The Entrepreneurial Manager Introduction - Welcome to the Territory 5 Classes Fundamentals for the Entrepreneur 12 Classes

• Recognizing Opportunity• Forecasting Cash Flow• A Venture as a Series of Experiments• Sources of Startup Funding

Building the Successful Venture 9 Classes• Starting Right• Building and Developing the Team• Managing Relationships

Alternatives for the Successful Venture 4 Classes• Achieving Liquidity &Sustaining Enterprise

Summary - Pulling it all Together 2 Classes

The Entrepreneurial Manager

Harvard Business School

28 March 2001

Entrepreneurial Manager Tool Kit

Designing Entrepreneurial Experiments& Sources of Financing

What is an Experiment? Experiment - A test made to demonstrate a known

truth, to examine the validity of an hypothesis, or to determine the efficacy of something previously untried.

An Entrepreneurial Experiment is a low-cost test designed to reduce a critical source of uncertainty prior to committing more resources:• Cost of Test < Full Investment

• Test Precedes Investment

• Test Need Not be 100% Accurate

Examples of Experiments Venture capitalists invest small amount before

investing larger amount. Customer research before introducing product. Product trial before full launch. Develop prototype before final product. Conduct due diligence before investing. Interview candidate before hiring.

Benefits of Staged Experimentation Staged Experimentation is an Entrepreneurial

Approach that Allows for:• Reduction of Risk over Time

– Technical– Market– Pricing/Distribution– People– Execution– Others?

• Acquisition of Information

• Preservation of Options– Know when to Drop back and Punt!

Staged Experiments

Time

Level of Commitment

Idea

Validation

Prototype

Commercialization

Mitigate Risks

Goal of the Entrepreneur?

Increase the Size of the Value Pie!

Minimize risk with as little cash as possible as quickly as possible!

Stages of Investment Seed Stage - A couple of entrepreneurs, a cool idea and a prayer!

Start-Up - Product development, Refining Biz Model, Bringing Together Management Team...

Expansion- Prototype complete, some sales and customer feedback, moving toward profitability,

still cash poor.

Late/Mezzanine - Establish market share, rapid growth, IPO

Concept LiquidityProfitsSalesCompany

Start-UpSeed MezzanineExpansionReducing Risk over Time

Raising Capital to Run Experiments Think of the amount of capital you raise in terms of paying

for experiments and the time to obtain experimental results. Think about the experiments and time as means of

obtaining the information you need to uncover the opportunity or the trap before you.

Experiments are incomplete, inaccurate and controversial - yet they must drive action.

How Do I Design Experiments? Step 1: Translate key risks into milestones and actions

• Identify key uncertainties.

• Determine milestones that would signify that uncertainties had been reduced to an acceptable level to move on to the next stage.

• Develop action plan to hit these milestones.

Step 2: Clearly cap the experiment’s cost and duration• Money invested and Time spent

Step 3: Design in external validation• Potential investors: ONSET’s “projection and reflection”

• Potential employees: attract and hire key management members

• Potential customers: letters of intent

Structuring Experiments to Test How can we structure experiments to assess the possible risks and

rewards? How long should we run the experiment? Can we do it quicker? At what cost? Can we do it cheaper? Who should we talk to? Who should we listen to? How do we structure

the conversations? What combination of resources do we need to run a fair experiment? What end products do we expect to have at the end of this stage? What information will we gather to evaluate the experiment? What criteria will we use to determine whether or not to move to next

level of commitment? How will we (or the market?) determine the magnitude of next level of

commitment? How will we morph our business model in light of new information?

The Entrepreneur Runs an Experiment

SUCCESSPayoff - Investment

INVEST NOW

- InvestmentFAILURE

SUCCESSPayoff - Investment - Cost of Test

INVEST

GOOD RESULTS - Investment - Cost of Test1 FAILURE

ABANDON- Cost of Test

1RUN A TEST

SUCCESSPayoff - Investment - Cost of Test

INVEST

- Investment - Cost of Test1 FAILURE

BAD RESULTS

ABANDON- Cost of Test

ABANDON0

P S|G

(1-P S|G )

P S|B

(1-P S|B )

P S

(1-P S)

(1-P G )

P G

Value of the Experiment Generally, Value of the Experiment is Greatest when:

• There is a Significant Cost of Failure.• There is a Significant Probability of Failure.• Cost of Test is Low Relative to the Investment.• The Experiment Yields Fairly Accurate Results.

Value of Information Depends on Your Alternatives• If Alternative is to Abandon

– Value goes up as Probability of Success goes up.

• If Alternative is to Invest– Value goes down as Probability of Success goes up.

