Database Management Systems Ramakrishnan (Raghu Ramakrishnan)

Weigel, S. (2011) “Medical Technology’s Source of Innovation”,
European Planning Studies, 19(1): 43–61.

Wentrup, R. (2016) “The Online-Offline Balance: Internationalization
for Swedish Online Service Providers”, Journal of International
Entrepreneurship, 14(4), 562–594.

Yoo, Y., Henfridsson, O. and Lyytinen, K. (2010) “The New Organizing
Logic of Digital Innovation: An Agenda for Information Systems
Research”, Information Systems Research, 21(4): 724–735.

Yoo, Y., Boland, R.J., Lyytinen, K. and Majchrzak, A. (2012)
“Organizing for Innovation in the Digitized World”, Organization
Science, 23(5): 1398–1408.

Zahra, S.A. and George, G. (2002) “International Entrepreneurship: The
Current Status of the Field and Future Research Agenda”, in M. Hitt,
R. Ireland, M. Camp and D. Sexton (eds), Strategic Leadership:
Creating a New Mindset. London: Blackwell, 255–288.

Zhang, J.J., Lichtenstein, Y. and Gander, J. (2015) “Designing Scalable
Digital Business Models”, Advances in Strategic Management, 33:
241–277.

Zucchella, A., Palamara, G. and Denicolai, S. (2005) “The Drivers of
the Early Internationalization of the Firm”, Journal of World
Business, 42(3): 268–280.

11.18 GLOSSARY OF TERMS

Adaptation or A process whereby the organisation adjusts
Localisation certain elements of the marketing mix in order to
Agent better meet customer needs.

Direct Exporting An individuals or organisation that markets your
Distributor product on your behalf in foreign markets. An
agent is a low-cost option; however, they may
Entrepreneur also represent your competitor, so you need to be
careful when choosing an agent.
Foreign Direct
Investment A process whereby a manufacturer sells directly
to a buyer or importer in a foreign market.

Similar to an agent. However, they take
ownership of the product and therefore have a
higher motivation to market products and to
make a profit from them.

An individual who possesses certain traits that
allow them to successfully run an organisation.
Entrepreneurs often have innovative business
ideas that have not been seen before.

When the home firm makes an investment in
foreign-based facilities. This may be in the form

of mergers, acquisitions or wholly owned
subsidiaries.

Foreign Market The mode an organisation utilises in order to
Entry Strategies gain entry into a new foreign market. The choice
of foreign market entry strategy is dependent on
the amount of commitment, the risks the firm is
willing to take and the potential profits.

Franchising A process whereby the franchisor (in the home
market) gives the franchisee (in the foreign
market) the right to use a business concept or
system in return for payment and royalties.

High-Context Communication and building relationships are
Culture important to this kind of culture. Examples of
high-context cultures include Japan, China and
Middle Eastern nations.

Hybrid Option The middle point between standardisation and
adaptation. With hybrid options some elements
of the marketing mix are standardised, while
others are adjusted.

International A method in which an organisation can detect
Entrepreneurship and exploit opportunities outside of its home
market. By doing this, the firm may create a
competitive advantage.

International Related to the amount of experience a firm has
Experience operating in foreign markets. The firm itself may
have international experience, or its employees
may have previous experience operating in
foreign markets.

International A process whereby an organisation identifies the
Marketing needs and wants of customers in foreign markets,
allowing it to conduct business outside of its
home market.

International New An organisation that from its inception has a
Venture global mindset. From the beginning, these
organisations aim to create a competitive
advantage through buying and selling into
foreign markets.

Internet A relatively new channel for use in penetrating
foreign markets. Using the internet as an entry
mode into foreign markets involves the home
firm setting up a website in the foreign market
where locals can buy its products and services.

Joint Venture Two organisations coming together in order to

(Strategic Alliance) create a third jointly owned organisation (the

child). There are two types of joint ventures:

contractual non-equity joint ventures and equity
joint ventures.

Licensing When the home firm gives something of value to
a firm in a foreign market in return for payments
and certain performances.

Low-Context Reliant on explicit business information, such as
Culture legal contracts. Ireland, the UK and countries in
Northern Europe are all examples of low-context
cultures.

Mediating Factors The mental mindset of the organisation.
Mediating factors stem from the interaction
between the dynamics of push and pull factors in
the organisation.

Objective The entrepreneur’s knowledge-related
Capabilities capabilities, such as prior experience in a firm’s
internationalisation process.

Organisational The process whereby international new ventures
Adaptability adapt and are willing to learn the needs of
individual buyers and local ways of doing
business.

Pull Factors Internal or external to an organisation. Pull
factors encourage the organisation to
internationalise in order to increase profit and
growth.

Push Factors Forces within the organisation that drive it to
internationalise.

Standardisation A process whereby the marketing mix is
identical in all foreign markets. This provides the
organisation with the lowest cost for entry into
foreign markets.

Strategic Resources and capabilities that allow a firm to
Attributes develop and sustain competitiveness in foreign
markets at an early stage in its life cycle.

Strategic Options There are a number of options from which a firm
for can choose when considering internationalising.
Internationalisation The options depend on the readiness of the firm

to internationalise and the potential it has to
internationalise or to stay in the home market.

Subjective The entrepreneur’s personal traits and
Capabilities capabilities that enable them to grow the venture.



FUNDING Chapter
AND
FINANCING 12
NEW
VENTURES

12.1 LEARNING OBJECTIVES

After reading this chapter, you will be able to:

1. Differentiate between funding and financing of new ventures and describe
how these activities link to the new venturing process from idea inception to
investment;

2. Understand the centrality of maximising value to the entrepreneur in
entrepreneurial finance and recognise the terminology used in new venture
funding and financing;

3. Appreciate the key operational imperatives for the financial planning of a
new venture;

4. Relate financial theory to new venturing, in a way that leads to better
investment, financing and operations decisions and a higher success rate
for new ventures;

5. Identify some of the major trends in the entrepreneurial finance landscape
and how they can inform the practice of new venturing.

12.2 CHAPTER STRUCTURE

The core elements of this chapter are as follows:

• Introduction
• The Financial Context for New Ventures
• Funding and Financing
• Negotiating a Deal with an Investor
• Operations Decisions – Managing Cashflow
• Making Investment Decisions
• Conducting Due Diligence
• Valuation Primer
• Harvesting and Exit Strategies
• The Evolving Nature of Entrepreneurial Finance
• Chapter Summary
• Case Study 12.1 – Facebook IPO
• Revision Questions
• Further Reading and Resources
• References
• Glossary of Terms

12.3 INTRODUCTION

While good business ideas are a dime a dozen, it is harder to find
people with the eye for detail to implement them. Entrepreneurs
need to have the financial literacy to turn their visions into a
reality. This chapter aims to provide readers with tools to apply
financial theory to investing in, financing and funding, and
making operations decisions for a new venture.

Investment decisions tend to focus on whether or not to
pursue a new opportunity by investing time and money in the

creation of a new asset (Huang and Pearce, 2015). These
decisions are based on the asset’s ability to generate future
cashflows as well as on the riskiness of those cashflows. Given a
decision to invest, funding and financing decisions tend to focus
on how best to acquire the necessary capital to support the
investment (Schwienbacher et al., 2015), how to structure
ownership, what proportions of capital should be provided by the
entrepreneur and by outside investors respectively, and the types
of financial claims that can be offered to investors, for instance
debt, equity or some hybrid, such as preferred stock. Operations
decisions refer to the choices that entrepreneurs must make in
running their business. These choices inevitably affect financial
performance as measured by cashflow, profitability and other
financial metrics.

These three types of decisions – investment decisions,
funding and financing decisions and operations decisions – are
never entirely divorced from each other. Their interrelationship
necessitates that this chapter is written as four parts. The first
part, Section 12.3, provides a financial context for new venture
development and the entrepreneurial finance landscape used to
support investment decision-making. The second part, Section
12.4, explores the funding and financing decision-making
processes, in which a distinction is made between the funding of
early-stage start-ups and financing as a process of acquiring
capital from external investors. The third part, Section 12.5,
deals with operations decision-making processes that affect
cashflow and profitability. The fourth part, Section 12.6, deals
with investment decisions. Finally, the chapter concludes with a
review of new players in entrepreneurial finance that are blurring
traditional boundaries, such as providers of crowdfunding
(Kraemer-Eis et al., 2016).

12.4 THE FINANCIAL CONTEXT FOR NEW
VENTURES

Statistics on high-potential start-ups point to very low odds of
success. Although it is difficult to define what is meant by
“failure”, proxy data indicates that risks to both the entrepreneur
and the investor are very high (Grant et al., 2019). In the UK, for
example, on average almost 54 per cent of start-ups fail within
the first three years, falling to almost 50 per cent in London

(Nilsson, 2017). A study of 128 UK start-ups reported a highly
skewed distribution of returns to early-stage investors, with 34
per cent being a total loss; 13 per cent of the exits at breakeven
or a partial loss; 30 per cent having a internal rate of return
between 0 and 50 per cent; and 23 per cent having an internal
rate of return above 50 per cent (Mason and Harrison, 2002).
This is the backdrop against which early-stage investors select
start-ups for investment. Data from the Australian Bureau of
Statistics (2016) reported that of the 294,210 new business
entries in 2010–11, 79 per cent were still operating in June 2012;
59 per cent were operating in June 2013; and 50 per cent were
operational in June 2014 (Figure 12.1).

Figure 12.1 Survival rates of 2011 start-ups in Australia

Various studies over different periods and in different
countries have found similarly low rates of survival (Gonzalez,
2017). High failure rates have become accepted as the inevitable
cost of entrepreneurship offset by wealth creation, innovation
jobs and socioeconomic advancement. This acceptance creates a
chasm, as the risk becomes intolerable for many, including
institutional investors, such as banks who are accustomed to
lower-risk investments (Table 12.1).

