UW Business Plan Resource Night Financial Considerations

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UW Business Plan Resource NightFinancial
Considerations

• Alan Dishlip
• CFO WildTangent, Inc.
• February 2, 2006
• 600 P.M. 730 P.M.

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Defining Entrepreneurial Finance

• Entrepreneurship
• The relentless pursuit of opportunity without
  regard to the resources currently controlled
• Finance
• The study of the allocation of cash and risk
  with the goal of creating value for the
  enterprise
• Entrepreneurial Finance
• How to manage cash and risk to create value in
  the relentless pursuit of opportunity

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Entrepreneurial Finance is Management

• View problems from the all perspectives
• Creating value is a key responsibility
• Finance - a way of thinking about cash, risk
  value
• Finance does not answer questions
• It does not make decisions
• Finance can help identify the right questions to
  ask and narrow down the options
• When viewed from the finance perspective, some
  decisions will turn out to be illogical or
  unfeasible.

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The Questions

• Should I invest in this new venture?
• How much cash will my new venture really need?
• What are the risks and rewards of pursuing this
  opportunity?
• How can these be managed successfully?
• What is the value of my company? What factors
  affect this value?
• How can I obtain financial capital for my growing
  company?

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Whats Wrong With Most Financial Plans?

• Waste too much ink on numbers
• Too little focus on information that really
  matters
• Numbers should support strategy and key drivers
  of the ventures success or failure
• Manufacturing - yield on a production process
• Magazine publishing - the anticipated renewal
  rate
• Software - impact of using various distribution
  models
• At what level of sales does the business begin to
  make a profit?
• When does cash flow turn positive?

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Whats Wrong With Most Financial Plans?

• No need for detailed, month-by-month projections
  that stretch out for years
• Few entrepreneurs correctly anticipate how much
  capital and time will be required to accomplish
  objectives.
• Financials are typically wildly optimistic.

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Projections - Overview

• A reflection of your business plan quantified
• Consistent with the plan strategy
• Will help demonstrate whether your strategy is
  financially feasible
• A key indicator of the amount of outside
  financing necessary to support the execution of
  your strategy
• Understand the quantitative and financial
  elements of your business plan
• Not doing so is the fastest way to lose
  credibility
• Include key financial ratios and compare to
  competitors/industry averages

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Projections - Overview

• High level figures
• Underlying detail should be available
• Projections should answer
• How will the company perform financially? P L
• What will the company's cash position be? - Cash
  Flow
• What will the company's financial position be? -
  Balance Sheet
• Five-years - integrated
• Monthly for the first two years
• Quarterly for the remaining three years
• Avoid straight line assumptions
• Include any historical financial information

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Key Financial Elements of a Business Plan

• Top Level
• Profit Loss
• Statement
• Balance Sheet
• Cash Flow
• Statement

• Supporting
• Milestones
• Revenue forecast and growth
• Detailed operating expenses
• Assumptions and data sources
• Manpower plan
• A/R A/P collection/payment periods
• Sensitivity analysis
• Debt
• Capital expenditures depreciation
• Fixed vs. variable cost analysis
• Other relevant analysis market size,
  industry-specific measures, pricing,
  competition, marketing programs, RD

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Projections - Overview

• Include a list of significant assumptions
• Dont be afraid to make material assumptions -
  especially uncertain ones
• Individualize
• e.g., don't just show advertising costs as a of
  sales. Most advertising expenditures are made
  months before sales result
• Include financial obligations of bringing your
  product or service to the marketplace
• New employees
• Additional physical space
• Purchasing support materials and services
• Increases in inventory and accounts receivable.
• Deviations from historical trends
• Especially uncertain
• Support your assertions and assumptions with
  valid data
• Identify what data you have and also be clear
  about what you dont know

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Understanding Cash

• First rule Cash is the most important resource
• More cash is better than less cash
• Cash now is better than cash later
• Focus is on cash flow versus accounting income
• Growth must be supported by investments in assets
  (that consume cash flow)
• Focus on the dynamic picture of cash flow
• Cash cycles, seasonality
• Todays investments are tomorrows growth
  opportunities
• Cash management is critical
• DONT RUN OUT of CASH!!

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Income Statement
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Balance Sheet
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Cash Flow
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Other Information
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What Investors Look For

• Good return on investment
• Realistic assessment of risks
• Is the plan and the management team credible?
• Is there a fit between the investor and the firm
• CEO and team with passion and vision
• Detailed and realistic financial plans
• Are financials really conservative?
• Is the company growing or is it scaleable?
• Exit strategies within 4 - 7 years
• Unique value proposition - not another me too

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Understanding Risk

• Significant value can be created by managing risk
• Financial risk is the total amount of uncertainty
  about future cash flows
• Uncertainty of future events creates risk, but
  uncertainty can usually be analyzed to understand
  risk
• Risk profiles vary depending on who bears the
  risk (e.g. some investors might not be able to
  diversify)
• Discount rates are used to account for risk
  factors
• Investors have standard discount rates depending
  on risk factors
• Stage, market, management, product, competition

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Sources of Money

• Commercial Bank Loans
• Angel Investors
• Venture Capitalists
• Credit Cards
• Accounts Receivable
• Equipment Sales and release
• Advances on credit card receipts
• IPO
• Home Equity Loan
• SBA Loan Guarantee Programs

