Entrepreneurial Finance, 7th Edition PDF by J Chris Leach and Ronald W Melicher

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Entrepreneurial Finance, Seventh Edition

By J. Chris Leach and Ronald W. Melicher

Entrepreneurial Finance, 7th Edition PDF by J Chris Leach and Ronald W Melicher

Contents

Preface xi

About the Authors xvii

PART 1

The Entrepreneurial

Environment 1

CHAPTER 1

Introduction to Finance for Entrepreneurs 3

1.1 The Entrepreneurial Process 5

1.2 Entrepreneurship Fundamentals 6

Who is an Entrepreneur? 6

Basic Definitions 7

Entrepreneurial Traits or Characteristics 7

Opportunities Exist but Not Without Risks 8

1.3 Sources of Entrepreneurial Opportunities 9

Societal Changes 9

Demographic Changes 12

Technological Changes 12

Emerging Economies and Global Changes 13

Crises and “Bubbles” 14

Disruptive Innovation 15

1.4 Principles of Entrepreneurial Finance 15

Real, Human, and Financial Capital Must be Rented

from Owners (Principle #1) 16

Risk and Expected Reward Go Hand in Hand

(Principle #2) 16

While Accounting is the Language of Business, Cash

is the Currency (Principle #3) 17

New Venture Financing Involves Search,

Negotiation, and Privacy (Principle #4) 17

A Venture’s Financial Objective is to Increase Value

(Principle #5) 18

It is Dangerous to Assume that People Act Against

their Own Self-Interests (Principle #6) 19

Venture Character and Reputation Can be Assets or

Liabilities (Principle #7) 20

1.5 Role of Entrepreneurial Finance 21

1.6 The Successful Venture Life Cycle 23

Development Stage 24

Startup Stage 24

Survival Stage 24

Rapid-Growth Stage 24

Early-Maturity Stage 25

Life Cycle Stages and the Entrepreneurial Process 25

1.7 Financing Through the Venture Life Cycle 26

Seed Financing 27

Startup Financing 27

First-Round Financing 28

Second-Round Financing 28

Mezzanine Financing 29

Liquidity-Stage Financing 29

Seasoned Financing 30

1.8 Life Cycle Approach for Teaching Entrepreneurial

Finance 30

Summary 34

CHAPTER 2

Developing the Business Idea 41

2.1 Process for Identifying Business Opportunities 43

2.2 To be Successful, You Must Have a Sound Business

Model 44

Component 1: The Business Model Must

Generate Revenues 45

Component 2: The Business Model Must

Make Profits 45

Component 3: The Business Model Must Produce

Free Cash Flows 46

2.3 Learn from the Best Practices of Successful

Entrepreneurial Ventures 47

Best Marketing Practices 47

Best Financial Practices 48

Best Management Practices 49

Best Production or Operations Practices are also

Important 49

2.4 Time-to-Market and Other Timing Implications 49

2.5 Initial “Litmus Test” for Evaluating the Business

Feasibility of an Idea 51

2.6 Screening Venture Opportunities 53

An Interview With the Founder (Entrepreneur) and

Management Team: Qualitative Screening 54

Scoring a Prospective New Venture:

