Financing the Venture valuation of the venture

							Financing Your Venture
     Valuation of the Venture
Objectives
   How do you determine how much cash
    you will need?
   How do you manage cash and working
    capital?
   What types of finance are available?
   Advantages: debt vs. equity
   How is the deal structured?
   How does the entrepreneur create value?
Basic Financial Concepts
Basic Financial Concepts
Balance
 Accounting is like a balance beam,
Basic Financial Concepts
Balance
  When we add to one side,
Basic Financial Concepts
Balance
  We must add the same amount to the
 other side.
Basic Financial Concepts
Definitions
 Asset:
    Something we own
       Cash, inventory, building, land
    Something that someone owes to us
       Account receivable, loan receivable
   Liability:
    Something we owe to someone else
       Account payable, loan payable
Basic Financial Concepts
Definitions
 Revenue:
    When we earn something
      Sell inventory, charge interest, bill for time worked
   Expense:
    When we do something to earn revenue
      Advertising, COGS, wages
   Income:
    Revenues less Expenses
Basic Financial Concepts
Definitions
 Equity:
  The owners’ (shareholders’) investment
     Share capital
  Accumulated income, year after year
     Retained Earnings
Basic Financial Concepts
Definitions

     Assets = Liabilities + Owners’ Equity
        A = L               +E
Basic Financial Concepts




      A       =    L + E
Basic Financial Concepts
Financial Statements
 Balance Sheet

 Income Statement

 Statement of Cash Flows
Basic Financial Concepts
Financial Statements – Income Statement
 How much money we made in the period
    Revenue less Expenses
   Continuity of Retained Earnings
    At the bottom of the IS we add the current
     period’s income to the Retained Earnings at
     the beginning of the period (opening RE) to
     get Retained Earnings at the end of the
     period (closing RE)
Basic Financial Concepts
Financial Statements – Balance Sheet
 How much we have, what we owe, and
  what we’re worth
  Assets
  Liabilities
  Equity
Basic Financial Concepts
Financial Statements – Statement of Cash
  Flows
 Where the cash came from and where the
  cash went
  Shows how each of the 3 business activities
   affected cash during the period
Basic Financial Concepts
The Activities of a Business
 Each business has 3 types of activity
  Operating Activities
  Investing Activities
  Financing Activities
Basic Financial Concepts
The Activities of a Business - Operating
  Activities
 The activities that the business was
  formed to carry out
  Most items found on the Income Statement
     Day to day sale of goods, advertising, wages
     Excludes some unusual activities on the IS: e.g.
      Gain on Sale of Assets
  Some activities not found on the Income
   Statement
Basic Financial Concepts
The Activities of a Business – Investing
  Activities
 Purchase or sale of fixed assets
  Buy land or a building
  Sell a car
  Purchase production equipment
Basic Financial Concepts
The Activities of a Business – Financing
  Activities
 Getting enough money to run the business
  Borrow money from the bank
  Repay money to the bank
  Pay interest to the bank
  Issue new shares
Basic Financial Concepts
The Activities of a Business
 The 3 activities can be found in certain
  parts of the FS
  Operating activities
     Income Statement (after adjusting for non-
      operating items)
     Balance Sheet (current assets & current liabilities)
  Investing Activities
     Balance Sheet (fixed assets)
  Financing Activities
Financial Projections Overview
   Financial projections: simply future Financial
    Statements
    Projected Balance Sheet
    Projected Income Statement
    Projected Statement of Cash Flows
   A ―Baht & Satang‖ summary of the business
    plan
    Your business plan in the language of numbers
Financial Projections Overview
 The projections must be consistent with
 and support the written part of the
 business plan

  Any difference between the written plan
 and the projections means instant loss of
               credibility and
NO MONEY from your potential investor!!!
Financial Projections Overview
Elements & Chronology of the Projections
 Explicitly stated assumptions

 Projected Income Statement

 Projected Statement of Cash Flows

 Projected Balance Sheet

 Analysis
How Much Money Do We Need?
   Money for capital investment:
     Equipment
     Buildings
   Permanent Working Capital
     To produce goods or services at lowest level of
      demand:
        Inventory (raw material, WIP, finished goods)
        Expenses (salaries, marketing programs, etc.)
     Level of permanent WC grows as business grows
   Temporary Working Capital: to meet seasonal or
    peak periods
Managing Cash (Working Capital)
   Increasing accounts payable increases
    WC
   Increasing accounts receivable decreases
    WC
   Minimize inventory (raw, WIP, finished
    goods) as much as possible, to minimize
    permanent working capital.
Financing Options: Debt and
Equity
   In most cases, Equity is more expensive than Debt
    financing.
                                                  +New stock issue
+New debt issue
                       Liquidity                  -Dividends
+Tax shield
                       Level                      -Stock repurchase
-Interest payments
-Principal repayment                 -Taxes


