How to Finance your Business

1
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

3
W versus L - Preparation - 2

• Dont overvalue yourself
• Clean up your do-do!
• Understand what a proof of concept is
• Get quality legal/accounting advice
• Find partners with money
• Dont sell your opportunity to soon Stale Bread
  is harder to eat.

4
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

• Dont apologize for asking
• Actually ask for the money
• Answer objections with real facts or dont know
• Do you believe in your idea?
• Discuss creating value that generates returns
  When?
• Dont oversell?
• Discuss current problems and concerns?

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The Founders Dilemma 1

• Most surrender management control 3 years/50,
  lt20 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 Founders Dilemma 2

• 51 make the same or less than employees
• Boards job includes replacement whether the CEO
  does or doesnt 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 Founders 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 Founders 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 companys 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 logos 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 its 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 cant
  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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TProduct Development and ScalingTechnical
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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TOrganizational 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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TMarket Segmentation Analysis

• Model Company Beg, Borrow steal
• Compliments Channel Development
• Competitors
• How much they charge
• Revenue Streams they have subscription,
  maintenance support, per use, per seat, one
  time/upsell, etc.
• Staff size validation
• Brand Strategy/cost
• Marketing / Cost of Customer Acquisition
• s

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TFinancial 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
1,000
Low
Investment Risk
Valuation (MM)
100
10
1
High
ROI
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Traditional Financial Reporting Framework
Balance Sheet
Income Statement
Revenues
Assets
Receipts Cash Flow Disbursements
Liabilities
Expenses
net profit
net equity
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Value Dynamics Detailed Framework
Customer Customers Channels Affiliates
Physical Land Building Equipment Inventory
Organization Leadership Innovation Strategy
Knowledge Structure Systems Culture
Processes IP Brand
Financial Cash Receivables Debt Investments
Equity
Employee Supplier Employees Su
ppliers Partners
Intellectual Property
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Top Ten List of Value Assets
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
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Top Ten List (cont)
5. Technology investment
4. Profit margin
3. Revenue Growth
2. Employee retention
1. CUSTOMER SATISFACTION!
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TYPICAL METHODOLGIES
Determining value by comparing multiple methods.
Market comparables Discounted cash flow
analysis Hurdle (Venture Capital) Approach
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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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Private Market Comparables
Definition Compare to recent private
transactions of comparable companies.
Advantages Provides insight into to current
market pricing for similar size and stage deals
Disadvantages Comparability still suspect,
Results of analysis must be discounted for
Company Stage, Management, timing (seasonal down
turns), a multitude of obvious differences.
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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Net Present Value of Future Cash Flows
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.
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Net Present Value
Strengths 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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Venture Capital Hurdle rate method
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.
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Venture Capital Method
Strengths 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 cant get!

• Academic exercises that give you answers you know
  arent 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