254 ENTREPRENEURSHIP
Sthe quote that opens this chapter indicates, it is now time to talk about money.
New venture financing deals with obtaining the money the entrepreneur will
need to start the business, but it is more than that. It is also about creating value
and wealth, allocating that value among the investors and founders, and determining
financial risk for the business. This chapter and the next will explore and elaborate on
these matters.
The quote has particular meaning for the financing of new businesses. It means that
the parties to a transaction, especially an investment, should not take unfair advantage
of each other; there should be consideration (a fee) for rights and privileges granted.
Also, no matter how close it is, the personal relationship of the investors and founders
takes a back seat to the overriding priority—the successful launch of the new venture.
The quote is also a reminder that money is important, and its importance must never be
minimized. People can and will talk about their devotion to the business, their concern
for the products and customers, their involvement with the “cause.” These may be very
real, valid, intrinsic motivations, but dismissing the importance of money and the cre-
ation and protection of wealth is naive and dangerous. People are concerned with finan-
cial issues, and some people care passionately about money. If the entrepreneur is such
a person, he or she is not alone.
Financing is one of the major hurdles for an entrepreneur. A Dun and Bradstreet sur-
vey reported that financial trouble (e.g., excessive debt and operating expenses, insuffi-
cient working capital) is responsible for 38.4 percent of business failures. Add an addi-
tional 7.1 percent for inexperience (including financial inexperience), and it is clear that
almost half of all ventures fail because of poor financial management.^1
We begin the chapter by discussing the nature of financial resources. Next, we turn
to the crucial issue of determining how much money the new venture will need at the
outset. The initial financing requirement depends largely on the enterprise’s cash and
working capital management. We summarize these elements.
The chapter continues with a discussion of the sources and types of debt and equity
financing and concludes by presenting a number of models for valuing new firms. The
valuation process is crucial to both investors and entrepreneurs as a vehicle for deter-
mining how the profits of the firm will be allocated. It sets the stage for financial nego-
tiation and deal structures.
A word of caution before beginning our financial analysis: Modern financial theory was
developed in an attempt to understand the performance of the stock market, specifically
the New York Stock Exchange. Many of the concepts and tools taught as foundations of
financial theory are best employed when analyzing companies represented on major stock,
bond, commodities, currency, options, and futures exchanges. Because the underlying the-
ory and techniques were not built with entrepreneurs in mind, applying them to new ven-
ture financing may not be appropriate. Entrepreneurs and the individuals and firms who
invest in new ventures must, therefore, be cautious in applying financial theory developed
for stocks and bonds, a theory that may send incorrect signals for firm value and risk.^2DETERMINING FINANCIAL NEEDS
We now turn to the financial aspects of starting a new business. Financing alone seldom
provides a sustainable competitive advantage, but most ventures need financial resourcesA