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Georgia Institute of Technology College of Management

Entrepreneurial Finance and Private Equity

Syllabus

MGT 6086 Fall 2011 T, Th 12:05-1:25 P.M

Instructor: Narayanan Jayaraman

406 College of Management 404-894-4389

e-mail:[email protected] www.mgt.gatech.edu/directory/jayaraman.html

________________________________________________________________________

"The entrepreneur casts aside his assurance of 40-hour weeks, leaves the safe cover of

tenure and security, and charges across the perilous fields of change and opportunity. If

he succeeds, his profits will come not from what he takes from his fellow citizens, but

from the value they freely place on the gift of his imagination." George Gilder

"Good judgment comes from experience. Experience comes from bad judgment." Walter

Wriston

TOPIC PAGE CAREER FOCUS 2 OBJECTIVE 2 COURSE STRUCTURE AND CONTENTS 2 RECOMMENDED TEXT 5 GRADING SCHEME 6 HONOR CODE 6 CLASS PARTICIPATION 6 GROUP CASES 6 GROUP PROJECT 6 OFFICE HOURS 6 COURSE OUTLINE 7

2

Career Focus

This course is intended for students who may at some point be interested in

pursuing careers in entrepreneurial sector. This group includes students interested in

starting a business, buying an existing one, playing a managerial role in a rapidly

growing business, provide financial and other resources to entrepreneurial companies, or

working in new business development in larger companies.

Objective

This is a course with two fundamental objectives. The first is to teach current and

future managers and entrepreneurs to use financial perspective in the value creation and

enhancement process. The second objective is to teach effective entrepreneurial practice

from the perspectives of users and suppliers of capital and other stakeholders.

Finance is the study of value and resource allocation. The value of any cash

stream is influenced by its magnitude, timing, and riskiness. Finance is also concerned

with the cost of capital and determining the least expensive source to fund projects.

These issues are very critical for start-up and growing firms. The course will focus on

financial management within entrepreneurial firms. The course will cover all phases of

their life cycle, from the initial idea generation to ultimate harvesting of the venture.

Suggested readings, class discussions, case analyses, and guest lectures will aim

to increase the participant's understanding of key concepts and issues.

Course Structure and Contents

Module 1: Identifying Opportunities

Here we explore the structural model of entrepreneurship. We use William

Sahlman’s framework that identifies four critical factors for entrepreneurial ventures:

people, opportunity, deal, and context.

People

An important task is to identify the key players. What is their experience? How does

this experience prepare or not prepare for the opportunity that exists? What are the

strengths and weaknesses of the people involved in all sides of the transaction? Are there

key individuals that the company should add or replace?

3

Opportunity

The opportunity that arises may be a new product or service, a new method of delivery,

or a new production technique that provides a cost advantage. Many questions such as

the following need to be answered. What is the nature of the opportunity? Is there a

sustainable competitive advantage? Must the opportunity be exploited immediately or is

there a possibility to wait? Are there intermediate milestones that can be used to assess

the success of the project?

Deal

Once the people and opportunity pass minimum criteria, a proper deal needs to be

structured. The proper deal needs o minimize moral hazard and adverse selection

problems. From whom should the firm raise money: wealthy individuals, banks, venture

capitalists? What is the proper financing instrument: debt, equity, convertible securities,

or a combination? Who bears the downside risk?

Context

Probably the most difficult part to assess. Some of the issues such as potential

competitors, changes in government regulations are hard to predict. One should have a

very clear understanding of economic conditions and trends that will influence a

particular market.

The concept of “FIT”

An understanding of the big picture is very important. How do the above four elements

relate to each other? Do the people have the requisite skills and experience to exploit the

opportunity? Doe the deal provide proper incentive to all the players? Will the context

change the nature of the opportunity?

Module 2: Valuation.

