Coping with transition: from doctoral research to teaching and from corporate to entrepreneurial finance.

Stowe, Charles R.B. ; Stretcher, Robert

CASE DESCRIPTION

The primary subject matter for this case concerns the re-thinking of teaching methods and strategies in shifting from a doctoral research orientation to one of teaching emphasis, and from a typical business school orientation in financial management and business strategy to a more directed approach toward entrepreneurial finance. The case has a difficulty level appropriate for an exercise for business school professors faced with this particular challenge, as well as for PhD graduates coming into an environment where innovative and deeper pedagogical thought is necessary. The case is designed to be used in a seminar setting and should take no more than one hour for a seminar exercise, less if the case is available in advance for reading purposes.

CASE SYNOPSIS

Richard LeMont, a recent graduate of a Midwestern university with a Ph.D degree in Finance with a minor in Strategy/Policy, is faced with teaching a course in entrepreneurial finance at an AACSB-accredited College of Business. His doctoral training, while preparing him to deal with research and typical business school courses, has failed him where the entrepreneurial course is concerned. The reader is tasked with developing solutions to the problems highlighted by his first four weeks of the course.

INTRODUCTION

Richard LeMont glared at the test scores from the first exam of the semester in his entrepreneurial finance course. Not a student had passed. He had set what he believed to be a reasonable standard, and the students had simply failed. Richard reviewed the transcripts to see that all the students enrolled had completed the first two accounting principles courses and a course in corporate finance. All the students had the necessary prerequisites. He then set about reviewing his examination questions. Half of the questions on the exam were taken from the publisher's test bank. The other questions were developed from his lectures. Every student completed the exam within the allocated time of one and one half hours. The first part of the exam focused on financial statement analysis and the interpretation of financial ratios. The second half of the exam was a problem set based on financial information which the students were to use to compute basic financial ratios and then write a short analysis based on their findings. From a very simple financial statement, the students were told to develop a cash flow statement.

Richard had a fairly straightforward approach to class policies. His grading system was based on four exams, all counting equally. He would assign but not collect homework problems (to avoid spending a lot of time grading some 45 papers). The final was not comprehensive unless a student missed an exam. For students missing an exam, he had a comprehensive final which would count double. Richard decided to talk to some students before giving back the disastrous results.

He quickly learned that most students admitted that they did not read the text. "We expect you to tell us what we need to know because we are working and don't have time to read." was the general response. He was also surprised to find that while the students had the two principles of accounting courses, they all claimed to have forgotten most of their accounting. Once these students completed their accounting course, they figured it was best forgotten since they never intended to do bookkeeping or accounting as a career. All the students reported that they sold their accounting text at the end of the semester "...since the course is over. I don't want to teach, so why should I have a textbook?" they would respond. Richard also discovered that these particular students had almost a phobia over computing simple ratios. Decimal errors showed that students were unable to recognize the difference between ratios and percentages! The problems portion of the test, where students were given a simple income statement and balance sheet and told to analyze the company's liquidity, revealed that nearly one quarter of the class confused accounts receivable and accounts payable. "I really like finance," stated one coed, "but I hate accounting because I don't like numbers and don't like worrying about what the accounts mean."

Richard sought advice from his more experienced colleagues. Several noted that the average student learns just enough to "get through a course." Most students sell their textbooks back to the bookstore as soon as they have finished studying for their final. "Once the course is over, I can get some spending money to celebrate the end of the semester." chirped one student. Richard found out that students often work 15-20 or more hours a week and therefore expect a teacher to teach them only what they "need to know."

"Because so many students failed your test, the class will feel quite justified in blaming you for their failure," warned a senior professor. The young professor decided he better spend some time outside of class trying to get to know his entrepreneurial finance students. In casual conversation, Richard learned that most of his students were taking the course to either fulfill an advanced elective toward their major in management or general business. There were only one or two finance students who were taking the course as an elective within their major and they sought out the course because "the text looked less mathematical than other electives like courses in investments, financial analysis, or commodities and futures."

To get a better perspective on his students, Richard designed and conducted a survey which produced some interesting results. His first discovery was that the majority of his students had read less than 50% of the text and a good 20% of the class did not even own a textbook. The average GPA in the class was a 2.0 on a 4.0 scale. Most of the students took the course not for the content, but due to the convenient time it was offered. Most of the students had no idea what they would do after college in terms of what industry they would work in or what job function they would seek. The typical response to the questions over future careers was "How can we know what we want to do if we haven't already done it?" Several students reported that they would be returning home to work in their parent's small business and several students indicated an interest in banking or financial planning. Only one student had a career oriented internship.

