FIN 444 Study Guide 1
FIN 444 Study Guide 1 FIN 444
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This 11 page Study Guide was uploaded by Patricia Soto on Wednesday February 24, 2016. The Study Guide belongs to FIN 444 at University of Illinois at Chicago taught by John Bintz in Winter 2016. Since its upload, it has received 104 views. For similar materials see Small Business Finance in Finance at University of Illinois at Chicago.
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Date Created: 02/24/16
FIN 444 Study Guide 1 Chapter 1 – Introduction & Overview Entrepreneurship Fundamentals • 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 to create value • 65-75% businesses remain after 2 year • About half the companies fail after 4 years, and 6 years • Remember: It’s not easy but can be really rewarding. Characteristics: Optimistic, Passionate, Willingness to Fail, Learn from your mistakes, come up with a distinct path (strategy), if you don’t know what you’re doing then LISTEN (be a sponge), hard work (if you don’t have this you are doomed to fail). There is no substitute for hardwork 60-80% new jobs are created by small businesses Small businesses (under 500 employees) employ 65% of the work force. A successful entrepreneur • Sees and seizes a commercial opportunity • Tends to be doggedly optimistic (perhaps even to a fault) • Plants to obtain the physical, financial and human resources needed for the venture to succeed Sources of Entrepreneurial Opportunities • Research suggests 12% of Inc. 500 success is due to extraordinary idea • 88% due to exceptional execution of ordinary idea Trends suggesting possible entrepreneurial innovations • Societal changes • Demographic changes • Technological changes Societal Changes • Industrial Society to Information Society o Suggested focus on human response to information • Global economy o Awareness of international innovation and sourcing E-finance Principle #1 o Real, Human, and Financial Capital Must be Rented from Owners o o -Money has owners and therefore costs § Time value FIN 444 Study Guide 1 § Risk o Expect to provide a return or the venture will not survive in a market economy o *****FICO – credit score (350-850) § Reliability on payments, bankruptcy, how old you are § Important when you borrow money o o US Treasury bond 10 year (least riskiest bond) – 2.05% o 15 year home mortgage – 3.00% § biggest benefit: the interest on paying it off is tax deductible (tax benefit) ex 100,000 / yr 15,000 interest income = 85,000 pay tax on that new amount § Another benefit, built up equity § Value of the home increases 3% each year o Prime Rate – 3.50% § The rates that banks charge people with the best credit (usually companies) § It can be adjusted if you’re not the best customer o HELOC – 5.50% § Home Equity Line of Credit ú Ex. 200,000 home, value 250,000, owes only 100,000 & invest in a business (50,000) pay this amount ú Using the equity on the house as collateral to borrow more money o Now Recourse loan – 7.75% § No cash tied to it, promise to pay it back o Corp debt – 9% § Corporate goes and borrows money with ok credit o Credit card – 14-25% o o Why do companies fail? Why businesses fail Shrink – people stealing from the business Adapt or die Too much debt/ no capital Not enough sales Management Business/ family conflict E-finance Principle #3 FIN 444 Study Guide 1 While accounting is the language of Business, cash is the currency • Two important reasons to employ accounting o Tracking and accountability for actions taken o Quantifying different visions Principle #4 New venture financing involves search, negotiation and privacy • Public financial markets- standard contracts traded on organized exchanges • Private Financial markets- customized contracts bough and infrequently sold in inefficient private negotiations Principle #6 It’s dangerous to assume that people act against their won self- interest • Aligning incentives (stakeholders = investors, founders, employees, spouses, etc.) is critical • As situations change, incentives diverge and renegotiation is important • Owner-manager conflicts: differences between a manger’s self interest and that of the owners who hired him/her • Owner-debt holder agency conflict: divergence of the owners’ and lenders’ self-interest as the firm gets close to bankruptcy • Week 3 Successful Venture Life Cycle – stages of a successful venture’s llfe • Development stage • Start up stage • Survival stage • Rapid growth stage • Maturity stage What can a company do with money? • Pay Dividends (Large mature companies) • Reinvest into the company (HR, R&D, equipment) • Acquisitions (Product Diversification, Vertical Integration, Synergies, Integration) • Retire Debt • Keep it (save it for a rainy day) • You can buy back your own stock (to rise the price) o Shareholders hate when companies do nothing with their cash on the balance sheet. Selected Financing Definitions • Seed Financing – funds needed to determine whether the idea can be conveted into a viable business opportunity FIN 444 Study Guide 1 • Startup Financing – funds needed to take the venture from having established a viable business opportunity to initial production and sales Vocab • Venture Capital • Venture capitalists • Business Angels • Investment Banker • First Round Financing • IPO Chapter 2 Various Types of Firms • Salary replacement firms- firms that provide