Questions and Answers of Entrepreneurial Finance

How are the stages of development related to the financial performance of the venture? How do the stages relate to availability of financing?
Explain how milestones are related to development stages and to real options.
What are some important differences between new venture business plans and business plans of established firms?
How can entrepreneurs make their business plans more convincing?
Identify types of financing that are associated with each of the following stages of new venture development: research and development, start-up, early growth, rapid growth, and exit.
Why are the following important factors when choosing among financing sources: immediacy of financing need, the size of the need, the permanency of the need, and the cumulative need?
What, besides providing financial capital, are the advantages to a new venture of attracting angel group financing? Venture capital financing?
What factors should an entrepreneur consider when differentiating between CVC and VC investors?
When is vendor-provided credit (trade credit) an important form of financing for new ventures and how do the credit terms affect the cost of using trade credit?
How do government programs encourage new venture development?Give examples of government programs that facilitate financing of new ventures.
Why do small firms, especially new ones, have limited access to the public debt market? Under what conditions are ventures likely to be able to access the bond market?
What are the differences in financing choices for for-profit firms and not-for-profit firms?
Identify the basic U.S. securities laws that affect new venture financing options. How has the JOBS Act (2012) affected new venture financing?
What are accredited investors and why are they important to new ventures seeking registration of their equity securities?
How is turnaround financing different from financing associated with a healthy growing firm?
Referring to Figure 3.1, review the major developments that have affected the growth in the VC market in the U.S. Explain, for example, the impact of the Investment Company Act, ERISA’s prudent
What types of deals are most appropriate for VC and why?
What are some possible explanations for the variation across countries in the development of VC markets?
Describe the primary features of the LP structure of VC funds, including the roles of the GP and LPs, the length of the partnership, and the compensation mechanisms for the partners.
How do VCs add value to new ventures? When can syndication add value and why?
Describe the steps in the VC investment process (Figure 3. 8). FIGURE 3.8 The VC investment process Year 0 Secure commitments from investors Development of Fund Concept Closing of Fund First capital
Explain how VCs distribute capital gains associated with a successful exit of a portfolio company (the waterfall). How is a clawback provision related to the overall distribution of returns to LPs
Explain the economic rationale for key provisions in a limited partnership agreement, such as limitations on additions of general partners and key person provisions.
Why is reputation so important in the VC market?
How do angel investors add value? What does the evidence show?
How do angel syndicates work?
Explain the difference between moral hazard and adverse selection. Why do these two concepts pose contracting problems for new ventures?
What is the difference between an information problem and an incentive problem? Give an example of each in an entrepreneurial setting. How do these two problems relate to moral hazard and adverse
What is the difference between a screen and a signal? How can screens and signals help to mitigate contracting problems?
What are the meanings of bonding and monitoring in the context of new venture finance? What, from an economic standpoint, makes a bond effective?
Why is convertible preferred equity the most common instrument used by venture capitalists when investing in new ventures? What incentive and/or information problem does this form of equity address
Liquidation preferences and participation are both common features of term sheets. How do these provisions work when there is a liquidation event like a winding up of the company or an acquisition?
What problem does a ratchet (antidilution provision) try to address?Why would a full ratchet be less appealing to the entrepreneur than is a weighted average ratchet?
Why is a convertible note an attractive type of financing instrument for seed-stage ventures?
What are the roles of a cap and a discount in a convertible note instrument?
Identify some common provisions of a term sheet. What information and incentive problems do these provisions anticipate, and how do they help to mitigate the problems?
How are product-market, organizational, and financial strategies interdependent?Why, for new ventures, is it important to consider them simultaneously rather than sequentially? Give some examples.
What are the three aspects of a decision that make it strategic?
Why is it important for strategic planning to begin with a clear sense of the objective?
How might the objective for an entrepreneurial venture be different from that of a project pursued by a publicly held corporation?
How do embedded real options affect the values of investment opportunities?Why, when assessing investment alternatives, is it important to consider the embedded real options?
What are three important differences between real options and financial options?
Describe an investment opportunity that includes at least one real option.On what does the value of the option depend?
Explain how you would construct a decision tree that includes the real option(s) and uncertainty. How would you use the tree to decide on a course of action?
How are game trees different from decision trees? For what kinds of decisions would you want to use game trees instead of decision trees?
How is the business plan related to strategic planning?
What value did Merck see in using simulation in its R&D process?
What are some ways that simulation can foster better decision making for new ventures? In each case, explain how simulation could be beneficial.
What are the steps involved in using simulation to evaluate a strategy?Explain each using a specific example of your own or use the DCF illustrationin Section 6.4 to identify the steps and explain
What potential problems do you see with using normal distributions to project revenues or stock prices in simulation modeling? What are some ways of addressing these problems?
If you were trying to simulate the value of a call option, why would you first simulate the value of the underlying stock rather than simulating the option risk directly?
Give some examples from new venture development that fit the distributions depicted in Figure 6.5 (e.g., arrival probabilities on a website could be modeled as a binomial distribution). Frequency 100
Describe how you could use simulation to evaluate an expansion option.How could you determine the value of the option?
