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Explore key financial resources and strategies for entrepreneurs, including measuring financial health, forecasting outcomes, obtaining funding, and managing financial statements. Learn about balance sheets, income statements, ratios, forecasting, and challenges in obtaining financing. Master the art of financial planning and understanding proforma statements.
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Assembling Key Resources: Obtaining, Managing and Using Financial Assets
Three Key Goals for Entrepreneurs • Measuring financial health of new venture—can it survive? • Forecasting its future financial outcomes—earnings, losses, etc. • Obtaining funding—the essential ingredient! • These are necessary in order to know what you will need in terms of outside financing—and whether you can provide internal financing
Measuring Current Financial State: Historical Financial Statements • Reflect past performance—quarterly, annual. • Balance Sheet: most basic—shows assets and liabilities, and owner’s equity • Income Statement: results of operations—over a specific period of time--income (revenues) and expenses during a given period • Shows whether a company is taking in more than it spends—good! Or the opposite—BAD! • Net income; cost of sales; operating expenses are key aspects
Where Are We Now? • What are the new venture’s resources? • What are its debts/obligations • In other words, what’s “going out” • What funds are coming “into” the company • What will happen in the future???
Balance sheet • A snapshot of company’s assets, liabilities, and owner’s equity—at a particular time
Balance Sheets, Continued • Working capital: a company’s current assets minus its current liabilities • Current ratio: current assets divided by current liabilities
Statement of cash flow • This summarizes the changes in a firm’s cash position for a specific period of time, and how these changes occurred • Investing activities • Financing activities • Answers the question: is the firm solvent!
Ratios—a key measure of firm financial health • Return on assets: net income/average total assets • Return on equity: net income/average shareholder’s equity • Profit Margin: Net income/net sales • Liquidity: Measure of extent to which a company can quickly liquidate assets to cover short-term liabilities (and avoid a crisis!) • Current: current assets/current liabilities • Debt: Total debt/total assets
Forecasting The New Venture’s Future Outcomes—Proforma Statements • Forecasts: projections of sales, expenses, income, other costs • Often want to forecast sales, costs of sales, which include break even point • These are the basis for proforma financial statements—ones that project future events rasher than summarize historical ones • Proforma Income Statement: forecasts of future income and expenses—how a firm’s activities will affect its ability to meet short-term liabilities and how finances will change overt time • Proforma Balance sheet: shows current assets and liabilities and projects changes over some period of time • This is where we move from “science” (number, fact) to “art”—”Your guess is as good as mine…”
What is a proforma balance sheet? • A pro forma balance sheet is a financial document that discloses a business’s assets, liabilities, and equity at a specific point in time. This financial statement is not prepared in accordance with Generally Accepted Accounting Standards (GAAP). It is considered more of a balance sheet projection. • Pro forma statements such as the pro forma income statement and the pro forma balance sheet are used in the financial planning process to help determine a business’profitability.
Receivables and Payables • Receivables may refer to the amount due from individuals and companies. Receivables are claims that are expected to be collected in cash. These are frequently classified as: • Accounts Receivable • Notes Receivable • Accounts payable amounts that a person or company owes to suppliers, but has not paid yet (a form of debt), sometimes referred as trade payables. • When an invoice is received, it is added to the file, and then removed when it is paid. Thus, the A/P is a form of credit that suppliers offer to their customers by allowing them to pay for a product or service after it has already been received.
How to Forecast sales, earnings, etc. for a truly new venture? • Definitely an art, not a science • Very tricky—but you must try • Be as realistic and fact-based as possible in order to come up with forecasts that make sense and are in the realm of what’s reasonable
Why Is It Often Difficult for Entrepreneurs to Obtain Financing • Information asymmetry: “I know more about the company than you can ever know…”and than I will ever reveal • This leads to the potential to take advantage of investors • Adverse selection: How can we tell qualified entrepreneurs from others? (Con Artists! Like Bernie Madoff) • Uncertainty problems: How can we predict which new venture(s) will succeed?
How Did Bernie Madoff Con $65 Billion from Investors? • Madoff used a so-called Ponzi scheme, which lures investors in by guaranteeing unusually high returns. • The money from new, incoming investors is used to pay off the promised returns to older ones. • This makes the operation seem profitable and legitimate, even though no actual profit is being made. • Meanwhile, the person behind the scheme pockets the extra money or uses it to expand the operation.
