Entrepreneurship Test 2
Content
Chapter 7: Ethics and Legalities Ethical and Legal mistakes need to be taken care of in the beginning, can t be underestimated. Public companies must comply with the SEC and SOX Establish a Strong Ethical Culture
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Most important thing founders can do is to create a strong ethical culture. 55% of people reported seeing unethical behavior; a strong culture is the best way to stop it. Biggest issue is putting own interests ahead of the organization. Lead by Example- Best way a team can build a strong ethical culture. o Leaders make ethics a part of daily activities o Supervisors emphasize ethics with direct reports o Peers encourage each other to be good. Establish a Code of Conduct o Code of Conduct- Formal statement of an organizations values on certain ethical and social issues. o Provides specific guidance on what is expected. o Employees report misbehavior more often if codes are in place Implement Ethics Training o Ethics Training Programs- Teach ethics to help employees deal with dilemmas and improve conduct o Ethical Dilemma- Doing something that is beneficial for yourself or your organization that is unethical.
Choosing an Attorney
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Need to select an attorney early, who knows about starting a business. Group together legal matters in one meeting, help the attorney write documents, ask them to join your advisory board, Don t give your attorney too much power, make your own decisions.
Drafting a Founders Agreement
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Founders Agreement- Written document that deals with issues like the split of equity among founders, how founders will be compensated for own cash or work, how long the founders will have to remain for their shares to fully vest. o Includes: Nature, business plan, Founder Titles, Stock splits, Description of Capital, Consideration, Buyback Clause, etc Buyback Clause- Legally obligates departing or deceased founders to sell their interest in the firm to the remaining founders. o Founders need the shares to offer to replacement. o If the person is mad, it keeps shares with committed founders.
Avoiding Legal Disputes
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Meet All Contractual Obligations- Pay/deliver on time. If you can t, inform those affected. Avoid Undercapitalization- Make sure you raise enough money, or stem growth. Everything in Writing- Solves many disputes. o Nondisclosure Agreement- Binds an employee or other to not disclose trade secrets. o Noncompete Agreement- Prevents an individual from competing against a former employee for a time. Set Standards- Govern behavior beyond ethics codes o Mediation- An impartial third part helps those involved in a dispute reach an agreement.
Obtaining Business Licenses and Permits
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Business License- Needed to operate. Can get one at the city office where the business will operate. o If business in home, need a separate HOME license o If a business has employees, is LLC, Limited Partnership, etc, need STATE business license. o Retail or service business needs SALES TAX license o Many other special licenses; Liquor, doctor, restaurant, etc o FEDERAL business licenses are needed by investment advising, drug MFG, meat preparation, trucking, and ATF MFG or sale. o Employer Identification Number (EIN)- Tax ID number used for filing for tax returns. Sole Proprietorships with no employees don t need one. Business Permits o For special circumstances; Health permit, Fire Permit, o Fictitious Business Name Permit- Business will go by any name other than owners. DBA
Business Organization Forms
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Choosing a form is not a 1 time event, can be changed without many problems. Look at Cost of the form, Liability of assets, Taxes, and Number of investors involved. NO ONE BEST FORM. Sole Proprietorship- Simplest. One person, they are the same as their business. o Most Common Form. Separate legal entity. Ends with owners death or quit. o Poor Choice for aggressive business plan. o Advantages: Owner has complete control. Can deduct business loses against tax return, other income. Cheap and easy to set up. o Disadvantages: Responsible for all liabilities, could lose all personal assets. Liquidity- Ability to sell business or assets fast at close to market value. Hard for SP. Hard to raise investment capital since you cant share ownership. Partnerships- Two or more people start a business. o General Partnership- Two or more people pool skills, abilities, and resources to run a business. Partnership Agreement- Details responsibilities and ownership shares of the partners involved. Ends at the death or withdrawal of a partner Typically found in service industries. Advantages: y Not dependant on a single person for survival. y Profit or loss flows through each partner equally, other income they have. y Easier to get a loan. Disadvantages: y Partners liable for any partner s debts. y Unlimited potential liability. y Liquidity is low o Limited Partnership- Partnership with two owner classes, limited and general. No limits to the number of each type. General partners have unlimited liability, while limited partners are only liable for investment. Formed to raise money, spread out risk Limited Partnership Agreement- Sets rights and duties of partners, how managed and dissolved. Corporation- Organized under state authority. o C Corporation- Company separate from owners by law. Shields shareholders from personal liability.
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Governed by a board of directors Preferred Stock- Listed to investors who have more rights over common, get dividends first, and get assets first in event of liquidation. Common Stock- Have voting rights, elect board. Last to get paid by dividends or liquidation. Articles of Incorporation- Include name, purpose, stock shares, etc. Filed at state office. Piercing the Corporate Veil- If owners don t file annual paperwork, pay feels or commit fraud, courts can go after then as full liability, not as a corporation. Taxed as a separate legal entity, person Double Taxation- Taxed on its own net income, and when dividends are paid, they are taxed too. Companies keep dividends to reinvest. Public Corporations- Listed on NYSE and NASDAQ. Traded instantly. Very liquid Liquid Market- Stock and be bought and sold easily through organized stock exchanges. Closely Held Corporation- Voting stock is held by small number of people, rarely traded. Private Corporation- All shares held by few, like MGT or family, not traded publically. MOST COMPANIES IN US. y Illiquid- Hard to find buyers of stock for private companies Advantages: y Easier to raise capital, not personally liable. Only up to their investment y Easy to allocate partial ownership through stock y Can share stock with employees as an incentive plan, motivate employees. o Stock Options- Incentive, giving employees chance to buy stock at a lower price for a time. Disadvantages: y Hard to set up and maintain y Double taxation y Business losses aren t deducted from other income, its all the corporation o Subchapter S Corporation- Combines Partnership and C Corporation Not subject to double taxation Owners pay taxes through their individual returns Owners don t have unlimited liability. Only earnings paid as SALARY are subject to payroll tax, NOT dividends to shareholders Standards: Cannot be subsidiary, Must be citizens, Partnerships or C Corporations cant own shares, Only one stock type preferred or common, Only 100 members, Limited Liability Company o Not subject to double taxation, profits flow through owners o All partners have limited liability, only invested o Very flexible, can have as many shareholders o Must be private, cant be traded o Complex to set up and maintain o Can split profits any way they want.