                        -Uses of capital
Debt                                            Equity


         -Net Working Capital       -Capital Expenditures
Debt
   Debt is typically cheaper (long-term
    interest on loans is less than investment
    return of stock markets).
   Debt offers a tax shield: interest is
    deducted from earnings, before taxes.
   So, why wouldn’t we always use debt
    financing?
Debt
   Debt requires regular repayment…
       …or default (and bankruptcy, or loss of
        collateralized asset).
   Lenders tend to be more conservative
    (which is reflected in the lower interest
    rate), and require collateral…
   …or, as is frequently the case for new
    ventures, will not lend at all.
Equity
   Inside equity: founders, friends, family
   Private equity (―Angels‖)
     May or may not offer business advice in addition to
      funds
     Usually have a limit for on-going funding
   Venture Capital
   Public Offering: The ultimate in wealth creation
   Any increase of equity beyond inside equity will
    often lead to dilution, or a lowering of the
    percentage of ownership in the company.
Sensitivity Analysis
   Things never turn out as you expect.
   A spreadsheet allows easy—and thorough—
    ―What If?‖ analysis:
   ―What if our sales are less than expected?‖
   ―What is our profit margins are less than
    expected?‖
   ―What if a key raw material cost rises?‖
   Determine significant variables for your business
    and find out how much they can vary and still
    allow you to break even.
Financing Stages (and desired
returns from a VC)
   Seed Capital (80%): to prove viability of
    concept.
   Start-up Capital (60%): to get the business
    operating.
   Expansion Stages (30-50%): to support
    first commercial sales, expansion,
    international growth, or to go public.
                Valuation
What is your hard work worth?
What do you get from your
company?
   Ideally, a stream of cash-flows in the
    future.
   What are those cash flows worth today?
    The Time Value of Money
Which would you rather have?



 THB 1000        THB 1000
  Today           One Year
                 from Today
What is THB 1000 worth?
   Today => THB 1000
   One year from now?
       Answer comes from the Time Value of Money
   What is the Discount Rate?
       For an investor, what return does he or she want on
        an investment?
If you had THB 1000 today…
…in one year it would be worth…


              10% THB 1,100
              20% THB 1,200
              30% THB 1,300
              40% THB 1,400
              50% THB 1,500
And, if you wanted THB 1,000 in
one year…
…you would need to invest…


              10% THB   909
              20% THB   833
              30% THB   769
              40% THB   714
              50% THB   667
The Formula
FV = PV * (1 + r)n

PV = FV / (1+r)n

     Where:
       FV = Future Value
       PV = Present Value
       r = Return (also called Discount Rate)
       n = number of years
Some more definitions
   NPV (Net Present Value) is the sum of all
    cash flows calculated at Present Value:




   IRR (Internal Rate of Return) is the
    percentage return on an investment to get
    a NPV = 0.
Other Methods of Valuation
   We just studied the Discounted Cash Flow
    method, which is derived from the capital
    budgeting process that large firms use. But,
    there are others:
   Asset-Based: Book value, adjusted book value,
    liquidation value, replacement value.
   Earnings-Based Valuations: Based on historical
    P-E ratio of industry, or similar firms.
     But, P-E is only historical and may not reflect the
      future (good or bad).
     Publicly traded firms have a liquidity premium.
Some Final Lessons on Raising
Money
   The longer you wait (and the more developed
    the opportunity), the less the cost to you (less
    risk to the investor).
   Seek money BEFORE you need it.
   Investors will probably give their money in
    stages, providing you hit certain targets.
   Investors may ask for seats on the board of
    directors, and other controls before investing.
Building up your financial
              projections

  Instruction Slides to explain
Sample Projections Worksheet
    Financial Projections Preparation
Assumptions
 The critical part of creating the projections
    Reflects the research carried out as the project
     develops
   The assumptions also reflect your business
    model
    Consider:
       Direct sales force vs. distributors
       Manufacture vs. outsource
       Licensed technology vs. owned technology
       Target market, market segments, and order of entry
       Revenue model: charge per use, per unit, per period
    Financial Projections Preparation
Assumptions
 Carry the assumptions forward
    Time periods match the periods in the projected FS
       E.g. monthly for the 1st year, annually for next 4 years
   Layout for Sensitivity Analysis
    Identify key drivers of your business
       Price per unit, sales volume, CGS, market growth
    These key drivers will be subject to sensitivity
     analysis later
    Incorporate sensitivity in your assumptions layout
       See sample projections
Financial Projections Preparation
Assumptions