In this module, we will discuss different valuation techniques. There are several

approaches to valuation. The easiest way to value an early-stage firm is to examine the

valuation of another early-stage firm. It could be a difficult task given that it is hard to

find valuations of privately held firms. The other methods are i) The Net Present Value

Method, ii) Adjusted Present Value Method iii) Comparable Firm Analysis, iv) Option

analysis, and v) The “Venture Capital Method.” We will discuss the strengths and

weaknesses of the above techniques through several examples.

4

Module 3: Financing the Entrepreneurial Firm

This section discusses questions such as who are the suppliers of necessary

financial resources, what type of deals should be struck with each of these resource

suppliers. The other issues addressed are the criteria these sources utilize and evaluate

fund raising proposals, and the legal process involved in raising outside risk capital.

There are four primary factors that influence the source of funds. Uncertainty

exists about whether the research program or new product will succeed. This in turn

affects the willingness of outsiders to contribute capital, the desire of suppliers to extend

credit among other things. This often times results in the investor staging the capital.

Asymmetric information may also affect project-financing decisions. Typically, an

entrepreneur will know more about the company’s prospects than investors, suppliers, or

strategic partners. This may result in an entrepreneur pursuing a risky investment

strategy or shirking work. The third factor that influences the source of financing is the

nature of the assets. Firms with more tangible assets will find it easier to raise external

capital. Lastly, market conditions often play a very important role in terms of the

ability of the firm to raise capital. The supply of capital dramatically varies over time.

Currently, it is a lot harder for a biotechnology firm to raise capital as compared to an

internet firm.

The type of financing (i.e. debt, equity, or convertible security) used often times

mitigates some of the potential conflicts. Monitoring and evaluation by investors play a

critical role in minimizing these conflicts. Some of the techniques used in this regard

include having an active and qualified board of directors. The combination of cases and

notes used in this course will provide a useful framework understand the above issues.

Module 4: Harvesting

Harvesting can take several forms. We will explore modes such as initial public

offerings (IPOs) and acquisitions. Successful exits by providers of capital are critical to

insuring attractive returns for investors and, in turn, to raising additional conflict. But

private equity investors’ concerns about exiting investment can sometimes to lead severe

problem for entrepreneurs. We will discuss the pros and cons of going public. We will

explore the IPOs of Netscape Communications and Amazon.Com through cases. We will

5

also talk about acquisitions as an important mode of harvesting. The ability to find the

best buyer and negotiate the best deal terms is important for the entrepreneur.

Module 5: Corporate Venturing

This final module focuses on the role played by corporations in the venture

investing process. At the one end, the corporation invests directly in start-ups, which

give them a greater ability to tailor their portfolios to their particular need. At the other

end, some large corporations attempt to tap the entrepreneurial sprit within their

organizations. They attempt to establish programs that are conducive to creativity and

innovation. We use Xerox Technology Ventures case to understand this process.

Required Text Course Notes – Available for download from t-square HBS Cases (available in the bookstore) How to write a great business plan HBR 97409

A note on valuation in private equity settings HBS 9-297-050

Recommended Text and Readings Entrepreneurial Finance, Smith, Smith and Bliss, 2011, John Wiley.

6

Venture Capital Journal, CFO Magazine, Wall Street Journal, INC., SUCCESS.

Grading Scheme Case Analysis 25 % Mid-Term 25% Class Participation 25 % Group Project and Presentation 25 %

Honor Code

Students are expected to adhere to the Georgia Tech Honor Code. A substantial documentation exists at www.honor.gatech.edu. Please feel free to ask me any clarifications about this issue at any time.

Class Participation

Class participation grades will be determined on the basis of participation in the class discussion of the cases. You are required to participate in the class. A necessary (but not sufficient) requirement for participation is presence. If you are not in the class, you cannot have participated. I do “cold call” on individuals.

Group Case Write-ups

A group can consist of maximum of five students. The cases are listed in the course outline. The list of questions to analyze the case is listed in the outline. The group has to submit a two-page single space write-up (excluding graphs and tables) at the beginning of the class on the day the case is planned to be discussed. There will be a peer evaluation.

