Finance and business planning

Differences from Corporate Finance Diversification and Value Involvement of Investors Harvesting

Keys to Financing the New Venture

Alec Johnson, Ph.D.

University of St Thomas

The Problem

“Small business management is cash flow management.” Dr Robert Pricer, Weinert Applied Ventures Program, Unviersity of Wisconsin

“Cash is King.” Dave Stassen, Partner, St Paul Venture Capital

“You’re not an entrepreneur until you’ve written payroll checks

on Friday and spent the weekend collecting the cash to cover them.” Keith Streckenbach, founder and CEO of PharmacyOneSouce.com

Entrepreneurial Finance vs

Corporate Finance

Differences from Corporate Finance

– Diversification and Value

– Involvement of Investors

– Harvesting

The Problem - Objectives

ReturnMaintain

Control

Maximize Ownership

The Problem - Management What is the Ultimate Task of an Entrepreneur?

• Job #1 is Risk Management

• Largest risk is Financial and

question becomes “How?”

• Largest risk is Financial and

question becomes “How?”

The Problem - Structure

Type, i.e Do I use debt, equity or some

combination.

Timing, i.e When do I need it?

Amount, i.e How much do I need?

Type – Two General Classes

Debt

– Represents a fixed cost

– Represents more risk

– Cheapest type of outside

financing

Equity

– No interest payment– No obligation to repay– Most Expensive type of financing

Sources of Debt Financing

Friends and Family

Banks

Leasing

Factoring

Factors buy company’s accounts receivables at

a discount.

Recall R&R case.

Gets cash to company quickly, but must have cost of factor available in profit margin.

When to use equity?

– Every company has some form of equity.

– Founders raise equity when:

• there is no collateral to secure debt

• insufficient cash flow to secure debt

• required growth capital more than banks can provide

Types of Equity Instruments

Typically used in small business placements:

– Common Stock

– Preferred Stock

Types of Equity Instruments

Common Stock Characteristics:

– Most common form of issuance

– Last in liquidation = ?

– Represents Entire ownership of firm.

Types of Equity Instruments

Preferred Stock Characteristics:

– Pays dividends

– Preference in liquidation

Types of Equity Instruments

Preferred Stock Characteristics:

– Looks a lot like Debt!

– Used by Venture Capitalists to gain position in liquidity event while minimizing risk.

Types of Equity Investors

Angel Investors

Venture Capitalists

Types of Equity Investors: Angels

Typical Angel Investor

– Private individual (not an institutional fund)

– Age: 47 –54 years

– Gender: Male

– Net Worth: $1,000,000 +

Types of Equity Investors: Angels

Typical Angel Investor

– Education: Bachelors or greater

– Average Investment: $59,000

– Preferred Stage: Start-up (56%) and infant or young (24%)

Types of Equity Investors: Angels

Typical Angel Investor

– Required Rate of Return: 15% - 45%

– Length of Investment 3 – 10 years

– “Patient Money”

Types of Equity Investors: Venture

Capital

Typical Venture Capital Firms

– Institutional Firm

– Raises money from various sources, including Angels

– Creates “pool” of capital, a fund

– Develops portfolio of firms under management

Types of Equity Investors: Venture

Capital

Typical Venture Capital Firms

– Average Investment: $1 M to $50 M per investment.

– Industries: High Growth, early or later stages

– Services Provided: None to direct management decision making and board control.

– Required Rate of Return: 10X in 3-5 years.

– Typically invest using Preferred Stock

Venture Capital Investments, Q2 2001

2.2% of Venture Capital invested in Midwest!

Biopharm Semiconductors Med Sftwr Retailers Consumer &

Bus.

Dollars Share

Timing – Sources of New Venture

Financing*

Development Start-Up Early

Growth Rapid Growth ExitEntrepreneur/

Timing - Cash Needs

Goal is to manage risk to business and to

investor.

Minimize risk by staging investments

Establish stages by developing solid business plan and financial projections!

Case Study – Ascend Medical

Facts:

• Development stage Medical Device company

• Prototype of catheter for stroke victims nearly complete

• Market need unclear

• FDA process is three years and $30M in expense

• No guarantee of approval

Case Study – Ascend Medical

Analysis – Type?

