CIE From Invention to Start-Up Cash Flow – More Important Than Your Mother

1. CIEFrom Invention to Start-UpCash Flow – More Important Than Your Mother Alan Dishlip CFO – WildTangent, Inc. February 13, 2007 3:30 P.M. – 5:00 P.M.

2. Agenda • Introduction • Financial Planning • Financial Projections • Cash Planning • Raising Capital • Summary

3. Financial Planning - Understanding Risk • Finance - a way to think about cash, risk & value • Creating value is a key responsibility • Financial risk - uncertainty about future cash flows • Uncertainty creates risk, but uncertainty can usually be analyzed to understand risk • Significant value can be created by managing risk • Market, Management, Technology, Competition • Finance does not answer questions • It does not make decisions • Finance can help identify the right questions to ask and narrow down the options • When viewed from the finance perspective, some decisions will turn out to be illogical or unfeasible.

4. Financial Planning10 Must Answer Questions • How much cash will we really need? • What do the 5 year financials look like? • What’s the path to profitability? • What are the risks and rewards? • How can these be managed successfully? • How large is the addressable market? • How fast is the market growing? • Who’s the management team? • What is the value of my company? • What is the exit strategy?

5. Financial Projections Financial Projections

6. One angel to others on a cloud Don’t let this be you!

7. Financial Projections - Investor Quotes • “Financial projections consistently are the weakest part of business plans.” • “I rarely see a financial plan I can’t take apart quickly.” • “No consistent formats” • “Lack of detail – not bottoms up” • “Unrealistic and overly optimistic assumptions – especially timing related (revenues, development schedule, cash flow break even)” • “Model cannot be easily manipulated (too much hard wiring and not enough assumptions-driven)” • “Omission of costs and balance sheet items” • Understates capital requirements

8. Projections - Overview • A reflection of your business plan quantified • Consistent with the plan strategy • Will help demonstrate whether your strategy is financially feasible • A key indicator of the amount of outside financing necessary to support the execution of your strategy • Understand the quantitative and financial elements of your business plan • Not doing so is the fastest way to lose credibility • Include key financial ratios and compare to competitors’/industry averages

9. Projections - Overview • High level figures • Underlying detail should be available • Projections should answer • How will the company perform financially? • P & L • What will the company's cash position be? • Cash Flow • What will the company's financial position be? • Balance Sheet • Five-years - integrated • Monthly for the first two years, quarterly for the remaining 3 years • Well-thought out assumptions • Include key financial ratios and compare to competitors & industry • Include any historical financial information, if any

10. What’s Wrong With Most Financial Plans? • Waste too much ink on numbers – • Too little focus on information that really matters • Numbers should support strategy and key drivers of success • Manufacturing - yield on a production process • Magazine publishing - the anticipated renewal rate • Software - impact of using various distribution models • At what level of sales is the business profitable? • When does cash flow turn positive?

11. What’s Wrong With Most Financial Plans? • No need for detailed, month-by-month projections that stretch out for years • Financials are typically wildly optimistic. • Few entrepreneurs correctly anticipate how much capital and time will be required to accomplish objectives.

12. Projection Assumptions • Organize input assumptions in an easily accessible separate worksheet • Helps identify key items in one place • Can be used for sensitivity and breakeven analysis • Don’t be afraid to make material assumptions – especially uncertain ones (e.g. re-purchase rate, returns, collections cycle) • Individualize • e.g., don't just show advertising costs as a % of sales. • Most advertising expenditures are made months before sales result • Include financial obligations of bringing your product/service to market • New employees ► Deviations from historical trends • Additional physical space ► Increases in inventory and A/R • Support your assertions with valid data • Identify what data you have and also be clear about what you don’t know

13. Assumptions – Some to Consider • Revenue by distribution channel • Volume • Pricing • Sales per sales person • Manpower plan • COGS detail (labor, material, overhead) • Expenses by department • Dependent on manpower (payroll, space, benefits, supplies) • Independent of manpower (insurance, prof. fees, advertising, depreciation) • Fixed assets purchases and depreciation • Debt and related collateral calculations • Interest income and expense • Ratios & Metrics • Compare to industry averages and specific competitors • Sensitivity Analysis

