Exam 2 Content Foundations of Entrepreneurship Fall 2012

Chapter 6 Building the Founding Team

The biggest challenge “There’s plenty of entrepreneurs, plenty of venture capital. What’s in short supply is great teams. Your biggest challenge will be building a great team.” John Doerr – Partner, Kleiner, Perkins, Caulfield, & Byers (kpcb.com)kpcb.com

Anchoring vision in team philosophy and attitudes The most successful entrepreneurs seem to anchor their vision of the future in certain entrepreneurial philosophies and attitudes: –What a team is –What its mission is –How it will be rewarded Unwritten ground rules, rewards, compensation, and incentive structures rest o these philosophy and attitudes

Anchoring vision in team philosophy and attitudes “The capacity of the lead entrepreneur to craft a vision, and then to lead, inspire, persuade, and cajole key people to sign up for an deliver the dream makes an enormous difference between success and failure.” Jeffrey Timmons

Way To Success Feedback Increased skill set Higher social level of support Moral support Capacity for innovation Extended network Advantages of having a team for a start-up

Things to keep in mind when creating a start-up Evaluate your skills Use your strengths Ask for feedback of your actions

Building a powerful team Create a staffing plan Find people to fill positions Your personal network Your advisors’ Network Your extended Network  Friends  Family  Professors  Alums

Attributes of successful teams Cohesion – “We’re in this together” Teamwork – make others’ job easier; no individual heroes Integrity – hard choices and trade-offs based on what is good for the customer Commitment to the long haul – no one benefits by signing up now and bailing out early Harvest mind-set – capital gain is the goal, not a paycheck

Attributes of successful teams Commitment to value creation – making the pie bigger for everyone Equal inequality – democracy does not work well in start-ups (more on next slide) Fairness – rewards are based on contribution, performance, and results over time Sharing of the harvest – 10 – 20% of “winnings” is frequently set aside to distribute to key employees; characteristic of the most successful entrepreneurs

Equal inequality Company A - 4 employees 34% to president, 23 % each for marketing and technical VPs, 6% for controller

Equal inequality Company B – 7 employees 22% to president, 15% each for four VPs, 9% each to two other contributors

Filling the gaps “Successful entrepreneurs search for people and form and build a team based on what the opportunity requires, and when.”* Team members contribute high value when they complement and balance the lead entrepreneur and each other The process of evaluating and deciding who is needed, and when, is dynamic and not a one- time event * Timmons, 1975

Filling the gaps The founder Every team starts with the founder (aka, the lead entrepreneur) Founder determines whether team is needed, assesses talent, skills, track record, and contacts of possible members Founder needs to determine what the venture requires in order to succeed

Filling the gaps The opportunity Whatever the team needs are depends on the fit between the lead entrepreneur and the opportunity Entrepreneur must clearly define: –the value added and logic of business model (revenues and costs) –Critical success factors –Extent to which s/he has access to critical resources and relationships

Filling the gaps Outside resources Gaps can be filled by external resources: Boards of directors, accountants, lawyers, consultants, etc. Entrepreneur must consider: –Whether need is specialized, one-time or part- time or a critical continuous need –What trade secrets might be compromised if external expertise is used

External Team Members Virtual team Outside Investors LawyersAccountants Board of Advisors Board of Directors

Do Nots of double employment Do not use your employer’s resources Do not expropriate intellectual property from your current employer Do not solicit your employer’s customers until you quit the job Do not conceal the fact that you are founding your own venture

Compensation nameAdvantagesDisadvantages Founder SharesAttracts co-foundersDilutes owner’s equity Option poolTies employees’ goals to those of the company Employees may leave the company if the price falls Restricted stockVested over time, expensed at current share price Expensed at current price Stock appreciation rightsLow cost to the companyDilutes owner’s equity Phantom stockEmployees do not receive equity Needs cash to be exercised Types of Compensation

Problems that new venture teams face Burn-out Interpersonal Conflicts Family Pressure

Slicing the founder’s pie Making the pie as big as possible is the primary consideration The ultimate goal of any VC-backed firm is to realize a 5x to 10x ROI, usually via IPO or acquisition by larger company “Work backwards” from IPO capital structure to determine what will happen and who will get what

Chapter 8 Building Your Pro Forma Financial Statements

Reduced survival chance Underestimating time to secure financing Top-down versus bottom-up forecasting Lack of comparables Underestimating time to generate revenues Underestimating costs Not understanding the revenue drivers Common mistakes entrepreneurs make

Financial Statements Income Statement Balance Sheet Statement Of Cash Flows

Building Integrated Financial Statements BUILDING YOUR PRO FORMA FINANCIAL STATEMENTS Build-up Method Comparable Method Final Steps

BUILD-UP METHOD Revenue Projections COGS Operating Expenses Revenue Worksheet COGS Worksheet Operating Expense Worksheet Preliminary Income Statement