How it Works—Continued • To avoid having too many investors reclaim their "profits," Ponzi schemes encourage them to stay in the game and earn even more money. • The "investing strategies" used are vague and/or secretive, which schemers claim is to protect their business. • Then all they need to do is tell investors how much they are making periodically, without actually providing any real returns. • Bottom line: It is based on…GREED!
Solutions: What Entrepreneurs, VC’s, Banks, Angels, etc. Do to Lessen These Problems • Self-financing by entrepreneurs • Contract provisions—from VCs and others— • Mandatory redemption rights • Convertible securities • Forfeiture provisions, anti-dilution provisions • Control Rights (30% of shares, 51% of board) • Long Vesting Periods—entrepreneurs can’t sell • Specialization, Geographic Localization • Timing—through stages
Why most new ventures need financing..Or Do They? • Most new ventures have a high burn rate—and if they burn through their start-up funds, they can go bankrupt • So, they need a line of credit from a bank or investment capital • Why? For capital expenditures; for lengthy product development cycles—two major causes
Where do start-up funds come from? • Personal funds—especially first year • Friends and Family—of course! • Bootstrapping: use your ingenuity, thriftiness, cost-cutting to avoid requiring external funds • How to Bootstrap?
How to Bootstrap • Buy used equipment • Lease equipment instead of buying • Get payments in advance from customers (good luck!) • Avoid unnecessary expenses • Share/Rent office space • Hire interns
Preparing to raise debt or equity financing • You should prepare—funding is not easy to get! • Figure out how much you need—be realistic! • Identify the most appropriate type of financing or funding • Develop a strategy for engaging potential investors or bankers—elevator pitch
Sources of Financial Resources for Entrepreneurs • SBA (government) • Banks • VCs (private equity investors) • Angels • Brokerage Firms • Bootstrapping
Angel Investors… • What are angel investors or business angels? • Individuals who invest personal capital directly • They can truly benefit: e.g., Mike Markklula--$91,000 in Apple in 1977; in 1980—worth $150 million! • Lots of business angels—including me! • They invest up to $200 billion each year
SBA—what it does • SBA: provided business financial assistance for the past 50 years • Total financial assistance has amounted to $232.9 billion dollars in loans and venture capital financing to small businesses, creating more than 6million jobs. • More than 56 % of business development assistance goes to businesses operating in distressed areas.
SBA by the Numbers • From August 1, 1953 to July 31, 2003, the SBA has provided the following: • 1,182,707 direct and guaranteed 7(a), 504 loans and microloans, totaling $193.11 billion. • 136,000 SBIC financings of venture capital for $39.8 billion to 96,050 businesses since 1958. • 322,582 SBP bids guaranteed for $64 billion contracts. • 1.57 million disaster loans for $30.9 billion. • 64,000 awards worth $11 billion. 2,900 SBTT awards worth $549 million. • 542,000 US Government contracts worth $88 billion. • SBA also provides debt financing—more on this below
- The SBIR Program is structured in three phases: Phase I. The objective of Phase I is to establish the technical merit, feasibility, and commercial potential of the proposed R/R&D efforts and to determine the quality of performance of the small busines s awardee organization prior to providing further Federal support in Phase II. SBIR Phase I awards normally do not exceed $150,000 total 1. costs for 6 months. 2. Phase II. The objective of Phase II is to continue the R/R&D efforts initiated in Phase I. Funding is based on the results achieved in Phase I and the scientific and technical merit and commercial potential of the project proposed in Phase II. Only Phase I awardees are eligible for a Phase II award. SBIR Phase II awards normally do not exceed $1,000,000 total costs for 2 years. 3. Phase III . The objective of Phase III, where appropriate, is for the small business to pursue commercialization objectives resulti ng from the Phase I/II R/R&D activities. The SBIR program does not fund Phase III. Some Federal agencies, Phase III may involve follow - on non - SBIR funded R&D or production contracts for products, processes or services intended for use by the U.S. Governmen t. SBIR: Free Money When You Need It?