14. Assumption Cost of Sales Benefits & payroll taxes Depreciation Exp Headcount Driven Expenses Interest Expense Interest Income Income Taxes Net Profit Accounts Receivable Bad Debt Reserve Inventories and Reserves Balance Sheet Accruals Linked to Sales Headcount & Salaries Fixed Assets & Accum Dep Manpower Plan Specific Debt Instruments Cash and Investments Profit before Tax (w/ NOL) Equity Section of Bal Sheet Sales Bad Debt Expense COGS Underlying Expenses Projections – Assumptions Linking

15. Bottoms Up Projections • Build from low levels of detail • Vs. Tops Down • Revenues extrapolated from market size & share • Expenses are forecast as percentages of revenue • Start with line items that are relevant to describing the business model

16. Bottoms Up Projections • Revenues • Forecast sales at the lowest level of product or service detail (channel, sales person, region) • Assumptions of volume and pricing • By geographic market, customer or distribution channel • Expenses • Break into relevant categories • Separate line items for most important and/or magnitude

17. Bottoms Up Projections Create Line Items that are Activity Driven • Don’t plan the dollars – plan the underlying activities that drive profits and cash flow • Assumptions come from table above • Don’t forget that productivity improves over time • Sales ramp over time • Understand the cost impacts • By linking between selling activities, productivity assumptions and cost rates for the variable expenses

18. Projections Should be Integrated • Enter assumptions and data and set up links • The statements build themselves according to GAAP • P&L • Segregate revenues, COGS, Op Ex, Income Taxes • Subtotals for gross margin, operating profit, net income • Balance Sheet • Segregate short- and long-term assets and liabilities • Account for retained earnings and equity capital • Cash Flow • Tie out to balance sheet • Segregate operating, investing and financing activities

19. Projections - Alternative Scenario Analysis • Changing many assumptions for different strategy or business environment • Vs. Sensitivity where change an individual assumption to reveal financial impact • Examples • Alternate distribution channels strategy • Timing issues (sales or development delayed) • Alternate volumes and pricing • Use this to run your business!!

20. Projections - Plug Cash • On the balance sheet • Cash = [Total Liabilities + Equity] minus [Total Assets other than Cash] • If cash is negative, the company is undercapitalized • Need to raise equity capital or borrow or both • If cash is positive and growing, the company is generating positive cash flow • Identifies seasonality needs

21. Income Statement

22. Balance Sheet

23. Ratios and Metrics • Ratios • Gross margin % • Days sales in A/R; days sales in inventory • Current Ratio & quick ratio • Debt to equity • EBITDA • Metrics • Headcount • Sales per employee • Sales per sales person • Customer acquisition cost • Unique ratios to your business • Show trends and compare to similar companies

24. Other Information

25. Financial Projections Cash Planning

26. Understanding Cash • First rule : Cash is the most important resource • More cash is better than less cash • Cash now is better than cash later • Focus on cash flow versus accounting income • Growth often absorbs cash flow because of a higher need for working capital and fixed investments • Entrepreneurial firms with negative income and high growth can have a very fast cash burn rate • Today’s investments are tomorrow’s growth opportunities • Focus on the dynamic picture of cash flow • Cash cycles (A/R collections, A/P payments), seasonality • Last rule:CFIMITYM !!! • Cash Flow is More Important Than Your Mother!! DON’T RUN OUT of CASH!!

27. How Does Cash Planning Work? • One part of financial statement forecasting • Falls out of developing the Income Statement and Balance Sheet • Goal: Provide well-balanced cash flow (ins & outs) • Understand the Operating Cycle (“OC”) • The OC is the system through which cash flows (purchase inventory, collect A/R, expenses, loan borrowing & payments). • Measures flow of assets into cash. • Need to finance a continuous OC • Cash flow analysis shows whether daily operations generate enough cash to meet obligations. • Compare actual cash flow to plan • Analysis allows opportunity to prepare for growth and fine tune plan