Richard then realized that he was dealing with students who were really not upper level finance students, but were 'generalists' who had no appreciation for either accounting or finance! Richard wondered why they were even taking entrepreneurship as a minor. Quite by accident, at lunch in the Student Center, Richard was introduced to retired Professor Don Filbert, the professor that Richard was hired to replace. In addition to corporate finance, Dr. Filbert had taught both entrepreneurship and the entrepreneurial finance course. Dr. Filbert explained that most of his students had not aspired to create vast wealth, nor did they profess to have the ambition of becoming executives in medium to large companies. Some of his students were future heirs to small "mom and pop" operations but most students were merely in college to get a degree and get a job. "Our students" Filbert noted, "are first generation college and their parents either work for a small business or own a small business. They take entrepreneurship thinking it is a program on how to run a small business for the purpose of producing an income for themselves." Filbert used the general course on entrepreneurship to introduce the concepts of wealth creation through going public or selling out to competition, in addition to getting students to write business plans.

After talking to students and Dr. Filbert, Richard felt that he had misunderstood the level of sophistication of his students as he had thought that such a specialized course in finance would attract those individuals expecting to earn a living either as investment bankers, venture capitalists, or entrepreneurs. Instead, his students made no distinction between being an entrepreneur and being self-employed. Required courses to his students were a means to getting a degree and not for attaining an education or for use in the real world.

THE "DOCTORAL CANDIDATE" PERSPECTIVE

Later that afternoon, Richard decided to have a snack at the student center when he was approached by another newly hired professor that he had met during the university's new faculty orientation program. Dr. Nancy Hernandez had finished her doctorate in accounting. Conversation quickly turned to their respective experiences. "I just don't understand how students expect to learn accounting without doing any homework." She told Richard that while students seemed to like her as a person, the whole tone of the class changed after the first exam results were provided to her students. Nancy told Richard that many students told her they don't have time for "busy work" and that if homework only counted for 20% of the grade, they were better off just "studying the material than doing busy-work for a homework grade." As a result of not doing the homework, my students did ok on the objective, multiple choice questions which focused on vocabulary, but they could not compute depreciation in order to fill out simple depreciation schedules. Two out of 40 students earned over 78 on the first exam with most of the class only scoring in the high 60's. Nancy lamented, "If they had done the homework they would have understood that accounting is recording accounting transactions, making the proper debit-credits and not just memorizing some terms." Nancy also seemed concerned that her students would blame her for their laziness and shortcomings. Nancy understood that worrying about student evaluations was not very conducive to concentration on research, which was a significant requirement at the university.

Richard responded that he was also having troubles. Both reminisced about the faculty orientation program. Various administrators including the Vice President of Academic Affairs and the Dean of the College of Business had talked about the need to grow class enrollments and to improve retention rates while "raising the bar" on academic expectations. Ringing in his ear was the comment that all the administrators made was that "we are here to support you." The Dean mentioned the relatively new AACSB standard of assessing student outcomes and the importance of external assessments. The Dean encouraged faculty to consider using standardized exit tests. He stressed the need to develop other assessment tools and informed them that the Deans office would be working the whole issue of assessment over the coming year. The Associate Dean reported that the entire university was facing external pressure from major stakeholders to justify budgets on the basis of proving student outcomes. Both faculty members concluded that perhaps they had heard mixed messages? Richard gained some comfort that his frustration was not strictly due to the course content or design of his course. He had discovered that Dr. Hernandez was encountering difficulties due to similar student attitudes in her courses in accounting. However, he wondered if her situation was as serious as his.

ALIGNING COURSE CONTENT AND OBJECTIVES WITH STUDENT REALITIES

Turning to his own plight, Richard began reviewing his course materials. The entrepreneurial finance course and its related text covered the elements of a business plan, forms of organization, measuring and evaluating financial performance of a business using some 19 financial statistics. The text had a significant amount of narrative on non-quantitative issues such as the form of business, the selection of a bank, the selection of members of the Board of Directors, and the importance of establishing banking relationships. The text explored financial forecasting, the process of estimating additional financing to support corporate growth, cash burn rates, and the process of cash planning. The text provided examples of small firms and how they would use project and budget future revenue and expenses to determine future cash needs. The additional funds needed formula coupled with various examples of a small business experiencing rapid growth illustrated the problems that can arise for small firms due to sales volatility.

