Introduction to Entrepreneurial Finance

entrepreneurial Finance Philippe Gregoire Louvain School of Management Universite catholique de Louvain commendation book Entrepreneurial finance, a casebook. Paul A. Gompers and William A. Sahlman. John Wiley & Sons, Inc. 2002 1 Entrepreneurial finance Project assessment (POCD) Funding (amount, sures judge, topper retainer) Deal (ownership / control / incentives) Exit (IPO) Project Assessment 4 unfavour adequate to(p) mastery factors for entrepreneurial ventures ? ? ? ? People Opportunity Deal context 3 People Id rather back a A squad with a B idea than a B team with an A idea Who are the strike players What is their suffer How does this experience specify or not prepare them for the hazard that exists What are strengths and weakness of the mint involved on all sides of the transaction Are there key individuals that the company should add or replace 4 Opportunity refreshed masterduct / service ? Smartphone, New method of delivery ? Amazon. com New line of products technique ? Ernest Solvay patent (1861) to manufacture soda ash (enter in detergent, glass, ) Is there a sustainable competitive advantage Must the opportunity be exploited immediately Are there intermediate milestones 5Deal Spending inter tilt is not enough. Incentives and contingencies are important considerations. ? Key to all these structural features is the image of the entrepreneur earning his/her equity through value creation. Moral hazard and inauspicious selection ? Entrepreneur bear the downside risk Choice of appropriate devoteors ? for whom you overturn corking is often more important than the terms Selection of the veracious financial instrument ? ? ? Debt Equities Convertibles / preferred convertibles 6 Securities held by Venture expectantists (Source Kaplan-Stromberg, 2003) Context Competition Regulation International environment Economic conditions 8 incoming to entrepreneurial finance Finance ? Study of value and resources allocation ( crownwork bud shoot foring) look on of capital stream = f(magnitude, timing, riskiness) Economic value = Expected return = PV ? ? T t ? 1 E? Rt ? ? rf ? Risk premium CFt ? 1 ? E ? Rt t ? Cost of capital Capital rationing Entrepreneurship ? focalize on opportunities rather than controlling existing resources Entrepreneurial finance ? ? monetary management within entrepreneurial firmsStudy on both sides of the balanced tack 9 The Balance Sheet of a Corporation Assets = use of property real (Short-term) assets immediate payment Accounts receivable Inventories Others (various claims) Fixed (long-term) assets Land Buildings Machineries & Equipment Liabilities = sources of funds (Capital structure) Current (Short-term) Liabilities Accounts payable Short-term debt Long-term Liabilities Equity Provided by shareholders (= owners of the company) Long-term Debt Provided by creditors such as banks 10 Others Accounting Income versus Cash Flow Cash income ? ccounting income Whereas accountants try to match revenues with expenses, managers and investors focus on the difference in the midst of hard cash influx and cash out extend. Cash flow = the amount of cash income (= inflow outflow of cash) that is gene prised in any period Formally, 11 The Cash motorbike of a Firm Cash cycle average time between when a firm pays for its inventory and when it receives cash from the sale of its product 12 Sources of Entrepreneurial Finance Bootstrapping Stock markets (IPO) 3Fs Leasing Governmental organizations 13 Section 1. investment funds analysis Module 1. A Source of value ? ? Introduction to entrepreneurial finance causal agency study Module 1. B Financial statements and pro forma models ? Case study Module 1. C Purchasing firms, buyouts, and valuation ? ? military rating in entrepreneurial finance Case study Additional (Optional) variant and References Smith/Smith Entrepreneurial Finance, Wiley Edition. Sahlman/Stevenson/Roberts/Bhide The Entrepr eneurial Venture, HBS Press. 14 Section 2. finance the entrepreneurial firm Module 2. A Venture capital ? ? unavowed equity Case study Module 2.B Angel financing ? Case study 15 Section 3. Harvesting Module 3. A initial Public Offerings ? ? IPO process Case study Module 3. B Acquisitions ? Case study 16 Module 1A. Sources of value 4 stages of entrepreneurship ? ? ? ? Identifying opportunities getting the financial, professional, and productive resources Implementing a plan of actions Harvesting the rewards 4 critical success factors for entrepreneurial ventures ? ? ? ? People Opportunity Deal Context 17 The dishevel People Opportunity Valuation Deal structuring Source of capital 18 Business Case Success as one of the early AOL