FIN4717

ENTREPRENEURIAL
FINANCE
Lesson 2
(i) ORGANIZING AND FINANCING A NEW
VENTURE

(ii) EVALUATING OPERATING AND

FINANCIAL PERFORMANCE
FIN4717
ENTREPRENEURIAL FINANCE

ORGANIZING AND FINANCING

A NEW VENTURE

Reading: Chapter 3

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Outline

Forms of Business Organization

Comparing Various Business Organizational
Forms

Protecting Intellectual Property

Seed and Startup Financing

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Forms of Business Organization

Proprietorships

Partnerships

General Partnerships

Limited Partnerships

Corporations Don't sue individuals, will sue the "Partnership" entity

Corporations (regular corporations, sometimes called

“C Corporations”)

S (or Subchapter S) Corporations

Limited Liability Companies (LLCs)
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Proprietorships

Business venture owned by one person – the proprietor.

Ease and low cost of setup.

The main source of equity funds is the proprietor’s funds.

The proprietor has sole responsibility for venture decision
making.

The proprietor is considered to personally own all assets
of the venture, as well as having personal obligation
(using personal assets) to pay all venture liabilities not
covered by the venture’s assets – Unlimited Liability.

The life of the venture does not outlast the life of the
proprietor.
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Partnerships

Business venture owned by two or more persons – the
partners.

Ease and moderate cost of setup.

Transfer of partners’ ownership positions is difficult.

By default a partnership will terminate upon the death of
a partner.

All partners are jointly liable for the venture decisions of
any partner. Liability is not based on proportion of paid-up capital by
partners

Partnership Agreement may spell out how profits and

losses are to be shared.
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Partnerships (cont’d)

All partners have personal obligation (unlimited liability)
for the venture’s liabilities to third parties, and such
obligation cannot be altered by the Partnership
Agreement (although it can state how partners can
recover funds from each other). Inpartners.
the event of legal disputes, partners will sue
They will sue and claim back however
much they put in...?

Legal action treats all partners equally as a group.

Most business partnerships are General Partnerships,
but some special partnerships are Limited Partnerships,
in which a limited partner’s liability is limited to his equity
capital contribution to the partnership. However, limited
partnerships must have at least one general partner with
unlimited liability.
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Corporations

A legal entity that separates personal assets of the
owners (shareholders) from the assets of the business.

Relatively more difficult and costly to set up.

Shareholders have limited liability – creditors can seize
the corporation’s assets but have no recourse against the
shareholders’ personal assets.

The Corporate Charter is the legal document that
establishes the corporation.

S Corporation (in the US) provides limited liability for
shareholders while the corporate income is taxed like
personal income to the shareholders. To avoid double taxation. Without this, company will
pay tax first, then pass down to employees.
Employees get tax again.

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Corporations (cont’d)

Professionals such as medical doctors, lawyers and
accountants are generally not protected by limited liability
under the structure of a corporation, and remain
personally liable for their wrongful professional acts.

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Limited Liability Companies (LLCs)

A business organization that combines the benefits of
both the corporation and the partnership forms of
business organization – similar to the S Corporation.

Owners of LLC enjoy the same limited liability
protection as shareholders of a typical corporation, but
corporate income before tax is distributed to them and is
taxed at personal levels (no corporate tax) like those of a
partnership. Combination/Hybrid of Corporations and Partnerships

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Comparing Various Business
Organizational Forms

The different forms of business organization can be

compared based on the following:
1. Number of Owners and Ease of Startup
2. Owners’ Liabilities
3. Equity Capital Sources
4. Firm Life and Liquidity of Ownership
5. Taxation

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1. Number of Owners & Ease of Startup

Proprietorship
One owner; low time and legal costs.

General Partnership
Two or more owners (may have a limit in some
countries); moderate time and legal costs.

Limited Partnership
One or more general partners plus one or more limited
partners; moderate time and legal costs.

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1. Number of Owners & Ease of Startup
(cont’d)

Corporation
One or more owners; high time and legal costs.

S Corporation (in the US)
Less than 100 owners; high time and legal costs.

Limited Liability Company (LLC)
One or more owners; high time and legal costs.

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2. Owners’ Liabilities

Proprietorship
Unlimited liability.

General Partnership
Each partner has unlimited liability.

Limited Partnership
General partners have unlimited liabilities, while limited
partners’ liabilities are limited to their investments.

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2. Owners’ Liabilities (cont’d)

Corporation
Liabilities limited to shareholders’ investments.

S Corporation
Liabilities limited to shareholders’ investments.

Limited Liability Company (LLC)
Liabilities limited to owners’ investments.

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3. Equity Capital Sources

Proprietorship
Owner.

