Chapter 20—Entrepreneurial Finance and Venture Capital
MULTIPLE CHOICE
1. Entrepreneurial growth companies
a.
usually consume more cash than they generate.
b.
usually have tangible assets as a large part of their values.
c.
usually have low risk for investors.
d.
usually compensate employees with large salaries.
2. Formal business entities with full-time professionals who seek out and fund promising ventures are
a.
angel capitalists
b.
institutional venture capital funds
c.
vulture funds
d.
business incubators
3. With few exceptions over time, ____ have generally provided more total funding to entrepreneurial
companies each year.
a.
angel capitalists
b.
institutional venture capital funds
c.
vulture funds
d.
government sponsored enterprises
4. Which of the following institutional venture capital fund categories controls the dominate share of
industry resources?
a.
small business investment companies
b.
financial venture capital funds
c.
corporate venture capital funds
d.
venture capital limited partnerships
5. A rapidly growing source of new money for institutional venture capital funds is
a.
bank loans
b.
pension funds
c.
individuals
d.
government grants
6. Pensions are well-suited to the institutional venture capital fund area of investing because
a.
pension fund managers are able to take more risk like venture capital fund managers.
b.
pension fund managers are able to hold investments with longer time horizons like venture
fund managers
c.
pension fund managers do not face investor scrutiny like other fund managers.
d.
pension fund managers need high risk/high return investments to boost fund returns as the
baby boom generation reaches retirement.
7. A growing firm seeks $30 million to develop and market its promising new technology. An
institutional venture capital fund steps in with an $8 million initial investment. This is an example of
a.
low base financing
b.
staged financing
c.
scaled financing
d.
intermittent financing
8. Venture capitalists use staged financing
a.
to limit other investors’ returns.
b.
to increase the venture capitalist’s ownership stake.
c.
to reduce the venture capitalist’s risk exposure.
d.
to increase the probability the portfolio company succeeds.
9. If a venture capital investment contract provides for the protection of the venture capital group’s
ownership stake if the firm sells new equity under duress, then the contract has a(n)
a.
demand registration rights provision
b.
stock option plan
c.
ownership rights agreement
d.
ratchet provision
10. The investment contract provision that gives the venture capital fund the right to compel the firm to
file with the SEC for a public offering is a
a.
repurchase rights provision
b.
participation rights provision
c.
demand registration rights provision
d.
ownership rights agreement
11. A provision in the venture capital fund’s investment contract that limits the firm’s ability to sell assets
without prior investor approval is an example of
a.
a ratchet provision
b.
a negative covenant
c.
a positive covenant
d.
a participation rights provision
12. Venture capital funding is usually not straight equity initially, but rather
a.
senior debt
b.
staged loan agreements
c.
convertible debt or preferred stock
d.
stock options
13. Convertible securities are attractive to venture capital investors because
a.
they allow for the venture capitalist to exercise control without majority ownership of the
firm’s equity.
b.
they provide seniority for the venture capitalist relative to the entrepreneur.
c.
they allow the venture capitalist in the upside of firm success.
d.
all of the above.
14. Venture capital funded firms often use stock options in their compensation plans
a.
to hide compensation costs from investors.
b.
to attract and retain talented employees with lower cash outlays.
c.
to transfer risk to the venture capital investors.
d.
to enhance the future venture capital fund returns.
15. Why is the cancellation option a key aspect of staged financing?
a.
It allows the entrepreneur the opportunity to exit the contract.
b.
It allows the venture capital fund to extract excessive returns.
c.
It allows the venture capital fund to invest at lower expected returns because risks are
reduced.
d.
It provides either party a “no fault” exit from the investment contract.
16. Which of the following will make it more likely the entrepreneur receives funding on more attractive
terms?
a.
the firm is a true start-up, at first stage financing
b.
the entrepreneur is new to the venture capital market
c.
the firm has a promising product/technology close to launch
d.
there are many alternative investments available to the venture capital investor
NARRBEGIN: IGBB
It’s Gonna Be Big (IGBB)
It’s Gonna Be Big (IGBB) is seeking venture capital investment of $8 million. The founder and the
venture capital fund agree the firm is worth $15 million today, and the venture capital investor asserts
it requires a 35% (compounded annually) expected return. IGBB and the venture capital investor
foresee an IPO in four years, at which time IGBB is expected to be valued at $90 million.
NARREND
17. What share of IGBB’s equity is necessary for the venture capital investor to achieve its required
return?
a.
45%
b.
40%
c.
35%
d.
