University of Colorado-Boulder



University of Colorado-Boulder

Leeds School of Business

ESBM 4570 Sanjai Bhagat

Entrepreneurial Finance Office: KOBL S431

Spring 2012 Office Hours: W (1 pm – 3 pm)

TR 2:00 pm – 3:15 pm, KOBL 302 sanjai.bhagat@colorado.edu, Tel. 303-492-7821

TR 3:30 pm – 4:45 pm, KOBL 302

I. Course Objective

The objective of the course is to provide the student with a state-of-the-art understanding of

• valuation of small and mid-cap public and private firms, and

• the economics of contracts as it applies to entrepreneurship and new venture finance.

The course will cover the following topics: finance and the entrepreneur; project and business valuation; creating value through financial contracting (staging of financing); financing sources (venture capital, other); and exit strategies (initial public offering, other).

II. Course Materials

Course materials consist of Entrepreneurial Finance (Wiley, by J.K. Smith and R.L. Smith, 2003) and Damodaran On Valuation (Second Edition, Wiley, by A. Damodaran, 2006), and scholarly journal articles and working papers.

Lecture notes/overheads and class announcements can be accessed from my home-page:



III. Course Outline and Readings

A. Valuation

1. Free corporate valuation app for the iPad:

2. A. Damodaran, “Valuation Approaches and Metrics,” 2005, Foundations and Trends in Finance.

3. Valuation Chapter 1, Introduction to Valuation.

[ “Books & Support” “Damodaran On Valuation (Second Edition)” “Website for book”]

4. Valuation Chapter 2, Estimating Discount Rates.

5. Valuation Chapter 3, Estimating Cash Flows.

6. Valuation Chapter 4, Estimating Growth and Terminal Value.

7. Valuation Chapter 6, Firm Value DCF Models.

8. Valuation Chapter 9, Firm and Enterprise Value Multiples.

9. Valuation Chapter 12, The Value of Intangibles.

10. Valuation Chapter 14, The Value of Liquidity.

11. Entrepreneurial Finance Chapters 8, 9, 10, New Venture Valuation.

12. S. Bhagat, "Real Options in the Telecommunications Industry," in Real Options: The New

Investment Theory and its Implications for Telecommunications Economics (1999), Kluwer Academic Publishers, Boston, MA. Options Real Options

13. L. Courteau, J.L. Kao and T. O’Keefe, “Gains to Valuation Accuracy of Direct Valuation Over Industry Multiplier Approaches,” 2003, University of Alberta working paper. [ValuationAccuracy.pdf]

14. A. Schreiner and K. Spremann, “Multiples and their Valuation Accuracy,” Yale University working paper, 2007.

15. J. Liu, D. Nissim, and J. Thomas, “Is Cash Flow King in Valuations?” Financial Analysts Journal 63, Number 2, 2007.

16. H.J.Seppanen, “Financial Statement Information and Evaluation of Newly Listed High-Technology “Nano Caps”” Aalto University (Finland) working paper, 2010.

B. Financial Contracting

1. Entrepreneurial Finance Chapters 11, 12, 13. VC-update siliconvalley

2. S. N. Kaplan and P. Stromberg, "Venture Capitalists as Principals: Contracting, Screening, and Monitoring," 2001, American Economic Review, v91(2,May), 426-430.

ImpliedReturn

3. S.N. Kaplan and Per Stromberg. "Financial Contracting Theory Meets The Real World: An Empirical Analysis Of Venture Capital Contracts," Review of Economic Studies, 2003, v70(2,Apr), 281-315.

4. S. N. Kaplan, B. A. Sensoy, and P. Stromberg, “Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies,” Journal of Finance 64, 2009, 75-115.

5. O. Bengtsson and B. A. Sensoy, “Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts,” Ohio State University working paper, 2009.

6. O. Bengtsson and B. A. Sensoy, “Investor Abilities and Financial Contracting: Evidence from Venture Capital,” Ohio State University working paper, 2009.

7. O. Bengtsson and S.A.Ravid, “The Geography of Venture Capital Contracts,” Ohio State University working paper, 2009.

8. H. Chen, P. Gompers, A. Kovner, and J. Lerner, “Buy Local? The Geography of Successful Venture Capital Expansion,” Harvard University working paper, 2009.

