Entrepreneurial Finance, 1st Edition

by Richard L. Smith (Claremont Graduate Univ.); Janet Kiholm Smith (Claremont McKenna College)

• ISBN13: 9780471322870
• ISBN10: 0471322873
• Format: Hardcover
• Copyright: 2000-01-01
• Publisher: Wiley

Summary

Let Financial Economic Foundations Guide You in Your Decision Making! Providing unique insight, this is the first text to apply current financial economics research and theory to the study of entrepreneurship and new venture finance. This approach will help you use financial economic foundations as a framework to guide you in your decision-making process. You'll learn to think of new ventures as portfolios of real options, value financial claims of the entrepreneur and venture capital investors, and structure financial contracts in light of new venture information problems. And with the help of real-world examples, you'll gain a better understanding of the broad range of situations and problems that you'll likely face as an entrepreneur. Key Features * The importance of strategy in new venture planning is stressed to help you develop a successful business plan for a new venture. * A valuation perspective is used to describe topics such as strategic planning, business planning, financial modeling, assessing financing needs, raising outside financing, structuring financial contracts with investors, and harvesting. * Relevant examples are integrated throughout the text to provide a real-world perspective. Also discussed is the fact that entrepreneurs and outside investors have different expectations for performance of a venture, and different requirements for a return on investment. * Spreadsheet modeling and simulations using custom software are used to enhance learning. Get Interactive! The book's Web site contains valuable resources including: * PowerPoint presentations * Active Excel spreadsheets * Venture.SIM-a simulation software program * Tutorials on how to use the software * Extensive links to other sites and much more!

Author Biography

<b>Richard Smith</b> is Professor of Financial Management at the Peter F. Drucker Graduate School of Management, Claremont Graduate University, where he teaches courses on new venture finance, and corporate financial policy and strategy. He is also Director of the Venture Finance Institute at Claremont. Professor Smith has served on several boards that are responsible for investing on behalf of pension funds and university endorsements, and has consulted extensively on matters involving investment, valuation, financial contracting, securities litigation, and antitrust. <p> <b>Janet Kiholm Smith</b> is Professor of Economics and Chair of the Department of Economics at Claremont McKenna College, where she teaches courses on the economics of strategy and industrial organization. She currently serves on the College's investment committee and consults on matters related to working capital management, the economics of contracts, and antitrust. She is the author of numerous journals articles, including publications in Journal <i>of Legal Studies, Journal of Finance, Journal of Corporate Finance, Journal of Law and Economics,</i> and <i>Journal of Law, Economics and Organization</i>.

