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Entrepreneurship Ch. 6

Balance sheet
this provides a picture of the company’s current assets and liabilities and the owner’s equity. It is s snapshot of the company’s financial standing at a particular moment
Assets include
fixed assets (property, buildings equipment and furniture) and current assets (cash and items that can be easily converted to cash)
Liabilities include
long term liabilities (loans, mortgages, etc.) and current liabilities (debts that are payable within one year)
Owner’s Equity consists of
assets minus liabilities
Assets=
liabilities + equity
Equity
book value of the company
Market value=
(share price)(# of shares issued)
Income statement is also called a
profit and loss statement
The Income Statement
Reflects results of company’s operations during a specific period of time
The Income Statement Includes:
-Net sales (Revenue)
-Cost of sales (C.O.G.S.)
-Operating expenses
What are some examples of operating expenses?
Wages, Labor, rent, phone service, light bill, etc.
Statement of Cash Flows:
Shows changes in company’s cash during a specific period of time
Statement of Cash Flows Indicates
Operating activities
Investing activities
Financing activities
How is cash flow different from income?
Timing: Revenues and costs are not necessarily recognized when: Cash is transacted (e.g. accounts payable and receivable, salaries payable, depreciation vs. capital equipment purchase)
Investment Activities: Firm also receives cash from sources not related to operations (e.g. issuance of stocks and bonds)
Projecting the Future: Proforma
Projects the financial condition of the new venture
Proforma balance sheet
Proforma income statement
Proforma statement of cash flows
Proforma means
projected (it’s a guess)
Startup Costs
-All costs incurred to get the business off the ground
-Determine the capital you need
-Determine what you’ll do with the capital once you get it
Bootstrapping
starting a business without external help or capital with limited funds
Strive for a lean startup
-Eliminate wasteful practices and increase value producing practices
-Invest your time into iteratively building products or services to meet the needs of early customers, thereby reducing the market risks and sidestepping the need for large amounts of initial project funding and expensive product launches and failures
Breakeven Analysis Level of Sales of Product
-Calculate the amount of sales you need to achieve to cover your costs
-Determine sales price (per unit)
-Estimate variable cost (per unit)
-Subtract variable cost from sales price to calculate contribution margin
-Estimate fixed costs
-Divide fixed costs by contribution margin
-There are other ways to create a BE; use the method that works well for your venture
Methods of Business Valuation
-VC method of Valuation
-Discounted Cash Flow
-Comparative Appraisal
It is better to have a mediocre idea with a great founding team than
a great idea with a mediocre team
Changing conditions occur often, so the
talents, skills and abilities of the founding team are very crucial
60% of all new ventures require less than
$5,000 of capital to get started
Only 3% of new ventures require more than
$100,000
Only 3,000 companies receive
VC financing per year (including all stages)
Debt
financial obligation to return capital provided plus a scheduled amount of interest
Equity definition
a portion of ownership received in an organization in return for money provided
Sources of Capital: A Summary
-Savings, personal credit cards, equity in home
-Friends, family, and fools (3 F’s)
-Crowd-funding
-Business angels
-Venture capitalists
-Corporations
-Banks
-Asset-based lenders
-Factors
-Government programs: SBIR loan, loan guarantee program
Savings:
The single biggest source of new ventures funds are entrepreneurs’ own saving
70% of all new firms are financed with
Entrepreneur’s own money
Business Angel Investors
private individuals who invest in new ventures
Business Angel Investors invest about
$10,000-$200,000 average investment
More about Business Angel Investors
-Often become somewhat involved in new venture
-Usually in exchange for convertible debt or ownership equity
-May form angel groups or angel networks
-Angel investments bear extremely high risk and are usually subject to dilution from future investment rounds
-High risk means they demand high returns
-Silicon Valley dominates the destination of angel funds, receiving 39% of the $7.5B invested in US-based companies
Venture Capitalists
people who work for organizations that raise money from large institutional investors and then invest those funds in new firms
Venture capitalists also provide:
-advice and assistance in operating new businesses,
-help identify key employees customers and suppliers
-assist with operations and strategy formulation and implementation
While venture capitalists offer a lot to new companies, they also are
very demanding investors
impose a large number of
restrictions on the actions of the entrepreneurs
Venture capitalists usually appoint
new CEO and management team
Venture Capital
is financial capital provided to early-stage, high-potential, high risk, growth startup companies
VC invest in new ventures with
innovative technology, potential for rapid growth, a well-developed business model, and an impressive management team.
