Entrepreneurship - Previous Exam Answers

You have started a new venture and have to make strategic decisions. Identify the three most important interdependent components of your strategy and indicate under what circumstances your financing needs would increase. (5 p)

(Interrelated choice matrix) The figure above shows the interconnected nature between financial strategy, product market strategy and the organizational strategy. Where the financial strategy deals with how to finance and partner with others, outside verses entrepreneur and debt versus equity. The organizational strategy is the vertical and horizontal boundaries, the scale and scope of the venture. The product market strategy refers to the product and its price, margin, quality and differentiation. Your finance needs would increase if for example: You want to have rapid growth with an integrated entry (Manufacturing and distribution) would have to increase the financial needs meaning external capital and thus might lose stakes in the company and also control, and also sharing the return with other investors. So financial needs would increase when I want to have a larger scale and also faster growth. As stated earlier this comes with other effects such as sharing the return with the investors that makes it possible for me to grow faster.

Which are the four valuation methods for new ventures?

- Discounted Cash flow method (DCF) - Relative value method (RV) - Venture Capital method (VC) (Metod 1 & 2) - First Chicago Method

The most important concept in contemporary entrepreneurship research is Entrepreneurial orientation. Describe the three dimensions of entrepreneurial orientation as presented in Rausch et al. (2009). (3 p)

- Innovativeness (emphasis on research and development, introduction of new products and changes to current products) - Proactiveness (imitativeness towards competities and introducing new products and overall position) - Risk-taking (willingness to take risk, dealing with uncertainty and exploring potential opportunities)

What makes entrepreneurial financing different from corporate financing?

-​ ​Interdependence between Investment and Financing Decision -​ ​Diversifiable Risk and Investment Value -​ ​Managerial Involvement of Investors -​ ​Information Problems and Contract Design -​ ​Incentive Alignment and Contract Design -​ ​The Importance of Real Options -​ ​Harvesting the Investment -​ ​Value to the Entrepreneur Investment decisions are treated as independent in Corporate finance. When deciding on what project to invest in you compare the return on the investment to the market interest rate for projects that bares the same risk. This decision does not involve how ownership of the assets will be financed or how the shareholders will be paid. This inter-dependency are usually easy NPV calculations, while for start-up business the entrepreneurs have different believes of the value than well-diversified investors. In corporate finance the risk factor is applied by a discount rate on the expected future cash-flows. This discount-rate is only depended on non-diversifiable risk. Entrepreneurs on the other hand usually invest their financial wealth and human capital into the venture and cannot diversify the risk resulting in a other project value for the entrepreneurs Corporate finance investments do not contribute with managerial services while investments in new start-ups, angels, venture capitalists provide more than just capital. There can arise differences in value between the entrepreneur and the investors because of the magnitude and importance of asymmetric information.

In what way is entrepreneurial finance different from corporate finance? Mention at least four differences. (2 p)

1. In entrepreneurial finance the financing decision and investment division is more connected and complex compared to corporate finance where it can often be seen as two separate decisions. 2. The under diversification of the entrepreneur compared to the investor plays an important role when valuing a venture. 3. Real options are of high importance when evaluating a venture in entrepreneurial finance 4. The contract and deal structure is more complex in entrepreneurial finance because of insecurities in incentives and interest due to information asymmetry 5. In entrepreneurial finance the harvest possibilities are important to the investor while in corporate finance the cash flows and profitability is more important to the investor 6. The goal in entrepreneurial finance is to maximize value to the entrepreneur while in corporate finance it is to maximize value to shareholders

Mention five categories of real options

1. Option to wait 2. Option to learn 3. Option to expand or contract 4. Option to switch inputs or outputs 5. Option to abandon

Historically the IPO is the exit form that has generated the highest return for an investor. An IPO is a relatively structured process with a number of important steps. Describe the IPO process from start to finish. (3p)

1. Selecting underwriter: Investment Bank 2. Due diligence, financial DD, commercial DD and technical DD 3. Pricing - through relative valuation, DCF, comparables, multiples etc. 4. Double check with the VC and market, more due diligence if necessary 5. Apply for necessary legal papers - legal due diligence 6. Registration at stock exchange 7. Go public 7a.Primary market, limited number of investors 7b. Secondary market, public

Professor Björn Berggren gave a lecture on market analysis, distributions channels and business models. Evaluate your value proposition by mentioning five factors that are important. (5 p)

1. What product or service is your company selling? 2. What is the end-benefit of using it? 3. Who is your target customer for this product or service? 4. What makes your offering unique and different? 5. Willingness to pay for the product or service?

Characteristics of venture capital and business angels' investments and their differences:

5 differences: -​ ​Source of money -​ ​Stages of development -​ ​Analysis ex ante investment -​ ​Diversification -​ ​Investment timeline The first distinct difference between VC and BA are where the money comes from. V​ enture capital​ investment with other people and institutions money so called Limited Partners (LP) which stands for approximately 99% of the capital and the VC own money of around 1%, also called the General Partner (GP) Limited partners under. -​ ​Pension funds -​ ​Life insurance Companies -​ ​Endowments -​ ​Corporations -​ ​Individuals The Business Angels​ (BA) investments come from individuals' own money. They invest the money in ventures they believe in. This can be former successful entrepreneurs themselves, or rich heirs for example.The stages of development and when they invest are a bit similar. BA and VC tend to enter ventures in a relatively early face. The VC investments are often a bit later than the BA. Regarding the ​analysis ex ante of the investments​ there is a clearer difference between the two. B​usiness Angels​ do not analyze the ex-ante investment so deep in the beginning, they follow their "gut feeling", so if there is an idea, they believe in their GO. Later on, after the investment they help and try to shape the venture in a way that they believe will suit the company. ​VC investments​ on the other hand have usually better organizational structure and more finance that can be put into analysis. In the same way, they do not invest their own money which makes it even more important to be better informed/prepared. They do not want to lose others' money. Business angels and VC firms are also different in size and scale of investments (Diversification).​ VC firms tend to have more investments planned and on-going at the same time. VC larger portfolios of companies can be managed since their organization is larger. Business angels work alone or sometimes together with others but do not make investments in the same number of scales, meaning they might invest in some ventures and focus on them. BA cannot manage too many investments at the same time and also hope for success, then it's better to focus on a couple of investments. This means that VCs can be more diversified​ in their investments. VCs funds have a determined Lifecyle, for example 7 - 10 years. After that the money should be harvested and returned to their investors. This does not have to be the case with Business Angels who might want to stay in the company for longer or short time spans depending on how well the company goes. Meaning that BA do not always set investments horizons (time to exit) Venture Capital:​ ​Are specialized "financial institution" with a well-organized structure. They target special niches and market segments with high-risk ventures that they believe will have rapid and significant growth. The investments do generally not give the VC majority control.

Governments in most Western economies have used different strategies to promote the financing of entrepreneurship and SMEs. One particular type of vehicle is the partial credit guarantee. Describe how a partial credit guarantee works and why it has become so popular, according to Cowling (2010). (4 p) (​3 av 4 poäng)

A partial credit guarantee (PCG) is when a financial institution party guarantees a bank loan for an SME/Start-up who wouldn't have the opportunity to qualify for a bank loan otherwise. The loans have a higher interest rate than normally and are also associated with a fee to the financial institution but are still popular as they increase the possibility for a risker/innovative venture to find funding, hence it can be a positive initiative for increased entrepreneurship

Professor Magnus Henrekson discusses and measures entrepreneurial developments across regions. He finds that Europe suffers from an "entrepreneurial deficit" compared to the United States. In what way is Europe underperforming according to him? (3 p)

According to Magnus Henreksen Europe is lacking "Schumpeterian entrepreneurship" compared to the US. By this he refers to the lack of innovative entrepreneurship in Europe. We have a lot of SMEs in Europe but mostly replicative entrepreneurs with a lack of innovation and willing to expand. Henrekson also finds it important to differ replicative and "self employed" entrepreneurs from innovative and schumpeterian entrepreneurs when measuring entrepreneurship.