This is the only place where numbers are
               “hard keyed”!
Financial Projections Preparation
Assumptions
Steps
  Label a worksheet ―ASMP‖
  Format for the appropriate time periods
  Develop assumptions for the business
   environment
  Develop assumptions for each Business
   Activity Type
  Review the assumptions with your advisor
Financial Projections Preparation
Assumptions – Business Environment
 Economy
    Exchange rates, base interest rates, GDP
     growth, inflation
   Industry
    Market size, annual market growth
Financial Projections Preparation
Assumptions – Business Activity Types
 Operating Activities
  Revenue: price per unit, market share >> # units
   sold
  CGS: raw materials, labor
    Are CGS components expressed as % of sales, or
     fixed cost per unit?
  Expenses: fixed expenses, variable expenses
    Fixed consider: rent, salaries, advertising, professional
     fees
    Variable consider: royalties, reserve for litigation,
     distribution costs
Financial Projections Preparation
Assumptions – Business Activity Types
 Operating Activities
  Income Taxes: tax holiday (BOI), tax rate
  Non-cash current assets & liabilities: A/R, A/P,
   Inventory
    How & when will customers pay us? (A/R)
    How & when will we pay suppliers? (A/P)
    How much raw material & finished goods will we
     keep on hand? (Inventory)
Financial Projections Preparation
Assumptions – Business Activity Types
 Investing Activities
  When will fixed assets be purchased?
    Consider: production equipment, land & building,
     car, leasehold improvements, computer, office
     equipment
  What will the depreciation rates be?
  Will any assets be disposed of during the
   projection period?
Financial Projections Preparation
Assumptions – Business Activity Types
 Financing Activities
  Non-current liabilities: loans
     Consider: Amount of loan, timing of loan, interest
      rate, repayment terms
  Equity: shares to founders, shares to new
   investor
     Consider: pricing & # of shares to founders;
      pricing, #, type, and timing of shares to new
      investor; dividend policy
 Financial Projections Preparation
Assumptions – Review
 Make sure that you:
   Have included all of the relevant variables for the particular
    business
   Have identified the critical drivers of the business: these will
    be the variables targeted for subsequent sensitivity analysis
   Challenge your numbers (are they supported by research
    results?)
      Note that not all numbers will be ―firm‖ at the first review: highlight
       those areas that require further research in order to ―firm up‖ certain
       numbers
   Check the consistency of your assumptions with the
    business plan
      This may happen later if the written plan is not yet ready
Financial Projections Preparation



Remember, the Assumptions section is
                  the
 only place where numbers are “hard
               keyed”!
Financial Projections Preparation
Income Statement
 Created from the information on ASMP
  If it is not on ASMP, it can’t go on IS
Financial Projections Preparation
Income Statement
 Steps
  Label a worksheet ―IS‖
  Create the format
  Enter formulas to pick up the #’s from ASMP
   (1st month)
  Ask a different group member to review the
   formulas
    Does R/E build correctly? (Closing R/E = Opening
     R/E + this period’s income)
  Carry the formulas forward to all time periods
  Review again, same as above, checking
   formulas & annual totals
Financial Projections Preparation
Statement of Cash Flows
 Created from information on ASMP, BS, &
  IS
  If it is not on ASMP, BS, or IS it can’t go on
   SCF
  Financial Projections Preparation
Statement of Cash Flows
 Steps
   Label a worksheet ―SCF‖
   Create the format
   Enter formulas to pick up #’s from ASMP, BS, & IS (1st
    month)
   Ask a different group member to review the formulas
      Do numbers carry forward from IS?
         Net Income, depreciation, interest expense
      Check that Closing cash = Opening cash + cash flow in the period
      Check that changes in current assets & current liabilities flow
       correctly from BS
   Carry the formulas forward to all time periods
   Review again, same as above, checking formulas & annual
Financial Projections Preparation
Balance Sheet
 Created from information on ASMP, IS, &
  SCF
  If it is not on ASMP, IS, or SCF it can’t go on
   SCF
Financial Projections Preparation
Balance Sheet
 Steps
   Label a worksheet ―BS‖
   Create the format
   Enter formulas to pick up #’s from ASMP, IS, & SCF
    (1st month)
   Ask a different group member to review the formulas
      Does Closing R/E carry forward from IS?
      Does Closing cash carry forward from SCF?
   Carry the formulas forward for all time periods
   Review again, same as above, checking formulas &
    annual totals
Financial Projections Preparation
Using Formulas
 Use the ―sum‖ function for all vertical or
  horizontal totals of more than 2 numbers
 Use ―$‖ to lock cell in horizontal of vertical
  direction, or both, for easy copying
 On ASMP set each cell to the right of the
  first column as equal to the cell to the left
  (See Sample Projections)
  This way, the only number to be hard-keyed is
   in the first column
Financial Projections Preparation
Analysis
 Comparison to industry norms
  Include suitable industry ratios for each
   statement: BS IS SCF
  Unjustified differences result from formula or
   assumption errors
  Justified differences result from differences in
   situation
     Different technology
     New product
Financial Projections Preparation
Analysis
 Sensitivity analysis
    Use the function ―Goal Seek‖ to see how far your
     key drivers change before NPV goes to zero, or IRR
     goes to a minimum
   Investment analysis
    What are the returns to the founders? The new
     investor? How do returns increase/decrease for
     changes in your key drivers?
   Scenario analysis
    Base case, best case, & worst case
File: Sample Financial Projections
   A new product for the plastics industry
    An additive in the production of certain plastic
     products
    Speeds curing time (hardening) time of
     finished product
   Distribution method: distributors
   Manufacture of hardener is done ―in-
    house‖
   Will continue to do ongoing related
    research
   Technology for the product is licensed