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Entrepreneurial and New Venture Financing

small business is one that is independently owned and operated, not dominant in the field, and does not engage in any new marketing or innovative practices. An entrepreneurial venture is one . [where] the principle goals. are profitability and growth and the business is characterized by innovative strategic practices.

Firms

with fewer than 100 employees were responsible for over half of the new employment generated economy-wide during 1976-1982. The bulk of these jobs was generated by fewer than 15% of the firms in question.

For those who dare to dream the dreams, and then are foolish enough to try to make those dreams come true.

Seed

Stage (pre-startup or R&D stage) Startup Stage Early-Growth Stage Expansion Stage
Rapid-Growth

Stage Sustained-Growth Stage Bridge (Mezzanine) Stage

Our Course Seed Stage Angel Investor Start-up Stage An Entrepreneurial Venture

Expansion Stage

Venture Capitalists

Initial Public Offerings Valuation

How

often does business fail?

900,000

enterprises opening in a typical year. 800,000 terminations and 70,000 companies go under with loss to creditors.
Failures

because of:

inadequate

knowledge of business. Failure in gathering and evaluating information on business before start-up. Poor accounting skills. Poor cash managers. Poor knowledge for sources of capital.

Evaluating

the Opportunities. Developing the Business Concept Assessing Required Resources. Acquiring Necessary Resources. Managing the venture. Harvesting and Distributing Value.

What

are the dimensions of the window of opportunity? Is the profit potential adequate to provide satisfaction return? Does the opportunity open up additional options for expansion, diversification, or integration? Will the profit stream be durable in the face of probable obstacles? Does the product or service meet a real need?

Can

barriers to entry be created? Are customers identifiable, reachable, and open to change? Will suppliers control critical resources and capture rents for profits? Will buyers be so strong as to demand uneconomic concessions?

What skills, resources, and relationships does the entrepreneurial group already possess? Who are the likely suppliers of missing resources? What skills and resources must be a part of the internal organization? What amount of each resources or skill is required? What is unique about the proposed business concept? What quality trade-off can be made among the required skills and resources? What are the major requirements for regulatory compliance? What critical checkpoints will mark the lowering of risks?

What

mechanisms for control of each critical skill or resources are available? What are the critical motivations of potential providers of required sources and skills? Can incentive be structured to meet these motivations? Will the opportunity produce a return adequate to meet resources providers needs and provide the entrepreneurial reward?

Does

the management concept include both the critical internal and external elements of the organization? How will employees be attracted and selected? How will the entrepreneurial role evolve?

Is

there a specific mechanism for harvesting? Has the venture been structured financially and legally to maximize the after-tax yield from harvest? What condition should trigger harvest? What conditions could preclude a harvest? How will responsibilities to other participants be fulfilled at harvest?

Real Sector The Firm Financial Sector Corporate Investment Corporate Financing Decisions: Utilization of Funds Decisions: Acquisition of Funds Business Markets Financial Markets The Firm's Balance Sheet __________________________________________________________ Cash A/P A/R Other Current Inventory Liabilities _________________ _____________________ Products Total Current Assets Total Current Liabilities Customers Competitors Savers/ Employees Investors Tangible Assets Technology Fixed Assets: Plant & Equipment Capital: Debt Preferred Stock Common Equity --Retained Earnings --Common Stock _____________________ Total Liabilities & Equity

________________ Total Assets

Financing

(sources of funds) must equal the investment in assets (use of funds).


Managers

make investment decisions that generate earnings so that investors get a return on investment. Management is defined as the planning for, acquiring, and utilization of funds in a manner that maximizes the firms economic efficiency.

Financial

The Corporate Finance View of the World:


Commercial Sector -Customers -Products -Technology -Competitors Bus. Transactions Firms Balance Sheet Assets Liab. Capital $$ Firms Income Statement Revenue -Expenses -Taxes Net Income Retained Earnings? Dividends? Securities $$ Financial Sector Savers/Investors: -Individuals -Corporations -Partnerships -Banks Return on Investment

The

corporation has advantages over the other forms or organization: Unlimited lives that extend beyond the lives of the founders or original managers. Simple transferability of ownership: investors and managers are two separate groups, so investors can buy or sell the common stock without disrupting corporate operations. Limited liability in the corporation: investors can lose only the total amount they invested in the common stock.

The

stock market monitors the publicly-traded corporations performance:


Stock

price changes signal whether managerial decisions are good (stock price goes up) are bad (stock price goes down). Because of the requirements to disclose information that publicly-traded corporations face, the stock market can monitor these firms better than it can the other forms of organization.

