LAKEHEAD

K. Hartviksen
Value (5) 1.

Business 3215 FA Principles of Entrepreneurship Final Examination MARKING KEY

UNIVERSITY
December 11, 2006

Briefly explain the meaning of the following terms as they are used in this course: Love money. Seed money to a new venture from family and friends. Friends and family are a common source of funds for many new ventures. This form of contribution is often called love money, which can consist of outright gifts, loans, or investments but often comes in the form or forgone or delayed compensation or reduced or free rent. Founders Agreement - (also known as a shareholders agreement) a written document that deals with issues such as the relative split of the equity among the founders of the firm, how individual founders will be compensated for the cash or the sweat equity they put into the firm, and how long the founders will have to remain with the firm for their shares to fully vest. Tranche a word used to describe a round of financing. Venture capitalists and other providers of capital provide capital in tranches to limit their overall risk to the venture and yet, with success in each round, is willing to put further money at risk. Stealth mode Companies that formulate their initial business plans in secret refer to themselves as operating in stealth mode. Companies with highly proprietary products, services or business methods, will often operate in stealth mode until their patents are applied for and they are ready to unveil their products. They do this to avoid losing the proprietary aspect of what they are doing to competitors, and to build anticipation about their product offering. Domain name A domain name is a companys Internet address (e.g., www.intel.com). Elevator Speech - An elevator speech is a brief, carefully constructed statement that outlines the merits of a business opportunity. Why is it called an elevator speech? If an entrepreneur stepped into an elevator on the 25th floor of a building and found that by a stroke of luck a potential investor was in the same elevator, the entrepreneur would have the time it takes to get from the 25th floor to the ground floor to try to get the investor interested in his or her business opportunity. In the same fashion, entrepreneurs typically only have a few short minutes to interest any investor in a business opportunity, whether it is in an elevator or any other setting. Provide several suggestions for how new firms can avoid litigation.

(5) 2.

Most legal disputes are the result of misunderstandings, sloppiness, or a simple lack of knowledge of the law. Getting bogged down in legal disputes is something an entrepreneur should work hard to avoid. There are several steps that an entrepreneur can take to avoid legal disputes: Meet all contractual obligations Avoid undercapitalization Get everything in writing Promote business ethics (4) 3. Describe the purpose of a nondisclosure agreement. Provide an example of when a nondisclosure agreement kicks in.

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Answer: A nondisclosure agreement is a promise made by an employee or other party (such as a supplier) to not disclose the companys trade secrets. An example would be an employee who is privy to a companys marketing strategy. If the employee quit her job and went to work for a competitor, it would be a violation of her nondisclosure agreement to tell her new employer the details of her previous employers marketing strategy. (6) 4. Distinguish between angel capital and venture capital. Discuss thoroughly.

Angel capital is equity or debt investment in a new venture from wealthy local individual investors in an informal
setting. Investments range from $50,000 to $500,000 and perhaps to as much as $1,000,000 especially when groups of angels are involved. Angel investors like to invest in businesses they know and in people they believe in. Angels invest their own personal money.

Venture capital involves investment of $1,000,000 or more usually in the form of equity ownership. VCs will

