Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 14 Raising Equity Capital
14.1 Equity Financing for Private Companies
1) When a company founder sells stock to outside investors in order to raise capital, the
share of the company owned by the founder and the founder’s control over the company
will be reduced.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Equity investors in a private company usually plan to realize a return on their investment
by selling their stock when that company is acquired by another irm or sold to the public
in a public ofering.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) Which of the following is LEAST likely to be a possible source of funds to inance a
growing business?
A) angel investors
B) venture capital irms
C) institutional investors
D) family investors
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
1
4) Nature’s Bounty, an organic seed company, is seeking to grow from a small company
selling seeds in local markets into a company that sells seeds across several states. The
funding for this expansion comes from a wealthy individual who uses his considerable
inherited wealth to fund a variety of eco-friendly businesses. Which of the following best
describes the individual’s relationship with Nature’s Bounty?
A) an angel investor
B) a venture capitalist
C) an institutional investor
D) a corporate investor
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
5) Why do most people launching a start-up company acquire their funds through the
venture capital industry rather than through angel investors?
A) Most entrepreneurs are not willing to relinquish the control of their business demanded
by angel investors.
B) Most entrepreneurs do not want the fees associated with investment by an angel
investor.
C) Most entrepreneurs do not need the expertise brought to a young irm by an angel
investor.
D) Most entrepreneurs do not have any relationships with individuals with substantial
capital to invest.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
6) Which of the following is NOT a reason why an investor would choose to invest in new
and growing irms as a limited partner in a venture capital irm rather than making those
investments directly by themselves?
A) Venture capital irms use their control of the companies they invest in to protect those
investments.
B) The investments of venture capital irm are more diversiied than the investments of a
single individual.
C) A venture capital irm generally has a wide range of expertise among its general
partners.
D) The investor will have a direct say in how the companies that the venture capital irm
funds will be run.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
2
7) Which of the following best describes a limited partnership that specializes in raising
money to invest in the private equity of young irms?
A) venture capital irms
B) institutional investors
C) corporate investors
D) family investors
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
8) A large publishing irm specializing in college textbooks wishes to expand into online
delivery of its materials. In order to facilitate this, it invests in a number of small start-up
companies that deliver college courses online and uses these companies to start
diversifying the delivery of its content. Which of the following best describes the role of the
publishing irm as described above?
A) a venture capitalist
B) an institutional investor
C) a corporate investor
D) a family investor
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
9) The Ontario Teachers’ Pension Plan is a pension fund for public school teachers in the
province of Ontario. It has a large and diverse portfolio of investments, both in Canada and
internationally, and had net assets in December 2007 of C$108.5 billion. Which of the
following best describes the Ontario Teachers’ Pension Plan?
A) an angel investor
B) a venture capitalist
C) an institutional investor
D) a family investor
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3
10) A irm’s founder sells equity to outside investors for the irst time in the form of
preferred stock. In what way is this preferred stock most likely to difer from the preferred
stock issued by an established public irm?
A) It will have a larger dividend.
B) It will most likely not pay cash dividends.
C) It will give the holder seniority in any liquidation of the company.
D) It cannot be converted into common stock.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
11) Simone founded her company using $200,000 of her own money, issuing herself
200,000 shares of stock. An angel investor bought an additional 100,000 shares for
$150,000. She now sells another 500,000 shares of stock to a venture capitalist for $1.5
million. What is the post-money valuation of the company?
A) $1,200,000
B) $1,320,000
C) $2,400,000
D) $3,600,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
12) Simone founded her company using $200,000 of her own money, issuing herself
300,000 shares of stock. An angel investor bought an additional 100,000 shares for
$150,000. She now sells another 400,000 shares of stock to a venture capitalist for $2
million. What percentage of the irm does Simone now own?
A) 11%
B) 23%
C) 38%
D) 41%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4
13) An entrepreneur founded his company using $200,000 of his own money, issuing
himself 200,000 shares of stock. An angel investor bought an additional 100,000 shares for
$150,000. The entrepreneur now sells another 400,000 shares of stock to a venture
capitalist for$2 million. What is the post-money valuation of the company?
A) $1,750,000
B) $1,925,000
C) $3,500,000
D) $4,025,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
14) Jeremy founded a company. He issues 100,000 shares of series A stock for his own
$100,000 investment. He then goes through three further rounds of investment, as shown
below:
Round Price Number of Shares
Series B $1.00 500,000
Series C $1.50 300,000
Series D $1.75 500,000
What is the post-money valuation for the series D funding round?