This chasm has traditionally been filled by risk-tolerant
business angels and government funding schemes that include a
variety of supports linked to structured programmes designed to
de-risk high-potential start-ups for investor readiness (Figure
12.2). It is in this context that we can differentiate between
funding and financing. Funding typically refers to support, in the
form of capital for early-stage start-ups with the aim of helping
them to become investor ready, whereas financing refers to the
process of receiving capital money, for commercial purposes,

from investors, such as business angels and venture capitalists or
lending institutions. While these investors mitigate risks through
diversification, entrepreneurs usually do not have this luxury. In
choosing to launch a new business, entrepreneurs face the
prospect of salary loss, erratic income, using up their savings and
mortgaging their homes as they transition out of steady
employment. The modus operandi of business angel venture
investors is premised on achieving very few exceptional returns
among many failures or mediocre returns (Gregson et al., 2017).
There are legendary examples of trade sales of 10 times revenue,
100 times earnings or 50 times investment, and exemplar initial
public offerings (IPOs), such as those of Mastercard, Google and
Facebook (see Case Box 12.1), that point to staggering returns.
Presented with the same set of financial projections for a new
venture, the entrepreneur’s perception of risk is, therefore, often
much higher than that of external investors. An common strategy
deployed by entrepreneurs to de-risk the new venture is to bring
external investors on board who have the financial wealth to
absorb potential losses if the new venture fails.

Table 12.1 Start-up risk versus requirements of institutional investors

Start-up Banks and institutional investors prefer
characteristics

Little business experience Track record

Fluctuation of cashflows Steady cashflow profiles

New markets and Easy-to-understand market
technologies

High growth rates Steady growth forecasts

High debt ratios Low gearing

Figure 12.2 The funding chasm for technology start-ups – transitioning from
employee to entrepreneur

CASE BOX 12.1 FACEBOOK’S MILLIONAIRES

With Facebook’s initial IPO valuation close to $100 billion, rock star Bono from
U2 is among a range of finance heavyweights, including Goldman Sachs
tycoon Yuri Milner, tech hotshots Zynga co-founder Mark Pincus and PayPal
co-founder Peter Thiel, who became (if not already) billionaires overnight. This
does not include associates, friends and family members of Facebook CEO
Marc Zuckerberg, whose net worth is estimated at $75 billion.

This strategy begs the question of how much Lady Luck plays
a role. Did Zuckerberg and his early slew of early-stage investors
happen to be in the right place at the right time? Possibly, yet
there are underlying patterns in the few spectacular successes
and the multitude of failures that may help to turn Lady Luck
into a set of useful heuristics for optimising returns. Studies
show that there are some very good predictors of failure and
success (e.g. VanGeldern et al., 2005). Particularly on the failure
side, investors often seek to identify fatal flaws to weed out those
investment opportunities that they deem to be too risky. Yet
predicting successful start-ups for investment remains far from
deterministic and, for those start-ups that do become successful,
not every entrepreneur makes the right financial decisions: Mark
Zuckerberg’s co-founding partner, Eduardo Saverin, saw his 34
per cent share diluted to less than 5 per cent in an early funding
round, and he was not the first and is unlikely to be the last to
miss out on a big payday. Ronald Wayne, who co-founded Apple
with Steve Wozniak and Steve Jobs in 1976, sold his 10 per cent

share for a total of $2,300: a position that would now be worth
over $60 billion.

While we know that the failure rate of new ventures is high,
we also know that many new ventures fail due to poor financial
decision-making. Sometimes, even when a new venture is
successful, early financing mistakes prevent the entrepreneur
from sharing in the rewards. The contemporary definition of
entrepreneurship focuses on the pursuit of opportunity by
galvanising resources outside the control of the entrepreneur
(Eisenmann, 2013). Implied in this definition is that
entrepreneurship is a multi-stage activity (Figure 12.3).

The first step, opportunity identification, typically involves
the screening of business ideas. Not all ideas have the potential
to create value, so the entrepreneur must use their experience to
assess the opportunity. This is, to a large extent, a cost/benefit
analysis: to what extent do the potential awards exceed the
opportunity cost forgone by pursuing something else? If the
opportunity stacks up, then the second step usually involves the
entrepreneur devising a strategy to marshal resources, often
outside their control, to realise the opportunity. Significant
investment, funding and financing decisions are typically made
at this point. New ventures frequently require multiple cash
injections before they are sustainable, usually at a cost to the
entrepreneur, who may need to share equity in the business to
acquire the resources needed. The third stage requires execution
of a plan to realise the opportunity. The common perception from
investors is that, while good opportunities are relatively easy to
find, entrepreneurs with the management skills for execution are
far less common. Outside investors often bet on the jockey as
well as the horse, factoring into their decision-making the ability
of the entrepreneur to make sound operations decisions. The final
stage of this process is where the entrepreneur “harvests” the
rewards. In May 2012, for example, Zuckerberg sold a tiny
fraction of his shareholding in Facebook prior to the IPO, netting
him $1.1 billion. Of course, every new venture will not
necessarily yield the expected rewards. Entrepreneurs need to be
financially literate so that the appropriate operations and strategic
decisions can be taken to realise the rewards.

Although Figure 12.3 depicts the entrepreneurial processes as
linear, the reality is usually much more complicated. The

landscape for entrepreneurial finance has evolved in recent years
(Block et al., 2018). In the wake of the 2008 global financial
crisis, new providers of entrepreneurial finance, beyond business
angels and venture capitalists, have emerged, addressing the
funding and financing challenges of entrepreneurs. These players
operate across the funding and financing spectrum, offering a
variety of debt and equity instruments. New ventures seeking
financing often use several financial instruments simultaneously
(Moritz et al., 2016), and there is growing interest from business
angels and venture capitalists in screening crowdfunded ventures
as potential investments (Colombo and Shafiq, 2016).

Notwithstanding, the fundamentals of entrepreneurial finance
rest on the uncertainty of new ventures, requiring an application
of financial theory that differs to that in more mature and
structured contexts, such as investing in large corporations. In
large corporations, risk reduction is premised on the investors’
ability to diversify their portfolios. Corporations themselves tend
to have well-diversified businesses. So a corporate decision to
invest in a new venture is usually far less risky than an
entrepreneur making a very specific decision to start the same
venture. The undiversified entrepreneur is thus likely to have a
different perception of risk and hence a different valuation of the
new venture, even if they agree on projected future earnings.
Corporate decision-making is usually vested in an executive
team responsible for maximising shareholder value. Decision-
making in a new venture setting resides with the entrepreneur.
Yet, in the case where the entrepreneur raises capital by securing
outside investors, the investor often insists on playing a role in
decision-making and may even bring in a new CEO to replace
the entrepreneur. Information problems between entrepreneurs
and outside investors are typically much more acute than those
between insiders and outsiders in corporations. Corporate
shareholders tend not to get involved in day-to-day project
decisions. In a start-up scenario, the entrepreneur has to convince
investors of the merits of their business idea. Often the only way
to do this is to prepare a business plan and to offer contract terms
to outside investors that signal the entrepreneur’s confidence in
the venture. Incentives play an important role in both start-ups
and corporations. In corporations, performance bonuses and
stock options can align management and investor interests. In

start-ups, contract terms between an outside investor and an
entrepreneur are usually designed to incentivise the entrepreneur
to develop the business quickly. Uncertainty associated with new
ventures is usually higher than that for corporations. Hence, the
use of options in contracts between investors and entrepreneurs
can be advantageous to both parties hedging their bets on the
likely outcomes of the venture.

Figure 12.3 Typical entrepreneurial process

Traditional valuation, involving cashflow forecasts and
discounting them back to the present, does not reflect the value
of these options. Options that might be exercised include staging
of capital injections, linking them to milestones, abandonment,

increasing the investment in the new venture, converting debt to
equity or equity buy-back (Mason and Harrison, 2002). Shares in
corporations are usually liquid, as they can be traded easily in the
markets. Hence, investment decisions are based on the
corporation’s ability to generate free cashflows and yield
dividends. Investing in new ventures presents a different
investment scenario. These investments are not liquid and often
fail to generate free cashflows for several years. Returns on
investment are therefore harvested through liquidity events, such
as public offerings or trade sales. Due to the importance of
liquidity events, their timings are usually built into the business
plan (as an exit) and factored into the valuation of the
investment. The entrepreneur’s priority in financial planning for
a new venture is to balance retaining as much of the financial
claims as possible as the business grows with maximising the
value created by the business.

The application of financial theory to new ventures is,
therefore, highly contextualised to the nuances and unique set of
circumstances that characterise the entrepreneurial process.

12.5 FUNDING AND FINANCING

There are two main options open to the entrepreneur for funding
or financing: debt or equity. Debt refers to borrowed money,
secured in some way by an asset. Equity refers to contributed
capital, usually in the form of a cash injection or other asset.
New ventures often need a mix of debt and equity to support
anticipated rapid growth. Borrowing has the advantage in that it
can be relatively quick to arrange and does not dilute equity
ownership. However, debt subjects the venture to a long-term
obligation and therefore increases risk. It is common for
entrepreneurs to mix equity, debt and self-funding. The
entrepreneur’s personal assets as well as those of family and
friends are commonly used to finance concept or seed-stage
companies. Banks and other institutional investors assess
business plans for loan applications on the basis of whether or
not they deem downside risk to be small enough that loans will
be repaid. They are less concerned with upside potential; that is,
whether the new venture will exceed expectations. Cash-for-
equity investors, however, will be more interested in upside
potential. The use of debt requires equity as a prerequisite. As a

general rule of thumb, for every dollar of equity, an entrepreneur
could raise a dollar of debt. Lenders recognise that a start-up is
usually unable to generate immediate sales or profits and,
consequently, will seek to have the debt secured. This debt will
most likely be short-term debt for working capital to be paid
back from sales. Long-term borrowing is typically used to
finance property or equipment, which in turn could be used to
secure short-term debt. A big advantage of debt financing is that
it does not dilute the entrepreneur’s equity position. However, if
the costs of credit rise due to a rise in interest rates, or if sales fail
to meet targets, then cashflows can be squeezed and bankruptcy
can become reality. It is up to the entrepreneur to determine what
blend of debt and equity is optimal for the particular stage of
development of the business that they are seeking to finance.