Group Project A group can consist of maximum of five students. The group has to make presentation of the project during the last week of the course. Projects can include a) Detailed analysis of an entrepreneurial venture focusing on finance issues, b) Detailed discussion of expected financing for an entrepreneurial venture you already may be

planning to embark upon, c) Case studies of venture capital fund etc. I need a one-page

outline by the fourth week of the course. I expect the written report to be no longer than fifteen pages (excluding the appendices). Please plan for a presentation of about twenty minutes during the last week of classes.

Office Hours

Physical Office Hours: Tuesdays, Thursdays 2-3 p.m. or by appointment

http://www.honor.gatech.edu/

7

Virtual Office Hours: I will respond to all e-mails once a day at least.

8

Course Outline

CN - Course Notes SS- Entrepreneurial Finance HBS - Harvard Business School Case ***** Write up required

Module Date Description Remarks

1 8/23 Introduction CN

2 8/25 Business Plan CN, HBR 97409

3 8/30 Outdoor Scenes Inc - Case CN

4 9/1 Financial Perspective and Options CN and HBS 9-293-045

5 9/6 Financial Perspective and Options CN

6 9/8 Obtaining Risk Capital Ch 2 SS, CN

7 9/13 Digital Think: Start Up Case***** HBS 9-898-186

8 9/15 Methods of Financial Forecasting: Revenues Ch 6 SSB, CN

9 9/20 Methods of Financial Forecasting: Planning Ch 7 SSB, CN

10 9/22 Assessing Financial Needs Ch 8 SSB, CN

11 9/27 Valuation CN and HBS 9-297-050



14 10/6 Penelope Pocket Phones Case***** HBS 9-299-004

15 10/11 Yale University Investments Office: Jun 06 HBS 9-807-073

16 10/13 Venture Leasing CN and HBS E-147

17 10/20 Project time – No Class

18 10/25 Aberlyn Capital Management Case***** HBS 9-294-083

19 10/27 Mid-term Exam Modules 1 through 17

20 11/1 Obtaining Debt Capital CN

21 11/3 Xedia and Silicon Valley Bank (A) HBS 9-298-119

22 11/8 GO Corporation – Case HBS 9-297-021

23 11/10 IPO and Exit Strategies CN

24 11/15 Amazon.Com – Case***** HBS 9-899-003

25 11/17 Nantucket Nectars - Case HBS 9-898-171

26 11/22 The Fojtasek Companies and Heritage

Partners –Case

HBS 9-297-046

27 11/29 Corporate Venturing CN

28 12/1 Intel 64 Fund Case HBS 9-800-351

29 12/6 Project Presentations

30 12/8 Project Presentations

9

Date: 8/23/2011

Module No: 1

Module Title: Introduction

Module Objectives:

The objective of this module is to provide a framework for the study of the financial decisions made by the entrepreneurs. The root of most new ventures lies in the creation and recognition of an idea for a new improved product or service, or in better ways of managing or delivering these. The concepts, analytical skills, and entrepreneurial finance perspective are laid out in an overview form.

Student’s Preparations:

None

Student’s Materials: Course Notes. How to Write a Great Business Plan by Sahlman (HBR Jul-Aug 97)

Student’s After-Class Assignment:

None ================================================================

Date: 8/25/2011

Module No: 2

Module Title: Business Plan

Module Objectives:

The objective of this module is to provide a discussion of business plan.


None

Student’s Materials: Course Notes. How to Write a Great Business Plan by Sahlman (HBR Jul-Aug 97)


None

10

Date: 8/30/2011

Module No: 3

Module Title: Outdoor Scenes Inc - Case

Module Objectives: The case is used to understand and critically evaluate the business plans.


Before class, read the cases from the book.

Prepare to discuss the following questions.

Outdoor Scenes Inc - Case A) What should JC and John do? B) Would you invest in them? In other words, how will you evaluate the business opportunity and the entrepreneurs as a team? C) What will it take to launch and succeed in this business?