Chapter 8: New Venture Strength and Viability Financial Management- Deals with raising money, and managing finances for a high rate of return.
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Do we need Internal finances (selling products) or external finances (investments)?
4 Financial Objectives
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Profitability- Ability to earn a profit. Not profitable in first few years Liquidity- Ability to meet short term financial obligations. Keep enough money in the bank to make payables o Watch AR and Inventory, make sure they don t get too high, so we have cash. Efficiency- How productively a firm uses assets relative to its revenue and profits. EX: Airline Stability- Strength and vigor of the firms overall posture. Earn profit, remain liquid, watch DEBT o Debt To Equity Ratio- Long Term Debt/Shareholders Equity. Don t want it too high. Companies use Buying Groups- Band together with other small firms to get discounts, and compete with larger
Financial Management Process
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Financial Statement- Written report that quantitatively describes the firms financial health. o Income Statement, Balance Sheet, Cash Flows Forecasts- Estimate of a firms future income and expenses based on past performance, current circumstances and future plans. Budgets- Itemized forecasts of companies income, expenses and capital needs. Important for planning and control. Processo Prepare Historic Financial Statements Look at 2 to 3 past years o Prepare Forecasts- 2 to 3 years in the future o Prepare Pro Forma Statements o Ongoing Analysis of Results Financial Ratios- Depict relationships between items on financial statements, used to check objectives and how a company stacks up to peers. Asses trends. y Make sure to look at ratios in context, they can be misleading.
Financial Statements
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Historical Financial Statements- Reflect past performance, prepared on a quarterly or annual basis. o Public companies are required by the SEC to prepare them and make them available. o Prepared IS, BS, and CFs in that order. o Income Statement- Operations results over period. Shows revenue & expenses, profit or loss. Net Sales- Total sales minus any returns or discounts Cost of Sales (COGS)- All direct costs of producing or delivering a product. Includes material and direct labor. Operating Expense- Marketing, Admin, other expenses not directly related to production. Profit Margin- Return on sales. [Net Income/Net Sales] y What % of every dollar of sales goes to the bottom line. Want High. Price to Earnings Ratio (P/E Ratio)- Measures price of stock to earnings. Want High o Balance Sheet- Snapshot of Assets, Liabilities, and OE at a SPECIFIC POINT of time. Current Assets- Cash and highly liquid items, AR, Securities, Inventory Fixed Assets- Long time, real estate, buildings, equipment Other Assets- Miscellaneous assets, goodwill Current Liabilities- Payable items in a year, AP, accrued expenses, current portion of long term debt Long Term Liabilities- Notes or loans that are longer than a year, building, equipment liabilities. Owners Equity- Equity invested by owner plus the accumulated earning retained by the business after paying dividends. Balance sheets show items recorded at COST. Intellectual property receives no value, even though it may have lots Goodwill and training time, etc not shown on balance sheet Working Capital- Current Assets minus Currenet Liabilities. Gives total LIQUID ASSETS
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Current Ratio- Current assets/ current liabilities, Shows assets to liab, ability to pay debts Debt Ratio- Total Debt/ Total assets, How much is financed by debt, Want LOW o Statement of Cash Flows- Summarizes changes in a firms cash for a period, why it changed. How much cash is on hand, how much was gained and how much was spent Operating Activities- Net income or loss, depreciation, change in current assets and liabilities, other than short term debt or cash. Investing Activities- Purchases, Sales, or investment in fixed assets like real estate, equipment Financing Activities- Cash raised during the period by borrowing money, or selling stock. Cash used to pay dividends, by back stock or bonds Not always good sign to see LOTS of cash 10-K Report similar to annual report but has most detailed information about company business. Pro Forma Financial Statements- Projections for the future based on forecasts, completed 2 to 3 years ahead. o Not required by SEC o Should be created with conjunction of all activities o Pro Forma Income Statement- Plug in forecasted numbers o Pro Forma Balance Sheet- Shows how activities will evolve over time o Pro Forma Cash Flows Statement- Sufficient Cash?
Ratios
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Profitability- Income earned for resource used Want HIGH o Return on Assets- Net Income/Avg total assets o Return on Equity- Net Income/Avg Shareholder equity o Profit Margin- Net Income/Net Sales Liquidity- Extent you can liquefy assets - COVER SHORT TERM LIABILITIES WITH CASH o Current Ratio- Current Assets/ Current Liab o Quick Ratio- Quick Assets/ Current Liab Overall Financial Stability WANT LOW! LESS DEBT o Debt Ratio- Total Debt/Total Assets o Debt to Equity- Total Liab/Owners Equity
Forecasts
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New firms base off of good faith estimates, or similar start ups Assumptions Sheet- Document in business plan, showing where you get your start up numbers for a new firm, Sales Forecast- A projection of a firms sales for the period. o First made, used as a basis. o Existing firms use past sales, production demand, etc o ESTIMATE ACCURATELY! o Regression Analysis- Statistical technique used to find relationships between variables for the purpose of predicting values. Cost of Sales Forecast o Percent Of Sales Method- Expressing each expense item as a percent of sales. Remain same percent Depreciation or other easily estimated items wouldn t use percent of sales Allows items to grow at the same RATE as sales o Constant Ratio Method of Forecasting- Using percent of sales, expenses grow at RATE of sales Break Even Analysis- Total FC/(price-Avg Variable costs) o Gives you re the number of units you need to sell to break even.
Chapter 9: New Venture Team New Venture Team- Group of founders, key employees and advisors that move the venture from idea to firm.
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Formed, not built, as they cant afford to hire. Have a high propensity to fail. Liability of Newness- Companies falter because people who start them aren t able to adjust fast enough to new roles because they lack a track record with outside buyers and suppliers o Good new teams can help this High level individuals who join as directors gain the company legitimacy.