Quantitative Screening 58

Industry/Market Considerations 61

Pricing/Profitability Considerations 62

Financial/Harvest Considerations 65

Management Team Considerations 67

Opportunity Screening Caveats 67

2.7 Key Elements of a Business Plan 69

Cover Page, Confidentiality Statement, and Table of Contents 69

Executive Summary 71

Business Description 71

Marketing Plan and Strategy 71

Operations and Support 71

Management Team 72

Financial Plans and Projections 72

Risks and Opportunities 73

Business Plan Appendix 75

Summary 75

Appendix A Applying the VOS Indicator™: An Example 81

PART 2

Organizing and Operat ing the

Venture 85

CHAPTER 3

Organizing and Financing a New Venture 87

3.1 Progressing Through the Venture Life Cycle 89

3.2 Forms of Business Organization 89

Proprietorships 92

General and Limited Partnerships 93

Corporations 97

Limited Liability Companies 99

3.3 Choosing the Form of Organization: Tax and Other Considerations 100

3.4 Intellectual Property 104

Protecting Valuable Intangible Assets 104

What Kinds of Intellectual Property Can be

Protected? 104

Copyrights 111

Other Methods for Protecting Intellectual Property

Rights 111

Employment Contracts 112

3.5 Seed, Startup, and First-Round

Financing Sources 113

Financial Bootstrapping 114

Business Angel Funding 117

First-Round Financing Opportunities 119

Summary 120

CHAPTER 4

Preparing and Using Financial Statements 127

4.1 Obtaining and Recording the Resources Necessary

to Start and Build a New Venture 129

4.2 Business Assets, Liabilities, and Owners’

Equity 130

Balance Sheet Assets 132

Liabilities and Owners’ Equity 133

4.3 Sales, Expenses, and Profits 134

4.4 Internal Operating Schedules 136

4.5 Statement of Cash Flows 140

4.6 Operating Breakeven Analyses 142

Survival Breakeven 142

Identifying Breakeven Drivers in Revenue

Projections 147

Summary 149

Appendix A NOPAT Breakeven: Revenues Needed

to Cover Total Operating Costs 156

CHAPTER 5

Evaluating Operating and Financial

Performance 159

5.1 Users of Operating and Financial Performance

Measures by Life Cycle Stage 161

5.2 Using Financial Ratios 162

5.3 Cash Burn Rates and Liquidity Ratios 165

Measuring Venture Cash Burn and Build Amounts

and Rates 165

Beyond Burn: Traditional Measures of Liquidity 167

Interpreting Cash-Related and Liquidity-Related

Trends 168

5.4 Leverage Ratios 170

Measuring Financial Leverage 170

Interpreting Changes in Financial Leverage 172

5.5 Profitability and Efficiency Ratios 173

Income Statement Measures of Profitability 173

Efficiency and Return Measures 175

Interpreting Changes in Profitability

and Efficiency 177

5.6 Industry Comparable Ratio Analysis 178

5.7 A Hitchhiker’s Guide to Financial Analysis 179

Summary 182

PART 3

Planning for the Future 191

CHAPTER 6

Managing Cash Flow 193

6.1 Financial Planning throughout the Venture’s Life

Cycle 194

6.2 Surviving in the Short Run 196

6.3 Short-Term Cash-Planning Tools 198

6.4 Projected Monthly Financial Statements 202

6.5 Cash Planning from a Projected Monthly Balance

Sheet 205

6.6 Conversion Period Ratios 206

Measuring Conversion Times 206

Interpreting Changes in Conversion Times 210

Summary 212

CHAPTER 7

Types and Costs of Financial Capital 221

7.1 Implicit and Explicit Financial Capital Costs 223

7.2 Financial Markets 223

7.3 Determining the Cost of Debt Capital 225

Determinants of Market Interest Rates 227

Risk-Free Interest Rate 227

Default Risk Premium 228

Liquidity and Maturity Risk Premiums 231

A Word on Venture Debt Capital 234

7.4 What is Investment Risk? 234

Measuring Risk as Dispersion Around an

Average 234

Historical Return Versus Risk Relationships 238

7.5 Estimating the Cost of Equity Capital 240

Cost of Equity Capital for Public Corporations 241