Unlike the corporate finance book, the examples and illustrations described relatively simple service business such as repairing computers or cleaning swimming pools and simple manufacturing businesses such as bakeries. The entrepreneurial finance text dealt with issues like whether to lease or buy equipment, how to estimate cash burn rates, and the importance of managing accounts receivable from a small firm perspective. The text had chapters on the role of angel investors, small banks, and venture capital firms. The text was oriented to address finance from the perspective of either a small family operated businesses or an entrepreneurial venture whose owner/managers were committed to rapid expansion. The entrepreneurial finance text had extensive descriptions of the venture capital industry, how venture capital firms are organized, sources of their funds, and typical investment criteria. The text described three types of equity valuation methods: maximum dividend method, pseudo dividend method, and delayed divided approximation. In addition, the text offered commentary on venture capital valuation methods and typical terms demanded by venture capital investors. He hoped to expose students to the issue of how to properly structure a growing enterprise through common, preferred, convertible debt, warrants and options. A portion of the course would deal with financially distressed companies and operating under Chapter 13 or 11 of the bankruptcy code.

During his doctoral work, Richard had taught the basic corporate finance course and since his current institution used the same book, he felt his students could move quickly through the overlapping topics. Richard made the following chart comparing the content of the two courses:

The above chart reflected that many financial formulas are covered in both courses. The significant difference was in the application of these financial tools and financing options available. The corporate finance course generally provided examples of the application of these formulas to large, publicly-held corporations. The entrepreneurial finance course focused on the environments that small and growing firms face. Small firms and entrepreneurial businesses generally don't issue bonds, play on currency rates, or use hedge funds. They simply don't have the size or expertise to use sophisticated financial strategies. Nor was their budgeting process as sophisticated as in larger organizations. While getting comparative data for large firms is relatively easy, smaller firms must use industry or trade publications which are more difficult for students to obtain to compare their financial performance to other companies.

Small firms are unlikely to have an employee devoted to financial analysis. Realistically, family- owned enterprises expect their general management to be capable of making sound decisions based on their own financial analysis or in consultation with the company's accountant or accounting firm. The traditional corporate finance course focuses on strategic issues facing large, publicly held enterprises that have finance departments. The corporate finance course prepares future employees to work as financial analysts or in a treasury function within a large organization. The entrepreneurial finance course, on the other hand, must be designed to prepare employees who will spend most of their time either producing or selling the product or service. Most small to medium firms do not have the luxury of specialized employees for finance and accounting. These organizations will either have relatively static work forces or are striving to grow quickly to realize a capital gain for their founders and venture capital investors through an initial public offering.

Richard assumed that overlapping topics meant that he could simply assign homework problems and discuss the solutions the following day. Because students did not ask questions about the solutions to the homework exercises, he assumed that they were keeping up. Actually, his students were not doing homework on a consistent basis nor were they reading the text. Richard noted that many students did not even take notes in his class but he inaccurately interpreted this to mean that they were bored because they already understood the concepts. When it came time for the first exam which would count 25% of the course grade, the students actually felt lost and frustrated. Richard's assumptions had obviously been erroneous.

Richard overheard some students talking in the hallway. The student who did the best on the first exam told another student that the test was unfair. "We are not a bunch of graduate students." she said. "He better curve this exam or else we will get him on the faculty evaluations." Later that same day, a colleague told Richard that his first exam was the subject of student comments in his marketing class. As he turned on his laptop and connected it to the computer, he overheard two of his students discussing the entrepreneurial finance course in the hall. The students were complaining that Richard was not teaching and that he was unreasonably expecting them to remember details from other courses. What pricked the marketing professor's attention was the comment that "we'll end his teaching days when the faculty evaluations come around." And one of his better marketing students remarked "These professors are out to lunch 'cause they don't realize we are paying them to teach us and we don't have time to teach ourselves."

