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?

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


Balance

Accounting is like a balance beam,


Balance

When we add to one side,


Balance

We must add the same amount to the other side.


Definitions Asset:

Something we ownCash, inventory, building, land

Something that someone owes to usAccount receivable, loan receivable

Liability:Something we owe to someone else

Account payable, loan payable


Definitions Revenue:

When we earn somethingSell inventory, charge interest, bill for time worked

Expense:When we do something to earn revenue

Advertising, COGS, wages

Income:Revenues less Expenses


Definitions Equity:

The owners’ (shareholders’) investmentShare capital

Accumulated income, year after yearRetained Earnings


Definitions

Assets = Liabilities + Owners’ Equity

A = L + E


A = L + E


Financial Statements Balance Sheet Income Statement Statement of Cash Flows


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)


Financial Statements – Balance Sheet How much we have, what we owe, and

what we’re worthAssetsLiabilitiesEquity


Financial Statements – Statement of Cash Flows

Where the cash came from and where the cash wentShows how each of the 3 business activities

affected cash during the period


The Activities of a Business Each business has 3 types of activity

Operating ActivitiesInvesting ActivitiesFinancing Activities


The Activities of a Business - Operating Activities

The activities that the business was formed to carry outMost items found on the Income Statement

Day to day sale of goods, advertising, wagesExcludes some unusual activities on the IS: e.g.

Gain on Sale of Assets

Some activities not found on the Income StatementPay money we owe to a supplierCollect money from a customerIncrease or reduce our inventory


The Activities of a Business – Investing Activities

Purchase or sale of fixed assetsBuy land or a buildingSell a carPurchase production equipment


The Activities of a Business – Financing Activities

Getting enough money to run the businessBorrow money from the bankRepay money to the bankPay interest to the bankIssue new shares


The Activities of a Business The 3 activities can be found in certain

parts of the FSOperating activities

Income Statement (after adjusting for non-operating items)

Balance Sheet (current assets & current liabilities)

Investing ActivitiesBalance Sheet (fixed assets)

Financing ActivitiesBalance Sheet (non-current liabilities & Equity)

Financial Projections Overview Financial projections: simply future Financial

StatementsProjected Balance SheetProjected Income StatementProjected Statement of Cash Flows

A “Baht & Satang” summary of the business planYour 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.

Liquidity Liquidity LevelLevel

Liquidity Liquidity LevelLevel

DebtDebt

+New debt issue

+Tax shield

-Interest payments

-Principal repayment

+New stock issue

-Dividends

-Stock repurchase

EquityEquity-Uses of capital-Uses of capital

-Net Working Capital-Net Working Capital -Capital Expenditures-Capital Expenditures

-Taxes-Taxes

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

Today

THB 1000

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% 1,100THB

20% 1,200THB

30% 1,300THB

40% 1,400THB

50% 1,500THB

And, if you wanted THB 1,000 in one year…

…you would need to invest…

10% 909THB

20% 833THB

30% 769THB

40% 714THB

50% 667THB

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 PreparationAssumptions The critical part of creating the projections

Reflects the research carried out as the project develops

The assumptions also reflect your business modelConsider:

Direct sales force vs. distributorsManufacture vs. outsourceLicensed technology vs. owned technologyTarget market, market segments, and order of entryRevenue model: charge per use, per unit, per period

Financial Projections PreparationAssumptions Carry the assumptions forward

Time periods match the periods in the projected FSE.g. monthly for the 1st year, annually for next 4 years

Layout for Sensitivity AnalysisIdentify 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 layoutSee sample projections

Financial Projections Preparation

Assumptions

This is the only place where numbers are “hard keyed”!


Assumptions

StepsLabel a worksheet “ASMP”Format for the appropriate time periodsDevelop assumptions for the business

environmentDevelop assumptions for each Business

Activity TypeReview the assumptions with your advisor


Assumptions – Business Environment Economy

Exchange rates, base interest rates, GDP growth, inflation

IndustryMarket size, annual market growth

Financial Projections PreparationAssumptions – Business Activity Types Operating Activities

Revenue: price per unit, market share >> # units sold

CGS: raw materials, laborAre CGS components expressed as % of sales, or

fixed cost per unit?

Expenses: fixed expenses, variable expensesFixed consider: rent, salaries, advertising, professional

feesVariable consider: royalties, reserve for litigation,

distribution costs


Assumptions – Business Activity Types Operating Activities

Income Taxes: tax holiday (BOI), tax rateNon-cash current assets & liabilities: A/R,

A/P, InventoryHow & 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)


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?


Assumptions – Business Activity Types Financing Activities

Non-current liabilities: loansConsider: Amount of loan, timing of loan, interest

rate, repayment terms

Equity: shares to founders, shares to new investorConsider: pricing & # of shares to founders;

pricing, #, type, and timing of shares to new investor; dividend policy

Financial Projections PreparationAssumptions – 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 planThis may happen later if the written plan is not yet ready


Remember, the Assumptions section is the

only place where numbers are “hard keyed”!


Income Statement Created from the information on ASMP

If it is not on ASMP, it can’t go on IS

Financial Projections PreparationIncome Statement Steps

Label a worksheet “IS”Create the formatEnter formulas to pick up the #’s from ASMP

(1st month)Ask a different group member to review the

formulasDoes R/E build correctly? (Closing R/E = Opening

R/E + this period’s income)Carry the formulas forward to all time periodsReview again, same as above, checking

formulas & annual totals


Statement of Cash Flows Created from information on ASMP, BS, &

ISIf it is not on ASMP, BS, or IS it can’t go on

SCF

Financial Projections PreparationStatement 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 periodCheck 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

totals


Balance Sheet Created from information on ASMP, IS, &

SCFIf it is not on ASMP, IS, or SCF it can’t go on

SCF

Financial Projections PreparationBalance 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


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


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 situationDifferent technologyNew product

Financial Projections PreparationAnalysis 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 analysisWhat are the returns to the founders? The new

investor? How do returns increase/decrease for changes in your key drivers?

Scenario analysisBase 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

Documents

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?