STRATEGIC BUSINESS PLANNING
Welcome!
Session 3 – July 20, 2004
Instructor - Kevin Hawley
Kevin.Hawley.wg01@wharton.upenn.edu
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STRATEGIC BUSINESS PLANNING
The Wharton SBDC is part of Wharton Entrepreneurial Programs and the Sol C. Snider Entrepreneurial Research Center. The Wharton Small Business Development Center is in part financed by a grant from the Commonwealth of Pennsylvania, Department of Community and Economic Development. The Wharton SBDC is funded under Cooperative Agreement No. 4-603001-2-0040-24 by the U.S. Small Business Administration. The support given by the U.S. Small Business Administration through such funding does not an expressed or implied endorsement of any of the co-sponsors’ or participants’ opinions, findings, conclusions, recommendations, products, or services. All SBDC programs are non-discriminatory and open to the public. Reasonable arrangements for persons with disabilities will be made if requested at least two (2) weeks in advance. Please contact Dr. M. Therese Flaherty, Director, Wharton Small Business Development Center, University of Pennsylvania, 433 Vance Hall, Philadelphia, PA 19104, (215) 898-8635.
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Agenda – Session 3
Recap from Session 2 Where We Are and What’s Left Financial Plans Cash Flow Tying It All Together Preparation for Next Session
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Recap – Session 2
Industry Analysis
Were you able to identify your NAICS code? Research? Sources? Surprises?
Number and types? Business performance data?
Competitor Analysis
Sales Projections
Were you able to define your sales unit(s)? Can you describe the reasoning behind your projections? Do they closely tie in to sales projections? How did you select your “marketing mix”?
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Marketing Plans
STRATEGIC BUSINESS PLANNING
Session 2 Homework Review
Develop a draft Operating Plan
Develop draft Sales Projections Develop a draft Marketing Plan
How did you do? Trouble spots? How to move forward
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Where We Are and What’s Left
Executive Summary – discussed in Session 1 Business Description – discussed in Session 1 Product/Service Description – discussed in Session 1 Marketing Plan – discussed in Session 2 and tonight Operations Plan – discussed in Session 2 and tonight Financial Plan – tonight Funding Your Business - tonight Attachments/Supporting Documents – next week Milestone Driven Planning – next week Finishing your Business Plan and Next Steps – next week
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Building the Business Model
Industry, Buyer & Competitor Analyses
Operating Plan Cost Projections
What will it cost to produce your product or service?
Marketing Plan
Sales Projections
What will it cost to sell any given amount of your product or service?
Financial Plan Pro Forma Financial Statements
How will your business make money? How much? For how long? Risks?
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Timing Example - Operations, Marketing, and Sales Interactions in the Financial Statements
January February March April May June
Marketing Expenses
Sales Related Operating Expenses
Fulfillment Related Operating Expenses
Operating Expenses
Revenues (Sales)
Fictional example for illustration purposes only!
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Book Recommendation
The Interpretation of Financial Statements by Ben Graham “Highly practical and accessible, it is an essential guide for all business people…”
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The “Big Three” - Financial Statements
Income Statement (aka “P&L”)
Lists your income, expenses, and net income (or loss) for a given period, usually one year.
Balance Sheet
A “snapshot” of the net worth of your company, listing assets and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually December 31.
Outlines the regular inflow and outflow of cash in your business on a month-to-month basis.
Cash Flow Statement/Plan
These sections make up your “pro forma” financial statements.
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Other Areas of the Financial Statement
Break Even Analysis
Shows at what point your company begins to make money. Online calculator at “http://dinkytown.com/java/BreakEven.html”
Shows the impact of unplanned results on your business (higher or lower costs, sales, etc.)
Sensitivity Analysis
Funding Schedule
Details the amounts of money you expect to need and when Details the titles, salaries/benefits, and timing of hiring for people you’ll be adding to the company.
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Staffing Plans
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Financial Assumptions
Key sales and cost drivers Basic information about the market and opportunities in the environment Start with:
Unit sales projections Prices Cost projections – fixed and variable Key drivers for each
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Financial Projections
“Pro Forma” financial statements
Income Statement – revenue minus expenses Balance Sheet – assets and liabilities Cash Flow Statement – actual cash on hand
Critical to you, essential to others Predictions of business performance Financing requirements Sources and uses of cash
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Constructing Credible Financial Statements Important first step: educated assumptions What are the key revenue drivers? What are the key cost & expense drivers?