COMPARABLE METHOD Choose industry metrics Compare your projections to other companies and industry average Benchmark other companies in the industry

BUILDING INTEGRATED FINANCIAL STATEMENTS INTEGRATED FINANCIAL STATEMENTS Income Statement Monthly forecasts for years 1 and 2 Adjust monthly forecasts according to seasonality Annual forecasts for years 3-5 Balance Sheet Consider Accounts Receivable Show outflow and depreciate PP&E Consider Accounts Payable Statement of Cash Flows

 Focus on major infusions of cash describe the nature of your  accounts receivables and payables  Mention PP&E expenses PUTTING IT ALL TOGETHER 2-3 page explanation of your Financial Spreadsheets  Talk about revenue drivers  Talk about seasonality  Discuss the expense categories  Focus on major infusions of cash  Describe the nature of your cash flows  Accounts receivables and payables  Mention PP&E expenses  Talk about major asset categories, and any Liabilities that aren’t clear from the previous discussion Discuss the Income Statement Discuss the Cash Flow Statement Discuss the Balance Sheet

The Business Plan

Why write a business plan? Always when a new venture needs outside funding Early in the planning process when you are looking at a large-scale project Later or not at all when you are bootstrapping Dollinger, 2008

Costs and benefits of planning Writing a plan takes considerable time, money, and energy Every plan deals with economic uncertainty and risks posed to new venture – founders may be uncomfortable confronting risks and uncertainties and avoid writing a plan Writing the plan helps founders confront risks and conflicts before they become serious problems Dollinger, 2008

The plan demonstrates how you 1.Create or add significant value to a customer or end user 2.Solve a significant problem or meet a significant need for which someone is willing to pay a premium 3.Have robust market, margin, and money- making characteristics 4.Have a good fit with the founders, management team at time of market entry, and the risk/reward balance Timmons, 1999

After you write the plan It becomes a point of departure for due diligence for potential investors and to determine risks of venture (technology, market, management, competitive, financial risks) This homework is crucial even if you don’t try to raise outside capital The most valuable investors will see weaknesses, even flaws, and will propose tactics and people to fix them Timmons, 1999

Tips for business planning and raising outside funds RE: Venture capitalists There are a lot of them; don’t talk to all of them Getting a “no” is as difficult as getting a “yes;” qualify your targets and force others to say no Be vague about which other VCs you are talking to Do not meet with an associate or junior member twice without a partner Timmons, 1999

Tips for business planning and raising outside funds RE: The plan Stress your business concept in the executive summary The numbers matter less than the economics (value proposition and business model) Make the business plan look and feel good w/o using “filler” Be prepared to provide copies of published articles, contracts, market studies, purchase orders, resumes, etc. Timmons, 1999

Tips for business planning and raising outside funds RE: The Deal Make sure investors want you as bad as you want them Create a market for your venture Never say no to an offer price Use a lawyer with venture deal experience Don’t stop selling until the money is in the bank Timmons, 1999

Tips for business planning and raising outside funds RE: The fund raising process It is much harder than you ever thought it would be You can last much longer than you ever thought you would The venture capitalists have to do this the rest of their careers Timmons, 1999

Critiquing the plan – General criteria Comprehensiveness – use a template to help Analysis – resource, industry, competitor and product analysis; financial projections with percentages, returns, and comparisons with analogs Reasonableness – assumptions are comparable to benchmarks and facts Writing and presentation – well written and organized Dollinger, 2008

Critiquing the plan – Specific criteria Management – experience, honesty, integrity Resources – rare, valuable, hard to copy, unique Projections and returns – all data must have solid foundation in reality, yet optimistic enough to attract investors Exit – how and when will investors recoup money? Dollinger, 2008

Level 4 Product/ svc fully developed Many users, established mkt 4/14/24/34/4 Level 3 Product / svc fully developed Few users, mkt assumed 3/13/23/33/4 Level 2 Product / svc pilot operable, not developed for production, mkt assumed 2/12/22/32/4 Level 1 Product / svc idea but not operable, mkt assumed 1/11/21/31/4 Evaluation System Level 1 Single would-be entrep Level 2 2 founders, Level 3 Partly staffed mgt team, Level 4 Fully staffed, experience d mgt team Product / svc levelProduct / svc level Management status and experience levels

Writing and editing the plan Steps: Prewriting, writing and rewriting/editing, editing – despite importance of good writing: Research on 20 business plans in a competition: 30% didn’t include specific strategy 40% of teams had no marketing experience 55% failed to discuss technical idea protection 75% failed to identify details of competitor 10% had no financial projections; 15% omitted balance sheets; 80% failed to provide adequate details of the financial projections Dollinger, 2008