• Debt is not an option

• Angels to get the product through prototype development, further market study, conduct focus groups with doctors

$500,000

• Venture Capital to take it through FDA process and initial market launch $45M

Case Study – Sporto

Facts:

• Start up phase winter apparel company

• One season’s sales under it belt

• Moderate growth plans

• Required funds: $1.5 M

• Needs immediate funds of $100,000 to expand sales organization and $1.4 M to expand product line and related marketing expenses over the next 18-24 months

Case Study – Sporto

Analysis – Type?

• Venture Capital not an option – growth too slow

• All debt not an option – unless financials can demonstrate adequate cash flow and plenty of collateral available

• Private equity with debt mix is viable option

• Factoring after sales grow, leasing office equipment

• Alternative?

Case Study – Sporto

Analysis – Timing?

• Could split rounds up, reduce overall cost of capital

• Rounds are close enough that it might make sense to raise all at one time

• Unless founder gets lucky? Example

The Big Picture – Business Plan

Business Plans

What is a business plan?

– Something you produce because the bank expects it?

– Something you produce because every says you should?

– ?

Business Plans – Make Your

Argument

Argument contains some consistent themes

– What is the product or service?

– Who is MOST likely to buy it?

– How much are they willing to pay for it?

– How many of “THEM” are there?

Business Plans – Make Your

Argument

Argument contains some consistent themes

– Who is MOST likely to buy it?

– Where and How will they purchase the product?

– How will I let them know about it?

– Does my team have the ability to execute the plan?

“Everything should be made as

simple as possible, but not more so.”

Albert Einstein

Business Plan-The Purpose

A Sales Document to Raise Capital

A Road Map to Developing a Successful

Organization-Do we have a product the market wants and do we

have an organization that can see it to market?

The Plan makes an argument for why the business will be successful!!!!!

Business Plan Outline

Operations-Management Team

Risks

Financial Analysis

Company Description

What business are you in?

What are your:

– products or services?

– customers?

– applications? (Different uses and needs satisfied

What is your distinctive competence?

What is your competitive advantage?

What is your Mission Statement

Sustainable Competitive Advantage

Versus Distinctive Competence

Ask the question “What do we have that can’t be replicated by our competitors?”

vs “What are we good at?”

Market Analysis & Marketing

Industry description and outlook

Target markets (segments)

Competition

Reaction from prospective customers

Marketing activities (strategy/pricing)

Selling activities

The Key is your Feasibility Study

Example 1: Brew on Premise

Example 1 - Brew on Premise

•Counties are comparable

•15 batches per day in Boulder

•Ratio of target population 1.6:1

•Expected revenues for Badgerland to reach 24 batches per day after 2 years of operation

Example 2 – Ascend Medical

Different approach to argument

Focus isn’t one likely demographic

Focus is on treatable number of cases

Example 2 – Ascend Medical

Process:

1 Population growth through 2010 (Source: US

Census)

2 “Target” population not important All medical

research data based on incidence in US

population.

3 Medical data implies number of treatable cases by

type of stroke.

Example 2 – Ascend Medical

Process:

1 Once number of treatable cases established by

type of stroke, can then establish type of

treatments received.

2 Those requiring clot removal (vs stenting, etc.) are

established as likely candidates for this procedure.

3 356,000 treatable cases today, growing to 560,000

in 2010.

Management and Ownership

Key management positions

Background of personnel

Board of Directors

Ownership

Starting a business is about building a successful

organization and working in a “team.”

Does your team cover all the necessary roles or have you developed a plan to cover areas that are weak?

Granite Gear

Level of Sophistication

Product Development

Level of Complexity

Granite Gear

Time To Market

Granite Gear

Moderate 9 to 18 months

Granite Gear

Market Risk

Granite Gear

Product Acceptance

Low < $50,000 Moderate High > $2M

$500K to $2M Granite Gear

Competitive Risks

Technological Risks

Organizational Risks

Main Point: Identify them and develop a plan

to deal with them if and when they arise.

Funds Required and Their Uses

How much money do you require now?

How much will you require over the next five

years?

How will the funds be used?

Funds Required and Their Uses

Debt/Equity mix

What terms do you ask? (Let the commercial

money market help you select winners)

Do you plan to “harvest?” Be explicit about the deal you offer…

Financial Data

Historical financial statements and projections for the next five years

Key assumptions

The Big Picture