Alternatives for IPO and when they are better

Acquisitions: Synergies can arise if another company buys the venture MBO: Management and VC has a dispute and the venture is relatively successful but may not be ready for an IPO ESOP: For smaller ventures when long-term incentives and employee performance should be tied. Possible for employees to get better compensated in the longer term and for the venture to receive smaller periodic cash infusion.

Venture capital is extremely important for the financing of entrepreneurial ventures. At the same time the venture capital industry has gone through drastic changes since the high tide of the dot.com era. Analyze the development of the venture capital industry since the turn of the millenium and the reasons for the changes, as put forward by for instance Söderholm (2012). (5 p) Endast 3 p

After the dot-come crash in the 2000s the venture capital industry experienced a change of landscape. Fewer investments were made in earlier phases and there was a renewed focus in cash flow due to the instability in the market. According to Söderholms research, there was a rapid decrease in the total number of VC funds in the swedish market decreased with a 65% and a large number of small funds were stead replaced by a fewer large funds.

Fear of failure

An irrational fear that holds back an individual from starting out

Governments in most Western economies have used different strategies to promote the financing of entrepreneurship and SMEs. Why do most governments perceive that entrepreneurship and SMEs are important for the economy?

Around 90 % of the business in Western economies are SMEs. They also account for a large amount of employment and generate tax income to the government. innovation is important for the Western economies since many of them are innovation-driven. Entrepreneurship contributes to innovation and the creation of new companies. This doesn't just mean more money to the government but also helps the society to develop. Research shows that it is easier to start and develop your business in developer countries than non-development countries. Entrepreneurship can also be used as a total to take people from poverty. therefore need to be supplied and provided by governments.

Bootstrapping

At an early stage, the entrepreneur looks for ways to finance the venture from personal savings and from borrowing where repayment do not depend on success. Bootstrap techniques include, for example, drawing down savings accounts, taking out second mortgages, using the credit lines of multiple credit cards, and borrowing on life insurance policies. In a sense, bootstrapping is not a form of new venture financing. Rather, the entrepreneur is financing the venture from personal resources

Whether a government should intervene on the market in order to, for instance, increase the supply of capital to SMEs has been debated for a long time. Give two benefits and two drawbacks with governmental intervention regarding the financing of entrepreneurial ventures? ​

Benefits: - Relatively cheap financing - Easy to get access to Drawbacks: - Tend to underperform - Lack of control. They just give money without following up or monitoring - Misuses

Over time, different ways of financing entrepreneurial ventures have evolved as responses to changing conditions on the market as well as innovations. One such form of financing or strategy has been called financial bootstrapping. explain what financial bootstrapping is and give a number of concrete examples of this financial solution.

Bootstrapping refers to the method of raising capital when you financial needs without raising the traditional financing such as debt or equity. - Factoring: Selling account receivable to a third part - Buying used equipment machinery - "Hiring" friends and family - "cheap labor" - Work with other business - Battering Alternative answers:​ ​At an early stage, the entrepreneur looks for ways to finance the venture from personal savings and from borrowing where repayment does not depend on success. Bootstrap techniques include, for example, drawing down savings accounts, taking out second mortgages, using the credit lines of multiple credit cards, and borrowing on life insurance policies. In a sense, bootstrapping is not a form of new venture financing. Rather, the entrepreneur is financing the venture from personal resources. ​Bootstrapping normally cannot be a source of permanent financing. Credit card loans carry high interest rates and eventually must be repaid​. ​The entrepreneur's resources include not only personal savings and assets but also debt capacity.

Informal venture capital, also known as business angels, are also an important source of finance for startups. Describe the key characteristics of business angels and the pros and cons of being a part of a business angel network. (5 p) Endast 4,5 poäng

Business angels are commonly experienced entrepreneurs, interested in supporting their local entrepreneurs. BAs typically operate within an industry and geographical market which they know well, and invest their own money in ventures they believe in and continue both capital and well-needed advice and competence as they become active investors in early stages. A BA network is positive as it can complete competence as well as own production and development, as well as improved credibility, however in networks unwritten norms many apply, making it difficult to innovate and expand hower in the early phase of a ventures development, a wider network of contracts with advice and competence is very well appreciated.

Informal venture capital, also known as business angels, is an important source of finance for startups. Describe the key characteristics of business angels and the pros and cons of being financed by a business angel.

Business angels are high net worth individuals, often experienced in the field they invest in. They invest their own money in early stage of a start-up. The have no predetermined time horizon and contribute to the growth of the company by their experience and network, in other words, an active investor. The con could be that the BA wants to be active in the management, sit in the board for instance, which leads to less control of the business. The pros is of course the experience and network that the BA contributes with. BA often invest in a small number of ventures, enough to handle and manage actively. They often have genuine interest in the field and supports the entrepreneur.

In the litterature a distinction is often made between craftsmen entrepreneurs and opportunistic entrepreneurs. Describe the major differences between these two types of entrepreneurs.

Craftsmen entrepreneurs are an entrepreneur with focus on developing already existing business ideas. When an economy is growing, it creates a need for goods and service, such as restaurants, grocery stores, cleaning services ets. craftsmen entrepreneurs fill that gap in the economy. - market is limited to geographic area and is driven by relationships with customers - no desire to "go global" Opportunistic entrepreneurs are also called innovative entrepreneurs who focus on creative new markets through new ideas. - Their products and/or services create relationships with the customers - Not limited to a specific geographic area and therefore have (often) a global market

Yet another form of financing is crowdfunding. Explain what crowd funding is and describe the different sorts of crowdfunding that are available on the market and how they work in practice, using examples.

Crowdfunding is a way of financing business or individual project with funds raised from a large number of people (crowd), mostly through internet-based platforms such "kickstarter, Tessin and indiegogo. Equity based crowdfunding:​ As crowdfunder you will recieve a share of a company (private) or a project and gain return (capital gain) after a period of time.​ For example: Tessin, a real estate crowdfunding platform in Sweden, by investing in real estate project, your money will be locked under a period of time, Tessin then promises a return for your money of 5-10% in exchange. Debt/loan based crowdfunding​: (Peer to peer lending) Mostly for companies that have difficulties to get funding from banks and other lending institutions. This method works like a regular loan where you pay interest to the lender. The main difference is that you will have many lenders (bankers) ​For example​ Toborrow; a swedish loan-based crowdfunding platform Grant-based crowdfunding: ​(Donation based) Most for smaller project and non-profit business. Backers donate money to projects that suit their causes. In return they might receive some perks. ​Example​: Kickstarter, one of the biggest platforms in the world. Music project, by backing this kind of projects you may help a younger musician to realise his dreams. In return you may get his album of CD (With a single)

Explain crowd funding and the pros and cons from the entrepreneur's point of view of being financed in this way.

Crowdfunding is when a group of people invest in a venture/project together, often a large number of smaller investments and usually through a digital platform. There are equity-based which means that the investors become shareholders in the company and there are loan based where investors get paid interest and amortization. Pros are that it could be easier to get finance through crowdfunding than through banks, it could also be a cheaper alternative. Another pro is that investors usually don't get managerial involvement. However, the venture loose the network and experience that business angels usually contribute with.

The starting point for any financial forecast for your startup is an estimate of revenue. Describe the two main forecasting analyses that you would use, and also what three techniques you would use (and how) to reflect uncertainty in your analysis.