Founders
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Founders have a lot to do with how the team takes shape Most important is SIZE and QUALITIES Size- One person or a founding team? o A Team is better, bring more to the table. o Teams that have worked together before have an edge. o Heterogeneous- Team is diverse in terms of abilities and experiences, Create constructive conflict, HELP o Homogeneous- Similar team, makes decisions too fast o Team over 4 people is usually too large. o Problems when someone becomes CEO Qualities o Knowledge, skills, experience, are the most important thing you got in the early days o People judge the TEAM on the potential for the business, not really assets o Prior Entrepreneurial Experience- Most consistent predictors of future performance. o Relevant Industry Experience- Understand subtleties, have larger network. o Networking- Broad social networks help lots, professional networks
Recruiting Key Employees
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Sometimes management teams are hired immediately, other times founders go at it Skills Profile- A chart that depicts the most important skills that are needed, and where gaps exist. o Explain s how gaps are also being dealt with. o Finding GOOD employees is hard. Founders ask networks and friends for referrals. Founders need to be flexible and take on any job needed.
Roles of the Board of Directors
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Board of Directors- Panel of individuals who are elected by a corporations shareholders to oversee firm management. Inside Director- A person who is ALSO an officer of the firm. Outside Director- Not employed by the firm. Board Appoints officers, declares dividends, and oversees company affairs. New firms pay board members in stock, or ask them to wait until profitable. Boards provide expert guidance and legitimacy Guidance- Need board members with good experience, who can help and give input. Legitimacy- Respected members bring INSTANT credibility. o Signaling- When a high quality member joins your team, shows all others your legit. o Huge help in getting investments, pick members who can get you in
Board of Advisors
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Advisory Board- A panel of experts who are asked by a firms managers to provide counsel and advice ongoing. No legal responsibility, unlike directors, just give advice. Can be for a specific need or problem 5 to 15 members, pay them a little bit Not just for boasting, advisors will WANT to play a role Want advisors from many backgrounds Can make your start up STAND OUT
Lenders and Investors
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They put money in new firms, have an interest Venture capitalists help a ton, they want their money back Gives legitimacy May sit on board of directors
Consultants- An individual who gives professional or expert advice.
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Conducts in depth analysis for the firm Takes too much time for a director or advisor, need a paid consultant Non profit consultants can be used too o SCORE volunteers are retired business owners
Chapter 10: Getting Financing Raising money is a balancing act, its very important, cant put it off Why?
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Cash Flow Challenges- New firms need cash to start up, before they see revenue gained. o Burn Rate- The rate at which a firm is spending its capital until it reaches profitability. Operating in the red. o A firm fails if it burns through all its capital before becoming profitable. Capital Investments- Need money to invest in capital, equipment, buildings, etc Lengthy Product Development Cycle- Can take a while to develop product, need up front cash.
Personal Financing
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Money that gets you off the ground is usually the founders Personal Funds- Most founders use their own resources the first year or so. Close to 50% use their own stuff o Sweat Equity- Value of time an effort the founder puts in. Friends and Family Be businesslike with them, if it s a loan, make payback plans in writing. Bootstrapping- Finding ways to avoid external funding through creativity, thriftiness, cost cutting, etc. Any means!
Preparing to Raise Debt
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Step 1: Determine Exactly How Much Money You Need- Analyze cash flow and projections. Step 2: Determine the most appropriate financing typeo Equity Financing- Exchanging partial firm ownership, stock, for funding. Not a loan, dividends pay back. Liquidity Event- An occurrence that converts some or all of a companies stock into cash. y Happens when they go public, find a buyer or merge Hard to get equity investors on board o Debt Financing- Getting a loan. Bank or SBA
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Step 3:Develop a strategy for engaging potential investors o Develop an elevator speech, 45 seconds to 2 mins o Research your investors or find a contact that knows them o Present business plan
Sources of Equity Funding
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May lose some control, but investors want to help Business Angels- Individuals who invest personal capital directly into start ups. o Rich people who live in your area, want the firm to grow 30 to 40% a year o Usually sit on the board of directors, give lots of input Venture Capital- Money that is invested by venture capital firms in start ups with HIGH growth potential. o Come in later than angels in a businesses life. o Capitalists raise money from wealthy people, invest in a bunch of companies o Carry- The percent of profits the capitalists actually get. o Only looking for home runs, don t fund as many as Angels do. o Rounds- Stages the firm gets money, called Follow On Funding. Seed, Start up, First Stage, Mezzanine o Due Diligence- Capitalists go through the business plan, making sure its legit.
Initial Public Offering
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IPO- First sale of stock by a firm to the public. Secondary Market Offering- Any later issuance of shares. Going public helps you get equity funding, makes you a bigger deal, and is a LIQUIDITY EVENT. Going public means you have to comply with SOX Investment Bank- An underwriter or agent for a firm issuing securities. Helps a firm go public. o Preliminary Prospectus- Red Herring, Describes the offering to the general public. While SEC investigates. o Final Prospectus- Sets a date and issues price for offering. o Road Show- Management team is taken to cities to show off business plan. Taped. Private Placement- the direct sale of an issue of securities to a large institutional investor. Not public offering.
Debt Financing- Getting a loan.
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Single Purpose Loan- Specific amount is borrowed that must be repaid with fixed interest time. Line of Credit- Borrowing CAP is established and borrowers can take at their discretion. Periodic interest payments. Loan interest payments are tax deductible. May have to put up collateral (house) Commercial Banks- Risk averse, don t really help small firms, only big. SBA Guaranteed Loans- 50% of banks do this. o 7(A) Loan Guarantee Program- For sure loan, individuals pledge ALL ASSETS. Good for small businesses.
Leasing- Cheaper for firms to gain a building and equipment.
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Venture Leasing Firms- Act as brokers, bringing businesses and leasers together.
SBIR and STTR Grant Programs Don t have to pay back
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Small Business Innovation Research & Small Business Technology Transfer Provide cash grants to businesses working in specific areas. SBIR Program- Competitive Grant that provides over 1 billion a year to small early businesses. o Phase 1- 6 month long FA. $75,000 to $100,000 o Phase2- Up to 2 years long, create a prototype. $300 to $750 thou. Can Fast Track both 1 and 2
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Phase 3- Product moves to the market place, no funding.
