ENTREPRENEURIAL FINANCE

LECTURE 1. INTRODUCTION.

OLGA GUSEVA, HSE Icon made by Icongeek26 www.flaticon.com 1

COURSE INFORMATION

Email: oguseva@hse.ru; olga.gusevaa@gmail.com

Course literature:
¢ [SMITH] Smith, J., Smith, R. L., Smith, R., & Bliss, R. (2019). Entrepreneurial finance:
strategy, valuation, and deal structure. Stanford University Press.
¢ [LEACH] Leach, J. C., & Melicher, R. W. (2011). Entrepreneurial finance. Nelson
Education.
¢ [Metrick] Metrick, A., & Yasuda, A. (2021). Venture capital and the finance of
innovation. John Wiley & Sons.

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 GRADING POLICY

3 written homeworks, incl.: 50%

Business plan preparation* - group 15%

Valuation exercise - group 15%

Written case - individual 20%

Active participation in course 10%

Final class participation, incl.: 40%

Presentation 30%

Evaluation of peers’ presentation 10%

*https://www.forbes.com/sites/allbusiness/2018/09/17/dont-waste-time-on-a-startup-business-plan-do-these-5-
things-instead/#2a4e91e537a6
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SYLLABUS

1. Introduction. Entrepreneurship: from idea to business. Identification of

entrepreneurial opportunities. New venture life cycle. Innovative industries.
2. Entrepreneurial characteristics. Corporate governance and entrepreneurial firms.
Sources of financing
3. Unit economics. Business plan and pitch deck.
4. Financing options of a new venture. Financing choices. Assessing financial needs.
Real options.
5. New venture valuation. Real option valuation. Entrepreneur’s and venture capital
fund’s perspective on valuation.
6. Venture capital and private equity finance: organization, investment selection.
Government venture funds.
7. Deal terms. Incentive problems, information problems. Contract design.
8. Exit options. Recent research: crowdfunding, angel and venture fund finance and
debt for entrepreneurs.

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 WHAT IS ENTREPRENEURIAL FINANCE?

¢ Entrepreneurship: the pursuit of opportunity without regard to tangible

resources currently controlled

¢ Finance: allocation of scarce resources – cash/risk/value

¢ Entrepreneurial Finance: the pursuit of opportunity to create value

Literature: Sahlman (1997)

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 ENTREPRENEURIAL FINANCE VS. CORPORATE FINANCE

1. Interdependence between investment and financing decision

¢ Entrepreneur has to convince investor
¢ Different value on the new venture of entrepreneur and well-diversified investor
¢ Some investment choices are contingent upon certain financing choices

2. Underdiversification as a determinant of the investment value

¢ In corporate finance discount factor depends only on nondiversifiable risk
¢ The entrepreneur often has to invest a large fraction of his or her financial and human
capital

Literature: Smith, chapter 1

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 CORPORATE FINANCE VS. ENTREPRENEURIAL FINANCE

3. Managerial involvement of investors

4. Information problems and contract design

¢ Information gaps need not materially affect the investment decisions of public
corporation managers
¢ Importance of signals of entrepreneur’s confidence in new venture

5. Importance of incentive alignment and contract design

¢ Investors often invest in the project with unproven entrepreneurs

6. Importance of real options

¢ Stages of capital investments, abandonment of the project, growth rate acceleration,
etc. all involve real options

Literature: Smith, chapter 1

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 CORPORATE FINANCE VS. ENTREPRENEURIAL FINANCE

7. Harvesting the investment

¢ Illiquidity of new venture investments
¢ Specific harvesting opportunities to realize returns on investment in new venture:
acquisition for cash, IPO

8. Value to the entrepreneur

¢ Aim of the entrepreneur is to maximize the value of the financial claims and other
benefits that the entrepreneur is able to retain

Literature: Smith, chapter 1

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 ENTREPRENEURSHIP
Definition:
”The pursuit of opportunities to combine and redeploy resources, without regard to
current ownership or control of the resources”

What are characteristics of good entrepreneurial opportunities?

¢ Satisfy need or solve a problem for a customer
¢ Identify new product, process, service, market
¢ Demonstrate an advantge over existing solutions
¢ Create value for involved parties

*Although in 1989 founders of the nation’s 500 fastest-growing privately held companies
responded that 88% of them attributed success to exceptional execution of an ordinary
idea and 12% - to an unusual or extraordinary idea. (Case, 1989, Inc.)