Cost of Equity Capital for Private Ventures 243

Sources and Costs of Venture Equity Capital 245

7.6 Weighted Average Cost of Capital 247

A Life Cycle–Based Wacc Example 248

Summary 250

Appendix A Using WACC to Complete the

Calibration of EVA 258

CHAPTER 8

Securities Law Considerations When Obtaining

Venture Financing 261

8.1 Review of Sources of External Venture

Financing 263

8.2 Overview of Federal and State Securities Laws 265

Securities Act of 1933 266

Securities Exchange Act of 1934 266

Investment Company Act of 1940 267

Investment Advisers Act of 1940 267

Jumpstart Our Business Startups Act of 2012 268

State Securities Regulations: “Blue-Sky” Laws 269

8.3 Process for Determining Whether Securities Must be

Registered 270

Offer and Sale Terms 270

What is a Security? 271

8.4 Registration of Securities Under the Securities Act of

1933 272

8.5 Security Exemptions from Registration Under the

1933 Act 276

8.6 Transaction Exemptions from Registration Under

the 1933 Act 278

Private Offering Exemption 278

Accredited Investor Exemption 280

8.7 SEC’s Regulation D: Safe-Harbor Exemptions 281

Rule 504: Exemption for Limited Offerings and Sales

of Securities not Exceeding $5 Million 282

Rule 506: Exemption for Limited Offers and Sales

Without Regard to Dollar Amount of Offering 283

8.8 Regulation a Security Exemption 289

8.9 JOBS Act Innovations 290

Summary 290

Appendix A Schedule A (Securities Act of 1933, as

Amended) 294

Appendix B Selected SEC Regulation D

Materials 299

Appendix C Other Forms of Registration

Exemptions

and Breaks 326

PART 4

Creat ing and Recognizing

Venture Value 329

CHAPTER 9

Projecting Financial Statements 331

9.1 Long-Term Financial Planning Throughout the

Venture’s Life Cycle 332

9.2 Beyond Survival: Systematic Forecasting 334

Forecasting Sales for Seasoned Firms 334

Forecasting Sales for Early-Stage Ventures 336

9.3 Estimating Sustainable Sales Growth Rates 340

9.4 Estimating Additional Financing Needed to Support

Growth 344

The Basic Additional Funds Needed Equation 345

Impact of Different Growth Rates on Afn 347

Estimating the Afn for Multiple Years 348

9.5 Percent-of-Sales Projected Financial

Statements 349

Forecasting Sales 349

Projecting the Income Statement 350

Projecting the Balance Sheet 351

Forecasting the Statement of Cash Flows 353

Financing Cost Implications Associated with the

Need for Additional Funds 354

Summary 355

CHAPTER 10

Valuing Early-Stage Ventures 361

10.1 What is a Venture Worth? 363

Does the Past Matter? 363

Looking to the Future 364

Vested Interests in Value: Investor and

Entrepreneur 364

10.2 Basic Mechanics of Valuation: Mixing Vision and

Reality 366

Present Value Concept 366

If You’re not Using Estimates, You’re not Doing a

Valuation 367

Divide and Conquer with Discounted Cash

Flow 369

10.3 Required versus Surplus Cash 372

10.4 Developing the Projected Financial Statements for a

DCF Valuation 374

10.5 Just-In-Time Equity Valuation: Pseudo

Dividends 378

10.6 Accounting versus Equity Valuation Cash Flow 385

Origins of Accounting Cash Flows 385

From Accounting to Equity Valuation Cash

Flows 386

Summary 390

CHAPTER 11

Venture Capital Valuation Methods 409

11.1 Brief Review of Basic Cash Flow-Based Equity

Valuations 411

11.2 Basic Venture Capital Valuation Method 413

Using Present Values 416

Using Future Values 416

11.3 Earnings Multipliers and Discounted Dividends 417

11.4 Adjusting VCSCs for Multiple Rounds 419

First Round 420

Second Round 420

11.5 Adjusting VCSCs for Incentive Ownership 421

First Round 422

Second Round 422

Incentive Ownership Round 422

11.6 Adjusting VCSCs for Payments to Senior Security

Holders 423

11.7 Introducing Scenarios to VCSCs 424

