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ENT3423 Chapter 1 Notes

by: Lauren Carstens

ENT3423 Chapter 1 Notes ENT3423

Marketplace > Florida State University > ENT3423 > ENT3423 Chapter 1 Notes
Lauren Carstens
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These notes come directly from Chapter 1 of our textbook.
Funding Sources for Entrepreneurial Opportunities
Dr. Tatum
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This 12 page Class Notes was uploaded by Lauren Carstens on Friday September 9, 2016. The Class Notes belongs to ENT3423 at Florida State University taught by Dr. Tatum in Fall 2016. Since its upload, it has received 4 views.


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Date Created: 09/09/16
Chapter 1: Introduction and Overview 1.1: The Entrepreneurial Process  The Entrepreneurial Process: Developing opportunities, gathering resources and managing and building operations, all with the goal of creating value o Begin by focusing on developing opportunities  Take time and effort to examine the feasibility of an idea  Screen it as a possible venture possibility  Analyze the related competitive environment  Develop a sound business model  Prepare a convincing business plan o Gather physical assets/resources  Intellectual property (IP)  Human resources  Financial capital  Every start up needs “seed” financing and must have a strategy for acquiring it o Managing and building the venture’s operations  Generate revenue to cover operational costs  Provide cash flow to cover planned expansion and reinvestment 1.2: Entrepreneurship Fundamentals  Entrepreneurship: A way of thinking, reasoning and acting that is opportunity obsessed, holistic in approach and leadership balanced for the purpose of value creation and capture o The process of changing ideas into commercial opportunities and creating value  Entrepreneur: An individual who thinks, reasons and acts to convert ideas into commercial opportunities and to create value o Recognize and seize commercial opportunities, frequently before others recognize the potential o Are doggedly optimistic o Not consumed with the present  See a bright future and make a plan to get there  Entrepreneurial Firms are major players in high technology industries o Small business account for ¼ of all jobs and ½ of U.S. innovations and new technologies o Small technology firms are responsible for twice as many product innovations per employee  Risk and return go together o Nearly half of business failures are do to economic reasons  40 more % were due to financial causes 1.3: Sources of Entrepreneurial Opportunities  Entrepreneurial Opportunities: ideas that have the potential to create value through new, repackaged or repositioned products, markets, processes or services  Study on the top 500 high growth firms o 12% thought their success was due to extraordinary ideas o 88% thought their success was due to exceptional execution of ordinary ideas  Megatrends: large societal, demographic or technological trends or changes that are slow in forming, but once in place, continue for many years  Fads: Non predictable, short lived and do not have macro changes o Many degrees between megatrends and fads that provide entrepreneurs with business opportunities o Main megatrend categories  Societal trends or changes  1982: Naisbitt recognized that the US economy centered on the creation and distribution of information  Americans are rekindling the entrepreneurial spirit o The pace of entrepreneurial innovation is increasing throughout the world o To succeed in this environment, you must have an understanding of current megatrends and the anticipation of new ones  Ex: Demographic shifts associated with the baby boom generation and our increasingly information-oriented society  Demographic trends or changes  The most important generation wave is the baby boom of the 20 century o Boomers will dominate managerial positions and peak in the 2020s o The aging boomers continue to provide enduring business opportunities  Technological trends or changes  Most important source of opportunities  The genesis of our information society was in the 195-s/60s o The computer chip moved us from an industrial society to an information society o The Internet has dramatically changed the way people go about daily business  E-commerce: involves the use of electronic measn to conduct business online o We will never do business the same way we did before the Internet o Attention continues to shift from the age-old strategy of owning and controlling natural resources to a strategy of owning and controlling information o Many e-commerce business plans were funded with the belief that part of the belief could be captured by sellers (producers and retailers) o The Web so efficiently facilitates price competition that it is hard for suppliers and retailers to protect margins  Crises and “bubbles”  The first decade of the twentieth century: extreme economic swings and the bursting of several asset and financial “bubbles” o 9/11 o 2007-2009 financial crisis  When the ‘’ economy began to falter, an economic recession that began in 2001 was exasperated by the 9/11 terrorist attack o Government spending was increased and tax cuts were implemented in 2002 o By the second half of 2008, a perfect financial storm had been created and many worried about the potential for financial collapse o Entrepreneurs were stymied by a lack of venture capital  For entrepreneurs, these dark times almost always come with a silver lining o Some fail, but others prosper because of the lowering levels of competition o Many entrepreneurs are made during a fallout from major economic crisis 1.4: Principals of