The analogy is often drawn between undertaking a new
venture and launching a rocket (Reis, 2011): the probability of
success is low and slight deviations can lead the venture way off
target. The long journey proceeds in stages, at which there is an
option to either terminate (abandon) or make minor adjustments.
Early-stage ventures tend not to generate enough profit to
support further growth. Hence, their development is fuelled by
cash injections, just enough to get them to the next stage, at
which it is hoped that the venture will be able to raise more cash
on more favourable terms. A new venture is essentially an
experiment in which the assumption-to-knowledge ratio is high.
Information about the potential of the business opportunity may
be incomplete and asymmetrical. The entrepreneur may have
more accurate information about the product or technology,
whereas the investors may have more information about the
market.

How does the investor test the ability of the entrepreneur?
And how can the entrepreneur avoid giving too much
information about the business while convincing the investor that
the opportunity is worth pursuing? Information problems can be
solved by staging the funding or finance. Rather than committing
cash up front, staging allows the investor to “wait and see” if the
entrepreneur can deliver. Staging can also benefit the
entrepreneur. Early cash injections can be costly, as a large
fraction of ownership would need to be exchanged for a small
investment. Staging not only allows the entrepreneur to retain

more ownership, but makes the investment more attractive.
Staging is often event driven, each stage validating previous
assumptions (Block and Macmillan, 1992). It is generally
accepted that different types of funding and financing are tailored
to different stages of venture development (Figure 12.5).

Figure 12.4 Indicative use of external finance by UK small to medium
enterprises

Figure 12.5 Sources of funding and financing linked to stages of venture
development

12.5.1 Early-Stage Funding and Financing
Technology start-ups usually burn lots of cash in the early stages
of development. Cash is the fuel that propels a start-up to
sustainability. Start-ups are limited by particular types of
financing, such as personal savings or personally secured debt.
Conversely, businesses with a track record find it easier to
acquire finance from banks, business angels and venture

capitalists. The challenge for start-ups is that institutional
investors tend to invest in lower-risk opportunities and, unless a
new venture can generate positive cashflows, it may struggle to
obtain significant debt financing. BDRC (2018) suggests that
micro and small enterprises tend not to access formal sources of
external finance, apart from short-term loans, credit cards and
overdrafts (Figure 12.4). Instead, they rely on trade credit from
their suppliers or retained earnings. Only a small minority use
equity finance from either business angels or venture capitalists
(Figure 12.5).

CASE BOX 12.2 HEWLETT-PACKARD – AN EXAMPLE

OF BOOTSTRAPPING

As far back as the 1940s, two young graduates from Stanford University, Bill
Hewlett and Dave Packard, with a mere $538 in start-up capital
(Entrepreneur.com, 2008), began their entrepreneurial endeavours in a
garage in Palo Alto as they continued their collaboration with mentor
Professor Frederick Terman. The professor watched his prime protégés
graduate and three years later, Terman managed to entice them back with
Stanford fellowships and part-time jobs (Jacobson, 1998). He suggested their
first marketable product: an audio-oscillator based on a principle of negative
feedback he had taught them at university. Soon after, the partners won their
first big business. Disney ordered eight oscillators to fine-tune the soundtrack
of Fantasia (Packard, 1995). This provided their first injection of working
capital to move their premises and hire employees. This genesis story of
Hewlett-Packard, a $120 billion company with over 300,000 employees and
bellwether of the Dow Jones Industrial Average, has inspired many
entrepreneurs.

Data on the extent to which personal finances of founders,
family and friends are used in new venturing varies, but there are
plenty of examples of successful start-ups that bootstrapped or
self-funded (see Case Box 12.2). Bootstrap start-ups have to find
a way to attract sales, so they tend to focus on developing
products that customers need and on finding customers willing to
pay for them.

Of course, not all start-ups bootstrap or are self-funded. With
limited resources, it is difficult for an entrepreneur to sustain
growth through bootstrapping, in which case external financing
must be pursued. Friends, family and founders (the 3Fs) typically
invest modest amounts of money, normally below $25,000. An
important source of early-stage finance that entrepreneurs can

access is the business angel or angel investor (see Case Box
12.3). Business angels are high net worth individuals, often
experienced and risk-tolerant entrepreneurs, who provide
financing and expertise to start-ups in exchange for an equity
stake in the new venture. Business angels are frequently thought
of as bridges, filling the equity gap between the 3Fs and venture
capital, who invest relatively small amounts in early-stage
projects with high growth potential. Business angels are
increasingly investing alongside government agency funding in
technology start-ups.

CASE BOX 12.3 TENMOU – BAHRAIN’S FIRST
BUSINESS ANGEL COMPANY

Tenmou provides relatively small amounts of funding, typically BD 20,000
($53,000) for 20–40 per cent equity. More importantly, Tenmou’s network of
established entrepreneurs in the Middle East island kingdom offers a package
of mentorship and funding to high-potential start-ups. Tenmou’s investment
fund is financed by some of Bahrain’s best-known businesses, including
Bahrain Development Bank and Bahrain’s aluminium giant Alba (MacDonald,
2012). While angels have been a traditional source of financing for high-
growth ventures in the West, it is a new concept in the Middle East, in which
Tenmou hopes to contribute to the growing culture of entrepreneurship.

Business angels tend to organise as networks, pooling their
expertise and investing together in early-stage ventures. These
networks provide channels of communication between business
angels and entrepreneurs seeking capital (see Case Box 12.4).
There are examples of business angel networks in the United
States, Canada and Europe (Harrison and Mason, 1996). They
typically provide equity financing and offer management support
and network access. As a network, they can provide higher
amounts of financing than individual business angels (Lange et
al., 2003).

CASE BOX 12.4 HBAN – HALO BUSINESS ANGEL
NETWORK

Halo Business Angel Network (HBAN) is an umbrella group that is responsible
for the development of business angel syndicates on the island of Ireland.
HBAN actively works to increase the number of angel investors who are
interested in investing in early-stage technology start-ups and supporting the
entrepreneurial community. In 2018, HBAN business angels invested circa

€9.3 million in 44 companies. HBAN works on a regional basis to support
existing and new angel networks, developing their capability and capacity
across a range of industry sectors. HBAN is a joint initiative of Enterprise
Ireland, InterTradelreland and Invest Northern Ireland.

Accelerators and incubators represent another funding option
open to entrepreneurs (see Case Box 12.5). They provide start-
ups with training, mentorship, network access and shared
resources to help them become successful. Broadly speaking,
accelerators and incubators assist entrepreneurs with building
and testing their initial products, identifying potential customer
segments and galvanising resources, including financial and
human capital (Cohen, 2013). In some cases they offer office
space, back-end office services and a small amount of seed
funding. Most accelerator programmes are limited in duration,
lasting between three and six months, thereby tending to be
shorter in length than incubator support. Incubators and
accelerators are, in the main, not-for-profit organisations, focused
on supporting regional economic development, and many are
affiliated to government agencies or located on university
campuses.

CASE BOX 12.5 THE LINC

The LINC is a Technological University Dublin campus innovation centre. It
assists start-ups through its incubator and accelerator programmes. Its
Enterprise Garage programme is an accelerator open to all TU Dublin
students. It runs over the summer months, providing students with an
opportunity to work on their business ideas under the expert guidance of a
panel of mentors, industry experts and entrepreneurs. The LINC is also a
provider of Enterprise Ireland’s New Frontiers incubator programme for
innovation-based, knowledge-intensive and exported-orientated start-ups.
While the initial phase of this programme resembles an accelerator, providing
a series of workshops over a six-week period, the second phase of the
programme offers a €15,000 stipend to successful applicants over six months.

Increasingly universities are also providing funding to support
innovative ideas from university faculty, staff, students and
alumni. These ideas typically come from the outputs of scientific
or technological research in university laboratories and, as such,
require funding to bring them to market. The funding is as much
for preparing technology to be licensed and commercialised by a

private partner as it is for supporting start-ups from faculty, staff,
students and alumni.

In recent years, crowdfunding over the internet has become an
attractive means of funding for pre-seed and early-stage start-
ups, whereby large groups of people commit small amounts of
money to support a particular goal (Bruton et al., 2015).
Technology is therefore advancing the way in which
entrepreneurial finance is provided. Social networks and online
platforms have created new opportunities for entrepreneurs to
raise capital. Block et al. (2018) identify four types of
crowdfunding of interest to entrepreneurs. In the first, rewards-
based crowdfunding, cash is sought by a project from a crowd of
backers, in return for which is the development of a product or
delivery of a service. Kickstarter, an established rewards-based
crowdfunding platform (see Case Box 12.6), reports that the
most successful projects typically raise less than $10,000, but
there are a growing number of projects raising six-figure sums.
In the second type, donation-based crowdfunding, cash is sought
from individuals or organisations, often for a social cause. In the
third, lending-based crowdfunding, money is borrowed from the
crowd, who invest to receive fixed-interest payments on their
loans. From the lender’s perspective, lending-based
crowdfunding platforms provide individual investors with a
means to commit their spare money to a project and to announce
the returns that they are willing to receive. From the
entrepreneur’s perspective, these platforms provide a means for
them to stipulate the requirements of the loan, such as the
amount of money needed.

