Lecture 13 Everything you wanted to know

1. Lecture 13 Everything you wanted to know • Housekeeping • Course Evaluation Questionnaire • Discussion of Course • What worked and what needs improvement • Giving a Good Talk • Types of Corporations • Accounting 101 • Thoughts on Entrepreneurship at Caltech • Midnight thoughts

2. Housekeeping • On Thursday, we will have a rehearsal. • Tell me what you are going to tell me • Ask questions on approach • On Friday we will have the Final Presentations • Get everyone involved • Enthusiasm, confidence • Fact-based • Avoid hyperbola • Final paper is due at midnight on Sunday

3. A Great Talk – thanks Tony Luna • Point of View • Experiences, influences, human condition • Continuity • Consistant thread carried throughout • Professionalism • Vocab, eye contact, gestures, voice projection • Simple Message • Clear takeaway • Uniqueness • Original voice • Relevance to audience

4. The concept of “Lessons Learned” Performed usually after a project is complete • Object to benefit from an analysis of history to avoid repeating error to learn what works • Cycles of Learning • Forgetting curve Supplements “benchmarking” Learning from the best Applying lessons to next iteration

5. Apply to new company • Don’t make dumb mistakes you could have avoided - make your own dumb mistakes! • Examine case histories (retrospective analysis- especially in analogous space) • Interview participants • Examine clichés • Huge markets • Hockey stick • First mover advantage • Put people on advisory Board with multiple and diverse experiences • Smart money Investors • Appropriate modesty about predictive ability of Business Plans- Think risk, Think Contingency Planning

6. On the back of the paper write 1. What did I like best about this course? 2. What could be improved? 3. Did it meet my expectations? 4. Any other comments?

7. E 102 What worked/didn’t work for you Score 1-10 (10 high) • Guests • Bill Collins • Sales • Chris Halliwell • Marketing • Gil Elbaz • Met Expectations • Team formation • Problem selected • Team activities • Lecture/HW presentation format • Ken • Vedran

8. What worked/Didn’t Work • Tech Coast Angel meeting • Pasadena Angel Meeting • Mentors • Making contacts • Making presentations

9. Team Experience in E102 Has it worked? What went right? What went wrong? How could the process be improved?

10. Please go online and fill out TQFR Survey

11. Entrepreneurship • Creation of a nation’s wealth • Creation of jobs • Creation of great products • Creation of leaders • Complements and funds great science

12. Company Types Financial Statements Income Statement Balance Sheet Cash Flow Statement Gross Margin of Product Important Negotiation Tools Term Sheet Subjects for Today

13. Sole Proprietorship Partnership “S” Corporation “C” Corporation Limited Liability Corporation Choices

14. Company continues regardless of incapacity or death of one or more stockholders. Can have ownership changes without disturbing ability to conduct business. pays taxes and dividends are also taxable to stockholders. Corporate shield protects other investments and savings of the stockholders The annual meetings of stockholders can provide more comprehensive guidance for management. Depending on the corporation's business record and the policies and practices of prospective lenders, access to credit and the ability to secure needed resources may be improved. “C” Corporation

15. “C” Corporation vs. “S” Corporation - What's the difference? “S”=“C” with one exception “S” corporation has a single tax imposed at the shareholder level "C" corporation has a tax imposed both at the corporate level and then again when the corporation makes a distribution to the shareholders.To be eligible for “S Less than have more than seventy-five shareholders, all of whom must be individuals or certain trusts in estates, one class of stock outstanding. “S” Corporation For tax purposes, the "S"

16. Lenders may require personal guarantees from corporate officers as a condition of supplying credit, thus negating the limitation of liability. Conflicts or disagreements among the stockholders (usually a small group of persons) may immobilize decision making. Restrictions on the sale of stock and/or buy-back agreements included in the bylaws may prevent minority stockholders from being able to recover the value of their investment in the corporation. If appreciated assets are owned by the corporation and the corporation is dissolved, significant income taxes on the appreciation amount will be generated. The corporate shield of limited liability may be lost: When corporate formalities are not followed — that is, when director and shareholder meetings are not held and minutes of such meetings are not kept. When corporate assets are treated as personal assets — for example, when a corporate vehicle is used for family vacation and the corporation is not reimbursed for the nonbusiness use. When limited liability is lost, shareholders become personally liable for any corporate legal or financial obligations. In addition, if corporate income tax returns are audited, failure to observe corporate formalities or treating corporate assets as personal assets can cause penalties and interest years. “C” Corporation Disadvantages

