DEAS Seminar Series
Michael J. Roberts
Sources of Financing
Recurring View (Monthly) – Blended Model
Key
Lease
Access
May ’00 Biz Plan/ Actual
September Data
Insurance
Costs/ Car
Parking
Maintenance
Car Cost/
Member
Fuel
Hours used/ month
Members/ Car
Contribution
Margin/ Member
Utilization rate
Monthly Fee
# Uses
Hours/Use
Revenues/ Member
Total Contribution
Margin/ Month
Monthly Usage
$/Hour
Miles/Use
$/ Mile
Monthly interest
$/ member
i rate (monthly)
Beginning Members
# Members
New Members
Attrition
Restaurant Business Model
• What do you think it looks like?
From the Business Model…build a
set of financial statements
• P&L
• Balance Sheet
• Cash Flow
Balance Sheet
- The company’s financial position at one moment
in time.
- Basic equation: Assets = Liabilities + Owners’
Equity
Assets: provide benefit to the firm in the future,
valued at lower of cost or present market value.
Liabilities: amounts or obligations owed to third
parties.
Owners’ Equity: what’s left. Also = to original
paid-in capital and retained earnings, less
dividends.
Income Statement (Profit & Loss
Statement)
- Operations over a period of time (quarter, year).
- Basic equation: Revenue earned-expenses
incurred = net income - dividends = retained
earnings
Four main categories of expenses:
- cost of goods sold
- selling, general, and administrative costs
- interest cost
- provision for income taxes
Statement of Cash Flow
Beginning Balance
+/- Operating Activities: Money generated by and
spent in doing business, and Interest & Taxes
+/- Investing Activities: Money used in things that
support operations or in financial assets. Primarily
used for purchasing assets that increase productive
capacity.
+/- Financing Activities: Money used for issuing or
retiring debt or equity, or paying dividends.
= Ending Balance
Beginning cash+cash inflow-cash outflow=ending
cash
The Cash Flow Cycle for a Venture
Cumulative Cash Flow in $
Date of First Cash Flow Positive
Time
Date of Cumulative Cash Breakeven
Maximum Financing Needs
Burn Rate
Remember
• People who are giving you money want to
get it back, plus a return
• Required Return is a function of perceived
risk
– Core risk of project
– Capabilities/track record of entrepreneur
– “Security”
Investor Background also Influences
Perception
• Functional /Industry Experience
• Investing Experience
• Potential involvement in venture
Risk & Reward
Reward
Risk
Risk/Reward Management
Probability
of
Occurrence
Expected Value
Probability of
Losing 100%
Goal # 2
Goal # 1
Goal # 3
-100%
+25%
+100%
Return on Investment
The horse race……..
Valuation
Risk
Time
Sources of Financing
•
•
•
•
•
•
•
•
Own Money/Customers/Suppliers
Friends and Family
“Angels” and Sophisticated Angels
Early Stage / Seed VC
Traditional VC
Banks
Corporate Partners or Strategic Investors
Public Capital Markets
No External Financing is the Best
Option
• Keep control and equity upside
• Minimize pressure for exit / liquidity event
• Creative use of contracting, collect-inadvance, pay later strategies
• Not possible when large absolute amounts
of capital are required
F&F & Angels
• Individual investors often invest for some
reason other than pure cash return
• What are their reasons: a + or – for you
• Managing info flows is key
Venture Capital
• Require Probability of exceptional returns –
swinging for the fences
• Need to put large amounts of capital to
work
• High stakes – majority of founders do not
make it
Banks
•
•
•
•
Will always look to cash flow first
Then to corp assets
Then to personal assets, guarantees
You can reach a point where it is in their
interests to pull the plug – their last chance
to get out whole - will not be in the equity
holders’ best interests
Questions to Ask
• What are the venture’s MONTHLY cash flows?
• How much cash is required in total – how deep is
the trough?
• What size bites do we want it in?
• What are the particular risks and rewards and who
has an appetite for them?
• How can the Reward / Risk ratio be managed?
• What returns will investors expect?
More ?s
• What terms matter other than price, and am I
willing to live with these terms ?
• Do the deal terms align our interests, or not?
• What alternatives do I have?
• What do I need other than $$, and What do they
bring other than $$?
• Likely exit routes / liquidity path?
• What will the returns look like for me after I give
up what will be required?
Pluses and Minuses
Source
+
Own money/Customers/  Relatively Easy
Suppliers
 Helps assure future success
 Retains control with minimum
oversight
 Requires well-established network
 Requires some personal wealth
 Requires positive cash flow
Friends & Family
 Easily Accessible
 Good Terms
 Little Due Diligence
 Thanksgiving Dinner
 Lack of sophistication
Angels & Sellers
 Eager/Knowledgeable
 “Good” Terms
 Idiosyncratic
 More or Less sophisticated
Early Stage VC
 Expertise
 Legitimacy
 Managerial control
 Scarcity of Early Stage VC firms
Traditional VC
 Expertise
 Legitimacy
 Deal Terms
 It’s about the money
Asset Lenders
 Leverage Benefits
 No/Little Equity dilution
 Covenants
 Bankruptcy Exposure
Corporations
 Extensive Resources
 Provide Credibility
 Exit Strategy
 Slow Decision Making Process
 Foreclosing Exit Options
21
30%
CEO’s average equity holdings
by round of financing
25%
25%
20%
17%
16%
15%
10%
12%
Founder CEO
8%
6%
6%
6%
2
3
4
5%
Professional
CEO
0%
1
Source: Noam Wasserman, “Inside the Black Box of Entrepreneurial Incentives.” Based on survey conducted in July/August 2000 of
211 private Internet/software firms.
When do you need to consult a lawyer?
• Early
• There are lots of legal risks
– forgotten founders
– danger of unprotected intellectual property
– employment/stock agreements
• You often can’t fix them later, even if you have
more time and money
Valuation
• Implied or Implicit or Imputed Valuation is
Different than “Calculated (NPV)
Valuation”
• Have you ever bought a share of stock?
• do the math: $/% = Implicit Valuation
Investors generally Back into a
valuation, don’t start there
• What is my best guess about terminal value
and exit time
• What is my best guess about future funding
requirements and resultant dilution
• What is the most I can afford to pay now
i.e., what is the smallest % ownership I can
walk away w/ and still get my required
return
The Math
REQUIRED/TARGET RETURN = R
YEARS UNTIL EXIT = n
INVESTMENT = I
REQUIRED STAKE % = I * [(1+R)^n]
TV
I/POST$ = ACQUIRED STAKE %
I/POST = I * [(1+R)^n]
TV
The Lesson:
Good decisions come
from having good
alternatives from among
which to choose
Where 100 of the 1989 Inc. 500 founders got their ideas
Swept in by PC
revolution
5%
Discovered by
luck
20%
Systematic
search
4%
Idea from
previous job
71%
7 casual job into business
6 wanted as consumer
4 happened to read about industry
Source: Amar Bhide (1994), “How entrepreneurs craft strategies that work,” Harvard Business
Review (March-April).
Career Implications
If you are interested in finding an opportunity
(or being involved in someone else’s), then
the following matter a lot:
–
–
–
–
Industry you work in
Whether you are known in your industry
Where you live
Your network of personal and professional
contacts
– Your reputation
– Planned serendipity