New Venture Creation
Professor Alexander Settles
Entrepreneurial versus Administrative
Drivers of Growth
Life Cycle
Traits Characterizing Rapidly
Growing Companies
• High levels of change, ambiguity, and
uncertainty
• Ongoing succession of nonlinear and
nonparametric events
• Inexperience of management team
• Counterintuitive, unconventional patterns of
decision-making
• Informality and fluidity of organization
structure and procedure
Entrepreneurial Actions
Entrepreneurial Influence Skills
• Interpersonal/teamwork skills
– Ability to create, through management, a climate
and spirit conducive to high performance
– Ability to understand the relationships among tasks
and between the leader and followers
– Ability to lead in those situations where it is
appropriate
Characteristics of Successful
Managers
• Managers skilled in leadership, vision, and
influence
– Skillful in creating clarity out of confusion,
ambiguity, and uncertainty
– Able to define adroitly and gain agreement on who
has what responsibility and authority
– Manage in a way that builds motivation and
commitment to cross-departmental and corporate
goals, not just parochial interests
Characteristics of Successful
Managers
• Managers skilled at helping, coaching, and
conflict management
– Creatively handle conflicts, generate consensus
decisions, and share power and information
– Recognize that high-quality decisions require a
rapid flow of information in all directions
– Accept that knowledge, competence, logic, and
evidence need to prevail over official status or
formal rank in organization
The Key to Growth
• Team traits
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Cohesion
Teamwork
Integrity
Commitment to the long haul
Harvest mind-set
Commitment to value creation
Equal inequality
Fairness
Sharing of the harvest
Key Questions for the Lead
Entrepreneur/Founder
• Is formation of a team desirable or necessary?
• Do I want to grow a higher potential company?
• What talents, know-how, skills, track record,
contacts, and resources are currently available?
• What is needed to succeed?
• Who is needed to complement me?
Forming and Building a Team
• Three issues for consideration
– Values, goals, and commitment
– Definition of roles
– Peer groups
Common Pitfalls
• Do not use the “honeymoon” period of start-up
advantageously
• Do not answer the questions of who is in
charge, who makes the final decisions, and
how real differences of opinion are resolved
• Do not address or recognize the deficiencies of
the lead entrepreneur or the management team
Common Pitfalls
• Do not recognize that creating and building a
new venture is a dynamic process
• Do not identify and defuse destructive
motivations of investors, prospective team
members, or the lead entrepreneur
• Do not value trust and integrity
Slicing the Founder’s Pie
• How much stock ownership should go to
whom?
– Share the wealth with those who help to create the
value and thus the wealth
– Realize a harvest of at least 5 to 10 times the
original investment
– Make sure the company prospers and grows thus
creating a huge, shared pie
Distribution Issues
• Differentiation
– Reward system recognizes differences in
contributions among team members
• Performance
– Reward is a function of performance (as opposed
to effort)
• Flexibility
– Reward system acknowledges and accounts for
changes in contributions of team members
Stock-Vesting Agreement
• Stock-vesting agreement—An agreement
between venture and team member used to
guard against the event that some portion of
the stock has been earned and some portion
will remain unearned, as when a team member
quits or dies; the venture places the stock
purchased by team members in escrow to be
released over a two- or three-year period.
Stock-Vesting Agreement
• Fosters longer-term commitment to the
success of the venture
• Provides a method for a civilized, no-fault
corporate divorce if things do not work out
• Establishes a period of years, often four or
more, where founding stockholders can “earn
out” their shares
Consideration of Value
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Idea
Business plan preparation
Commitment and risk
Skills, experience, track record, or contacts
Responsibility
The Entrepreneurial Approach to
Resources
• Resources
– People, such as the management team, the board of
directors, lawyers, accountants, and consultants
– Financial resources
– Assets, such as plant and equipment
– Business plan
Resource Minimization Strategy
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Staged capital commitments
Less capital
More flexibility
Low sunk cost
Lower costs
Reduced risk
Relationship with the Board of
Directors
• Simple rules for a productive relationship with
the board of directors
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Treat your directors as individual resources
Always be honest with your directors
Set up a compensation committee
Set up an audit committee
Never set up an executive committee
Financial Resources
• Cash is the lifeblood of the venture
• Computers and spreadsheet programs are tools
that save time and increase productivity and
creativity.