30%
18. If the venture capital investor pushes for a 40% per year expected return, what share of IGBB’s equity
will it receive in exchange for its $8 million investment?
a.
34%
b.
39%
c.
30%
d.
26%
19. Suppose the venture capital investor’s share of the equity in IGBB is 25%, and that in four years at the
IPO the firm is valued at $120 million. What annual (compounded) return did the venture capital
investor earn?
a.
46%
b.
39%
c.
30%
d.
26%
NARRBEGIN: Pickswinners
Pickswinners Venture Fund
Pickswinners Venture Fund invested $10 million five years ago in Robotronics Co. The fund received
6 million shares of convertible preferred stock, each of which can be converted into three shares of
common stock. Robotronic is now set to complete an IPO, and its shares are being priced at $40 each.
Pickswinners will convert its preferred stock to common at the IPO, and will sell its shares along with
Robotronic. The investment banking firm handling the IPO will charge an 8% underwriting fee.
NARREND
20. If Pickswinners’ common stock position represents 40% of Robotronics equity, how many shares are
being offered in the IPO?
a.
15,000,000
b.
18,000,000
c.
25,200,000
d.
45,000,000
21. What proceeds does Pickswinners expect to receive?
a.
$662,400,000
b.
$220,800,000
c.
$720,000,000
d.
$552,000,000
22. What is the annual (compounded) return on Pickswinners’ investment?
a.
13%
b.
31%
c.
131%
d.
231%
23. Palooka Products negotiates a venture capital investment contract, receiving $5 million today, with the
expectation that the firm will seek an IPO in five years with an expected value of $50 million. If the
venture capital investor requires a 40% expected return, what share of Palooka Products’ equity does it
accept in exchange for its $5 million investment?
a.
54%
b.
38%
c.
26%
d.
14%
24. China has one of the fastest growing and potentially largest economies in the world, yet there is very
little or no private equity investment. Why?
a.
There are not enough attractive investment opportunities yet.
b.
Basic contracting and property rights issues cannot be legally supported or enforced at this
time.
c.
Stock market growth provides more than enough funding.
d.
None of the above.
25. Which country shows a great potential for future private equity investment?
a.
Canada
b.
China
c.
India
d.
Japan
26. The financing provided for equity investments in rapidly growing private companies is called
a.
venture capital
b.
junk bonds
c.
initial public offerings
d.
none of the above
27. Which of the following is not considered a type of an institutional venture capital fund?
a.
small business investment companies
b.
financial venture capital funds
c.
corporate venture capital funds
d.
all of the above are types of institutional venture capital funds
28. Which of the following is a type of covenant in a private equity investment contract?
a.
ownership right agreements
b.
ratchet provisions
c.
stock option plans
d.
all of the above
29. Among the possible exit strategies employed by venture capitalists, which of the following describes
the redemption option?
a.
exit through an initial public offering
b.
exit through a sale of the company directly to another company
c.
exit through selling the company back to the founders
d.
none of the above
30. A wealthy individual who makes private equity investments on an ad hoc basis, is called a(n)
a.
angel capitalist
b.
small business investment company
c.
financial venture capital fund
d.
venture capital limited partnership
31. John Smith seeks $15 million from a VC fund. John and the VC agree that the company should be
ready to go public in 8 years. At that time the company should have a net income of $6.75 million. If
comparable firms are expected to be trading at a P/E ratio of 25, what will be the company’s market
capitalization at the time of the IPO?
a.
$375 million
b.
$168.75 million
c.
$126.35 million
d.
$254.75 million
32. John Smith seeks $15 million from a VC fund. John and the VC agree that the company should be
ready to go public in 8 years. At that time the company should have a market capitalization of $368.75
million. If the VC requires a 45% return on their investment, what is the VC’s stake at the time of the
IPO?
a.
$368.75 million
b.
$293.11 million
c.
$202.65 million
d.
$15 million
33. John Smith seeks $15 million from a VC fund. John and the VC agree that the company should be
ready to go public in 8 years. At that time the company should have a market capitalization of $368.75
million. If the VC requires a 45% return on their investment, what is the fraction of the firm that the
VC will receive for its $15 million investment?
a.
20.51%
b.
15%
c.
79.49%
d.
63.47%
NARRBEGIN: Miller Venture Capital
Miller Venture Capital
Miller Venture Capital made a $5 million investment in Bavarian Sausage Technology (BST) 8 years
ago and in return received 1 million shares of convertible preferred stock that can be converted into 2
shares of common stock. After all stock has been converted BST will have 15 million shares
outstanding. In addition, the company is planning on issuing an additional 3 million shares in an IPO.