17. Business entity and your other affairs (personal and business) are merged. As the proprietor, you own and control the business. All proprietorship debt is payable by the proprietor (proprietor's family unit) lenders customarily require signatures on debt agreements by both the proprietor and spouse All profits accrue to, and all losses are borne by, the proprietor (the family). Must separate finances and records for your business unit and your household. Sole Proprietorship

18. Advantages Simplicity and flexibility. established, modified, bought, sold, or terminated very quickly. No organizational arrangements (bylaws, organizational charter, etc.) required Only routine permits and licenses required legal assistance not required to start, terminate, redirect, or modify the business. The proprietor can decide to start a business and almost immediately can say, "I'm open for business and I'm my own boss.“ Limitations mingling of business and household finances often occurs everything the proprietor and family own can be at risk in both personal and business activities the resource base limited including credit availability and capacity to respond to business opportunities Sole Proprietorship

19. An association of two or more persons formed to carry on a business each of whom has a specified ownership interest General Partnership or Limited Partnership Most business partnerships are organized as general partnerships. In many, the partners are related by blood or by marriage (Should be) based on a written agreement Typically not an income tax paying entity Profits and losses pass through to the partners' individual tax returns in proportion to their respective ownership interests. Unless specified otherwise, partnership is dissolved upon the death or withdrawal of one of the partners. Partnership

20. Advantages easy In a general partnership partners can specialize In a limited partnership only the general partner can be manager Limited partners enjoy a limited liability Borrowing capacity of a partnership may be greater than the total borrowing capacity of the partners as individuals. Cost of establishing a partnership is relatively low , record keeping and tax filing relatively easy Partnership

21. Limitations General partnership- all assets of each partner are at risk Limited partnership- all assets of the general partner are at risk and capital invested by the limited partners is at risk. Any partner in general partnership and the general partner of a limited partnership can enter into contracts binding on all General partnership can end upon the death or divorce of any partner Any general partner can require dissolution of the partnership at any time. It may be very difficult to get out of a partnership without undue financial loss Conflicts can immobilize business decision making Partnership

22. A record of a companies earnings or losses for a given period. Shows all of the money a company earned (revenues) and all of the money a company spent (expenses) during this period. The basic measure of profitability. Income Statements

23. Wilma's Widgets Income Statements for the Years Ending 1998 and1999 1998 1999 Net Sales $900,000 $990,000 Less Cost of Sales (250,000) (262,500) Gross Profit on Sales 650,000 727,500 Less General Operating Expenses (120,000) (127,500) Less Depreciation Expense (30,000) (30,000) Operating Income 500,000 570,000 Other Income 50,000 30,000 Earnings Before Interest and Tax 550,000 600,000 Less Interest Expense (30,000) (30,000) Less Taxes (50,000) (54,500) Net Earnings 470,000 515,500 Sample Income Statement

24. Net Sales = Gross sales - Returns Company’s “top line” revenue from its main or core business. (Issue how do you define revenue?) Cost of Sales What did it cost the company to directly produce or generate the goods or services represented in the net sales figure. Includes direct costs such as raw materials or acquisition cost of the goods Does not include indirect spending Marketing Sales, or Administrative expenses Income Statement

25. Gross Profit = Net Sales – Cost of Sales Operating Income = Gross Profit – Operating Expenses- Depreciation where Operating Expenses comprise SG &A Selling General and Administrative Expenses. general overhead, administrative, sales, marketing, and some other expenses are listed. In general, operating expenses are the costs (expenses) associated with keeping the doors open, generating business, and filling orders R&D expense Expense associated with developing new products How much is appropriate? And Depreciation is Income Statement

26. Depreciation Records the loss in value of a fixed asset. Purpose is to spread the initial purchase price of the fixed asset over its useful life. Used for purchased machines, equipment ,some software A "non-cash" charge. i.e. no money is actually paid at the time in which the expense is incurred. Income Statement

27. Operating Margin = Operating Income/Sales How profitable are the companies lines of business?

28. Earnings before Interest and Taxes (EBIT)= Operating Income – other income (loss) – extraordinary income (loss) Income Statement