The

stock market disciplines the firm by causing the stock price to decline. In response, the firm can:
Change

strategies. The Board of Directors can replace the managers ( this is called internal governance). The firm can be merged/taken over (this is called the market for corporate control). Declare bankruptcy.

In

the Theory of Finance, the appropriate goal of the firm is to maximize the value of shareholder wealth. Shareholders commit part of their wealth to the firm when they buy the firms common stock. Equivalent ways of stating this goal are:
To

maximize the market value of the firm. To maximize the stock price of the firm.

Observability,

moral hazard:

asymmetric information, &

Investors cannot observe everything managers do. Managers have more information about the firm.

Investors
Investor

monitor the firm, and the firm incurs monitoring costs.


relations staffs, annual reports, SEC and other regulatory reports consume resources.

If

managers actions cannot be observed directly, then periodic disclosure must be made:
Disclosure: information sets become more symmetric. Are bank loan officers' salaries a monitoring cost?

Agency

problems can be solved if the interests of managers and investors are aligned, if both managers and investors have the same incentives. Agency theory suggests if managers are bonded to the firm, managers would behave in the shareholders' best interests.
This

entails bonding costs. For example, stock options or stock purchase programs (like at 85% of the market price) transform managers into owner/managers. But managers are buying into the firm at below-market prices. The bonding cost is the loss of wealth suffered by other shareholders when the stock is sold cheap.

These
We

costs cause shareholder wealth to be less than if managers didn't pose a moral hazard.
live in an imperfect world. A perfect world of symmetric information no moral hazards is not attainable.

Financial
For

contracting solutions are often used.

example, bond indenture contracts often contain restrictive covenants that limit the behavior of managers, like no new mortgages on the assets. Bank loans also contain restrictions, like limitations on paying dividends, the amount of additional borrowing, or a minimum current ratio requirement.

closer look at financial contracting. Bonds are loan contracts, and common stocks have legal ties to the firm via the firm's charter.
Bonds

are fixed income securities that have finite lives: bonds have a fixed maturity date, pay a set amount of interest each period, and borrowings must be repaid. Stocks are variable income securities that have infinite lives. Dividends are not guaranteed and stock never maturesas long as the firm is alive. Stocks can be repurchased by the firm, but that is different: stock can be retired but it does not mature. Stocks represent an equity, or ownership, interest in the firm.

basic principle of Finance: more risk should be rewarded with a higher return. In the Theory of Finance, taking risk is a good thing since it creates new wealth (new products, new technologies, etc.) Thus, there should be rewards for bearing risk.

Expected Return

Risk-free Rate: kf

Risk premium Time value of money ______________________________________________________________Risk Treasury Bonds Corporate Bonds Common Stock New Ventures, Options, Futures, and other Derivatives

Venture
Seed.

Economics Stage Definitions: Early Stage


A relatively small amount of capital provided to prove a concept, maybe involving product development but not initial marketing. Startup. Financing for product development and initial marketing; no product sales, management team assembled, business plan written, market research done. First Stage. Financing for initial commercial manufacturing and sales.

Expansion
Second

Stage. Working capital financing provided; likely to have no profits. Third Stage. Financing for plant expansion, marketing, and working capital. Bridge Stage. Financing for firm expected to go public in 6-12 months; often repaid from IPO proceeds.
Management/Leveraged

Turnaround
later-stage

Buyout (MBO/LBO) and

companies: buying out existing firms or financing firms with operational or financial difficulties.

WHAT IS AN ENTREPRENEUR?
Entrepreneur Person who seeks a profitable opportunity and takes the necessary risks to set up and operate a business. Differ from many small-business owners in their strong desire to make their business grow. Differ from managers through their overriding responsibility to sue the resources of the organization to accomplish their goals. Willing to take risks.

CATEGORIES OF ENTREPRENEURS

REASONS TO CHOOSE ENTREPRENEURSHIP AS A CAREER PATH


More than 11 percent of Americans run their own business. In an average month, Americans start approximately 550,000 new businesses. Motivated by dissatisfaction with organizational work world. May believe their ideas are opportunities to meet customer needs.

Being Your Own Boss


Example: Liz Lange, founder and CEO of Liz Lange Maternity. Had idea for upscale maternity wear. Borrowed $50,000 and opened an office to sell her designs. Now has annual sales exceeding $10 million.

Financial Success
Two-thirds of all millionaires are self-employed. Path to riches is uncertain due to high failure rate.

Job Security
Over last decade, large companies have downsized, eliminating more jobs than they created. Key difference from traditional job is that an entrepreneurs job depends on the decisions of customers and investors and cooperation of ones own employees.

