Agenda for Today

1
Agenda for Today

• What You Needed More of in Gate 1
• What You Need in Gate 2
• Financial Concepts in Raising Money
• Peter Kent Financial Models for Startup
  Companies
• Insight Model Discussion
• Major Issues in Early Stage Models
• Dan Dorosin Intellectual Property and Other
  Legal Stuff

2
Opportunity Assessment Gate 1

• VCs All Have ADD
• You Have About 5 Minutes to Get My Attention
• Need to Show
• A Significant Customer Problem that
• A Customer Will Pay to Solve (externally vetted)
• There Are a Lot of These Customers
• Your Compelling Solution (Not Me Too)
• NO WARP DRIVE!!!
• Is Feasible to Create

3
Gate 1 Slideware

• Some Awesome Slides and Some Not So Awesome
• The Slide and Ordering Must Support Your Pitch
• Build the Slide
• Use Graphics and Big Type
• Avoid Lots of Words No Eye Charts

4
Gate 2 Operating Plan

• A Compelling Elevator Pitch
• A Quick Exec Summary Explaining the Busin.
• Product Development Timeline, headcount, costs
  Supported, no Hand-waving. Includes ODMs etc.
• Revenue Fcst for Five Years
• SGA Costs for Five Years
• Clear Exposition of Business Model
• Nominal Identification of Equity Rounds
• Be Prepared to Defend Your Operating Stacks
• Lets Looks at An Example

5
Non-Stick Probes for Research Diagnostics
Operating Plan Financials
MSE 273
November 4th, 2006
Dorothea Koh, Robert Hanson, Greg Rieker, Tania
Rojas
6
Presentation Outline

• The Need Our Technology
• Value Chain Market
• Operating Plan
• Financials

7
The Need Sensitive Diagnostics
Sectors involved in Disease Diagnostics
Sector 1
Sector 2
Hospitals Reference Labs (Disease Diagnostics)
Private, Government Academic Labs (RD)
8
The Need Sensitive Diagnostics
Early Detection is the Holy Grail of
Medicine! -UCSF Doctor

• Test for HIV in blood banks

• More sensitive hepatitis tests to protect blood
  supply

• Monitor effectiveness
• of Prostate cancer treatment

• Test for low concentrations of ß Amyloid
• Diffusible Ligand

New Disease Markers

• Detect Troponin-1 for earlier
• diagnosis of heart failure

9
A Day in the Life of a Patient
Test Results!
Blood is drawn from patient
Blood sample is input into an Immunodiagnostic
System
?
10
How does an Assay work?
Disease-specific antibody
HIV disease marker
Incubate Wash
Particle binds to HIV antigens in patients blood
Incubate
Detect Fluorescence!
Add a Fluorescently-labeled Secondary probe
11
Problem A Sticky Situation
Disease markers are Present in ng/mL!
40 mg/mL
40 mg/mL
More than 10,000 serum proteins in blood!
12
Problem Non-Specific Binding

• High Background Signals

• Generate false positives!

13
Problem Non-Specific Binding
Disadvantages of Current Methods
1. Coating with Blocking Agents

• E.g. Bovine Serum Albumin, Casein etc.
• Long periods of incubation prior to assay (2-4
  hours)
• Coating cannot achieve 100 reduction in
  background signal

2. Depletion of High Abundant Proteins
Agilent HPLC Affinity Column

• Costly Purification systems (2000)
• Lengthy and Time consuming
• Can only remove 98 of the most high abundant
  proteins
• May deplete target further reduction in
  detection sensitivity!

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Problem The Key Issue
How can I find the needle in the haystack without
removing all the hay?
(i.e. No Protein removal No Complex
Purification No Big Bulky Devices)
15
Technology Non-Stick Probes
Disease-specific antibody
Special Polymer coating
Non-stick Pan
Non-stick Probe
We turn blood into buffer
16
Technology Non-Stick Probes

• Probes that behave like non-
• stick pans towards the
• non-specific binding of proteins
• Experimental results show a
• 99.45-100 reduction in
• protein adsorption in 40 mg/mL
• of Human Serum Albumin (HSA)
• Unique IP We intend to file a
• provisional patent to protect our idea
• Initial IP search has yielded no similar
• patents