Chapter 11: Marketing Issues Selecting a Market
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Segmenting the Market- Study your industry and identify different target markets. o Can only really target one area initially o Make sure your segment has enough people o Markets can be segmented in many different ways, type, price, distribution, etc Select Target Market- Target a Niche Market o Niche Market- Place in a market segment that has a narrow group of customers with similar interests. o Don t want to be another face in the crowd, KNOW your customers. Establish a Unique Position- Your area compared to competitors. o Create differentiation in your firm. o Product Attribute map- Illustrates a firms positioning strategy relative to its major rivals. o Tagline- A phrase used that is consistent in company literature, promotions, etc
Selling Benefits Rather Than Features- Focus on BENEFITS, what your product will do for them. Establishing a Brandy y y y y y
Brand- Set of positive or negative attributes associated with a company. Brand Management- Program used to protect the image and value of a brand to the consumers mind. Have your product create MEANING for the consumer, and you got em. Buzz= Creating awareness and a sense of anticipation about a company. Don t use too much advertising. Brands can charge more, and get a ton more market share. Brand Equity- A set of assets and liabilities that are linked to a brand and enable it to raise a firms valuation. o Name, quality perceived, trademarks, etc
4 P s of Marketing
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Marketing Mix- A set of controllable, tactical marketing tools used to produce the response it wants in its target market. Product- The good or service offered to your market. o Needs to add VALUE in the minds of customers. o Products that stop pains are very useful. o The product is the name, features, warranty, packaging, o Reference Account- Early user of a firms product who is willing to give testimonial. Many times given for free, good publicity Price- Amount of money consumers pay to buy a product. Produces REVENUE o Cost Based Pricing- The list price is determined by adding markup percent to costs. Markup is easy to see. Hard to INCREASE price. o Value Based Pricing- Price determined by what consumers are willing to pay for a product, backed up. Gives perceived value of the product. Shouldn t lower prices to gain market share, wont bring profit. Price Quality Attribution- Consumers naturally assume that a higher priced product is better quality. o Price is determined on QUALITY and PERCIEVED VALUE Promotion- Activities a firm takes to communicate the merits of products to its target market. o Advertising- Make people aware, tell features and link lifestyle with product. Costly, can be intrusive and many who see it may not be target.
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Public Relations- Efforts to establish and maintain a companies image in the public Not costly Press Kit- A folder containing info about the company and a list of accomplishments. Trade Show- Industry products are shown. Press release, blogs, conference, trade magazines, etc o Free samples, Free Trials, Viral Marketing, Guerilla Marketing Place- or distribution. All activities that move a product from origin to the consumer. o Distribution Channel- The route a product takes from the place its made to the end user. o Selling Direct- Sell right to customers. More capital in assets, like buildings to sell, etc. Disintermediation- Eliminating layers of middlemen, wholesalers, Internet causes this Channel Conflict- Occurs when two or more marketing channels, (online and in stores) are in conflict over their roles in selling a product. o Selling Through Intermediaries- Use wholesalers and distributors. Must pitch your product. Don t make as much money if you go through them Exclusive Distribution Arrangements- Give a retailer or other intermediary exclusive rights to sell your product. The more intermediaries you go through, the chance your product wont be displayed as your brand wants. o
Chapter 12: Intellectual Property All firms have intellectual property and it may be their most important asset. Intellectual Property- Any product of human intellect that is intangible, but has value in the marketplace. Creativity.
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Mistakes: Not identifying property, not recognizing value, not legally protecting property, and not using property in plan for success. Protect items that DIRECTLY relate to your competitive advantage. Name, special systems, etc. Protect items that have VALUE in the marketplace. A one time logo doesn t need to be protected. Four Key Forms o Patents- A grant from the government, stopping others from making, selling, or using an invention for the term of the patent. You get a legal monopoly for a limited time. Only stops OTHERS from your item, you cant infringe on patents that your item breaks. Patent requires: Useful, novel in relation to field, and not obvious to a person of ordinary skill. Utility Patents- Most common. New inventions. 20 years, then public. Used or works y Must be in depth description of process or invention, not just idea. y One Year After First Use Deadline- Must file a patent in a year, or its public. y Business Method Patent- a patent that protects inventions of a business way. Design Patent- New, original designs for manufactured products. 14 years. Way it looks. Plant Patent- Protects new plant varieties. 20 years. Only the INVENTOR(s) can apply. Assignment of Invention Agreement- If an invention is found while employed, the employer has rights to the product. Can also SELL rights to a patent. Patent Process y Step 1: Practical Invention y Step 2: Document when the invention was made- Logbook, keep dates, I o If two people come up with same thing, person who can prove they did it first has rights. First to Invent Rule
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y Step 3:Hire Patent Attorney y Step 4:Do Patent Search y Step 5:File for Application y Sep 6: Obtain USPTO decision Provisional Patent Application- For UTILITY PATENTS, allows patent pending status. Trademarks- Any word, name, symbol or device used to identify the source or origin of products and distinguish them from others. Service Marks- Used identify the services of intangible activities of a business, rather than physical product. Collective Marks- TMs or SMs used by members of a group, indicates membership. Certification Marks- Marks, words, names, symbols, or devices used by a person other than its owner to certify a particular quality about a product. Safety standard marks. Lanham Act Protects: Words, Numbers, Logos, Sounds, Smell, Shape, Color, Packaging. Unprotected : Immortal or scandalous things, profane words, Deceptive names, descriptive names, surnames You don t HAVE to register a TM, once its used, its protected. However, Registered Marks get the R symbol and can get damages from infringement. Secondary Meeting- Over time consumers associate a TM with a product. Intent to Use TM- Gives them rights, but if they don t use it in 6 months its over Copyrights- Owner has right to determine how their WORK is used, and to obtain money. Must be tangible, article, book, etc Manuals, training videos, etc Protected as soon as it is created. Literary works, musical work, Derivative Works- new rendition of something,(song), software, drama, choreographic work, pictorial or graphic work CANNOT protect IDEAS Idea Expression Dichotomy- Cant save idea, but if you express it, you can Cannot copyright facts, titles or ingredient lists No need to apply the copyright, its automatic. Attach the Copyright Bug Protected for authors life plus 70 years Fair Use- Can use some items for news, parody, teaching, criticism, etc Trade Secrets- Any formula, pattern, device, ides, process or information that provides the owner with a competitive advantage. Financial forecasts, employee logs, sales calls, etc Storage doesn t matter, memory counts. Economic Espionage Act Must be highly protected, cant talk about it, need to know Cant take secrets to a new job, even if its JUST in your head Owners must take steps to protect it. Intellectual Property Audit- Identifies all property, helps show valuation of your company.