Utopian Approach 425

Mean Approach 426

Summary 431

PART 5

Structuring Financing for the

Growing Venture 455

CHAPTER 12

Professional Venture Capital 457

12.1 Historical Characterization of Professional Venture

Capital 459

12.2 Professional Venture Investing Cycle: Overview 463

12.3 Determining (Next) Fund Objectives and

Policies 464

12.4 Organizing the New Fund 465

12.5 Soliciting Investments in the New Fund 468

12.6 Obtaining Commitments for a Series of Capital

Calls 469

12.7 Conducting Due Diligence and Actively

Investing 470

12.8 Arranging Harvest or Liquidation 477

12.9 Distributing Cash and Securities Proceeds 478

Summary 479

CHAPTER 13

Other Financing Alternatives 483

13.1 Business Incubators, Seed Accelerators, and

Intermediaries 485

Business Incubators and Seed Accelerators 485

Intermediaries, Facilitators, and Consultants 486

13.2 Business Crowdsourcing and Crowdfunding 487

13.3 Commercial and Venture Bank Lending 488

13.4 Understanding Why You May not Get Debt

Financing 491

13.5 Credit Cards 493

13.6 Foreign Investor Funding Sources 494

13.7 Small Business Administration Programs 494

Overview of What the Sba does for Small

Businesses 495

Selected Sba Loan and Operating Specifics 496

13.8 Other Government Financing Programs 497

13.9 Factoring, Receivables Lending, and Customer

Funding 498

13.10 Debt, Debt Substitutes, and Direct Offerings 500

Vendor Financing: Accounts Payable and Trade

Notes 500

Mortgage Lending 500

Traditional and Venture Leasing 500

Direct Public Offers 501

Summary 502

Appendix A Summary of Colorado Business

Financial

Assistance Options 505

CHAPTER 14

Security Structures and Determining Enterprise

Values 507

14.1 Common Stock or Common Equity 509

14.2 Preferred Stock or Preferred Equity 510

Selected Characteristics 510

Convertible Preferreds 511

Conversion Value Protection 513

Conversion Protection Clauses 514

Conversion Price Formula (CPF) 514

Market Price Formula (MPF) 514

14.3 Convertible Debt 516

14.4 Warrants and Options 517

14.5 Other Concerns About Security Design 523

14.6 Valuing Ventures with Complex Capital Structures:

The Enterprise Method 524

Summary 531

PART 6

Exit and Turnaround Strategies 543

CHAPTER 15

Harvesting the Business Venture Investment 545

15.1 Venture Operating and Financial Decisions

Revisited 547

15.2 Planning an Exit Strategy 548

15.3 Valuing the Equity or Valuing the Enterprise 550

Relative Valuation Methods 550

Dividing the Venture Valuation Pie 551

15.4 Systematic Liquidation 553

15.5 Outright Sale 554

Family Members 554

Managers 555

Employees 558

Outside Buyers 559

15.6 Going Public 561

Investment Banking 561

Some Additional Definitions 564

Other Costs in Issuing Securities 565

Post-Ipo Trading 566

Contemplating and Preparing for the Ipo

Process 569

Summary 574

CHAPTER 16

Financially Troubled Ventures: Turnaround

Opportunities? 581

16.1 Venture Operating and Financing Overview 583

16.2 The Troubled Venture and Financial Distress 584

Balance Sheet Insolvency 585

Cash Flow Insolvency 586

Temporary versus Permanent Cash Flow

Problems 587

16.3 Resolving Financial Distress Situations 588

Operations Restructuring 590

Asset Restructuring 593

Financial Restructuring 595

16.4 Private Workouts and Liquidations 596

Private Workouts 596

Private Liquidations 597

Venture Example: Jeremy’s Microbatch Ice Creams,

Inc. 598

16.5 Federal Bankruptcy Law 598

Bankruptcy Reorganizations 599

Reasons for Legal Reorganizations 600

Legal Reorganization Process 602

Bankruptcy Liquidations 605

Summary 609

PART 7

CAPSTONE CASES 615

CASE 1

Eco-Products, Inc. 617

CASE 2

Spatial Technology, Inc. 647

Glossary 673

Index 681

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