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Thoughts on Raising Capital

• Be prepared to concisely link the strategy
  financial elements of your plan
• Raising capital is a long, hard and challenging
  process that requires a substantial time effort
• Who you raise capital from is much more important
  than how much capital you raise
• Listen, learn improve your plan along the way
• Have realistic expectations about how much money
  you can raise and have a plan B in case money
  is not there
• Friends, family personal funds are usually the
  only source of capital available for new ventures

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The Fully Funded Folly
A Customer Buys
TechnologyWorks
Idea isFeasible
Valuation
Risk (ß)
Capital
Fully Fund
IPO
(.pray.)
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Funding to Milestonesaka Old-Fashioned Venture
Capital
Idea isFeasible
TechnologyWorks
A Customer Buys
P(success) 80 Reqd IRR 30
Valuation
P(success) 50 Reqd IRR 50
P(success) 40 Reqd IRR 70
P(success) 30 Reqd IRR 100
Risk (ß)
Capital
Seed Funding
RDCapital
Go-to-MarketCapital
ExpansionCapital
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Milestones

• Milestones and expected cost
• Shows business understanding and intention to
  track performance closely against the business
  plan
• Milestone Examples
• Hiring of a full management team
• Completing product specifications
• Completing prototype design
• Completing prototype
• Product testing
• First customer shipment
• First full quarter of profitability
• Attaining X million in revenue

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What is the planned "Use of Proceeds"?

• VCs want to know how their money is being
  deployed
• Accelerate the business opportunity
• Determine timely ROI
• VC money to invest in sales/market growth
• What will it allow you to accomplish?
• When will your company break even in terms of
  profitability and cash flow?
• The ultimate goal is to reach an exit scenario
• Profitable businesses are more attractive to
  potential buyers or public markets

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Typical Company Life Cycle

• Seed Financing
• 500,000 - 1 M
• Pre - 1M
• Friends, Family,
• Angels, Govt. Funds (SBIR)
• Technology
• development, Hire key
• personnel, Focus groups,
• Business/mktg plan

• Series A 2M - 4M
• Pre - 3-5M
• Angels, Early-
• stage VCs
• Complete product
• launch, Hire key
• personnel, Initial sales
• marketing programs

• Series C
• 5M - 30M
• Pre - 25M
• Existing investors, Later stage
• VCs, Strategic investors
• Expansion of revenues
• markets, Prod Dev, Hire
• additional employees
• mngt

• Series B
• 5M - 10M
• Pre - 5-10M
• Existing investors,
• New VCs
• Sales mktg, Prod Dev, Hire
• additional employees
• mngt

Valuation
Rev 500K-2M Cust 4 - 6 Emp 20 - 30
Rev 4M - 8 M Cust gt 10 Emp 50
Rev 0-200K Cust 0 - 3 Emp 10 - 20
Rev 0 Cust 0 Emp 3 - 8
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Understand The Valuation Process

• Identify the major risks in your business
• Reduce the perceived risks to increase value
• Management, sales, product develop.
• Understand investors' ROI criteria
• Discount rates for earlier stage cos. are
  significantly higher vs. later stage ones
• Identify a clearly definable exit strategy

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Summary

• To get a deal done focus on
• Delivering a compelling value proposition
• Communicating the business strategy in easily
  understandable and believable financial terms
• Strategy and financials are complementary and
  consistent
• Constructing a business plan that minimizes
  equity capital
• Meeting funding milestones within cash and
  revenue projections
• Reducing risks of the business
• Especially management quality and experience

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A Simple VC Valuation Formula

• VCs look for a 10X return on investment (I)
• Where I is the investment required to get to
  positive cash flow
• Exit Valuation n times revenue (R) at exit
• Where n is determined by industry segment and
  expected exit strategy IPO or acquisition
• n typically ranges from 3 10X forward revenue
• Can also use P/E for n (15 20X EPS)
• Investors must own a certain of the company for
  the deal to be attractive
• Investor ownership 10 ? I
• n ? R

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Financing Needs
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Company A Tough, but Fundable
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Company B Not Fundable
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A More Detailed Analysis of VC Valuation Model
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A Present Value Valuation Approach

• Value Projected Earnings in YearT x Comparable
  P/E
• Discounted at 50-70
• Value EYrT X P/E
• (1 r)T

E Earnings P/E price to earnings ratio R
discount rate T Year of liquidity
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Internal Rate of Return
Internal Rate of Return (IRR) on a multiple of
original capital investment (Horizontal Scale)
realized over an assumed period of years
(Vertical Scale). e.g. (1.58)5 10X
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Ownership Equity Considerations

• How will equity in the venture be distributed?
• Will the founders retain control?
• Will employees be able to earn equity for their
  performance?
• How much equity will investors have, and how will
  that change over time?
• How do the investors get their money out, and
  when?

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Summary

• To get a deal done focus on
• Delivering a compelling value proposition
• Communicating the business strategy in easily
  understandable and believable financial terms
• Strategy and financials are complementary and
  consistent
• Constructing a business plan that minimizes
  equity capital
• Meeting funding milestones within cash and
  revenue projections
• Reducing risks of the business
• Especially management quality and experience