VC’s target minimum returns in excess of
40% per year
Typical exit strategy is 3-7 years. Most funds have
10 year lifecycles
Rule of thumb:
a fund may invest in 1/400 opportunities presented to it
Corporations:
other established companies provide important marketing and manufacturing support for new ventures
Banks: they lend money generally in two forms:
commercial loan, line of credit
Commercial loans
the borrower takes the whole loan amount out at one time and pays interest on the money borrowed
Line of credit
the entrepreneur draws up to a set amount of money at a particular interest rate, whenever it is needed
Commercial loans and Line of credit are used mostly to
buy existing businesses and franchises, typically not available for new ventures
Factors:
specialized organizations that purchase accounts receivable of a business at a discount
Government programs:
Federal and state governments offer a variety of programs. Used mostly to buy existing businesses and franchises, not suitable for new ventures
Investors look at the
executive summary of the entrepreneur’s business plan. From these alone, they weed out ninety-five percent of the plans
The business plan should contain evidence indicating
-that the venture opportunity has real economic value
-that this entrepreneur can capture that value
Convertible Securities
Financial instruments that allow
investors to convert preferred stock, which receives preferential treatment in the event of a liquidation, into common stock at the investor’s option.
Covenants
Restrictions on the behavior of entrepreneurs contractually agreed upon by investors and entrepreneurs.
Debt Ratio
Total assets divided by total debt, measures financial health
Discount Rate
The annual percentage rate that an investor reduces the value of an investment to calculate its present value.
Due Diligence
The review of a new venture’s management, business opportunity, technology, legal status, and finances prior to investment.
Factors
Specialized organizations that purchase the accounts receivable of businesses at a discount.
Forfeiture Provisions
Contract terms that require an entrepreneur to lose a portion of the ownership of the venture if agreed-upon milestones are not met.
Illiquidity Premium
Additional return demanded by investors to compensate them for the fact that an investment cannot be sold easily.
Income Statement
A statement (sometimes known as the profit and loss statement) that includes all income and expenses during a period to reflect the results of a company’s operations during that time.
Mandatory Redemption Rights
Contract terms that require an entrepreneur to return to the investors their capital, when requested.
Milestone
A jointly agreed-upon goal between entrepreneurs and investors that the entrepreneur needs to meet to receive another stage of financing.
Negative Cash Flow
A situation in which a venture spends more cash then it brings in
Option
A right, but not an obligation, to make a future investment
Proforma Income Statement:
A form illustrating projected operating results based on profit and loss
Social Capital
Extracting benefits from close interpersonal relationships among individuals, characterized by mutual trust, liking, and identification.
Staging
The provision of capital in pieces conditional on the achievement of specified milestones.
Syndicate
The sharing of an investment across a group of investors.
Terminal Value
The estimated value of a new venture at the time that the investment is liquidated in an initial public offering or an acquisition.
Venture Capital Method:
How venture capitalists calculate the amount of equity that they will take in a new venture in return for their investment of capital.
Venture Capitalist:
A person who works for an organization that raises money from institutional investors and invests those funds in new firms.
Vesting Periods:
Periods of time during which entrepreneurs cannot cash out of their investments
Which of the following is NOT an advantage provided to entrepreneurs by venture capital?
All of the above are possible advantages.
When starting a new business, entrepreneurs often know more about the opportunities and problems related to the business than do potential investors. This is known as
Information asymmetry.
When someone is unable to distinguish between two people, one who has a desired quality and the other who doesn’t, it presents a problem known as
adverse selection.
Why do investors require entrepreneurs to put in a lot of their own capital?
All of the above
Why might venture investors limit their investments to local entrepreneurs?
All of the above.
Which of the following can be used by an entrepreneur to help determine how much money will be needed to start a new business?
Break Even Analysis
Of the following statements, which one is false?
Proforma financial statements are also called breakeven reports.