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Assumptions – Revenue
Market size and opportunity Number of potential customers Your particular business cycle Product/service pricing Sales growth curve Avoid the “moving hockey stick”!!!
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Assumptions – Cost of Sales/Goods Sold Direct inputs to delivery of service Direct inputs to delivery of product Examples: materials, parts, labor, shipping a/k/a – variable costs Not your expenses
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Gross Profit
+ Revenue - COGS = Gross Profit Margin (GPM) a/k/a Operating Profit = $ earned before overhead expenses
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Expenses and Cash Flow
+ Operating Profit - Expenses = EBITDA
• • • • • • salary rent utilities telephone marketing legal
i.e., “keeping lights on” a/k/a fixed costs
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EBITDA
Earnings Before Interest Taxes Depreciation Amortization
• a/k/a Free Cash Flow • Businesses valued as a multiple of EBITDA
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How Much Money Do I Need?
1. 2. 3. Prepare detailed Income Statement Then Balance Sheet Then Cash Flow Statement
Monthly negative Cash Flow = operating cash
Cumulative negative Cash Flow = total needed
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STRATEGIC BUSINESS PLANNING
Balance Sheet
A
“snapshot” of the net worth of your company, listing assets and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually the end of the month or the end of the year. Spreadsheet Exercise
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STRATEGIC BUSINESS PLANNING
Cash Flow Statement/Plan
Outlines
the regular inflow and outflow of cash in your business on a month-to-month basis.
Spreadsheet Exercise
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STRATEGIC BUSINESS PLANNING
EXAMPLE: Startup Jewelry Distribution Business
How much do they need?
MONTH
($000) Revenue Expenditures Cash Flow Cumulative
1
2
3
4
5
6
7
8
9
10
11
12
TOTALS
0
17 (17) (17)
0
5 (5) (22)
0
8 (8) (30)
0
8 (8) (38)
0
9 (9) (47)
3
9 (6) (53)
3
11 (8) (61)
7
19 (12) (73)
7
19 (12) (85)
38
33 5 (80)
38
42 (4) (84)
42
40 2 (82)
138
220 (82)
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Income Statement (aka “P&L”)
Lists
your income, expenses, and net income (or loss) for a given period, usually one year.
Spreadsheet Exercise
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Break Even Analysis
at what point your company begins to make money. Online calculator at “http://dinkytown.com/java/BreakEven.html”
Shows
Spreadsheet Exercise
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Sensitivity Analysis
Shows
the impact of unplanned results on your business (higher or lower costs, sales, etc.)
Spreadsheet Exercise
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Funding Schedule
the amounts of money you expect to need and when Typically tied to milestones and achievements Allows investors to decide on a commitment level January 2004 - $250,000 for start up expenses
June 2004 - $75,000 for advertising and marketing
Details
March 2005 - $175,000 for expansion to 2nd location
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Staffing Plans
Details
the titles, salaries/benefits, and timing of hiring for people you’ll be adding to the company.
Hire Date January-04 January-04 April-04 April-04 June-04 June-04 October Salary $80,000 $35,000 $35,000 $24,000 $30,000 $30,000 $30,000 $264,000 Benefits $26,400 $11,550 $11,550 $7,920 $9,900 $9,900 $9,900 $87,120 Bonus $15,000 $2,000 $2,000 $1,200 $3,000 $3,000 $3,000 $29,200 Total Expense $121,400 $48,550 $48,550 $33,120 $42,900 $42,900 $42,900 $380,320
Title President Machine Operator Machine Operator Shipping Clerk Salesperson Salesperson Salesperson Totals
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- 10 Minute Break -
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STRATEGIC BUSINESS PLANNING
Funding Your Business
Types of Investors
Venture Capital and Angel Investors
Valuation of Early Stage Companies What You Give for What You Get - Examples Alternative Sources of Funding for Your Business
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Getting to the Investment Requirements and Pre-Start Valuation
Draft the business plan narrative sections – tell your story! Run the numbers – does the story hold up? Income Statement Balance Sheet Cash Flow Statement/Plan Determine funding needs from the Cash Flow Projections Examine “pro-forma” EBIDTA projections at 5 years Determine if the ROI fits the Angel Investor targets If so, begin “pitching your plan” to prospective investors! If not, you can either rework the plan, or… Go to alternative funding sources and/or self-fund the plan
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Comparing Venture Capital and Angel Investors
Venture Capital Firms Typically do not invest in start-ups Responsible for about 10% of all start-up funding Angel Investors Provide about 90% of the seed and early stage outside equity capital for start-up entrepreneurs
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Source: Ewing Marion Kauffman Foundation – www.emkf.org
STRATEGIC BUSINESS PLANNING