28. The Cash Flow Projection • How cash flows in & out of your business • Indicates capital investment requirements • Components • From operations • Net income or loss (revenues, expenses) • Changes in operating assets and liabilities (A/R, A/P, Prepaid Expenses, Accrued Expenses) other than cash • From Investing • Property & equipment • From Financing • Long and short-term debt • Issuance of equity

29. Control Your Cash Flow • Prepare realistic projections • Compare actual results to the plan • Identify patterns and constantly refine projections • Investigate variances and make operating changes, if necessary • Spend most time in areas you can make quick and large impact • A/R, A/P, Inventory, Discretionary Expenses

30. Increasing Cash Flows • Collect receivables • Actively manage and quickly collect past dues • Shortens operating cycle • However, increasing sales (on credit), actually decreases cash flow (timing of collection and purchase of inventory) • Tightening credit requirements • More cash sooner • But may cost in less sales • Need the proper balance • Pricing • Proper pricing is critical to achieving a profit and maintaining positive cash flow • Must understand market, competition and distribution channels structure • Manage your expenses – necessary and reasonable

31. Cash Reserve • Always keep enough cash on hand to cover expenses for at least 3 months and, preferably more. • Provides cushion against “unknown unknowns” • But don’t keep too much in cash • Invest excess in interest bearing instruments with priority: • Safety (gov’t securities, CDs, etc.) • Liquidity • Return

32. Cash Flow and Accounting Punch List • Prepare monthly financial statements. • Compare with prior periods. • Frequently update your projections and cash flow plan. • Keep track of key income statement percentages. • If you're in manufacturing, your COGS % should be relatively the same or better as competitors in your industry. • Maintain good internal controls to prevent dishonesty and shrinkage. • Do not delegate the authority to sign checks or purchase orders. • Don't use money that you have withheld for payroll taxes or sales taxes for other purposes. • A "payroll service provider" can be used to manage these responsibilities. • Liquidity is not the same as making money. • You can be making a profit and still go broke by running out of cash. Learn and practice cash flow control. • Arrange for financing well before the need arises.

33. Cash Flow

34. Thoughts on Raising Capital • Be prepared to concisely link the strategy & financial elements of your plan • Milestone-based • Raising capital is a long, hard and challenging process that requires a substantial time & effort • Who you raise capital from is much more important than how much capital you raise • Listen, learn & improve your plan along the way • Have realistic expectations about how much money you can raise and have a “plan B” • Friends, family & personal funds are usually the only source of capital available for new ventures

35. Milestones • Milestones and expected cost • Shows business understanding and intention to track performance closely against the business plan • Milestone Examples • Hiring of a full management team • Completing product specifications • Completing prototype • Product testing • First customer shipment • First full quarter of profitability • Achieving $X million in revenue

36. The “Fully Funded” Folly TechnologyWorks A Customer Buys Idea isFeasible Valuation Risk (ß) Capital Fully Fund IPO (……….pray……………….)

37. Funding to Milestonesaka “Old-Fashioned Venture Capital” Idea isFeasible TechnologyWorks A Customer Buys P(success) = 80% Req’d IRR = 30% Valuation P(success) = 50% Req’d IRR = 50% P(success) = 40% Req’d IRR = 70% P(success) = 30% Req’d IRR = 100% Risk (ß) Capital Seed Funding R&DCapital Go-to-MarketCapital ExpansionCapital

38. What is the planned "Use of Proceeds"? • Investors want to know how their money is being deployed • Capital to invest in sales/market growth • What will it allow you to accomplish? • When will your company break even in terms of profitability and cash flow? • The ultimate goal is to reach an exit scenario • Profitable businesses are more attractive to potential buyers or public markets

39. Summary • Create value by managing risk • Communicate the business strategy in easily understandable and believable financial terms • Strategy & Financials - complementary and consistent • Projections need to be realistic and believable • Focus on information that really matters • Numbers should support strategy and key drivers of success • Integrate assumptions and statements • Bottoms Up approach • Funding milestones within cash and revenue projections • Reduce risks of the business • Funding milestones Especially mng’t quality and experience • Understand the Operating Cycle • Don’t run out of Cash!! ►