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Most important thing founders can do is to create a strong ethical culture. 55% of people reported seeing unethical behavior; a strong culture is the best way to stop it. Biggest issue is putting own interests ahead of the organization. Lead by Example- Best way a team can build a strong ethical culture. o Leaders make ethics a part of daily activities o Supervisors emphasize ethics with direct reports o Peers encourage each other to be good. Establish a Code of Conduct o Code of Conduct- Formal statement of an organizations values on certain ethical and social issues. o Provides specific guidance on what is expected. o Employees report misbehavior more often if codes are in place Implement Ethics Training o Ethics Training Programs- Teach ethics to help employees deal with dilemmas and improve conduct o Ethical Dilemma- Doing something that is beneficial for yourself or your organization that is unethical.
Choosing an Attorney
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Need to select an attorney early, who knows about starting a business. Group together legal matters in one meeting, help the attorney write documents, ask them to join your advisory board, Don t give your attorney too much power, make your own decisions.
Drafting a Founders Agreement
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Founders Agreement- Written document that deals with issues like the split of equity among founders, how founders will be compensated for own cash or work, how long the founders will have to remain for their shares to fully vest. o Includes: Nature, business plan, Founder Titles, Stock splits, Description of Capital, Consideration, Buyback Clause, etc Buyback Clause- Legally obligates departing or deceased founders to sell their interest in the firm to the remaining founders. o Founders need the shares to offer to replacement. o If the person is mad, it keeps shares with committed founders.
Avoiding Legal Disputes
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Meet All Contractual Obligations- Pay/deliver on time. If you can t, inform those affected. Avoid Undercapitalization- Make sure you raise enough money, or stem growth. Everything in Writing- Solves many disputes. o Nondisclosure Agreement- Binds an employee or other to not disclose trade secrets. o Noncompete Agreement- Prevents an individual from competing against a former employee for a time. Set Standards- Govern behavior beyond ethics codes o Mediation- An impartial third part helps those involved in a dispute reach an agreement.
Obtaining Business Licenses and Permits
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Business License- Needed to operate. Can get one at the city office where the business will operate. o If business in home, need a separate HOME license o If a business has employees, is LLC, Limited Partnership, etc, need STATE business license. o Retail or service business needs SALES TAX license o Many other special licenses; Liquor, doctor, restaurant, etc o FEDERAL business licenses are needed by investment advising, drug MFG, meat preparation, trucking, and ATF MFG or sale. o Employer Identification Number (EIN)- Tax ID number used for filing for tax returns. Sole Proprietorships with no employees don t need one. Business Permits o For special circumstances; Health permit, Fire Permit, o Fictitious Business Name Permit- Business will go by any name other than owners. DBA
Business Organization Forms
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Choosing a form is not a 1 time event, can be changed without many problems. Look at Cost of the form, Liability of assets, Taxes, and Number of investors involved. NO ONE BEST FORM. Sole Proprietorship- Simplest. One person, they are the same as their business. o Most Common Form. Separate legal entity. Ends with owners death or quit. o Poor Choice for aggressive business plan. o Advantages: Owner has complete control. Can deduct business loses against tax return, other income. Cheap and easy to set up. o Disadvantages: Responsible for all liabilities, could lose all personal assets. Liquidity- Ability to sell business or assets fast at close to market value. Hard for SP. Hard to raise investment capital since you cant share ownership. Partnerships- Two or more people start a business. o General Partnership- Two or more people pool skills, abilities, and resources to run a business. Partnership Agreement- Details responsibilities and ownership shares of the partners involved. Ends at the death or withdrawal of a partner Typically found in service industries. Advantages: y Not dependant on a single person for survival. y Profit or loss flows through each partner equally, other income they have. y Easier to get a loan. Disadvantages: y Partners liable for any partner s debts. y Unlimited potential liability. y Liquidity is low o Limited Partnership- Partnership with two owner classes, limited and general. No limits to the number of each type. General partners have unlimited liability, while limited partners are only liable for investment. Formed to raise money, spread out risk Limited Partnership Agreement- Sets rights and duties of partners, how managed and dissolved. Corporation- Organized under state authority. o C Corporation- Company separate from owners by law. Shields shareholders from personal liability.
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Governed by a board of directors Preferred Stock- Listed to investors who have more rights over common, get dividends first, and get assets first in event of liquidation. Common Stock- Have voting rights, elect board. Last to get paid by dividends or liquidation. Articles of Incorporation- Include name, purpose, stock shares, etc. Filed at state office. Piercing the Corporate Veil- If owners don t file annual paperwork, pay feels or commit fraud, courts can go after then as full liability, not as a corporation. Taxed as a separate legal entity, person Double Taxation- Taxed on its own net income, and when dividends are paid, they are taxed too. Companies keep dividends to reinvest. Public Corporations- Listed on NYSE and NASDAQ. Traded instantly. Very liquid Liquid Market- Stock and be bought and sold easily through organized stock exchanges. Closely Held Corporation- Voting stock is held by small number of people, rarely traded. Private Corporation- All shares held by few, like MGT or family, not traded publically. MOST COMPANIES IN US. y Illiquid- Hard to find buyers of stock for private companies Advantages: y Easier to raise capital, not personally liable. Only up to their investment y Easy to allocate partial ownership through stock y Can share stock with employees as an incentive plan, motivate employees. o Stock Options- Incentive, giving employees chance to buy stock at a lower price for a time. Disadvantages: y Hard to set up and maintain y Double taxation y Business losses aren t deducted from other income, its all the corporation o Subchapter S Corporation- Combines Partnership and C Corporation Not subject to double taxation Owners pay taxes through their individual returns Owners don t have unlimited liability. Only earnings paid as SALARY are subject to payroll tax, NOT dividends to shareholders Standards: Cannot be subsidiary, Must be citizens, Partnerships or C Corporations cant own shares, Only one stock type preferred or common, Only 100 members, Limited Liability Company o Not subject to double taxation, profits flow through owners o All partners have limited liability, only invested o Very flexible, can have as many shareholders o Must be private, cant be traded o Complex to set up and maintain o Can split profits any way they want.