Developing a revenue forecast for a venture with no track record is difficult, and the result is likely to be uncertain. Two common approaches are (1) yardstick and (2) fundamental analysis. (1)​ A​ n approach that is useful for some new ventures is to identify reasonable yardstick companies for which public data are available. A yardstick is an established firm that is comparable to the venture on some dimensions that are important to forecasting. They don't necessarily need to produce same product or be identical in business model, instead comparability can be based on factors such as expected market for the product, distribution channel, adoptions rate, uniqueness of the product, or manufacturing technology. Data availability is one advantage of this method since hundreds of small companies go public every year. Sometimes IPO prospectus contain historical numbers. When you have found comparables you could investigate the numbers, revenues per store etc, you could observe the stores to see how many customers visit and what they order in order to get your own estimate. Of course, depending on your business it could be harder to forecast. Then fundamental analysis could be a better method. (2)​ F​undamental analysis is an alternative to reliance on yardsticks. Approaches to fundamental analysis can vary. For a venture such as a coffee shop that is similar to others already in operation, the fundamental approach might be mainly empirical, such as observing the traffic at other coffee shops, analyzing their product offerings and pricing, and talking to customers. For an innovative undertaking like the navigation venture, the analysis is more conceptual, such as starting with an estimate of the size of the relevant market. Sales estimates for a venture can be generated from either the demand side or the supply side. The demand-side approach assesses consumer willingness and ability to buy the product, assuming that the venture has adequate capacity to supply all that is demanded. The approach begins with an estimate of the venture's market share that depends on such demand-related factors as number of competitors, pricing, location, and intensity of marketing efforts. In contrast, the supply-side approach seeks to determine how fast the venture can grow given managerial, financial, and other resource constraints. Possible supply-side constraints include limits on access to raw materials, financing, and technology; there also may be constraints on the ability to hire and train employees. In other words, even if demand increases rapidly, the venture's growth rate may be limited on the supply side. Combining the supply- and demand-side approaches, the venture's expected rate of growth is whichever is lower. Slow-growth scenarios normally are constrained by the limits of market demand, whereas rapid-growth scenarios normally are constrained by the organization's ability to manage growth. One advantage of the yardstick approach is that it uses the actual experiences of other firms and therefore implicitly considers both supply- and demand-side factors. In sensitivity analysis, we vary the assumptions of the model and observe the impact on our forecast. Used effectively, this can clarify which parameters are most important in the forecast. Once we identify the critical input parameters, we need to develop reasonable descriptions of their uncertainty. Some of the limitations of sensitivity analysis can be overcome by considering specific scenarios. Scenarios allow several assumptions to be evaluated simultaneously and can incorporate correlations between variables. Simulation is the final technique we consider for incorporating uncertainty into a revenue forecast. We first identify the assumptions behind the forecast. Then we assign a probability distribution to each key assumption and estimate correlations among the variables. These assumptions can be developed using historical data, evidence drawn from other companies, and/or fundamental evaluation of the market and potential demand for the product.

As mentioned above, venture capital is of importance in financing innovations, therefore support to the venture capital industry has been at the forefront of governmental interventions. In Gallagher & Smith (2015) three approaches that have been put into practice are analyzed. Describe and analyze these three approaches and the lessons learned from them. (3 p)

Direct, indirect and timed approach. The direct approach:​ Addresses the financial gap directly by governmental investments in ventures via either governmental or governmental-supported VC funds The indirect approach​: Aims at creating a favourable and supportive environment where venture capital can flourish. The timed approach​: Involves organization and development of the VC market and new VC institutions. Is performed by using both direct and indirect market.

Three methods for valuations are "The discounted cash flow model", "The venture captital method" and "The relative value method". Explain the pros and cons of using these three models when valuing a startup. (6 p)

Discounted cash flow method: The value is computed by discounted future cash flows at a reasonable discount rate regarding risk and the time value of money. By far the most complex method, needing a lot of inputs and data but also provides the most accurate valuation when the input is good. The venture capital method: The traditional method used in venture capital investments computes firm value at the terminal date by using eg. P/E or other multiple, then discounting the value into PV with a hurdle rate to account for risk (often ranging 40-60% for seed and startup investments). The PV is then multiplied with the aimed ownership share to arrive at the amount of the investments. Pretty easy but not as accurate as DCF. The Relative value market: The RV method is commonly used in real estate valuation and involves collecting data from public companies and public and private transactions. A firm's value is derived from profitability, expected growth and risk and is computed by using multiples from the collected IPOs/M&A transactions. Not always very accurate for start-ups as they lack track records to base benchmarks on.

Describe relation contracting and discrete (or transactional) contracting. What are the differences between them? Pros and Cons?

Discrete contracting has a specific content and a specific duration. This works best for simple exchange when parties have similar expectations and performance are easy to measure. These contracts are often used when there is no uncertainty due to for example no asymmetric information. Relational contracts are used in opposite of discrete contracts when the parties may have different expectations and (example: enthusiastic entrepreneur en realistic VC). These contracts usually form when there is asymmetric information. These are more flexible and dependent on development.

Two types of contracting is relational contracting and discrete contracting. What is the difference between these two types of contracts? (2 p)

Discrete contracting is written strictly and formally, meaning that there are strict terms and conditions, whereas a relational contract is much more flexible and written with regards to changes due to pre-contract information asymmetries, like growth and development that may change the fundamental conditions.

In the GEM report yet another typology of entrepreneurs is presented. What are the three types of entrepreneurial economies that are presented in the GEM report and how are these economies different when it comes to growth, survivability, etc of startups.

Factor driven economies​: The majority of startups in the economie are located in the agriculture sector and the exploration of resources such as forest and fishing. The goal with start-ups businesses is to be able to bring food to the table and survive. These types of entrepreneurial economies can be found in Africa and Latin America Efficiency driven economies: ​These economies already have an established manufacturing industry. Entrepreneurship is driven by large corporations and some SMEs in development. The target in this type of entrepreneurial economies is to create efficiency, therefore most start-ups are somehow connected to the larger corporations. Brazil, Russia and South africa Innovation driven economies: ​Research and development knowledge extensive entrepreneurship. The goal in this entrepreneurial economy is to reach a high tech environment or society. For example Sweden, Israel, USA and Germany.

In the GEM report from 2016 three distinct types of economies are presented, based on what drives economic development. Describe the three types of economies with examples of each category and the key characteristics of the economies. (3 p)

Factor-driven economies​ - From subsistence agriculture to exploitation of natural resources. Often involves development countries where the target is basic conditions. Ex: Ghana, Egypt, Iran Efficiency-driven economies: ​Improved industrialization and focus on economies of scale. Large manufacturing companies dominate, but there is also an increase in SMEs target efficiency. Ex China, Brazil, South Africa, Russia Innovation-driven-economies: ​Research & development (R&D) focus within an increased service sector and a large probability of ground breaking actrivity through innovation. Target: Hightech research driven entrepreneurship example: Sweden, USA & Japan

Which method or methods would you prefer if you would like to exit as soon as possible, your venture is small-to-medium in size, and you would like to contain your costs of harvesting. Give arguments for your choice/s. (2 p)

I would go for an acquisition. First, an IPO would be too expensive considering the size of the business. While transaction costs are more related to the size and complexity of the company. Also if there are chances of synergies between the two companies the acquirer might value the target higher than everyone else would have done. There is also a benefit with being able to form the contract suitable for these specific acquisitions. I could choose to harvest all at the same time and not be forced to do it gradually as if i would harvest through an IPO or reverse merger.

