CHAPTER 8: SOURCES OF CAPITAL FOR ENTREPRENEURS

True/False:

1. Use of debt to finance a new venture involves a payback of funds plus an interest fee for the use of the
money.

ANS: T

2. Sources of debt financing include trade credit, accounts receivables, factoring, and finance companies.

ANS: T

3. Equity financing is money invested in the venture with legal obligations to repay the principal amount of
interest or interest rate on it.

ANS: F

4. Because the advantages of going public outweigh the disadvantages, it is in a corporation’s best interest to
go public.

ANS: F

5. Private placement is a method of raising capital through the private placement of securities.

ANS: T

6. Regulation D augments the regulations for reports and statements required for selling stock to private
parties, friends, employees, customers, relatives, local professionals.

ANS: F

7. Sophisticated investors are wealthy individuals who invest more or less regularly in new and/or early- and
late-stage ventures.

ANS: T

8. Venture capitalists, surprisingly, require little information before they make an investment.

ANS: F

9. Informal risk capitalists are those who have already made their money and now seek to help new
ventures.

ANS: T

10. Informal risk capitalists are often referred to as “business angels.”

ANS: T
Multiple Choice:

1. Which of the following is not a type of debt financing?

a. private placement
b. trade credits
c. finance companies
d. accounts receivables
ANS: A

2. A disadvantage of debt financing is

a. regular interest payments.
b. possible cash flow enhancement.
c. inhibition of growth and development due to equity investments.
d. relinquishment of ownership.
ANS: A

3. Which of the following is a type of equity financing?

a. convertible debentures
b. common stock
c. loan with warrants
d. loan without warrants
ANS: B

4. The most common source of debt financing is

a. trade credit.
b. factoring.
c. commercial banks.
d. finance companies.
ANS: C

5. Advantages of debt financing include all of the following except:

a. low interest rates that justify the opportunity cost.
b. regular interest payments.
c. potential greater return on equity.
d. no relinquishment of ownership.
ANS: B

6. One of the advantages of public offerings is

a. liquidity.
b. disclosure.
c. requirements.
d. cost.
ANS: A
 7. The main objective of Regulation D is to
a. increase investment in private placement.
b. regulate new small-business investment.
c. make it easier and less expensive for small ventures to sell stock.
d. reduce debt financing by small enterprises.
ANS: C

8. Major trends in the venture capital field today include all of the following except
a. less specialized and more homogenous funds
b. emerging feeder funds
c. decrease in start-up investment amounts
d. global reach
ANS: A

9. Which of the following terms is not synonymous with social lending?

a. crowdfunding
b. peer-to-peer (P2P) lending
c. banking 2.0
d. commercially viable lending
ANS: D

10. Which of the following statements is not true of venture capitalists?

a. They want the entrepreneur and the management to run the company.
b. They expect high return on investments.
c. They are interested in trying to manage firms themselves.
d. They take a long time to raise venture capital.
ANS: C
11. Which is an important question for the entrepreneur to ask when evaluating the venture capitalist?
a. Is the person someone with whom the entrepreneur can work?
b. Is the person a close relative?
c. Is the person wealthy?
d. Is the person a college graduate?
ANS: A

12. The entrepreneur should ask the venture capitalist _____ questions.
a. at most ten
b. exactly twenty
c. an unlimited number of
d. no
ANS: C
 13. Which is one of the most important questions for entrepreneurs to ask regarding venture capitalists?
a. What is it like to work with their firm?
b. Are they good communicators?
c. Are they wealthy?
d. Are they good at financial computation?
ANS: A

14. An informal risk capitalist is referred to as:

a. your neighbor.
b. a business angel.
c. a retiree.
d. someone with extra money to invest but who is not interested becoming an entrepreneur.
ANS: B

15. Which of the following does not represent a category of angel investors?
a. micromanagement angels
b. entrepreneurial angels
c. amateur angels
d. corporate angels
ANS: C

Short Answer:

1. What are the major types and uses of debt financing?

ANS:
Many new ventures find that debt financing is not a choice but a necessity. Short-term borrowing (one
year or less) often is required to obtain working capital and is repaid out of proceeds from sales. Long-
term debt (term loans of one to five years or long-term loans maturing in more than five years) is used to
finance the purchase of property or equipment, with the purchased asset serving as collateral for the loans.
The most common sources of debt financing are commercial banks.

2. What is the potential future of crowdfunding sites to raise capital with respect to entrepreneurs?

ANS:
If the social equity investing sites (crowdfunding) continue, entrepreneurs will have an
effective weapon in their arsenal to combat the cash-flow issues inherent in running a business.
As with any investors, entrepreneurs need to carefully review the policies and procedures as well
as the reputation for any funding site they are considering taking money through. In 2014, there
were over 450 crowdfunding platforms (Kickstarter and Indiegogo are the most well-known) as
the industry grew to be over $5.1 billion worldwide. It is now estimated that crowdfunding now
raises over $2 million per day with some predictions of 100% growth each year. For those
 individuals who have been putting their entrepreneurial aspirations on hold due to financial fears,
crowdfunding could provide the peace of mind needed for them to dust off their ideas and put
them into action.

3. How does a public offering differ from a private placement?

ANS:
A public offering involves entering the stock exchange. Once the stock is publicly offered, anyone can
buy shares and, in turn, ownership. Public offerings are very expensive and highly regulated. These
disadvantages are offset by the large amounts of capital and liquidity the offerings can provide. A private
placement is used more often by small ventures. It allows the sale of the stock to private, personally
selected individuals. The Securities and Exchange Commission has enacted special rules to make private
placement easier and less expensive for small businesses. Both of these equity financing plans differ
from debt financing. They require a relinquishment of ownership, but don’t demand a fixed payback of
the invested principal.

4. Should entrepreneurs accept proposals from the first venture capitalist that offers?

ANS:
Entrepreneurs must evaluate their capitalist just as their capitalist evaluates them. Not every capitalist is
right for every entrepreneur, even if he or she does have the money needed. The entrepreneur must look
at the capitalist’s skills and knowledge, and decide how well they can work together, while keeping in
mind that venture capital is hard to come by.

5. Are formal firms the only source of venture capital?

ANS:
There are many individuals willing to invest where venture capitalists will not. These are usually wealthy
people looking for investments and are referred to as “business angels.” These people are generally well
off. They don’t need the high, immediate rate of return required by the venture capital firms. They often
seek social rather than purely financial returns on their investments.