Quality of Life
Lifestyle Entrepreneur Person who starts a business to reduce work hours and create a more relaxed lifestyle. Yet, most entrepreneurs work long hours and at the whims of their customers. Many define quality of life by their ability to fulfill social objectives.

THE ENVIRONMENT FOR ENTREPRENEURS

Globalization
Market products abroad and hire international talent. Growing internationally.

Education
One hundred U.S. colleges and universities offer entrepreneurship majors, 73 offer an emphasis in entrepreneurship, hundreds of others offer courses. Universities are helping students launch businesses. Some programs teach entrepreneurship to young people. Students who graduate from entrepreneurship programs are three times as likely as others to be self-employed and to help start new businesses.

Information Technology
Helps entrepreneurs work quickly and efficiently, provide attentive customer service, increase sales, and project professional images. Entrepreneurs also produce and market products that apply new information technology. Internet also presents a challenge because customers can check prices and buy online from large or small companies anywhere in the world.

Demographic and Economic Trends


New opportunities: Aging of U.S. population. Emergence of Hispanics as nations largest ethnic group. Growth of two-income families.

CHARACTERISTICS OF ENTREPRENEURS

Vision
An overall idea for how to make their business a success.

High Energy Level


Hard work of the entrepreneur compensates for small staff and limited resources available.

Need to achieve
Enjoy the challenge of reaching personal goals and are dedicated to personal success.

Self-confidence and Optimism


Believe in their own ability to succeed and instill optimism in others.

Tolerance for Failure


Try and try again when others would give up and view setbacks and failures as learning experiences.

Creativity
Typically conceive new ideas for products and services and devise innovative ways to overcome difficult problems and situations.

Tolerance for Ambiguity


Take uncertainty in stride but not reckless gamblers.

Internal Locus of Control


Believe they control their own fates and take personal responsibility for success and failure.

STARTING A NEW VENTURE


Selecting a Business Idea
Two most important considerations: Finding something you love to do and are good at. Determining whether your idea can satisfy a need in the marketplace. Guidelines for selecting an idea that is a good entrepreneurial opportunity: List your interests and abilities. List the types of businesses that match your interests and abilities. Identify future needs for products that no one yet offers. Evaluate existing goods and services and ways you can improve them. Choose a business that offers profit potential. Conduct marketing research to determine potential profitability. Learn as much as you can about the appropriate industry.

Buying an Existing Business Advantages: Employees already in place serve established customers and deal with familiar suppliers. Good or service is known in the marketplace. Necessary permits and licenses secured. May be easier to get financing. Some buy successful businesses to build on their success. Turnaround entrepreneurs buy struggling businesses and improve them to generate profits. Buying a Franchise Less risky than starting a new firm, but requires careful and energetic preparation.

Creating a Business Plan


Forty-seven percent of the most recent Inc. 500 CEOs did not create a formal written plan. Still advisable because it helps an entrepreneur prepare enough resources and stay focused on key objectives.

AllBusiness.com Kaufman eVenturing MoreBusiness.com

Equity Financing Equity financing Funds invested in new ventures in exchange for part ownership. May benefit entrepreneur with a good idea and skills but little or no money. Venture capitalists Business firms or groups of individuals that invest in new and growing firms in exchange for an ownership share. Angel investors Wealthy individuals who invest directly in a new venture in exchange for an equity stake. Angel networks match business angels with entrepreneurs. Isabella Capital and Springboard Enterprises focus on women. U.S. Hispanic Chamber of Commerce aids minority-owned businesses.

INTRAPRENEURSHIP
Intrapreneurship Process of promoting innovation within the structure of an existing organization. Example: 3M Researchers spend 15 percent of their time working on their own ideas without approval from management. A skunkworks project is initiated by an employee who conceives an idea and then recruits resources from within to turn it into a commercial product. Pacing programs are company-initiated projects that focus on a few products and technologies in which company sees potential for rapid marketplace winners. Helps firms retain valuable employees.

Development of Fund Concept


Secure Commitments from Investors Year 0 Screen Business Plans Generate Deal Flow

Closing of Fund
First Capital Call Evaluate and Conduct Due Diligence Negotiate Deals and Staging Additional Capital Calls Invest Funds

2-3 years

4-5 years

Value Creation and Monitoring


Board service Assist with external relationships Performance evaluation and review Help arrange additional financing Recruitment management

2-3 years or more

Harvesting Investment
IPO Acquisition LBO Liquidation

Distributing Proceeds
Cash Public Shares Other

7-10 years plus extensions

Working Capital Management

Current

assets Current liabilities It measures how much in liquid assets a company has available to build its business. A short term loan which provides money to buy earning assets. Allows to avail of unexpected opportunities. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash.