Student’s Materials: Course Notes


None

11

Date: 9/1/2011

Module No: 4

Module Title: Financial Perspective and Options

Module Objectives:

This module is used to bring the financial perspective in understanding value creation. It highlights and provides a structure to think about cash, risk, and value. It also is used to understand basic terminology about options.


Before class, read the material.

Student’s Materials: Course Notes HBS


None ================================================================

Date: 9/6/2011

Module No: 5

Module Title: Financial Perspective and Options

Module Objectives:

This module is used to bring the financial perspective in understanding value creation. It highlights and provides a structure to think about cash, risk, and value. It also is used to understand basic terminology about options.



Student’s Materials: Course Notes HBS

Student’s After-Class Assignment: None

12

Date: 9/8/2011

Module No: 6

Module Title: Obtaining Risk Capital

Module Objectives: This module focuses on different sources of risk capital. A detailed discussion about angels, venture capitalists, SBA and SBIC is provided.



Student’s Materials: Chapter 2 (SS) and Course Notes


None

13

Date: 9/13/2011

Module No: 7

Module Title: DigitalThink: Start Up Case

Module Objectives:

This case is used to understand some of the decisions faced by an entrepreneur in the early stages of a new venture.


Please give the write-up before the discussion in the class.

A) How should Goettner choose a lawyer and an accountant? What “deal” makes sense between a startup and a service provider like a lawyer? Should Mario Rosati and John Kelm work with DigitalThink?

B) What is sensible financing plan for DigitalThink? How much money should the company raise? From whom? On what terms?

Student’s Materials: HBS 9-898-186


None

14

Date: 9/15/2011

Module No: 8

Module Title: Methods of Financial Forecasting: Revenues

Module Objectives:

This module helps you understand the elements of the cash flow cycle and understand the critical determinants of a firm’s financial needs.


Before class, read course notes and chapter 6 (SSB).

Student’s Materials: SS and course notes


None ================================================================

Module No: 9

Module Title: Methods of Financial Forecasting: Planning

Module Objectives:

This module helps you understand the elements of the cash flow cycle and understand the critical determinants of a firm’s financial needs.


Before class, read course notes and chapter 7 (SSB).



None

15

Date: 9/22/2011

Module No: 10

Module Title: Assessing Financial Needs

Module Objectives:

This module helps you understand the sustainable growth model and application of it to determine the financing requirements for a new venture.


Read chapter 8 (SSB)

Student’s Materials: CN and SS


16

Date: 9/27/2011

Module No: 11

Module Title: Valuation

Module Objectives: Different techniques of valuation are presented. The methods addressed include a) NPV, b)Adjusted Present Value, c) Comparable firms, d) Option analysis, e) The “Venture Capital Method.”

Student’s Preparations: Read up on the following handouts.

Student’s Materials:

A note on valuation in private equity settings HBS 9-297-050 The Venture Capital Method – Valuation HBS 9-396-090 Course Notes


None ================================================================

Date: 9/29/2011

Module No: 12


Module Objectives: Different techniques of valuation are presented. The methods addressed include a) NPV, b)Adjusted Present Value, c) Comparable firms, d) Option analysis, e) The “Venture Capital Method.”

Student’s Preparations: Read up on the following handouts.




None

17

Date: 10/4/2011

Module No: 13


Module Objectives:

This module is continuation of the previous module and applies the concepts to valuation of a private firm.


Read the course notes before the class.




18

Date: 10/6/2011

Module No: 14

Module Title: Valuation Case

Module Objectives:

This case is used to illustrate the usefulness of option framework to value young firms.


Please give the write-up before the discussion in the class.

A) What is the NPV of Penelope’s first generation phone if we ignore the possibility of investing in the second generation project? What valuation methodology would you use to get a value? Does it seem appropriate for the first stage?

B) How large does the current expected net present value of the second stage project have to be in order to justify $10 million investment in the first year on the first generation phone project? What happens to the value of opportunity to invest in the second project if the volatility of expected value increases? What does this say about investments in young, high technology companies?