9. Brian Broughmana and Jesse Fried, “Renegotiation of cash flow rights in the sale of VC-backed firms,” Journal of Financial Economics 95, Issue 3, March 2010, Pages 384-399.

C. Financing Sources

1. Entrepreneurial Finance Chapter 14.

2. S. Bhagat, “Why Do Venture Capitalists Charge Such High Discount rates?” University of Colorado working paper, 2009. venture-discount-rates.doc VentureCapital.ppt

3. R. Nanda and M. Rhodes-Kropf, “Investment Cycles and Startup Innovation,” Harvard University working paper, 2011.

4. Hellmann, Thomas, Laura Lindsey and Manju Puri. “Building Relationships Early: Banks in Venture Capital,” Review of Financial Studies, 2008, v21(2,Mar), 513-541.

5. D. Hsu, “Why Do Entrepreneurs Pay For Venture Capital Affiliation,” Journal of Finance 59, 2004, 1805-1841.

6. Hochberg, Yael V., Alexander Ljungqvist and Yang Lu, “Networking as a Barrier to Entry and the Competitive Supply of Venture Capital,” Journal of Finance, 2010, v65 (June), 829-859.

7. J. Lerner and A. Schoar, “Transaction Structures in the Developing World: Evidence From Private Equity,” Quarterly Journal of Economics, 2005.

8. M. Wright and R. Chopra, “Returns to Venture Capital,” forthcoming, 2010.

9. R. Smith, R. Pedace, and V. Sathe, “Venture Capital: Performance, Persistence, and Reputation,” University of California – Riverside working paper, 2009.

10. N. Dai and V. Ivanov, “Entrepreneurial Optimism, Credit Availability, and Cost of Financing: Evidence from U.S. Small Business,” SEC working paper, 2009.

11. Paul Gompers, Anna Kovnerc, Josh Lernera and David Scharfstein, “Performance persistence in entrepreneurship,” Journal of Financial Economics 96, Issue 1, April 2010, Pages 18-32.

12. Lowrey, Ying, “Estimating Entrepreneurial Jobs: Business Creation is Job Creation”, U.S. Small Business Administration, 2010.

13. Estrin, Saul and Tomek Mickiewicz , Size Matters: Entrepreneurial Entry and Government,” London School of Economics, 2010.

14. Audretsch, David and Taylor Aldridge, “University Entrepreneurship and Economic Growth,”Indiana University, 2010.

15. Kerr, William, Josh Lerner and Antoinette Schoar, “The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis,” Harvard University, 2010.

16. S. Bhagat, “How to Grow Employment and the Economy,” University of Colorado working paper, 2011. LaborParticipationRates

D. Exit Strategies

1. Entrepreneurial Finance Chapter 16.

2. J.R. Ritter, “Equilibrium in the IPO Market,” Annual Review of Financial Economics 3, 2011. IPO.ppt IPO-US-World March2012-SenateHearings-1 March2012-SenateHearings-2

3. A.P Ljungqvist and W. J. Wilhelm, “IPO Pricing in the Dot-Com Bubble,” Journal of Finance 58, 2003, 723-752.

4. R. Aggarwal, S. Bhagat and S. Rangan, “Impact of Fundamentals on IPO Valuation,” Financial Management, 2009, 253-284. IPO Valuation.ppt

5. A. Poulsen and M. Stegemoller, “Moving from Private to Public Ownership: Selling Out to Public Firms vs. Initial Public Offerings,” 2005, University of Georgia working paper.

6. F. Degeorge, F. Derrien and K. Womack, “Auctioned IPOs: The U.S. Evidence,” Journal of Financial Economics 98, November 2010, 177-194.

7. Hsu, Hung, Adam Reed and Jorg Rocholl, “The New Game in Town: Competitive Effects of IPOs,” Journal of Finance 65, April 2010, 495-528.

8. Ugur Celikyurta, , Merih Sevilirb, 1, and Anil Shivdasani , “Going public to acquire? The acquisition motive in IPOs ,” Journal of Financial Economics 96, Issue 3, June 2010, Pages 345-363.