Comparing Venture Capital and Angel Investors
Venture Capital Firms Operate like mutual fund companies General partners such as managers, analysts,etc. Limited partners are pension funds, corporations, etc. Angel Investors Loosely formed groups or wealthy individual investors “Tried and true” entrepreneurs Typically have invested in several companies
Source: Ewing Marion Kauffman Foundation – www.emkf.org
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Comparing Venture Capital and Angel Investors
Venture Capital Firms Typically invest in rounds valued at $7MM or more Average investment in the $2MM range Later stage interest Angel Investors Typically invest in rounds valued between $250K and $2MM. Average investment per individual of $25K to $250K
Source: Ewing Marion Kauffman Foundation – www.emkf.org
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Comparing Venture Capital and Angel Investors
Venture Capital Firms Invested ~$20B in startups last year About 3,000 deals About 700 investors Averaged about $7MM per round 2 or 3 investors per round Angel Investors Invested ~$30B in startups last year About 50,000 deals 400,000 investors Averaged about $750K per round 6 to 10 investors per round
Source: Ewing Marion Kauffman Foundation – www.emkf.org
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Venture Capital and Angel Investors
Venture Capital Firms
Stage Primary Interest
Control Level Assistance Provided Process Length Exit Timeline
Angel Investors
Early stage The Individual
Support and Influence Hands-on Advisor Networking Help 2 to 4 months Up to 10 years
Later stage The Business
Significant Control Executive Team Selection Financial Management 6 to 12 months 3 to 5 years
Where they Invest
Regional/National
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Strictly local
Source: Ewing Marion Kauffman Foundation – www.emkf.org
STRATEGIC BUSINESS PLANNING
How Angels Evaluate Start-ups…
The Management Team’s experience, intelligence, drive, and personalities are typically the most important criteria for Angel Investors, followed by the overall size of the opportunity.
Quality of the management team………… 0-30% Size of the opportunity……………………..0-25% The product or service…………………….. 0-10% Sales channels…………………………….. 0-10% What stage the business is in……………. 0-10% How much money you’re trying to raise….. 0-5% Need for funding in future rounds…………. 0-5% Quality of your business plan……………… 0-5%
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Source: Ewing Marion Kauffman Foundation – www.emkf.org
STRATEGIC BUSINESS PLANNING
Valuation of Pre-Start Companies
The typical Angel Investor opportunity looks like this:
Total amount of money raised
$250,000 to $1,000,000
(raised in total from multiple angel investors)
Pre-start value of the company Amount of ownership (percentage) taken by Angel Investors Expected ROI in five years “Real world” performance; how many Investments in start-up companies actually return between 10X and 30X?
$1,000,000 to $4,000,000
20% to 40%
30X return on investment
About 10%
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Source: Ewing Marion Kauffman Foundation – www.emkf.org
STRATEGIC BUSINESS PLANNING
Valuation Walk-through - Example 1
Here’s how a deal might be structured:
Total amount of money raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple* Projected 5-year value of company
$250,000 5 $50,000 $7,500,000 (30X) $5,000,000 6 times earnings $30,000,000
Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company
* alternatively, does 1x revenue in Year 5 equal 30x investment? Copyright © March 2004 Wharton Small Business Development Center
25% $1,000,000
STRATEGIC BUSINESS PLANNING
Where the Numbers Come From…
Total amount of money needed/raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment
Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company $250,000 - Cash Flow Projections 5 - Based on avg. AI investment $50,000 - Specific AI profiles $7,500,000 (30X) – Roughly 100%
ROI per year
$5,000,000 - Income Statement 6 times earnings - Industry research $30,000,000 - multiply
25% - Projected 5-year value of the
company divided by the AI’s expected 5-year return amount
Ownership percentage required by Angel Investors at five-year exit horizon
Current (pre-money) valuation of company
$1,000,000 - Amount of money raised
divided by the AI’s required ownership percentage
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Expected Return Depends on Time To Exit/Harvest…
Expected 5-year return on initial $250,000 investment
$7,500,000 (30X)
Roughly 100% ROI per year
End of Year 1 - $250,000 plus 100% return = $500,000 (current value of investment) End of Year 2 - $500,000 plus 100% return = $1,000,000 End of Year 3 - $1,000,000 plus 100% return = $2,000,000 End of Year 4 - $2,000,000 plus 100% return = $4,000,000 End of Year 5 - $4,000,000 plus 100% return = $8,000,000 (32X) End of Year 6 - $8,000,000 plus 100% return = $16,000,000 End of Year 7 - $16,000,000 plus 100% return = $32,000,000 End of Year 8 - $32,000,000 plus 100% return = $64,000,000 End of Year 9 - $64,000,000 plus 100% return = $128,000,000 End of Year 10 - $128,000,000 plus 100% return = $256,000,000 And so on… every $1 invested 10 years ago turns into $1,024!!!