CASE BOX 12.6 3DOODLER

In 2013, a small toy company called Wobbleworks managed to raise $2.3
million from 26,000 backers on Kickstarter for 3Doodler, a 3D printing pen. A
second crowdfunding campaign followed in 2015 for the next version of
3Doodler, raising nearly $1.6 million from more than 10,000 backers. By 2016,
the company had sold almost 300,000 pens, priced at $99 each. For
Wobbleworks, one of the biggest advantages of the Kickstarter campaigns
was that it could circumvent the stage of seeking retailers for an audience by
instead proving the concept in a crowd-funding campaign. By early 2017,
Wobbleworks had achieved sales of almost $20 million from its 3D pens.

In the fourth type, equity crowdfunding, entrepreneurs raise
finance by making an open call to sell a specified amount of
equity. In contrast to traditional financing, whereby business
angels and venture capitalists rely on face-to-face interactions,
equity crowd-funding affords little opportunity for entrepreneurs
to interact face to face with investors, as all of the information is
disclosed online. Information asymmetry and, hence, convincing
investors are particularly challenging (Ahlers et al., 2015). The
UK was the first country to authorise equity crowdfunding and is
home to several platforms, including Seedr, Crowdcube (see
Case Box 12.7) and SyndicateRoom, which are regulated by the
Financial Conduct Authority (FCA).

CASE BOX 12.7 MONZO

In 2017, UK-based fintech company Monzo, known for its pink debit card,
raised £1 million in just 96 seconds on Crowdcube. The company delayed its
initial launch date after a rush of eager investors overwhelmed the Crowdcube
servers. On the day, 1,861 people invested an average of £542 each for 3.33
per cent equity. A second crowdfunding campaign resulted in more than £12
million being pledged, prompting further effort to give people who missed out
the first time another shot at investing. In its most recent funding round (2019),
Monzo raised £20 million from over 30,000 investors. It raised nearly £3
million in 60 seconds and £17,961,551 in just under three hours from over
30,000 new investors. After closing the funding campaign, Monzo had doubled
its value to £2 billion.

Crowdfunding therefore allows entrepreneurs to raise money
from a large number of individuals for the purposes of financing
a project, venture, business or cause. The internet has enabled
entrepreneurs to access thousands, if not millions, of potential
funders. The role of crowdfunding in supporting start-ups is
explored in more depth later in this chapter.

12.5.2 Later-Stage Funding and Financing
Venture capital (VC) firms typically invest a large fund in a
portfolio of high-growth ventures. Each fund is organised as a
limited partnership, in which participating investors tend to be
institutional and well diversified, such as pension funds,
corporations, insurance companies and banks. The expertise of
VC firms is in raising new funds and identifying ventures with
high growth potential in which to invest. Not all ventures are

suited to this type of finance. VC investments are targeted at
later-stage investments in which negative cashflow early on is
offset by very fast growth rates later (revenue of $0–20 million
within five years) or opportunities with large market potential
($50–100 million in revenue). VCs monitor the progress of their
investees to the extent that they often have a hands-on approach
to managing their ventures: they sit on the board of directors, tie
financing to strict milestones and appoint key managers. They
frequently have industry-specific expertise and invest in
technology ventures.

Not all VC investments pay off. Anywhere from 20 to 90 per
cent of portfolio companies may fail to make a return. However,
if a VC does well, a fund can offer returns of 300–1,000 per cent
(3× to 10×). Because the failure rate can be high, VCs often seek
10× returns on their investments, on the basis that extremely few
investments are likely to hit that number. A 10× return sounds
spectacular, but not necessarily to a VC: a 10× on a $1.5 million
investment would barely have an impact on a $800 million fund
designed to return $2.4 billion. If the VC really wanted to
influence their reported returns to their limited partners, then
they would need several $5–10 million investments, each
returning $50–100 million on exit. If the dollar amount invested
is not enough of a constraint, the planning horizon for most
planned VC investments constrains the pool of suitable investees
even further. To ensure a decent return for the overall fund, a VC
typically plans each individual investment over a 5–7-year
horizon. VCs operate in post-seed (Series A) investments, where
the amount of invested capital is significant and the timeline to
exit is short. In these scenarios, the technology developed has
already been beta-tested.

The entrepreneur may consider strategic partners in place of a
VC. Strategic partners could be vendors, customers or other
business partners with whom the venture is currently working,
who might be interested in investing in the company. A strategic
investor often has deeper pockets than an angel, but typically has
a specific reason for investing, so it is always important to know
the reason behind the investment and to ensure that interests are
aligned. The investor may only want to leverage the venture’s
technology for its own purposes, or may want a favourable
licensing distribution agreement if the venture succeeds.

While VCs bring with them business expertise, critical
connections to the business community, additional resources and
access to future funding rounds, there are some potential pitfalls
for entrepreneurs who decide to pursue VC funding. A large
injection of cash and professional expertise by VCs often comes
with loss of control for the entrepreneur. VCs typically seek
board membership, aggressive voting rights and active
involvement in the management of the entrepeneur’s business in
order to protect their investments. Depending on the size of the
VC’s stake in the business, which could exceed 50 per cent,
entrepreneurs may lose management control, particularly if they
are under-performing. Transitioning from single-handed
decision-making to a culture in which major decisions have to be
discussed and formally approved by stakeholders can be a major
challenge for the entrepreneur. Entrepreneurs therefore need to
ask themselves: Are they open to more active involvement from
a VC in the running of the business? Is loss of ownership and
control a deal-breaker for them? To what extent are the
additional expertise and resources brought by a VC beneficial to
the business?

Given the risks involved, the due diligence process of vetting
the business often takes a large amount of time. Hence, the long
wait before receiving a term sheet can be a huge drawback. VC
contracts are inherently more complicated than the straight
equity for cash deals associated with angel investors, and the
entrepreneur usually does not have much leverage when
negotiating the deal. VC investments rely on achieving high
returns within a short time frame, so VCs will typically seek
terms and conditions that will allow them to redeem their
investments within 3–5 years. This may conflict with the
entrepreneur’s business plan, which might require a much longer
time frame to provide liquidity. The entrepreneur’s equity in the
business may dilute further in subsequent funding rounds.

Given that VC funding involves large amounts of capital, the
VC will usually not release all the funds at once. VC contracts
typically require start-ups to reach key milestones in order to
receive their next tranche of funding, placing huge pressure on
the entrepreneur to perform. Finally, entrepreneurs also need to
beware of VCs in a hurry to sell their equity, leading to a
potential undervaluation of the business. There may be undue

pressure on the entrepreneur to exit in an untimely way, leading
to a failure in recouping the full value of their equity. For the
entrepreneur, finding a VC investor can be distracting and take
the focus away from developing the business. Fundraising may
take several months and should not detract from managing the
business effectively. It is important for entrepreneurs to plan the
potential funding needs of the business before funding becomes
critical, buying themselves enough time both to continue
growing the business and to raise sufficient funds to keep
growing.

In addition to private VC firms, two variations have emerged:
corporate venture capital (CVC) and government venture capital
(GVC). CVC refers to investments by large multinational
corporations, such as Google or Intel, in innovative start-ups.
Large corporations often provide venture funds as a vehicle for
advancing their technology and product-market strategies. CVC
investors tend to have a strategic interest in the companies in
which they invest and, consequently, they tend to be more patient
than private VCs. GVC funds are typically used by governments
to co-invest with private VCs. These funds usually have a
broader aim of promoting economic development and job
creation. While there is considerable scepticism regarding the
role of GVC finance, enterprises funded by both GVCs and
private VCs obtain more investment than enterprises funded
purely by private VCs and there tends to be a positive correlation
between co-investments and successful exits (Brander et al.,
2015). One of the best-known GVC initiatives is the Small
Business Innovation Research (SBIR) programme in the United
States, which encourages small businesses to engage in
government research that has the potential for commercialisation.
In many countries, provision of SME finance is seen an
instrument of economic policy. Many governments therefore put
in place appropriate interventions, often targeting the funding
gaps left by private equity. In the United States, the federal
government provides subsidies on financing through the Small
Business Administration (SBA). Small Business Investment
Companies (SBICs) access soft loans, guaranteed by the SBA,
and tend to invest in chunks of between $250,000 and
$5,000,000 in later-stage ventures (Klein, 2011). There are over
300 SBICs in the United States with $16 billion in capital under

management. In Europe, there are various schemes in place to
foster technological innovation and deal with the gap between
publicly funded research and technology spin-offs. In 2018, the
European Investment Fund invested €10.1 billion in SMEs,
which it expected to leverage an additional €43.7 billion of
additional financing (EIF, 2018).

Innovation vouchers are another example of government
funding (see Case Box 12.8). These are small lines of credit or
lump-sum grants provided by governments to SMEs to purchase
services from public knowledge providers, such as universities,
with a view to introducing innovations (e.g. new products or
processes). There has been some noted success with innovation
voucher schemes in Ireland, Singapore, Belgium, Cyprus, Poland
and the Czech Republic. The United States offers a similar
scheme, called the Small Business Technology Transfer (STTR)
programme. Although these schemes offer small amounts of
funding, many governments offer larger funding schemes for
high-tech companies whose innovations are further on in their
development.

