
Build Website
Build Sales and Marketing Team
Assess/Update Business Plan Assess/Update Business Plan
Assess Strategic Alternatives
Build Research Team
Stages of New Venture Development
Acquire Facilities and Equipment Work Toward Breakeven Work Toward Proven Viability
Obtain Continuing Financing:
Obtain Seed Financing Obtain R&D Financing Obtain Start-up Financing Obtain Early-Growth Financing Obtain Rapid-Growth Financing
Figure 1.4
Measuring Progress with Milestones
• Enable the parties to postpone financial
commitments until needed
• Function as a working hypotheses
• Milestones provide ways to enhance the
expected benefits of the project by structuring
opportunities to adapt to new information
• Critical in determining if and how the venture
should continue
20
Some Common Milestones
• Scientific proof of concept
• Prototype completion
• Commercial scale production
• Bellwether sale
• Profitability
• First competitive action
• First redesign or redirection
• First significant price change
21
Financial Performance and the Stages of
New Venture Development
• Development
• Start-up
• Early-growth
• Rapid-growth
• Exit
22
Figure 1.5
23
The Sequence of New Venture Financing
• Bootstrapping
• Seed financing
• R&D financing
• Start-up financing
• First-stage financing
• Second-stage financing
• Third-stage financing
• Mezzanine financing
• Bridge financing
24
The New Venture Business Plan
• Presents the conclusions of the strategic planning
exercise, i.e., the strategic planning comes first
• Writing and circulating a business plan too early can
be a costly mistake
• Different than for an established business
– uncertainty about assumptions
– milestones and real options
– used for raising capital
25
Overview of the Business Plan
• Focus on the purposes and uses of the plan
• Identify and support key assumptions
• Highlight critical factors for success or failure
• Delineate milestones so users can evaluate
success
• Include financial projections to test the plan,
commit the entrepreneur, and facilitate
negotiation
26
Outline of a Typical Business Plan
Executive Summary
I. Background and Purpose of Venture
II. Market Analysis
III. Products and Services
IV. Development, Production, and Operations
V. Organization and Management
VI. Ownership and Control
VII. Financial Information
27
What Makes a Business Plan Convincing?
• Demonstrate understanding of the
technology, market, risks, and customer needs
• Defensible assumptions that yield testable
hypotheses
• Credible evidence of irrevocable commitment
• Evidence of reputation and certification
• Signals the quality and capabilities of the team
28
Some Pitfalls to Avoid in the Business Plan
1. Failing to identify clearly the customer
problem that the venture would address
2. Failing to identify clearly a narrow target
market
3. Relying on a business model that does not
make economic sense
4. Relying on a highly credentialed team that
lacks the critical expertise the venture needs
5. Failing to recognize the threats and potential
problems
29
Summary
• There are many types of entrepreneurial activity
• The Finance Paradigm and maximization of value
for the entrepreneur will guide decision making
• Milestones can create value and may benefit the
entrepreneur and investors
• A venture’s financing needs and options are
linked to its stage of growth
• Business plans are both important and different
for new ventures
30

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Chapter 01.ppt

  • 1. Chapter 1 INTRODUCTION TO ENTREPRENEURIAL FINANCE Material from ENTREPRENEURIAL FINANCE: STRATEGY, VALUATION, AND DEAL STRUCTURE, by Janet Kiholm Smith, Richard L. Smith, and Richard T. Bliss, © by Stanford University, all rights reserved. Instructors may make copies of PowerPoint Presentation contained herein for classroom distribution only. Any further reproduction, distribution, or use of this material, in any way or by any means, is strictly prohibited without the prior written permission of the publisher.