The choice of exit is important for a number of reasons both for the entrepreneur and the investor, and could be done in different ways. Describe the three most common forms of exits with the most important pros and cons with each form. (6 p)

IPO ​- an initial public offering is an exit strategy occuring when the stock of a private company is offered to the public for the first time, by becoming listed on a stock exchange. An IPO is generally the exit that raises the most capital to the firm but is also very costly and associated with more scrutiny for the company. Trade sale ​- often considered as the second-best exit to IPOs. Involves the sale of the company's shares or assets and liabilities to another company, in whole or in part. Compared to an IPO, the price with a trade sale (hence the money raised) is generally lower as it is associated with an illiquidity discount. However, the transaction costs are much lower and the firm still has less scrutiny. LBD -​ a leveraged buyout is an acquisition of a company using a significant amount of debt (in other ways, like a highly-leveraged trade sale). The assets of the acquired company land of the acquired is used as collateral of course, high debt is associated with high risk, but LBOs also make it possible for firms to do large acquisitions without having to commit a lot of capital, as well as have the possibility to leverage when the firm is acquired by the existing management team (often also high amounts of debt), it is called an MBO.

You are an entrepreneur and have decided to harvest your investment. Discuss and evaluate four alternative methods of harvesting from the cost and benefit perspective (4 p).

IPO​: initial public offering - taking the company public with help from an underwriter. This is the option that raises the most capital and you get a "market valuation" of the firm. Although this option takes much time and is very costly with several fixed costs. Acquisition​: being acquired by another company. This option might create value if there are chances of synergies between the two companies. Also the transaction costs are not as high as costs for an IPO and are related to company size. Although this exit can still be very time consuming and costly depending on the size of the company. Reversed merger​: going public by being acquired by a public shell-company. This is a cheaper and quicker way of going public than an IPO. The con is that it does not raise any money to the company. MBO/LBO: management/leveraged buyout. This has some benefits since the management already knows the company, no due diligence is required which saves time. Although it requires a substantial amount of debt and therefore the company has to be successful and stable in order to finance the debt.

Why do you need to do forecasting of revenues when starting a new venture, and what methods can you use? (3 p)

In order to decide on financial needs and to calculate a value of a venture and forecast cash flows. It is also important to be able to show numbers during the pitch so that the investors can make their valuation. For example it is important to forecast if and when the venture is going to make profit. Methods for forecasting: 1. Yardstick - look into comparable firms and choose a multiple to estimate your own sales etc. 2. Fundamental analysis - deeper analysis of market revenues, costs, etc.

​IPO

Initial Public Offering refers to the first time that the stock of a private company is issued for sale for the public by listing the company on a stock exchange. Often performed by young, smaller companies aiming to raise capital for grants.

IRR

Internal Rate of Return is the yearly rate of return that a VC fund generates to its investors. IRR is one of the most important measures of a fund's performance

CEQ

Is a method in DCF valuation when instead of taking risk into account in the discount rate you take it into account in the cash flows and then you discount cash flows with the risk free rate only.

Adverse selection

Is a pre-contractual issue due to asymmetric information. It may cause the investor to make a bad decision due to a mislead from the entrepreneur who did not give the correct information.

Milestone

Is used as a measure of performance of the business. An example of a milestone can be a monthly sales goal or a number of subscribers to a server.

Pro-forma-analysis

I​ncludes an - I​ncome statement:​ In your income statement you have to figure out which cost that are fixed and which cost that are variable. You compute your expenses and your assumptions regarding incomes. The net income does not necessarily mean your actual cash flow from operations and financing. - Balance sheet: describes/depicts the ventures financial position at a certain point in time. The balance sheet is divided in to the left side which your assets owns and the right side how the assets you owns been financed (Through liabilities & equity) Your assets are the resources of your business. -​ ​Current assets​: C​ash, marketable securities, accounts receivable and inventories. -​ ​Fixed assets​:​ Plant, machinery, equipment and buildings, R&D expenses Your ​Liabilities​ are the obligations or the business -​ ​Long-term liabilities: B​onds, capital leases and long-term credits -​ ​Short-term liabilities: A​ccounts payable, wages and salaries, short-term lending, any portion of the long-term loans due in one year. - Equity: I​s the residual of the business (rest), such as common stock outstanding, additional paid-in capital and retained earnings Cash-flow statement: -​ ​Provides information about the cash receipts and cash payments in a given time for the business -​ ​It shows the cash effects of operating, investing and financing activities -​ ​Important for every business, but especially important for start-ups and growing firms. -​ ​The liquidity problem is often underestimated among managers These statements combined with an market-analysis will allow us to project cash-flows "Pro-forma" in order for us to estimate the company value.

Two major influencers when it comes to entrepreneurship is Joseph Schumpeter and Israel Kirzner. Describe their thoughts on what entrepreneurship is and how their views on entrepreneurship is similar and how they differ. (4 p)

Joseph Schumpeter describes entrepreneurship as creative destruction that moves markets from equilibrium. This means that the new venture needs to be innovative, new product, new service etc. - new markets - new products - new services Israel Kirzner - how can i better something → Alertness - entrepreneurs specialize in alertness and find new opportunities - Find a product and make it more appealing or an alternative product? - Entrepreneurial discovery - Entrepreneurship according to Kirzner: The job of correcting misallocations by specializing in the discovery of missed opportunities - Entrepreneur alertness to opportunities that already exist and are waiting to be noticed.

Joseph Schumpeter and Israel Kirzner both studied entrepreneurship, but had two different perspectives. What is the economic thought behind these two perspectives? (2 p)​

Joseph Schumpeter thought entrepreneurship was "creative destruction" meaning in order to innovate, the old market might be destroyed. His view on entrepreneurship was innovative, new market, new goods etc. According to him entrepreneurship moved the market away from the equilibrium. Israel Kirztner thought an entrepreneurship was entrepreneurial discovery meaning entrepreneurs' most valuable quality was alertness helping them find already existing but undeveloped markets. According to him entrepreneurship moved the market towards the equilibrium. Kirzner is about entrepreneurial discovery.

Describe Joseph Schumpeter and Israel Kirzner views on entrepreneurship and the primary contribution entrepreneurial ventures gives society:

Joseph Schumpeter​ views entrepreneurs where they actively seek opportunities to innovate. He believed that they are the driver of economic progress. He's way of seeing entrepreneurship was that it moves the market away from equilibrium, by combinations of new goods, methods of production, new markets, sources of supply and organization. They have an ability to see new ways of using already established businesses by for example replacing the human workforce with a machinery automatic cost effective and efficient more profit/higher margin. ​In short:​ The ability to see where something already established can be improved by something totally new. ​"Creative destruction" Israel Kirzner ​means that entrepreneurship moves the market towards equilibrium. The entrepreneur's alertness to opportunities that already exist and are waiting to be noticed. An example of this is Elon Musk that has targeted the already established car-market and made electric cars in a time where the environment is keen to many customers. He saw a new market for cars. "Entrepreneurial discovery"

Financing truly innovative firms might be problematic for a number of reasons. In Lee et al. (2015) some of these structural changes are highlighted. Describe and analyze some of the inherent, structural problems with financing of innovative firms. (3 p)

Like another start-up, innovative companies lack a track record which implies that an investment in the company is associated with high risk. In addition, innovative companies may be hard to benchmark as their market, competition etc may not be easily determined. Some innovations could also be difficult to understand as they may be very complex for someone who is not an expert in the area, for example for innovations within IT, software etc. Lookin at the statistics a large fraction of innovation start-ups do not survive, but the one who does can have an exponential growth and significant impact on the market. However, the statistics may not be very appealing for financiers with regard to the risk.

Explain and discuss what the three financial systems mean for entrepreneurs seeking finance in each system.

