entrpreneurship

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
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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
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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
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5. Figure 1.1
5

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
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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

9. Figure 1.2
9

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

13. Figure 1.3
13

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
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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”
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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
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19. Stages of New Venture Development
19
Stages
Opportunity
Research and
Development
Start-up Early Growth Rapid Growth Exit
Description
Real
Options
Actions
Assess/UpdateBusinessPlan
Assess/UpdateBusinessPlan
AssessOpportunity
ContinuetoNextStage
TestMarket/MarketResearch
InitiateRevenueGeneration
DetermineOrganizationalStructure
ConductR&D Activities,e.g.: ExpandTeamasNeeded ExpandTeamasNeeded Acquisition
DetermineOrganizationalForm
SecurePatent
InitiateProduction
ExpandFacilitiesasNeeded ExpandFacilitiesasNeeded Buy-Out
PrepareBusinessPlan
DevelopPrototype
BuildStartingInventory
Abandon
ExtendStage/Financing ModifyProduction/Financing ExtendStage/Financing ExtendStage/Financing
ModifyR&D Strategy ModifyMarketing/Financing Abandon
Abandon Abandon
Allresearchanddevelopment
activitythatmustbecompleted
beforerevenuegenerationcan
commence.
Allactivitiesrelatedtostartof
productionandmarketingand
initiationofrevenue-generating
activities.
Allactivitiesduringtheperiod
beforetheventurereachesalevel
ofsalessufficientforcash-flow
breakeven.
Allactivitiesduringtheperiod
afterbreak-evenandbefore
sustainableviabilityis
established.
Allactivitiesrelatedto
establishingcontinuingfinancing
andenablingearlyinvestorsto
harvest.
Allactivitiesthroughpreparationof
businessplanandbeforeincurring
significantexpense.
IPO
ModifyConcept
ContinuetoNextStage ContinuetoNextStage ContinuetoNextStage ContinuetoNextStage ChooseFormofExit
Assess/UpdateBusinessPlan BuildTrackRecordforHarvest EarlyInvestorsHarvest
BuildWebsite
BuildSalesandMarketingTeam
Assess/UpdateBusinessPlan Assess/UpdateBusinessPlan
AssessStrategicAlternatives
BuildResearchTeam
Stages of New Venture Development
AcquireFacilitiesandEquipment WorkTowardBreakeven WorkTowardProvenViability
ObtainContinuingFinancing:
ObtainSeedFinancing ObtainR&D Financing ObtainStart-upFinancing ObtainEarly-GrowthFinancing ObtainRapid-GrowthFinancing
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
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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

23. Figure 1.5
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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
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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
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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
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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
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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
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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
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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
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