Lecture 12 Financial Modeling of a Start-up Business Feb 23, 2012

HW for Feb 28 Write an expense plan for the first 3 years. How much money will you need to start the company? 50% Latest marketing results primary and secondary 30% How will your company be managed? Show org chart including hires 20%

Financial Modeling How do you model a future set of events of which you know little? Why would you model such events? Who would believe it if you did?

Why do it? – Plans for the future Have you forgotten anything? – Creates debate No one right answer – Isolates assumptions for testing – Self-Consistency Look for inconsistencies – Sensitivity Analysis What’s important?/what’s not? Informs management focus – Drives funding events

Hockey Stick Revenue $$ Time Now What’s wrong with this picture?

requires lots of money earlier revenue is much more desirable low credibility Hard to value How long will the flat section last Bored with seeing it. Very common Leave out how high it is going to go

Can I improve it? Hard If Biotech or some other product that requires government certification If product is still in the lab requiring development If the market is not ready for the product If the product requires enormous investment Breaking into an established market Spike in the cost of inputs Macroeconomic Factors Other?

Sharpen your pencil Consider every line item of expense with the question – How can I eliminate it? – How can I reduce it? – How can I delay paying it? Consider the times to bring money into the enterprise with the question – How can I reduce them? Consider the revenues that are earned with the question – How can I increase them?

Can I improve it? How to improve Think of some short term product that can earn money quickly License Get DARPA or other government funding Mixed Consulting/Product development model Technology so incredibly compelling that can get “patient money”* Get larger investment to speed up

Assume Angel/VC Funding of $5M $M T years Is this a viable investment?

Assume Angel/VC Funding of $5M $M T years Is this a viable investment? More likely a “lifestyle business - not an Angel candidate

Assume Angel/VC Funding of $5M $M T years Is this a viable investment?

So let’s say that this is a good investment $M T years Is this not a good place to start?

$M T years Consider number of products Consider number of markets So we have the “answer” Can we make it real?

$M T years Assume n=3 So we have the “answer” Can we make it real? Product 1 Product 2 Product 3

What assumptions can we make? (keep track!) What must we consider now in our model? What are the risks? (and how would you abate them) Let’s assume that this “answer” is not too ridiculous

Consider revenue side first Start with time What is the sales cycle? – Amount of time to make sale – How can you accelerate? Consider distribution modes – What is the price of your product? – How many can you sell? In what period of time? – Can you increase the number of business models to earn revenue? – How do you phase your product introduction?

accelerate Publications Third party validation Competition Refer to waldo Advertising Free trials Partner with complementary companies

Month Sales Volume Avg. PriceTotal Sales $ Jan Feb-11 - Mar-11 - Apr-11 - May-11 - Jun-11 - Jul-11 - Aug-11 - Sep-11 - Oct-11 - Nov-11 - Dec-11 -

Consider now costs SGA People – Marketing – Sales – Technology Accounting Equipment Office Rent and expenses Materials for product Legal – Incorporate or partnerships – Patent – Capital – Employment – Contracts

What is COGS? Cost of Goods Sold is the direct cost to make and sell product. – Direct labor (hours X rate) – Purchased materials used in product

Month Revenue - COGS =Gross margin Jan-11 - Feb-11 - Mar-11 - Apr-11 - May-11 - Jun-11 - Jul-11 - Aug-11 - Sep-11 - Oct-11 - Nov-11 - Dec-11 -

Selling General and Administrative Expenses (SGA) Payroll costs (salaries, commissions, and travel expenses of executives, sales people and employees) Advertising expenses Other

SG&A MonthSalariesRentLeasesOtherTotal Jan-11 $0 Feb-11 0 Mar-11 0 Apr-11 0 May-11 0 Jun-11 0 Jul-11 0 Aug-11 0 Sep-11 0 Oct

Capital costs Equipment Computers - Lease as much as you can! Add to monthly expenses

R&D Costs of developing new products – Salaries – Equipment – Licenses – Consulting – Etc Many businesses are all R&D in the beginning