their owners with income levels comparable to what they could have earned working for much larger firms • Lifestyle firms- firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do • Serial Entrepreneurs Best Financial Practices • Prepare monthly financial plans for the next year & annual financial plans for the next five years • Anticipate & obtain multiple rounds of financing as the venture grows • Efficiently & effectively manage the firm’s assets, financial resource, & operating performance • Plan an exit strategy Best Management Practice • Most critical part of the organization, organizational chart usually as follows: Chairman Board members – usually an odd number CEO (C-Suite) COO CMO CFO CAO President Accounting Finance o Time to Market and Other Timing Implication • Business Opportunities exist in real time • Most ideas have a relatively narrow window of opportunity to become a successful business venture • Sometimes ideas are ahead of their time • Of course, being “first to market” does not necessarily ensure success FIN 444 Study Guide 1 Qualitative Screening: interview • Four factor categories initially evaluating a potential venture’s attractiveness: o The Big Picture o Know Thy Customer o Production and Development Challenges o Financial Fortune Telling Quantitative Screening: VOS Indicator • Attempt to quantify the following areas o Industry/Market o Pricing/Profitability o Financial/ Harvest o Factor Category: Industry/Market • Potential Attractiveness o Market Size Potential § Average: $20-100 million o Venture Growth Rate § Average 10%-30% o Market Share (Year 3) § Average: 5%-20% o Entry Barriers § Average: Timing/Size Key Elements of a Business Plan • Business Plan – written document that describes the proposed product or service opportunity, current resources, & financial projections • Cover page – should identify the venture & provide the name, address & phone number of the entrepreneur or other contact person • Confidentiality Statement- Ex. This business plan contains information that (the firm) considers proprietary. By accepting this business plan the recipient acknowledges…” 1. Executive Summary 2. Business Description 3. Marketing Plan & Strategy 4. Operations and Support 5. Management Team 6. Financial Plans and Projections (3 Years) 7. Risks and Opportunities 8. Appendix Chapter 3 Forms of Business Organization FIN 444 Study Guide 1 • Proprietorships – business venture owned by an individual who is personally liable for the venture’s liabilities o Unlimited liabilities – personal obligation to pay a venture’s liabilities not covered by the venture’s assets • Partnerships o General o Limited • Corporations o C Corporations o S (or Subchapter S) companies • Limited Liability Companies (LLCs) Number of Owners & Ease of Startup • Proprietorship – one; low time & legal costs • Partnership (general) – two or more; moderate time & legal costs • Investor Liability • Propertiership – unlimited Taxation • Properitership – personal tax rate • Partnership (general) – personal tax rates • Limited Partnership – personal tax rates • C- corp – corporate taxation dividends subject to personal tax rates • S –corp – income flows to shareholders; taxed at personal tax rates • LLC – income flows to owners; taxed at personal tax rates Protecting Valuable Intangible Assets • Patents – granted for inventions, useful, novel and non- obvious • Trade Secrets • Trademarks • Copyrights Utility Patents: Application Process • Develop or conceive an invention • Prepare (you, or a registered patent attorney on your behalf) a patent application • File the application in U.S. Patent & Trademark Office • If successful, the utility patent life will be 20 years (prior to mid- 1995 the life was 17 years) Other Methods for Protecting Intellectual Property • Confidential Disclosure Agreements – documents used to protect an idea or other forms of intellectual property when disclosure must be made to another individual organization FIN 444 Study Guide 1 • Employment contracts – agreements between an employer and employee whereby the employer employs the employee in exchange for the employee agreeing to keep confidential information secret Seed and Startup financing • Financial Bootstrapping – minimizing need for financial capital and finding unique ways to find • Week 5 Basic Income Statement Terms & Concepts • Operating income or earning before interest & Taxes (EBIT) – indicates a firms profit after operating expenses, excluding financing costs, have been deducted from net sales 4, 5, 6, Bill Snow Investment Banking Intermediary • EBITDA (Earning before income and taxes depreciation and amoritization) – what you’re making on a monthly/annual basis, free cash flow of the business. used for selling a business for figures in multiples of 10. o Ex. $10 x 10-15x = 100M • Net Cash Burn occurs when the sum of cash flows from operations and investing is negative (how much money you’re losing) Chapter 5: Evaluating Financial Performance • Important because entities want to know how your business is doing financially (the health of the business) o Health determined by the income statement/ balance sheet and manipulating ratios Financial Measure Life Cycle Life cycle stage, type of financing, financial ratios and measures, users of financial ratios and measurers Liquidity Ratio • Indicate the ability to pay short term liabilities when they