Paraphrasing Answers

1. Provide a description of the financing cost implications associated with a venture’s need for additional funds.

— The cost of obtaining additional funds may be explicit, such as additional interest expense associated with debt. Interest expense shows up directly on the projected income statement and, in turn, impacts the AFN shown on the balance sheet. In contrast, added “costs” associated with obtaining equity capital from venture capitalist and other investors are based on the expected rates of return the investors receive when they exit their investments. These implicit costs do not show up on the projected financial statements.

2. What are the three components of the cash conversion cycle (C3)? How is each component calculated?

— The three components of the cash conversion cycle are inventory-to-sale conversion period, sales-to-cash conversion period, and purchase-to-payment conversion period. The inventory-to-sale conversion period is calculated by dividing average inventories by the venture’s average daily cost of goods sold. The sale-to-cash conversion period is calculated by dividing the average receivables by the net sales per day. The purchase-to-payment conversion period is calculated by dividing the sum of average payables and accrued liabilities by the venture’s cost of goods sold per day.

3. What are the three steps typically used to forecast sales for early-stage ventures?

——A new venture usually begins its forecast with a “top-down” market-driven approach. First, an estimate is made of what the overall industry or market demand is likely to be next year and over the following four years. The second step is to estimate a market share that the venture believes it could attain. The third step should be an attempt to further refine the sales forecast by working with existing and potential customers.

4. Identify and describe the four-step process typically used to forecast sales for seasoned firms.

—– Forecasting sales or revenues for a firm that has been in operation for a number of years usually begins with a review of the firm’s sales for the past several years. Typically, a five-year period is used, if possible. The four steps are : (1) forecast future growth rates based upon multiple scenarios and their likelihoods; (2) check the results of the first step with industry growth rates and expected market shares – the “top-down” or “market-share-driven” approach to projecting growth rates; (3) refine the sales forecast using direct contact with existing and potential customers – the “bottom-up” or “customer-driven” approach to projecting growth rates; and (4) consider the likely impact of major strategic changes including changes in pricing policy, credit policies, marketing approach and R&D developments and strategy.

5. What is a systematic liquidation of a venture? What are some of the advantages and disadvantages of a systematic liquidation?

— A systematic liquidation of a venture is the process of liquidating the firm by distributing the cash flows of the firm to the owners. This usually happens when the firm is in the mature stage and their free cash flow exceeds the amount need to maintain sustainable growth.

Potential advantages include: (1) the entrepreneur and other owners maintain control throughout the harvest period, (2) the harvesting of the investment value can be spread out over a number of years, and (3) the time, effort, and cost of finding a buyer for the venture can be avoided.

Potential disadvantages include: (1) the treatment and taxation of liquidation proceeds as ordinary income (rather than capital gains), (2) the commitment of the entrepreneur’s wealth, abilities, and focus to a dying venture, rather than other venture pursuits that might be more lucrative, and (3) acceleration of the rate of decline in the going concern value as other industry participants respond to the reduction in investment.

6. Describe what is meant by (a) a leveraged buyout (LBO), and (b) a management buyout (MBO).

—- An LBO occurs when a firm is bought out by investors who finance the majority of it with debt. An MBO is a type of LBO with the managers’ being a large part of the equity investors.

7. What is an employee stock option plan (ESOP)? How is an ESOP used to buy out a venture?

—- An ESOP is typically a benefit plan where employer and employee contributions are combined with debt to purchase a venture’s equity. If the ESOP plan is sufficiently large in a mature firm, it can possibly take the role of the majority equity investor in the venture after venture investors have exited.

8. Identify major factors that cause ventures to get into financial trouble.

—- Ventures get into trouble by mishandling strategic issues, failing to unite management on key initiatives, and having poor finance and accounting practices and controls. Since we are primarily examining entrepreneurial finance, we concentrate on the finance and accounting origins of vent5ure troubles, including overextension of credit, excessive use of financial leverage (borrowed funds), and lack of adequate cash planning and financial forecasting.

Factors that cause ventures to get into financial trouble are very similar to those that bring about venture failure. The U.S. Business Administration found that two-thirds of business failures are due to either economic factors (inadequate sales, insufficient profits, etc.) or financial factors (excessive debt, insufficient financial capital, etc.).

9. What are some of the basic requirements of a successful turnaround plan?

—- A successful turnaround plan should provide immediate remedial actions (once serious financial problems are recognized) and detail the financial ramifications expected given the remedial actions.

Often the immediate goal of a turnaround plan is raising survival cash quickly and beginning to restore creditor confidence. Components of the plan may involve employee unpaid leaves or layoffs, the sale of receivables at deep discounts, and the liquidation of finished goods inventories. The turnaround plan needs to explain credibly how both short-term survival and long-term financial health will result for such actions.

10. Define financial restructuring and describe what is meant by debt payments extension and debt composition change.

—- Financial restructuring involves changing the contractual terms or composition of the firm’s debt obligations to help the firm meet those obligations. Debt payment extension is allowing the firm to pay their interest or principal payments at a later date. Debt composition change is when the creditor reduces its claim (typically interest or principal) against the firm.

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