SBIR Eligibility Only United States small businesses are eligible to participate in the SBIR program. An SBIR awardee must meet the following criteria at the time of Phase I and II awards: Organized for profit, with a place of business located in the United States More than 50% owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States, or by another for-profit business concern that is more than 50% owned or controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States, and No more than 500 employees, including affiliates. For awards from agencies using the authority under 15 U.S.C. 638 (dd)(1), an awardee may be owned and controlled by more than one VC, hedge fund, or private equity firm, so long as no one such firm owns a majority of the stock. Phase I awardees with multiple prior awards must meet the benchmark requirements for progress towards commercialization.
Friends and Family… • Good source of seed capital • Generally fills < $250,000 funding needs • Very few strings attached • Contribution may take the form of: • Personal loan • Equity purchase • Loan guarantees only, enabling bank financing • Lower expectations for both ownership % and returns • Less capacity for further investment, but often the only source of capital available until further development
Venture Capital… • U.S. VC funds generally look for: • Equity investments > $1 million • Time horizon of 2-5 years to a realizable exit strategy • Merger / Acquisition • IPO • High growth objective (high risk & reward) • VC aims for an average of 30-40% returns per annum upon exit • VCs heavily scrutinize company’s management, growth potential, industry, and valuation • Around 3 in 100 opportunities will get funded • They want, ultimately, 5-20 times their initial investment
What VC’s Provide—and Expect • What VCs provide: • Capital (of course) • Strategic direction and contacts • Staffing • Customers Suppliers • What VCs expect: • A large ownership position in your company, which will dilute the founders ownership, but increase the overall value long-term • Prefer to get their money back at least several times over before sharing profits with other shareholders • Seats on the board of directors • An exit strategy that will allow them to cash out of the company within a relatively short period of time (typically two to five years)
Incubators can help… • Incubators and Raising Capital • Incubators can an take an active role in increasing attractiveness to investors • Provide business, marketing, and strategic plan development and refinement • Offer dedicated on-site marketing support, IT support, and business coach • Provide seminars and workshops to educate owners and employees • Offer help in identifying financing sources, including angel and venture investors • Can assist companies with the preparation of presentations to investors
Crowdfunding—Help With No Strings • What is crowdfunding? • A new way for entrepreneurs to acquire the funds they need • How does it work? • Entrepreneurs place requests for funding on various crowdfunding sites—
Crowdfunding Sites These are popular And More—and new ones all the time Razoo. ... Crowdrise. ... PledgeMusic. ... Sellaband. • Here’s a partial list: • Kickstarter– biggest raised a total of $220 million from 61,000 launched projects so far. .. • Indiegogo. ... • RocketHub. ... • GoFundMe. ...
Crowdfunding Sites Have Different Rules • Kickstarter: “All or Nothing” entrepreneurs set a target, and if they reach it they get the contributions; if they don’t—the money is returned to donors • Gofundme: You can use “all or nothing” or not. Fees are higher if you don’t reach your goal.
Underwriters • These are the big brokerage firms that help market IPOs • They distribute the shares to a large market—much larger than any other route could produce • But they charge high fees for this service • They help to price a new stock
Taking a Company Private: The Opposite of Going Public • Why would anyone do this? • They believe they can run the company better and after it is a success, return it to the marketplace as a public company • They don’t like the rules governing a public company—much more freedom for privately held companies • It gives control to the people who take it private—sometimes, the original founders who have lost control in an IPO
IPO’s: The Dream Realized? • Most entrepreneurs dream about taking their company public • But this is not as unmixed a blessing as they think • Lock-up: can be several years and if the stock drops….! • The regulations (SEC, etc.) for public companies are staggering—and entrepreneurs often don’t know about them or want to deal with them • The price of most new offerings drops within the first year or two, so there is no guarantee of the huge gains most entrepreneurs dream about • Still, this is the Golden Ring—and a successful IPO can make an entrepreneur into a billionaire! (e.g., Google)
How is an IPO Stock Priced? • Look at the multiples (price x earnings) in the industry • Look at competing companies (if there are any) • Look at the balance sheet • Then, there can be discounting (underpricing) • Why does it occur? To help the stock move!