normally look for controlling interest, seats at the board and are prepared to take an active role in day to day management of the firm. VCs are normally organized as for profit corporations and have been capitalized by the sale of shares either to a single corporation or to the general public. They will invest in a portfolio of ventures, knowing that 3 out of 10 investments will fail outright. 3 they may recover their initial investment and four will be spectacular successes. Overall portfolio returns will be greater than 20% per annum. VCs always have an entry and an exit strategy and an investment time horizon of 3 to 5 years. During this time they plan to contribute money (financing) and offer additional benefits to more the venture from a startup to perhaps the IPO stage where they can double, triple or quadruple their original investment. Funding from VCs are usually structured in layers or tranches (rounds) forcing the venture to prove its worth and potential with each successive round. In this way the VC manages its exposure to the risk of the new startup. (6) 5. Discuss ways entrepreneurs bootstrap their organizations or limit costs to help underwrite their venture. Minimizing personal expenses and putting all profits back into the business Avoiding unnecessary expenses, such as lavish office space or furniture Establishing partnerships and sharing expenses with partners Leasing equipment rather than buying Sharing office space or employees with other businesses Utilizing the services or a university or community incubator Buying items cheaply but prudently through discount outlets or online auctions, such as eBay, rather than at full-price stores Describe what is meant by a general partnership and a limited partnership. Describe the major difference between the two. A general partnership is a form of business organization where two or more people pool their skills, abilities, and resources to run a business. A limited partnership is a modified form of a general partnership. The major difference between the two is that a limited partnership includes two classes of owners: general partners and limited partners. Similar to a general partnership, the general partners are liable for the debts and obligations of the partnership, but the limited partners are liable only up to the amount of their investment. General partners are jointly and severally liable for the financial obligations of the business. Business 3215 Fall 2006 Final Examination MARKING KEY Page 2

(4) 6. Answer:

Limited partners have liability that is limited to the amount of money they have invested in the business. Limited partners are not allowed to play an active role in day-to-day operation of the partnershipthe extent of their involvement is investment in the business and participation in net profit. (4) 7. What is meant by the term piercing the corporate veil? How can the corporate veil be pierced?

Answer: In most provinces, corporations must file papers annually, to maintain their status as a corporation and to comply with provincial regulations. It is important that a corporations owners fully comply with these regulations. If the owners of a corporation dont file their annual paperwork, neglect to pay their annual fees, or commit fraud, a court could ignore the fact that a corporation has been established, and the owners could be help personally liable for actions of the corporation. This chain of events is referred to as piercing the corporate veil. (6) 8. Why do most firms need funding? (Three reasons) Provide a brief explanation of each reason.

Answer: There are three reasons that most new firms need to raise money during their early life: cash flow challenges, capital investments, and lengthy product development cycles. In regard to cash flow challenges, as a firm grows, it requires an increasing amount of cash to service its customers. Often, equipment must be purchased and new employees hired and trained before the increased customer base generates additional income. In regard to capital investments, firm often need to raise money early on to fund capital investments. While it may be possible for the firms founders to fund its initial activities, it becomes increasingly difficult for them to do so when it comes to buying property, constructing building, and purchasing equipment. In regard to lengthy product development cycles, firms often need to raise money to finance the upfront costs of lengthy product development cycles. (6) 9. Name four specific items that are contained in the articles of incorporation for a Canadian company. Can articles of incorporation be changed, and if so, how?

Legal name of the corporation Location of registered office Objects of the corporation restrictions, if any, on the activities the corporation can engage in Minimum and maximum number of directors Types of share capital and maximum numbers of shares together with any special rights or restrictions on that share capital (subject to the proviso that there must be at least one type of share capital (ownership) that has voting rights and residual rights to the corporate assets) Names and addresses and signatures of original incorporators. Yes, the articles can be changed. However, this requires a vote by a 2/3 majority of voting shareholders. This requires the calling of a Special Shareholders Meeting for the express purpose of changing the articles

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of incorporation. Once this is passed, the motion, and proposed changes need to be submitted on requisite forms with requisite fees to the minister. (8) 10. What are corporate bylaws and what do they normally include?

Corporate bylaws are approved and changed by shareholders resolution only. They cover organizational issues pertinent to the operation of the corporation especially the organization and operation of the board of directors including: Size of the board, election and terms of office Officers appointments and terms of office Committees of the board Meetings and procedures of the board (frequency, timing, quorum, notice of meeting, agenda, chair, secretary, minutes) (12) 11. In this course you were introduced to government-assisted funding programs for smaller enterprises started by individuals your own age. Identify three different sources of government-assisted funding programs and discuss each one in turn, addressing: eligibility for financing requirements types of costs covered (purposes) limits of funding available AnibiAski Development Fund Northern Ontario Heritage Young Entrepreneur Program FedNor Thunder Bay Ventures PARO Canadian Youth Business Foundation

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(3) 12.

