MBA Entrepreneurial Finance Harvard Case Solution & Analysis

MBA Entrepreneurial Finance Study Case Solution 

1. An asset-intense startup can be profitable and at the same time lack enough cash flow for the business to be sustainable, sometimes leading to bankruptcy.

True

The reason for the bankruptcy is the fact that profits are associated with the revenues and expenses which the company earned over the cost of sales and incurred expense regarding interest and other payments. Whereas, negative cash flows only focuses on higher payments and lower receipts. Therefore, under the sustainable conditions, it is said that a company would be bankrupted due to un-ability to pay future cash payments to the creditors and other holders.

2. Entrepreneurs prefer lower valuation caps on convertible notes because it guarantees a higher equity stake.

True

As the convertible note is an instrument that would be converted into equity, and involved in the raising capital of the company. Therefore, lower valuation cap is the method which involves less risk for the capital enhancements. In this particular approach, the more equity would be received by the company from the holders of the convertible notes.

Section 2: Qualitative Short Answer (5 points each)

3. Let’s say that you are a potential VC investor in an early round. How does this prospect of potential dilution in subsequent rounds affect your thinking about the nature of your investment in an early round?

As, the start-up companies are looking towards the initial investments to manage the operational activities and future growth.Therefore, this option would be prefer a bleto them but can be costly due to high expected rate of return for the related venture capitalists. So, there are various rounds to execute the investments in the business activities (early stage to balanced stage). If I will be a venture capitalist and consider investment in the early round (Round of investments for product development and initial marketing), then a potential dilution would happen in the business perspective because such investment might not generate enough outcome to process the company’s long-term objective. It would consider the lack of product’s feature for the particular market  less aggressive marketing initiatives. Therefore, it could not allow to invest the same proposed amount in the later stage further, and could potentially reduce the investment’s criteria overtime (subjected to dilution).

4. How does the amount of funds raised by a VC firm influence the size of the deals it makes, that is, the average amount invested in a company?

Raising funds is sometimes not good for the company which deals with the criteria of average invested amount. It also means that the average amount represents that almost all the investors funded at the same level. However, the increase in the investment could potentially damage the average value and thus, involve misbalance of the proposed return on investment. In the case, the company set a proposed average return over the pool of average invested amount, but if a new venture capitalist would offer the funds more than the average, then different return criteria would be set that would potentially reduce the average return of other investments (More return for new venture capitalist).

5. Under what circumstances will a convertible preferred stock (assuming it has a zero dividend) prove to be a better investment vehicle for a VC than straight, plain equity?

Convertible preferred stock is the stock that can be converted into common shares at the specified time. So, if the condition seems that the company would earn more profits or retain earnings in the future, then such stock would be converted into common shares because the preferred is the fixed earnings whereas the more retain earnings would increase the return of common stocks over time. On the other side, equity would also consider returns on investment not subjected to retain earnings (that would be attributable to common shareholders). Therefore, the convertible preferred stock is better than plain equity.

MBA Entrepreneurial Finance Harvard Case Solution & Analysis

6. Why might entrepreneurs prefer bootstrapping to raising external capital?

Sometimes, the entrepreneurs preferred bootstrapping to be a better way to raise external capital because it is the most efficient and inexpensive method to raise money. In that case, a company would not pay any interest or payments. The example includes sell out trade credit to the buyer and increase the capital in addition, to less borrowing to execute the financing activities. Therefore, with low borrowings and less risk of default, most of the entrepreneurs apply the method to minimize the future long-termfinancing risks.
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