9. C.F. Foley and R. Greenwood, “Giving Up Control to Pursue Growth: The Evolution of Corporate Ownership After IPO,” 2008, Harvard University working paper.

10. C.W. Smith, Jr., "Investment Banking and the Capital Acquisition Process," Journal of Financial Economics 15, 1986, 3-30. RaisingCapital.ppt

E. Current Topics

1. R. Ball, “The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?” Journal of Applied Corporate Finance, Volume 21, Issue 4, pages 8–16, Fall 2009.

2. S. Bhagat and B. Bolton, “Bank Executive Compensation And Capital Requirements Reform” University of Colorado working paper, 2011. IBCompensation

3. Anat R. Admati, Peter M. DeMarzo, Martin F. Hellwig, Paul C. Pfleiderer, “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive,” Stanford University working paper, September 2010.

4. Steven J. Davis , John Haltiwanger , Ron S. Jarmin , Josh Lerner and Javier Miranda, “Private Equity and Employment,” US Census Bureau Center for Economic Studies Paper No. CES-WP-08-07R. Private Equity

5. Paige Ouimet and Rebecca Zarutskie, “Who Works for Startups? The Relation between Firm Age, Employee Age, and Growth,” Duke University working paper, October 1, 2011.

6. Kauffman Foundation, “Anatomy of an Entrepreneur,” 2009.

7. G. Jones and L. Bouamane, “Historical Trajectories and Corporate Competencies in Wind Energy,” Harvard University working paper, 2011.

8. A. P. Morris, W. T. Bogart, A. Dorchak, and R. E. Meiners, “Green Jobs Myths,” University of Illinois working paper, 2009.

9. Lauder Institute – University of Pennsylvania, “Global Risk: New Perspectives and Opportunities,” 2011.

IV. Course Schedule

January 17: Introduction

January 19: Valuation

January 24: Valuation

January 26: Valuation

January 31: Valuation

February 2: Valuation. Term Paper proposal due.

February 7: Valuation

February 9: Valuation.

February 14: Valuation

February 16: Valuation.

February 21: Valuation.

February 23: Financial Contracting CapTable Case Overheads

February 28: Financial Contracting CapTable

March 1: Financial Contracting

March 6: Financial Contracting. Term Paper draft due.

March 8: Financial Contracting

March 13: Venture Financing

March 15: Venture Financing.

March 20: Venture Financing.

March 22: Venture Financing

March 27: Spring Break

March 29: Spring Break

April 3: Exit Strategies

April 5: Exit Strategies. Real Options

April 10: Exit Strategies PrivateEquityCaseStudy

April 12: Exit Strategies.

April 17: Exit Strategies. Term Paper due

April 19: Exit Strategies

April 24: Student Presentations

April 26: Student Presentations

May 1: Student Presentations

May 3: Review for Final Exam

May 5 1:30 pm – 3:00 pm Final Exam

V. Course Policies

Grading

The grade breakdown is as follows:

Item Weight

A. Class participation and attendance 10%

B. Term Paper (proposal, due: February 2) 6%

C. Two group-meetings with instructor to discuss term paper 4%

D. Term Paper (draft, due: March 6) 15%

E. Term Paper (write-up, due: April 17) 15%

F. Term Paper (presentation) 15%

G. Peer evaluation by other team-members 5%

H. Final Exam 30%

A. Class participation is critical to the success of this course. Student questions and comments are expected and welcome. Attendance will be taken at random (unannounced). Students are requested to place their name-cards (to be provided) in front of their desk at all times during class.

The class will be conducted in a professional manner: Students and the instructor are expected to be prepared for each class, and behave professionally in the class.

B. Proposals for the term paper are due on February 2, 2012, before the start of class. The proposal should answer the following two questions:

▪ What will the paper be about?

▪ Why is this topic interesting and important?

You should also include a list of at least four academic papers or book chapters that you intend to read as background for your paper. The proposal should be no more than a page.

C, D, E and F. The term paper draft is due on March 6, 2012, before the start of class. The term paper draft should be at least ten pages long, and include the following:

▪ What is the paper about?