  • 2. Learning Objectives • Describe the evolution of thinking about entrepreneurship • Recognize that studying entrepreneurial finance leads to better investment and financing decisions • Understand why maximizing value for the entrepreneur is central to the study of entrepreneurial finance • Describe the process of new venture formation from inception to harvesting • Distinguish the various stages of new venture development • Understand the value of tying new venture financing to milestones that mark a venture’s progress • Understand how the business plan is related to strategic planning and implementation 2
  • 3. Entrepreneurship and the Entrepreneur • What is an Entrepreneur? – R. Cantillon – bearer of risk in provision of capital – J. B. Say – shifter of resources to higher productivity – J. Schumpeter – innovation as disturbing status quo – Knight – directs resources in the presence of uncertainty – P. Drucker – creating something new, transmuting value • Modern view – pursuit of opportunities to combine and redeploy resources without regard to current ownership or control of the resources 3
  • 4. Entrepreneurship is Multidimensional • The entrepreneur must: 1. perceive an opportunity to create value by redeploying society’s resources 2. devise a strategy for marshaling control of necessary resources 3. implement a plan of action to bring about the change 4. harvest the rewards that accrue from the innovation 4
  • 6. New Venture Survival Rates • 50% of new ventures survive at least four years and 30% at least ten years • “High growth” firms have a better survival record; 72% survive at least four years • One-third of non-surviving entrepreneurs still considered their venture a success 6
  • 7. Economic Downturns and Entrepreneurship • Benefits of starting a venture in a downturn – lower opportunity cost – competition may be less intense – easy to hire high quality employees • Famous companies started during economic downturns 7
  • 8. Globalization of Entrepreneurship • Entrepreneurship now comes from all over the world and is driven by – increased competition for ideas and for financing – technological advances: communications and computers – government policies and subsidies 8
  • 10. Types of Entrepreneurship • Replicative versus innovative • Opportunity-based versus necessity-based • Corporate Venturing • Social Venturing 10
  • 11. Replicative vs. Innovative Entrepreneur • Replicative entrepreneurs function as efficient coordinators of resources – start and maintain businesses that mimic predecessors – provide more of existing goods and services • Innovative entrepreneurship reshapes industries and has the potential to add huge value to economies – e.g. Google, Intel, Facebook, and e-Bay 11
  • 12. Necessity-based vs. Opportunity-based Entrepreneurship • Necessity-based entrepreneurs start businesses due to a lack of alternatives – small, low-capital ventures – almost always replicative – common in emerging economies • Opportunity-based entrepreneurs are motivated by the idea – accounts for virtually all innovative entrepreneurship – most frequently found in developed economies 12
  • 14. Corporate Venturing • Corporate venturing is common for projects requiring – large and complex research teams – generic testing equipment – lengthy development times • Incentives to encourage entrepreneurship are difficult to implement in large organizations – motivating people to work on the right projects – rewarding success – perceived inequities 14
  • 15. Social Venturing • Primary objective of the venture’s product or service is to address a social issue • Financial returns are traded off against social objectives • Includes efforts by non-profit entities to create for-profit subsidiaries, e.g. museum shops • Recent trend in “green-tech” or “clean-tech” 15
  • 16. The Finance Paradigm 1. More of a good is preferred to less. 2. Present wealth is preferred to future wealth. 3. Safe assets are preferred to risky assets. We use these guidelines to make: – investment decisions, i.e., what assets to acquire – financing decisions, i.e., the types and mix of funding sources 16
  • 17. The Importance of Real Options • A real option is a right, but not an obligation, to undertake a decision about a non-financial (i.e., “real”) asset. • Examples: abandon a poorly performing venture or expand a venture doing well • Values of real options depend importantly on the degree of uncertainty surrounding the investment. 17
  • 18. Objective: Maximizing Value for the Entrepreneur • Corporate managers often focus on maximizing shareholder value • We focus decision making on maximizing the value for the entrepreneur • May be different from maximizing the value of the venture • All investors may benefit from knowing the entrepreneur’s objective 18
  • 19. Stages of New Venture Development 19 Stages Opportunity Research and Development Start-up Early Growth Rapid Growth Exit Description Real Options Actions Assess/Update Business Plan Assess/Update Business Plan Assess Opportunity Continue to Next Stage Test Market/Market Research Initiate Revenue Generation Determine Organizational Structure Conduct R&D Activities, e.g.: Expand Team as Needed Expand Team as Needed Acquisition Determine Organizational Form Secure Patent Initiate Production Expand Facilities as Needed Expand Facilities as Needed Buy-Out Prepare Business Plan Develop Prototype Build Starting Inventory Abandon Extend Stage/Financing Modify Production/Financing Extend Stage/Financing Extend Stage/Financing Modify R&D Strategy Modify Marketing/Financing Abandon Abandon Abandon All research and development activity that must be completed before revenue generation can commence. All activities related to start of production and marketing and initiation of revenue-generating activities. All activities during the period before the venture reaches a level of sales sufficient for cash-flow breakeven. All activities during the period after break-even and before sustainable viability is established. All activities related to establishing continuing financing and enabling early investors to harvest. All activities through preparation of business plan and before incurring significant expense. IPO Modify Concept Continue to Next Stage Continue to Next Stage Continue to Next Stage Continue to Next Stage Choose Form of Exit Assess/Update Business Plan Build Track Record for Harvest Early Investors Harvest Build Website Build Sales and Marketing Team Assess/Update Business Plan Assess/Update Business Plan Assess Strategic Alternatives Build Research Team Stages of New Venture Development Acquire Facilities and Equipment Work Toward Breakeven Work Toward Proven Viability Obtain Continuing Financing: Obtain Seed Financing Obtain R&D Financing Obtain Start-up Financing Obtain Early-Growth Financing Obtain Rapid-Growth Financing Figure 1.4