General Partnership
Partners.

Limited Partnership
General partners and limited partners.

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3. Equity Capital Sources (cont’d)

Corporation
External investors and founders.

S Corporation
External investors and founders.

Limited Liability Company (LLC)
External investors and founders.

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4. Firm Life & Liquidity of Ownership

Proprietorship
Life determined by the life of owner; often difficult to
transfer ownership.

General Partnership
Life determined by the life of partners; often difficult
to transfer ownership.

Limited Partnership
Life determined by the life of general partners; often
difficult to transfer ownership.

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4. Firm Life & Liquidity of Ownership
(cont’d)

Corporation
Unlimited life; usually easy to transfer ownership.

S Corporation
Unlimited life; often difficult to transfer ownership.

Limited Liability Company (LLC)
Life determined by the life of owners; often difficult to
transfer ownership. Not called shareholders, are called members

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5. Taxation

Proprietorship
Personal tax rate.

General Partnership
Personal tax rates.

Limited Partnership
Personal tax rates.

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5. Taxation (cont’d)

Corporation
Corporate tax rate on business income; personal tax
rates on dividends.

S Corporation
Income flows to shareholders; taxed at personal tax
rates.

Limited Liability Company (LLC)
Income flows to owners; taxed at personal tax rates.

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Protecting Intellectual Property

Intellectual Property (IP) is a venture’s

intangible assets and human capital (knowledge
in particular), including inventions that can be
protected from being freely used or copied by
others.

As a venture may have valuable IP as one of its
key assets and one of its critical ingredients for
success, it is important to protect it wherever
possible.

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Protecting Valuable Intangible Assets
There are four forms of IP protection methods:
1. Patents
Intellectual property rights granted for
inventions that are useful, novel, and non-
obvious.
2. Trade Secrets
Intellectual property rights in the form of
inventions and information, not generally
known to others, that convey economic
advantages to the holders.
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Protecting Valuable Intangible Assets
(cont’d)

3. Trademarks
Intellectual property rights that allow firms to
differentiate their products and services
through the use of unique “marks”.
4. Copyrights
Intellectual property rights to writings in printed
and electronically stored forms.

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Patents

Four kinds of patents:

Utility Patents - cover mechanical or general
inventions, chemical inventions, and electrical
inventions.

Design Patents - cover the “appearance” of items (e.g.
sports uniforms, electronic products, and automobiles,
etc.).

Plant Patents - protect discoveries of asexual
reproduction methods of new plant varieties.

Business Method Patents - protect specific ways of
doing business and the underlying computer codes and
technology. Ebay and its online auction site. Sues anyone doing the same thing.
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Patents (cont’d)

What does having a Patent do for the inventor?

The government does not enforce the inventor’s rights.

The burden of enforcing the patent lies with the
inventor and enforcement can be costly.

Records indicate that over half of patent infringement
suits taken to court are NOT upheld in favor of the
inventor!
Thumb Drive, invented by SIngapore Company Trek 2000.

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Trade Secrets

Inventions and information classified as Trade
Secrets are those that are not generally known
to others, and they convey economic
advantages to the holder.

Why consider protection as a Trade Secret
instead of as a Patent?

Trade secret law can sometimes protect inventions
that do not qualify for patents.

Patent application process may be complex.

There are no time restrictions on trade secrets (in
contrast to patents).
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Trade Secrets (cont’d)

Drawbacks of protection under Trade Secrets:

There is no formal procedure for obtaining protection
as a trade secret.

Protection is established by the secret’s characteristics
and efforts to protect it.

Holder does not have exclusive “rights” to what
comprises the secret (someone could independently
replicate the secret without infringement or prior
knowledge). Unlike Patents. Hence, patents are alot stronger.

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Trademarks

Trademarks allow consumers to easily identify the
source and quality of products or services.

Most trademarks take the form of names, words, or
graphic designs.

Trademarks also can be on the shape of packages,
colors, odors, and sounds.

Trademarks are the most valuable form of
intellectual property for many firms.

A trademark should be suggestive of (but not
describe) a product or product line.
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Trademarks (cont’d)

How do you obtain and register a Trademark?

Trademarks can usually be registered in the patent and
trademark office of the respective countries.

However, trademarks need not be registered. Ownership of a
trademark may be established by being first to use the mark
on products.

A trademark can be lost if the mark becomes a generic term
Because it's treated as
or label (e.g. “panadol”, “aspirin” or “cellophane”). being the material.

In Singapore, registration of a trademark is not compulsory
for a holder to act against any misrepresentations by third
parties.
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Copyrights

Protects the “form of expression of an idea” and not
just words themselves.