Our Solution
17
Presentation Outline

• The Need Our Technology
• Value Chain Market
• Operating Plan
• Financials

18
Value Chain Overview
STAGE I
Research Labs
Large Diagnostic Companies
No FDA approval required!
Marketing
Money flow
STAGE II (reagent kits)
Reference Labs
Hospitals
FDA approval required for Diagnostic kits!
19
Sizing the Market Stage I

• Stage 1 Molecular Beads Manufacturer
• Market Size 500 M
• Customers Research laboratories and large
  diagnostic companies
• Business Model
• Direct sales to research labs
• Partnerships with diagnostic companies
• Competition
• Big Players (e.g. Invitrogen, Seradyn,
  Polysciences)
• Proxy
• Dynal Biotech, acquired for 406 M by Invitrogen
  in 2005

20
Sizing the Market Stage I

• 2005 molecular diagnostics market 6.5 B
• 7.7, 500 M, are molecular probe diagnostics

21
Value Chain Stage I
Partner and sell directly to Abbott, Bayer,
Roche, etc.
Large Diagnostic Companies
Research Labs
No FDA approval required for raw beads!
22
Value Chain Stage I
AACC leads tradeshows, Publications, Journal
advertisements, Website
Large Diagnostic Companies
Research Labs
No FDA approval required for raw beads!
23
Sizing the Market Stage II

• Stage 2 New Diagnostics Manufacturer
• Market Size 10 Billion
• Business Model
• Licensing to big companies (e.g. Abbott, Roche,
  Bayer)
• Partner with dominant players
• Sell reagent kits directly to hospitals
• Competition
• Existing Diagnostic Manufacturers (e.g. GenProbe,
  Nanosphere, Abbott)
• Proxy
• Igen and chemi-luminescence technology acquired
  by Roche for 1.4 B

24
Presentation Outline

• The Need Our Technology
• Value Chain Market
• Operating Plan
• Financials

25
Operating Plan Stage I
Quarter 1-3
Quarter 3-6
Quarter 7-15
26
Operating Plan Stage I
Quarter 1-3
Quarter 3-6
Quarter 7-15
27
Operating Plan Stage I
Quarter 1-3
Quarter 3-6
Quarter 7-15
28
Presentation Outline

• The Need Our Technology
• Value Chain Market
• Operating Plan
• Financials

29
Financials Assumptions

• 1) Cost Model

List Price (1000 per unit)
Revenue (600 per unit)
COGS 150 per unit
Discounts 400 per unit
Profit SGA rD 450 per unit

• 2) Sales Marketing
• Diagnostic Companies Direct Sales force
• Research Labs Tradeshows, Website,
  Advertisements

• 3) Lab Space
• Molecular Medicine Research Institute(MMRI)

30
Financials Income Statement
Millions
31
Financials Operating Stack
Headcount
12
19
37
55
100
32
Financials Cash Flow
Millions
Month
33
Questions?
34
Financial Projections for Start-Up Businesses

• Concepts for Creating Meaningful Financials

Mike Lyons Mike.lyons_at_compasscapital.com 650.823.3
199
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Financial Projections

• Why do A Financial Plan?
• Basic Building Blocks
• Key Variables
• Bottoms up / Tops Down
• Model Companies
• Planning Issues
• Financial Models the crucible to test ideas
• What-if Scenarios
• Lest we forget

36
Why do a financial Plan?

• Cant raise money without one?
• Create and Test Business Models
• Understand the key variables for your business
• Understand the cash requirements
• Sharpens focus on key planning areas
• Focus on key operating metrics
• Oh, yeah
• Cant raise money without one!!!

37
Business Models From Forty Thousand Feet

• A Simple Idea But the Devil is in the Details
• E.G., If I Sell Dollar Bills for a Discount I Get
  Market Share Fast and Go Broke
• Realism in the Assumptions Is Critical Remember,
  Profitability is the Difference Between Two Large
  Numbers
• Revenue Does Not Come Without Significant Costs,
  Not Just to Build the Product, But More
  Importantly, To Sell It and Support It.
• Earnings Potential Must Be Aligned with Required
  Investment Resources (realizable payback period)
• E.G., If My 1 Part Requires a 3B Fab..The
  Financing Corollary to the first bullet.

38
Business Models Revenue Assumptions

• How Much Revenue Can I Get and When Can I Get It?
  
• What Segments Am I Going For and What Is the ASP?
  
