How to Finance your Business & Financial Projection Development Winners versus Losers The Founders...
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How to Finance your Business & Financial Projection Development
• Winners versus Losers• The Founders Dilemma• Thinking Correctly• Building the Plan• Technical Necessities• Building Assumptions for Financial
Projections• Valuation Analysis & Methodologies
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Winners versus Losers - #1
• Clear Mission
• Large, accessible market
• Unfair advantage
• Superior Management Team
• No warts
• Razor sharp operating methodology
• Path to profitability
• A plan that makes sense
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W versus L - Preparation - #2
• Don’t overvalue yourself
• Clean up your do-do!
• Understand what a “proof of concept” is
• Get quality legal/accounting advice
• Find partners with money
• Don’t sell your opportunity to soon – Stale Bread is harder to eat.
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W versus L - Have you done your Research? - #3
– Identify the amount / stages of funding to profitability
– Identify who your customers will be / when
– Identify who your competitors and complements are
– Identify who your investors should be at a given stage
– Identify potential Board Members with a money path
– Identify the “real” amount of money you need – 2 years
– Identify, understand and finalize the IP
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W versus L - Do you understand the fund raising process? - #4
• Is it a quality Executive Summary and Plan? • Is their a date to close the Round?• Has a valuation been set – Why 10x or 20x?• Are the financial proformas within Bounds? 60/20% rule• Who else is being asked to invest?• How much are the Board and Advisors committing?• Who is your first stop and the last?• How much money do you really need versus asking for?
Why? Underfunding because you can get it?
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W versus L - Asking for Money - #5
Don’t apologize for asking
Actually ask for the money
Answer objections with real facts or don’t know
Do you believe in your idea?
Discuss creating value that generates returns – When?
Don’t oversell?
Discuss current problems and concerns?
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The Founder’s Dilemma #1
• Most surrender management control – 3 years/50%, <20% are in control at sale
• 4 out of 5 founders forced down or out – a major cause of business failure
• Founders usually make the same as if employed and less accounting for risk
• Do you want to be rich or king? Why did I start the company?
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The Founder’s Dilemma #2
• 51% make the same or less than employees• Boards job includes replacement whether the CEO
does or doesn’t do the initial job • The faster Founders needs/capital the quicker they
loose management control • Investors have greatest influence just before they
invest• Founders who give up more equity sooner build
value quicker – but they have less control
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The Founder’s Dilemma #3
• Initially Founder/CEOs want wealth and power – Then they find out which is most important – Learning this makes it easier to make decisions
• VCs use the founder - money vs. control paradigm to determine whether they should invest
• Board members need to understand this paradigm before they take the job
• Founders must decide on the rules, the stakes and when to quit. Are they a failure if they lose control?
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The Founder’s Dilemma #4
• Keeping Founders around –37% of Founder CEOs leave when replaced, 23% take a demotion – 40% become Chairman, 50% remain on the Board
• Serial Founders remain CEO for much longer periods in subsequent businesses.
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Thinking Correctly -#1
• Many think they know their customer/market…
• Market validation from friends
• Ready, fire, aim approach to products
• Consumes capital at a furious pace
• The best Entrepreneurs seek market validation• Right product, features and markets sooner
• Natural alpha, beta and first customers emerge
• Recruits savvy employees
• Raises smart capital
• Optimizes company’s capitalization
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Thinking Correctly - #2
• Think you have to ship a killer product…
• ‘Boiling the ocean’ feature sets
• Delays time to market, and the market always is moving
• Uses large amounts of capital
• Real entrepreneurs build it, buy it, partner for it
• Prioritized market feedback from validation
• Get to market faster and with less capital
• Go after partners like you go after customers
• Ship ‘minimal functionality’ products / upsell
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Thinking Correctly - #3
• Think you must raise a lot of capital quickly…
• Lots of capital before any value is created
• Not jealous of dilution
• Has a spend mentality
• Output versus execution orientation
• Good entrepreneurs focus on value inflection points
• Validate markets and business models
• Customer traction
• Bring on key executives and advisors
• Raise enough capital to get through the next set of value inflection points
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Thinking Correctly - #4
• Some of you think good ideas are scarce…
• Ideas are commodities
• Get to market first fallacy
• No competition fallacy
• Characteristics of a solid concept
• New approach to an existing business process
• Real, existing corollaries today
• Solution today has market potential of $ 1 billion
• Multiple adjacent markets just as large
• Start up team with execution skills in the space
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Thinking Correctly - #5• Think you can use partners to sell their wonderful product
• Many technology focused companies rely on others to ‘go to market’
• Companies forget sales as a form of ongoing market validation – Product is that good.
• Think Partners work throughout a life-cycle instead of only after a strong market position has been established.
• How do early stage companies really sell? Market segmentation?