Richard was aware that effective teaching and high student evaluations would not result in a positive tenure vote without at least three refereed journal articles within a five year period. Richard rightly feared that low teaching evaluations along with minimal research could also sabotage his tenure. At an AACSB accredited program, Richard knew that publishing in refereed journals was not optional; it was a requirement. He knew he had to allocate substantial resources to his research. Because his institution's mission emphasized teaching, though, his teaching performance was also relevant if he expected to gain tenure. In addition, the university had a merit-based pay system. Faculty evaluations accounted for 50% of the evaluation score used for both merit and for the major (but not exclusive) consideration for tenure and promotion.

Student ratings accounted for half of the teaching score with the department chair's rating accounting for the other half. Research officially counted for 25%, and service counted for the other 25%. In reality, however, he knew that in order to earn tenure it would take student evaluations near the top of his colleagues if he merely met the minimum research standard.

To earn an annual merit pay increase, Richard knew his overall student evaluation score must be in the top half of the faculty. If students bad-mouthed his teaching and his class enrollments dropped, his department chair's teaching evaluation would work against him for both merit pay and tenure. Starting out with no publications and poor teaching evaluations would not be a good position to be in, especially since he had asked to teach the elective in entrepreneurial finance. Richard was clearly justified in being concerned over his reputation as a teacher, the potential impact on his merit pay and the potential impact on his tenure.

Several days later, Richard bumped into the Dean of the Business School who dropped the bomb: "Richard, you need to do what you can to minimize the number of students coming to my office about you and your entrepreneurial finance course." Unfortunately, another professor interrupted the comment resulting in the Dean walking off to tend to another issue. Richard had a sinking feeling that some of his students had jumped the chain by going directly to the dean.

Charles R. B. Stowe, Sam Houston State University

Robert Stretcher, Sam Houston State University

Comparison of Content
Entrepreneurial Finance versus Corporate Finance

Corporate Finance Entrepreneurship

Financial Statements Financial Statements
 --Income Statement --Income Statement
 --Balance Sheet --Balance Sheet
 --Statement of Retained Earnings --Statement of Retained Earnings
 --Cash Flow Statements --Cash Flow Statements
Analysis of Financial Statements Analysis of Financial Statements
 --Ratio analysis --Ratio analysis
 --Liquidity analysis --Liquidity analysis
 --Asset Management Ratios --Asset Management Ratios
 --Debt Management Ratios --Debt Management Ratios
 --Profitability Ratios --Profitability Ratios

 Overlapping except examples are
 Small Business or
 Entrepreneurial ventures that are
 not publicly held.
 --Financial structure of
 different industries
 --Obtaining comparative data
 --Obtaining research--industry
 surveys and analyses

 Selection of the form of business
 Selection of Board of Directors
 Obtaining Professional advice
 Realities of bookkeeping and
 accounting practices
 among small business.
 --Importance of using
 'enterprise' software and
 ability to generate:
 --Cash flow statements, budget
 and variance
 reports, aging reports
 --Costing systems to measure
 contribution and pricing of
 different services and products

 Break Even analysis
 --by units
 --NOPAT

Du Pont Equation
Management's duty and
responsibilities as related to
MVA and EVA

Markets and Institutions Markets but in the context of
 IPOs and valuation of new
 ventures.
 Role of Venture Capital firms:
 --Organization
 --Source of Funds
 --Investment criteria
 --Types of VCs
 --SBICs

 Accounting/Enterprise systems
 for the small--entrepreneurial
 firm.

Risk and Rates of Return Interest rates but in the context
--Market Risk Premium of lending to small firms.
--Beta and CAPM
--Volitility and risk

Time Value of Money Implicit in topic of issuing
Bonds bonds as part of a financing
 package with an SBIC or venture
 capital firm.
 Cost of capital issues.

Stocks and their Valuation None except for concept of
 valuation of firms thinking
 about going public and timing the
 market for their best price

Weighted average cost of capital. Applied to reality of small
Examples taken from --entrepreneurial firms.
publicly held companies.

Cash flow estimation and risk Cash flow

Distributions to Shareholders

Working Capital Management Working Capital Management but
--Commercial Paper from a small firm/entrepreneurial
--Sources of short term financing venture perspective. Emphasis on
 banking relationships, role of
 angels, supplier relationships,
 strategies to minimize external
 funding.

Financial Forecasting Financial Forecasting
--AFN formula --Heavy emphasis on AFN formula
 --Researching local economic
 factors, industry trends.

Multinational Financial Management