– Answer “what if” questions
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Capital Requirements
Pro Forma Income Statements
Balance Sheets
Budgeting
Break-Even Calculations
• Cash Flow Projections
Part 2
Entrepreneurial Finance
• Three core principles of entrepreneurial
finance
– More cash is preferred to less cash
– Cash sooner is preferred to cash later
– Less risky cash is preferred to more risky cash
Finance Process
Bargaining Power
• Three vital corollaries determining bargaining
power
– Burn rate
– Time to OOC (Out Of Cash)
– TTC (Time To Close)
Free Cash Flow
• The cash flow generated by a company or
project is defined as follows:
– Earnings before interest and taxes (EBIT)
– Less tax exposure (tax rate times EBIT)
– Plus depreciations, amortization, and other
non-cash charges
– Less increase in operating working capital
– Less capital expenditures
Operating Working Capital
• Operating working capital can be defined as
follows:
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Transactions cash balances
Plus accounts receivable
Plus inventory
Plus other operating current assets
Less accounts payable
Less taxes payable
Less other operating current liabilities
Factors Affecting Financing
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Accomplishments and performance to date
Investor’s perceived risk
Industry and technology
Venture upside potential and anticipated exit
timing
Factors Affecting Financing
• Venture anticipated growth rate
• Venture age and stage of development
• Investor’s required rate of return or internal
rate of return
• Amount of capital required and prior
valuations of the venture
Factors Affecting Finance
• Founders’ goals regarding growth, control,
liquidity, and harvesting
• Relative bargaining positions
• Investor’s required terms and covenants
Examples of Entrepeneurial Ventures
Five Year Performance Trends
US Venture vs Buyouts vs Stocks
Venture Capital Funding
Obtaining Risk Capital
• Three central issues to be considered
– Does the venture need outside equity capital?
– Do the founders want outside equity capital?
– Who should invest?
Angel Investors
• Who are angel investors?
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Most are self-made entrepreneur millionaires
Many are in their 40s and 50s
Most are well educated
Ninety-five percent have college degrees from
four-year colleges
– Fifty-one percent have graduate degrees (Fortyfour percent are in a technical field and thirtypercent percent are in business or economics)
– Ninety-six percent are men
Informal Investors
• What type of ventures lends themselves to the
use of informal investors?
– Ventures with capital requirements of between
$50,000 and $500,000
– Ventures with sales potential of between $2 million
and $20 million within 5 to 10 years
– Small, established, privately held ventures with
sales and profit growth of 10% to 20% per year
Informal Investors
• What type of ventures lends themselves to the
use of informal investors?
– Special situations, such as very early financing of
high-technology inventors who have not developed
a prototype
– Companies that project high levels of free cash
flow within three to five years
Venture Capital Deals
$120,000,000,000
4000
3500
$100,000,000,000
3000
$80,000,000,000
2500
$60,000,000,000
2000
1500
$40,000,000,000
1000
$20,000,000,000
500
$0
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Investment
# of Deals
What to Look for in Investors
• Seek investors who:
– Are considering new financing proposals and can
provide the required level of capital
– Are interested in companies at the particular stage
of growth
– Understand and have a preference for investments
in the particular industry
What to Look for in Investors
• Seek investors who:
– Can provide good business advice, moral support,
and has contacts in the business and financial
community
– Are reputable, fair, and ethical and with whom the
entrepreneur gets along
– Have successful track records of 10 years or more
advising and building smaller companies
Advantages of Going Public
• To raise more capital with less dilution than
occurs with private placements or venture
capital
• To improve the balance sheet
• To reduce or eliminate debt (thereby enhancing
the company’s net worth
• To obtain cash for pursuing opportunities that
would otherwise be unaffordable
Advantages of Going Public
• To access other suppliers of capital and to
increase bargaining power, as the company
pursues additional capital when it needs it least
• To improve credibility with customers,
vendors, key people, and prospects
• To achieve liquidity for owners and investors
Advantages of Going Public
• To create options to acquire other companies
with a tax-free exchange of stock, rather than
having to use cash
• To create equity incentives for new and
existing employees
IPO Proceeds
Exhibit 13.11
Issues Leading to Possible Crises in
Rapid Growth
• Opportunity overload
– Choosing from among an abundance of sales or
new market opportunity
• Abundance of capital
– Evaluating investors as “partners” and the terms of
deals with which they were presented
• Misalignment of cash burn and collection rates
– Cash burn rates racing ahead of collections
Issues Leading to Possible Crises in
Rapid Growth
• Decision making
– Executing functional day-to-day and week-to-week
decisions, rather than strategizing
• Expanding facilities and space . . . and
surprises
– Coping with surprises, delays, organizational
difficulties, and system interruptions spawned by
space or facility expansion
Organizational Climate
• Six basic dimensions
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Clarity
Standards
Commitment
Responsibility
Recognition
Esprit de corps
Common Approaches to Successful
Management
• Leadership
– Roles, tasks, responsibilities, accountabilities, and
appropriate approvals clearly defined
– Leadership based on expertise, not authority
– Emphasis placed on performing task-oriented
roles
• Consensus Building
– Emphasis placed on overall goals
– Emphasis on participation and listening
Common Approaches to Successful
Management
• Communication
– Information sharing
– Willingness to alter individual views
• Encouragement
– Encouragement of innovation and calculated risktaking
Common Approaches to Successful
Management
• Trust
– Do what they say they are going to do
– Traits include openness, spontaneity, and
straightforwardness
• Development
– Develop human capital