• Three basic sales models for early stage companies; direct, telesales and OEM
• Proven economic model that has reasonable customer acquisition costs
• Understand your sales cycle, sales model and who in the organization is in the decision chain
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Building the Plan - #1• Is the plan a “well crafted novel” that is consistent – Look for
inconsistency (time/costs/milestones/people)?
• Is Who/What/Where/When/How & Why quickly defined?
• Have you determined whether you are a product or services
• based business – Catalysts?
• General Metrics – Products: GM 55-65% EBITDA --20%+
• - Services: GM 32-40% EBITDA – 14%+
• What is the unfair advantage – Why can “you do this”?
• How has the plan evolved since inception or not?
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Building the Plan - #2
• Names and logo’s can be costly – “with whose money”
• Early Advertising and press releases – “with whose money”
• Referrals: Who gets the plan/how versus the Exec Summary – Who are they?
• Having Non-competes/confidentiality? Why or why not? Proprietary material?
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Building the Plan - #3
• Are you baffeling the potential investors with technical B___ S____! – or explaining why it’s a good idea?
• Do you discuss IP protection and potential problems/costs/service providers?
• Do you discuss the product(s) evolution and timing/contingencies (no one trick ponys)?
• Do you discuss “Blue Sky” ? – How do we get there????
• Do you discuss related technology and markets and then differentiate?
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Technical Necessities - Markets - #1• Technical market knowledge is very important within the team?
• Has the market segmentation analysis been completed despite it being very difficult and expensive to prepare?
• Definition of typical sales channels?
• Definition of needed sales and marketing support costs?
• Research of “others” unfair advantage?
• Pricing guides and strategy??
• Competitors (who and what to steal)?
• Compliments – who might cooperatively help you buy and sell?
• Determination of component product costs, production timing?
• Market entry strategy and time to market?
• Potential leverage and value propositions (beyond your “good” idea)?
• OEMs and resellers – comp. and revenue models / manage-costs?
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Technical Necessities - Organization - #2
• Does everybody have a title? Top heavy? Why? Reason for a title? • What will the org look like in the future? Why? When? Contingencies?• When will you reach the limits of you or your teams expertise?• Do they invent roles for partners that can’t contribute?• Are all roles and timing are directly tied to the financial model?• Do they add or expect to add roles before they need them?• Do they set compensation expectations for staff before or after financing? • Are their outsourcing plans realistic and cost effective? When? • Do they understand the cost of managing resellers (time and money)?• Do they understand that OEMs need management (time and money)? • Do they have an HR VP, Manu VP, Marketing VP or CFO now? Why?• Do they have the beginnings of a corporate culture and critical success factors?• Do they understand the proper ways to motivate staff without money being the
end all?
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Technical Necessities – Finance Model #3
• Can you demonstrate financial knowledge and acumen?
• Do you talk about anticipated return (ever)?
• Realistic milestones and value creation w/ interdependencies / cash requirements when– problems and upside (pictures)
• Basis of the financial model – the income statement (example)
• Facilities, compensation and management agreements disclosure
• Cash requirement timelines (cash-flow statement)
• Cap Table and investment history of existing investors (example)
• Term sheets with expectations - pros and cons (example components)
• Normal financial metrics (per above)
• Understanding utilization and overhead (metrics) - billing
• Bank financing expectations - yea right
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Technical Necessities – the Investor - #4
• What are the investors bringing to the table?
• Money (now) – Evaluate the investors negotiating leverage – lots or a little?
• Money later and the ability to syndicate other investors into the deal based on milestones – can these investors support you or throw rocks? Ask them?
• Strong industry knowledge and expertise to help refine the plan?
• Support in the hiring of the best and brightest into the company?
• Support in monitoring the business/industry?
• Do they listen when the CEO talks or asks the investor to help?
• Investors prior history of building successful companies and teams?
• Knowledge of compliments and competitors and their operating models?
• Someone with whom you can develop mutual respect with and work with during difficult periods.