Entrepreneurial Finance  New ventures require financial capital to develop opportunities, start business ventures and create value  Seven principles of entrepreneurial finance o 1. Real, human and financial capital must be rented from owners  The time value of money is an important component of the rent one pays for using someone else’s financial capital  You should expect to compensate the lender for the loss of ability to lend that money to someone else  A founder’s own financial capital invested in the firm deserves a fair compensation  The venture should expect to compensate all investors for their financial capital o 2. Risk and expected reward go hand in hand  The time value of money is not the only cost involved in renting someone’s financial or other capital  The total cost is typically significantly higher due to the possibility that the venture won’t be able to pay o 3. While accounting is the language of business, cash is the currency  Accounting for entrepreneurial firms has two purposes  To provide for checks, balances, integrity and accountability in tracking a firm’s conduct  Quantify the future in a recognizable dialect of the official language o Entrepreneurs need to be able to quantify certain aspects of their venture’s future and translate them into appropriate financial statements  Entrepreneurs often underestimate the amount of cash needed to get their ventures up and running  Cash burn: measures the gap between the cash being spent and that being collected from sales o It is typical for new ventures to experience a large cash burn, which is why they must seek additional investment from others  Cash build: measures the excess of cash receipts over cash disbursements, including payments for additional investment o 4. New venture financing involves search, negotiation and privacy  Public Financial Markets: Where standardized contracts or securities are traded on organized securities exchanges  A large number of investors and intermediaries compete  Much of corporate finance deals with the financial decisions of public companies raising money here  Corporate finance concentrates much of its attention on public financial markets where standardized contracts or securities are traded on organized securities exchanges  Publicly traded prices may be considered good indicators of true values o These public markets exhibit  Efficiency (prices reflect information about the company or its industry)  Liquidity (Investors who disagree with prevailing prices can buy and sell the security to express their objection)  Corporate finance tends to downplay significant frictions in the markets for new financial capital  New ventures seldom have financing waiting to fill any potential gaps  When they do find investors, competition is weak and this leads to bargaining between the venture and the investor o Private financial markets: Where customized contracts or securities are negotiated, created and held with restrictions on how they can be transferred  Characterized as  Inefficient (prices may not reflect significant information known to the venture or its investors)  Illiquid (Investors who disagree cannot easily sell or buy to express discontent or approval) o 5. A venture’s financial objective is to increase value  Increasing value is the sole objective entrepreneurs can agree on  Profit has to give rise to free cash to be returned to investors in a timely matter  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  Return on equity, especially in new ventures, will be low because profits are nonexistent o 6. It is dangerous to assume that people act against their own self-interests  When doing good for you will do good for me, we can assume that I will do good for you  When doing good for you will do bad for me, I will renegotiate  Incentives should be aligned because ignoring self- interest is not a good idea  Owners need to constantly monitor incentive alignments for everyone associated with the venture and be ready to renegotiate to improve failing alignments  It is typical to need to give up some control when in need of external capital  To keep incentives aligned, it is common to provide a constant increase in the entrepreneurs ownership  It is wise to allow managers and other employees’ to visualize a future reward  The owner-debt holder conflict: Divergence of the owners’ and lender’s self interests as the firm approaches bankruptcy  When a venture has borrowed money to help fund itself  When a venture is indebted, it is not uncommon to take what little money it has and buy lottery tickets to improve the chance of keeping the business o 7. Venture character and reputation can be assets or liabilities  Characterizations can grow and evolve as others accumulate evidence on how the individuals and the entity behave  In the early stages, the venture’s character and the founder’s character tend to coincide  It is significantly more difficult to increase value without positive character  Successful entrepreneurs are prime candidates for charitable fundraising  Some ventures were founded with the idea of designating charities as the recipients of the financial returns  Increasing these ventures’ values is the same as increasing the value of the stream of cash support promised to the charities 1.5: Role of Entrepreneurial Finance  Entrepreneurial Finance: The application and adaptation of financial tools, techniques and principles to the planning, funding, operations and valuation of an entrepreneurial venture o focuses on the financial management of a venture as it moves through the entrepreneurial process o Most entrepreneurial firms will need to regroup and restructure one or more times to succeed  