Entrepreneurial Finance in Less than One Hour Michael Dearing Stanford University 2010 Copyright 2008 Michael Dearing.

WARNING TONS of details are missing from this You have to do a lot more reading and learning You should get a lawyer to help you But you will know more than most people at the end of this Copyright 2008 Michael Dearing.

Promise This is mostly seventh grade math and basic common sense It's wrapped up in a vocabulary created by elites who like to stay elite by making this sound hard; it's not hard at all You will annoy the finance priesthood with your knowledge If you learn these concepts, read a few suggested books, practice with a calculator and spreadsheet, you can handle anything related to financing a new venture Copyright 2008 Michael Dearing.

Agenda I. Five Basic Concepts II. Four Nouns III. Three Rules of Thumb Copyright 2008 Michael Dearing.

I. Five basic concepts Cash is life Cash comes from debt, equity, or operations Growth eats cash Risk goes down in chunks Value = f (all future cash flows) Copyright 2008 Michael Dearing.

Cash is life CASH ASSET S SALE S BILL S “PRODUCT S” LEFTOVER CASH Copyright 2008 Michael Dearing.

ACME Lemonade Stands Copyright 2008 Michael Dearing.

Balance Sheet = Assets Liabilities & Shareholders' Equity Where does the money come from? Copyright 2008 Michael Dearing.

Balance Sheet = Assets Liabilities & Shareholders' Equity Where does the money come from? Cash + What we buy with the capital to be in business Copyright 2008 Michael Dearing.

Balance Sheet = Assets Liabilities & Shareholders' Equity Where does the money come from? Debt Shareholders Operations Cash + stuff we buy with the capital to be in business Copyright 2008 Michael Dearing.

Balance Sheet = Assets Liabilities & Shareholders' Equity Where does the money come from? Debt Shareholders Operations Cash + stuff we buy with the capital to be in business Lemons Sugar Water Stand Copyright 2008 Michael Dearing.

Profit & Loss Copyright 2008 Michael Dearing.

Financial Plumbing RIGHT SIDE (where $ came from) LEFT SIDE (the stuff we need) = Sales Gross profit Expenses Op profit Taxes Net Income P&L Balance Sheet Turn Net Income into Cash Flow* * See Higgins for a great explanation of how to calculate cash flow from net income; we don't have time to do it now! Copyright 2008 Michael Dearing.

Financial plumbing Cash raised on right side of balance sheet Cash invested in stuff to make the business run on the left side of the balance sheet Humans use stuff on the left side of the balance sheet to make revenue Revenue pays bills Profits turn into cash Cash comes back to the balance sheet Copyright 2008 Michael Dearing.

Growth eats cash Go back to the lemonade stand financial statements Copyright 2008 Michael Dearing.

Growth Eats Cash? RIGHT SIDE (where $ came from) LEFT SIDE (the stuff we need) = Sales Gross profit Expenses Op profit Taxes Net Income P&L Balance Sheet Turn Net Income into Cash Flow* * See Higgins for a great explanation of how to calculate cash flow from net income; we don't have time to do it now! Copyright 2008 Michael Dearing.

Growth eats cash Go back to the lemonade stand financial statements If you grow sales, expenses or assets faster than you grow internally generated cash flow to pay for them you *must* raise cash from outside the company.(1) (1) Robert Higgins, Financial Analysis for Managers, Chapter 4, "Managing Growth." Copyright 2008 Michael Dearing.

Raising capital When? How? How much? Copyright 2008 Michael Dearing.

Risk goes down in chunks Can I make lemonade? Will anyone buy it? Can I advertise to increase sales? Can I produce enough to satisfy demand? Can I reduce my costs in order to increase profits? Can I expand from one stand to many? t = 0 Copyright 2008 Michael Dearing.

Risk goes down in chunks Can I make lemonade? Will anyone buy it? Can I advertise to increase sales? Can I produce enough to satisfy demand? Can I reduce my costs in order to increase profits? Can I expand from one stand to many? t = 0 SEE D SERIES A SERIES B Copyright 2008 Michael Dearing.

Value = f (cash flows) Robert Higgins – Analysis for Financial Management o Why cash drives value o What is present value and the time value of money o How to incorporate these concepts into your plans and actions Copyright 2008 Michael Dearing.

II. Four Nouns Convertible debt Preferred stock Angel investors Venture capitalists Copyright 2008 Michael Dearing.

Back to the Balance Sheet (R) Debt financing o Trade credit o Bank loans o Convertible debt ** o Public debt Equity financing o Common stock o Preferred stock ** Retained Earnings Copyright 2008 Michael Dearing.

Convertible debt Borrow money from one or more entities Converts to equity when equity is raised at some future date Converts at a discount to the price paid by the new equity investors Copyright 2008 Michael Dearing.

Preferred stock Ownership in the company in exchange for cash Price (value of the company) is negotiated: “pre” money “Post” = “pre” + new capital raised Staged in series (seed, A, B, C …) Better liquidation rights than common A bunch of other terms – rights, resale, conversion to common Copyright 2008 Michael Dearing.

Angels Wealthy individuals Range of sizes – small ($25-50k) to large (up to $1 mil) Some do notes, some do “priced rounds” (preferred stock) Some are active, some are passive Silicon Valley has lots of them Copyright 2008 Michael Dearing.

Venture capitalists Typically operate a fund made of other people’s money: pensions, endowments, rich people, institutions Focus on equity investments, rarely do convertible debt Invest larger sums than angels on average Make money via carried interest and a management fee on the fund Copyright 2008 Michael Dearing.

Investor and security type Convertible debtPreferred stock AngelsOften (smaller)Sometimes (larger) Venture capitalistsRarelyAlmost always Copyright 2008 Michael Dearing.

III. Three Rules of Thumb Match your financing to your milestones to your strategy to your values and dreams Know what is “market” – what has happened in other deals -- it will level the playing field and simplify the process You will make money by building great products and a great business – not by negotiating “great” terms on your financings (this goes for both sides of the deal!) Copyright 2008 Michael Dearing.