Forecasting Financial Statements in Start-Ups

Forecasting Financial Statements in Start-Ups Michael E. Solt, SJSU Solt_m@cob.sjsu.edu Rob Fernandez, Comerica Bank rfernandez@comerica.com 1 What is a Business Plan?   The business plan is a document meant to communicate and provide information. Timmons & Spinelli in New Venture Creation say that it reveals the business’ ability to: • Create or add value to a customer or end user • Solve a significant problem, or meet a significant • • want or need, for which a premium will be paid Have a robust market, profit margin, and moneymaking characteristics Fit well with: 1) the Founding Team, 2) the Market Space, and 3) the Risk-Reward Balance 2 Why Is the Business Plan Important?   The B.P. has three main purposes; it is a: • Fund-raising tool • Communication tool • Management tool An entrepreneur wants to approach investors for financing, but if he or she cannot: • Communicate effectively, no one will invest • Manage the business and achieve milestones, no one will invest in future rounds of financing 3 The Timmons Model of the Entrepreneurial Process Communication Opportunity (2) Resources (4) Ambiguity Creativity Uncertainty Business Plan Fits and gaps Exogenous forces Leadership Capital market context Team (3) Founder (1) 4 Timmons’ Thoughts about Business Plans    The B.P. is obsolete at the printer The B.P. is a work in progress • You will always get feedback and learn more • Be flexible and ready to continually adjust course • A polished B.P. is not enough; it defines the blueprint, strategy, and resource requirements The B.P. is not the business  The entrepreneur/team should write the plan • Don’t hire someone to write your B.P. • You should be intimately involved in its writing 5 Resources for Writing a Business Plan   Engineering Your Start-Up, A Guide for the Hi-Tech Entrepreneur, by Swanson and Baird, 2nd Edition PriceWaterhouseCooper’s Vision to Reality: http://www.pwcglobal.com/Extweb/industry.nsf/docid/ 466A775D8620563985256AB2007BEBB5/  The Silicon Valley Business Competition web page offers many good links: http://www.cob.sjsu.edu/svbpc/ 6 Business Plan Table of Contents I. EXECUTIVE SUMMARY II. THE INDUSTRY AND THE COMPANY III. MARKET RESEARCH AND ANALYSIS IV. COMPETITIVE ANALYSIS V. MARKETING PLAN VI. DESIGN AND DEVELOPMENT PLAN VII. MANUFACTURING/OPERATIONS PLAN VIII. MANAGEMENT TEAM 7 Business Plan Table of Contents IX.THE FINANCIAL PLAN Actual income statements & balance sheets Pro forma income statements & balance sheets Pro forma cash flow analysis Breakeven chart and calculations X. PROPOSED COMPANY OFFERING Desired financing Offering Capitalization Use of funds 8 Financial Statements  Income Statement: period of time • Revenues & Expenses accruing over a   Balance Sheet: Cash Budget: • Assets & Financing at a point in time • A detailed look at actual cash inflows and outflows over a period of time 9 Financial Statements  Periods of Time: • Monthly for two years • Quarterly for two to five years • Annually for five years  Often a Financial Summary is included in the Executive Summary: • Five years of annual Revenues and Profits 10 Example: WhiteGlove Wireless Hospitality Housekeeping Management System  Business Model: • Provide hotel and motel industry with wireless housekeeping management tools using handheld and tablet PCs  Value proposition: • Improve guest satisfaction with better control over housekeeping services while increasing the efficiency of operations and lowering housekeeping costs 11 WhiteGlove Wireless Hospitality Housekeeping Management System  Business Strategy: • Market WhiteGlove systems to hotels and motels with housekeeping staffs of 5 or more • Include both hardware devices and software system that manages housekeeping staff and links to front desk and mgt. staff • Sell and install system, provide training • Charge annual service fee and for upgrades 12 Hotel and Motel Industry  Over 40,000 U.S. establishments (excluding casinos) • 17,000 with hotels with rooms of 25 or more • 22,000 motels   Hotels and lodging places generated $106B in tourism-related sales in 2003 Best Western with 4,100 hotels and 310,000 rooms world-wide is the world’s largest chain • 2,355 hotels in the U.S. 13 WhiteGlove Financial Summary: A Hypothetical Example Systems Sold Market Share Revenue Net Income Gross Profit Margin Net Profit Margin 2004 2005 2006 2007 2008 2 60 180 480 960 0.0% 0.2% 0.0% 1.9% 4.3% $40,000 $1,200,000 $3,600,000 $9,600,000 $19,200,000 ($60,000) $20,000 $18,000 $480,000 $960,000 65.0% 70.0% 75.0% 80.0% 80.0% -150.0% 1.7% 0.5% 5.0% 5.0% 