Financial Distress: When cash flow is insufficient to meet current liability obligations o Anticipating and avoiding financial distress is one of the main reason to study and apply entrepreneurial finance  Generating cash flows is the responsibility of all areas of the venture o Marketing o Production/engineering o Research and development o Distribution o Human resources o Finance/accounting  The entrepreneur must help the team relate their actions to the growth of cash flow and value  Financial Manager: responsible for monitoring the firm’s operating efficiency and financial performance over time o Involves record keeping, financial planning, monitoring the venture’s use of assets and arranging for any necessary financing 1.6: The Successful Venture Life Cycle  Venture Life Style: Stages of a successful venture’s life from development through various stages of revenue growth (usually determined graphically) o Early stage ventures: New or very young firms with little operating history o Seasoned firms: Firms with successful operating histories and operating in their rapid-growth or maturity life stages o Development stage: Period involving the progression from an idea to a promising business opportunity  The feasibility of an idea is put on trial  Initial reactions test whether or not it is worth pursuing further  About a year before market entry  Developing opportunities o Startup stage: Period when the venture is organized and developed and an initial revenue model is put in place  6 months prior to market entry and 6 months after market entry  Ventures requiring little resources and simple production can move to the actual startup in less than one year  Gathering resources o Survival stage: Period when revenues start to grow and help pay some, but typically not all, of the expenses  6 months to 18 months after market entry  The financial gap is covered by borrowing or allowing others to own a part of the venture  Here is when venture’s find the most financial difficulty and concerns about the financial impression they leave on others  Gathering resources, managing and building operations o Rapid-growth stage: Period of very rapid revenue and cash flow  Cash flows grows much more rapidly than cash outflows  appreciation in the venture’s value  1.5 to 4.5 years after market entry  By passing through the survival stage, they become the recipients of substantial gains in market share taken from less successful firms struggling to get through the survival stage  Managing and building operations o Early maturity stage: Period when the growth of revenue and cash flow continues but at a much slower rate than in the rapid- growth stage  Years 4-5 after market entry  Often coincides with decisions by the entrepreneur to exit the venture through a sale or merger  The successful venture can have a very long total maturity stage by providing value to the entrepreneur for longer periods of time  Gathering and building operations 1.7: Financing Through the Venture Life Cycle  Early stage ventures are often under-capitalized from the beginning  Once a venture is able to produce a successful operating history, it becomes a seasoned firm and new larger sources of financial capital become attainable  Seed Financing: funds needed to determine whether an idea can be converted into a viable business opportunity o Developmental stage o Entrepreneurs own assets o Financial Bootstrapping: creative methods, including barter, to minimize the cash needed to fund a venture o Founders often sell personal assets or obtain a loan by pledging these assets as collateral  Family members and friends provide an important secondary source of seed financing  Startup Financing: Funds needed to take a venture from having established a viable business opportunity to initial production and sales o Startup stage o Targeted at firms that have established a solid management team, developed a business model and plan and are beginning to generate revenues o Depending on the need during seed financing, the entrepreneur’s assets (if any) might be used now o Sales begin but the necessary financial capital is still larger than the cash inflow o Venture Capital: Early stage financial capital often involving substantial risk of total loss, but also the potential for extraordinarily high returns o Two primary sources of formal external venture capital  Business angels: wealthy individuals operating as informal or private investors who provide venture financing for small business  Individually or in joint effort with others  Many are self-made entrepreneur millionaires  Typically invest in technologies, products and services in which they have a personal interest and previous experience  Venture Capitalists (VCs): Individuals who join in formal, organized firms to raise and distribute venture capital to new and fast-growing ventures  Typically invest the capital they make in several different ventures in an effort to reduce the risk of total loss of their invested capital  First-Round Financing: Equity funds provided during the survival stage to cover the cash shortfall when expenses and investments exceed revenues o Even though revenues begin during the startup stage, the race for market share generally results in a cash deficit o The need for first-round financing may begin during the end of the startup stage o Ventures usually find it advantageous to ask their suppliers fr trade credit  Trade credit: Financing provided by suppliers in the form of delayed payments due on purchases made by the venture  Upstream users of the firm’s goods and services may also be willing to provide formal capital or advances against future revenues  Delayed payments to