An investor will provide money for a new business only if she can get the money back when she wants it. This is known as
mandatory redemption right.
An investor has joined a small group of other investors in an attempt to invest a relatively small amount of money in each of 15 different businesses. This is known as
syndication.
To calculate the amount of cash that a business has at a given point in time, the manager must construct a(an)
cash flow statement.
To convert information from your income statement to your cash flow statement, which of the following would you NOT do?
Add increases in accounts receivable.
Which of the following would be a step towards increasing cash flow and attempting to keep a business from becoming insolvent?
Sell your receivables to companies that purchase accounts receivable at a discount in return for immediate cash.
Which of the following are needed to calculate breakeven?
All of the above.
Which one of the following types of debt is the most common for new ventures that do obtain debt financing?
a. Guaranteed by personal assets.
b. Asset-based financing.
c. Supplier credit.
-A, B, and C.
Which of the following statements about business angels is NOT true?
They tend to demand higher return on their investment than venture capitalists.
People who work for organizations that raise money from large institutional investors and invest those funds in new firms are called
venture capitalists.
The venture capitalists themselves, who make investment decisions in start-ups and manage those investments, are called
general partners
Venture capitalists do:
a. provide assistance in operating new businesses.
b. help to identify key employees.
c. assist with operations and strategy formulation and implementation.
d. develop strong relationships with investment bankers who underwrite initial public offerings.
e. do all of the above.
^^^—All of the above—–^^^
A system for guaranteeing loans to new and small businesses to finance inventory or accounts receivable is offered by
CAPLine Program.
Due diligence typically includes an investigation of
-the business model.
-the market.
-the legal entity.
-the financial records.
Entrepreneurs might use an initial investment to reach a milestone, or a set target that they need to achieve for investors to consider additional financing. Which of the following is an example of a milestone?
a. The development of a prototype for the product.
b. Obtaining customer feedback through a survey or focus group.
c. Organizing the relevant venture team.
d. Hiring employees.
^^^^^Any of the above^^^^^
When dealing with the staging of investment, staging
-helps to protect investors against efforts by entrepreneurs to use their information advantage to gain at the expense of the investor.
-gives the investor the opportunity to gather information about how the venture is doing before putting more money into the venture.
-helps investors manage the uncertainty of investing in new ventures.
Investors in new ventures demand high rates of return for several reasons. Which of the following is NOT a reason?
Investors in new ventures are able to diversify their risks fairly well.
An entrepreneur needs office equipment for the new business. In order to raise the money to buy the equipment, the entrepreneur takes a loan and pledges the equipment as collateral for the loan. This type of financing is known as
asset-based.
An investor who wants to invest in only one start-up business is trying to decide between two new businesses. The entrepreneurs in both businesses seem quite similar to the investor. However, they are not similar. One has much better skills than the other, who is misrepresenting his skills. The investor is facing the situation known as
adverse selection.
An investor will provide money for a start-up business only if the entrepreneur will agree to giving the investor the right to approve any purchase or sale of assets totaling $100,000 or more. This is known as
a covenant.
Which of the following is a fixed asset?
A building
Total assets divided by total debt is called
debt ratio.
Net income divided by net sales is known as
both profit margin and return on sales.
The financial statement that shows assets, liabilities, and owners’ equity is known as
balance sheet.
An entrepreneur wants to start a new business and is writing down estimates of sales, cost of sales, and net profits. This entrepreneur is crating a
pro-forma income statement.
Two separate entrepreneurs have approached a potential investor to raise money for starting up their new businesses. One entrepreneur has good experience and skills for the planned new business. The other entrepreneur has considerably less experience and skills. The potential investor does not know this and decides to invest in the new business proposed by the entrepreneur with less experience and skills because that person was a more convincing speaker. This demonstrates the idea of
adverse selection.
Assume that you are running a small business and you estimate that you will run out of cash in two months. Which of the following could you do to avoid running out of cash?
-Arrange to pay accounts payable later.
-Offer customers a discount for paying more -quickly.
-Reduce raw materials.
^All of these will help to increase cash available^
Because investors in a new business venture cannot sell the investment easily, they might demand some form of extra compensation. This is known as
an illiquidity premium.

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