14 What Investors Are Looking For  A very large opportunity • • • Company can become 1st, 2nd, or 3rd in market Market share, profitability, long term competitiveness 10x return on investment      How much total financing will the company need How probable is liquidity and how long to get there When does BEP occur and on what revenues When does profitability occur Milestones and fundraising events  Beta, MOU, LOI, invoice, prototype, patent filing 15 Hidden in the Financials  Does the business model “scale” well • Revenue increases at greater rate than expenses    Are sales projections realistic (another Cisco?) Is the total amount of financing needed realistic Have the costs of growth been factored in     Marketing / Sales Legal / IP Employees and burden Executive management 16 It’s About Trust Remember at all times: investors do not invest in technology…they invest in people • Display partnering skills. Investors ponder what it would be like to “marry” you and the team for the next three to four years, or longer • Know the investor you are talking to, let them know why you chose them as a potential partner • Listen attentively and answer the questions being asked! • Be secure, respond calmly and clearly during difficult questioning • Tell investors where problem areas are, or areas where you are still unsure, get them involved • You are interviewing them too. Ask "What can you do to help our company" 17 Who Do You Know Get Referrals to Investors • Participate in seminars • Submit your Business Plan to Venture Showcase events • When you meet someone influential who has an interest in your market space offer to take them to lunch to ask their advice • Become affiliated with industry groups or standards bodies 18 It They Believe in You, So Can We Attract senior level management as quickly as possible, and/or a strong Advisory Board • Be honest with yourself, how far can you realistically take the business • If you have mid-level management experience or strong technical skill but no upper management experience, create a transition plan • Tell investors what kind of senior management you need to attract and what stage of growth, and build this into your financial projections • If you can’t attract full-time senior management right now, build a top notch Advisory Board, but not too thick quite yet 19 Do You Have the Energy Be passionate about your business • If you don't truly believe that launching this business is the most important thing in your life, it'll never fly, and investors know this • In the beginning you are CEO, and the VP of Sales and Marketing (importance of industry and domain experience and expertise) • Be excited and be confident that the strategy is sound, while being open to discussion. Remember that you hope to establish a partnership • You know the business opportunity is a good one because you know your industry forwards and backwards 20 Build your Story, Keep More of Your Company Raise non-VC money as long as you can • Typically better terms, more lenient, relatively faster process • Trade finance, customer upfront payments, SBA, Angel, F-n-F • Establish a strong argument for professional investors by showing proof of concept, customer interest, and reduced development risk • Get some of the product and team kinks worked out prior to going to professional investors 21 If Your Accomplish Your Goal You Will Have Enough Take the money being offered ... now • "Eat while they're serving the hors d’oeuvres", because the main course may not make it out of the kitchen • Be careful, a lot of things can happen in six months • You may achieve your milestones, or you may falter • • • • • New competitor may emerge You may not close a key strategic partnering deal The IP development project may hit a snag Customer acceptance may be slower than you expected An unexpected market or industry event may occur 22 Finding Your Investment Partner Don't interpret a "no" as a judgment against your business vision … "no" doesn't mean your business is "uninvestable ” “No” Reason #1: Most of the time an investor says "no" because the opportunity is not right for THEM “No” Reason #2: The market opportunity doesn’t appear big enough “No” Reason #3: The team hasn’t done a good job of presenting a compelling opportunity 23 Some Final Reminders • Aggressively control your cash burn • Establish clear cut and achievable milestones and tie them directly to your financial plan • Solve customer problems, not investor problems • Find as much non-venture money as you can • Sell and evangelize, don’t hype • Integrity, honesty, dependability 24