Entrepreneurial Finance Chapter 12 Dowling BA 560 Fall Term 2006

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

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

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

Exhibit 12.4

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

Entrepreneurial Finance The crux of it is anticipation The crux of it is anticipation What does it mean to grow too fast in our industry? 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 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? How much can be financed internally and how much will have to come from outside sources? What about our pricing, our volume, and costs? What about our pricing, our volume, and costs?

Entrepreneurial Finance Value Creation Shareholders Customers Employees

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

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

Exhibit 12.3

Entrepreneurial Finance The Owner’s Perspective The Owner’s Perspective Cash flow and cash Cash flow and cash Cash flow and cash are King and Queen in entrepreneurial finance Cash flow and cash are King and Queen in entrepreneurial finance Time and timing Time and timing In entrepreneurial finance, time for critical financing moves often is shorter and more compressed In entrepreneurial finance, time for critical financing moves often is shorter and more compressed Capital markets 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. 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.

Entrepreneurial Finance The Owner’s Perspective The Owner’s Perspective Conventional financial ratios Conventional financial ratios Financial ratios are misleading when applied to most private entrepreneurial companies Financial ratios are misleading when applied to most private entrepreneurial companies Goals Goals Creating value over the long term, rather than maximizing quarterly earnings, is a prevalent mind-set and strategy among successful entrepreneurs Creating value over the long term, rather than maximizing quarterly earnings, is a prevalent mind-set and strategy among successful entrepreneurs

Entrepreneurial Finance Financial Strategy Framework 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. 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. 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.

Entrepreneurial Finance Free Cash Flow: Burn Rate, OOC and TTC 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). 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).

Exhibit 12.5

Entrepreneurial Finance Raise Money Money When WhenYou Do Do NOT NOT Need Need It. It.

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

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

Exhibit 12.6

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

Entrepreneurial Finance Financial Life Cycles Financial Life Cycles Foundation firms 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 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 High-potential firms Grow rapidly; likely to exceed $20 to $25 million; strong prospects for IPO and have widest array of funding opts. Grow rapidly; likely to exceed $20 to $25 million; strong prospects for IPO and have widest array of funding opts. Lifestyle firms Lifestyle firms Limited to personal resources of founders, and whatever collateral or net worth they can accumulate. Limited to personal resources of founders, and whatever collateral or net worth they can accumulate.

Entrepreneurial Finance Class Activity

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

Additional Ch. 12 Materials

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

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