29. And Finally, the bottom line Net Earnings= EBIT – Interest expense (income)- tax expense (refunds) Income Statement

30. EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization – EBITDA) How much money a company would have made if it didn’t have to pay interest on its debt, taxes, or take depreciation and amortization charges. What is the value of EBITDA? Income statement

31. Check year to year trends Can still go broke with a profitable business Compare with competitors/industry Check R&D expense as a % of sales. Is it appropriate? Look at each of the line items and test for robustness. e.g. What is the interest expense? From Balance sheet what would happen if interest rates rose? Some Key issues with income statements

32. Each product has a gross margin Gross Margin= price - direct cost of product Products can be created and pruned on the basis of their Gross Margins. Issue with Internet is that the Gross Margins were too thin Gross Margin

33. Gross Margin =Sales Price – Cost of Sale Consider GM1=SP1-CS1 GM2=SP2-CS2 GM3=SP3-CS3 Can compare and decide which to build Gross Margin of Product

34. The theoretical value of the enterprise if you were to purchase it, liquidate the assets, and shut its doors Unlike an income statement, it doesn’t cover a range of dates but is a snapshot. Why is this statement important?  Balance Sheet

35. Assets include all the things of value that are owned or due to the business Liabilities represents a company's obligations to creditors Stockholders Equity represents the owners’ investment in the company Basic “Law” Assets = Liabilities + Stockholders Equity Balance Sheet

36. Current Assets mature into Cash in <12 months Cash Accounts Receivable (A/R) Inventory (Inv) Notes Receivable (N/R) Prepaid Expenses Other Current Assets Non-Current Assets mature into cash > 12 months. Net Fixed Assets Land Building Machinery and Equipment Furniture and Fixtures Leasehold Improvements Investment into Subsidiaries Intangibles Other Assets Balance Sheet Assets

37. Intangibles Goodwill (examples a strong brand name, good customer relations, good employee relations) Research and Development Patents Market Knowledge Organizational Expense Balance SheetAssets (cont.)

38. Current liabilities need to be paid in < 12 months Accounts Payable -- Trade (A/P) Accrued Expenses (e.g. wages) Notes Payable -- Bank Notes Payable -- Other Current Portion of Long term Debt Non-Current Liabilities obligations that are due in > 12 months Non-current Portion of Long Term Debt Contingent Liabilities (e.g. guarantees, lawsuits) Balance SheetLiabilities

39. Stockholders' Equity the remainder of the company's assets Common stock Preferred stock Treasury stock Retained earnings Balance SheetStockholders Equity

40. Advantages and Disadvantages in Financing (getting cash) through Debt or Equity i., e., bonds/loans or stocks For new company For established company For fast growing company For business cycle company Some Financing Issues

41. How is this a function of industry? Debt to Equity Ratio

43. Financial document detailing the exchange of cash between a business and the outside world From Operations cash made (lost) by selling goods and services Flow from Financing cash company raised by selling stocks and bonds Flow "out" to Investing cash the company spent investing in its future growth Cash Flow StatementPeriod statement does not have to balance

45. Cash Flow Statement (cont.

46. Entrepreneurship • Positives • Act of Creation • Passion • Habit-Forming • Large potential cash-outs • Negatives • Failure is the Norm • 24/7 existence • Compromises • family, • building a “total” rounded person • Self doubt

47. Subjects very imperfectly covered • Ethics • Financing • Corporate structure • Choosing a Team • Operational challenges • Liquidity Events • Legal considerations • Human Resources • Outsourcing

48. For the final, consider including Ethics and Social Responsibility guidelines for your company.

49. History of Entrepreneurship Classes at Caltech • Started by Prof. John Baldeschwieler c. 1995 • Entrepreneurial Fellows Program 2001-2002 • Ken takes over E 102 in 2003. This is the tenth iteration • Many professors have contributed to this class • Some projects (typically in a different form) have gone on to be businesses

50. Major advantages for students (my view) • Learning something about business. Remember the synthesis argument. • Learn something about Entrepreneurship • Helpful for self-exploration • Realistic problems to work on • Team skills • Helpful in interviewing for consulting or technology positions • Relief from “formal methods” courses?