New Venture Creation

Professor Alexander Settles

Entrepreneurial versus Administrative

Drivers of Growth

Life Cycle

Traits Characterizing Rapidly Growing Companies

• High levels of change, ambiguity, and uncertainty

• Ongoing succession of nonlinear and nonparametric events

• Inexperience of management team

• Counterintuitive, unconventional patterns of decision-making

• Informality and fluidity of organization structure and procedure

Entrepreneurial Actions

Entrepreneurial Influence Skills

• Interpersonal/teamwork skills– Ability to create, through management, a climate

and spirit conducive to high performance– Ability to understand the relationships among

tasks and between the leader and followers– Ability to lead in those situations where it is

appropriate

Characteristics of Successful Managers

• Managers skilled in leadership, vision, and influence– Skillful in creating clarity out of confusion,

ambiguity, and uncertainty– Able to define adroitly and gain agreement on who

has what responsibility and authority– Manage in a way that builds motivation and

commitment to cross-departmental and corporate goals, not just parochial interests

Characteristics of Successful Managers

• Managers skilled at helping, coaching, and conflict management– Creatively handle conflicts, generate consensus

decisions, and share power and information– Recognize that high-quality decisions require a

rapid flow of information in all directions– Accept that knowledge, competence, logic, and

evidence need to prevail over official status or formal rank in organization

The Key to Growth

• Team traits – Cohesion

– Teamwork

– Integrity

– Commitment to the long haul

– Harvest mind-set

– Commitment to value creation

– Equal inequality

– Fairness

– Sharing of the harvest

Key Questions for the Lead Entrepreneur/Founder

• Is formation of a team desirable or necessary?

• Do I want to grow a higher potential company?

• What talents, know-how, skills, track record, contacts, and resources are currently available?

• What is needed to succeed?

• Who is needed to complement me?

Forming and Building a Team

• Three issues for consideration– Values, goals, and commitment– Definition of roles– Peer groups

Common Pitfalls

• Do not use the “honeymoon” period of start-up advantageously

• Do not answer the questions of who is in charge, who makes the final decisions, and how real differences of opinion are resolved

• Do not address or recognize the deficiencies of the lead entrepreneur or the management team

Common Pitfalls

• Do not recognize that creating and building a new venture is a dynamic process

• Do not identify and defuse destructive motivations of investors, prospective team members, or the lead entrepreneur

• Do not value trust and integrity

Slicing the Founder’s Pie

• How much stock ownership should go to whom?– Share the wealth with those who help to create the

value and thus the wealth– Realize a harvest of at least 5 to 10 times the

original investment– Make sure the company prospers and grows thus

creating a huge, shared pie

Distribution Issues

• Differentiation– Reward system recognizes differences in

contributions among team members

• Performance– Reward is a function of performance (as opposed to

effort)

• Flexibility– Reward system acknowledges and accounts for

changes in contributions of team members

Stock-Vesting Agreement

• Stock-vesting agreement—An agreement between venture and team member used to guard against the event that some portion of the stock has been earned and some portion will remain unearned, as when a team member quits or dies; the venture places the stock purchased by team members in escrow to be released over a two- or three-year period.

Stock-Vesting Agreement

• Fosters longer-term commitment to the success of the venture

• Provides a method for a civilized, no-fault corporate divorce if things do not work out

• Establishes a period of years, often four or more, where founding stockholders can “earn out” their shares

Consideration of Value

• Idea

• Business plan preparation

• Commitment and risk

• Skills, experience, track record, or contacts

• Responsibility

The Entrepreneurial Approach to Resources

• Resources– People, such as the management team, the board of

directors, lawyers, accountants, and consultants– Financial resources– Assets, such as plant and equipment– Business plan

Resource Minimization Strategy

• Staged capital commitments

• Less capital

• More flexibility

• Low sunk cost

• Lower costs

• Reduced risk

Relationship with the Board of Directors

• Simple rules for a productive relationship with the board of directors– Treat your directors as individual resources– Always be honest with your directors– Set up a compensation committee– Set up an audit committee– Never set up an executive committee

Financial Resources

• Cash is the lifeblood of the venture

• Computers and spreadsheet programs are tools that save time and increase productivity and creativity.– Answer “what if” questions

• Capital Requirements

• Pro Forma Income Statements

• Balance Sheets

• BudgetingBreak-Even Calculations

• Cash Flow Projections

Part 2

Entrepreneurial Finance

• Three core principles of entrepreneurial finance– More cash is preferred to less cash– Cash sooner is preferred to cash later– Less risky cash is preferred to more risky cash

Finance Process

Bargaining Power

• Three vital corollaries determining bargaining power– Burn rate– Time to OOC (Out Of Cash)– TTC (Time To Close)