creditors and accelerated receipts from customers, although it brings more cash flow, requires more careful planning o Federal and some small state and local governments provide some financing to small ventures during their survival stages  Government Assistance Programs: Financial support, such as low interest rate loans and tax incentives, provided by state and local governments to help small businesses o Commercial banks: financial intermediaries that take deposits and make business and personal loans  Difficult for survival-stage ventures to secure bank financing because they prefer lending to established firms with two years of financial statements  Second-Round Financing: Financing for ventures in their rapid growth stage to support investments in working capital o Rapid-growth stage o Comes from business operations, suppliers and customers, commercial banks and financing intermediated by investment bankers o Operating cash flows are helpful but inadequate to support desired growth o Most firms commit sizable resources to investing in working capital o Very important to project their cash needs  Mezzanine Financing: funds for plant expansion, marketing expenditures, working capital and product or service involvements o It takes about 2.5 years to achieve operating breakeven and 6 years to recover an initial equity investment o Warrants: Rights or options to purchase a venture’s stock at a specific price within a specified time period o At the end of the mezzanine stage, the successful firm will be close to leaving the traditional domain of venture investing and will be prepared to attract funding from the public and large private markets  Liquidity Financing o If organized as a corporation, a venture may want to provide venture investor liquidity by establishing a public market for its equity o Bridge (temporary) Financing: Temporary financing needed to keep the venture afloat until the next offering  Used to permit the restructuring of current ownership and to fill the gap leading to the firm’s first public offer  Initial Public Offering (IPO): A corporation’s first sale of public stock to the investing public  Part will be used to repay the bridge loan  Secondary Stock Offering: Founder and venture investor shares sold to the public o Some firms are not seeking a public market for their equity and may attempt to slow to a growth rate that can be supported by internal funding, bank debt and private equity  Existing and potential investors usually have strong preferences regarding the planned liquidity event o Investment Banking Firms: Firms that advise and assist corporations regarding the type, timing and costs of issuing new securities o Investment banker: Individual working for an investment banking firm who advises and assists corporations in their security financing  Clever at helping the successful venture firm undertake an IPO  Facilitate the sale of firms through their mergers and acquisitions divisions o Venture Law Firms: Law firms specializing in providing legal services to young, fast-growing entrepreneurial firms  Can craft a firm’s legal structure, it’s tax and licensing obligations, it’s intellectual property strategy, it’s employment agreements and incentive compensation  Seasoned Financing o Maturity stage o Retained earnings from business operations are a major source of financing for a mature venture o If additional funds are needed, loans from commercial banks or new issues of bonds and stocks, usually with the aid of investment bankers, can be obtained  Seasoned securities offering: The offering of securities by a firm that has previously offered the same or substantially similar securities o Mature firms usually approach financing as a way to cut taxes, fine tune investor returns and provide capital for mergers, acquisitions and extraordinary expansion  They can sell seasoned versions of their securities directly to a restricted number and class of investors, but not to the general public 1.8: Life Cycle Approach for Teaching Entrepreneurial Finance  At each stage, the entrepreneur must make critical decisions about the future of the venture o Should we abandon the idea or liquidate the venture? o Should we rethink the idea, redesign a product or service, change manufacturing, selling or redistributing practices, or restructure the venture? o Should we continue? Questions: -People often move on to the next stage when they get funding. They do not usually leave successful businesses because they are necessary in the process and the buyer wants to keep them on board. -We count on ethical standards as consumers because we want what we can trust. Ethics is monetized when consumers will pay more for a company’s product that they trust. When an investor deviates from ethical standards  We vote with our money (Free Market Capitalism)  Profit is the amount that a customer knowingly provides a company above it’s cost structure for the value they receive o Applause: Profit is the applause from the customers o Small companies work really hard to keep their customers satisfied o Large companies get you to pay more for the brand (Apple, Tiffany’s)  We pay for the value, it’s not cheating  Profit is the amount that a company extracts from its customers to their disadvantage without their knowledge/cheating o Most companies in the U.S. make their money with this definition (in my opinion) Think more into this o When we don’t have a choice, we are forced to pay more o Socialism: State or government takes control over production  Comcast has a monopoly (exclusive possession or control over a supply or trade of a service o Consumer stupidity


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