Value as a Function of Probability of Success

Probability ofSuccess Range

Decision Strategy Valueof theTest

Low Abandon Venture 0

Low to MiddleRun the Experiment, but the second best

decision is to AbandonVT

Middle to HighRun the Experiment, but the second best

decision is to Invest.VT-VI

High Invest 0

Staged Capital Commitment, Risk and Marketplace Information

CASH FLOW

TIME

Seed Stage 1 Stage 2 Stage 3

IPO/Partial Sale

Seed. Intense Customer/ Supplier/ Investor Interviews

Stage 1. Construction of Prototype or Simulation

Stage 2. Beta Site Selection & Installation

Stage 3. Broad Customer Interviews & Targeting

… Always Accumulation of Information to Launch the Next Stage of the Attack

Free Cash Flow and Burn Rates

CASH FLOW

TIME

Conserve Fuel

Step on the Gas

Moderate Spending Rate

Phased Investment Decisions

Seed

Second

FirstAbandon

Invest Abandon

Invest Abandon

Invest Abandon

Invest

Founding The option to abandon can be more valuable than the option to continue.

Thoughts on Experiments

I should like to have a more perfect knowledge of things, but I do not want to buy it as dear as it costs.

– Michel de Montaigne

One must learn by doing the thing. For though you think you know it, you have no certainty until you try.

– Sophocles

I have not failed; I have found 10,000 ways that won’t work.– Thomas Edison

Don't be too timid and squeamish about your actions. All life is an experiment. The more experiments you make the better.

– Ralph Waldo Emerson

The Entrepreneurial Manager

Harvard Business School

28 March 2001

Entrepreneurial Manager Tool Kit

Sources of Financing

How much money will we need?• How deep is the cash trough?

• What stage are we in the life-cycle of this opportunity? How close to break-even?

• What are the exit options? From whom should we raise money?

• What do they provide in addition to funds? Expertise? Networks? Credibility?

• What will be their impact on our future fund-raising efforts?

• How will this deal influence our future flexibility? What are my personal preferences?

• How much control am I willing to give up?

• Am I willing to make a personal guarantee?

• What level of risk can I--and my family/significant other--live with? Is this a good time to raise money?

• What is happening in the broader capital markets right now?

• Is the IPO market hot right now? Will it still be hot when we want to sell?

Which Funding Source Do I Pursue?Ask Yourself…

Cash Flow Characteristics

VenturesBuyouts

Time Time

Free Cash Flows

Investment

TV

SeedStart-Up

First

Second

Technical Risk

Market Risk

Execution Risk

Cash Flow

Time

Nature of Opportunity Drives Financing Needs

IPO

Equity Markets

Bank Debt

Angels

VC

VCVC

Cash Flow

Time

Nature of Opportunity Drives Financing Needs

AngelsFriends & familyFounders’ capital Credit card debt Second mortgageMicroloans

Bootstrapping SBA loansCommunity banks Asset-backed borrowing Factoring A/RStrategic partners

Own Money/Customers/Suppliers Friends and Family Angels Incubators Venture Capitalists Asset Lenders (Banks) Corporations

Sources of Financing

Alternative Sources of Funding

InternallyGenerated Funds

AravindR.R. Donnelley

Retain Control Minimize Oversight

Need Positive CF May Limit Growth

Friends & Family TDC, R&R, PCC Quick Due Diligence Retain Control

Lack of Assistance Personal Conflicts

Angels Walnut/RBS Higher Valuations Retain Control

Varied Sophistication Can Turn off Future

Funding

Incubators ClubTools Mix of Services Access to Networks

Unproven Model Expensive Services/$$

Venture Capitalists Vermeer,ONSET, Anasazi

Professional Investors Access to Future Capital

Aggressive Terms Loss of Control

Bank Debt Jim Sharpe Retain Equity Fixed Obligations

Corporate Partners ParentingMagazine

Higher Valuations Access to Resources

Bureaucratic Limits Liquidity Options

Financing Source Cases Pros for Entrepreneur Cons for Entrepreneur

From Whom You Raise Capital is Often More Important than the

Terms

Bill Sahlman

Second-Year ElectivesEntrepreneurial Finance: (29 Sessions & Exam)

Objectives: To improve the practice of finance in entrepreneurial settings to enhance students' understanding of the relationships between the investment, financing, and organizational decisions confronting managers. Instructors: Professor William Sahlman, Professor Paul Gompers, Senior Lecturer G. Felda Hardymon

Venture Capital & Private Equity: (20 sessions & paper)Objectives: Seeks to help students understand how:1) Venture capital and private equity organizations work; 2) Why they take the forms that they do; and, 3) Where crucial problems and opportunities for innovation exist. Instructors: Professor Josh Lerner <<http://www.people.hbs.edu/jlerner/vcpe.html. >>

Senior Lecturer G. Felda Hardymon

International Entrepreneurial Finance: (30 Sessions & Exam)Objectives: 1) To enhance the understanding of the relationship between finance and entrepreneurship in an

international and cross-border context; 2) To improve the practice of finance in entrepreneurial firms and in private equity firms; and,3) To enhance the understanding of the relationships between investment, financing and

organizational decisions confronting owners and managers in fast-growing firms.Instructor: Assistant Professor Walter Kuemmerle