Literature: Smith, chapter 1

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 TYPES OF ENTREPRENEURSHIP

Replicative Innovative

• Efficient resources coordinators • Add huge value to the economy

• Often stay small • High-risk and high-return
• Copy predecessors business models • Challenge existing business models

Literature: Smith, chapter 1

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 TYPES OF ENTREPRENEURSHIP

Opportunity-based Necessity-based

• Innovative entrepreneurship is mostly • Lack of alternatives as motivation

opp.-based

Source: Smith, chapter 1; Global Entrepreneurship Monitor 2018/2019

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 SOURCES OF ENTREPRENEURIAL OPPORTUNITIES

¢ Societal trends or changes

¢ Changes in preferences about food (e.g., gluten- free), housing, leisure, etc.
¢ Economic shifts (e.g. changing savings patterns)
¢ Changes in legal environment (e.g. banking deregulation)

¢ Demographic trends or changes

¢ Aging of the population
¢ Increase in number of migrants worldwide

Literature: Leach, chapter 1

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 SOURCES OF ENTREPRENEURIAL OPPORTUNITIES

¢ Technological trends or changes

¢ Major advances in technology: computer industry, instant messaging, e-commerce

¢ Crises and “bubbles”

¢ Significant government support in times of crisis
¢ Lower level of competition

Literature: Leach, chapter 1

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 ENTREPRENEURIAL OPPORTUNITIES AND IDEAS

Guidelines for entrepreneurial ideation:

¢ Immersion
¢ Obsession
¢ Incubation
¢ Recombination
¢ Clarification
¢ Collaboration

Source: Eisenmann et al. (2013)

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 Y COMBINATOR

Source: https://www.ycombinator.com/topcompanies
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 ENTREPRENEURIAL OPPORTUNITIES AND IDEAS

Sam Altman (president of Y Combinator)

¢ “Having ideas is among the most important qualities for a startup founder to have—
you will need to generate lots of new ideas in the course of running a startup.”
¢ ”It’s important to be in the right kind of environment, and around the right kind of
people. You want to be around people who have a good feel for the future, will
entertain improbable plans, are optimistic, are smart in a creative way, and have a very
high idea flux.”
¢ “Another way to do this is to think about the most important tectonic shifts happening
right now. How is the world changing in fundamental ways? Can you identify a leading
edge of change and an opportunity that it unlocks?”
¢ “When you can say “I am sure this is going to happen, I’m just not sure if we’ll be the
ones to do it”, that’s a good sign. A good question to ask yourself early in the process of
thinking about an idea is “could this be huge if it worked?”
¢ “A good test for an idea is if you can articulate why most people think it’s a bad idea, but
you understand what makes it good.”

Source: https://blog.samaltman.com/idea-generation
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 SOURCES OF ENTREPRENEURIAL OPPORTUNITIES

¢ ”Every startup should start with a very small market”.

¢ “All happy companies are different: each one earns a monopoly by solving a
unique problem. All failed companies are the same: they failed to escape
competition.”

As of May 2014, it owns

about 68% of search
market

Source: Thiel P. (2014). Zero to One: Notes on Startups, or How to Build the Future
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 SURVIVAL RATES OF NEW VENTURES
Survival rates of new ventures in the US

Literature: Smith, chapter 1 based on Bureau of Labor Statistics

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 100
120

0
20
40
60
80
New Zealand
Georgia
Canada
Singapore
Hong Kong SAR, China
Jamaica
Australia
Uzbekistan
Azerbaijan
Armenia
Greece
Kosovo
Moldova
Estonia
Togo
Brunei Darussalam
United Arab Emirates
United Kingdom
Tunisia
Mauritius

Doing business

Based on Doing Business (doingbusiness.org/rankings)

Taiwan, China
Kazakhstan
Ireland
Netherlands
Norway
Latvia
China

Starting business
Israel
Côte d'Ivoire
Belarus
Finland
Oman
Korea, Rep.
Lithuania
Rwanda
Tajikistan
France
Saudi Arabia
Sweden
Russian Federation
Slovenia
GLOBAL DIFFERENCE IN SUPPORT FOR STARTING AND DOING BUSINESSS

Kyrgyz Republic
Morocco
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 WHY DO STARTUPS FAIL?

Source: https://www.cbinsights.com/reports/CB-Insights_Top-Reasons-Startups-Fail.pdf? 20
QUIBI

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 QUIBI

Source: https://www.cnbc.com/2020/10/21/quibi-to-shut-down-after-just-6-months.html 22
 STARTUP FINANCING

Investment materials as storytelling in fundraising:

¢ Pitch: section of an investor meeting where you present your case.
¢ Memo: a clear and concise articulation of the key components of your company
and what the rationale is for investing in it.
¢ Deck: a visual support to the words said in a pitch.

Source: YCombinator
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 GUIDE TO PITCHING FROM SEQUOIA

¢ Company purpose: single declarative sentence.

¢ Problem: pain of your customer.
¢ Solution Why is your value prop unique and compelling?
¢ Why now?
¢ Market potential: your customer and your market.
¢ Competition / alternatives
¢ Business model: How do you intend to thrive?
¢ Team
¢ Financials
¢ Vision: what will be in 5 years?

Source: https://www.sequoiacap.com/article/writing-a-business-plan/#
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 SOME STATISTICS

Which pages matter most within the pitch?

“Although the financial category takes the place, only 58 percent of successful decks
have this section.”

