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FIN510 - Chapter #1.docx

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ECN 204
Christopher Gore

Chapter 1 – Introduction and Overview ­ Small Business Administration (SBA) - established by the federal government to provide financial assistance to small businesses The Entrepreneurial Process ­ Process: o Developing opportunities  Must take time and effort to examine the feasibility of an idea screen it as a possible venture opportunity, analyze the related competitive environment, develop a sound business model and prepare a convincing business plan o Gathering resources  Physical assets, intellectual property, human resources, and financial capital necessary to move from opportunity to entrepreneurial venture  Every startup needs “seed” financing and must have a strategy for acquiring it o Managing and building operations  Generate revenues to cover operating costs in the foreseeable future  provide enough cash flow to cover planned expansion and reinvestment ­ Goal: o Creating value ­ Entrepreneurship: process of changing ideas into commercial opportunities and creating value ­ Entrepreneur: individual who thinks, reasons, and acts to convert ideas into commercial opportunities and to create value Entrepreneurial Traits or Characteristics ­ A successful entrepreneur o Sees and seizes a commercial opportunity o Tends to be doggedly optimistic (perhaps even to a fault) o Plans to obtain the physical, financial, and human resources needed for the venture to succeed o Personality à Behavior à Result o Can one learn behavior? Yes o Can one change own personality? Maybe, provided own desire + systematic effort are present Non-Entrepreneurial Traits or Characteristics ­ Success is unlikely if you o “are seldom able to see an opportunity, until it ceases to be one” (Mark Twain) o “view the glass as being half empty instead of half-full” (unknown) o are paralyzed by a fear of failure Opportunities Exist but Not Without Risks ­ Opportunities: o New U.S. business formations in the millions annually  Small and growing enterprises are critical to the US economy  small firms provide 60 to 80 percent of net new jobs o Firms with less than 500 employees  represent over 99 percent of all employers  account for about one-half of the annual gross private domestic product o Small high-technology firms are responsible for twice as many product innovations per employee, and obtain more patents per sales dollar, than large high-technology firms. ­ Risks: o Annual employer firm births (~659,093 in 2005-07) slightly exceeds births (~578,793 in 2005-07) o Note, however, that bankruptcies are only a fraction (~29,073) of terminations - terminations not all “bad” o For new firms, a representative study found  (a) one-third of new employer firms endure < 2 years  (b) one-half endure < 4 years  (c) 60 percent endure < 6 years  (d) but, about one-third were “successful” at closing o Small high-technology firms are responsible for twice as many product innovations per employee, and obtain more patents per sales dollar, than large high-technology firms o Nearly half of business failures are due to economic factors such as inadequate sales, insufficient profits, or industry weakness o Almost 40 percent cite financial causes, such as excessive debt and insufficient financial capital. Other reasons include insufficient managerial experience, business conflicts, family problems, fraud, and disasters o Commercial vision, an unrelenting drive to succeed, the ability to build and engage a management team, a grasp of the risks involved, and a willingness to plan for the future are some of the ingredients for success EXAMPLE: You have the opportunity to invest $3,000 in one of two investments. The first investment would pay you either $2,700 or $3,300 at the end of one year (50%-50%) depending on the success of the venture. The second investment would pay you either $2,000 or $4,000 at the end of one year depending on the success of the venture. Which investment would you choose and why? Now, would your answer change if your investment were only $1? First investment: ($2700 + $3300)/2 = $3000 Second Investment: ($2000 + $4000)/2 = $3000 Investment #2 is riskier, risk averse will choose #1, risk loving will choose #2 if initial investment is $3000. Risk neutral will not interest. Sources of Entrepreneurial Opportunities ­ Entrepreneurs are the primary engine of commercial change in the global economy ­ Entrepreneurial opportunities are ideas that have the potential to create value through new, repackaged, or repositioned products, markets, processes, or services ­ Megatrends are large societal, demographic, or technological trends or changes that are slow in forming but, once in place, continue for many years ­ Fads are not predictable, have short lives, and do not involve macro