Lecture 12 Financial Modeling of a Start-up Business

Feb 23, 2012

HW for Feb 28• Write an expense plan for the first 3 years. How much

money will you need to start the company? 50%

• Latest marketing results primary and secondary 30%

• How will your company be managed? Show org chart including hires 20%

Financial Modeling

• How do you model a future set of events of which you know little?

• Why would you model such events?

• Who would believe it if you did?

Why do it?– Plans for the future

• Have you forgotten anything?– Creates debate

• No one right answer– Isolates assumptions for testing – Self-Consistency

• Look for inconsistencies– Sensitivity Analysis

• What’s important?/what’s not?• Informs management focus

– Drives funding events

Hockey StickRevenue$$

TimeNow

What’s wrong with this picture?

What’s wrong with this picture?

What’s wrong with this picture?

• requires lots of money• earlier revenue is much more desirable • low credibility• Hard to value• How long will the flat section last• Bored with seeing it. Very common• Leave out how high it is going to go

Can I improve it?Hard• If Biotech or some other product that requires

government certification• If product is still in the lab requiring development• If the market is not ready for the product• If the product requires enormous investment• Breaking into an established market• Spike in the cost of inputs• Macroeconomic Factors• Other?

Sharpen your pencil• Consider every line item of expense with the

question – How can I eliminate it?– How can I reduce it?– How can I delay paying it?

• Consider the times to bring money into the enterprise with the question– How can I reduce them?

• Consider the revenues that are earned with the question– How can I increase them?

Can I improve it?How to improve • Think of some short term product that can earn money quickly• License• Get DARPA or other government funding• Mixed Consulting/Product development model• Technology so incredibly compelling that can get “patient

money”*• Get larger investment to speed up

Assume Angel/VC Funding of $5M

0

10

20

$M

T years1 2 3 4 50

Is this a viable investment?

Assume Angel/VC Funding of $5M

0

10

20

$M

T years1 2 3 4 50

Is this a viable investment?More likely a “lifestyle business- not an Angel candidate

Assume Angel/VC Funding of $5M

0

50

100

$M

T years1 2 3 4 50

Is this a viable investment?

So let’s say that this is a good investment. . .

0

50

100

$M

T years1 2 3 4 50

Is this not a good place to start?

0

50

100

$M

T years1 2 3 4 50

Consider number of productsConsider number of markets

So we have the “answer”Can we make it real?

0

50

100

$M

T years1 2 3 4 50

Assume n=3

So we have the “answer”Can we make it real?

Product 1

Product 2

Product 3

• What assumptions can we make? (keep track!)• What must we consider now in our model?• What are the risks? (and how would you abate

them)

Let’s assume that this “answer” is not too ridiculous

Consider revenue side first

• Start with time • What is the sales cycle?

– Amount of time to make sale– How can you accelerate? Consider distribution modes– What is the price of your product?– How many can you sell? In what period of time?– Can you increase the number of business models to earn

revenue?– How do you phase your product introduction?

accelerate

• Publications• Third party validation• Competition• Refer to waldo• Advertising• Free trials• Partner with complementary companies

MonthSales Volume

Avg. Price Total Sales $

Jan-11 50 100

Feb-11     -

Mar-11     -

Apr-11     -

May-11     -

Jun-11     -

Jul-11     -

Aug-11     -

Sep-11     -

Oct-11     -

Nov-11     -

Dec-11     -

Consider now costsSGA• People

– Marketing– Sales– Technology

• Accounting• Equipment• Office Rent and expenses• Materials for product• Legal

– Incorporate or partnerships– Patent– Capital– Employment– Contracts

What is COGS?

• Cost of Goods Sold is the direct cost to make and sell product.– Direct labor (hours X rate)– Purchased materials used in product

Month Revenue - COGS = Gross margin

Jan-11     -

Feb-11     -

Mar-11     -

Apr-11     -

May-11     -

Jun-11     -

Jul-11     -

Aug-11     -

Sep-11     -

Oct-11     -

Nov-11     -

Dec-11     -

Selling General and Administrative Expenses (SGA)

• Payroll costs (salaries, commissions, and travel expenses of executives, sales people and employees)

• Advertising expenses• Other

SG&A

Month Salaries Rent Leases Other Total

Jan-11 $0

Feb-11 0

Mar-11 0

Apr-11 0

May-11 0

Jun-11 0

Jul-11 0

Aug-11 0

Sep-11 0

Oct-11 0

0

Capital costs

• Equipment• Computers

- Lease as much as you can!Add to monthly expenses

R&D

• Costs of developing new products– Salaries– Equipment– Licenses– Consulting– Etc

• Many businesses are all R&D in the beginning