An increase in working capital indicates that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for example has paid off some short-term creditors.

Decisions relating to working capital and short term financing are referred to as working capital management. Short term financial management concerned with decisions regarding to CA and CL. Management of Working capital refers to management of CA as well as CL. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. These involve managing the relationship between a firm's short-term assets and its short-term liabilities.

The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. Businesses face ever increasing pressure on costs and financing requirements as a result of intensified competition on globalized markets. When trying to attain greater efficiency, it is important not to focus exclusively on income and expense items, but to also take into account the capital structure, whose improvement can free up valuable financial resources

Active working capital management is an extremely effective way to increase enterprise value. Optimizing working capital results in a rapid release of liquid resources and contributes to an improvement in free cash flow and to a permanent reduction in inventory and capital costs, thereby increasing liquidity for strategic investment and debt reduction. Process optimization then helps increase profitability.

The fundamental principles of working capital management are reducing the capital employed and improving efficiency in the areas of receivables, inventories, and payables.

Investment

in CA represents a substantial portion of total investment. Investment in CA and level of CL have to be geared quickly to changes in sales.

Gross

Working Capital Net working Capital

Total Current assets Where Current assets are the assets that can be converted into cash within an accounting year & include cash , debtors etc. Referred as Economics Concept since assets are employed to derive a rate of return.

CA

CL Referred as point of view of an Accountant. It indicates liquidity position of a firm & suggests the extent to which working capital needs may be financed by permanent sources of funds.

CURRENT

ASSETS

Inventory Sundry Debtors Cash and Bank Balances Loans and advances

CURRENT

LIABILITIES

Sundry creditors Short term loans Provisions

As

profits earned depend upon magnitude of sales and they do not convert into cash instantly, thus there is a need for working capital in the form of CA so as to deal with the problem arising from lack of immediate realization of cash against goods sold. This is referred to as Operating or Cash Cycle . It is defined as The continuing flow from cash to suppliers, to inventory , to accounts receivable & back into cash .

Thus

needs for working capital arises from cash or operating cycle of a firm. Which refers to length of time required to complete the sequence of events. Thus operating cycle creates the need for working capital & its length in terms of time span required to complete the cycle is the major determinant of the firms working capital needs.

1. 2. 3.

Conversion of cash into inventory Conversion of inventory into Receivables Conversion of Receivables into Cash

Phase 3
Cash

Receivables

Phase 2
Inventory

Phase 1

PERMANENT

WORKING CAPITAL VARIABLE WORKING CAPITAL

THERE

IS ALWAYS A MINIMUM LEVEL OF CA WHICH IS CONTINOUSLY REQUIRED BY A FIRM TO CARRY ON ITS BUSINESS OPERATIONS. THE MINIMUM LEVEL OF INVESTMENT IN CURRENT ASSETS THAT IS REQUIRED TO CONTINUE THE BUSINESS WITHOUT INTERRUPTION IS REFERRED AS PERMANENT WORKING CAPITAL.

THIS IS THE AMOUNT OF INVESTMENT REQUIRED TO TAKE CARE OF FLUCTUATIONS IN BUSINESS ACTIVITY OR NEEDED TO MEET FLUCTUATIONS IN DEMAND CONSEQUENT UPON CHANGES IN PRODUCTION & SALES AS A RESULT OF SEASONAL CHANGES.

Monetary policy is the process by which the govt.,central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy.Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy involves variations in money supply , interest rates , lending by commercial banks etc.

Credit gives the customer the opportunity to buy goods and services, and pay for them at a later date. Clear, written guidelines that set (1) the terms and conditions for supplying goods on credit , (2) customer qualification criteria (3) procedure for making collections , and (4) steps to be taken in case of customer delinquency . Also called collection policy. Where delinquency means Failure to repay an obligation when due or as agreed. Thus in consumer installment loans, missing two successive payments will normally make the account delinquent

Usually results in more customers than cash trade. Can charge more for goods to cover the risk of bad debt. Gain goodwill and loyalty of customers. People can buy goods and pay for them at a later date. Farmers can buy seeds and implements, and pay for them only after the harvest. Stimulates agricultural and industrial production and commerce. Can be used as a promotional tool. Increase the sales.

Risk

of bad debt. High administration expenses. People can buy more than they can afford. More working capital needed. Risk of Bankruptcy.

