entrepreneurial business

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 • • • • Profit and Loss Statement Free Cash Flow Statement Sources and Uses Statement Net Present Value (Valuation) • • • • • • • • • Supporting Detailed statements Assumptions and data sources Scenarios and sensitivity analysis Working capital analysis Capital expenditures schedule 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 Cost of Goofs Sold (COGS) Gross Profit Selling, General & Administrative Costs (SG&A) Operating Profit (EBIT) Interest Net Profit Before Taxes Taxes Net Profit After Taxes EBIT: Earnings Before Interest and Taxes $ 100 ($55) $ 45 ($25) $20 ($2) $18 ($4) $14 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 R&D Marketing Expenses Working Capital Operating Losses Total Uses Sources: Operational Cash Flow Cash Equity Bank financing Total Sources Entrepreneurial Finance FSanchez $0.2M $0.3M 0.5M $1M $0.5M $2.5M $0.5M $1.5M $0.5M $2.5M 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’s = FCF yr1 + FCF yr2 … + FCF yrT + TV T 1+r (1 + r)2 (1 + r)T (1 + r)T TV T = FCF yrT (1+ g) 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