Introduction to Entrepreneurial Finance

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Entrepreneurial Finance
Philippe Gregoire
Louvain School of Management – Université catholique de Louvain

Reference 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, firm’s value, best partner)

Deal (ownership / control / incentives)
Exit (IPO)

Project Assessment
• 4 critical success factors for entrepreneurial ventures
   

People Opportunity Deal Context

3

People
I’d rather back a ‘A’ team with a ‘B’ idea than a ‘B’ team with an ‘A’ idea

• Who are the key players

• What is their experience
• How does this experience prepare or not prepare them for the opportunity that exists

• What are strengths and weakness of the people involved on all sides of the transaction • Are there key individuals that the company should add or replace

4

Opportunity
• New product / service


Smartphone,

• New method of delivery


Amazon.com

• New production 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 5

Deal
• Spending money is not enough. Incentives and contingencies are important considerations. 

Key to all these structural features is the concept of the entrepreneur earning his/her equity through value creation.

• Moral hazard and adverse selection


Entrepreneur bear the downside risk

• Choice of appropriate investors


for whom you raise capital is often more important than the terms

• Selection of the proper financial instrument
  

Debt Equities Convertibles / preferred convertibles

6

Securities held by Venture Capitalists

• (Source: Kaplan-Strömberg, 2003)
7

Context
• Competition • Regulation • International environment • Economic conditions

8

Introduction to entrepreneurial finance
• Finance


Study of value and resources allocation (capital budgeting)
• • • Value of cash 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


Focus on opportunities rather than controlling existing resources

• Entrepreneurial finance
 

Financial management within entrepreneurial firms
Study on both sides of the balanced sheet
9

The Balance Sheet of a Corporation
Assets = use of funds Current (Short-term) assets Cash 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  accounting income

• Whereas accountants try to match revenues with expenses, managers and investors focus on the difference between cash inflow and cash outflow. • Cash flow = the amount of cash income (= inflow – outflow of cash) that is generated in any period • Formally,

11

The Cash Cycle 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 analysis
• Module 1.A : Source of value
 

Introduction to entrepreneurial finance Case study

• Module 1.B : Financial statements and pro forma models


Case study

• Module 1.C : Purchasing firms, buyouts, and valuation
 

Valuation in entrepreneurial finance Case study



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