CASE BOX 12.8 INNOVATION VOUCHERS – A

SUCCESS STORY FOR FIRMS AND COLLEGES

Frozen yoghurts for pets, portable sterilisers for babies’ bottles, software,
pharmaceuticals and chocolates are just some of the products developed in a
wave of new links created between third-level researchers and innovative Irish
companies. So far, more than 1,000 small companies have availed
themselves of the Irish government’s €5,000 “innovation vouchers”, which
allow them to link up with college researchers to solve business problems.
Enterprise Ireland manages the innovation vouchers. One beneficiary has
been Frozen Pet-Zerts, whose frozen organic yoghurts in banana, blueberry,
peanut butter and vanilla flavours have been brought to market with the help
of St Angela’s food research centre in Sligo. Another is Shasta, an Athlone
company that has developed a portable baby bottle steriliser. It used the
vouchers to work with Athlone Institute of Technology on prototyping the
steriliser. Shasta then worked with the Irish operation of global manufacturing
company Nypro to manufacture this product. Meanwhile, higher education
institutions in Ireland, such as Waterford Institute of Technology (WIT),
continue to make use of the innovation vouchers.

Tom Corcoran, Research and Innovation Manager at WIT-based Arclabs, said:
“The €5,000 voucher is only the key. In fact, researchers working with SMEs
tend to keep going until they produce something concrete. The real gain has
been to show companies that colleges are not some grand seat of learning.
The business people sit down with the researchers and to talk about what can
be achieved. I give a guide that the €5,000 gives them about eight to ten days
of one researcher’s time. In fact, these projects are often done by teams. The

companies get great value for money. That’s the real gain.” Corcoran’s role is
to match businesses with the best researcher for their goals – creating product
prototypes, developing new markets, working on quality management systems
and so on. The firms cover everything from IT to consumer goods and
pharma.

WIT has worked on quality processes for an anti-cancer drug with local
company Eirgen. In this case, the voucher has led on to further R&D work and
deeper relations between the college and the company. WIT has also worked
on developing sales management strategies for hand-made chocolate
producer Gallweys Chocolates, which has since expanded its product range
and opened two cafés. Minister for Science, Technology and Innovation,
Conor Lenihan, said that passing the milestone of 1,000 innovation vouchers
suggests the scheme will continue to pay dividends for small Irish companies.
“The vouchers are an important early bridge between firms and academic
researchers. The scheme has helped small firms to explore how they can play
their part in building the knowledge economy,” Mr. Lenihan said. “The
vouchers have brought firms and researchers together in finding innovative
ways to overcome challenges and give products a more competitive and
commercial edge for the marketplace.” Small Irish firms are now working with
research teams in more than 41 research institutions across the island.

There are also a growing number of intellectual property (IP)
investment funds (Block et al., 2018) allowing innovative
ventures to commercially exploit their IP and use the funds
generated to grow their venture. These investment funds provide
neither equity nor debt, but are used to purchase the IP of a
company. Given the potential for IP to generate revenue streams
from licensing royalty agreements, IP can also be used as
collateral to secure loans from banks and other financial
institutions (Fischer and Ringler, 2014).

Family offices are also increasingly investing in later-stage
growth ventures. Family offices are, in essence, vehicles for
extremely wealthy families to indirectly own large firms by
operating as private companies that manage their investments
and trusts. In addition to managing family fortunes, family
offices perform other functions, such as generational planning,
legal and tax services, and promoting the family’s legacy through
philanthropic work. Family offices typically provide equity, have
financial and philanthropic goals and are considered long-term,
patient investors. Some family offices have developed innovative
business models to support the commercialisation of scientific
research.

The challenges for SMEs in accessing growth financing
became particularly acute in the wake of the global financial
crisis. Traditionally, short-term financing has never been

particularly problematic for SMEs. However, longer-term
financing has been a hindering factor, preventing SMEs from
growing to become large ones. One solution to this problem has
been the emergence of mini-bonds, a form of debt financing,
which are essentially mini versions of corporate bonds with
lighter regulation (Forestieri, 2014). Although trading of mini-
bonds takes place mostly in traditionally regulated markets, this
is also beginning to occur on crowdfunding platforms.

Trade credit is perhaps the most common form of short-term
financing for SMEs. If, for example, a venture makes a purchase
then receives the goods almost right away but does not need to
pay for 30 days, then this is equivalent to getting a 30-day
interest-free loan. However, it can be costly, as often discounts
are offered to those who pay up front or within a shorter time
frame. If, for instance, a 2 per cent discount is offered for those
who pay within 10 days but the venture chooses to pay on the
30th day, then it is effectively borrowing the invoiced amount at
2 per cent for 20 days, which is equivalent to an annualised rate
of 44 per cent. Entrepreneurs must consider this in managing
their cashflow. When a venture offers trade credit to its
customers, it generates accounts receivable. Factoring is a
financial transaction whereby a business sells its accounts
receivable to a third party (called a factor) at a discount.
Similarly, invoice discounting is a cashflow solution that releases
the cash (up to 90 per cent of the value of the invoices) tied up in
debtors. It can be a confidential facility, and it also allows the
entrepreneur to control credit. When the full amount is collected,
the factor remits to the venture the remaining 10–25 per cent and
charges a 1–2 per cent fee.

Figure 12.6 Mezzanine finance fills the gap between senior debt and equity

Mezzanine finance is a form of debt used by companies that
have positive cashflows with revenues over $10 million. It is a
layer of financing rated between a company’s senior debt and its
equity. It is subordinate to senior debt, but senior to common
stock or equity (Figure 12.6).

Private ventures may choose to “go public” for several
reasons, the most common being that capital raised through an
IPO does not have to be repaid, whereas debt securities must be
repaid with interest. An IPO is an offering of shares for sale in a
previously unlisted company to the wider public for the first
time. Prior to an IPO, a company is considered to be private with
a limited number of shareholders, such as business angels and
venture capitalists, founders, family and friends. An IPO is seen
as a convenient exit mechanism for these investors to realise
their investment gains, achieve liquidity and diversify. Many
firms who choose to go public need additional capital to execute
long-range business models, increase brand name recognition
and acquire funds for possible acquisitions. By “going public”, a
company can return to the market and offer additional shares
through a secondary offering. Getting an IPO right can be tricky,
nevertheless: some recent IPOs have been associated with huge
first-day gains following by flops in share price. The time and
cost of engaging with the Securities and Exchange Commission
are also key factors, as they can divert energies away from the
core business.

12.5.3 Negotiating a Deal with an Investor

The deal defines the allocation of risk and returns to both the
entrepreneur and the investor, and the details are usually
documented in a term sheet. Rather than the parties getting
locked into detailed legal negotiations straight away, the term
sheet facilitates a non-binding agreement between the investor
and the entrepreneur with basic terms and conditions, by setting
out the amount to be invested and the ownership claims to which
the investor is entitled (see Table 12.2).

Table 12.2 The entrepreneur’s and the investor’s concerns in negotiation

Entrepreneur’s main concerns Investor’s main concerns

• Loss of management control of • Current and projected valuation
the venture
• Evaluating the risk associated
• Dilution of personal stock with this investment

• Repurchase of personal stock in • Projected levels of return on
the event of employment investment
termination, retirement or
resignation • Liquidity of investment and exit
strategies (downside protection)
• Adequate financing
• Protection of the investor’s ability
• Future capital requirements and to participate in future funding
dilution of the entrepreneur’s rounds if venture meets exceeds
ownership projections

• Leveraging indirect benefits of the • Influence over decision-making
investor, such as access to key
contacts

Consider, for example, a deal where a venture is seeking
funding of $4 million to carry it to the next milestone. An
investor is proposing to provide the capital in exchange for 2
million shares of common stock. The entrepreneur is to retain 8
million shares of common stock.

• The investor prices each share at $4 million/2 million shares = $2 per

share

• The post-money valuation is $2/share × 10 million shares = $20 million

• The pre-money valuation is $20 – $4 million = $16 million

The post-money valuation is a measure of how much the outside
investor believes the venture is worth. This becomes more
complicated when the deal includes terms beyond a
straightforward cash for equity swap. Preferred stock, for
example, has a higher claim on assets and earnings than common
stock. Dividends must be paid to holders of preferred stock
before being paid to ordinary shareholders. This makes
preference shares more expensive. If, for example, the investor
offers $4 million in exchange for 1.5 million shares of preferred
stock convertible on a 1:1 basis to common stock, then it would
provide that investor with some downside protection if the
venture does not perform well, yet facilitate conversion to
common stock if the venture does better than expected. This deal
would also allow the entrepreneur to retain a reasonably high
shareholding in parallel with downside protection and, therefore,
a more valued position. In this case the valuation would be:

• The investor prices each share at $4 million/1.5 million shares = $2.67

per share

• The post-money valuation is $2.67/share × 9.5 million shares = $25.3

million

• The pre-money valuation is $25.3 million – $4 million = $21.3 million

It is important not to focus solely on the post-money valuation by
the investor but also to assess the “sweeteners” promised to the
investor that could affect that valuation. Due to the uncertainty
associated with investing in new ventures, the investor is likely
to include a number of options, rights and contingencies as part
of any detailed agreement. In the example above, the investor
might insist on a warrant to acquire an additional 2 million
shares if the venture fails to achieve a certain revenue threshold
in two years. A common provision used to protect investors in
the event of a lower valuation in a subsequent funding round is a
ratchet provision that prevents dilution of the investor’s
shareholder value. This is usually provided by warrants to
acquire additional shares at a set price or convertible stock with a
floating conversion price. Other key provisions often included
are:

• Voting Trust: Voting rights are assigned to the investor if the

entrepreneur does not perform. It provides the investor with the ability to
take control, even in a minority position.

• Put Provision: A put provision gives the investor the option to sell the

business to the best bidder if there is no exit by a pre-defined date.

• Piggyback Option: This provides the investor with the right to sell its

shares any time the entrepreneur decides to sell shares, either in a public
offering or in a trade sale.