Traditional way to establish a copyright is to “publish”
your work accompanied by a copyright notice using
the word “Copyright” or the symbol ©. This C is just a warning/notice, not registered.
R circle is registered and have 2 levels of
protection.

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Other Methods for Protecting
Intellectual Property Rights

Confidential Disclosure Agreements

Documents used to protect an idea or other forms of
intellectual property when disclosure must be made to
another individual or organization (such as potential
investors or potential strategic partners).

Employment Contracts
Agreements between an employer and employee
whereby the employer employs the employee in
exchange for the employee agreeing to keep confidential
information secret and to assign ideas and inventions to
the employer.
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Financing Options at Different Stages
of the Business Life Cycle

Generally not
accessible to
young ventures

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Seed & Startup Financing

Seed and startup ventures usually do not have access to loans from
commercial banks, due to the lack of collateral and healthy business
cash flows.

They generally obtain their capital from the following sources:

Owner’s equity

Personal unsecured credit

Mortgage of personal assets

Family and friends

Business angels

Crowdfunding

Early-stage venture capital funds

(Financial Bootstrapping)
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Seed & Startup Financing (cont’d)

Owner’s equity
This is usually obtained from the entrepreneur’s
personal savings, liquidation of personal
investments, and sale of personal assets.

Personal unsecured credit
The entrepreneur may have bank overdraft facility
obtained personally from the bank. Such a facility is
usually unsecured, but the amount may be limited
and interest costs may be high.

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Seed & Startup Financing (cont’d)

Mortgage of personal assets
If the entrepreneur has valuable assets that are fully
paid for (such as an apartment or a car), he may be
able to use them to secure a mortgage loan from the
bank.

Family and friends
Borrowing from family and friends for business is
very common for many entrepreneurs. But
entrepreneurs should be cautious, as many
cherished relationships have been destroyed due to
over-optimistic expectations and business failures.
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Seed & Startup Financing (cont’d)

Business angels
Business angels refer to wealthy individuals who
invest in entrepreneurial ventures. Many of them are
successful entrepreneurs in their own rights, so they
may also contribute their business skills through their
investments.

Crowdfunding
Using the reach of internet to seek funding from
many people  the general public, who may or may
kickstarter is
not look towards financial gains. There are reward, reward
donation, debt, and equity forms of crowdfunding.
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Seed & Startup Financing (cont’d)

Early-stage venture capital funds
Some VC funds specialize in early-stage
investments, so they are possible sources of funds
for young ventures.

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Seed & Startup Financing (cont’d)

Financial Bootstrapping
Entrepreneurs may want to minimize the need for
financial capital and employ some means to
conserve valuable cash in a new venture:

Lease (instead of outright purchase)

Hire purchase (instead of paying upfront)

Use home as “office” (to avoid rental)

Take advantage of government grants…etc.

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FIN4717
ENTREPRENEURIAL FINANCE

EVALUATING OPERATING AND

FINANCIAL PERFORMANCE

Reading: Chapter 5

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Outline

Cash Burn, Cash Build and Net Cash Burn

Liquidity Ratios

Leverage Ratios

Profitability Ratios

Efficiency & Return Ratios

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Financial Ratios & Analysis

Financial Ratios
Show the relationship between two or more financial
variables.

Trend Analysis
Used to examine a venture’s performance over time.

Cross-sectional Analysis
Used to compare a venture’s performance against other
similar firms at the same point in time.

Industry Comparables Analysis
Used to compare a venture’s performance against the
average performance in the same industry.
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MPC – Income Statement

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MPC – Balance Sheet

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Cash Burn, Cash Build & Net Cash Burn

Cash Burn
Cash that is used for its operating and financing expenses as
well as its investments in assets.

Cash Build
Cash received by the venture, usually from sales: Net Sales
minus Receivables.

Net Cash Burn
Cash Burn minus Cash Build.

Cash Burn Rate/Cash Build Rate/Net Cash Burn
Rate
Cash Burn/Cash Build/Net Cash Burn for a fixed period of
time, typically one month.
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Cash Burn

For MPC (2016):
Cash Burn = COGS (380,000) + Admin
expenses (65,000) + Marketing
expenses (39,000) + R&D
expenses (27,000) + Interest
expenses (20,000) + Taxes (8,000)
+ Inventory (45,000) – Payables
(27,000) – Accrued Liabilities
(1,000) + Capital investment
(50,000)
■ From Income Statement 2016
= $606,000 ■ From Balance Sheet 2015 & 2016
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Cash Build, Net Cash Burn

For MPC (2016):
Cash Build = Net sales – Receivables
■ From Income Statement 2016
= 575,000 – 30,000 ■ From Balance Sheet 2015 & 2016

= $545,000

Net Cash Burn = Cash Burn – Cash Build
= 606,000 – 545,000
= $61,000
Net Cash Burn Rate = $61,000 / 12 ≈ $5,083

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Liquidity Ratios

Indicate the ability to pay short-term liabilities
when they come due.
2016 ratio

Current Ratio
= Average current assets In reality/practice, people just use the
current year (2016 numbers)

Average current liabilities

2015 + 2016 years

= (250,000 + 180,000)/2
(204,000 + 110,000)/2

= 1.37
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Liquidity Ratios (cont’d)

Liquid assets: sum of a venture’s cash plus its
receivables (excludes inventories).

