Entrepreneurial Finance Week 01 Lecture Notes PDF

ENTREPRENEURIAL FINANCE WEEK 01 AD203 – Wednesday 6pm-8:30pm Jes Black (Ph.D + MBA) Entrepreneurial Finance: Week 01 Entrepreneurial Finance: Week 01 Course Objectives: (1) Understand challenges facing those looking for financing (2) Learn different stages of financing (3) Analyze sour...

ENTREPRENEURIAL FINANCE WEEK 01 AD203 – Wednesday 6pm-8:30pm Jes Black (Ph.D + MBA) Entrepreneurial Finance: Week 01 Entrepreneurial Finance: Week 01 Course Objectives: (1) Understand challenges facing those looking for financing (2) Learn different stages of financing (3) Analyze sources of financing and their characteristics (4) How to value a business and agree to a price (5) How to structure the investment deal Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Entrepreneurship books, they typically touch upon the venture’s funding needs but rarely look at the fundraising process itself We will discuss the needs of a startup How the fundraising process works How a startup and a VC / Angel can agree on funding terms Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Entrepreneurial Finance: The Art and Science of Growing Ventures (Chapter 1-3 available online, book is in the library) https://books.google.es/books?id=1LBoDwAAQBAJ&printsec=copyri ght&redir_esc=y#v=onepage&q&f=false Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Week 01: Build on concepts learned in Bootstrap Finance 99% of startups first have to boostrap their company because: What it takes to start a business often conflicts with what venture capitalists require How is Bootstrapping so different from Raising Outside Money? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance There isn't anyone questioning you You can choose to go slow if it is just you Bootstrapping has limitations on growth (due to lack of funds) VC-backed companies have funds and are expected to grow fast What is a potential problem with growing fast? Why did VC funding rise in 2021? Why did it fall back to 2019 levels? Was it good or bad to raise a lot of $$ in 2021? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance How startups raise money (1) VC's raise money from investors (2) VC's have to allocate this money (not sit on it) (3) They choose startups to invest in (4) A lot of money chasing after startups means the valuations go high (5) The startups can't meet the valuation expectations, then get stuck Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance The biggest challenges in obtaining financing are (1) Raising the right amount of money (2) From the right people (Angels, VC) at your stage of development (3) Asking for money at the right time (4) Exchanging money for shares on the right terms And of course, maintaining positive cash flow as you are trying to grow Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Five principles are basic for successful start-ups before financing: (1) Get operational as fast as possible (bootstrapping or minimal investment) (2) Look for quick, break-even, cash generating projects (3) Offer high-value products and personal selling to get sales (4) Focus on cash-flow and cultivate relationships (banks, investors) (5) Try to go slow until you must go fast, wait to hire the perfect team Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Moreover, the funding provided by Angels and Venture Capitalists will reflect the overall state of the economy To survive you must understand how to manage risk & cash flow Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What is more important? Profit Cash Flow Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Profit is the revenue remaining after deducting business costs Cash flow is the amount of money flowing in and out of a business at any given time. Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Profit is more indicative of your business's long-term success Cash flow is needed to keep the business operating on a short-term day-to-day basis Without cash flow there is no business (today, short-term) without profit there is no business (tomorrow, long-term) Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance The overall economic situation will impact your ability to raise capital Knowing how to forecast the overall economy will make you smart Not have easy access to financing will make you stronger Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Macroeconomic conditions affect the supply of capital Good conditions money is easy to find, investors seek risk Bad conditions and money is very hard to find, investors avoid risk Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance How can you prepare? You need to construct an economic model to help manage Risk Cash Flow Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be tested. Economic models can be quite simple The best economic model is one that is simple and accurate Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance The best model would be one that had 3-4 variables that explain about 75% - 90% of what actually happens This way you can focus with all your time and effort at understanding these most important variables Unfortunately, the news bombards us with data and a thousand variables that aren´t as important as those 3 or 4 big ones Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance You must understand how the economy really works to ask for $$$ Because there is only one way to succeed when making investments Avoid catastrophic mistakes and take calculated risks at the right time This requires using deductive reasoning and risk management Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance To be in the Top 1% You must understand how the economy really works Must understand 4 variables that make up our macroeconomic model (1) Trend in Productivity (2) Trends in Demographics (3) Short-term Business Cycle (4) Long-term Credit-Debt Cycle Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Knowing how the economy really works will impress your investors You don't have to be an economist to understand the economy Entrepreneurs must know underlying economic conditions at all times Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What is productivity? Why is understanding productivity important? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What is productivity? Productivity is the real value of output per hour worked during a certain time As technology improves we can do more with less (But beware, just because we can do more, doesn´t mean we get paid more) Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Wealth creation is tied to productivity growth This is the same for an individual, a startup, established firm, and a country Spain Productivity Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Why do you think that productivity rose in Spain during the crisis? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Why do you think that productivity rose in Spain during the crisis? (1) Inefficient firms closed (2) Many people lost their jobs (3) The same amount of output was done with fewer workers Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Using what we have learned so far: (1) Productivity has slowed down from 3% to 1% over the last 20 years (2) Technology hasn't generated the productivity we hoped for (3) Startups that target inefficiencies can increase a nation's wealth Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What is demographics? Why is understanding demographics important? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Demographics are a key part of your small business marketing strategy, as they help you identify the individual members of your audience by certain characteristics, wants and needs. Demographic data is used by businesses to help them understand the characteristics of the people who buy their products and services. Entrepreneurial Finance: Week 01 Aging populations will cause shifts in consumption patterns away from activities that are easier to enter for first-time entrepreneurs If you know the underlying trends you will appear very smart when talking to investors Remember that investors are worried about losing money Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What does demographics tell us about spending patterns? Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance What does demographics tell us about spending patterns? Its shows us Buyers vs Dyers Buyers boost the economy Dyers drag the economy down Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Under 18s drag the economy as they consume more than produce But young people add to the economy when they enter the workforce in 20s The biggest driver of the economy are the parents who are spending both on themselves and their under 18 children (25-55 age groups) So the economy is stimulated most by those in the 25-55 groups Finally, the economy will be slowed down by 65-100 year old Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Peak spending occurs in the 25-55 group borrowing Demographic bulges boost the economy followed by a major drag If we have a demographic bulge in the 25-55 it will result in very high growth Credit borrowed today adds to spending but is debt that is repaid later This has major effects on the economy (first good, then bad) Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Different age groups have different spending patterns What can we learn from demographics to understand the economy What type of products do you think will be important in the future Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance That brings us to the next two economic factors Short-term business cycle Long-term business cycle  Ray Dalio – How the Economic Machine Works https://www.youtube.com/watch?v=PHe0bXAIuk0&t=427s Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance The macroeconomy Interest payments as a % of GDP Growing faster than actual increase in GDP Interest payments > Productivity US Personal Interest Payments Spain Public (Government) Debt to GDP Ratio 2060: Japan, Korea, Spain, Greece, Portugal, Italy Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance How could we make a model of this? Productivity Demographics Short-term business cycle Long-term business cycle Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance GDP Spending = Productivity (Producing more with less resources) Demographics Credit Growth Credit Repayment Entrepreneurial Finance: Week 01 Introduction to Entrepreneurial Finance Demographic bulges lead to higher spending in the economy Higher spending leads to a booming economy A booming economy leads people to borrow money to spend more This increases the overall level of debt When that bulge then retires, if debt remains, growth slows down