Über die Autorin bzw. den Autor

Janet Kiholm Smith is the Von Tobel Professor of Economics at Claremont McKenna College. Richard L. Smith is Philip L. Boyd Chair and Professor of Finance and Management Science and Chairman of the Department of Finance and Management Science at the University of California, Riverside. Richard T. Bliss, is an Associate Professor of Finance and was most recently the Division Chair and Barefoot Family Endowed Chair for Finance at Babson College.

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Entrepreneurial Finance

Stanford University Press

Contents

List of Illustrations.........................................................................xviiAbbreviations.................................................................................xxiiiPreface.......................................................................................xxviiAcknowledgments...............................................................................xxxixAbout the Authors.............................................................................xliChapter 1 Introduction........................................................................3Chapter 2 new Venture Financing: Considerations and Choices...................................37Chapter 3 Venture Capital.....................................................................79Chapter 4 new Venture Strategy and Real options...............................................125Chapter 5 Developing Business Strategy Using Simulation.......................................162Chapter 6 Methods of Financial Forecasting: Revenue...........................................205Chapter 7 Methods of Financial Forecasting: Integrated Financial Modeling.....................243Chapter 8 Assessing Financial needs...........................................................297Chapter 9 Foundations of new Venture Valuation................................................341Chapter 10 Valuation in Practice..............................................................386Chapter 11 the entrepreneur's Perspective on Value............................................432Chapter 12 Deal Structure: Addressing Information and Incentive Problems......................477Chapter 13 Value Creation and Contract Design.................................................529Chapter 14 Choice of Financing................................................................571Chapter 15 Harvesting.........................................................................611Chapter 16 the Future of entrepreneurial Finance: A Global Perspective........................658Index.........................................................................................695

Chapter One

What distinguishes the successful entrepreneur and promoter from other people is precisely the fact that he does not let himself be guided by what was and is, but arranges his affairs on the ground of his opinion about the future. He sees the past and present as other people do; but he judges the future in a different way. Ludwig von Mises, Human Action

Thousands of business ventures are started every year. Most fail within a short period. Of those that survive, most achieve only meager success, some achieve rates of return high enough to justify the initial investment, and a few achieve phenomenal success. What distinguishes the successes from the failures? There is not just one answer. A new venture based on a good idea can fail because of poor implementation or bad luck. One that is based on a bad idea can fail despite excellent implementation. Many that survive but do not thrive should never have been undertaken. Sometimes, even when a venture is hugely successful, early financing mistakes limit the entrepreneur's ability to share in the rewards.

This is a book on financial decision making for new ventures. In it, we provide the fundamentals for thinking analytically about whether an opportunity is worth pursuing and about how to apply the tools of financial economic theory to enhance the expected value of the undertaking. Corporate ventures and social ventures face similar challenges to those faced by stand-alone, for-profit ventures. Where there are important differences, we discuss the application of these tools to corporate venturing and social venturing.

1.1 Entrepreneurship and the Entrepreneur

The term "entrepreneur" is of French origin. Its literal translation is simply "undertaker," in the sense of one who undertakes to do something. In the early 1700s, the English banker Richard Cantillon coined the use of the word in a managerial context. He emphasized the notion of the entrepreneur as a bearer of risk, particularly with respect to provision of capital. This early usage, however, does not adequately characterize our current understanding of what it means to be an entrepreneur. Clearly, risk bearing is an aspect of entrepreneurship, but risk is also borne by capital providers who may have no involvement in managing the venture and by employees who may have no financial capital invested.

In the early 1800s, the French economist J. B. Say described the entrepreneur as a person who seeks to shift economic resources from areas of low to areas of high productivity. Although Say's notion points us in a useful direction, it is too general. Most purposeful human activity can be described as shifting economic resources to higher-valued uses (or at least attempting to do so).

The contributions of Cantillon and Say gained renewed attention in the early 1900s through the writings of two other economists. Joseph Schumpeter (1912) viewed the entrepreneur as actively seeking opportunities to innovate. In his view, the entrepreneur is the driver of economic progress, continually seeking to disturb the status quo in a quest for profits from deliberate and risky efforts to combine society's resources in new and valuable ways. In contrast, Frank Knight (1921) conceived of the entrepreneur as a manager of uncertainty and the entrepreneurial function as one of directing resources in the presence of uncertainty (and realizing a reward for performing successfully). Uncertainty, in Knight's view, is an unavoidable aspect of the ordering of economic activity.

Current use of the term "entrepreneurship" derives from these views and from more recent thinking by management scholars such as Peter Drucker. Drucker, who was a personal friend of Schumpeter, describes entrepreneurs as individuals who "create something new, something different; they change or transmute values" (Drucker [1985], p. 20). Today, entrepreneurship is most often described as the pursuit of opportunities to combine and redeploy resources, without regard to current ownership or control of the resources. This notion clearly draws on the definition offered by Schumpeter but adds structure by recognizing that the entrepreneur is not constrained by current control of resources.

Thinking of entrepreneurship in this way suggests a multidimensional process. The entrepreneur must do the following:

1. Perceive an opportunity to create value by redeploying society's resources

2. Devise a strategy for marshaling control of the necessary resources

3. Implement a plan of action to bring about the change

4. Harvest the rewards that accrue from the innovation

This definition is broad enough to encompass entrepreneurship that arises in the for-profit sector, including extant corporations, as well as in the not-for-profit sector, including in universities and charitable foundations.

Survival and Failure Rates of New Businesses

The sequence of actions just outlined seems to suggest that successful innovation necessarily yields a reward. This, of course, is far from true. To be successful, an entrepreneur...