Chapter 9

Question 1

working capital

Answer 1

short-term operational needs such as paying suppliers or employee salaries

Question 2

Investment capital

Answer 2

(medium/long) fund the purchase of a one-off physical asset such as a car or machinery or breaking into a new market, marketing and sales development, supporting research and development.

Question 3

Insider finance

Answer 3

own money, own loan, friends, family etc.

Question 4

retained earnings

Answer 4

keep money made (profit) in business useful because you don’t rely on other people for money.

Question 5

External sources of finance

Answer 5

money from outside sources.

Question 6

Kinds of external sources

Answer 6

Public funders, Banks, Crowdfunders, Asset financiers, Trade creditors, Factors and invoice discounters, Equity funders

Question 7

Public funders

Answer 7

local, regional and national governments provide grants, ‘soft’ loans, loan guarantees, and equity finance.

Question 8

Types of crowdfunding

Answer 8

donations, rewards, loans and equity-based funding.

Question 9

Asset financiers

Answer 9

they pay for assets and you pay them back or lease from them.

Question 10

Trade creditors

Answer 10

suppliers agree to supply a good or service on account and ask for payment at a specified later date.

Question 11

Factors and invoice discounters

Answer 11

A third party gives you money for your invoices (facturen) that are not paid yet on condition they have a % of the invoice amount.

Question 12

2 types of equity funders

Answer 12

1. Business angels (own money), 2. Venture capitalists (others money)

Question 13

What do most small businesses use

Answer 13

bank loans and internally funded loans from their directors or family. Few use equity funders.

Question 14

the pecking order

Answer 14

people prefer to first use their own and insider money than external debt and then external equity.

Question 15

Why is there a pecking order

Answer 15

because businesses desire to stay in control of their own business.

Question 16

what is another reason start ups need to rely on own funds

Answer 16

because alot of info is opac (only available to the company) and not available to the public like public companies so the investors can’t look at what the entrepreneur is doing + has no asset collateral to fall on.

Question 17

how can a business solve this (assymetry)

Answer 17

give more information so the information is not asymmetrical anymore and once the business is going and shows some revenue it is easier to identify where the business is going.

Question 18

2 forms of asymmetries

Answer 18

adverse selection and moral hazard

Question 19

Adverse selection

Answer 19

when one party (the entrepreneur) has more information than another (the financier) before a deal is struck.

Question 20

Moral hazard

Answer 20

occurs after a deal is struck, usually because the financier (the principal) has failed to anticipate a change in the agent’s (entrepreneur) behaviour.

Question 21

what do bank and others use to prevent this asymmetry

Answer 21

credit scores to get information about credit history get other hard information from management accounts and business plans

Question 22

what is soft information and what does it do

Answer 22

you build a relationship → relationship-based lending → reduce the need for collateral, improve the prospects of getting finance and reduce interest rates costs.

Question 23

permanent non-borrowers

Answer 23

have not sought external finance in the last five years

Question 24

how to prevent moral hazard

Answer 24

have collateral

Question 25

skin in the game

Answer 25

putting an x amount of money in your own business

Question 26

what is the sequence of funding

Answer 26

often start the stamp of self-funding complemented with public funding, crowdfunding, or business angel finance, once revenue starts you can get a bank loan, and post revenue with the potential to fast growth you can use venture capital equity funding

Question 27

four main consequences of financial constraints

Answer 27

1. It prevents talented but poor individuals from becoming entrepreneurs, 2 Start-ups are under-capitalised, 3. Business costs increase, and 4. Business growth is restricted and productivity falls.

Question 28

difference men and women internal and external capital

Answer 28

women use at start up more internal capital and later on use about half of external capital men use and this remains as business grow.

Question 29

discouraged borrowers

Answer 29

The fear of being rejected can also be enough to discourage some businesses from applying for finance, even if they are creditworthy.

Question 30

four main sources of finance

Answer 30

the bank, business angels, venture capitalists and crowdfunders.

Question 31

CAMPARI screening banks use

Answer 31

Character, Ability, Margin, Purpose, Amount, Repayment, Insurance.

Question 32

misunderstanding about angels

Answer 32

they also provide debt funding

Question 33

Angels’ common complaints

Answer 33

Weak team or management, Lack of intellectual property rights, immature working prototypes, limited sales, incomplete financial model, Sluggish market growth, Immature understanding of competitors, Limited plans for marketing.

Question 34

2 key metrics angels focus on

Answer 34

1. Return on Investment (ROI), 2. Internal Rate of Return (IRR) (ROI, but additionally takes account of time).

Question 35

What are 4 important things for angels

Answer 35

value business now, value when sold, how long it will take to sell, and what the ROI and IRR will be.

Question 36

what aim angels investors for

Answer 36

25% IRR across the portfolio.

Question 37

pros and cons after having an angel investment

Answer 37

pro: extra knowledge, expertise, and connections
cons: may want different things (sell business for profit) then owners (grow the business)

Question 38

What are VCs looking for when screening

Answer 38

Strength of the team, their industry and entrepreneurial experience, the passion, ability and teamwork, as well as business-related factors such as the product, technology, business model and strong revenue growth potential. They also consider financial prospects (expected IRR and ROI), entrepreneurial passion and the business’ fit with the fund, because they typically will only invest in industries or sectors where they believe that they have expertise.

Question 39

What is the VCs target

Answer 39

IRR is around 30 percent or a 5x multiple

Question 40

IPO

Answer 40

public stock market

Question 41

what do VCs make

Answer 41

2% management fee of the fund and 20% of the profit above an agreed target (carried interest)

Question 42

carried interest

Answer 42

taking a percentage of the extra profit made on top of the agreed profit

Question 43

Disadvantages of venture capital

Answer 43

they get on board, want to sell the company, get paid when the company is sold before the entrepreneurial team bc preferred shares, can choice to have certain rules set that they pay in stages,anti-dilution clauses → entrepreneur sees their equity share diluted= ,take money out first etc. often only in big cities, similar professional backgrounds needed, entrepreneurs have similar norms, went to the same universities and schools, are male and have shared networks → women and minorities have a smaller chance of getting vc funding

Question 44

advantages of venture capital

Answer 44

add legitimacy, help leverage other funding sources such as bank finance, offer huge sums, they are patient for a return, have money to repeatedly invest, they help society by making it possible for more start-ups to succeed and create wealth. Their networks can help recruitment and business development, while their expertise supports improved managerial professionalism, speeds product development and supports greater innovation towards a successful exit.

Question 45

crowdfunding

Answer 45

the efforts by entrepreneurial individuals and groups – cultural, social, and for-profit – to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries.

Question 46

four basic types of crowdfunding campaigns

Answer 46

1. Donations, 2. Preorders, 3. Peer-to-peer (P2P) loan funding, 4. P2P equity funding.

Question 47

what to be careful about when doing crowdfunding

Answer 47

The crowdfunding platform, Previous successful campaigns, Planning the campaign, The need for a formal pitch deck and business plan, Marketing the campaign.

Question 48

Problems with crowdfunding

Answer 48

all or nothing, pretty low success rate, last resort, hard sometimes to convince investors for more rounds, need to disclose your product and service to market which may result in copycat.

Question 49

summary banks

Answer 49

Banks follow a low-risk, low-return business model that seeks to separate out ‘good’ from ‘bad’ borrowers (adverse selection)

Question 50

summary angels & VCs

Answer 50

Business angels and venture capitalists follow a high-risk, highreturn business model that offers significant amounts of finance, as well as monitoring and value-adding services to fast-growing businesses in the hope of realising a sizeable capital gain.