Chapter 8: New Venture Strength and Viability Financial Management- Deals with raising money, and managing finances for a high rate of return.
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Do we need Internal finances (selling products) or external finances (investments)?
4 Financial Objectives
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Profitability- Ability to earn a profit. Not profitable in first few years Liquidity- Ability to meet short term financial obligations. Keep enough money in the bank to make payables o Watch AR and Inventory, make sure they don t get too high, so we have cash. Efficiency- How productively a firm uses assets relative to its revenue and profits. EX: Airline Stability- Strength and vigor of the firms overall posture. Earn profit, remain liquid, watch DEBT o Debt To Equity Ratio- Long Term Debt/Shareholders Equity. Don t want it too high. Companies use Buying Groups- Band together with other small firms to get discounts, and compete with larger
Financial Management Process
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Financial Statement- Written report that quantitatively describes the firms financial health. o Income Statement, Balance Sheet, Cash Flows Forecasts- Estimate of a firms future income and expenses based on past performance, current circumstances and future plans. Budgets- Itemized forecasts of companies income, expenses and capital needs. Important for planning and control. Processo Prepare Historic Financial Statements Look at 2 to 3 past years o Prepare Forecasts- 2 to 3 years in the future o Prepare Pro Forma Statements o Ongoing Analysis of Results Financial Ratios- Depict relationships between items on financial statements, used to check objectives and how a company stacks up to peers. Asses trends. y Make sure to look at ratios in context, they can be misleading.
Financial Statements
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Historical Financial Statements- Reflect past performance, prepared on a quarterly or annual basis. o Public companies are required by the SEC to prepare them and make them available. o Prepared IS, BS, and CFs in that order. o Income Statement- Operations results over period. Shows revenue & expenses, profit or loss. Net Sales- Total sales minus any returns or discounts Cost of Sales (COGS)- All direct costs of producing or delivering a product. Includes material and direct labor. Operating Expense- Marketing, Admin, other expenses not directly related to production. Profit Margin- Return on sales. [Net Income/Net Sales] y What % of every dollar of sales goes to the bottom line. Want High. Price to Earnings Ratio (P/E Ratio)- Measures price of stock to earnings. Want High o Balance Sheet- Snapshot of Assets, Liabilities, and OE at a SPECIFIC POINT of time. Current Assets- Cash and highly liquid items, AR, Securities, Inventory Fixed Assets- Long time, real estate, buildings, equipment Other Assets- Miscellaneous assets, goodwill Current Liabilities- Payable items in a year, AP, accrued expenses, current portion of long term debt Long Term Liabilities- Notes or loans that are longer than a year, building, equipment liabilities. Owners Equity- Equity invested by owner plus the accumulated earning retained by the business after paying dividends. Balance sheets show items recorded at COST. Intellectual property receives no value, even though it may have lots Goodwill and training time, etc not shown on balance sheet Working Capital- Current Assets minus Currenet Liabilities. Gives total LIQUID ASSETS
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Current Ratio- Current assets/ current liabilities, Shows assets to liab, ability to pay debts Debt Ratio- Total Debt/ Total assets, How much is financed by debt, Want LOW o Statement of Cash Flows- Summarizes changes in a firms cash for a period, why it changed. How much cash is on hand, how much was gained and how much was spent Operating Activities- Net income or loss, depreciation, change in current assets and liabilities, other than short term debt or cash. Investing Activities- Purchases, Sales, or investment in fixed assets like real estate, equipment Financing Activities- Cash raised during the period by borrowing money, or selling stock. Cash used to pay dividends, by back stock or bonds Not always good sign to see LOTS of cash 10-K Report similar to annual report but has most detailed information about company business. Pro Forma Financial Statements- Projections for the future based on forecasts, completed 2 to 3 years ahead. o Not required by SEC o Should be created with conjunction of all activities o Pro Forma Income Statement- Plug in forecasted numbers o Pro Forma Balance Sheet- Shows how activities will evolve over time o Pro Forma Cash Flows Statement- Sufficient Cash?
Ratios
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Profitability- Income earned for resource used Want HIGH o Return on Assets- Net Income/Avg total assets o Return on Equity- Net Income/Avg Shareholder equity o Profit Margin- Net Income/Net Sales Liquidity- Extent you can liquefy assets - COVER SHORT TERM LIABILITIES WITH CASH o Current Ratio- Current Assets/ Current Liab o Quick Ratio- Quick Assets/ Current Liab Overall Financial Stability WANT LOW! LESS DEBT o Debt Ratio- Total Debt/Total Assets o Debt to Equity- Total Liab/Owners Equity
Forecasts
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New firms base off of good faith estimates, or similar start ups Assumptions Sheet- Document in business plan, showing where you get your start up numbers for a new firm, Sales Forecast- A projection of a firms sales for the period. o First made, used as a basis. o Existing firms use past sales, production demand, etc o ESTIMATE ACCURATELY! o Regression Analysis- Statistical technique used to find relationships between variables for the purpose of predicting values. Cost of Sales Forecast o Percent Of Sales Method- Expressing each expense item as a percent of sales. Remain same percent Depreciation or other easily estimated items wouldn t use percent of sales Allows items to grow at the same RATE as sales o Constant Ratio Method of Forecasting- Using percent of sales, expenses grow at RATE of sales Break Even Analysis- Total FC/(price-Avg Variable costs) o Gives you re the number of units you need to sell to break even.
Chapter 9: New Venture Team New Venture Team- Group of founders, key employees and advisors that move the venture from idea to firm.
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Formed, not built, as they cant afford to hire. Have a high propensity to fail. Liability of Newness- Companies falter because people who start them aren t able to adjust fast enough to new roles because they lack a track record with outside buyers and suppliers o Good new teams can help this High level individuals who join as directors gain the company legitimacy.