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Valuation Walk-through - Example 2
Here’s an example of a “no go” for angel investors:
Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company
$250,000 5 $50,000 $7,500,000 (30X) $1,000,000 6 times earnings $6,000,000
Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company
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125% --
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Valuation Walk-through - Example 3
Can you find the potential problem in this example?
Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company
$1,000,000 40 $25,000 $30,000,000 (30X) $8,000,000 9 times earnings $72,000,000
Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company
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41.67% $2,400,000
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Valuation Walk-through - Example 4
Can you find the potential problem in this example?
Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company
$300,000 4 $75,000 $9,000,000 (30X) $15,000,000 5 times earnings $75,000,000
Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company
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12% $2,500,000
STRATEGIC BUSINESS PLANNING
Finding Angel Investors…
Starting points for finding Angel Investors and other resources…
Wharton SBDC Website http://whartonsbdc.wharton.upenn.edu Innovation Philadelphia http://www.IPphila.com Inc.com (“Inc. Magazine”) Website http://www.inc.com/guides/finance/20797.html Google Search Engine Enter these terms - “angel investors” Philadelphia
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Alternative Funding Sources…
Suppliers and Customers Personal Funds and “Bootstrapping” Friends and Family Private Equity Debt
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Suppliers and Customers
Suppliers allowing deferred payments A “float” from suppliers Customers offering advance payment Advance ordering and order guarantees
If you don’t ask, you won’t know if you can get it!
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Personal Funds and “Bootstrapping”
Cash savings Converting assets “Sweat equity” The “apple cart” approach
Try to think like an impartial investor even when ESPECIALLY when using your own money!
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Friends and Family
Traditional startup funding sources The investment they make is in YOU! Business metrics usually less important Usually a higher tolerance for problems
Written agreements still very important! Consider the potential impact on relationships if the business is not successful and the investment is lost!
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Private Equity
Sophisticated “Angel Investors” Professional investors – typically take a sole investor position in startups Minimal margin for error and a low tolerance for underperformance
Generally reserve the right to replace the management team if projections aren’t met! Contracts tend to be complex with lots of strings attached to investment
Talk with other companies they’ve invested in!
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Debt Financing
Local banks Small Business Administration loans Credit cards Borrowing against home equity Borrowing against insurance policies Borrowing against your retirement IRA Be aware of the risks and consequences!
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Rules for External Financing
Rule # 1 – Try to use other people’s money (OPM) Rule # 2 – Let your customers and suppliers finance the business to the greatest extent possible Rule # 3 – Use money you can afford to lose or can emotionally handle losing Rule # 4 – Get money as inexpensively as possible
Rule # 5 – A smaller percentage of something big is worth more than 100% of nothing!
Rule # 6 – Seek advice from advisors, i.e. lawyer, accountant, consultants, family, etc.
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Homework Assignments
Develop a draft Financial Plan
Use the discussions from this evening to build a integrated
financial plan for your business.
Revise and refine Financial Projections
Based on your operating, marketing, and sales expenses,
how much money will the company need to get started, what are your cash flow projections, and how much money will the business make and when?
Complete the Operating Plan
Go back into your narrative plan and adjust your story based
on the realities of your financial plan.
Questions about the assignments?
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Next Session (Session 4)
Attachments and Supporting Documents
Other things to include in your blockbuster plan
Milestone Driven Planning How to stay on track and build confidence among investors Bringing It All Together We’ll walk through plans from participants in our class, discuss strength’s and weaknesses, try to highlight areas that need additional work. We’ll use the templates from Sessions 1-3 to evaluate the plan. Next Steps Staying focused, accessing additional SBDC resources, finding and using an expert advisory board.
See You Next Week!
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