Chapter 16—Funding a Rapidly Growing Venture
TRUE/FALSE
1. When venture capitalists scrutinize a new opportunity, they typically evaluate the market,
management, and technology in that order.
2. The venture capital firm invests in a growing business through the use of debt and equity instruments
to achieve long-term appreciation on the investment within a specified period of time, typically five to
seven years.
3. The term sheet is a letter of intent that spells out the terms the VC is prepared to accept.
4. VCs often want both equity and debt⎯equity because it gives them an ownership interest in the
business, debt because they will be repaid more quickly.
5. An antidilution provision ensures that the selling of stock at a later date will increase the economic
value of the venture capitalist’s investment.
6. Following the IPO registration statement, an advertisement called a “tombstone” announces the
offering in the financial press.
7. The principal advantage of a public offering is that it provides the offering company with a
tremendous source of interest-bearing capital for growth and expansion, paying off debt, or product
development.
8. Intrinsic value is the perceived value arrived at by interpreting balance sheet and income statements
through the use of ratios, discounting cash flow projections, and calculating liquidated asset value.
9. Nearly all valuation techniques rely on the analysis of the future market for the company’s products.
10. Comparable companies are those that are similar to the new venture in value characteristics such as
risk, rate of growth, capital structure, and the size and timing of cash flows.
MULTIPLE CHOICE
1. ____ take an equity position through ownership of stock in the company.
a.
Investment bankers
b.
IPOs
c.
Venture capital firms
d.
Angel networks
e.
Super angels
2. VCs are fundamentally risk averse, so it is the entrepreneur’s job to reduce risk in the three key areas:
management risk, technology risk, and ____ risk.
a.
business model
b.
investment
c.
legal
d.
R&D
e.
None of these choices
3. Most VCs invest in the ____ stage because it is more likely to bring them to the liquidity event they
need in three to five years to make the investment worthwhile.
a.
business model
b.
startup
c.
transition
d.
rapid growth
e.
None of these choices
4. If after exhaustive due diligence the VCs are still sold on the business, they draw up the ____, which
signals the start of a negotiation.
a.
business plan
b.
term sheet
c.
tombstone
d.
prospectus
e.
None of these choices
5. A VC may request a ____, a penalty requiring founders to give up some of their stock to the VC if the
company does not achieve its projected performance goals.
a.
fair market provision
b.
stop-loss statement
c.
forfeiture provision
d.
liquidation agreement
e.
letter of intent
6. ____ from lawyers, accountants, consultants, and investment bankers are essentially a promise not to
charge the full fee if an IPO fails.
a.
Fair market provisions
b.
Stop-loss statements
c.
Forfeiture provisions
d.
Liquidation agreements
e.
Registration statements
7. An underwriter draws up a/an ____, which outlines the terms and conditions of the agreement between
the underwriter and the entrepreneur/selling stockholder.
a.
fair market provision
b.
stop-loss statement
c.
forfeiture provision
d.
prospectus
e.
letter of intent
8. The ____ method is probably the technique most commonly used to account for the going-concern
value of a business, but it has problems as well.
a.
discounted cash flow
b.
venture capital
c.
comparables
d.
multiple of earnings
e.
real options
9. ____ tend to favor the types of businesses where the investment required is relatively small and it’s
easy to determine whether the business will be a success within six months to a year.
a.
Investment bankers
b.
IPOs
c.
VCs
d.
Angel networks
e.
Super angels
10. Which of the following are not “backend” costs for an entrepreneur seeking capital by selling
securities (shares of stock in the corporation)?
a.
Prospectus printing costs
b.
Investment banking fees
c.
Legal fees
d.
Marketing costs
e.
Brokerage fees
11. Entrepreneurs considering a strategic partner should do all of the following except ____.
a.
examine its business practices
b.
talk with customers
c.
talk with value chain members
d.
depend on a partner for significant revenue generation
e.
use a network of partners to hedge against risk
12. ____ is a floorless exchange that trades on the National Market System.
a.
AMEX
b.
NASDAQ
c.
NYSE
d.
SEC
e.
