chapter 10

Question 1

cash flow challenges

Answer 1

as a firm grows, it requires an increasing amount of cash to operate as the foundation for serving its customers. the lag between spending to generate revenue and earning income from the firm’s operations can create cash flow challenges.

Question 2

burn rate

Answer 2

a firm’s negative real-time cash flow, usually computed monthly, when a firm operates in the red. it is the rate at which it is spending its capital until it reaches profitability. a firm usually fails if it burns through all of its capital before it becomes profitable.

Question 3

personal funds

Answer 3

involve financial resources and sweat equity.

Question 4

sweat equity

Answer 4

represents the value of the time and effort that a founder puts into a firm.

Question 5

promissory note

Answer 5

details the terms of a loan agreement.

Question 6

bootstrapping

Answer 6

finding ways to avoid the need for external financing or funding through creativity, ingenuity, thriftiness, cost-cutting, or any means necessary. however, cost-cutting and saving money should not be pushed too far since it can hold a business back from reaching its full potential.

Question 7

equity financing

Answer 7

means exchanging partial ownership of a firm, usually in the form of stock, in return for funding. the stock is typically sold following a liquidity event. the primary disadvantage is that the firm’s owners relinquish part of their ownership interest and may lose some control. the primary advantage is access to capital. unlike a loan, the money received does not have to be paid back. the most common forms are; (1) business angels, (2) venture capital, and (3) initial public offering.

Question 8

liquidity event

Answer 8

an occurrence that converts some or all of a company’s stock into cash.

Question 9

debt financing

Answer 9

getting a loan.

Question 10

elevator speech/pitch

Answer 10

a brief, carefully constructed statement that outlines the merits of a business opportunity in 45 seconds to 2 minutes.

Question 11

business angels

Answer 11

individuals who invest their personal capacity directly in start-ups. angel investors can add tremendous value to companies through access to capital along with their expertise, networks, and guidance.

Question 12

yield rate

Answer 12

defined as the percentage of investment opportunities that are brought to the attention of angel investors that result in an investment.

Question 13

venture capital

Answer 13

money that is invested by venture capital firms in start-ups and small businesses with exceptional growth potential. a distinct difference between angel investors and venture capital firms is that angels tend to invest earlier in the life of the company, whereas venture capitalists come in later.

Question 14

limited partners

Answer 14

investors who invest in venture capital funds.

Question 15

general partners

Answer 15

the venture capitalists who manage the fund. they receive an annual management fee in addition to 20 to 25 percent of the profits earned by the fund.

Question 16

carry

Answer 16

the percentage of the profits the venture capitalists receive.

Question 17

follow-on funding

Answer 17

the subsequent investments made in rounds after a venture capitalists makes an investment in a firm.

Question 18

due diligence process

Answer 18

an important part of obtaining venture capital funding. it is the process of investigating the merits of a potential venture and verifying the key claims made in the business plan.

Question 19

corporate venture capital

Answer 19

type of capital similar to traditional venture capital except that the money comes from corporations that invest in start-ups related to their areas of interest.

Question 20

initial public offering (IPO)

Answer 20

the first sale of stock by a firm to the public.

Question 21

secondary market offering

Answer 21

public issuance of shares after the first sale of stock.

Question 22

Sarbanes-Oxley Act (2002)

Answer 22

established a number of new or enhanced reporting standards for public corporations to follow after the Enron scandal. it initiated many of the costliest requirements.

Question 23

preliminary prospectus

Answer 23

describes the offering to the general public during the time the SEC is investigating the potential offering.

Question 23

investment bank

Answer 23

an institution that acts as an underwriter or agent for a firm issuing securities. it acts as the firm’s advocate and adviser and walks it through the process of going public. it must satisfy a number of stipulations to assure the Securities and Exchange Commission (SEC) that the offer is legitimate.

Question 24

final prospectus

Answer 24

issued after the SEC has approved the offering.

Question 25

road show

Answer 25

a whirlwind tour that consists of meetings in key cities, where the firm presents its business plan to groups of investors. the investment bank takes the top management team of the firm wanting to go public, as the investment bank is responsible for drumming up support for the offering.

Question 26

private placement

Answer 26

the direct sale of an issue of securities to a large institutional investor. when it is initiated, there is no public offering and no prospectus is prepared. it is a variation of the IPO.

Question 27

single-purpose loan

Answer 27

a specific amount of money is borrowed that must be repaid in a fixed amount of time with interest.

Question 28

line of credit

Answer 28

a borrowing ‘cap’ is established, in which borrowers can use the credit at their discretion. it requires periodic interest payments.

Question 29

commercial banks

Answer 29

have not been viewed as practical sources of financing for start-up firms. they have been reluctant to lend money to historically because; (1) banks are risk averse, and (2) lending to small firms is not profitable as lending to large firms.

Question 30

SBA Guaranteed Loan Program

Answer 30

commercial banks, saving and loans, credit unions, and other specialised lenders are eligible to participate.

Question 31

7(A) Loan Guaranty Program

Answer 31

the most notable SBA program available to small businesses. it accounts for 90% of the SBA’s loan activity and operates through private-sectory lenders who provide loans that are guaranteed by the SBA.

Question 32

peer-to-peer lenders

Answer 32

underwrite borrowers but do not fund the loans directly. instead, they act as intermediaries between borrowers and individuals or borrowers and institutional investors.

Question 33

vendor credit

Answer 33

the credit extended to a business by a vendor in order to allow the business to buy its product and/or services up front but defer payment until later.

Question 34

factoring

Answer 34

a financial transaction whereby a business sells its account receivable to a third party, called a factor, at a discount in exchange for cash.

Question 35

crowdfunding

Answer 35

the practice of funding a project or new venture by raising monetary contributions from a large number of people, typically via the internet. there are two types of crowdfunding sites; (1) rewards-based crowdfunding, and (2) equity-based crowdfunding.

Question 36

rewards-based crowdfunding

Answer 36

allows entrepreneurs to raise money in exchange for some type of amenity or reward.

Question 37

equity-based crowdfunding

Answer 37

helps businesses raise money by tapping individuals and professional investors who provide funding in exchange for equity in the business. when it was first introduced, it was limited to accredited investors. it opened up to individuals regardless of net worth or income in 2016.

Question 38

accredited investor

Answer 38

a person who is permitted to invest in higher risk investments such as business start-ups.

Question 39

lease

Answer 39

written agreement in which the owner of a piece of property allows an individual or business to use the property for a specified period of time in exchange for payments.

Question 40

venture-leasing firms

Answer 40

act as brokers, bringing the parties involved in a lease together. most leases involve a modest down payment and monthly payments during the duration of the lease.

Question 41

Small Business Innovation Research (SBIR)

Answer 41

a competitive grant program that provides over $2.5 billion per year to small businesses for early-stage and development projects.

Question 42

Small Business Technology Transfer (STTR)

Answer 42

a variation of the SBIR for collaborative research projects that involve small businesses and research organisations. the main difference between SBIR and STTR programs is that the STTR program requires the participation of researchers working at universities or other research institutions.

Question 43

strategic partners

Answer 43

another source of capital for new ventures. they often play a critical role in helping young firms fund their operations and round out their business models.