Penelope’s Personal Pocket Phones Case HBS 9-299-004


None

19

Date: 10/11/2011

Module No: 15

Module Title: Yale University Investments Office: June 2006

Module Objectives: The focus of this case is to understand the objectives and perspectives of institutional investors in private equity funds.


1. How has the Investment Office selected, compensated, and controlled private equity fund managers? What explains the differences between their strategy in private equity with that in other asset classes (e.g., real estate)?

2. How has the Investment Office decided when to make private equity investments? What explains the differences between their strategy in private equity with that in other asset classes (e.g., real estate)?

3. How has the Investment Office made the international private equity investments? What explains the differences between the performance of their international and domestic private equity investments?

4. How is the private equity industry changing? How could Swensen’s private equity strategy go wrong?

5. Should David Swensen shift his private equity strategy?

Student’s Materials: HBS 9-807-073 and course notes


20

Date: 10/13/2011

Module No: 16

Module Title: Venture Leasing

Module Objectives:

The concept of venture leasing is presented.


Before class, read course notes

Student’s Materials: HBS E-147


None

21

Date: 10/20/2011

Module No: 17

Module Title: Project Time

Module Objectives:

To make progress on your group project.


-

Student’s Materials: -


None

22

Date: 10/25/2011

Module No: 18

Module Title: Aberlyn Capital Management - Case

Module Objectives:

We apply the venture leasing concept to the case. We use the Black-

Scholes option pricing model to price the warrants. We also use it to value a patent.


Before class, read the case

Case write-up due at the beginning of the class. A) How does venture leasing differ from traditional venture capital setting? B) What is Aberlyn’s competitive position in the venture leasing industry? What is their strategy? Are the proposed FLIP transactions consistent with their strategy? C) Is the structure of the Aberlyn partnership similar to and different from the more traditional venture partnerships? D) How did Aberlyn calculate how many warrants it should receive? Does the warrant exercise price of $1.45 reflect RhoMed’s value? E) What is the real rate of return to Aberlyn? To calculate this, you will need to compute the value of the options using the information above and in the case. Footnote 9 provides two suggestions as to what the current value of Aberlyn is today. F) Does the valuation of the patent transferred to Aberlyn as part of the FLIP, reproduced in exhibit 8, appear reasonable?

G) IF RhoMed succeeds in obtaining its FLIP and private placement, it may be able to go public without receiving traditional venture financing. Will venture leasing transactions be able to replace venture capital for a wide variety of firms?



None

23

Date: 10/27/2011

Module No: 19

Module Title: Mid-Term Exam


First seventeen modules including the cases. It will be an open book and open notes exam.

24

Date: 11/1/2011

Module No: 20

Module Title: Obtaining Debt Capital

Module Objectives:

The objective of the module is to discuss different sources of debt financing including trade credit, commercial banks, finance companies, and factoring.


Read course notes

Student’s Materials: SS and Course Notes


None

25

Date: 11/3/2011

Module No: 21

Module Title: Xedia and Silicon Valley Bank (A) - Case

Module Objectives:

The case is used to illustrate the role of banks in financing young, emerging companies is highlighted.


A) Why is it so difficult for young, high technology firms to

receive bank loans? B) Is the Silicon Valley Bank strategy appropriate for these types

of risks? C) Should Xedia be seeking financing from SVB? Does it make

sense? What are the risks? D) How would Xedia’s venture capital feel about the bridge loan? E) Is the loan to Xedia in the best interest of SVB? F) What is the appropriate interest rate to charge Xedia? Why? G) Should the loan include warrants? Stronger covenants?

Student’s Materials: HBS - 9-297-021


None

26

Date: 11/8/2011

Module No: 22

Module Title: Go Corporation - Case

Module Objectives:

The case is used to illustrate the concepts of valuation.


Please give the write-up before the discussion in the class. A) What are the key risks associated with the GO investment? How did John Doerr and his partners address these risks? B) Did Mr. Doerr and Kleiner Perkins add value to GO as an organization? If so, how? How much value had been created at the time of the case (March 1991)?