Exercises 1.Draft an outline of your business plan –What information do you already have? –What information is still required? How will you get it? 2.Prepare as much of the executive summary as you can. Be concise and informative 3.Critique a business plan –How well does the plan address key issues? –What changes and improvements would you make to the plan? –How well done is the presentation and writing? –Would you invest in this business? Why or why not? Dollinger, 2008

Chapter 10 Raising Money for Starting and Growing Businesses

Ways of raising money Turning to family and friends Approaching business angels Going PublicBeing Acquired Looking for Venture Capital

Four basic ways of evaluating a business  Earning-capitalization valuation  Present value of future cash flows  Market-comparable valuation  Asset-based valuation

Earnings Capitalization Method: Company value = Net Income/ Capitalization Rate Present Value of Future Cash Flows: PV = PV of the future free CF + the residual (terminal) value of the firm Market-comparable Valuation (Multiple of earnings): Total Equity Valuation = NI x P/E

Asset-based Valuation Modified (adjusted) book valueReplacement value Liquidation value

External Financing External Financing Services at reduced rates Vendor financing Leased equipment Government programs Reduced rent Customer financing

Finding business angels 1.Formal angel groups Pros: Easy to find Cons: May charge you for presentation or even business plan submission; Few in number (several thousand) 2. Individual angels Pros: Several hundred thousand Cons: Hard to find and approach – the best way is through your network

Types of Business Angels Entrepreneurial Angels Corporate angels Professional Angels Enthusiast Angels Micromanagement Angels Can be invaluable advisors and mentors Can take over or ruin your company Silent partners Passive investors Intervene in the business

Target Market Product/ Service Competitive Positioning Financial Returns Business Plan Management Team Top 6 factors according to VCs VCs may help you hire a Team Fragmented, accessible, and growing rapidly Better and protected No dominance, distribution channels are open 7X return in 5 years Competent written business plan

Assessing a VC Value added Patience Deep pockets Accessibility Board of directors

Harvesting (exiting) investments Initial Public Offering (IPO) An acquisition A buyback of the investor’s stock Very Unlikely

Pros and Cons of an IPO Financing High Expenses Follow-On Financing Public Fish Bowl Realizing Prior Investments Short-Term Time Horizon Prestige and Visibility Post-IPO Compliance Costs Compensation for Employees Management’s Time Acquiring Other Companies Takeover Target Employee Disenchantment UpsidesDownsides

Advantages and disadvantages of an acquisition for the seller Management Founder and CEO Company Investors Converting stock Employment Agreement Culture Expenses and Commissions Managers can stay focused on building the company Selling a “baby” can be traumatic The buyer usually has big pockets Investors easily exit their investments If it is a cash transaction, the entrepreneurs and employees get cash immediately Key employees sign non-competing agreement There is a risk there will be a clash of cultures The expenses are lower for an acquisition than for an IPO

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Chapter 11 Debt & Other Forms of Financing

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Getting access to funds

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Getting access to funds After using personal savings, start with Internal Sources Home Equity Lines Credit Cards

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Cash conversion cycle Key Components The Inventory Cycle The Accounts Receivable Cycle The Accounts Payable Cycle

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Integrative Approach to Working Capital Management

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Sources of short-term cash: More time for Payables & less for Receivables Sources of Short-term Cash Short-term Bank Loans Negotiating with Suppliers Trade Credit Seasonal Business Credit Terms Tightening up Accounts Receivable Collections

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Obtaining Bank Loans though Accounts Receivables Obtaining Loans against Inventory Obtaining Financing from Customer repayments Choosing the Right Mix of Short-term Financing Obtaining SBA-guaranteed Loans

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Chapter 12 Legal and Tax Issues

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © In this chapter we study Issues related to leaving your current employer to start your own company How to choose an appropriate attorney and accountant Issues related to the legal form for your business Shareholder relationships Insurance and issues related to selling stock to investors

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Corporate opportunity doctrine Identify the opportunity Notify the company about it Look for another opportunity You can use the opportunity The company uses the opportunity The company doesn’t use the opportunity

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Consider when leaving a company… Recruitment of fellow workers Proprietary information Non-competition You may be held liable for persuading people to leave the firm. You may not be allowed to compete with your former employer. Make sure that the information you learned from your previous job is not protected before using it.