▪ Why is this interesting and important to study/read?

▪ A critical survey of the literature.

▪ Outline of the original analysis that would be of interest to somebody in the real world: an investment banker, venture capitalist, or entrepreneur.

▪ References that includes at least four academic papers or book chapters.

The term paper is due on April 17, 2012, before the start of class. Student presentations are scheduled for April 24, 26, May 1 and 3. The paper can be on any topic that will be covered in the course. The paper should include a critical survey of the literature and some original analysis that would be of interest to somebody in the real world: an investment banker, venture capitalist, or entrepreneur. The paper (including exhibits) should be between 20 and 25, double-spaced pages (twelve-point font, one-inch margin all-around).

The paper is a group exercise; students should form/join groups consisting of no less than four students and no more than five students. You should form/join a group as soon as possible at the start of the semester. Please note that the first group assignment (term-paper proposal) is due on February 2, 2012. However, you should set up an appointment to see me with your other group-mates to discuss your term paper proposal – by January 26, 2012.

While you are welcome and encouraged to talk to your friends, work-associates, instructors, etc. regarding ideas, facts, institutional practices, real cases, and so on, the group should write the paper without assistance from anyone outside the group. Similarly, the presentation is also a group exercise. All students in the same group will get the same grade for the term paper proposal, draft, write-up, and presentation. However, to receive credit for the two group-meetings with the instructor (to discuss the term paper) you have to be present at these meetings; one of these meetings should be scheduled before January 26 and the other before March 15. To schedule these meetings, please send me an e-mail with a copy to all your group members with some suggested times that would be convenient for all the group members.

On your paper please note the following:

On my honor, as a University of Colorado at Boulder student, I have neither given nor received unauthorized assistance on this paper.

A Note on Academic Honesty & Plagiarism: The development of the Internet has provided students with historically unparalleled opportunities for conducting research swiftly and comprehensively. The availability of these materials does not, however, release the student from appropriately citing sources where appropriate; or applying standard rules associated with avoiding plagiarism. Please see

Also, please review ,

,

,

and .

Guidelines for the Term Paper

Suggested order for the sections:

Cover Page

Paper Title, Student Names, Course, Date

Executive Summary

No more than one page. The most important part of your paper! Briefly explain what the paper is about, why this is an interesting and important topic, and your main findings/conclusions. Consider an entrepreneur, investment banker, investor, or venture capitalist as your primary reader of this page.

Introduction

What is the paper about?

Motivation: Why is this interesting and important to study/read?

Overview of the paper.

(Main Body)

Please consider using sub-sections to better organize your paper, and improve its readability.

Please check the transition between paragraphs.

(Footnotes on same page.)

Summary and Conclusions

Exhibits (Tables, Graphs, etc.)

Captions and legends in the exhibits should make them self-explanatory. Cite data sources.

References

____________________________________________________________________

Check for grammar and spelling.

All arguments/assertions should be supported using:

logical constructs, and/or

theoretical considerations (cite references), and/or

previous empirical evidence (cite references).

Paper should be revised by you at least four times over a period no less than a week.

H. The exam will consist of essay-type questions, and will be closed-book, closed-notes, and in-class. The exam will be based on study questions that will be handed out during the semester. The exam will be graded anonymously in the sense that students will not write their names on the exam and at the time I grade the exam I will not know whose exam it is.

Readings

You are advised to read the “critical portions” of the assigned readings for a particular class before that class. The critical portions of a reading include the abstract, introduction, summary/conclusions of the paper. You might wish to read the main body of the paper after we have discussed it in class.

Study Questions for ESBM 4570 (March 20, 2012)

1. With the help of a numerical example discuss and explain the underinvestment problem. How could a business avoid this problem? Explain.