Founders
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Founders have a lot to do with how the team takes shape Most important is SIZE and QUALITIES Size- One person or a founding team? o A Team is better, bring more to the table. o Teams that have worked together before have an edge. o Heterogeneous- Team is diverse in terms of abilities and experiences, Create constructive conflict, HELP o Homogeneous- Similar team, makes decisions too fast o Team over 4 people is usually too large. o Problems when someone becomes CEO Qualities o Knowledge, skills, experience, are the most important thing you got in the early days o People judge the TEAM on the potential for the business, not really assets o Prior Entrepreneurial Experience- Most consistent predictors of future performance. o Relevant Industry Experience- Understand subtleties, have larger network. o Networking- Broad social networks help lots, professional networks
Recruiting Key Employees
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Sometimes management teams are hired immediately, other times founders go at it Skills Profile- A chart that depicts the most important skills that are needed, and where gaps exist. o Explain s how gaps are also being dealt with. o Finding GOOD employees is hard. Founders ask networks and friends for referrals. Founders need to be flexible and take on any job needed.
Roles of the Board of Directors
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Board of Directors- Panel of individuals who are elected by a corporations shareholders to oversee firm management. Inside Director- A person who is ALSO an officer of the firm. Outside Director- Not employed by the firm. Board Appoints officers, declares dividends, and oversees company affairs. New firms pay board members in stock, or ask them to wait until profitable. Boards provide expert guidance and legitimacy Guidance- Need board members with good experience, who can help and give input. Legitimacy- Respected members bring INSTANT credibility. o Signaling- When a high quality member joins your team, shows all others your legit. o Huge help in getting investments, pick members who can get you in
Board of Advisors
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Advisory Board- A panel of experts who are asked by a firms managers to provide counsel and advice ongoing. No legal responsibility, unlike directors, just give advice. Can be for a specific need or problem 5 to 15 members, pay them a little bit Not just for boasting, advisors will WANT to play a role Want advisors from many backgrounds Can make your start up STAND OUT
Lenders and Investors
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They put money in new firms, have an interest Venture capitalists help a ton, they want their money back Gives legitimacy May sit on board of directors
Consultants- An individual who gives professional or expert advice.
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Conducts in depth analysis for the firm Takes too much time for a director or advisor, need a paid consultant Non profit consultants can be used too o SCORE volunteers are retired business owners
Chapter 10: Getting Financing Raising money is a balancing act, its very important, cant put it off Why?
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Cash Flow Challenges- New firms need cash to start up, before they see revenue gained. o Burn Rate- The rate at which a firm is spending its capital until it reaches profitability. Operating in the red. o A firm fails if it burns through all its capital before becoming profitable. Capital Investments- Need money to invest in capital, equipment, buildings, etc Lengthy Product Development Cycle- Can take a while to develop product, need up front cash.
Personal Financing
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Money that gets you off the ground is usually the founders Personal Funds- Most founders use their own resources the first year or so. Close to 50% use their own stuff o Sweat Equity- Value of time an effort the founder puts in. Friends and Family Be businesslike with them, if it s a loan, make payback plans in writing. Bootstrapping- Finding ways to avoid external funding through creativity, thriftiness, cost cutting, etc. Any means!
Preparing to Raise Debt
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Step 1: Determine Exactly How Much Money You Need- Analyze cash flow and projections. Step 2: Determine the most appropriate financing typeo Equity Financing- Exchanging partial firm ownership, stock, for funding. Not a loan, dividends pay back. Liquidity Event- An occurrence that converts some or all of a companies stock into cash. y Happens when they go public, find a buyer or merge Hard to get equity investors on board o Debt Financing- Getting a loan. Bank or SBA
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Step 3:Develop a strategy for engaging potential investors o Develop an elevator speech, 45 seconds to 2 mins o Research your investors or find a contact that knows them o Present business plan
Sources of Equity Funding
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May lose some control, but investors want to help Business Angels- Individuals who invest personal capital directly into start ups. o Rich people who live in your area, want the firm to grow 30 to 40% a year o Usually sit on the board of directors, give lots of input Venture Capital- Money that is invested by venture capital firms in start ups with HIGH growth potential. o Come in later than angels in a businesses life. o Capitalists raise money from wealthy people, invest in a bunch of companies o Carry- The percent of profits the capitalists actually get. o Only looking for home runs, don t fund as many as Angels do. o Rounds- Stages the firm gets money, called Follow On Funding. Seed, Start up, First Stage, Mezzanine o Due Diligence- Capitalists go through the business plan, making sure its legit.
Initial Public Offering
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IPO- First sale of stock by a firm to the public. Secondary Market Offering- Any later issuance of shares. Going public helps you get equity funding, makes you a bigger deal, and is a LIQUIDITY EVENT. Going public means you have to comply with SOX Investment Bank- An underwriter or agent for a firm issuing securities. Helps a firm go public. o Preliminary Prospectus- Red Herring, Describes the offering to the general public. While SEC investigates. o Final Prospectus- Sets a date and issues price for offering. o Road Show- Management team is taken to cities to show off business plan. Taped. Private Placement- the direct sale of an issue of securities to a large institutional investor. Not public offering.
Debt Financing- Getting a loan.
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Single Purpose Loan- Specific amount is borrowed that must be repaid with fixed interest time. Line of Credit- Borrowing CAP is established and borrowers can take at their discretion. Periodic interest payments. Loan interest payments are tax deductible. May have to put up collateral (house) Commercial Banks- Risk averse, don t really help small firms, only big. SBA Guaranteed Loans- 50% of banks do this. o 7(A) Loan Guarantee Program- For sure loan, individuals pledge ALL ASSETS. Good for small businesses.
Leasing- Cheaper for firms to gain a building and equipment.
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Venture Leasing Firms- Act as brokers, bringing businesses and leasers together.
SBIR and STTR Grant Programs Don t have to pay back
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Small Business Innovation Research & Small Business Technology Transfer Provide cash grants to businesses working in specific areas. SBIR Program- Competitive Grant that provides over 1 billion a year to small early businesses. o Phase 1- 6 month long FA. $75,000 to $100,000 o Phase2- Up to 2 years long, create a prototype. $300 to $750 thou. Can Fast Track both 1 and 2
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Phase 3- Product moves to the market place, no funding.