C) What has been Kleiner Perkins’s overall approach to private Equity investments?



None

27

Date: 11/10/2011

Module No: 23

Module Title: IPO and other exit strategies

Module Objectives: Different exit strategies such as IPOs, acquisitions are discussed. We discuss the typical issues an investment banker brings up in taking a firm public.


Before class, read course notes and Ch 16 (SS).



None

28

Date: 11/15/2011

Module No: 24

Module Title: Amazon.Com - Case

Module Objectives:

The case is used to illustrate the exit strategy


Please give the write-up before the discussion in the class. 1. What is the business model for Amazon.com? How does their business model

differ from that of Barnes and Noble or Borders? How would you value Amazon.com?

2. Should Amazon.com go public? Why or why not? 3. What are the plausible scenarios for the period leading up to a final pricing

meeting, which typically takes place the night before an IPO? How should management respond to these scenarios (e.g., is there a price below which Amazon.com should not go public)?

4. What should Joy Covey, the CFO, do?

Student’s Materials: HBS - 9-899-003, HBS 9-8-093-298


None

29

Date: 11/17/2011

Module No: 25

Module Title: Nantucket Nectars

Module Objectives:

To examine the exit decision of a firm through a case.



What are the pros and cons of remaining independent? Going public? Selling the company?

If management decides to consider selling the company, how should they orchestrate the process? Should they hire an investment banker?

How would you identify and deal with prospective buyers? What is Nantucket Nectars worth? To whom? Why? If management decides to sell the business, how should they think about their role after the sale?

What should management do?


30

Date: 11/22/2011

Module No: 26

Module Title: The Fojtasek Companies and Heritage Partners Case

Module Objectives:

The case is used to illustrate the issues involved in intergenerational transition at the firm. Leveraged buyout, leveraged recap (do it yourself LBO), and private IPO concepts are discussed.



A) What is the Fojtasek family’s problem?

B) How does each of the three possibilities that the family is considering-- a buy-out, a leveraged recapitalization, and a “Private IPO” -- address its needs? What are the key concerns about each transaction? C) How reasonable is the payment for Fojtasek being offered by Heritage? How onerous are the control rights that it is demanding? What would you recommend the Fojtasek family to do? D) How common a problem is the Fojtasek family’s dilemma? Does Heritage’s “Private IPO” represent a more general solution to such problems?


HBS 9-297-046


None

31

Date: 11/29/2011

Module No: 27

Module Title: Corporate Venturing

Module Objectives:

To get an understanding of corporate venturing.


Read course notes before the class

Student’s Materials: Course notes


None

32

Date: 12/1/2011

Module No: 28

Module Title: Intel 64 Fund - Case

Module Objectives:

The case is used to illustrate the concepts of corporate venturing


Please be ready for the discussion in the class. 1. Should Intel accept Partridge’s proposal? Does it satisfy Intel’s goals? What

are the risks of implementing the proposal? 2. Even though Partridge’s group arrived at the structure by incrementally

solving individual issues, one could see it as a structure that separates strategic issues from financial investment issues. That is, in the final structure Intel vets investments on strategic issues and Morgan Stanley vets investments on financial return issues. Do you agree? Is this a good solution to the generic corporate venturing tension between strategic imperatives and financial return imperatives?

3. Is this workable operating structure? What will be the pitfalls going forward in making this work on a day-to-day basis? Is the complexity worth it?

4. Is this a good deal for the OEMs? For the end users in the EAF? 5. If you were the CEO of a private company with the choice of several

traditional VC capital sources including the Intel 64 fund, would you be inclined o take the money from the fund?

6. As a traditional financial VC, would you want to co-invest with the 64 Fund? What are the issues-distinct from more traditional VCs- of co-investing with the 64 Fund?



None

33

Date: 12/6/2011 and 12/8/2011

Module No: 29 and 30

Module Title: Group Presentations

Module Objectives:

None


Presentation of the project.

Student’s Materials: Project Report


None

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