Quick Ratio
= Average current assets – Average inventories
Average current liabilities

= (250,000 + 180,000)/2 – (140,000 + 95,000)/2

(204,000 + 110,000)/2

= 0.62
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Liquidity Ratios (cont’d)

Net working capital (NWC)
= Current assets – Current liabilities

NWC-to-Total Assets Ratio
= Ave. current assets – Ave. current liabilities
Ave. total assets
= (250,000 + 180,000)/2 – (204,000 + 110,000)/2
(446,000 + 343,000)/2
= 14.70%

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MPC
Burn Rates & Liquidity Ratios

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Leverage Ratios

Total-Debt-to-Total-Assets Ratio

= Average total debt / Average total assets

= (204,000 + 110,000)/2 + (80,000 + 90,000)/2

(446,000 + 343,000)/2
= 61.34%

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Leverage Ratios (cont’d)

Equity Multiplier

= Average total assets / Average owners’ equity

= (446,000 + 343,000)/2
(162,000 + 143,000)/2

= 2.59 times

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Leverage Ratios (cont’d)

Current-Liabilities-to-Total-Debt Ratio

= Average current liabilities / Average total debt

= (204,000 + 110,000)/2
(284,000 + 200,000)/2

= 64.88%

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Leverage Ratios (cont’d)

Interest Coverage Ratio

= EBITDA / Interest

= EBIT + D&A
Interest
= 47,000 + 17,000
20,000
= 3.20 times

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Leverage Ratios (cont’d)

Fixed Charge Coverage Impt ratio. Previous one only covers
interest. This covers all fixed expenses.

= EBITDA + Lease payments .

Interest + Lease payments + [Debt repayments/(1-T)]

Debt repayments here is principal
repayment.
T is Tax Rate

= 64,000 + 0
[20,000 + 0 + 10,000/(1 – 0.30)]
= 1.87 times
_
2 questions:
- why add Lease payments to both
numerator and denominator
- why debt repayments divide (1-T).
Is it Interest Tax Shield.

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MPC
Leverage Ratio Performance

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Profitability Ratios

Gross Profit Margin

= Gross Profit IS numbers cannot do average.

Only BS numbers can do the
(2015+2016)/2
Net Sales

= 195,000/575,000

= 33.91%

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Profitability Ratios (cont’d)

Operating Profit Margin

= EBIT .
Net Sales

= 47,000/575,000

= 8.17%

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Profitability Ratios (cont’d)

Net Profit Margin

= Net Profit
Net Sales

= 19,000/575,000

= 3.30%

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Profitability Ratios (cont’d)

NOPAT Margin

= EBIT(1 – T)
Net Sales

= 47,000(1 – 0.30)
575,000

= 5.72%

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Efficiency & Return Ratios

Sales-to-Total-Assets Ratio

= Net Sales .
IS number

Average total assets BS number - so can average

= 575,000 .
(446,000 + 343,000)/2

= 1.46 times

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Efficiency & Return Ratios (cont’d)

Return on Total Assets (ROA)

= Net profit .
Average total assets

= 19,000 _
(446,000 + 343,000)/2

= 4.82%

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Efficiency & Return Ratios (cont’d)

ROA Model

Net Profit Margin Sales-to-Total-Assets Ratio

ROA = (Net profit / Sales)(Sales / Ave TA)

= (3.30%)(1.46)

= 4.82%

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Efficiency & Return Ratios (cont’d)

Return on Equity (ROE)

= Net profit .
Average owners’ equity

= 19,000 _
(162,000 + 143,000)/2

= 12.46%

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Efficiency & Return Ratios (cont’d)

ROE Model
Sales-to-Total-Assets Ratio
ROE
= (Net profit/Sales)(Sales/Ave TA)(Ave TA/Ave Equity)

Net Profit Margin Equity Multiplier

= (3.30%)(1.46)(2.59)
ROE facilitates trouble-shooting

= 12.46%

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MPC
Profitability & Efficiency Performance

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MPC
Industry Comparables Analysis

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Next week:

Lecture
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Event 1