• How Big Are These Markets and What Is the Sales
  Ramp? (Assumes Ive Got the Right Channel)
• Will My Price Suffer Rapid Erosion (Commodity) or
  Not?
• Why Will I Become a Market Leader? You Cannot
  Create Revenue By Assuming a Small Percentage of
  a Huge Market
• How Do I Recognize Revenue? Accounting Rules May
  Get Me Here.

39
Business ModelsCost of Goods(COGS)

• Manufacturing Is A Key to Profitability
• Youll Need At Least 85 Gross Margin for
  Software Products, and 45-60 for Hardware or You
  Just Have An Expensive Hobby
• COGS Depends Critically on Volume
• Early On, Manufacturing Will Probably Be
  Outsourced
• If No One Knows How to Make It, You Have A
  Problem
• Channel Cost
• VARs, Dealers Margins, etc.
• Evaluate Margin Erosion Due to The Channel

40
Costs Below the Line, aka Operating Stacks The
Costs Incurred to Produce the Revenue

• Aside from Direct Costs of Manufacturing and
  Selling, You Have
• Development Costs plus On-Going rD
• Marketing Costs
• Sales Infrastructure including PSOs
• GA Expenses
• Usually Not Tied Directly to Revenue Early On,
  But Later Set as a Percent of Revenue in Steady
  State

41
Development Costs

• Initial Development and rD is Funded by
  Investment CapitalUltimately Supported by
  Product Revenue in Steady-State (10-20 for
  high-tech)
• Product Development Life Cycle is Typically 1-2
  Years
• Customer Testing and Feedback Is Critical

42
Business Models Marketing and Sales

• What Does It Cost to Sell the Product?
• Do I Sell Direct or Not? Depends on Price
• What Do Alliance Partners Want?
• Do I Use VARs?
• How Much Will Demand Creation Cost?
• Remember The Marketing/Sales Cost Could Exceed
  40 of Revenue in Steady-State Much More Early
  On. Watch Out!
• Complete Value Chain Is Key in the Business Model

43
Value ChainDirect to End User
Notice the little r and the big D !
End Conusmer

Source Mark Leslie
44
Value ChainResellers
End Conusmer

Source Mark Leslie
45
Value ChainDistributors / Resellers
End Consumer

Source Mark Leslie
46
Value ChainOEM or IP Licensing
Cost of Goods (Supply Chain)
End Consumer
Your Product Becomes your Customers COGs

Source Mark Leslie
47
Value ChainYour Acquired OEM Product or Licensed
IP
End Consumer

Source Mark Leslie
48
Basic Building Blocks Income Statement
Revenue Model
Income Statement Revenue COGS Expenses Profit
Product Cost Model
49
Income Statement

• Reports the economic results of a company over a
  time period. It shows the derivation of earnings
  or losses.

Income Statement of XYZ Corp. year 2005
Rev.

• Revenues
• - Cost of Revenue (product cost or COGS)
• Gross Margin
• Sales and Marketing
• General and Administrative
• research Development
• Depreciation and Amortization
• Operating Income (EBIT)
• Interest Income(expense) net
• Net Income before Taxes
• - Income Tax Provision
• - Extraordinary Items
• Net Income

50
Income Statement Analysis

• When does a transaction affect income? - When it
  changes the economic value of the company for the
  owners
• Some Profitability Measures
• Gross Margin () Gross Profit / Sales
• Operating Margin Operating Income / Sales
• Return on Sales Net Income / Sales
• Return on Equity Net Income / Shareholders
  Equity
• Other Important Measures
• Earnings Per Common Share (EPS) Net Income /
  Common Shares
• Price Earnings Ratio (P/E) Market Price /
  Earnings Per Share

51
Income Statement - Example

• KELLOG COMPANY
• Income Statement
• For the Year Ended December 31, 2001
• Net sales 8,853.3
• Cost of goods sold 4,128.5
• Gross Profit 4,724.8
• Selling admin. expense 3,523.6
• Income from Operations 1,201.2
• Interest expense 351.5
• Other expense 54.0
• Net Income Before Taxes 795.7
• Income tax expense 322.1
• Net Income 473.6

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Key VariablesRevenue Model (cross checked)
Revenue Model