• Drag-Along: This provides the investor with the right to force all other

shareholders to sell if it receives an acceptable price offer for its shares.

• Tag-Along: If an entrepreneur is offered a favourable deal for its shares,

then tag-along provides an investor with the option to notify the
purchaser that it too may wish to buy shares.

• Unlocking Provision: This provides the investor with the option of

insisting that the entrepreneur buys it out if the entrepreneur receives an
offer they do not wish to accept but the investor does.

These provisions appear in what is referred to as the term sheet.
A term sheet is a non-legally binding agreement that sets out the

basic terms and conditions under which an investment will be
made. It serves as a template to develop more detailed legal
agreements.

12.6 OPERATIONS DECISIONS – MANAGING
CASHFLOW

Managing cashflow effectively is critical to a start-up’s survival.
Without cash in the bank, a new venture simply cannot pay the
bills – wages, rent, raw materials and so on. Entrepreneurs often
report that on paper their cashflows seem positive, with the
venture appearing to make plenty of money, but in reality they
are cash poor and struggling with day-to-day operations. All too
often cash inflows seem to be slower at coming in than the speed
with which cash is being paid out and new business owners soon
discover a simple truth: first you pay for goods or services, then
eventually your customers pay you. This creates a drain on cash
resources. The period between payment of cash and receipt of
cash is called the “cash gap”. Cashflow reflects how long your
goods sit as inventory, how long it takes for your customers to
pay and how long your suppliers give you to pay them. Cashflow
is best explained as a cycle (Figure 12.7). The cash you use in
your business to acquire resources to sell products or services to
your customers is then collected by way of customer payments.
These payments are used to pay outstanding bills and to re-invest
in more resources to sell additional products or services (Walsh,
2008).

Figure 12.7 The cashflow cycle

The interval between payment of cash and receipt of cash
must be financed. The longer the interval, the more interest is
paid. Let us take the following illustrative example of how the
cash gap can drain financial resources. Table 12.3 shows
financial statements for a new venture.

Table 12.3 Financial statements

Profit and Loss Accounts

2020 2021
€’000
€’000 1,400

Sales 1,200 100
Less cost of sales 800
Opening stock 80 (150)
Purchases 700 750
Less closing stock (100) 650
680 (300)
Gross profit 520 350
Less expenses (200)

Net profit 320

Balance sheet at:

31 December 2020 31 December 2021
€’000 €’000

Fixed assets 1,000 1,000
Current assets
Stock 100 150
Debtors 100 150
Bank
20 120
220 420

Less current liabilities

Creditors 80 140 80 340
1,140 1,340

Financed by:

Capital at beginning of 870 1,140
year
Add net profit 320 350
1,190 1,490
Less drawings
50 150
1,140 1,340

Let us assume that the interest rate being charged for a short-
term facility in 2021 is 6 per cent. The calculations below
illustrate the cost of poor cashflow management. The cash gap is
essentially the average number of days for which the business is
relying on short-term credit, on which interest must be paid, to
survive.

CashGap − I nventory Days + Days Re ceived − Day P ayable

CashGap = 365 ( 150 + 150 20 180
− ) = 365 = 57Days

1,400 1,400 1,400 1,400

€€750,000
Daily Cost of Sales = 365 = 2, 054 each day.

In other words, to cover the cash gap, the company would need
to borrow €2,054 each day for 57 days, which totals €117,857.
At 6 per cent interest, the company would pay €7,071 in interest
on this borrowing. This represents a small but not insignificant
amount of cash off the bottom line. Normally, accountants
recognise income at the time a sale is made irrespective of
whether it is for cash or on credit. Using the accrual system, it is
possible to record revenues before cash payments are actually
received. Similarly, accounting expenses do not necessarily
equate to negative cashflows, as the company may have
purchased items but not yet paid for them. Depreciation, which is
expensed against profit, does not affect cashflow. This partly
explains why profitable ventures can have negative cashflows.
Common cashflow problems are outlined in Table 12.4.

Table 12.4 Cashflow problems

Reason Solution

Volatility in critical Monitor for trends, e.g. slowing sales, rising costs

business parameters Use risk management tools to reduce exposure to
changing interest rates, commodity prices and
exchange rates
Use insurance to protect against loss of assets or
income

Excessive capital tied Ensure effective raw materials planning
up in inventory and Reduce work-in-progress (WIP)
equipment Turn over excess stock, even at a discount
Consider using leasing solutions for equipment
instead of purchasing

Long-term assets Use longer-term lending solutions for capital assets
bought with cash Match the length of the loan to the life of the asset

Collecting accounts Have a system in place to follow up overdue
receivable too slowly accounts
Use electronic payment solutions
Take post-dated cheques

12.7 MAKING INVESTMENT DECISIONS

The business model and the business plan are addressed in
Chapter 6. Business plans are commonly used to document an
opportunity to potential investors and are often considered an
intermediary step between strategy and implementation.
Numerous websites provide aspiring entrepreneurs with
templates for business plans. From an investment perspective, it
is common to assess the underlying principles that will lead to
revenue growth. These principles are collectively enshrined in
the business model (Chapter 6). Business plans for new ventures
and start-ups differ considerably from those for established
businesses. The main difference relates to the accuracy of future
projections. Financial projections for established businesses can
be based on prior experience, whereas those for new ventures are
often premised on macro-economic data, conjecture and the
performance of similar ventures. Planning is frequently based on
unproven assumptions about the size of the market opportunity
and the level of market penetration that the venture can achieve.
A business plan typically outlines a number of underlying
assumptions about the new venture, such as time to market,
product cost, pricing, first customers and sales targets. As the
venture develops, these assumptions get tested as hypotheses,
either de-risking the investment (if the hypotheses are proved) or
triggering a re-evaluation of the venture (if the hypotheses are
disproved). Milestones and financial projections are therefore
critical to outside investors and if the entrepreneur needs to be

able to articulate why a projection was not achieved and its
implications for the business opportunity as the venture
proceeds. Investors typically seek evidence in a business plan
along three dimensions, described in Table 12.5.

Table 12.5 Evidence for investors from a business plan

1. Entrepreneurial 2. Business idea 3. Evidence of
team merit commitment

• Qualification and • Technology risk • Time and capital
reputation
• Alignment of product already invested
• Youth and
experience to market • Salaries of start-up

• Track record • Timing team

• Ability to implement • Potential size of • Equity buy-in for
the plan market opportunity achieving key
milestones
• Evidence of traction • Route to market
and partnerships identified • Investors protected
against early exit by
• Ability to function as • No fatal flaws start-up team
an effective team

A common problem for technology entrepreneurs is balancing
the need to articulate the merits of their business idea without
disclosing critical aspects that could be appropriated by others.
Providing evidence of IP may signal to potential investors that
the idea is based on deep-rooted know-how that cannot be copied
easily, thereby avoiding the need to disclose unnecessary secrets.
Where ideas are not protected by IP, the entrepreneur needs to be
cautious in choosing a reputable investor, or at least ensure that
they have sufficient first-mover advantage that stealing their idea
would not make much difference. There are differing views on
what financial information to include in a business plan.
However, it is commonly agreed that projecting the financial
performance of a new venture is as hard as forecasting the
weather. Investors often cite that prospective entrepreneurs
overstate sales projections, whereas entrepreneurs tend to believe
this to be posturing so that investors can negotiate a more
favourable deal. Yet financial projections provide the basis for
entrepreneurs and outside investors to come to a common
understanding about the potential value of a new venture. One
common way to deal with this problem is to provide the investor
with a long-term option, known as a warrant, to buy more shares

at a nominal price if the venture fails to meet key sales targets.
This not only signals the entrepreneur’s confidence in the targets,
but de-risks the investor’s investment and incentivises the
entrepreneur to achieve the targets.

12.7.1 Conducting Due Diligence

Investors will always take reasonable steps to verify the accuracy
of any business plan before pouring money into a new venture
(Shontel, 2012). It can be expected that the investor will conduct
due diligence on all aspects of the business plan, including the
entrepreneur’s character, their team, recent financial
performance, the current ownership structure of the business,
validation of any IP, who has invested how much in the business
to date, and a review of compliance and regulatory requirements
and of any pending litigation, insurance or taxation claims. This
process checks the integrity of the entrepreneur’s business as
well as provides a view on how it is managed. The investor is
likely to incur costs during due diligence, and they will want to
make sure that the entrepreneur’s intentions are bone fide during
the negotiation period. For protection, the investor may request
that the entrepreneur executes an exclusivity agreement whereby
the entrepreneur agrees not to proceed with negotiations with
other parties during due diligence. Due diligence should work
both ways, and entrepreneurs should also conduct due diligence
on any potential investor. A common mistake made by
entrepreneurs is to choose the investor who seeks the lowest
equity requirement for making the investment, where in reality
they may be better to choose an investor who can add greater
value. The entrepreneur should seek references from CEOs about
what the investor was like to work with and assess the investor’s
credibility in the investment community as an enabler for the
future.

12.7.2 Valuation Primer

Free cashflow (FCF) is perhaps the most conservative
description of cashflow. It represents cashflow after expenditure
on maintaining and investing in new capital is made to support
growth and is a key financial consideration in investment
opportunities.

F CF = EBI T (1 − T R) + Depreciation − ΔW orking Capital − Capex

EBIT = Earnings before interest and tax,TR=Tax
rate,Capex=Investment innew capital

In corporate finance, the main method of valuation is to calculate
the net present value (NPV) of future FCF. In valuing shares, for
example, the NPV calculation would include future dividends
and capital appreciation. Let us take the simple illustration in
Table 12.6, in which a farmer has an opportunity to plant willow
as an energy crop.

Table 12.7 shows that the cumulative net income transitions
from negative to positive (i.e. the breakeven point) somewhere
between year 3 and year 4.