2. Describe the various methods of estimating the cost of equity. Discuss the advantages and disadvantages of the various methods of estimating the cost of equity. [value-1.ppt; slides 37-39, slides 6-7]

3. Describe the stable growth, 2-stage growth, and 3-stage growth models. Discuss when each model is appropriate to use. [value-1.ppt; slides 72-74]

4. Describe and discuss how you would value a company that currently has negative earnings. [value-2.ppt; slides 185-186; example in slides 187-199]

5. What are the advantages and disadvantages of the following valuation techniques: Discounted Cashflow Valuation, Relative Valuation, Real Option Valuation. (Valuation.ppt)

6. Kaplan and Stromberg (2001, 2003) and note that VC contracts have the following features: antidilution rights, automatic conversion, and vesting and non-compete clauses. Describe these contractual features. What is the economic justification for including it in a VC contract? [VC-Contracting.ppt]

7. Bengtsson and Sensoy (2009) note that more experienced VCs are less likely to seek downside protection. What is meant by downside protection in a VC contract? Why do more experienced VCs seek less downside protection? [VC-Contracting.ppt]

8. Why are initial public offerings underpriced as discussed by Welch and Ritter (2002)? Please be sure to discuss the theories based on asymmetric information (both when the issuer is more informed than the investor, and the investors are more informed than issuer), theories based on symmetric information, and theories focusing on the allocation of IPO shares. [IPO.ppt]

9. (a) Why do venture-capitalists use such high discount rates? [venture-discount-class.doc]

(b) What are some of the determinants of an IPO’s value as discussed by Aggarwal, Bhagat and Rangan (2009). [IPO Valuation.ppt]

10. What are the significant determinants of whether a privately held firm is taken over by a publicly-held firm, versus conducting an IPO as discussed by Poulsen and Stegemoller (2005)? [IPO.ppt]

12. (a) What are the accounting relationships between revenue, net income, EBIT, and free cash flow to equity? [value1.ppt slide 53]

(b) Valuation professionals use both price/sales and price/earnings ratios to impute value of a company. When might price/sales be more appropriate than price/earnings? [IPO Valuation.ppt]

13. With the help of a schematic diagram, please explain how the U.S. international trade deficit and the U.S. unemployment rate are related. What might be some policy prescriptions to address the above concerns? [Bhagat (2011) “How to Grow Employment and the Economy”]

_____________________________

Please note: The Final Exam will consist of five questions drawn from the above; some more questions will be added to the above. You will be asked to answer three of these five questions. It is expected that the answer to each question would take about 30 minutes.

Education Is the Key to a Healthy Economy

If we fail to reform K-12 schools, we'll have slow growth and more income inequality.

• Article

• Comments (74)

By GEORGE P. SHULTZ AND ERIC A. HANUSHEK

In addressing our current fiscal and economic woes, too often we neglect a key ingredient of our nation's economic future—the human capital produced by our K-12 school system. An improved education system would lead to a dramatically different future for the U.S., because educational outcomes strongly affect economic growth and the distribution of income.

Over the past half century, countries with higher math and science skills have grown faster than those with lower-skilled populations. In the chart nearby, we compare GDP-per-capita growth rates between 1960 and 2000 with achievement results on international math assessment tests. The countries include almost all of the Organization for Economic Cooperation and Development (OECD) countries plus a number of developing countries. What stands out is that all the countries follow a nearly straight line that slopes upward—as scores rise, so does economic growth. Peru, South Africa and the Philippines are at the bottom; Singapore and Taiwan, the top.

The U.S. growth rate lies above the line because—despite the more recent shortcomings of our schools—we've long benefited from our commitment to the free movement of labor and capital, strong property rights, a limited degree of government intrusion in the economy, and strong colleges and universities. But each of these advantages has eroded considerably and should not be counted on to keep us above the line in the future.

Current U.S. students—the future labor force—are no longer competitive with students across the developed world. In the OECD's Programme for International Student Assessment (PISA) rankings for 2009, the U.S. was 31st in math—indistinguishable from Portugal or Italy. In "advanced" performance on math, 16 countries produced twice as many high achievers per capita than the U.S. did.

If we accept this level of performance, we will surely find ourselves on a low-growth path.

This doesn't have to be our fate. Imagine a school improvement program that made us competitive with Canada in math performance (which means scoring approximately 40 points higher on PISA tests) over the next 20 years. As these Canadian-skill-level students entered the labor force, they would produce a faster-growing economy.

