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					DEAS Seminar Series

   Michael J. Roberts
  Sources of Financing
Recurring View (Monthly) – Blended Model                                                    Lease
                                                                                            Access
  Key    May ’00 Biz Plan/ Actual
         September Data                                                                     Insurance
                                                   Costs/ Car
                                                                                            Parking

                                    Car Cost/                                               Maintenance
                                    Member                                                  Fuel


                                                                    Hours used/ month
                                                Members/ Car
                                                                    Utilization rate

                       Contribution
                      Margin/ Member                                Monthly Fee

                                                                                        # Uses
                                                                                        Hours/Use
                                                                                        $/Hour
                                                Revenues/ Member    Monthly Usage
Total Contribution                                                                      Miles/Use
   Margin/ Month
                                                                                        $/ Mile


                                                                    Monthly interest    $/ member
                                                                                        i rate (monthly)


                                                Beginning Members

                                                New Members
                         # Members


                                                Attrition
    Restaurant Business Model
• What do you think it looks like?
 From the Business Model…build a
     set of financial statements
• P&L
• Balance Sheet
• Cash Flow
                Balance Sheet
- The company’s financial position at one moment
in time.
- Basic equation: Assets = Liabilities + Owners’
Equity
Assets: provide benefit to the firm in the future,
valued at lower of cost or present market value.
Liabilities: amounts or obligations owed to third
parties.
Owners’ Equity: what’s left. Also = to original
paid-in capital and retained earnings, less
dividends.
 Income Statement (Profit & Loss
           Statement)
- Operations over a period of time (quarter, year).
- Basic equation: Revenue earned-expenses
incurred = net income - dividends = retained
earnings
Four main categories of expenses:
- cost of goods sold
- selling, general, and administrative costs
- interest cost
- provision for income taxes
         Statement of Cash Flow
Beginning Balance
+/- Operating Activities: Money generated by and
spent in doing business, and Interest & Taxes
+/- Investing Activities: Money used in things that
support operations or in financial assets. Primarily
used for purchasing assets that increase productive
capacity.
+/- Financing Activities: Money used for issuing or
retiring debt or equity, or paying dividends.
= Ending Balance
Beginning cash+cash inflow-cash outflow=ending
cash
  The Cash Flow Cycle for a Venture

Cumulative Cash Flow in $




            Date of First Cash Flow Positive


                                                                       Time


                                       Date of Cumulative Cash Breakeven




                                   Maximum Financing Needs
             Burn Rate
                Remember
• People who are giving you money want to
  get it back, plus a return
• Required Return is a function of perceived
  risk
  – Core risk of project
  – Capabilities/track record of entrepreneur
  – “Security”
Investor Background also Influences
            Perception
• Functional /Industry Experience
• Investing Experience
• Potential involvement in venture
         Risk & Reward
Reward




                         Risk
                Risk/Reward Management


Probability
     of
Occurrence
                        Expected Value




                      Probability of
                       Losing 100%



                                                Goal # 2



                      Goal # 1

                                                           Goal # 3


              -100%                      +25%    +100%      Return on Investment
The horse race……..