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Building Assumptions for Financial Projections
Model yourself after others
•Product Development and Scaling•Organizational Development/When•Market Segmentation Analysis •Financial Plan Analysis w/ revenue model types
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T
Product Development and Scaling
Technical costing from proforma example
• Ongoing Design and Development – Product Evolution
• Facilities & Outsourcing• Inventory for build w/ time• Logistics – Shipping – Packaging• Inventory for sale w/time• New product introductions / additions• Scaling/Planning for growth• Inputs to the revenue model
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T
Organizational Analysis / WhenOrganization Chart
• Where are you at today / Promises• Compensation Standards & Planning• Hiring timeline by position w/contingencies• Quarterly Staffing Reviews• Chiefs versus too many indians• True Cost of an employee – 1.44 x salary / 1860
hours = rate per hour – • Inputs to the revenue model
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T
Market Segmentation Analysis • Model Company – Beg, Borrow & steal• Compliments & Channel Development• Competitors
1. How much they charge2. Revenue Streams they have –subscription, maintenance &
support, per use, per seat, one time/upsell, etc.3. Staff size validation4. Brand Strategy/cost5. Marketing / Cost of Customer Acquisition
• s
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T
Financial Analysis &Rationalizing Use of Proceeds
• Revenue Model – Why/When• P & L Pro-forma• Cash Flow Forecast• Inventory• Balance Sheet• Due Diligence Examples
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Analysis & Information
• Revenue Contracts Analysis
• Company Capitalization Analysis
• Partnership Contracts Analysis
• Legal Analysis
• Salary / Benefits Analysis
• Administrative Evaluation
• Technical Evaluation
• Industry / Competitive Analysis
• Organizational Analysis
• Strategic Analysis
• Financial Analysis
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Valuation Analysis & Methodologies
• Creating Value with Milestones
• Value Dynamics
• Top 10 value assets
• Valuation Methodologies
• Strategic Analysis
• Financial Analysis
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Create Value by Achieving Milestones
Va
lua
tion
($M
M)
1
10
100
1,000
Inve
stm
ent
Ris
k
High
Low
>120 80-120 60-100 40-80 25-35 8-11%ROI
VC
Full Commercialization
$10MM+
CustomersDealsRevenue(-) Profit
Angel
$500K+
VC
Prove MgtExecutionProfitableStart Scaling
$5MM+
Proof of Concept
Seed
Idea
$50K+
Mezzanine IPO
$20MM+ IPO
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Traditional Financial Reporting Framework
Revenues
ExpensesLiabilities
Assets
Receipts
Cash Flow
Disbursements
Balance Sheet Income Statement
net equity net profit
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CustomerCustomers
ChannelsAffiliates
Employee & Supplier
EmployeesSuppliersPartners
FinancialCash ReceivablesDebtInvestments & Equity
PhysicalLandBuildingEquipmentInventory Organization
Leadership InnovationStrategy KnowledgeStructure SystemsCulture Processes IP* Brand
*Intellectual Property
Value Dynamics Detailed Framework
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10. Patent and new product development
9. Ratios (ROA, ROE, P/E)
8. Image of company amongst its shareholders
7. Market share
6. Brand Recognition
Top Ten List of Value Assets
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Top Ten List (con’t)
5. Technology investment
4. Profit margin
3. Revenue Growth
2. Employee retention
1. CUSTOMER SATISFACTION!
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Determining value by comparing multiple methods.
Market comparables
Discounted cash flow analysis
Hurdle (Venture Capital) Approach
TYPICAL METHODOLGIES
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MMM Method of Business Valuation
Make Me a Millionaire
“Determines the asking price of a business by multiplying the number of owners by $1.0 million.”
- Bryan Jamison, SMU BBA ’78 Wall Street Journal (circa 1985)
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Definition: Compare to recent private transactionsof comparable companies.
Disadvantages: Comparability still suspect, Results of analysis must be discounted for Company Stage, Management, timing (seasonal down turns), a
multitude of obvious differences.
Advantages: Provides insight into to current market pricing for similar size and stage deals
Private Market Comparables
Sources: Venture One, Venture Economics, Press Releases of Entrepreneurial Community
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Selecting Comparable Companies/Transactions
Lines of business
•Size
•Geography and diversification
•Financial condition
•Cyclically comparable
•Other risk characteristics
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Comparables Strengths Weaknesses
Quick to use Never really comparable
Simple to understand Adjustments often greater than similarity
Commonly used Only compare to the best
Market based Not in “market”
It is “private”.
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Definition: Present value in dollars of the future cash receipts at a selected hurdle rate less the investment made.
Source: Company financial projections compared against reality.
Net Present Value of Future Cash Flows
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Net Present ValueStrengths Weaknesses
Theoretically sound Cash flows difficult to estimate
Based on CASH Comparables for discounts difficult
Easily calculated WACC assumes constant structure
Common usage WACC assumes effective tax rate
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Definition: Determine an exit value at some point in time required to achieve a predetermined rate of return.
Source: Company financial projections compared against reality.
Venture CapitalHurdle rate method
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Venture Capital MethodStrengths Weaknesses
Simple to understand
Relies on exit value (IPO mentality)
Quick and easy to use
Complex capital structures negate ease of use
Commonly used Large discounts oversimplify
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Other Problem Areas•Any methodology that requires use of factors (variables in formulas) that you can’t get!
•Academic exercises that give you answers you know aren’t right!
•Endless mathematical models that take your focus away from analyzing the company
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References and Research
• Harvard Business Review• Kellogg School of Management• Hal Johnson/Diane Miller• National Association of Corporate Directors• Phil Jenkins – Bryn Mawr Associates• John Carver• Noam Wasserman