  • 20. Measuring Progress with Milestones • Enable the parties to postpone financial commitments until needed • Function as a working hypotheses • Milestones provide ways to enhance the expected benefits of the project by structuring opportunities to adapt to new information • Critical in determining if and how the venture should continue 20
  • 21. Some Common Milestones • Scientific proof of concept • Prototype completion • Commercial scale production • Bellwether sale • Profitability • First competitive action • First redesign or redirection • First significant price change 21
  • 22. Financial Performance and the Stages of New Venture Development • Development • Start-up • Early-growth • Rapid-growth • Exit 22
  • 24. The Sequence of New Venture Financing • Bootstrapping • Seed financing • R&D financing • Start-up financing • First-stage financing • Second-stage financing • Third-stage financing • Mezzanine financing • Bridge financing 24
  • 25. The New Venture Business Plan • Presents the conclusions of the strategic planning exercise, i.e., the strategic planning comes first • Writing and circulating a business plan too early can be a costly mistake • Different than for an established business – uncertainty about assumptions – milestones and real options – used for raising capital 25
  • 26. Overview of the Business Plan • Focus on the purposes and uses of the plan • Identify and support key assumptions • Highlight critical factors for success or failure • Delineate milestones so users can evaluate success • Include financial projections to test the plan, commit the entrepreneur, and facilitate negotiation 26
  • 27. Outline of a Typical Business Plan Executive Summary I. Background and Purpose of Venture II. Market Analysis III. Products and Services IV. Development, Production, and Operations V. Organization and Management VI. Ownership and Control VII. Financial Information 27
  • 28. What Makes a Business Plan Convincing? • Demonstrate understanding of the technology, market, risks, and customer needs • Defensible assumptions that yield testable hypotheses • Credible evidence of irrevocable commitment • Evidence of reputation and certification • Signals the quality and capabilities of the team 28
  • 29. Some Pitfalls to Avoid in the Business Plan 1. Failing to identify clearly the customer problem that the venture would address 2. Failing to identify clearly a narrow target market 3. Relying on a business model that does not make economic sense 4. Relying on a highly credentialed team that lacks the critical expertise the venture needs 5. Failing to recognize the threats and potential problems 29
  • 30. Summary • There are many types of entrepreneurial activity • The Finance Paradigm and maximization of value for the entrepreneur will guide decision making • Milestones can create value and may benefit the entrepreneur and investors • A venture’s financing needs and options are linked to its stage of growth • Business plans are both important and different for new ventures 30

Editor's Notes

  1. These are all elements of the entrepreneurial process
  2. Figure 1-1 – Survival Rates of New Ventures The figure shows survival rates of new business establishments that were initiated in 1992 or 1997, as well as survival rates for subsamples of establishments that were classified as high growth based on changes in number of employees from 1992 to 1993. The dashed line is an estimate of survivors plus non-survivors that were considered by the entrepreneur to have been successful. Source: 1998-2002 Business Information Tracking Series. Data available in “Small Business Growth: Searching for Stylized Facts,” Small Business Administration Working Paper, 2007, prepared by Brian Headd and Bruce Kirchhoff.
  3. Figure 1-2 – Global Difference in Supportiveness for Starting and Doing Business The figure shows country ranks (highest being best) for ease of doing business based on 10 equal-weighted factors that are assessed by the World Bank. Ease of starting a business is one of the 10 factors. Source: World Bank, 2009. Available at http://www.doingbusiness.org/ economyrankings/. Rankings are for large population countries.
  4. Figure 1-3 – Entrepreneurial Involvement of Workforce: 2006 The figure shows the percentage of a country’s workforce that is involved in entrepreneurial ventures. The workforce is defined as the working population between ages 18 and 64. Entrepreneurial involvement is classified as opportunity-based or necessity-based. Data are compiled by GEM consortium members via surveys of their local economies. Source: Global Entrepreneurship Monitor, 2006 Data Tables. Available at http://www.gemconsortium.org.
  5. Figure 1-4 – Stages of New Venture Development The figure shows the standard progression of development of a new venture from opportunity identification though stages culminating in exit. At each stage, the figure indicates the kinds of actions that normally are associated with the stage, as well as some of the real options the entrepreneur is likely to face.
  6. Figure 1-5 – Stages of New Venture Development The figure reflects five stages that are typical of new venture development. During the development stage, the venture generates no revenues, net income is negative, and cash flow is negative. Start-up begins when the firm acquires the facilities, equipment, and employees required to produce the product. During early growth, revenue is growing, but both net income and cash flow available to investors are negative. Rapid growth is the last stage during which external financing is required. During exit, the rate of growth declines to the point where cash flow available to investors is positive.