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Choosing an attorney and accountant Attorney Choose specialized Accountant Hire early Choose local

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Choice of legal form Forms availableBrief description Sole Proprietorship Owned and operated by one owner who is in total control Partnership Two or more persons go into business for profit, as co-owners, sharing profits and losses Corporation Separate legal entity, with legal existence apart from its owners, the stockholders Limited Partnership One or more general partners, who conduct the business and take on personal risk, and one or more limited partners, who act as passive investors Limited Liability Company Owned by “members,” who either manage the business themselves or appoint “managers” to run it for them

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Comparative table of entities Forms available ControlLiabilityTaxation Administrative obligations Sole Proprietorship Owner has complete control Unlimited personal liability Not a separate taxable entity Only those applicable to all businesses PartnershipPartners share control Joint and several unlimited personal liability Not a separate taxable entity Only those applicable to all businesses Corporation Control distributed among shareholders, directors and officers Limited personal liability Separate taxable entity unless subchapter S selection Some additional Limited Partnership General partners control, limited partners do not General partners: joint and several unlimited personal liability, limited partners: limited liability Not a separate entity unless affirmatively chosen Some additional Limited Liability Company Members share control or appoint managers Limited personal liability Not a separate entity unless affirmatively chosen Some additional

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Shareholder and operating agreement Negotiating employment terms between you and the investor Disposition of equity interests Distribution of company profits Redemption provisions Each party’s obligations -Redemption Agreement -Cross-purchase Agreement Provisions to resolve voting deadlocks between owners Protection for investors against being left behind

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Legal and tax issues in hiring employees Employees as Agents of the Company Employment Discrimination Other Employment Statutes Employment Agreements Equity Sharing

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Insurance Property Liability Key Person Life Business Interruption Group Life, Disability and Health Insurance for Employees

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Legal issues in the sale of securities to investors Two securities offerings that do not have to be registered with government authorities Intra-state offering exemption Offering under $1,000,000 Public placement Private placement

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Chapter take-aways Pay attention to issues related to leaving your current employer to start your own company Choose an attorney who specializes in your industry and an accountant who specializes in your local area Pick the legal form that’s most appropriate for your business Manage shareholder relationships Get the right insurance Know when you don’t need to register stock sales

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Chapter 13 Intellectual Property

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Practical Reasons for Protecting a New Idea  Investors are loath to put money into a venture that cannot establish a unique product niche.  Stockholders will challenge a corporation's investment of its resources in a program that can be easily copied once it is introduced to the market.  All the time, effort, and money people invest in perfecting a product, as well as advertising and promoting it, may be wasted if imitators can enter the market easily.  Moreover, the imitators can cut prices, because they have not incurred the startup expenses the company had to endure to bring the idea from conception to a mass- producible, reliable, and appealing product or service.

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Business Intellectual Properties Patents TrademarksCopyright Trade Secrets

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © International Protections for Intellectual Property

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Licensing and Technology Transfer  Common concerns and clauses  Defining the property being licensed  Limitation on licenses  Assigning value to a license  Royalty rates  Negotiating license agreements  Foreign licenses

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © Software Protection  All manner of software could be protected by patent regardless of how it is perceived, and many patents have been issued on software.  Software specific to the operation of the computer itself is patentable.  All forms of computer programs could be protected by copyright.  Companies can also protect software through a trade secret approach.

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © The Internet  Uploading and downloading of copyrighted material on the internet can be copyright infringement.  Copyright infringement has also been found in some cases against bulletin board operators and administrators who have received and stored such material.  Domain names are taking on some of the characteristics of trademarks.

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © IP Agreements  Preparing employment contracts  Transfer of employee rights to company innovations  How employee moonlighting might compromise confidentiality  Non-competition clauses  Preventing employee raiding  Employee ownership of copyright  Rights of prior employees  Consultant contracts  Confidential disclosure agreements

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. © 3 in 1 These “Bee Movie” Pez dispensers have all three types of intellectual property protections - patent, trademark and copyright.

Bygrave & Zacharakis, Entrepreneurship, New York: Wiley. ©

You’re “dead!” From USPTO.GOV, in the trademarks section…

Protecting trademark names

Seek non-descriptive words The purpose of the mark is to distinguish between products, not to describe the products “Celestial Seasonings” is OK “Tasty Seasonings” would be difficult to protect

Search for any other users Do so both before applying for registration and after registering Go after imitators as soon as you learn about them

Register the mark Register at the state level When it becomes clear you’ll be interstate, register at federal level Renew it six months before it lapses * Registration is not required to prove ownership of a mark, but it gives better protection

Use the mark as registered Do not alter it If change is needed, register a new mark Now Pre-1961

Refer to the trade name as brand Scotch “Brand” Kleenex “Brand” Xerox “Brand” Google “Brand” Why? See next slide

Do not use the name as a verb Using the brand name as a verb poses a challenge to protection of the trade name / trademark –Xerox does not use the term Xeroxing, which could make the term generic –Do Google employees “google?”

License mark to others carefully If others fail to maintain the quality the mark represents, it may lose its identity The “dark side” of brand licensing –Long-term impact. Consumers have expectations when they buy a product with your (brand) name on it - need to use quality monitoring or case auditing –Day-to-day issues. Call centers, customer contact points

Flaunt the mark Otherwise, it may be judged to have become abandoned Put it on the product, advertisements, displays, tags, and manuals