Case 7. Financial Tools for Promoting Start-ups

Although business and government regard start-up businesses as vitally important in the future,

the number of start-ups in Japan especially for those based on technology are still limited in

number. The low ratio of start-ups is associated with the low risk-taking behavior of Japanese

people. There are various and abundant initiatives such as "small business innovation research

(SBIR)" grant, and other incentives, available. Still people familiar with start-ups claim that the

real problem is the risk of cash flow of commercialization, ie. Risk of profitability of project in

terms of cost and sales. In response, certain tools for stimulating start-ups should be installed in

society.

Assume that there are start-up projects which have 90 percent of failure with zero profit, and

10 percent chance of success to achieve 100 Million USD profit. Analyze the following questions.

1. What is expected profit and variance for Million USD as unit?

2. A representative entrepreneur has risk attitude as shown in the utility function U(I)=I where I

is project profit, and U is utility of an entrepreneur. Based on "Expected Utility Theory", what is

his risk attitude: risk averse, neutral, lover ?

3. Design a tool like "insurance" where individual entrepreneurs pay a premium for the risk of zero

profit. With the utility function of U(I)=I, can you design such an insurance?

4. Design another financial tool such as stock issue or bank lending for this project. Discuss the

pros and cons of the financial tools including stock issue and insurance.