Entrepreneurial Finance

INTRODUCTION AND
OVERVIEW

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 E-Finance Principle #1
Real, Human, and Financial Capital Must be Rented
from Owners

• Money has owners and therefore costs

• Time value
• Risk
• Expect to provide a return or the venture will not
survive in a market economy

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 E-Finance Principle #2
Risk and Expected Reward Go Hand in Hand

• Time value is not the only cost when using others’ funds
• More risk => More expected reward
• How much more? Market-determined!

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 E-Finance Principle #3
While Accounting is the Language of
Business, Cash is the Currency
• Two important reasons to employ accounting
• Tracking and accountability for actions taken
• Quantifying different visions of the future
• But, remember cash flow is a new venture’s lifeblood
• “Get enough accounting to see through the accruals to the
cash account”
• Cash burn: gap between cash being spent and that being
collected
• Cash build: excess of cash receipts over cash distributions,
including payments for additional investment.

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 E-Finance Principle #4
New Venture Financing Involves Search,
Negotiation, and Privacy

• Public Financial Markets: standard contracts traded on

organized exchanges
• Private Financial Markets: customized contracts bought
and infrequently sold in inefficient private negotiations

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 E-Finance Principle #5
A Venture’s Financial Objective is to Increase Value

• Many objectives including personal ones

• But, the unifying financial objective is to increase value
• rather than price, margin or sales
• rather than profit, return or net worth
• (Market) Value derives from the ability to generate cash
to pay capital providers for their capital

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 E-Finance Principle #6
It is Dangerous to Assume that People Act Against
Their Own Self-Interest

• Aligning incentives (investors, founders, employees, spouses,

etc.) is critical
• As situations change, incentives diverge and renegotiation is
important
• Owner-manager conflicts: differences between a manager’s
self-interest and that of the owners who hired him/her
• Owner-debtholder agency conflict: divergence of the owners’
and lenders’ self-interests as the firm gets close to bankruptcy

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 E-Finance Principle #7
Venture Character and Reputation Can be Assets
or Liabilities

• Ventures have character that can be different from the

individuals who founded or manage it
• Many entrepreneurs state that high ethical standards are one
of a venture’s most important assets and are critical to long-
term success and value
• Ventures can - and do - make meaningful societal contributions
• Many successful entrepreneurs are financially and personally
involved in charitable endeavors

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Role of Entrepreneurial Finance
 Entrepreneurial Finance
• application and adaptation of financial tools and techniques
to the planning, funding, operation, and valuation of an
entrepreneurial venture
• focuses on the financial management of a venture as it
moves through its life cycle, beginning with its development
stage & continuing through to when the entrepreneur exists
or harvests the venture

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Successful Venture Life Cycle

 Venture Life Cycle:

stages of a successful venture’s life from
development through various stages of revenue
growth)
• Development Stage:
period involving the progression from an idea to a promising
business opportunity

• Startup Stage:
period when the venture is organized, developed, and an initial
revenue model is put in place

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Successful Venture Life Cycle

• Survival Stage:
period when revenues start to grow and help pay some, but
typically not all, of the expenses

• Rapid-Growth Stage:
period of very rapid revenue and cash flow growth

• Maturity Stage:
period when the growth of revenue and cash flow
continues but at a much slower rate than in the rapid-
growth stage

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Financing Through the
Successful Venture Life Cycle
1. Development Stage (Seed Financing)
2. Startup Stage (Startup Financing)
3. Survival Stage (First-Round Financing)
4. Rapid-Growth Stage (Second-Round
Financing, Mezzanine Financing, & Liquidity
Stage Financing)
5. Maturity Stage (Obtaining Bank Loans,
Issuing Bonds, & Issuing Stock)

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Selected Financing Definitions

 Seed Financing:
funds needed to determine whether the idea can be converted
into a viable business opportunity
 Startup Financing:
funds needed to take the venture from having established a
viable business opportunity to initial production and sales

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Selected Financing Definitions
 Venture Capital:
early-stage financial capital often involving substantial risk of total loss
 Venture Capitalists:
individuals who join in formal, organized firms to raise and distribute
venture capital to new and fast-growing ventures
 Business Angels:
wealthy individuals operating as informal or private investors who
provide venture financing for small businesses
 Investment Banker:
individual working for an investment bank who advises and assists
corporations in their security financing decisions and regarding
mergers and acquisitions

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Selected Financing Definitions
 First Round Financing:
equity funds provided during the survival stage to cover the cash
shortfall when expenses and investments exceed revenues
 Second Round Financing:
financing for ventures in their rapid-growth stage to support
investments in working capital
 Mezzanine Financing:
funds for plant expansion, marketing expenditures, working capital,
and product or service improvements

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Selected Financing Definitions
 Bridge Financing:
temporary financing needed to keep the venture afloat until the
next offering
 Initial Public Offering (IPO):
a corporation’s first sale of common stock to the investing
public
 Seasoned Securities Offering:
the offering of securities by a firm that has previously offered
the same or substantially similar securities

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Selected Accounting Terms
 Cost of Goods Sold:
direct costs of producing a product or providing a service
 Gross Profit:
revenues less the cost of goods sold
 Gross Profit Margin:
gross profit divided by revenues
 Net Profit:
dollar profit left after all expenses, including financing costs & taxes,
have been deducted from the firm’s revenues

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