Market oriented - The U.S and U.K. are the most prominent examples of market-oriented systems. Its characteristics are a diverse financial market with many different types of actors. Investors have a strong position due to rules and regulations. The private sector plays an important role. They often have a high rate of innovation of new financial products which could facilitate the search for finance - crowdfunding, bonds, convertibles etc. Bank-oriented - Austria, Germany, Japan and Sweden are good examples of countries with bank-oriented economies. Banks play an important role in the financing of corporations. Financial-industrial networks have historically been widespread. Private investors are less important for financing of new ventures. Rules and regulations (civil law) have given creditors a strong position. State-oriented - China and most emerging markets could be considered state-oriented financial systems. The state controls (direct or indirect) banks and other financial institutions. Rules, regulations and norms prioritize the state on behalf of private corporations. After the financial crisis many governments are (part) owners of large financial institutions.

What Is Mezzanine Financing?

Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid. (From Investopedia)

Monitoring is a complement to contracting and could be done both indirect and direct, according to Smith et al. (2011). Describe how an investor or financier can monitor a startup. (2 p)

Monitoring is done to mitigate problems with moral hazard for example an investor can monitor a start up directly by being active in the operation or indirectly by stagnin investments to make sure their interests and incentives are aligned. Financiers such as banks commonly use covenants in debt agreements to make sure that the entrepreneur works hard to fulfill their obligations, or else the financier can withdraw their money. As VC investors and BAs are active investors with a hands on approach monitoring becomes easier hence decreasing the risk of moral hazard.

Syndication

Occurs when two or several VC-firms or business angels go together to finance a deal. This method is used to minimize risks but also create more deal flow.

Mention and explain five categories of real options, and describe how you would go about when using real options in your strategic planning.

Option to wait If it is possible to postpone an action, the decision maker has an option to wait. Decisions involve comparing the value of acting now with the expected value of waiting. The owner of a forest can cut the trees today or wait until next year when the trees will have grown larger and lumber prices may have changed. Option to learn Learning options are similar to waiting options except that the focus is on the resolution of uncertainty. The holder of an option to wait can either make the best choice in light of the uncertain future or wait until some important uncertainty is resolved. A person who hopes to receive job offers from two different employers either could choose to minimize the expected commute today by buying a house located between the two or could wait for an offer and then locate near the ultimate employer. Options to expand or contract An entrepreneur who has the ability to in- crease the scale of a venture has an option to expand. One who has the ability to downsize has an option to contract. An entrepreneur might decide to acquire an expansion option by purchasing a facility that is larger than the anticipated need. An entrepreneur might acquire an option to contract by closing down a production line if demand is less than anticipated. The option can be acquired by building a flexible production process. Options to switch inputs or outputs An entrepreneur has an option to switch inputs or outputs when she can alter the mix of a production process in response to market prices. An entrepreneur who designs a facility to operate on either electricity or natural gas has the real option to switch between these two inputs. A refiner who can switch between producing heating oil and gasoline has the real option to switch outputs. Option to abandon An abandonment option is a right to discontinue an activity and redeploy the real assets to some other use. Abandonment options include the options to discontinue a research project, close a store, or resign from current employment.

Historically, Venture Capital funds have been of great importance for the growth of entrepreneurial ventures. From the start in the US, venture capital industry has been exported to numerous nations around the globe. Explain how a modern venture capital fund is financed, organized and managed in other words the life-cycle of a venture capital fund

Organizational Structure of venture Capital investment:​ ​VC funds are usually organized as limited partnerships, and general partners. The General Partners manages the fund, while LPs provide most of the investment capital. The fund invests in a portfolio of new ventures. The GP's primary contribution to the fund is in the form of effort. In addition, though specifics vary, the GP normally commits 1 percent of the fund's capital; limited partners provide the other 99 percent. A small fraction of invested capital is used each year to cover costs related to managing the operation of the fund. The balance is invested in portfolio companies, in exchange for financial claims on the companies. If and when these investments are harvested, the returns are distributed to LPs, first to repay their initial investments, with the balance (the capital gain) being shared between the LPs and the GP. Normally, the LPs receive 70 to 80 percent of the gain and the GP receives the balance as a "carried interest."

You are a venture capitalist and have entered into an agreement with an entrepreneur. Now you have come across post-contractual concerns and need help with techniques that can control these problems:i) Identify the post contractual concern, ii) give two examples of the investor's concerns about the entrepreneur and iii) recommend two techniques that can mitigate the concerns. (5 p)

Post-contractual concerns come from moral hazard when the investor and the entrepreneur are unsure about each other's interest and incentives. For example: 1.Before the contract is signed the investor can be concerned about the entrepreneurs focus on a certain thing, such as technical details of the product instead of focusing on monitoring the venture forward. 2. The entrepreneur may also have lost incentives of putting effort into the business and might not do his best anymore. Technique to mitigate moral hazard 1. Bonding is done from the entrepreneurs side making a promise, implicit or explicit, for example the entrepreneur can promise to leave the CEO post to someone else if the company is not performing as promised/expected. 2. Monitoring is done from the investors side to gain control. It can be direct ex. by sitting on the board or indirect by requiring regulatory updates on financial or non-financial results.

Strategy and forecasting: How would you forecast sales for a production that does not yet exist, and the full scope of applications, customers and competitors is yet not known. Show how to forecast the revenue by using two different approaches:

Principles for forecasting Revenue forecast can be measured/estimated in different ways either by using a comparable firm or a chain in your city for example Phils Burger or by using a comparable firm from another place. For a established business: To begin with you need to build and support a schedule of assumptions. The start is to begin with a forecast of revenues, here you decide on to use real or nominal values. New venture: It is harder to build a forecast for a new venture but also more important. To do so there are two ways: - Y​ardsticks ​ - F​undamental analysis.​ You can begin by looking for a company that is comparable to some extent where data is available. You have to do a fundamental analysis of your m​ arket, competitors, location etc. ​Yardsticks are one example where you look at the revenue for example on similar shops. How many shops does each company have and what is the revenue per shop? Data available is one advantage of the yardsticks approach, there are many companies that go public every year where they supply a lot of information. The financial information from yardsticks companies have a value that is beyond forecasting, information regarding how they met their financing needs before going public. Each of the companies that are used can work as a case study of how to choose finance. By using historical data on sales experience from other firms is used to generate a forecast. Having in mind that sometimes the historical data can be "unusable" for example companies that wait longer time periods before going public, then it's not so good to benchmark this for your earlier phases. The fundamental analysis consists of your demand and supply. This analysis is much broader than yardsticks where you might investigate further into: Demand side -​ ​Geographic market you will server -​ ​How many customers are there in this market -​ ​Hos rapidly is the market growing -​ ​What can be the typical purchase of a customer during a forecast period -​ ​Are the amounts changing in the future -​ ​What will the expected price be of the product -​ ​Quality -​ ​Competitors reaction Supply side -​ ​Given the existing resources, how much are you going to be able to produce, market and distribute? -​ ​How rapidly can the company add and integrate the resources needed for expansion of output? By doing sensitivity analysis and scenario analysis you can easier see how vulnerable you are to changes in different variables such as product development time, price, units sold, monthly growth and growth period. The fundamental analysis will give you a better view on the market that you are in. This will help you make your forecast better and more accurate. It is important to be as realistic as possible (easy to say) when doing sales forecasting. If you are under-optimistic your company might fail to meet the demand and your market shares will be lost. On the other hand, if you are over-optimistic about your venture, there is a risk of having too much inventory and also fixed assets. This can lead to low turnover ratios, higher cost of having storages and also depreciation. The write-offs obsolete inventory. You might also have higher personnel costs due to higher numbers of people. All of this above will make your company have lower profits, a lower rate of return on equity and have lower free cash flows.