• Market
• Available / Served
• Price
• List / discount / Avg selling price
• Forecast by Product
• Product mix
• Trajectory of Ramp
• Forecast by Channel
• Net cost by channel
• Forecast by Sales Capacity
• Sales Yield (sum of quota less safety margin)
• Productivity ramp
• Attrition calculation
• Staffing plan
• Cost for customer acquisition

53
Key VariablesCost Model

• Product
• Estimated BOM
• Rush charges
• Design changes
• Warranty
• Obsolescence / writeoffs
• Labor
• Volume
• Services
• Labor
• Training
• Efficiency

Cost Model
54
Key VariablesCapitalization (Funding) Plan

• Equity Financing amount and timing
• Seed
• Startup A
• Development B
• Mezzanine C
• IPO
• Post IPO
• Debt Financing
• Capital equipment Leasing
• Working capital bank Line
• Convertible debt securities

Capitalization Plan
55
Key Variables Capital Equipment

• Cost per head
• NRE
• Technology Buyout
• Tooling
• IT infrastructure
• Purchased Bldgs

Corp Cap Budget
56
Basic Building Blocks Balance Sheet and Cash
Flow
57
Balance Sheet

• A financial snapshot of a company at a given
  point in time

Balance Sheet of XYZ Corp. - 31 December of 2005
(in thousand )
Accounts Payable Accrued Expenses Short Term debt
Cash and Equivalents Accounts Receivable Inventori
es
Current Assets (liquid in less than a
year) Fixed Assets Other Assets
Current Liabilities (payable in less than a
year) Long-Term Liabilities(bonds issued, bank
loans) Shareholders Equity
Property, plant and equipment(less depreciation)
Common Stock Additional Paid-in Capital Retained
Earnings
Intangibles (less depreciation) Investment
Securities
Total Assets
Total Liabilities Shareholders Equity
58
Balance Sheet Analysis

• Working Capital measure of the amount of cash
  available in the short-term. Also, indication of
  the funds needed to operate within a given
  business size
• Current Assets Current Liabilities
• Liquidity ratios measures of the ability to meet
  short term financial obligations
• Current Ratio Current Assets / Current
  Liabilities
• Acid-test (Cash Accounts receivable) / Current
  Liabilities
• Operational Efficiency Measures
• Inventory Turnover Cost of Sales per year /
  Current Inventory
• Accounts Receivable Collection Period accounts
  receivable / sales
• Accounts Payable Collection Period accounts
  payable / cost of sales

59
Balance Sheet - Example
From Kimmel et. al. Financial Information For
Decision Making

• These financial statement items are for Tweeter
  Entertainment Group at year-end on September 30,
  2001. (in millions)
• Accounts payable 38.6
• Property, plant equipment 109.1
• Receivables 31.3
• Other current liabilities 23.3
• Stockholders equity 332.4
• Cash 3.3
• Long-term debt 36.7
• Inventories 129.2
• Accrued expenses 38.9
• Other current assets 7.5
• Other liabilities 10.5
• Other assets 200.0

60
Balance Sheet - Example
TWEETER HOME ENTERTAINMENT GROUP Balance Sheet
(in millions) September 30, 2001
Assets Current assets Cash 3.3
Receivables 31.3 Inventories 129.2
Other current assets 7.5 Total current
assets 171.3 Property, plant equipment
109.1 Other assets
200.0 Total assets 480.4
Liabilities and Stockholders Equity Current
liabilities Accounts payable 38.6
Accrued expenses 38.9 Other current
liabilities 23.3 Total current
liabilities 100.8 Long-term debt
36.7 Other liabilities 10.5 Total
liabilities 148.0 Stockholders equity
332.4 Total liab. stock. equity 480.4
61
Statement of Cash Flows

• The Statement of Cash Flows reports cash receipts
  and payments over a period, separating
  operational, investing and financing activities.