12.7.2.1 Net Present Value Method
A simple breakeven analysis does not discount the cashflows,
hence does not take into account the time value of money and
thus under-reflects the need to maintain and replace capital.
Table 12.8 shows the same cashflows discounted at 30 and 40
per cent.

The NPV is simply the summation of the discounted
cashflows (DCFs).

10

€ €N P V @30% = ∑ DCF = 501 per acre = 30, 000 f or 60 acre

0

10

€ €N P V @40% = ∑ DCF = 67 per acre = 4, 000 f or 60 acre

0

The value placed on this venture ultimately depends on the
discount rate used, which reflects the riskiness of the future
cashflow projections. The difficulty with this type of analysis is
that it may simply be impossible to predict what future cashflows
might be. Furthermore, investors often use very high discount
rates to reflect the risk of failure. The NPV method can therefore
be difficult to apply to new venture valuations. A very simple
method often used instead is price-to-earnings (P/E) ratios. For
example, the investor could look at the net income predicted at a
key milestone at some stage in the future and apply a multiple,

typical of similar ventures, to it. This method is frequently used
to arrive at a “ballpark” valuation. Firms that display similar
“value characteristics” are selected. These value characteristics
include risk, growth rate, capital structure and the size and timing
of cashflows. This valuation method is most useful when
historical information about publicly comparable firms and their
capital structure, revenue, profit margins and net profit figures is
known.

Table 12.6 Income statement

Table 12.7 Breakeven point

Table 12.8 Discounted cashflows

12.7.2.2 Venture Capital Method
The VC method of valuation recognises that many start-ups tend
have negative cashflows for several years, followed by highly
uncertain but potentially substantial positive cashflows (Figure

12.8). The NPV method, therefore, would not provide a
meaningful valuation technique. The VC will also have an exit
plan strategically linked to a key milestone at some stage in the
future when a trade sale or IPO can take place. The steps in this
method are as follows:

1. Select the year for valuation and estimate the net income or FCF for that
year.

2. Apply a P/E ratio to the net income and compute a valuation for that year.

3. Use a very high discount rate to calculate the present value (PV) of the
valuation.

4. Using the PV, calculate the fraction of ownership in exchange for the
investment.

As an example, if a new venture can achieve FCFs of $5 million
in the exit year (year 5) and well-managed companies in this
sector typically have a P/E ratio of 10, then we can calculate the
terminal value in the fifth year at $50 million. If the VC uses a
discount rate of 40 per cent, then the PV of this valuation is:

PV = FV = $50m = $9.3m

r 5

(1+r) (1+0.4)

Figure 12.8 Typical cashflow profile for a high-potential start-up

This is referred to as the post-money valuation. The required
equity to meet the target rate of return is the amount to be
invested by the VC divided by the PV of the terminal value of
the company. If, for example, $4.3 million is being invested, then
the equity stake should be:

Re quiredOwnershipbyV C = $4.3m = 46 per cent

$9.3m

If the venture currently has 50,000 shares outstanding, it would
need to issue a further 43,000 shares to the VC at a price of $100
per share. The pre-money valuation would be $5 million.

12.7.2.3 First Chicago Method
The VC method is successful in many cases, but the discount rate
applied is the determining variable that reflects many
assumptions. A variation on the basic VC method, known as the
first Chicago method, compensates for the fact that subsequent
performance of individual companies does not always match the
projections contained in the original plans. This valuation
method uses a lower discount rate applied to a cashflow
projection that is calculated as an average of three possible
scenarios, with each scenario weighted according to its perceived
probability.

12.7.2.4 Options
Investing in early-stage start-ups is high risk and often mirrors a
game of poker in which the players (entrepreneur and investor)
withhold information to convey a better hand than they actually
have. One way to hedge against risk is to embed flexibility for
the investor in any deal that allows them to:

• Increase their investment if the venture is going better than

planned;

• Decrease their investment if the venture is going poorer

than planned;

• Defer further investments (wait-and-see approach); or

• Abandon the venture altogether.

These real options affect the value of the firm in a way that
cannot be measured accurately using DCF methods. New
ventures backed by private equity companies often go through
multiple funding rounds. Investors use this multi-stage approach
to motivate the entrepreneur to perform better and limit their
exposure by exercising their options. Applying the famous
Black–Scholes formula (used for valuing financial options) to
valuing new ventures as a portfolio of real options is a
developing area of entrepreneurial finance.

C = SNd1 − Ke−rTNd2 C = Call option price
where S = Price of underlying stock
K = Option exercise price
d1 = In(s/k)+(r+σ2 /2)t N = Area under normal curve
σ√t r = Risk-free rate
t = Time to expiration
s = Stock volatility (risk)

and

d2 = d1 − σ√t

There are, of course, many factors that affect the valuation of
a business. Value refers to the monetised priced agreed by buyer
and seller, usually the entrepreneur and the investor. Most
entrepreneurs and investors have differing, oblique points of
view that do not intersect. In fact, often the two sides do not even
speak the same investment language. There is a value divergence
between the ideal valuation due to a venture’s growth rate and
the valuation of the investor’s shares due to dilution by
subsequent investors and other factors. Even in successful
ventures, divergence between the entrepreneur’s and investor’s
valuation can be anywhere between 3x and 5x. Considerable
interaction between the investor and the entrepreneur is therefore
required to come to some consensus on the valuation of a
business.

12.7.3 Harvesting and Exit Strategies

Harvesting can be considered to be the final stage in the
entrepreneurial process, whereby investors reap the financial
returns from their investments. Recall that, unlike shares in a
corporation traded over the stock exchange, shares in new
ventures tend not to be very liquid. Outside investors value
venture opportunities with an expectation of a liquidity event,
often tied to a key milestone, that enables them to realise the
return on their investment so that they can move on to other
investments. Harvesting is a critical factor in the initial
investment decision, as the valuation of the venture to both the
entrepreneur and outside investor depends on the expected
returns at the time of harvest. Despite the fact that entrepreneurs
tend to focus their energies on enticing investors into investing in

their ventures, investors will always look at potential exit
strategies when assessing a business plan. While some
entrepreneurs may wish to remain with the venture, harvesting
can facilitate earnings on their human capital and opportunity
costs associated with the start-up.

Table 12.9 Characteristics of IPO-suitable ventures
Characteristic Typical requirement for IPO

Revenue >$20 million

Earnings >$2 million; company must be profitable for a number of
before interest years prior to IPO application
and taxes
(EBIT)

Scope Company has usually internationalised and entered global
markets

Board High-profile board members with corporate experience
Management
Management team with significant experience in large
Business corporations
portfolio
Range of products to sustain income stream

Innovation Pipeline of product development to ensure continued market
leadership

Cash reserves Enough cash to meet growth requirements without further
capital

Brand Strong public awareness of brand

Competition Competitive advantage based on strong IP or business
model that erects barriers to entry

There are many famous stories of Silicon Valley
entrepreneurs making their fortunes in IPOs. Mark Zuckerberg
sold about 30 million shares at a price of $38 when Facebook
made its stock market debut. That is a staggering $1.14 billion!
The IPO has become the benchmark for many aspiring
entrepreneurs as the ultimate exit for themselves and their
investors. VCs, for example, invest in ventures that they deem
more likely to deliver an exit by IPO than by trade sale. Yet the
percentage of angel investor exits by IPO remains relatively
small. Table 12.9 shows some of the typical characteristics suited
to an IPO.

Few ventures in private ownership can meet these
requirements. Generally, it will cost in excess of $500,000 in

legal and accounting fees for even the smallest IPO. An IPO
consumes significant time in the months leading up to the event.
The management team must select an investment banker to
advise on share issuance and to underwrite the risk of share price
fluctuations during the IPO. The investment banker will act as
intermediary between the venture and the market. It will conduct
a full valuation of the company and due diligence. The IPO
market is also sensitive to prevailing economic conditions, and
timing is critical. High numbers of IPOs tend to coincide, for
example, with breakthrough innovations with global potential –
computing, silicon chips, the internet, genetics and green tech. A
venture also runs the risk of a post-IPO hangover, as the markets
tend to be much more wary of overvalued stock and misleading
forecasts. Nor does a successful IPO guarantee a successful exit.
In the aftermath of the Facebook IPO, its stock fell to its lowest
price, $19.69, as the initial lock-up expiration of 271 million
shares kicked in. Zuckerberg decided not to sell his shares for 12
months in order to dampen lock-up expirations and drive
confidence. Lockups prevent entrepreneurs and key investors
from selling shares for some period after the IPO. Failure to
manage the post-IPO period can delay an exit or decrease the
expected exit value. Notwithstanding these challenges, an
investor can harvest from an IPO in several ways. First, they can
sell a portion of their share in the IPO. Second, afterwards they
can sell small volumes of shares from time to time on the stock
exchange, or make a private sale to another investor based on
market value.

However, the main mode of harvesting for equity investors is
not the IPO but the trade sale (Fakhro et al., 2011). In a trade
sale, an interested party can purchase equity in a venture for cash
or a share swap. The purchasing party will normally conduct due
diligence and request warranties from the seller on the valuation.
If the seller cannot warrant the value of the venture, then the
price is likely to be reduced. Angel investors and venture
capitalists will always prefer selling their equity for cash. Any
new investor will want to be reassured that value is not highly
contingent on key members of the management team, such as the
founding entrepreneurs. In such circumstances, they may insist,
on earn-out provisions that keep key personnel within the
business for a period of time or until agreed milestones are met.