Source: DocSend. Fundraising research, 2020

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 FINANCIAL METRICS USED TO ANALYZE INVESTMENTS BY VC

Source: Gompers, P. A., Gornall, W., Kaplan, S. N., & Strebulaev, I. A. (2020). How do venture capitalists make
decisions?. Journal of Financial Economics, 135(1), 169-190.
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 STAGES OF NEW VENTURE DEVELOPMENT

Source: Leach (2010)

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 STAGES OF NEW VENTURE: OPPORTUNITY AND DEVELOPMENT

Opportunity (before significant

expenses)
Financial performance and stages of new development
Actions: obtain seed financing, assess
alternatives, determine organizational
form and structure, prepare business
plan/model
Development (before revenue
generation)
Actions: obtain R&D financing, develop
prototype, perform beta testing, market
research, update business model/plan
Revenue: no
Net Income: negative (increase in
resources for product development)
Cashflow: initially very negative (CAPEX)

Source: Smith, chapter 1

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 STAGES OF NEW VENTURE: START-UP AND EARLY-GROWTH

Start-up (start of production, marketing

and revenue generation)
Financial performance and stages of new development
Actions: obtain start-up financing,
purchase facility/eqiupment, start
production, complect sales and marketing
teams
Revenue: starts to grow
Cashflow: decrease (investment in
facilities/production)
Early-growth (before cash-flow break-
even)
Actions: obtain early-growth financing,
expand team and facilities
Revenue: growth
Net Income and Cashflow: negative

Source: Smith, chapter 1

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 STAGES OF NEW VENTURE: START-UP AND EARLY-GROWTH

Expansion (before sustainable viability)

Actions: obtain expansion financing, Financial performance and stages of new development
expand team and eqiupment, build track
for harvest
Revenue: rapid growth
Exit (activities enable harvesting of first
investors)
Actions: obtain continuing financing (IPO,
buyout), investors harvesting
Cashflow: positive

Source: Smith, chapter 1

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ANIMORPHS

Unicorns Camels

• Startup with valuation of over $1bn • Lower-risk and long-term approach

• As of September 2021 there are more than • Survive in volatile (and emerging) markets
800 unicorns around the world • Embrace VC, but less than unicorns
(cbinsights.com)
• Fewer than 1% of VC backed companies

Zebra Gazelles

• For-profit venture with social orientation • Rapid revenue growth

• Promote diversity • Revenue over $1mn
• Tend to avoid equity financing • Recently: successful startups from Africa

Icon made by Freepik from www.flaticon.com 31

 LIST OF UNICORNS

Source: https://www.cbinsights.com/research-unicorn-companies as of September 2021

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UNICORNS WITH RUSSIAN ROOTS

Global financial superapp Cyber portection solutions

UK Switzerland

Graphene nanotubes Passenger service

Luxemburg USA

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 LIST OF UNICORNS

Source: https://www.cbinsights.com/research-unicorn-companies as of September 2021

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 EPIC GAMES VS. APPLE

Source: https://www.bbc.com/news/technology-58522588
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 INNOVATIVE INDUSTRIES

Source: KPMG Venture Pulse, Q2 2021

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 INNOVATIVE INDUSTRIES: TOP-10 GLOBAL FINANCING IN Q2 2021

Source: KPMG Venture Pulse, Q2 2021

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STARTUP TECHNOLOGIES

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 STARTUP BAROMETER IN RUSSIA 2021

What technologies are used by Russian

startups?

Source: Startup Barometer (2021)

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 GOVTECH

$400 bn spend on government technologies worldwide (Accenture, 2018)

¢ Solutions for the effective delivery of public services to citizens
¢ Solutions to improve governance and the interaction of state mechanisms with
each other

Literature: Startup Barometer (2021)

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 GAMECHANGERS 2021: ENVIRONMENT
¢ Green hydrogen: a zero-emission ¢ Protein fermentation: producing
source of power that could animal-free protein that can be
substantially reduce CO2 emissions used for a wide range of foods

Source: CB Insights. (2021) Game changers 2021.

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 GAMECHANGERS 2021: HEALTHCARE
¢ Space-based R&D: space providers for ¢ Bioprinting: 3D printing using cells
space-based experimentation and biomaterials to create living
biological tissue

¢ Ambient intelligence: AI and IoT-enabled environments that are responsive to

the presence of people
Improving coverage in hospitals and nursing homes

Source: CB Insights. (2021) Game changers 2021.

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 GAMECHANGERS 2021: EDUCATION
¢ Intelligent tutoring: adaptive and personalized learnings

Source: CB Insights. (2021) Game changers 2021.

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 GAMECHANGERS 2021: PRIVACY
¢ Cookie-busting ads: analysis of media to understand the context and targeting
ads based on content

¢ Differential privacy: transformation of sensitive data with AI to analyze without

exposing confidential information

Source: CB Insights. (2021) Game changers 2021.

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 GAMECHANGERS 2021: FINANCIAL INDEPENDENCE

¢ Creator platform: infrastructure to support content producers

¢ Own-a-piece of anything: turning high-value items into investsble assets

Source: CB Insights. (2021) Game changers 2021.

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QUESTION TO YOU

What significant truth do the minority of people agree with you on?

Submit the answer by 04/10/2021

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