Free Cash Flow

• The cash flow generated by a company or project is defined as follows:– Earnings before interest and taxes (EBIT)– Less tax exposure (tax rate times EBIT)– Plus depreciations, amortization, and other

non-cash charges– Less increase in operating working capital– Less capital expenditures

Operating Working Capital

• Operating working capital can be defined as follows:– Transactions cash balances

– Plus accounts receivable

– Plus inventory

– Plus other operating current assets

– Less accounts payable

– Less taxes payable

– Less other operating current liabilities

Factors Affecting Financing

• Accomplishments and performance to date

• Investor’s perceived risk

• Industry and technology

• Venture upside potential and anticipated exit timing

Factors Affecting Financing

• Venture anticipated growth rate

• Venture age and stage of development

• Investor’s required rate of return or internal rate of return

• Amount of capital required and prior valuations of the venture

Factors Affecting Finance

• Founders’ goals regarding growth, control, liquidity, and harvesting

• Relative bargaining positions

• Investor’s required terms and covenants

Examples of Entrepeneurial Ventures

Five Year Performance TrendsUS Venture vs Buyouts vs Stocks

Venture Capital Funding

Obtaining Risk Capital

• Three central issues to be considered– Does the venture need outside equity capital?– Do the founders want outside equity capital?– Who should invest?

Angel Investors

• Who are angel investors?– Most are self-made entrepreneur millionaires– Many are in their 40s and 50s– Most are well educated– Ninety-five percent have college degrees from four-year

colleges– Fifty-one percent have graduate degrees (Forty-four

percent are in a technical field and thirty-percent percent are in business or economics)

– Ninety-six percent are men

Informal Investors

• What type of ventures lends themselves to the use of informal investors?– Ventures with capital requirements of between

$50,000 and $500,000– Ventures with sales potential of between $2

million and $20 million within 5 to 10 years– Small, established, privately held ventures with

sales and profit growth of 10% to 20% per year

Informal Investors

• What type of ventures lends themselves to the use of informal investors?– Special situations, such as very early financing of

high-technology inventors who have not developed a prototype

– Companies that project high levels of free cash flow within three to five years

Venture Capital Deals

$0

$20,000,000,000

$40,000,000,000

$60,000,000,000

$80,000,000,000

$100,000,000,000

$120,000,000,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0

500

1000

1500

2000

2500

3000

3500

4000

Investment

# of Deals

What to Look for in Investors

• Seek investors who:– Are considering new financing proposals and can

provide the required level of capital– Are interested in companies at the particular stage

of growth– Understand and have a preference for investments

in the particular industry

What to Look for in Investors

• Seek investors who:– Can provide good business advice, moral support,

and has contacts in the business and financial community

– Are reputable, fair, and ethical and with whom the entrepreneur gets along

– Have successful track records of 10 years or more advising and building smaller companies

Advantages of Going Public

• To raise more capital with less dilution than occurs with private placements or venture capital

• To improve the balance sheet

• To reduce or eliminate debt (thereby enhancing the company’s net worth

• To obtain cash for pursuing opportunities that would otherwise be unaffordable

Advantages of Going Public

• To access other suppliers of capital and to increase bargaining power, as the company pursues additional capital when it needs it least

• To improve credibility with customers, vendors, key people, and prospects

• To achieve liquidity for owners and investors

Advantages of Going Public

• To create options to acquire other companies with a tax-free exchange of stock, rather than having to use cash

• To create equity incentives for new and existing employees

IPO Proceeds

Exhibit 13.11

Issues Leading to Possible Crises in Rapid Growth

• Opportunity overload– Choosing from among an abundance of sales or

new market opportunity

• Abundance of capital– Evaluating investors as “partners” and the terms of

deals with which they were presented

• Misalignment of cash burn and collection rates– Cash burn rates racing ahead of collections

Issues Leading to Possible Crises in Rapid Growth

• Decision making– Executing functional day-to-day and week-to-week

decisions, rather than strategizing

• Expanding facilities and space . . . and surprises– Coping with surprises, delays, organizational

difficulties, and system interruptions spawned by space or facility expansion

Organizational Climate

• Six basic dimensions– Clarity– Standards– Commitment– Responsibility– Recognition– Esprit de corps

Common Approaches to Successful Management

• Leadership– Roles, tasks, responsibilities, accountabilities, and

appropriate approvals clearly defined– Leadership based on expertise, not authority– Emphasis placed on performing task-oriented roles

• Consensus Building– Emphasis placed on overall goals– Emphasis on participation and listening

Common Approaches to Successful Management

• Communication– Information sharing– Willingness to alter individual views

• Encouragement– Encouragement of innovation and calculated risk-

taking

Common Approaches to Successful Management

• Trust– Do what they say they are going to do– Traits include openness, spontaneity, and

straightforwardness

• Development– Develop human capital