You plan to start a business where you need new venture financing from different sources. Describe how you would like to go about it as the firm matures, i.e. from the early phase (R&D), start-up phase, early growth, mature growth, and exit. What are the choices of investors/financing during these five phases and what are your considerations for your choices? (5 p)

R&D - bootstrapping and business angel: - Family, friends and fools who already knows me and rely on my ability to start a business → risky mixing relationships - Entrepreneur (myself) by maximizing credit card, taking on a second mortgage or using savings → with a risk of "losing everything" since i put in both money and effort - Business angel who believes in my idea → i might lose some control but can also get support in competence and network Start up: Business angel Corporate strategic partner → might want control of business Venture capital → will require "more" from me. i might have to signal to show my believes in the firm Early growth: Corporate strategic partner Venture capital Asset - based lender → will require a collateral in form of assets Mature growth: - Venture capital - Asset-based lender - Commercial bank loan - needs to have stable cash flow and assets as collateral Exit - IPO - will raise me the most money but also the most time consuming and costly - M&A can be less time consuming than IPO but also costly - Public debt - not suitable if the business is small. requires a safe and stable firm

Describe different sources of financing in the entrepreneurial life cycle: From R&D, start-up, early growth, rapid growth to exit.

R&D:​ This stage of financing is also referred to as seed financing. And consist of smaller amounts of money to cover the R&D. In the research and development stage financing usually comes from: Prime focus -​ ​Entrepreneur (Bootstrapping)-​ ​Friends and Family (Bootstrapping) -​ ​Business Angels-​ ​Corporate strategic partner Secondary Focus -​ ​Venture Capitalist Start-Up:​ The financing usually is needed when the concept is worth pursuing and you have the team ready. You've sorted out the risks related to the development. This is where the venture acquires the facility, equipment, and employees that are required so that you can produce your product/service. This stage of financing is to cover activities later R&D to the initiation of sales. Finance comes from: Prime Focus -​ ​Business Angels -​ ​Corporate Strategic partner -​ ​Asset based lender -​ ​Venture Leasing Secondary Focus -​ ​Entrepreneur -​ ​Friends and family -​ ​Government Programs Early-Growth:​ ​The revenue is growing but net income and cash flows available to investors are still negative. It is called early growth because you may have a rapid growth in terms of percentages but the base that we calculate revenue growth is still low. Finance comes from: Prime Focus -​ ​Corporate strategic partner -​ ​Venture Capitalist -​ ​Asset Based Lender -​ ​Venture Leasing -​ ​Government Programs -​ ​Trade credit/vendor financing -​ ​Factoring -​ ​Franchising Secondary focus -​ ​Business Angels Rapid-Growth: ​There is no defined line between the early-growth and rapid-growth stage. Some business ventures have growth in the early stage that they cannot keep up with in a sufficient way so they die. Going into the rapid-growth face means net revenue increases at an increasing rate. Here it's important to get the finance needed to sustain the growth in order to survive, this by getting a positive net income. Finance comes from: Prime Focus -​ ​Corporate strategic partner -​ ​Venture Capitalist -​ ​Asset Based Lender -​ ​Venture Leasing -​ ​Government Programs -​ ​Trade credit/vendor financing -​ ​Factoring -​ ​Franchising -​ ​Commercial Bank Lending -​ ​Mezzanine Lender Secondary focus -​ ​Business Angel Exit: ​In this stage the rate of growth declines to a point where the cash-flows that are available to investors are positive. The new business (not so new anymore) do not have to take on more finance/debt from investors to repay/provide return to them. Now investors want to harvest the deal and realize the return on their investments Prime focus -​ ​Mezzanine Lender -​ ​Public Debt -​ ​IPO -​ ​Acquisition, LBO, MBO

Mention and explain the different types of entrepreneurship (four concepts).

Replicative versus Innovative. Innovative entrepreneurs are the ones who eliminate old sectors by introducing new technologies and challenge prevailing business models - creative destruction as Schumpeter wrote. Replicative entrepreneurs start and maintain businesses that mimic predecessors. For instance, a barber stylist or Mexican restaurant in a small town. They build on established business models and can often be financed with small investments. Opportunity-based versus necessity-based. Innovative entrepreneurship is basically all opportunity based, whereas replicative entrepreneurship is divided between opportunity and necessity. Necessity based entrepreneurship represents people driven by lack of alternatives. This kind of entrepreneurship is common in emerging markets.

Besides an IPO and a trade sale, there are other harvesting options for an investor. Three if those are a so called secondary sales, LBO/MBO and ESOP. Describe these exit options and if there are any particular benefits in using them (3p)

Secondary sales:​ refers to when a private equity firm or VC firm sells a portfolio firm (investment) to another private equity firm. The seller fully exits the investment. Benefit of this method can be to let another firm with better expertis continue to develop the venture. In that way the VC-firm (seller) can continue to have a good relationship with the sold venture. LBO/MBO:​ the management team takes over/buys the venture from its private owner (VC firm). Management team knows the venture well and believes that they can continue to develop the venture without external help from VC. ESOP:​ employer stock option plan. A way for the retiring owner to transfer the company to the next generation. Common in the US and have many fiscal benefits for example the transfer is tax free if ful-filling requirements for complete roll-over.

The DCF method

The D​ CF method​ has two different approaches that can be used, namly ​RADR​ and C​ EQ.​ When using the RADR method you discount the future cash flows with a discount rate that takes in consideration both the time value of money and also the riskiness of the investment. Referred to as the "Risk adjusted discount rate" because the effect of risk on value is built into the discount rate that is applied to the expected cash-flow. Often used in corporate finance due its convenient and information requirements. This method allows for data from comparable firms. You will need to distinguish market and non-market risk when doing your DCF with RADR. The other way of estimating your value with DFC is as mentioned above the CEQ method. Instead of adjusting the discount rate, the risk adjustment is made directly to the cash-flows The risk-adjusted cash-flow is then converted to a present value (PV) by discounting it with the risk-free rate. This method is said to be more friendly/usable for new ventures. The main difference between the two methods is the way we adjust for the risk. When doing a DCF valuation you need to: 1. identify the relevant cash flows for a period of years until the company reaches a so called "steady state" 2. Decide on a appropriate discount rate 3. Discount your free cash flows and continuing value These 3 steps will give you the ventures value. If you want to determine the value of equity you simple subtract debt (and add cash) Strengths of DCF - The method is conceptual and can be applied in a straightforward way - In the RADR the discount rate reflects risk and time Weakness of DCF - It can be hard to project your cash-flows and a correct discount rate

First Chicago method

The First Chicago method uses a small number of scenarios to value the new venture namly success, sideways and failure. The method has 6 steps 1. Terminal year for valuation 2. Estimating cash flows for the explicit value period for the three scenarios 3. Compute the continuing value for the three scenarios, applying a multiplier 4. Compute cash flow by weighting the scenarios 5. Compute the present value of the cash flows 6. Based on the present value you need to determine the minimum fraction of ownership that the investor should require. Strengths of Chicago method - Discrete scenarios provides a simple and easy method, values cash flow at opportunity cost of capital Weakness of Chicago method - How to assign probabilities to different scenarios - How to determine the discount rate

Describe the IPO process, i.e. the stages, the actors and the pros and cons of doing an IPO if you are an entrepreneur with harvesting in your mind

The IPO process: The first step in the IPO process is to get a​ preliminary estimate of the value​ of your firm. - Comparative firm values - Comparable transactions and IPOs - Discounted cash flow valuations - Information from the issuer. The second step is - new information from the market - new information from due diligence. - Filing range reported in preliminary prospects The third step is - New information from market - Indications of interest from road show - "Take-down" DD - Issue price reported in final prospectus Above are the 3 steps in the IPO process. In the first stage, underwriters (Usually investment banks) estimate a preliminar value using comparables and DCF. In the second stage, a Due Diligence is conducted in order to minimize the information gap and get out as much information as possible about the company. With the DD combined with other information from the market it is possible to get a potential range of the issue price. Third, the underwriter conducts a road-show and builds the book (Book building). New information from the market is collected and the issue price is reported in the final prospects. There are many people involved in a IPO, the​ underwriter​ who is an intermediary between the issuer and public market investors. The underwriter is sometimes a investment banker or team (syndicate), there are legal firms, consultant companies for specific task, the stock exchange (Nasdaq, OMX, First North, NGM) Pros of doing an IPO: - Historically yields the highest price for the shares - Higher liquidity for the shares of the company - Compensation programs for management (Option for company stock can be offered instead of bonuses). Good way of aligning long-term incentives between management and the company. Cons of doing an IPO: - Costly (Approximately 6 - 17 % of gross proceeds) - Time consuming - Hostile takeovers by other companies when the shares are out on an open market. Going public requires: 1. A well fluctuating stock market 2. Timing of the market, in order to achieve as high share price as possible When deciding on going forward with an IPO the company needs to have in mind that they need to put a lot of future resources on legal matters and investor relations. These resources could otherwise have been put on operation.