Chapter 11: Marketing Issues Selecting a Market
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Segmenting the Market- Study your industry and identify different target markets. o Can only really target one area initially o Make sure your segment has enough people o Markets can be segmented in many different ways, type, price, distribution, etc Select Target Market- Target a Niche Market o Niche Market- Place in a market segment that has a narrow group of customers with similar interests. o Don t want to be another face in the crowd, KNOW your customers. Establish a Unique Position- Your area compared to competitors. o Create differentiation in your firm. o Product Attribute map- Illustrates a firms positioning strategy relative to its major rivals. o Tagline- A phrase used that is consistent in company literature, promotions, etc
Selling Benefits Rather Than Features- Focus on BENEFITS, what your product will do for them. Establishing a Brandy y y y y y
Brand- Set of positive or negative attributes associated with a company. Brand Management- Program used to protect the image and value of a brand to the consumers mind. Have your product create MEANING for the consumer, and you got em. Buzz= Creating awareness and a sense of anticipation about a company. Don t use too much advertising. Brands can charge more, and get a ton more market share. Brand Equity- A set of assets and liabilities that are linked to a brand and enable it to raise a firms valuation. o Name, quality perceived, trademarks, etc
4 P s of Marketing
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Marketing Mix- A set of controllable, tactical marketing tools used to produce the response it wants in its target market. Product- The good or service offered to your market. o Needs to add VALUE in the minds of customers. o Products that stop pains are very useful. o The product is the name, features, warranty, packaging, o Reference Account- Early user of a firms product who is willing to give testimonial. Many times given for free, good publicity Price- Amount of money consumers pay to buy a product. Produces REVENUE o Cost Based Pricing- The list price is determined by adding markup percent to costs. Markup is easy to see. Hard to INCREASE price. o Value Based Pricing- Price determined by what consumers are willing to pay for a product, backed up. Gives perceived value of the product. Shouldn t lower prices to gain market share, wont bring profit. Price Quality Attribution- Consumers naturally assume that a higher priced product is better quality. o Price is determined on QUALITY and PERCIEVED VALUE Promotion- Activities a firm takes to communicate the merits of products to its target market. o Advertising- Make people aware, tell features and link lifestyle with product. Costly, can be intrusive and many who see it may not be target.
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Public Relations- Efforts to establish and maintain a companies image in the public Not costly Press Kit- A folder containing info about the company and a list of accomplishments. Trade Show- Industry products are shown. Press release, blogs, conference, trade magazines, etc o Free samples, Free Trials, Viral Marketing, Guerilla Marketing Place- or distribution. All activities that move a product from origin to the consumer. o Distribution Channel- The route a product takes from the place its made to the end user. o Selling Direct- Sell right to customers. More capital in assets, like buildings to sell, etc. Disintermediation- Eliminating layers of middlemen, wholesalers, Internet causes this Channel Conflict- Occurs when two or more marketing channels, (online and in stores) are in conflict over their roles in selling a product. o Selling Through Intermediaries- Use wholesalers and distributors. Must pitch your product. Don t make as much money if you go through them Exclusive Distribution Arrangements- Give a retailer or other intermediary exclusive rights to sell your product. The more intermediaries you go through, the chance your product wont be displayed as your brand wants. o
Chapter 12: Intellectual Property All firms have intellectual property and it may be their most important asset. Intellectual Property- Any product of human intellect that is intangible, but has value in the marketplace. Creativity.
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Mistakes: Not identifying property, not recognizing value, not legally protecting property, and not using property in plan for success. Protect items that DIRECTLY relate to your competitive advantage. Name, special systems, etc. Protect items that have VALUE in the marketplace. A one time logo doesn t need to be protected. Four Key Forms o Patents- A grant from the government, stopping others from making, selling, or using an invention for the term of the patent. You get a legal monopoly for a limited time. Only stops OTHERS from your item, you cant infringe on patents that your item breaks. Patent requires: Useful, novel in relation to field, and not obvious to a person of ordinary skill. Utility Patents- Most common. New inventions. 20 years, then public. Used or works y Must be in depth description of process or invention, not just idea. y One Year After First Use Deadline- Must file a patent in a year, or its public. y Business Method Patent- a patent that protects inventions of a business way. Design Patent- New, original designs for manufactured products. 14 years. Way it looks. Plant Patent- Protects new plant varieties. 20 years. Only the INVENTOR(s) can apply. Assignment of Invention Agreement- If an invention is found while employed, the employer has rights to the product. Can also SELL rights to a patent. Patent Process y Step 1: Practical Invention y Step 2: Document when the invention was made- Logbook, keep dates, I o If two people come up with same thing, person who can prove they did it first has rights. First to Invent Rule
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y Step 3:Hire Patent Attorney y Step 4:Do Patent Search y Step 5:File for Application y Sep 6: Obtain USPTO decision Provisional Patent Application- For UTILITY PATENTS, allows patent pending status. Trademarks- Any word, name, symbol or device used to identify the source or origin of products and distinguish them from others. Service Marks- Used identify the services of intangible activities of a business, rather than physical product. Collective Marks- TMs or SMs used by members of a group, indicates membership. Certification Marks- Marks, words, names, symbols, or devices used by a person other than its owner to certify a particular quality about a product. Safety standard marks. Lanham Act Protects: Words, Numbers, Logos, Sounds, Smell, Shape, Color, Packaging. Unprotected : Immortal or scandalous things, profane words, Deceptive names, descriptive names, surnames You don t HAVE to register a TM, once its used, its protected. However, Registered Marks get the R symbol and can get damages from infringement. Secondary Meeting- Over time consumers associate a TM with a product. Intent to Use TM- Gives them rights, but if they don t use it in 6 months its over Copyrights- Owner has right to determine how their WORK is used, and to obtain money. Must be tangible, article, book, etc Manuals, training videos, etc Protected as soon as it is created. Literary works, musical work, Derivative Works- new rendition of something,(song), software, drama, choreographic work, pictorial or graphic work CANNOT protect IDEAS Idea Expression Dichotomy- Cant save idea, but if you express it, you can Cannot copyright facts, titles or ingredient lists No need to apply the copyright, its automatic. Attach the Copyright Bug Protected for authors life plus 70 years Fair Use- Can use some items for news, parody, teaching, criticism, etc Trade Secrets- Any formula, pattern, device, ides, process or information that provides the owner with a competitive advantage. Financial forecasts, employee logs, sales calls, etc Storage doesn t matter, memory counts. Economic Espionage Act Must be highly protected, cant talk about it, need to know Cant take secrets to a new job, even if its JUST in your head Owners must take steps to protect it. Intellectual Property Audit- Identifies all property, helps show valuation of your company.