changes ­ Trends suggesting possible entrepreneurial innovations o Societal changes o Demographic changes o Technological changes o Crises and bubbles ­ Societal Changes o Naisbitt’s reflections still relevant! (Megatrends,1982)  “Industrial Society” to “Information Society”  He argued that successful new technologies would center on the human response to information  Many of the commercial opportunities in the past two decades have capitalized on information creation and organization and its central role in human decision support o Increasingly affected by a global economy  Awareness of international innovation and sourcing o Two that will undoubtedly influence future commercial opportunities  demographic shifts associated with the baby boom generation  our increasingly information-oriented society o Pervasive trends  Social changes are reflected in important changes in preferences • birth of many entrepreneurial opportunities as innovators position themselves to satisfy the demand for the related new products and services  Economic shift - the rise of two-career families, higher disposable incomes, changing savings patterns  Legal environment can introduce important economic opportunities by eliminating existing barriers to entry ­ Demographic Changes o Dent’s Generations – The Baby Boom  1970s and early 1980s – an innovation wave • Boomers were heavily involved in developing, innovating, and adopting new technologies  Spending wave (1990’s) • Behind the expansion of stock and bond market booms  Power wave (to peak in the 2020’s) • Aging baby boomers with great business influence • Aging baby boomers provide business opportunities – creating them, financing them, using them  Boomers continue to spend at record levels; “consumer confidence” is a key ingredient to America’s continued prosperity and expansion ­ Technological Changes o Information Age – late 1950’s – early 1960’s  Important factor was the computer chip  Introduction of telecommunication satellites o Internet  incredibly diffuse collection of computers networked together  Internet became the infrastructure for the “World Wide Web,” a user-friendly and commercially attractive foundation for many new ways of doing business  Electronic commerce, or e-commerce, involves the use of electronic means to conduct business online o Wireless o Cross-functionality o Truly global in reach and competition ­ Crises and Bubbles o 2007-09 Financial crisis changed the game o Cost-cutting coupled with economic growth during the 1990s led to the availability of excessive amounts of financial capital as the twentieth century came to an end o Unable to find funding for ventures o Cloudy time almost always have silver linings  Cost containment innovations  Alternative energy  Government stimulus ­ Importantly for aspiring entrepreneurs, these dark and cloudy times almost always come with a silver lining. ­ For this most recent financial crisis, it appears that one nascent sector that benefitted dramatically during the time of crisis was alternative and renewable energy. ­ Subsidies abounded with project credits, production and investment tax credits, and loan guarantees. ­ Additionally, even in the absence of crisis-related government favoritism for certain sectors, while many entrepreneurs suffer dearly as their ventures fail, others benefit from consolidation and the resulting lower level of competition due to the shakeout. ­ Many aspiring entrepreneurs and investor connections are made during the fallout from major economic crises. Principles of E-Finance ­ Real, Human, and Financial Capital Must be Rented from Owners o Money has owners and therefore costs  Time value • The time value of money is an important component of the rent one pays for using someone else’s financial capital • When you rent the money, it cannot be rented to others, and you must expect to compensate the money’s owner for that loss  Risk o The seed money used to start the venture could have been put to use elsewhere to earn interest o Expect to provide a return or the venture will not survive in a market economy ­ Risk and Expected Reward Go Hand in Hand o Time value is not the only cost when using others’ funds o More risk => More expected reward o How much more? Market-determined! ­ While Accounting is the Language of Business, Cash is the Currency o Two important reasons to employ accounting  Tracking and accountability for actions taken  Quantifying different visions of the future o But, remember cash flow is a new venture’s lifeblood  “Get enough accounting to see through the accruals to the cash account”  Cash burn: gap between cash being spent and that being collected  Cash build: excess of cash receipts over cash distributions ­ New Venture Financing Involves Search, Negotiation, and Privacy o Public Financial Markets:
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