Lecture 6 Timmons Chapter 12

1. Lecture 6Timmons Chapter 12

2. Entrepreneurial Finance • The Achilles’ Heel • Three core principles of entrepreneurial finance: • More cash is preferred to less cash

3. Entrepreneurial Finance • The Achilles’ Heel • Three core principles of entrepreneurial finance: • More cash is preferred to less cash • Cash sooner is preferred to cash later

4. Entrepreneurial Finance • The Achilles’ Heel • Three core principles of entrepreneurial finance: • More cash is preferred to less cash • Cash sooner is preferred to cash later • Less risky cash is preferred to more risky cash

5. Exhibit 12.4

6. Entrepreneurial Finance • The crux of it is anticipation • What is most likely to happen? When? • What can go right along the way? • What can go wrong? • What has to happen to achieve our business objectives and to increase or to preserve our options?

7. Entrepreneurial Finance • The crux of it is anticipation • What does it mean to grow too fast in our industry? • How fast can we grow without outside debt or equity? How much capital is required to increase or decrease our growth by X percent? • How much can be financed internally and how much will have to come from outside sources? • What about our pricing, our volume, and costs?

8. Entrepreneurial Finance Shareholders Value Creation Customers Employees

9. Entrepreneurial Finance Allocating Risks and Returns Slicing the Value Pie Cash-Risk-Time

10. Entrepreneurial Finance Debt: Take Control Covering Risk Equity: Staged Commitments

11. Exhibit 12.3

12. Entrepreneurial Finance • The Owner’s Perspective • Cash flow and cash • Cash flow and cash are King and Queen in entrepreneurial finance • Time and timing • In entrepreneurial finance, time for critical financing moves often is shorter and more compressed • Capital markets • Capital is one of the least important factors in success of higher potential ventures. High-potential founders seek not just capital, but investors who will add value, skills.

13. Entrepreneurial Finance • The Owner’s Perspective • Emphasis • Non-economic factors are important in raising capital. Backers should add knowhow, wisdom, counsel and help. • Strategies for raising Capital • Maximizing amounts raised also increases risk. Therefore, effectuation and staged commitment. Entrepreneurs may turn down capital if valuation is less attractive and prospects are good. • Downside Consequences • Consequences of failure are much higher for entrepreneur than CEO of a larger business.

14. Entrepreneurial Finance • The Owner’s Perspective • Risk-Reward Relationships • Capital markets are idiosyncratic and less efficient with these sorts of transactions. • Valuation Methods • Established valuation models tend to favor sellers. • Conventional financial ratios • Financial ratios are misleading when applied to most private entrepreneurial companies

15. Entrepreneurial Finance • The Owner’s Perspective • Goals • Creating value over the long term, rather than maximizing quarterly earnings, is a prevalent mind-set and strategy among successful entrepreneurs

16. Entrepreneurial Finance • Financial Strategy Framework • The opportunity leads and drives the business strategy, which in turn drives the financial requirements, the sources and deal structures, and the financial strategy. • Once the core market opportunity and strategy are defined, the entrepreneur can begin to examine the financial requirements in terms of operating and asset needs, and then pursue a fund-raising strategy.

17. Entrepreneurial Finance • Free Cash Flow: Burn Rate, OOC and TTC • The core concept in determining the external financing requirements of the venture is free cash flow. Three vital corollaries are the burn rate, time to OOC (out-of-cash time), and TTC (time to close financing).

18. Free Cash Flow • The cash flow generated by a company or project is defined as follows: • Earnings before interest and taxes (EBIT) • Less tax exposure (tax rate times EBIT) • Plus depreciations, amortization, and other non-cash charges • Less increase in operating working capital • Less capital expenditures

19. Operating Working Capital • Operating working capital can be defined as follows: • Transactions cash balances • Plus accounts receivable • Plus inventory • Plus other operating current assets • Less accounts payable • Less taxes payable • Less other operating current liabilities

20. Operating Working Capital • Operating working capital can be defined as follows: • Earnings before interest but after taxes (EBIAT) • Less: Increase in net total operating capital (FA+WC) • Where increase in net total operating capital is • Increase in operating working capital • Plus Increase in net fixed investments

21. Exhibit 12.5

22. Entrepreneurial Finance Raise Money When You Do NOT Need It.

23. Entrepreneurial Finance • Crafting financial and fund-raising strategies • Critical Variables affect availability of funds: • Accomplishments/performance to date • Investor’s perceived risk • Industry and technology • Venture upside potential and anticipated exit timing • Venture anticipated growth rate • Venture age and stage of development

24. Entrepreneurial Finance • Crafting financial and fund-raising strategies • Critical Variables affect availability of funds: • Investor’s required rate of return or IRR • Amount of capital required and prior valuations of venture • Founders’ goals regarding growth, control, liquidity and harvesting • Relative bargaining positions • Investor’s required terms and covenants

25. Exhibit 12.6

26. Entrepreneurial Finance • Financial life cycles • Ex. 12.6 details the types of capital available over time for different types of firms at different stages of development • Many equity sources are not available until firm survives early growth stages • Upside potential of firm is a big part of availability

27. Entrepreneurial Finance • Financial Life Cycles • Foundation firms • Will total 8-12% of all new firms; will grow more slowly but exceed $1 million in sales and may grow to $5 million to $15 million • High-potential firms • Grow rapidly; likely to exceed $20 to $25 million; strong prospects for IPO and have widest array of funding opts. • Lifestyle firms • Limited to personal resources of founders, and whatever collateral or net worth they can accumulate.

28. Entrepreneurial Finance • Team Activity • What are the key entrepreneurial finance issues that your IBP team will need to anticipate that are: • Critical to the venture? • Unique to the venture? • Your team has 20- 25 minutes to prepare answers to these questions. Select a spokesperson and prepare an overhead with your responses to present to the class.