How much faster? The results are stunning. The improvement in GDP over the next 80 years would exceed a present value of $70 trillion. That's equivalent to an average 20% boost in income for every U.S. worker each year over his or her entire career. This would generate enough revenue to solve easily the U.S. debt problem that is the object of so much current debate.

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The drag on growth is by no means the only problem produced by our lagging education system. Greater educational disparity leads to greater income-distribution disparity. If we fail to reform our K-12 education system, we'll be locking in inequality problems that will plague us for decades if not generations to come.

Take our own state of California. Once a leader in education, it is now ranked behind 40 other U.S. states in math achievement, placing it at the level of Greece and foreshadowing a bleak future of ballooning debt and growing income disparity.

But the averages mask the truly sad story in the Latino population, soon to become California's dominant demographic group. Hispanics attending school in California perform no better than the average student in Mexico, a level comparable to the typical student in Kazakhstan. An alarming 43% of Hispanic students in California did not complete high school between 2005 and 2009, and only 10% attained a college degree.

Anyone worried about income disparity in America should be deeply disturbed. The failure of the K-12 education system for so many students means that issues associated with income distribution—including higher taxes and less freedom in labor and capital markets—will be an ever-present and distressing aspect of our future.

Examples abound of the ability to make sharp improvements in our K-12 system. By not insisting on immediate and widespread reform we are forgoing substantial growth in our standard of living. The problem is obvious. The stakes are enormous. The solutions are within our reach.

Mr. Shultz is a former secretary of State and a distinguished senior fellow at Stanford University's Hoover Institution. Mr. Hanushek is a senior fellow at Hoover and a member of the Koret Task Force on K-12 Education.

A version of this article appeared May 1, 2012, on page A15 in some U.S. editions of The Wall Street Journal, with the headline: Education Is the Key to a Healthy Economy.

SmartMoney Glossary:

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• [pic]

• Updated March 20, 2012, 10:27 a.m. ET

Can Entrepreneurship Be Taught?



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I have seen successful executives who left corporations and joined start-ups and were unprepared for the experience. They knew how to manage, but they weren't ready for the uncertainty in almost every aspect of decision-making, informal handshakes in place of formal agreements, raw conflicts among company founders and investors and the need to do everything oneself—from emptying garbage cans to fixing jammed copiers.

Leading a start-up also demands a deep understanding of people that can only come from real-world experience.

Imagine a potential employee who's trying to decide between joining a large company or a tiny start-up. Just looking at the numbers, it would be insane to go with the smaller firm. You would almost certainly make less money, you would take on huge personal risk and emotional burden, and you could even wreck your reputation if the venture failed.

-----------------------------------------

Hello Professor Bhagat,

I am emailing from a company called GradStaff. We have a local office in Denver. I was doing some research on your program website and found your contact information.

I am so sorry to bother you. I know how busy you must be this time of the year. I wanted to share with you a Finance analyst that we are recruiting for that might be a good fit for someone graduating from your program.

GradStaff provides employment services focusing exclusively on a unique labor pool – the recent college graduate. Using our proprietary interviewing technique, we invest a considerable amount of time getting to know each candidate and understanding their core skills and attributes. In understanding our candidates better, we then identify exciting employment opportunities that help them combat the often-frustrating “Catch-22” of needing experience, but not finding a job where they can gain that experience.

We place our candidates in a variety of different areas: Banking, Benefit Administration, IT, Electronics, Customer Service/Sales, Financial Services, Human Resources, Insurance, Marketing, Operations and Retail Operations. All costs for our services are paid for by our client companies – graduates who apply with Gradstaff NEVER pay us a fee.

As I mentioned, we are currently recruiting for a Finance Analyst for a payment processing company called Transfirst, located in the Denver area. This position is ideal for a person with a bachelors in Finance or Business. Please feel free to pass the position on to graduating seniors or alumni who you feel might still be looking for a full time opportunity.

I appreciate any help you can provide.

If you should have any questions please do not hesitate in contacting me through email or phone at 612-600-7473 or mqueenan@.

Thank you for your time!

Maria Queenan

Gradstaff Inc

Manager of College Recruiting

612-600-7473

mqueenan@



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