Venture capital method

The V​enture capital method​ starts with an estimate of future value conditional on success. This means that a timetable for an exit is included. Usually of 3 to 5 years and then conjecturing as to the form of exit and resulting future value. Exit value conditional on success can be developed using RV and using multiples such as P/E or other multiple. The value is discounted to its PV using a reasonable hurdle rate. For example, the exit is expected to be in 5 years, and the entrepreneurs say they need 5 million to achieve their planned growth. Investors now demand 50% yearly return. Let's say that the company has earnings of 5 millions in 5 years and that they go public at a multiple of 20x earnings. Then the value of the firm is 5 times 20 which equals 100 million. Then you need to calculate the present value of the exit value: example 100mSEK/(1.50)^5 = 13.2mSEK (Post-money). 13.2mSEK - 5mSEK = 8.2mSEK (Pre-money). If entrepreneurs want 5 million to achieve their growth VC will ask for 5mSEK/13.2mSEK = 38% equity stake invest 5mSEK Strengths of VC - The most popular method, is it's intuitive application. The method is logical and focuses on success. - The hurdle rate factors the concerns from the VC, such as the probability to not succeed. Weakness of VC - Lack of precision (Long intervals of PV for a longer period, hard to select hurdle rate) - Biases from high hurdle rates and lack of information regarding uncertainty 2 ways of using VC method VC method 1 1. Forecast earnings 2. Determine exit value/terminal value 3. Calculate present value of exit value 4. Determine ownership fraction VC method 2 1. Determine capital need of company 2. Determine percentage of ownership that is a maximum for fund 3. Calculate value be dividing step 1 with 2

Why is it important that you as an entrepreneur value your own venture and do not trust the investor's valuation?

The entrepreneur should not trust the investors valuation since they are more diversified. An entrepreneur often puts all his effort and money into the venture compared to the investor who invest in multiple ventures and therefore due to the different level of diversification the two will use different discount rates of the venture.

Illustrate the interdependencies of strategy choices

The figure above shows the interconnected nature between financial strategy, product market strategy and the organizational strategy. Where the financial strategy d​eals with how to finance and partner with others, outside verses entrepreneur and debt versus equity. The o​rganizational strategy​ is the vertical and horizontal boundaries, the scale and scope of the venture. The product market strategy​ refers to the product and its price, margin, quality and differentiation. The financial needs and the choices of finance strategy is correlated to how the organizational and product-market strategy will be. These three strategies needs to be reflected simultaneous when consider what types of strategies you will have. Example in the product market: You choose to either have a high margin with slow growth approach or a low margin with a rapid-growth approach. The organizational strategy comes in now since you have to decide whether to enter the manufacturing level and contract for distribution or you can enter both manufacturing and distribution. For example: If I want to have rapid growth with an integrated entry I would have to increase the financial needs meaning external capital and thus might lose stakes in the company and also control, and also share the return with other investors. So financial needs would increase when I want to have a larger scale and also faster growth. As stated earlier this comes with other effects such as sharing the return with the investors that makes it possible for me to grow faster. Market analysis and value proposition: The value proposition is a proposition that clarifies why somebody should do business with you as an entrepreneur. The statement aims to convince potential customers why there is a demand and need for your business idea. What value are you going to bring the customers that others cannot provide? The statement should consist of the current problem so that the listener understands that there is a need and demand for the idea/business. How can you address the new business idea in order to make it compelling and make lives easier for the end-customer and in the end earn money from it? In order to do so you have to have a good insight in your customer-segment. What types of similar businesses do they use today or are there nothing like your idea? Are the customers satisfied with this already existing venture or is there a demand for a better one? One way is to use the user centered design (​UCD​) which is: -​ ​Understand the target users -​ ​Design for the users and their tasks -​ ​Evaluating designs -​ ​Provide adequate feedback -​ ​Designing for a total customer experience You need to have a special segment since all firms have limited resources and cannot help everyone. You need to decide where to focus your time, money and human capital since it is a limited resource. With this said - Identify the right size market Your fundamental analysis needs to see if there is a demand for the service. By deciding on that geographical market your business will serve, identify how many customers there is in the market, estimate some sort of market growing rate and estimate how much will be consumed by the typical customers. When planning and doing this, you need to be aware of factors such as changing demand in the future, price elasticity such as what's a reasonable price for your product, and what is the quality and overall "rating" of our service compared to your competitors. One cannot forget the other side - Supply side. How much can the business produce, market, distribute and support? And also the pace the venture has of adding and integrating resources needed for expansion output.

Lockup period

The period after an exit when some actors ex the entrepreneur are not allowed to sell their shares (Usually around 180 - 360 days) often in an IPO exit

What entrepreneurship does to the market according to Schumpeter and Kirzner.

The primary contributions entrepreneurial ventures (Opportunity based) gives the society are -​ ​Creating more jobs -​ ​New technology that helps driving society forward -​ ​Contribute to the economic growth in the world and in the country also welfare.

Why is it not a good idea for the entrepreneur to rely on the investors valuation in deciding whether to pursue a potential venture?

The reason for not relying on the investors valuation is mostly due to the fact that investors diversify their investments. By diversification in different investments the investors lower the risk. The entrepreneurs put most of their time, effort and own money into the business and are not diversified. This means that the entrepreneurs are heavily exposed to risk and the outcome of the venture. VC firms have many companies in their portfolios and are not exposed to the same extent as the entrepreneur. This means that entrepreneurs cannot use the same discount rate as the VC with a differentiated portfolio. Entrepreneurs are exposed to more risk and therefore should have a higher discount rate than investors.

Term-sheet

The term sheet reflects an agreed-upon valuation and sets out the amount of investment that is to be made, as well as the ownership claims the investor will receive. In addition, the term sheet may identify some of the options, rights, and responsibilities of each party. For example, the investor may have the right to make appointments to the board of directors and, under some conditions, may have the right to withdraw from the project or to terminate the entrepreneur. The entrepreneur may have the right to call on the investor for additional funds in the event that certain milestones are achieved or to acquire additional shares through the exercise of stock options. I​ t does not commit either party to the deal. T​ he term-sheet sets the terms for the agreement or contract.

A venture capital fund can contribute to the development of the entrepreneurial venture in a number of dimensions. describe in what ways that the venture capital fund can be of help in development of the entrepreneurial venture.

