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					    Financial Elements of Entrepreneurial Business Plans



                       Entrepreneurial Finance:
     “Financial Elements of Entrepreneurial
                Business Plans”


                   FIU Global Entrepreneurship Center
                                   March 12, 2005



Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                                   Agenda 03/12/05




                • Entrepreneurial Finance Perspective
                • Understanding Cash and Risk
                • Key Financial Elements of Business Plans
                • Communications
                • Raising Capital
                • Open discussion Q&A




Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                                      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?”



Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                              Entrepreneurial Finance is Management

•    Managers must be able to view problems from the financial
     perspective as well as from other perspectives.
•    Figuring out how a particular decision will create value is a key
     responsibility of management and does not require elaborate
     systems.
•    Finance is a way of thinking about cash, risk and value.
•    But 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. Deciding on what
     should not or cannot be done is a valuable aid to general
     managers

Entrepreneurial Finance FSanchez
Source: Note on Financial Perspective: What should Entrepreneurs Know? William Sahlman, HBS
    Financial Elements of Entrepreneurial Business Plans

                                   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”



Entrepreneurial Finance FSanchez
Source: Howard Stevenson, HBS
    Financial Elements of Entrepreneurial Business Plans

                                                Understanding Cash

•    First rule of entrepreneurial finance: Cash is the most important
     resource
      – More cash is better than less cash
      – Cash now is better than cash later
•    Focus is on free cash flow versus accounting income
•    Taxes affect cash (legal incorporation, investment, financing
     and accounting)
•    Growth must be supported by investments in assets (that
     consume cash flow)
•    Focus on the dynamic picture of cash flow
      – Cash cycles, seasonality, competition
      – Today’s investments are tomorrow’s growth opportunities
•    Cash management is critical for the new enterprise. Don’t run
     out of cash!

Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                                  Understanding Risk
•    Understanding risk is a complex task, but 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 in finance to account for risk factors
      – Estimating the “precise” discount rate or “technically
        correct” cost of capital might provide a false sense of
        security
      – But this does not alleviate managers’ responsibility for
        estimating the opportunity cost of investing

Entrepreneurial Finance FSanchez
        Financial Elements of Entrepreneurial Business Plans

                                       Key Financial Elements of a Business Plan

                  Top Level                                   Supporting

•      Profit and Loss Statement                  •   Detailed statements
•      Free Cash Flow Statement                   •   Assumptions and data sources

•      Sources and Uses                           •   Scenarios and sensitivity analysis
       Statement                                  •   Working capital analysis
•      Net Present Value                          •   Capital expenditures schedule
       (Valuation)                                •   Fixed vs. variable cost analysis
                                                  •   Contribution margin
                                                  •   Industry-specific measures
                                                  •   Other relevant analysis: market
                                                      size, pricing, marketing
                                                      expenditures, R&D

    Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                           Profit and Loss Statement


Revenues                                                $ 100
Cost of Goofs Sold (COGS)                                ($55)
    Gross Profit                                         $ 45
Selling, General & Administrative Costs (SG&A)           ($25)
    Operating Profit (EBIT)                               $20
Interest                                                  ($2)
    Net Profit Before Taxes                               $18
Taxes                                                     ($4)
    Net Profit After Taxes                                $14

EBIT: Earnings Before Interest and Taxes


Entrepreneurial Finance FSanchez
     Financial Elements of Entrepreneurial Business Plans

                                                      Free Cash Flow

 EBIT (Earnings Before Interest and Taxes)
   -            Taxes (EBIT x Tax Rate)
 +                Depreciation (and other non-cash charges)
 -                Increase in A/R and other Current Assets (1)
 +                Increase in A/P and other Current Liabilities (1)
 -                Capital expenditures
 =         Free Cash Flow


(1) Changes in Net Working Capital



Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                    Sources and Uses Statement
            Uses:
            Capital Expenses                  $0.2M
            R&D                               $0.3M
            Marketing Expenses                 0.5M
            Working Capital                    $1M
            Operating Losses                  $0.5M
                  Total Uses                  $2.5M
            Sources:
            Operational Cash Flow             $0.5M
            Cash Equity                       $1.5M
            Bank financing
                                              $0.5M
                  Total Sources
                                              $2.5M

Entrepreneurial Finance FSanchez
     Financial Elements of Entrepreneurial Business Plans

                                            Net Present Value

Net Present Value =
Sum of Present Value of FCF years one through “n”
Plus: Present Value of Terminal Value in year “n”
But:
• Estimating the value of a new venture is at best an inexact
  science and the technical tools are imperfect (but useful)
  tools that can help in the process.
• Many questions arise from the analysis that can help better
  understand the value (and risks) of the new venture
   – How to calculate an appropriate Terminal Value?
   – What discount rate to use?
   – What is an appropriate comparable?

 Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                                       Discount Rate


                          r =       rf + B (rm - rf)


              r = discount rate
              rf = risk free rate
              B = “beta” measure or systematic risk
              rm = “market” return on equity




Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                               Net Present Value Formulas

PV of                FCF yr1 + FCF yr2 … + FCF yrT + TV T
FCF’s =
                     1+r       (1 + r)2    (1 + r)T (1 + r)T


                              FCF yrT (1+ g)
       TV T =
                                   r-g         PV = present value
                                               TV = terminal value
                                               r = discount rate
                                               g = growth rate of cash flows



Entrepreneurial Finance FSanchez
     Financial Elements of Entrepreneurial Business Plans

                                    A “Venture Capitalist” 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




 Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                   Some Thoughts on Communications

•    Present financial statements in a standarized and summarized
     form
•    Be prepared to support financial conclusions with detailed
     analysis and assumptions schedules
•    Don’t be afraid to quantify or to make assumptions, this is a
     fundamental part of financial and business analysis
•    Support your assertions and assumptions with valid data:
     identify what you know and flag what you don’t know yet
•    Understand the quantitative and financial elements of your
     business plan, not doing so is one of the fastest way to loose
     credibility with investors
•    Identify what data you have and also be clear about what you
     don’t know

Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                   Some Thoughts on Raising Capital

•    Demonstrate your familiarity with the financial and quantitative
     elements of your plan
•    Raising capital is a long, hard and challenging process that
     requires a substantial investment in time and effort
•    From who you raise capital is many times more important than
     how much capital you raise: look for a business partner and
     not just for money
•    Listen, learn and improve your plan during the process
•    Have realistic expectations about how much money you can
     raise and have a “plan B” in case money is not available
•    Friends, family and personal funds are usually the only source
     of capital available for new ventures: institutional venture
     capital is usually focused on second-rounds or larger ventures

Entrepreneurial Finance FSanchez
    Financial Elements of Entrepreneurial Business Plans

                                   Additional Resources: Two “Must do”

•    Read “How Much Money Does Your New Venture Need? (Pg. 57-70)
     from Financing Entrepreneurial Ventures, Business Fundamentals
     Series Harvard Business School Press Compilation # 9202
•    Take the course Entrepreneurial Finance (aka “An Entrepreneur’s
     Guide to Managing the Financial Challenges of the Entrepreneurial
     Venture” aka FIN 6934 – Special Topics In Finance –
     Entrepreneurship) by instructor Federico Sanchez




Entrepreneurial Finance FSanchez