A) $1.23 million
B) $1.72 million
C) $2.21 million
D) $2.45 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5
15) Jeremy founded a company. He issues 100,000 shares of series A stock for his own
$100,000 investment. He then goes through three further rounds of investment, as shown
below:
Round Price Number of Shares
Series B $1.00 500,000
Series C $1.50 300,000
Series D $1.75 500,000
Which of the following is closest to the percentage of the company owned by the series D
investors?
A) 29%
B) 36%
C) 39%
D) 54%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
16) The founder of a company issues 100,000 shares of series A stock for his own $250,000
investment. He then goes through three further rounds of investment, as shown below:
Round Price Number of Shares
Series B $2.50 200,000
Series C $2.75 300,000
Series D $2.80 300,000
What is the post-money valuation for the series D funding round?
A) $2.27 million
B) $2.39 million
C) $2.52 million
D) $2.77 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6
17) The founder of a company issues 200,000 shares of stock of series A stock for his own
$250,000 investment. He then goes through three further rounds of investment, as shown
below:
Round Price Number of Shares
Series B $2.50 200,000
Series C $2.75 300,000
Series D $2.90 100,000
Which of the following is closest to the percentage of the company owned by the founder of
the company?
A) 25.0%
B) 50.0%
C) 62.5%
D) 68.8%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
18) Which of the following statements is NOT true regarding angel investors?
A) They are typically arranged as limited partnerships.
B) For many start-ups, the irst round of outside private equity inancing is often obtained
from them.
C) Because their capital investment is often large relative to the amount of capital already
in place at the irm, they typically receive a sizable equity share in the business in return
for their funds.
D) These investors are frequently friends or acquaintances of the entrepreneur.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7
19) Which of the following statements is NOT true regarding venture capitalists?
A) They can provide substantial capital for young companies.
B) Firms ofer limited partners a number of advantages over investing directly in start-ups
themselves as angel investors.
C) They use their control to protect their investments, so they may therefore perform a key
nurturing and monitoring role for the irm.
D) They might invest for strategic objectives in addition to the desire for investment
returns.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
20) Which of the following is NOT a common name for a corporation that invests in private
companies?
A) strategic investor
B) corporate partner
C) venture partner
D) strategic partner
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21) Which of the following statements is FALSE?
A) A venture capital irm is a limited partnership that specializes in raising money to invest
in the private equity of young irms.
B) Venture capitalists typically control about three-quarters of the seats on a startup’s
board of directors, and often represent the single largest voting block on the board.
C) The initial capital that is required to start a business is usually provided by the
entrepreneur and her immediate family.
D) Individual investors who buy equity in small private irms are called angel investors.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
8
22) Which of the following statements is FALSE?
A) The general partners work for and run the venture capital irm; they are called venture
capitalists.
B) An important consideration for investors in private companies is their exit strategy—how
they will eventually realize the return from their investment.
C) When a company founder decides to sell equity to outside investors for the irst time, it
is common practice for private companies to issue common stock rather than preferred
stock to raise capital.
D) Institutional investors such as pension funds, insurance companies, endowments, and
foundations manage large quantities of money.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
23) Which of the following statements is FALSE?
A) The preferred stock issued by young companies typically does not pay regular cash
dividends.
B) The preferred stock issued by young companies usually gives the owner an option to
convert it to common stock on some future date, so it is often called callable preferred
stock.
C) If a company runs into inancial diiculties, the preferred stockholders have a senior
claim on the assets of the irm relative to any common stockholders.
D) Preferred stock issued by mature companies such as banks usually has a preferential
dividend and seniority in any liquidation and sometimes special voting rights.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
9
24) Which of the following statements regarding exit strategies is FALSE?
A) An alternative way to provide liquidity to its investors is for the company to become a
publicly traded company.
B) An important consideration for investors in private companies is their exit strategy, or
how they will eventually realize the return from their investment.
C) Often large corporations purchase successful start-up companies. In such a case, the
acquiring company purchases the outstanding stock of the private company, allowing all
investors to cash out.
D) Roughly 25% of venture capital exits from 2001-2005 occurred through mergers or
acquisitions.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
25) You founded your own irm three years ago. You initially contributed $200,000 of your
own money and in return you received 2 million shares of stock. Since then, you have sold
an additional 1 million shares of stock to angel investors. You are now considering raising
capital from a venture capital irm. This venture capital irm would invest $4 million and
would receive 2 million newly issued shares in return. The post-money valuation of your
irm is closest to ________.
A) $10.0 million
B) $4.0 million
C) $9.0 million
D) $3.5 million
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
10