Money

Supply Bank Rate Reserve Ratios Interest Rates Selective Credit Controls Flow of Credit

This

is the sum total of money public funds and can be used for settling transactions to buy and sell things and make other payments constitutes the money supply of a nation. Money supply = Notes and coins with public + Demand deposits with Commercial papers

Standard rate at which bank is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under Reserve bank of India Act,1934. The rate of interest charged by central bank on their loans to commercial banks is called bank rate(Discount rate). An increase in bank rate makes it more expensive for commercial banks to borrow . This exerts pressure to bring about the rise in interest rates (lending rates) charged by commercial banks on their lending to public. This leads to a general tightening in economy. Whereas decrease in bank rate has the opposite effect and leads to general easing of credit in the economy.

The reserve requirement (or required reserve ratio) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault(vault cash), or with a central bank. The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's economy, borrowing, and interest rates .Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they prefer to use open market operations to implement their monetary policy

1. 2.

Thus central bank makes it legally obligatory for commercial banks to keep a certain minimum percentage of deposits in reserve. These are of 2 types:Cash reserves Liquidity reserves

CASH

RESERVE RATIO THIS IS DEFINED AS A cash reserve ratio (or CRR) is the percentage of bank reserves to deposits and notes. The cash reserve ratio is also known as the cash asset ratio or liquidity ratio.

Statutory Liquidity Ratio (SLR) is a term used in the regulation of banking in India. It is the amount which a bank has to maintain in the form: Cash Gold valued at a price not exceeding the current market price, Unencumbered approved securities (G Secs or Gilts come under this) valued at a price as specified by the RBI from time to time.

The quantum is specified as some percentage of the total demand and time liabilities ( i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities which are accruing in one months time due to maturity) of a bank. This percentage is fixed by the Reserve Bank of India. The maximum and minimum limits for the SLR are 40% and 25% respectively. Following the amendment of the Banking regulation Act(1949) in January 2007, the floor rate of 25% for SLR was removed. Presently the SLR is 24% with effect from 8 November, 2008. The objectives of SLR are: To restrict the expansion of bank credit. To augment the investment of the banks in Government securities. To ensure solvency of banks. A reduction of SLR rates looks eminent to support the credit growth in India.

This is generally done by stipulating min. rates of interest for extending credit against commodities covetred under selective credit control. Also, concessive or ceiling rates of interest are made applicable to advances for certain purposes ao to certain sectors to reduce the interest burden and thus facilitate their development. Further obj. behind fixing rates on deposits are to avoid unhealthy competition amongst the banks for deposits and keep the level of deposit rates in alignment with lending rates of banks for deposits.

These are Qualitative instruments which are aimed at affecting changes in the availability of credit with respect to particular sectors of the economy. Thus selective controls are called selective because they are aimed at movement of credit towards selective sectors of the economy.

The general instruments such as Reserve ratios, Bank rate and open market operations. They are called so because they influence the nations money supply and general availability of credit. Quantitative instruments are called quantitative because they affect the total volume(quantity) of money supply and credit in the country.

The

most widely used qualitative techniques are selective control and moral suasion. While the general credit controls operate on the cost and total volume of credit , selective credit controls relate to tools available with the monetary authority for regulating the distrubution or direction of bank resources to particular sectors of economyin accordance with broad national priorities considered necessary for achieving the set.

Industry

norm approach Economic modeling approach Strategic choice approach

THIS

APPROACH IS BASED ON THE PREMISE THAT EVERY COMPANY IS GUIDED BY THE INDUSTRY PRACTICE. LIKE IF MAJORITY OF FIRMS HAVE BEEN GRANTING 3 MONTHS CREDIT TO A CUSTOMER THEN OTHERS WILL HAVE TO ALSO FOLLOW THE MAJORITY DUE TO FEAR OF LOSING CUSTOMERS.

THIS

APPROACH RECOGNISES THE VARIATIONS IN BUSINESS PRACTICE AND ADVOCATES USE OF STRATEGYIN TAKING WORKING CAPITAL DECISIONS. THE PURPOSE BEHIND THIS APPROACH IS TO PREPARE THE UNIT TO FACE CHALLENGES OF COMPETITION & TAKE A STRATEGIC POSITION IN THE MARKET PLACE.

THE

EMPHASIS IS ON STRATEGIC BEHAVIOUR OF BUSINESS UNIT.THUS THE FIRM IS INDEPENDENT IN CHOOSING ITS OWN COURSE OF ACTION WHICH IS NOT GUIDED BY THE RULES OF INDUSTRY,

General nature of business Production cycle Business cycle Credit policy Production policy Growth and expansion Profit level Operating efficiency