june 2003 how do we make money? financial management, valuation and financing douglas abrams -...
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June 2003
How do we make money?
Financial management, valuation and financing
Douglas Abrams - Parallax Capital Management
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Douglas Abrams - Parallax Capital Management
How do we make money?
The business model
Financial management
Forecasting and valuation
Funding required and equity offered
ROI and exit strategy
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Douglas Abrams - Parallax Capital Management
Determine the business model
How do we create value?
Who do we create value for?
How do we differentiate ourselves?
How will we make money?
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Douglas Abrams - Parallax Capital Management
How do we make money?
The business model
Financial management
Forecasting and valuation
Funding required and equity offered
ROI and exit strategy
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Determine your needs
Think about your income and cash needs
Think about your sales and funding needs
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Two ways to look at your finances
Operating view - budgeting – Operating budget– Cash-flow budget
Accounting view - forecasting and valuation
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Expense and operating budget
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Cash flow budget
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The Path to Profitability (P to P)
What is profitability?
Startup can fund all operations from cash flow
How much investment needed until then?
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The burn rate and months remaining
Methods of calculating the burn rate– GAAP– EBIDTA (before interest, depreciation, taxes and amortization
Calculate months remaining– Remaining months liquidity – How many months worth of cash does the company have left?
Multiple burn rates may be required to reach milestones until startup can fund from its own revenues
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Principal financial statements
Balance statement - the company’s financial condition
Income statement (P&L) - the success of the business
Cash flow statement - cash availability and needs of the business
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Balance statements must balance
Economic resources of the company
Ability to provide future benefits to the firm
Cash
Inventory
Equipment
Left side - Assets
Liabilities - creditor’s claims on the assets of the firm
Accounts payable, bonds payable
Shareholder’s equity - the owner’s claim on the assets of the firm
Contributed capital
Retained earnings
Right side - Liabilities & Equity
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Why is financial information important to entrepreneurs?
No cash, no business
Financial information pulls together all information presented in the other segments of the business; marketing, manufacturing & management
It quantifies all assumptions & historical information concerning business operations
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How do we make money?
The business model
Financial management
Forecasting and valuation
Funding required and equity offered
ROI and exit strategy
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Forecasting requires predicting the future
Yr 1 Yr 2 Yr 3 Yr 4
Gross Revenues
Operating Expenses
EBITDA
Metric: Ex: Units sold/leased
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We predict using pro forma financials
Three to five years of:
Income statements
Balance sheet
Cash-flow statement
P&L
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Preparing your forecasts
Project from bottom up
Sales growth and market share are key
Project cash requirements
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What is the value of a firm?
Fundamental value?
Technical value?
Balance sheet value of assets?
Market value of assets?
Multiple of book value?
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Company valuation methods
Price to earnings (p/e)
Dividend yield
Multiple of book value
Comparables
Discounted Cash Flow (DCF)
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Comparables
Use value that has already been established either in public markets or through a sale for a comparable company
Difficulties– How to find comps– Accounting methods vary– Public versus private liquidity– Changing market conditions
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DCF Valuation Model
Firm value is discounted present value of future cash flows
Percent of sales forecasting
Tie income-statement and balance sheet figures to future sales
Variable costs and most current assets and liabilities tend to vary directly with sales
Only future sales require prediction; relationship between items can be calculated more easily
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Discounted cash flow
Project cash flow from operations for 3-5 years
Adjust the cash flow for factors such as non-recurring items of income and expense, depreciation, amortization, interest and taxes
Discount the cash flow as adjusted, using alternative assumptions for time and risk factors.
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What are our time, scope and size ambitions?
Subsistence model
Income model
Growth model
Speculative model
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Scalability and its costs
Scalability necessary for VC investment
$300MM gross profits within 5 years
Scalability is expensive - marketing, infrastructure, etc.
Demonstrate need and value of product or service with $3MM? Get to break even with less than $20MM with yearly revenues of $100MM in 5-10 years
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How do we make money?
The business model
Financial management
Forecasting and valuation
Funding required and equity offered
ROI and exit strategy
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What are sources of funds?
Profits/Retained earnings
Equity
Debt
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Funds needed
How much does the company need?
What percentage does the company want to sell?– Often too much or too little– This is the wrong question
Set performance and fund-raising milestones– How much money do you need to achieve the next milestone?– Divide defensible firm value by funds needed to determine
percentage to sell
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Sources of funds
Own money (OM)
Friends and Family (F&F[and Fools]) Angels
Incubators
Corporations
Customers, suppliers, lessors and strategic partners
Government grants and investments
Banks for VC loans
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Uses of funds
Be detailed
No big salaries for founders
How will these funds be used to fuel necessary growth?
Sufficient funding to reach next financing milestone
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Funding stages
Founder’s capital
Seed/Angel
Series A, B, C
Mezzanine
Pre-IPO
IPO
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Pre-money valuation
Worth of the business before VC investment
Amount invested by VC divided by– Agreed pre-money value of business + – Amount invested by VC = equity owned by VC – VC receives equity share based on post money total– $3MM pre + 1 MM VC = 25% VC equity
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How do we make money?
The business model
Financial management
Forecasting and valuation
Funding required and equity offered
ROI and exit strategy
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VC hurdle rate
Minimum yearly compounded rate of return VC expects from investment (risk assessment)
Seed stage 60-100%
Early stage 60%
Late stage with profits 40%
Bridge financing to cash out 20%
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Why are VC’s hurdle rates so high?
VCs must deliver above-average returns to their investors
Percentage of winners and losers– 20/80 at best
Overall return required by VC investors 30/40%– Do the math
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Post money valuation
Used to estimate the price the business must command at the liquidity event
If liquidity event is sale in 5 years, and hurdle rate is x%, can calculate sale price required
$4 million post money; 50% hurdle rate
Sale price must = $30 MM
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Calculate VC’s Projected ROI
Take projected earnings from DCF model in exit year
Multiply by comparable P/E multiple for industry to calculate price
Multiply by VC’s equity percentage at exit to calculate VC’s share
Divide VC’s share by original investment
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Exit strategy and market conditions
Liquidity event– Convert private equity to cash or freely tradable stock – Sale or IPO– Merger with public company– Back-door listing, – Reverse merger
Within 3-5 years
Only 10-15% of liquidity events
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Contact us
Douglas Abrams
Managing Director
Parallax Capital Management
www.parallaxcapital.com
65-6238-3492, 65-9780-5381 (hp)
390 Orchard Road, #11-01 Palais Renaissance, Singapore 238871