What is the purpose of a monthly cash budget forecast (cash flow forecast) when included in a business plan?

Forecast (anticipate) the timing, magnitude, and duration of forecast cash surpluses and deficits so that

appropriate financing can be secured before the need arises, in the correct amount, and structured such that the financing will be sufficient for the period of time required. In the case of forecast surpluses, it allows the business owner to make informed decisions with regard to investing the surpluses. If the surplus is small and is expected to be needed in a short time frame, the business owner will invest it only for the short term and not put the money at risk so that it is available when needed by the business. (8) 13. You are planning to establish a manufacturing company to produce micro chips that are used in micro wave ovens. It will take an initial investment of $2,000,000 in equipment and leasehold improvements to establish the business and this will require you to invest your total life savings. The business will be financed entirely through owners equity because you feel that the terms and conditions lenders will impose will restrict the growth potential of the business in the long run. You have done considerable research into the business and have determined that it will cost you $1.12 in direct materials and direct labour to produce each chip. You have estimated other costs as follows: Monthly lease costs for the firm Annual Salaries and Administrative expenses Annual depreciation expenses on equipment Selling, advertising and promotion expenses annually $3,450 $167,500 $255,000 $145,700

Calculate the annual and monthly break even point for this business in both numbers of units produced and sold, as well as in sales dollars assuming that the selling price per micro chip is $7.44. When doing market research for your business you determined that the global market for microwave ovens is 14,500,000 units annually. Given the strong competition in the microchip market you estimate you will probably capture 1% of that market. a. Units Sales Dollars b. Calculate the annual and monthly break even point in units and in sales dollars. Annual BE point 96,456 $717,631 Monthly BE Point 8,038 $59,803

According to your expectations, is this firm likely to breakeven in the first year of operation? What is the projected net income for this business in its first year of operation? Yes, it is expected to more than breakeven at the projected level of sales, given the forecasting assumptions. Projected net income for the first year = $245,440 Apart from the breakeven analysis, what else would you like to know about this business in a financial sense before proceeding further? What the cash flow forecast looks likewhen money is expected to leave the business and when it is expected to arrive. Often there are significant mismatches between cash inflows and cash outflows meaning that the business requires a great deal more financing than originally anticipated.

c.

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d.

If you dont need to borrow funds, is there any need to produce a business plan? Explain. Absolutely A business plan is required to guide implementation of the project, but further, to monitor the progress of implementation over time. If variances from plans are detected early in the project, it is easy with a plan, to anticipate the longer term implications and take corrective action immediately before getting into trouble.

$ Costs, Revenues and Profits $717,630

Break even point: TR=TC

Total Revenue

Total Costs

Fixed Costs

96,456

Volume of Production and Sales (in numbers of units)

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Fixed Costs: Annual lease Salaries and Admin Selling and Admin Depreciation TOTAL FIXED COSTS Selling Price per unit Variable Cost per unit Unit Contribution margin Annual Break even point in units Annual Break even point in sales dollars Monthly Break even point in units Monthly Break even point in sales dollars Total Market Size Projected Sales = Projected Cost of Goods Sold = Projected Gross Margin = Projected EBIT at expected volume of sales = Projected net income at expected sales volume = $41,400 167,500 145,700 255,000 609,600 $7.44 1.12 6.32 96,456 ## $717,630.38 8,038 $59,802.53 $14,500,000 $1,078,800 162,400 916,400 306,800 $245,440 Weighted Possible Volume 18,125 72,500 54,375 145,000

Probability 0.25 0.5 0.25

Possible Sales Volume (units) 72,500 145,000 217,500 Expected Sales Volume in units =

Obviously the firm is expected to make a net profit at the level of sales projected.

___________ / 77 TOTAL

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