The venture capital fund can help in many ways - Financing: ​Access to financing is crucial in order for the ventures survival. - Expertise/knowledge: ​The venture capital firm appoints a manager with experience and expertise for the portfolio company businesses. The fund manager will have contact with the venture on a regular basis to ensure that plans, goals and strategies are achieved. The manager will also help the venture to set ways to work in order to achieve set goals/or strategies and perform well. - Network:​ VC-Firms are well connected. A venture can use vc-firms connections to acquire missing/new expertise in order to keep developing. By being backed by strong VC-firms will also send positive signals in the market which can help the venture enhance its brand.

Information and incentive problems arising from adverse selection and moral hazard are important determinants of financial contract terms. Explain and give examples of these problems and analyze solutions to the problems.

There are different ways of complement relation contracts such and solving these problems Mechanism to address adverse selection - Signaling (When information is impossible to give, signaling can be used instead) can also address moral hazard (see p. 512 andra stycket). - Screening (From the investors side) Mechanism to address moral hazard - Bonding (A promise; implicit or explicit & Specific) - Monitoring (Direct or indirect) Moral hazard problems ​can be: A situation where a VC has invested in a venture but are not sure that the entrepreneur will act as agreed or take the best decisions ex post investment. The solution to minimize this problem is to let the VC sit in the board, known as d​irect monitoring.​ With a VC on the board the entrepreneur cannot act and take decisions on his own without the VC confirmation. One can also let an account firm go through the pro-forma statements periodically in order to monitor, this is called ​indirect monitoring​. The entrepreneur can also try to mitigate this problem by b​onding. ​The entrepreneur could promise to resign or change position in the company if the targeted areas are not met, for example: Sales levels, lowering cost, marketing etc. The bonding works as a penalty structure which reduces incentives for the entrepreneur to act in other ways than agreed on. Monitoring and bonding are solutions for moral hazard that arises ex post investment. Adverse selection can arise in situations during contracting (ex ante investment). For example: The VC and entrepreneur have different views on the venture's future, will it be successful or not? In this case, the first thing the VC could do is to offer a set of different alternative contracts for the entrepreneur. This allows for the VC to screen out the asymmetric information. The entrepreneur will choose the contract that is best aligned with his expectations for the venture and be of highest value for the entrepreneur. The entrepreneur can also send out signals in order to decrease the asymmetric information between the two. The entrepreneur can in this case suggest a contractual structure that's dependent on performance. Another suggestion would be to offer a maximum loss which then he takes the loss. Adverse selection is removed thru screening from the investors side and signaling from the entrepreneurs side.

Ball, Chiu and Smith ask the question "Can VCs time the market?" and differ between the market-timing hypothesis and the market conditions hypothesis (or pseudo-market timing). Discuss their main findings? (3 p)

They answer the question with a no. Although they did find that IPOs were avoided during the first quarters after the financial crisis in 2007-2008. They could also see patterns in VCs exit decisions depending on the current market situation. For example IPOs are not preferable in an unsecure market. Instead they found that the number of acquisitions were higher during weak market times which can be derived from the fact that it does not necessarily require much debt and the valuation relies on one actor and not on the market (as in an IPO).

Relative value method

This method uses market data on other companies or other transactions as bases for getting a value for the venture. Some like to call the method for the "comparables" or "multiples valuation". The logic behind the method is that if two different companies are expected to produce identical future cash flows and subject to the same risk, the value would be the same. Otherwise investors of the higher valued company would want to sell the high-valued company and buy the low-valued company. The value is therefore calculated based on profitability, expected growth and risk. Different multiples that can be used when valuing a company with this method are - P/S (price of share/revenues per share) - P/EBITDA - P/EBIT - P/E - PEG ratio (P/E/Growth) Strengths of Relative value - Quick and easy to use Weakness of Relative value - It can be hard to find comparable data. And also har to know that the comparable multiples are the correct ones to use for our company. The average of some companies might not be representative of our company.

An alternative to the IPO is a so-called trade sale. Describe what a trade sale is and what the major pros are with a trade sale in comparison with an IPO (4p)

Trade sale occurs when a Private Equity / VC firm sells an investment / portfolio company to another owner through M&A process. The buyer can be a corporation looking for synergies or entering a new market or just looking to expand its business. Trade sales are less costly than IPO and also less time consuming.

The traditional corporate finance literature neglects some important aspects of the real life of being an entrepreneur and looking for finance. Describe some of the major differences between corporate finance and entrepreneurial finance. (4 p)

Traditional corporate finance literature mainly involves the optimal capital structure depending on the pros and cons for debt and equity for a specific company in a specific industry. The real life for an entrepreneur involves difficulties in finding funding at reasonable terms, which means that the funding they obtain may not be the optimal - but the only alternative they can find. For example in the seed phase of the development of a venture the entrepreneurs only alternative may be reaching out to their own savings - or friends and family even though this is the most common, it does not mean it is optimal. They simply do not have sufficient alternatives.This problem is present up until the establishment phase when almost all funding sources have become available. These difficulties and financial gaps are when entrepreneurial finance differs from corporate finance, as corporate finance refers to mature companies.

There are a number of problems that SMEs and entrepreneurial ventures face when applying for finance. Describe three inherent problems that financiers experience when they are to evaluate a new venture.

Uncertainty:​ Financiers may not see the same future for the venture as the entrepreneur since new ventures do not have any track record to compare with. Therefore the evaluation will be based on the information provided by the entrepreneur. Leads to higher cost of capital. Asymmetric information:​ The entrepreneur knows more about the venture then its investors. To protect themselves against the risks related to asymmetric information, investors will require a higher interest rate. Unskilled personnel (labor)​: Investors may doubt on the venture ́s teams ability to deliver or achieve set goods.

Explain how a venture capital fund is financed, organized and managed.

Venture capital is a form of private equity and a type of financing that investors provide to startup​companies and small businesses that are believed to have l​ong-term growth potential. Venture Fund is the main investment vehicle used for venture investing. Each is structured as a limited partnership governed by partnership agreement covenants, of finite life (usually 7-10 years). It pays out profit sharing through carried interest (about 20% of the fund's returns).​ Management Company​ is the business of the fund. The management company receives the management fee from the fund (about 2%) and uses it to pay the overhead related to operating the venture firm, such as rent, salaries of employees, etc. It makes carried interest only after the Limited Partners have been repaid. Limited Partners (LPs)​ is someone who commits capital to the venture fund. LPs are mostly institutional investors, such as pension funds, insurance companies, endowments, foundations, family offices, and high net worth individuals. ​ General Partner (GP)​ is the venture capital partner of the management company. GPs raise and manage venture funds, set and make investment decisions, and help their portfolio companies exit, because they have a fiduciary responsibility to their Limited Partners. ​ Portfolio Companies (Startups) receive financing from the venture fund in exchange for shares of preferred equity. The fund can only realize gains if there is a liquidity event (such as mergers and acquisitions or IPOs) and these shares can be converted to cash.

Necessity-based entrepreneurship

occurs when people start new ventures because they have few or no other employment options

Covenant

refers to the contract between an entrepreneur and investor absout what the entrepreneur can and cannot do during the contract period. E.g. the entrepreneur is not allowed to take decisions that can harm the investors such as issuing new shares

Lock-up period

refers to the period within which the VC investor may not sell their stocks in an investment object after for example listing the company. Often 180 days sometimes 360 days and is supposed to decrease the risk of insider trade with information that was not made public

Real option

refers to the right, not the obligation, to make an "non-financial" decision. For example a decision to invest in a new plant or abandon a market where the company is not performing well. A real option could be the opportunity to buy a property in the future for a given price. If you think the property could be acquired for a discount at the time, the option should be exercised.

Private equity

the opposite is public equity however private equity refers to investments in mature companies both listed and unlisted. Private equity firms aim for large stakes in companies.

Personal guarantee

when an individual guarantees the debt on its firm for example a startup entrepreneur. If the firm cannot commit to their obligation, you get personally responsible for paying the debt