                 Valuation




                 Risk



                     Time
          Sources of Financing
•   Own Money/Customers/Suppliers
•   Friends and Family
•   “Angels” and Sophisticated Angels
•   Early Stage / Seed VC
•   Traditional VC
•   Banks
•   Corporate Partners or Strategic Investors
•   Public Capital Markets
  No External Financing is the Best
              Option
• Keep control and equity upside
• Minimize pressure for exit / liquidity event
• Creative use of contracting, collect-in-
  advance, pay later strategies
• Not possible when large absolute amounts
  of capital are required
             F&F & Angels
• Individual investors often invest for some
  reason other than pure cash return
• What are their reasons: a + or – for you
• Managing info flows is key
            Venture Capital
• Require Probability of exceptional returns –
  swinging for the fences
• Need to put large amounts of capital to
  work
• High stakes – majority of founders do not
  make it
                      Banks
•   Will always look to cash flow first
•   Then to corp assets
•   Then to personal assets, guarantees
•   You can reach a point where it is in their
    interests to pull the plug – their last chance
    to get out whole - will not be in the equity
    holders’ best interests
            Questions to Ask
• What are the venture’s MONTHLY cash flows?
• How much cash is required in total – how deep is
  the trough?
• What size bites do we want it in?
• What are the particular risks and rewards and who
  has an appetite for them?
• How can the Reward / Risk ratio be managed?
• What returns will investors expect?
                    More ?s
• What terms matter other than price, and am I
  willing to live with these terms ?
• Do the deal terms align our interests, or not?
• What alternatives do I have?
• What do I need other than $$, and What do they
  bring other than $$?
• Likely exit routes / liquidity path?
• What will the returns look like for me after I give
  up what will be required?
                   Pluses and Minuses
Source                 +                               -
Own money/Customers/  Relatively Easy                 Requires well-established network
Suppliers             Helps assure future success     Requires some personal wealth
                      Retains control with minimum    Requires positive cash flow
                        oversight
Friends & Family        Easily Accessible             Thanksgiving Dinner
                        Good Terms                    Lack of sophistication
                        Little Due Diligence
Angels & Sellers        Eager/Knowledgeable           Idiosyncratic
                        “Good” Terms                  More or Less sophisticated
Early Stage VC          Expertise                     Managerial control
                        Legitimacy                    Scarcity of Early Stage VC firms

Traditional VC          Expertise                     Deal Terms
                        Legitimacy                    It’s about the money

Asset Lenders           Leverage Benefits             Covenants
                        No/Little Equity dilution     Bankruptcy Exposure

Corporations            Extensive Resources           Slow Decision Making Process
                        Provide Credibility           Foreclosing Exit Options
                        Exit Strategy




                                                                                       21
           CEO’s average equity holdings
30%           by round of financing
                  25%
25%

20%                                         17%                        16%
15%                                                                                              12%
                                                                                                        Founder CEO
10%                8%
                                             6%                         6%                        6%
                                                                                                        Professional
 5%
                                                                                                        CEO
 0%
                    1                          2                         3                         4
Source: Noam Wasserman, “Inside the Black Box of Entrepreneurial Incentives.” Based on survey conducted in July/August 2000 of
211 private Internet/software firms.
When do you need to consult a lawyer?
• Early
• There are lots of legal risks
  – forgotten founders
  – danger of unprotected intellectual property
  – employment/stock agreements
• You often can’t fix them later, even if you
  have more time and money
                Valuation
• Implied or Implicit or Imputed Valuation is
  Different than “Calculated (NPV)
  Valuation”
• Have you ever bought a share of stock?
• do the math: $/% = Implicit Valuation
 Investors generally Back into a
   valuation, don’t start there
• What is my best guess about terminal value
  and exit time
• What is my best guess about future funding
  requirements and resultant dilution
• What is the most I can afford to pay now
  i.e., what is the smallest % ownership I can
  walk away w/ and still get my required
  return
            The Math
REQUIRED/TARGET RETURN = R

YEARS UNTIL EXIT = n

INVESTMENT = I

REQUIRED STAKE % = I * [(1+R)^n]
                     TV

I/POST$ = ACQUIRED STAKE %
I/POST = I * [(1+R)^n]
               TV
     The Lesson:
  Good decisions come
    from having good
alternatives from among
     which to choose
  Where 100 of the 1989 Inc. 500 founders got their ideas

                                             Systematic
                                               search
                   Swept in by PC
                                                 4%
                     revolution
                        5%



                Discovered by
                     luck
                    20%                                            Idea from
                                                                  previous job
                                                                      71%
         7 casual job into business
         6 wanted as consumer
         4 happened to read about industry




Source: Amar Bhide (1994), “How entrepreneurs craft strategies that work,” Harvard Business
Review (March-April).
         Career Implications

If you are interested in finding an opportunity
   (or being involved in someone else’s), then
   the following matter a lot:

  – Industry you work in
  – Whether you are known in your industry
  – Where you live
  – Your network of personal and professional
    contacts
  – Your reputation
  – Planned serendipity

				
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posted:8/14/2012
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