babys room companies 3-book deal with Bantam Doubleday Strong interest from advertisers Significant traffic at its website 2 issues Out of cash within 3 months Race for exceed economies on the internet To build the country s tote up- one wedding resource, Liu necessitate 10 millions 19 People (Core founding team) All media people with experience in software, video, etc. Good understanding of design and presentation deprivation of operational expertise, retail experience, and marketing 20 Opportunity Stable number of weddingRecessions have very little impact Event tied to world-shattering expenditures ? ? Wedding party Guests size of the market (35 billion) High advertising rate Stagnant competition, lethargic and not very innovative Couples planning to get married ? ? ? have relatively high income Are fairly infantile plan major life purchases ? are not very footing sensitive 21 Opportunity ? Cash Flow Transformed the opportunity into cash flow = Business model = set of factors that together experience the cash flows a company can generate and create value The entangle registry / advertising / merchandise / publishing and others 2 22 The Knot People Opportunity Valuation Deal structuring Source of capital 23 Valuation Cash flow is the source of value To date, the Knot has posted losses and is expected to post losses for at to the lowest degree 2 more years It is difficult to use earnings to image the probability of generating future cash flows. Revenues and mix of revenues appear to be a better measure Multiple of revenues method. Compare to firms on the basis of ? ? ? ? pose of development Business model Target market size Size of the investment round 24 List of comparable transactions 25Discount cash flow analysis Most forecasts are widely optimistic. Discounted cash flow valuations only work when one gets an estimate of the expected CF 26 Actual income statement 27 Split of Revenues 28 Forecasted statement of cash flows 29 Actual statement of cash flows In Millions of USD (except for per share items) dismiss Income/Starting Line Depreciation/Depletion Amortization Deferred Taxes Non-Cash Items Changes in Working Capital Cash from Operating Activities 201 1 5. 99 3. 74 0. 96 2. 78 11. 89 -1. 31 24. 05 2010 3. 65 3. 43 1. 78 2. 3 8 -8. 11 11. 06 2009 -4. 87 4. 75 5. 09 -1. 6 13. 83 -4. 92 12. 33 2008 4. 13 4. 84 3. 98 0. 56 6. 16 0. 2 19. 87 30 The Knot People Opportunity Valuation Deal structuring Source of capital 31 Initial deal Initial investment strategic partner ? Expect from AOL money, exposure and distribution more than just dollars to the deal AOL invested 1. 85 million in return for 45%, for royalties amounting to 20% of ad revenues on The Knots AOL site and a lesser % of ad revenues on The Knots internet site. ? The deal with AOL provided instant reach and credibleness to The Knot Is the deal expensive for The Knot? 32Ownership after AOL deal 33 Financing the Knot (new deal) 34 Convertible preferred Preferred has higher(prenominal) priority than common pains ? In the event of a firms sale or liquidation, holders of preferred stock get remunerative before common stockholders do. Entrepreneurs have greater ince ntive because if things dont go well, the investor will be paid first Downside risk is borne by the entrepreneur ? ? Tax considerations ? Entrepreneurs pay taxes on the value of common stock that they have received. ? Investing in preferred stock does not change the price of common stocks. 35 Financing the Knot Why should they invest? To develop The Knot brand, to build out the technological infrastructure, to develop the contribute registry business ? Practically, The Knot needs capital to fund the paysheet and pay for day-to-day operating expenses How much money? Forecasted statement of cash flow Who should invest in The Knot? Business Angel, Venture Capitalist, strategical Partner How should they value The Knot? Comparable deals on the market, multiple of revenues 36 Investors profile Angels + Higher valuation + Someone with an experience in the registry business Limited capital ? ay not be able to provide capital in the future if needed Less encouraging in recruiting o thers to the team Venture Capitalist + + Large pools of capital and hold multiple rounds of investment Network of contacts in the management and financial community of interests Lower valuation Strategic partner + + Experience in the business (retailer, wedding registries,) Provide distribution and name recognition Conflicts of interest 37 What happened? May 1998, Venture Capitalist invested $3m for 22% ? $10. 6m pre-money valuation (3/(10. 6+3)=22%) April 1999, Venture Capitalist invested $15m December 1999, IPO 38