Describe how you could use simulation to evaluate an abandonment option.How could you determine the value of the option?
If you simulate distributions of NPVs for two different strategies, why would it usually be inappropriate to compare the distributions and choose the one that is less risky?
When evaluating risk, why is it better to simulate the distribution of possible NPVs rather than taking the expected value of each risky factor and calculating the expected NPV based on the expected
In what ways can forecasting help entrepreneurs?
Why is forecasting revenue the logical starting point for preparing a new venture’s financial statements?
What factors are important in establishing the appropriate forecast period and forecasting interval?
How can naïve forecasting methods be used to develop a revenue forecast for an existing business where management believes that more recent historical years are more predictive of future performance?
What are some of the considerations when deciding whether to forecast in real or nominal terms?
What are the strengths and shortcomings of sensitivity analysis and of scenario analysis?
Why is simulation particularly suited to forecasting revenue of new ventures?
What techniques are available to introduce uncertainty into a revenue forecast? Describe the pros and cons of each approach.
How might you use publicly available information to calibrate an assumption about the development time needed to build a drone delivery service?
What can you learn from a prospectus? Are the data in an IPO prospectus relevant to a new venture just getting off the ground?
What information does each of the three main financial statements convey about the venture’s operations? Describe three important links across the statements.
Describe how to generate spontaneous financing by managing A/R and A/P.
Explain the cash flow cycle in Figure 8.1. 1 3 Pricing Policy Price/unit Quantity per day 100 Revenue Credit day Policy Accounts receivable $1,000 Days 45 $45,000 FIGURE 8.1 Working capital policy
What are the main components of a venture’s working capital policy?How does each impact the firm’s operations and cash flows? How much control does a new venture have over its working capital
Describe several common sources of industry and firm data that can be used as bases for developing forecast assumptions.
Under what conditions is the yardstick approach to preparing pro forma financials likely to produce accurate statements? When is fundamental analysis a preferable method?
Describe three different approaches to making the balance sheet balance when building an integrated financial model using spreadsheets.
Explain the concept of depreciation as a “noncash” expense. Does this mean it has no impact at all on a venture’s cash flows?
What can cause the retained earnings account to change from one period to the next?
What is the accounting impact of negative shareholders’ equity? How can a venture with negative book equity continue to operate and attract capital?
Describe the main factors that determine a venture’s sustainable growth rate. What are the key assumptions in the sustainable growth model?
List four ways in which managers can increase a venture’s sustainable growth rate. Which do you think is easiest to implement? Which is most difficult?
Explain how a venture’s sustainable growth rate is related to its financing needs.
What is the difference between accounting breakeven and cash flow breakeven analysis? Which is more important for a new venture and why?
Explain the difference between marginal and average contribution margins.Why is it important to distinguish between them when making operational decisions?
Why is it important for an entrepreneur to plan for unexpected productmarket success? What are the potential consequences of failing to do so?
How might you determine the number of scenarios needed to analyze a new venture’s uncertainty? Explain how you might estimate reasonable probabilities for each scenario.
What benefits does simulation bring to the analysis of venture uncertainty?
Explain how simulation and staging can be combined to estimate an optimal level of initial funding for a new venture.
Describe how you might use simulation with different assumptions about the amount of initial financing to help determine the investment that would help assure that good outcomes are not missed but
How might you respond to an entrepreneur who says, “There is so much risk and uncertainty associated with new ventures that forecasting future revenue and cash flows is a waste of time”?
Describe the recent performance of VC funds. Do the empirical results fit with your prior expectations? If not, how can you explain the discrepancy?
Explain the theoretical basis for discounted cash flow valuation. What are the key inputs required for DCF analysis?
Explain the intuition behind the Capital Asset Pricing Model. Is the CAPM a reasonable tool for estimating the required return for an investor?For an entrepreneur? Why or why not?
Why is it important to match the cash flows and discount rate when using DCF valuation?
What are the main differences between the RADR and CEQ approaches to DCF valuation? Why is the CEQ approach often preferable when valuing new ventures?
Explain the intuition behind each of the following valuation techniques:(a) relative valuation (b) the VC Method (c) the First Chicago Method.Describe the strengths and weaknesses of each approach
How would you reconcile the following? (a) VCs often use very high hurdle rates when valuing potential new investments. (b) The historical average return for a large sample of VC funds is around 14%.
Why should an entrepreneur’s cost of capital for valuing an opportunity depend on the fraction of the entrepreneur’s wealth that must be invested in the venture?
How is the benefit of diversifying related to the correlation of returns or cash flows between different assets in the portfolio?
What are some of the key criteria for choosing a valuation method?
Explain the theory behind continuing value. What are the important factors to consider when calculating continuing value?
What are some of the ways to estimate the beta for a new venture? Describe some of the challenges to developing an accurate estimate. How does financial leverage impact your beta estimate?
Is the dividend discount model a good shortcut for estimating the cost of equity for a new venture? Why or why not?

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