Table of Contents

PART I GETTING STARTED
Introduction	1	(21)
The Entrepreneur	2	(2)
Finance and the Entrepreneur	4	(1)
The Finance Paradigm	5	(1)
What Makes Entrepreneurial Finance Different from Corporate Finance?	5	(7)
Why Study Entrepreneurial Finance?	12	(1)
The Objective: Maximum Value for the Entrepreneur	13	(1)
The Process of New Venture Formation	13	(2)
Organization of the Book	15	(2)
Summary	17	(5)
An Overview of New Venture Financing	22	(33)
The Rocket Analogy	23	(1)
Choosing the Organizational Form	24	(3)
Information Problems Facing the Entrepreneur and Investors	27	(1)
Measuring Progress with Milestones	28	(2)
Stages of New Venture Development	30	(2)
Sequence of New Venture Financing	32	(2)
Sources of New Venture Financing	34	(12)
The Deal	46	(3)
Summary	49	(6)
PART 2 FINANCIAL ASPECTS OF STRATEGIC AND BUSINESS PLANNING
The Business Plan	55	(25)
Why Business Plans of New Ventures are Different	56	(3)
Make the Plan Fit the Purpose	59	(1)
Is Too Much Attention Devoted to the Business Plan?	59	(1)
Plan First---Write Second	60	(1)
Strategic Planning and the Business Plan	61	(1)
What to Include	62	(6)
Confidentiality	68	(1)
Financial Aspects of the Business Plan	69	(3)
Targeting the Investors	72	(1)
Due Diligence	72	(1)
Updating the Business Plan	73	(1)
Summary	73	(7)
Outline for a Business Plan	78	(2)
New Venture Strategy	80	(34)
Henry Ford and the Model T	81	(2)
What Makes a Plan or Decision Strategic?	83	(1)
Financial Strategy	84	(1)
Product-Market, Financial, and Organizational Strategy	84	(3)
Deciding on the Objective	87	(1)
Identifying the Alternatives	88	(1)
Recognizing Real Options	89	(4)
Strategic Decision Analysis and Decision Trees	93	(6)
Rival Reactions and Game Trees	99	(4)
Summary	103	(11)
An Introduction to Options	109	(5)
Developing Business Strategy Using Simulation	114	(30)
Simulation---An Illustration	117	(1)
Simulating the Value of an Option	118	(2)
Using Simulation to Evaluate a Strategy	120	(19)
Comparing Strategic Choices with Simulation	128	(11)
Summary	139	(5)
PART 3 FINANCIAL FORECASTING
Methods of Financial Forecasting	144	(47)
The Case Flow Cycle	145	(2)
Critical Determinants of Financial Needs	147	(4)
Working Capital, Growth, and Financial Needs	151	(4)
Pro Forma Analysis	155	(3)
Forecasting Sales	158	(9)
Estimating of Uncertainty	167	(2)
Forecasting Income Statement and Balance Sheet Information	169	(3)
Information Sources	172	(1)
Building a Financial Model: An Illustration	173	(7)
Summary	180	(11)
Using the Pro Forma Spreadsheet	186	(3)
Sources of Information for Forecasting	189	(2)
Assessing Financial Needs	191	(36)
Sustainable Growth as a Starting Point	194	(4)
Assessing Financial Needs When Growth is not Sustainable	198	(1)
Planning for product-Market Uncertainty	199	(2)
Cash Flow Breakeven Analysis	201	(6)
Assessing Financial Need with Scenario Analysis	207	(3)
Simulation of Financing Requirements: An Illustration	210	(5)
How Much Money Do You Need?	215	(5)
Assessing Financial Needs with Staged Investment	220	(1)
Summary	221	(6)
PART 4 VALUATION
The Framework of New Venture Valuation	227	(44)
Perspectives on Valuation of New Ventures	228	(2)
Myths about New Venture Valuation	230	(4)
An Overview of Valuation Methods	234	(1)
Valuation by the Risk-Adjusted Discount Rate Method	235	(11)
Valuation by the Certainty Equivalent Method	246	(3)
Limitations of the Capital Asset Pricing Model	249	(1)
Reconciliation with the Pricing of Options	250	(1)
Required Rates of Return for Investing in New Ventures	251	(1)
Summary	252	(19)
Mathematics of Time Value	260	(5)
Statistical Review	265	(6)
Valuation in Practice: The Investor's Perspective	271	(43)
Criteria for Selecting a New Venture Valuation Model	272	(1)
Using the Continuing Value Concept	273	(8)
New Venture Valuation Methods	281	(17)
Valuing the Investment	298	(8)
Summary	306	(8)
Valuation: The Entrepreneur's Perspective	314	(51)
The Entrepreneur as an Underdiversified Investor	316	(2)
Required Rates of Return for Full-Commitment Investments	318	(5)
Limitations of the Opportunity Cost Framework	323	(5)
Valuing Full-Commitment Investments	328	(1)
Implementation---Full Commitment	329	(6)
Required Rates of Return for Partial Commitment Investments	335	(5)
Implementation---Partial Commitment	340	(6)
Estimating the Entrepreneur's Wealth and Investment	346	(2)
How Undiversified Are Entrepreneurs?	348	(2)
Benefits of Diversification	350	(3)
A Sanity Check---The Art and Science of Good Investment Decisions	353	(3)
Using and Misusing Simulation in Valuation	356	(1)
Treatment of Sunk Costs in the Valuation	356	(1)
Summary	357	(8)
PART 5 ORGANIZATIONAL DESIGN AND FINANCIAL CONTRACTING
Financial Contracting with Symmetric Information	365	(31)
Some Preliminaries	366	(1)
Proportional Sharing of Risk and Return	367	(3)
Nonproportional Sharing of Risk and Return	370	(5)
Contract Choices that Allocate Expected Returns	375	(8)
Contract Choices that Alter Venture Returns	383	(4)
Implementation and Negotiation	387	(3)
Summary	390	(6)
Dealing with Information and Incentive Problems	396	(43)
Information Problems, Incentive Problems, and Financial Contracts	397	(15)
Contract Design	412	(11)
Organizational Choice	423	(6)
Summary	429	(10)
Financial Contracting	439	(56)
Staging of Investment: The Venture Capital Method	440	(6)
Single-Stage Investment---CAPM Valuation with Discrete Scenarios	446	(6)
Staging of Investment	452	(13)
Using Contracts to Signal Beliefs and Align Incentives	465	(1)
Using Simulation to Design Financial Contracts	466	(11)
Information, Incentives, and Contract Choice	477	(7)
Summary	484	(11)
Evaluating Alternative Financial Contracts	489	(6)
PART 6 FINANCING AND HARVESTING CHOICES
Venture Capital	495	(34)
An Overview of the Venture Capital Market	496	(3)
The Organization of Venture Capital Firms	499	(8)
How Venture Capitalists Add Value	507	(6)
Investment Selection and Venture Capitalist Compensation	513	(1)
Venture Capital Contracts with Portfolio Companies	513	(3)
Venture Capital Contracts with Investors	516	(2)
The Role of Reputation in the Venture Capital Market	518	(1)
Summary	519	(10)
Choice of Financing	529	(37)
Financing Alternatives	530	(1)
Start with the Objective and Basic Principles of the Financing Decision	531	(1)
First Step: Assess the Nature of the Venture's Financial Needs	532	(10)
Second Step: Assess the Current Condition of the Venture	542	(4)
Third Step: Assess the Relation between Financing Choice and Organizational Structure	546	(2)
How Financial Distress Affects Financing Choices	548	(4)
How Reputations and Relationships Affect Financing Choices	552	(1)
Total Availability of Financing for Small Businesses and New Ventures	553	(3)
Avoiding Missteps	556	(1)
Summary	557	(9)
Harvesting	566	(35)
Going Public	567	(11)
Acquisition	578	(5)
Management Buy-out	583	(1)
Employee Stock Ownership Plans of Private and Family Businesses	584	(3)
Roll-up IPO	587	(2)
The Harvesting Decision	589	(2)
Summary	591	(10)
PART 7 CONCLUSION
The Future of Entrepreneurial Finance: A Global Perspective	601	(32)
Completing the Circle	602	(5)
Breaking New Ground	607	(3)
An International Comparison of Entrepreneurial Activity	610	(13)
The Future of Entrepreneurial Finance	623	(10)
Index	633