NARREND
34. Refer to Miller Venture Capital. What fraction of BST’s common stock will Miller own after the IPO?
a.
15.24%
b.
11.11%
c.
45.32%
d.
23.56%
35. Refer to Miller Venture Capital. If the value of BST stock is $25 at the end of the first trading day,
what is the value of Miller’s investment?
a.
$50 million
b.
$25 million
c.
$30 million
d.
$5 million
36. Refer to Miller Venture Capital. If BST’s stock trades at $25 at the end of the first trading day, what is
the annual return on Miller’s investment?
a.
900.00%
b.
24.65%
c.
33.35%
d.
350.00%
37. Miller Venture Capital Fund wants to average a 34.375% return on its investments. Of the 15 total
investments 5 have failed (i.e a return of -100%), and 7 generated a zero return. Two other projects
yielded a return of 80% and 85%, respectively. What has to be the return on the last outstanding
investment in order for Miller to reach its investment goal?
a.
425%
b.
1,250%
c.
885%
d.
680%
38. Miller Venture Capital Fund wants to average a 50% return on its investments. Of the 15 total
investments 5 have failed (i.e a return of -100%), and 7 generated a zero return. What has to be the
average return on the three outstanding investment in order for Miller to reach its investment goal?
a.
268%
b.
417%
c.
124%
d.
930%
39. John Smith seeks $7.5 million from a VC fund. John and the VC agree that the company should be
ready to go public in 4 years. At that time the company should have a net income of $3.75 million. If
comparable firms are expected to be trading at a P/E ratio of 18, what will be the company’s market
capitalization at the time of the IPO?
a.
$7.5 million
b.
$67.5 million
c.
$135 million
d.
$95.7 million
40. John Smith seeks $7.5 million from a VC fund. John and the VC agree that the company should be
ready to go public in 4 years. At that time the company should have a market capitalization of $254.35
million. If the VC requires a 54% return on their investment, what is the VC’s stake at the time of the
IPO?
a.
$7.5 million
b.
$42.18 million
c.
$254.35 million
d.
$36.74 million
41. John Smith seeks $7.5 million from a VC fund. John and the VC agree that the company should be
ready to go public in 4 years. At that time the company should have a market capitalization of $146.75
million. If the VC requires a 54% return on their investment, what is the fraction of the firm that the
VC will receive for its $7.5 million investment?
a.
28.74%
b.
71.26%
c.
54.00%
d.
38.57%
NARRBEGIN: WIMMP Venture Capital
WIMMP Venture Capital
“Where Is My Money” Professional Venture Capital (WIMMP) made a $10 million investment in
Bavarian Sausage Technology (BST) 5 years ago and in return received 2.5 million shares of
convertible preferred stock that can be converted into 1.5 shares of common stock. After all stock has
been converted BST will have 22.5 million shares outstanding. In addition, the company is planning
on issuing an additional 5 million shares in an IPO.
NARREND
42. What fraction of BST’s common stock will WIMMP own after the IPO?
a.
16.67%
b.
11.11%
c.
9.09%
d.
13.64%
43. If the value of BST stock is $21.50 at the end of the first trading day, what is the value of WIMMP’s
investment?
a.
$48.375M
b.
$80.625M
c.
$63.425M
d.
$37.557M
44. If BST’s stock trades at $21.50 at the end of the first trading day, what is the annual return on
WIMMP’s investment?
a.
51.81%
b.
45.69%
c.
35.26%
d.
68.21%
45. Al Bert seeks $15 million from a VC fund. Al and the VC agree that the company should be ready to
go public in 6 years. At that time the company should have a net income of $8.95 million. If
comparable firms are expected to be trading at a P/E ratio of 18, what will be the company’s market
capitalization at the time of the IPO?
a.
$213.67 million
b.
$142.25 million
c.
$161.10 million
d.
$123.78 million
46. Al Bert seeks $15 million from a VC fund. Al and the VC agree that the company should be ready to
go public in 6 years. At that time the company should have a market capitalization of $161.1 million.
If the VC requires a 45% return on their investment, what is the VC’s stake at the time of the IPO?
a.
$139.41 million
b.
$21.75 million
c.
$112.67 million
d.
$156.23 million
47. Al Bert seeks $15 million from a VC fund. Al and the VC agree that the company should be ready to
go public in 6 years. At that time the company should have a market capitalization of $161.1 million.
If the VC requires a 45% return on their investment, what is the fraction of the firm that the VC fund
will receive for its $15 million investment?
a.
69.32%
b.
13.46%
c.
56.89%
d.
86.54%