Very few businesses pre-plan trades sales effectively. Many
entrepreneurs and early-stage investors end up being forced into
a fire sale, often due to running out of cash reserves. The key to a
successful sale is both parties arriving quickly at an agreed
valuation of the business. It is important for both early-stage
investors and entrepreneurs to work proactively towards a best-
case sale. This approach may enhance the locus of control over
potential buyers (Figure 12.9).

Figure 12.9 Planning a trade sale or private placement

The predominant approach taken by the investment
community to exits is extraordinarily one-dimensional: invest in
companies that have significant forecasted growth in sales and
profits and sell out on a multiple of the profits. This one-size-fits-
all approach fails to recognise some basic investment principles.
First, high growth in itself, as an investment strategy, is high risk
(Garvin, 2004) and statistically produces far more failures than
successes; second, the approach undervalues those ventures that
can add strategic value to potential buyers. The vast majority of
existing businesses employ fewer than five people, and any that
grow beyond a handful of employees are in the minority. In
Australia, for example, 60 per cent of SMEs are non-employing;

micro businesses (1 employee) account for less than 25 per cent;
other small businesses (5–19 employees) account for less than 12
per cent; medium-size businesses (20–199 employees) account
for 4 per cent; and large companies employing over 200
employees account for about 0.3 per cent (Australian
Government, 2011). Clearly, if growing a business to the size of
Facebook was easy, then there would be far more ventures
making it to IPO.

As a business grows, it has to cope with complexity and
challenges associated with increasing in size. Its different stages
of development will reflect change to its business fundamentals.
Complexity, for example, increases non-linearly with the number
of staff. Too many entrepreneurs fail to cope with these changes.
During the pre-seed and startup stages an entrepreneur is often
able to drive the business through sheer energy and passion. Yet
as the business hires staff a management structure needs to be put
in place, job descriptions and reporting lines get fixed and
performance targets become essential. Communications are also
more challenging. These and many other issues can undermine
growth, so much so that extremely few companies manage to
sustain double-digit growth for more than a few years. Therefore,
although high exit values occur when growth is significant,
ventures that pursue high growth are more likely to stall than
sustain their growth. Only rarely does a new venture achieve a
size that allows an IPO or a good trade sale. Both investors and
entrepreneurs should prioritise planning for an exit event as part
of the business plan.

12.8 THE EVOLVING NATURE OF
ENTREPRENEURIAL FINANCE

Bank lending remains the most common source of external
finance for entrepreneurs. They are often highly reliant on
traditional debt to meet their start-up, cashflow and investment
needs. However, bank finance is less accessible to newer,
innovative and fast-growing companies, with a higher risk-return
profile. Although bank financing will continue to be crucial for
SMEs, there is a growing concern that credit constraints have
become the “new normal” for SMEs and entrepreneurs, after the
global financial crisis (OECD, 2015).

Likewise, equity finance remains critical for start-ups with a
high risk-return profile, such as new, innovative and high-growth
firms. Seed and early-stage equity finance can boost firm
creation and development. Business angels and venture
capitalists remain the dominant source of equity finance and,
while they may have different motivations, targets, scale and
operating models, they are highly complementary in the
financing continuum for early-stage firms. Business angels need
a well-functioning VC market to provide the follow-on finance
that some of the businesses they support will require. Conversely,
a well-established angel market can create greater opportunities
and increase the deal flows for VCs. However, even the business
angel market is evolving. Business angels are increasingly
investing as part of organised and managed angel networks
alongside other angels rather than on their own (Mason et al.,
2019).

Block et al. (2018) highlight a range of new players with
innovative financing instruments for entrepreneurial ventures.
Recent developments including supply chain finance and peer-to-
peer lending may further help to fill gaps in the supply of bank
finance (Breedon, 2012), although these sources of finance are
currently used by only a tiny proportion of small businesses. On
the other hand, crowdfunding has grown rapidly in the past
decade, serving to finance pre-seed projects and new ventures. It
has become an important alternative source of funding across
many other sectors, and it is increasingly used to support a wide
range of start-ups. Different approaches to crowdffunding
include reward, lending, social and equity models. Individuals
with small amounts to invest have been particularly attracted to
lending-based crowdfunding due to the apparently greater returns
on offer than from banks (Belleflamme et al., 2014). An
emerging issue associated with alternative modes of financing,
such as peer-to-peer lending or crowdfunding, is that these
investors are often not in a position to undertake the value-added
roles played by angel or VC investors aside from providing
funding. Although crowdfunding and peer-to-peer lending
platforms may facilitate the flow of information in a way that
results in better monitoring and governance (Moenninghoff and
Wieandt, 2013), the exact role of the providers of these
alternative forms of financing in the context of monitoring and

governance remains somewhat unclear. As previously discussed,
accelerators enable entrepreneurs to access initial amounts of
funding together with mentoring support from experienced
entrepreneurs and business angels (Miller and Bound, 2011).
Accelerators are typically publicly funded and tend to support
entrepreneurial teams in the idea or working prototype stages,
helping entrepreneurs to attract funding from business angels and
VCs.

So entrepreneurial finance is evolving rapidly. Figure 12.10
shows the evolution over the past decade as new players, such as
crowdfunders, have entered the market.

Figure 12.10 Evolution of entrepreneurial finance

12.9 THE EMERGENCE OF CROWDFUNDING

Some examples of crowdfunded start-ups have been provided
earlier in this chapter. The basic idea of using many small
donations, often in advance, to support new ventures circulated
long before it came to be known as crowdfunding. Publications
of new manuscripts by Bach and Beethoven, the construction of
the Statue of Liberty and the rescue of Swedish carmaker Saab
all relied on variants of this concept (Hemer, 2011). However, it
was not really until after the turn of the new millennium that
companies such as British toy manufacturer Trampoline and
groups such as Artishare began raising equity through internet
calls to finance their projects. Perhaps Barack Obama’s 2008
presidential election, which raised much of its funding via small
cash donations over the web, was a game changer in raising the
profile of crowdfunding as an important mode of financing. The

predominant characteristic remains the raising of funds through
many small donations from individuals or organisations active in
internet communities.

Crowdfunding has become a substitute source of seed
financing for entrepreneurial ventures that have difficulties
raising capital from traditional sources such as banks and angel
investors, often where they appear too innovative to be
understood or too exotic to pass risk thresholds. For many
entrepreneurs, the crowdfunding process can appear daunting, so
they delegate the necessary tasks to so-called intermediaries.
These intermediaries tend to be internet based and hence call
themselves crowdfunding platforms. Rewards-based
crowdfunding platforms, such as Kickstarter and Indiegogo, have
been instrumental in funding entrepreneurial endeavours in the
arts, social enterprises and technology ventures. What is new, of
course, is that these platforms exploit the capabilities of social
media and the internet, which enable them to reach large
numbers of users in specific internet communities within a very
short time frame (Freeman and Nutting, 2015). Up to 2008, the
majority of these platforms offered rewards-based or donation-
based funding schemes. In the wake of the 2008–09 global
financial crisis, debt-based crowdfunding, otherwise known as
peer-to-peer lending, emerged as an investment vehicle, allowing
borrowers to apply for unsecured loans and, if successful, to pay
them back to “the crowd” with interest. While internet
automation simplified the application process, only a small
fraction of applications are typically approved and interest rates
are often favourable to lenders, reflecting the risk profile of the
borrowers.

Given the early success of rewards-based and donation-based
crowdfunding, it was only a matter of time before intermediaries
would seek to match start-ups with angel investors using the
internet, disclosing information and deal terms and processing
investment transactions, all online. Unfortunately, the idea of
entrepreneurs and startups advertising products or services and
raising capital from crowds of investors in exchange for equity
has been constrained by delays in and controversy over
regulation (Vignone, 2016).

12.1
0 CHAPTER SUMMARY

The application of financial theory to new venturing has
uniquely defining characteristics that differentiate it from classic
corporate finance. New venturing, particularly for high-growth
technology ventures, is inherently high risk, so financial
strategies, such as the use of real options, are required to mitigate
that risk and to maximise the returns to the entrepreneur. New
ventures are also inherently less liquid than corporate shares
traded on the open market. Exit strategies for investors and
entrepreneurs should therefore take account of potential liquidity
events, such as IPOs and trade sales, for harvesting returns.

Valuation is particularly contingent on future cashflow
projections and the riskiness of those cashflows. Traditional NPV
methods of valuation do not necessarily apply, as many new
ventures have negative cashflows in the early stages of their
development. The “cash is king” cliché also has a particular
relevance to new ventures in their early developmental stages.
Without cash a business cannot survive, and new ventures
usually do not have the same financial cushion as large
companies if they run out of cash. Many new venture failures can
attribute the root cause of failure to poor financial decision-
making.

Case Study 12.1 looks in depth at an example of an IPO that
has been used throughout this chapter.

CASE STUDY 12.1 THE FACEBOOK IPO

Facebook filed its application for an IPO with the Securities and Exchange
Commission in early 2012 and began trading in May. Its initial valuation was
estimated at $100 billion, four times that when Google went public in 2004,
but the stock market was not immediately kind to the social networking
company. The share price dropped steadily from the first-day price of $38,
and by August it had fallen below $25 (Figure 12.11).

Figure 12.11 Fall in Facebook share price post IPO
This, in part, was due to the increasing scepticism about how fast

Facebook’s profits and revenues could grow. It needed to make money from
its users, and it needed to find ways to do that from mobile devices where
there was little space for ads. Yet on its current share price, Facebook is now
valued at over $500 billion, which is staggering for a company only 16 years
old. Between 2005 and 2011, its valuation grew from circa $100 million to
$50 billion, but that was just the beginning. By 2013, its post-IPO valuation
had hit $130 billion. With its net earnings consistently positive since then,
Facebook’s valuation reached a staggering $500 billion in 2019, on the back
of $20 billion free cashflow (Figure 12.12).