come due • Current ratio: average current assets/average current liabilities = ((250,000+180,000)/2)/(204,000 + 110,000)/2 =1.37 • Covenance – when you don’t pay for your loans FIN 444 Study Guide 1 MPC Conversion Period Performance Conversion Ratio Leverage ratios Leverage ratio – indicates the extent to which the venture is in debt and its ability to repay its debt obligation Loan principal amount- dollar amount borrowed from a lender Interest- dollar amount paid Interest coverage ratio MPC Leverage Ratio Chapter 6 Venture Life Cycle – Development Stage, Start Up Stage, Survival Stage, Rapid Growth Stage PDC Company Operating & Cash Budget Forecasting Sales or Revenues Guest Speaker - David DMK restaurants Real estate Design – residential Distribution – Midwest grocery Businesses need to add value to the market -fish where there’s not a lot of boats & understand how to catch the fish if you don’t know what your edge is in business then you don’t have one Managers time is dictated by what people around you ask Leaders time is dictated by what they ask of the people Be passionate in what you do. -> how to make a burger better? Visit and try all burgers to find your competitive edge 99% of business fail before they open Think small and realistic. Try it out on a smaller scale Can you find 3 people crazy enough to trust you to allow you to do it for free How to build a brand -you have to be polarizing, have a really strong willingness to have people think about it Tell me not who you are but with whom you walk People invest in you! Not your idea! You need patience and discipline!!! FIN 444 Study Guide 1 Sleep 5 hours a night and take one day to rest See a therapist every week – business coach Question How to fund businesses? Restaurant side- horrible investment? • Set up investment funds (investing in a portfolio of restaurants is a good idea!) • Achievable revenues 4 times capital investments & 20% profit margin = 80% ROI Do you run all of the businesses or just a shareholder? • Rituals!!! (reading- time management) • Time Management o 4 hour work week /chef Tim o Steven Covey – 7 habits of high effective people § Important & not urgent o Ken Blanchart – 1 min manager o Built on Business • Live with a high level of trust • Micromanaging- coaching • Data o Profit and Loss Statement every week • Transparency • Close emotionally with people (shared success) Fears & Misconceptions • Terrified of failure • Finding the value in things • Letting people down Buy or rent? • BUY preferably but lease if not Week 7 Financial Markets • Public Financial Markets- markets for the creation, sale and trade of liquid securities having standardized features • Private Financial Markets- markets for the creation, sale and trade of illiquid securities having less standardized negotiated features. Determining Cost of Debt Capital • Interest rate – price paid to borrow funds • Default Risk- risk that a borrower will not pay the interest and/ or principal on a loan (US. Treasury (Low), Bank (High) • Nominal Interest Rate – observed or stated interest rate FIN 444 Study Guide 1 • Real interest rate –interest one would face in the absence of inflation, risk, illiquidity and any other factors determining the appropriate interest • Risk-free interest rate – interest rate on debt that is virtually free of default risk • Inflation – rising prices not offset by increasing quality of the goods or services being purchased • Inflation premium • Prime rate – interest rate charged by banks to their hightest quality (lowest default risk) business customers • Bond Rating – reflects the default risk of a firms bonds as judged by a bond rating agency • Senior agency – debt secured by a ventures assets • Subordinated debt – debt with an inferior claim (relative to sernior debt (gets paid first) to venture assets) Estimating the Cost of Equity Capital • Organized Securities Exchange • Over the counter Market • *Market capitilazation – determined by multiplying a firms current stock price by the number of share that are outstanding Cost of Equity Capital for Private Ventures • Venture Hubris Valuation Workshop PPT Valuation • $/$ + pre-money valuation • ex. 1/ 1+4 = 1/5 = 20% equity to capital • Rubber meets road • Why important? Importance of Entrepreneurship • Market based economy • Life’s supply & demand curves • Competition • Global economy • Relevant Facts o 1 million companies created per year o 60-80% of new jobs are small businesses Why Failure • Not working hard enough • Not enough resources • No market FIN 444 Study Guide 1 Levels of Value- when business owners gift their stock to family members* Test Question • Control Company Value o Minority Discount about 30% • Public Company Value o Marketability Discount about 15% • Restricted Stock Value o Marketability Discount about 25% • Private Company Value Three Valuation Approaches: • Income Approach – Values company by discounting future cash flows • Market Approach – values company using multiples of similar companies • Cost approach – values company assuming liquidation of tangible assets Know what an investment banker does* Accredited Investor – an individual that has either 1 million dollars in net worth or has had $250,000 in 2 consecutive years Entrepreneurship – starting your own business, taking a risk, “changing ideas into commercial activities”
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