Statement of Cash Flows of XYZ Corp. 2005

Cash Flow from operating activities
(reconciled from income statement) income -
net changes in working capital (except cash and
equivalents) depreciation and amortization
Cash Flow from investing activities Cash Flow
from financing activities Net Change in Cash
or Equivalents Cash or Equivalents at
beginning of period Cash or Equivalents at end
of period
62
Statement of Cash Flows - Analysis

• CFIMITYM !!!
• (Cash Flow is More Important Than Your Mother!! )
• Especially for an entrepreneurial firm...
• How is cash flow different from income?
• Income accrual is not necessarily linked to cash
  transactions (e.g., depreciation, sales by
  credit, not billed)
• Some activities affect cash flows but not income
  (e.g., investments in fixed assets, additional
  capital from shareholders)
• Growth often absorbs cash flow because of a
  higher need for working capital and fixed
  investments (Entrepreneurial firms with negative
  income and high growth can have a very fast cash
  burn rate)

63
Statement of Cash Flows - Example
From Kimmel et. al. Financial Information For
Decision Making

• SIERRA CORPORATION
• Statement of Cash Flows
• For the Month Ended October 31, 2004
• Cash flows from operating activities
• Cash receipts from operating activities
  11,200
• Cash payments for operating activities
  (5,500)
• Net cash provided by operating activities
  5,700
• Cash flows from investing activities
• Purchased office equipment (5,000)
• Net cash used by investing activities
  (5,000)
• Cash flows from financing activities
• Issuance of common stock 10,000
• Issued note payable 5,000
• Payment of dividend (500)
• Net cash provided by financing activities
  14,500
• Net increase in cash 15,200
• Cash at beginning of period 0
• Cash at end of period 15,200

64
Top 10 Accounting Principles for Entrepreneurs

• The fundamental equation inherent in financial
  statements is
• Assets Liabilities Owners Equity
• The balance sheet is a snapshot at a moment in
  time of financial position, while the income
  statement reports on financial performance for a
  period.
• An income statement details changes in retained
  earnings for the period.
• Accounting disputes turn almost solely on
  valuation and timing.
• Five key principles govern valuation Realization
  (accrual), conservatism, consistency,
  materiality, and historic cost.

Source Hank Riggs (AeA/SEI lecture 8/16/06)
65
Top 10 Accounting Principles for Entrepreneurs

• Since valuations require judgments, financial
  statements are necessarily only estimates.
• Book values seldom equal market values,
  particularly for long-term assets and owners
  equity.
• The lifeblood of any operation is cash.
• Ratios are the key tool for drawing meaning from
  financial statements.
• A companys ability to finance its growth
  internally is a function of its return on equity.

Source Hank Riggs (AeA/SEI lecture 8/16/06)
66
Bottoms-up / Tops-down

• Bottom-up
• Built from details
• Variable assumptions
• Start up and growth stage
• Top-down
• model of the mature company
• Similar to other companies / products / markets
• The Five-Year Plan
• Year 5 model company (or close to it)
• Year 1 raw start up
• Year 2 ? 5 development stage to mature company

67
The Model Company

• Income Statement
• Revenue
• Gross Margin
• Departmental expenses as percentage of revenue
• Operating Income
• Balance sheet items
• DSO (A/R days sales outstanding)
• Inventory turns
• Employee Metrics
• Revenue / employee
• Expense / employee
• Expenses as a percent of revenue

68
Basic Building Blocks Department Budget
S t a r t u p ? M o d e l
69
Company Proxies

• What is a company proxy?
• Why is a proxy important?
• How do you choose a proxy?
• When do you use your proxy?

70
Intergalactic Optical Nanotubes, Inc.Income
Statement
71
Operating Stacks
72
Operating Stacks
73
Common Sizing
74
Planning Issues

• Revenues (always) take longer
• Sales forecasts are optimistic
• Un-tested sales model
• Unrealistic productivity assumptions
• Margins arent as great as planned
• Design creep
• Hidden costs like yield, scrap, obsolescence,
  warranty
• Operating expenses higher than plan
• Capital needs are high . . . and not free
• Cost of capital is inversely proportional to the
  execution of the plan

75
Sanity Testing

• Rate of Sales Growth
• Staffing
• Growth
• Non-growth
• (engineer one product, sell it forever)
• Profits
• Proxy compare your plan to the experience of
  existing companies

76
Financial Models --The crucible to test your
ideas!

• If you understand the model, feasibility of ideas
  are more self-evident
• Make Key Assumptions into variables
• Investigate alternatives
• Sensitivity Analysis
• Determine CASH consumption
• Understand the path to profitability

77
Modeling What-if Scenarios

• Document assumptions
• Facilitates changes in future
• Operational (e.g.,product engineering
  plan/milestones)
• Develop a feel for the dynamics
• E.g., Reduced investment in engineering product
  schedule slip of X months revenue delay

78
Lest we forget

• Cash
• is King.
• Again!