Foundations of New Venture Finance 291
power because the courts protect them from the full payment of debts. Creditors are
usually loath to see anything less than full payment so they often cooperate with the
owners to avoid bankruptcy proceedings. The power of the owners derives from the
conflicts of interest among the creditors. Because creditors are paid off according to the
class to which they belong, their interests differ. Lower- priority creditors are more hes-
itant to put the firm in bankruptcy because they will receive less. Therefore, these lower-
priority, or unsecured, creditors may even be a source of additional credit to prevent an invol-
untary bankruptcy! It is often possible for the debtor to arrange postponement of pay-
ments, extended payment schedules, moratoriums on interest and principal payments,
renegotiated leases, and forgiveness of accrued interest under these circumstances.
Of course, creditors do not have to be so understanding and can move legally against
the firm. Good financial and personal relationships are extra insurance for a troubled
business.
Some of this has now been codified into law. Recent passage of the Bankruptcy
Prevention and Consumer Protection Act in April 2005 has resulted in major reforms
in bankruptcy law, outlining revised guidelines governing the dismissal or conversion
of Chapter 7 liquidations to Chapter 11 or 13 proceedings.^39
SUMMARY
Entrepreneurial finance builds on traditional financial theory yet goes beyond it in cer-
tain ways, recognizing that the entrepreneurial problem is unique and multifaceted.
Financial resources are required, and although they are seldom a source of competitive
advantage, they are a formidable hurdle for the entrepreneur.
The entrepreneur must be able to accurately determine the venture’s financial needs,
not only at the beginning, but throughout the venture’s lifecycle. Determining start-up
costs, predicting cash flows, managing working capital, identifying sources of financing,
and accessing this money are key activities. Equity must be raised both inside and out-
side the firm; debt, both asset-based and cash flow-based, will lower the overall cost of
capital for the new venture.
In the process of raising the money, the entrepreneur will have to confront and solve
the valuation question. Three types of valuations are possible: asset-based valuations,
earnings-based valuations, and discounted cash flow models. All have their strengths and
weaknesses. The use of a specific technique depends on the purpose of the valuation.
Last, the chapter covered some basic legal issues regarding new venture financing and
start-up. The choice of organizational form affects business and personal liability, cash
flow, and tax assessments. Careful consideration of securities laws can enable entrepre-
neurs and investors to avoid some of the more burdensome regulations. Bankruptcy,
although always a negative from someone’s point of view, can also be a bargaining tool
for a new venture that needs a little more time and patience from its creditors. Expert
legal advice is a must for all these issues.
In the next chapter, we will examine more comprehensive and complex models of val-
uation and discuss the elements and structure of new venture financial deals.