financing your venture valuation of the venture. objectives how do you determine how much cash you...
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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 ownCash, inventory, building, land
Something that someone owes to usAccount receivable, loan receivable
Liability:Something we owe to someone else
Account payable, loan payable
Basic Financial Concepts
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
Basic Financial Concepts
Definitions Equity:
The owners’ (shareholders’) investmentShare capital
Accumulated income, year after yearRetained 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 worthAssetsLiabilitiesEquity
Basic Financial Concepts
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
Basic Financial Concepts
The Activities of a Business Each business has 3 types of activity
Operating ActivitiesInvesting ActivitiesFinancing Activities
Basic Financial Concepts
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
Basic Financial Concepts
The Activities of a Business – Investing Activities
Purchase or sale of fixed assetsBuy land or a buildingSell a carPurchase production equipment
Basic Financial Concepts
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
Basic Financial Concepts
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”!
Financial Projections Preparation
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
Financial Projections Preparation
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
Financial Projections Preparation
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)
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: 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
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 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
Financial Projections Preparation
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
Financial Projections Preparation
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
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 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
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