K’NEX
13. All of the following disadvantages are associated with IPOs except ____.
a.
high cost
b.
being very time-consuming
c.
public scrutiny
d.
loss of control
e.
pressure to perform in the long term
14. When searching for a venture capital firm, what should you not do?
a.
Get recommendations from attorneys
b.
Shop around
c.
Get recommendations from accountants
d.
Look for venture capital firms that specialize in your industry
e.
Get a referral
15. Any investment deal includes all of the following components, except ____.
a.
the amount of money to be invested
b.
the timing and use of the investment moneys
c.
the liquidation strategy
d.
the return on investment to investors
e.
the level of risk involved
16. Venture capital firms in an early-stage investment characteristically demand a higher rate of return, as
much as ____ percent or more annual cash-on-cash return, whereas a later-stage investment demands a
lower rate of return, perhaps ____ percent annually.
a.
50 / 30
b.
60 / 30
c.
40 / 25
d.
30 / 10
e.
80 / 20
17. The historical peak for venture capital investment occurred in the year ____.
a.
1999
b.
2000
c.
2001
d.
2002
e.
2003
18. The ____ lays out the amount of investment the VC firm is willing to consider and the conditions
under which it is willing to consider making that investment.
a.
common stock
b.
negotiation deal
c.
term sheet
d.
antidilution provision
e.
None of these choices
19. VC funding is usually ____.
a.
early-stage funding
b.
mid-stage funding
c.
growth-stage funding
d.
later-stage funding
e.
None of these choices
20. Which type of venture typically requires considerable research and development cost prior to startup?
a.
Restaurants
b.
High-tech
c.
Construction
d.
Retail
e.
Manufacturing
21. The ____ determines the present value of the projected cash flows and is, in reality, the expected rate
of return for the investor.
a.
forecast period
b.
discount rate
c.
terminal value
d.
book value
e.
stable earnings history
22. A factor affecting the final valuation of the business is the degree of ____ that the owner has over the
business.
a.
estimated value
b.
legitimate control
c.
risk
d.
discount
e.
None of these choices
23. The value derived by assuming the sale of all assets and calculating the amount that could be
recovered from doing so is the ____ value.
a.
liquidation
b.
going concern
c.
intrinsic
d.
book
e.
investment
24. The price at which a willing seller would sell and a willing buyer would buy in an arm’s-length
transaction is the ____ value.
a.
book
b.
fair market
c.
investment
d.
intrinsic
e.
liquidation
25. A ____, or prospectus, discusses all the potential risks of investing in the initial public offering.
a.
book value
b.
tombstone
c.
stop-loss statement
d.
red herring
e.
None of these choices
26. The first step in the IPO process is to ____.
a.
choose an underwriter
b.
decide on a stock exchange
c.
file a registration statement
d.
publish a tombstone
e.
None of these choices
27. Once a company has become a public company, returning to private status is ____.
a.
a way of raising more capital
b.
easy to accomplish
c.
not allowed by the SEC
d.
a nearly insurmountable task
e.
not allowed by the board of directors
28. A form of startup capital managed by professionals is ____.
a.
corporate bonds
b.
private venture capital
c.
retained earnings
d.
common stock
e.
loans
29. Which industries have the highest venture capital investment?
a.
Software and medical
b.
Software and IT services
c.
Biotechnology and software
d.
Biotechnology and semiconductors
e.
Industrial and energy
30. The term ____ refers to tangible choices such as⎯in the case of a new venture⎯investing in research
and development for new technology.
a.
options
b.
real options
c.
assets
d.
discount rate
e.
None of these choices
SHORT ANSWER
1. What are the advantages of an IPO?
2. What are the steps in the IPO process?
3. When venture capitalists scrutinize a new opportunity, they typically evaluate three things. Identify
and discuss each.
4. What are the four components of an investment deal?
5. List the disadvantages of an IPO.
6. What is the difference between NASDAQ and the NYSE and AMEX?
7. List the six different definitions of value.
8. List the four components of discounted cash flow analysis (DCF).
9. List the main types of risk adjustment factors that influence the discount rate.
10. Briefly discuss due diligence as it pertains to the sequence of events in securing venture capital from a
VC firm.