Financing Your Venture

1. Financing Your Venture Valuation of the Venture

2. 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?

3. Basic Financial Concepts

4. Basic Financial Concepts Balance Accounting is like a balance beam,

5. Basic Financial Concepts Balance When we add to one side,

6. Basic Financial Concepts Balance We must add the same amount to the other side.

7. Basic Financial Concepts Definitions • Asset: • Something we own • Cash, inventory, building, land • Something that someone owes to us • Account receivable, loan receivable • Liability: • Something we owe to someone else • Account payable, loan payable

8. Basic Financial Concepts Definitions • Revenue: • When we earn something • Sell inventory, charge interest, bill for time worked • Expense: • When we do something to earn revenue • Advertising, COGS, wages • Income: • Revenues less Expenses

9. Basic Financial Concepts Definitions • Equity: • The owners’ (shareholders’) investment • Share capital • Accumulated income, year after year • Retained Earnings

10. Basic Financial Concepts Definitions Assets = Liabilities + Owners’ Equity A = L + E

11. Basic Financial Concepts A = L + E

12. Basic Financial Concepts Financial Statements • Balance Sheet • Income Statement • Statement of Cash Flows

13. 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)

14. Basic Financial Concepts Financial Statements – Balance Sheet • How much we have, what we owe, and what we’re worth • Assets • Liabilities • Equity

15. Basic Financial Concepts Financial Statements – Statement of Cash Flows • Where the cash came from and where the cash went • Shows how each of the 3 business activities affected cash during the period

16. Basic Financial Concepts The Activities of a Business • Each business has 3 types of activity • Operating Activities • Investing Activities • Financing Activities

17. Basic Financial Concepts The Activities of a Business - Operating Activities • The activities that the business was formed to carry out • Most items found on the Income Statement • Day to day sale of goods, advertising, wages • Excludes some unusual activities on the IS: e.g. Gain on Sale of Assets • Some activities not found on the Income Statement • Pay money we owe to a supplier • Collect money from a customer • Increase or reduce our inventory

18. Basic Financial Concepts The Activities of a Business – Investing Activities • Purchase or sale of fixed assets • Buy land or a building • Sell a car • Purchase production equipment

19. Basic Financial Concepts The Activities of a Business – Financing Activities • Getting enough money to run the business • Borrow money from the bank • Repay money to the bank • Pay interest to the bank • Issue new shares

20. Basic Financial Concepts The Activities of a Business • The 3 activities can be found in certain parts of the FS • Operating activities • Income Statement (after adjusting for non-operating items) • Balance Sheet (current assets & current liabilities) • Investing Activities • Balance Sheet (fixed assets) • Financing Activities • Balance Sheet (non-current liabilities & Equity)

21. Financial Projections Overview • Financial projections: simply future Financial Statements • Projected Balance Sheet • Projected Income Statement • Projected Statement of Cash Flows • A “Baht & Satang” summary of the business plan • Your business plan in the language of numbers

22. 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!!!

23. Financial Projections Overview Elements & Chronology of the Projections • Explicitly stated assumptions • Projected Income Statement • Projected Statement of Cash Flows • Projected Balance Sheet • Analysis

24. 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

25. 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.

26. Financing Options: Debt and Equity • In most cases, Equity is more expensive than Debt financing. +New stock issue • Dividends • Stock repurchase +New debt issue +Tax shield • Interest payments • Principal repayment Liquidity Level -Taxes -Uses of capital Debt Equity -Net Working Capital -Capital Expenditures

27. 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?

28. 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.

29. 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.

30. 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.

31. 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.

32. Valuation What is your hard work worth?

33. 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

34. Which would you rather have? THB 1000 Today THB 1000 One Year from Today

35. What is THB 1000 worth? • Today => THB 1000 • One year from now? Answer comes from the Time Value of Money • What is theDiscount Rate? For an investor, what return does he or she want on an investment?

36. If you had THB 1000 today… …in one year it would be worth…

37. And, if you wanted THB 1,000 in one year… …you would need to invest…

38. 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

39. 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.

40. 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.

41. 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.

42. Building up your financial projections Instruction Slides to explain Sample Projections Worksheet

43. Financial Projections Preparation Assumptions • The critical part of creating the projections • Reflects the research carried out as the project develops • The assumptions also reflect your business model • Consider: • Direct sales force vs. distributors • Manufacture vs. outsource • Licensed technology vs. owned technology • Target market, market segments, and order of entry • Revenue model: charge per use, per unit, per period

44. Financial Projections Preparation Assumptions • Carry the assumptions forward • Time periods match the periods in the projected FS • E.g. monthly for the 1st year, annually for next 4 years • Layout for Sensitivity Analysis • Identify 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 layout • See sample projections

45. Financial Projections Preparation Assumptions This is the only place where numbers are “hard keyed”!

46. Financial Projections Preparation Assumptions Steps • Label a worksheet “ASMP” • Format for the appropriate time periods • Develop assumptions for the business environment • Develop assumptions for each Business Activity Type • Review the assumptions with your advisor

47. Financial Projections Preparation Assumptions – Business Environment • Economy • Exchange rates, base interest rates, GDP growth, inflation • Industry • Market size, annual market growth

48. Financial Projections Preparation Assumptions – Business Activity Types • Operating Activities • Revenue: price per unit, market share >> # units sold • CGS: raw materials, labor • Are CGS components expressed as % of sales, or fixed cost per unit? • Expenses: fixed expenses, variable expenses • Fixed consider: rent, salaries, advertising, professional fees • Variable consider: royalties, reserve for litigation, distribution costs

49. Financial Projections Preparation Assumptions – Business Activity Types • Operating Activities • Income Taxes: tax holiday (BOI), tax rate • Non-cash current assets & liabilities: A/R, A/P, Inventory • How & 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)

50. 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?