Financial Projections & Valuation

Financial Projections The canvas tells the story of your venture in a structured way. Income Statement Balance Sheet Cash flow The financial projections are a model of your venture, showing how your assumptions will play out. A change in one must affect the other

Your financial model: data you’ll need REVENUE Price: What will your price(s) be, and why? Units: How will your units sold grow over time? What drives it? COST COGS: What is your cost for each unit? Expense: What costs will you need to expend to run the business?

Context for engineers A virtual simulation that models a real-life system in mathematical terms, enabling rapid and low- consequence scenario testing. Ditto.

Income statement How much you sold Your cost for the units you sold How much is left over Things you spent money on whether or not you sold anything Profit (or in this case loss)

What do you think investors look for? You have money to invest, and you are looking at two interesting ventures that are in a similar space What is the “investment ask” for each? What are the pros and cons of each venture? Growth rate Gross margins What implied assumptions do you see Cost of acquiring revenue Amount spent on R&D

What are investors looking for in your financial projections? A growth rate that is interesting Attractive gross margins (50-60% is good if you are a business with R&D) Red ink (losses) that match your funding request The “Smell test” re assumptions: –Based in reality –Well thought-out and reasonable –You know your assumptions and have a plan for validating them

Forecasting Revenue – one common approach We’ve developed an innovative new free-range donut. We plan to open a chain of free-range donut shops starting in Vancouver. Our revenue projection: The market size is $100 million in Vancouver. Conservatively, all we need is 1% of the market. So our annual sales in Vancouver will be $1,000,000. We’ll expand our market share, and add cities at 2 per year. With 10 cities we will be at $15,000,000 annually. Then we’ll expand into the US.

Forecasting Revenue – better: A DRIVER is a business lever you can adjust to affect your revenue. PRICE: for each “unit” sold CHANNEL: is someone taking a percentage? Number of UNITS: The number of units you sell increases over time. What are the actions you are taking to cause this? Consider your initial assumptions to be hypotheses, and determine how to test them. Your test results bring credibility. And these will be your operating metrics in future!

Example: a Web business DriverValue Monthly Google searches1,000,000 Other search engine searches 300,000 Total searches1,300,000 DRIVER: Clickthru rate5% Monthly traffic from search65,000 (5% of 1.3MM) Other traffic (Twitter, Facebook..)26,000 Total traffic91,000 DRIVER: Conversion - % that buy10% PRICE: Revenue per new customer$0.99 New revenue per month$9,009 Revenue/mo from repeat customers$4,000 DRIVER: Attrition rate 10%- $400 Total revenue per month$12,609

Example: a direct sales business DriverCalculation Leads generated per $100 marketing spend Input Marketing $, get lead quantity Lead conversion rate to opportunityEnter conversion %, get opportunity qty Opportunities handled per salespersonGet number of salespeople needed Average deal size & close ratio# of salespeople x avg deal size x close ratio = gross sales Average sales cycleNew Sales per unit time % of revenue from repeat customersAdd repeat Sales per unit time

Channel refresher 12 Cost of GoodsExpensesReseller Source:Mark Leslie, Stanford GSB Expenses Price paid by buyer (100%) Cost of Goods (COGS) Reseller Channel Profit Direct Sales Your Revenue Price paid by buyer (100%) Profit

Costs COGS – Cost of goods sold. –How much does each unit cost? Expenses –Amounts you spend each period whether or not you make any sales Capital –One time purchases of expensive things like manufacturing machinery

Jobs to be done Think about the “jobs to be done” Each “job to be done” has a cost Decide who is going to do the job. If indirect channel, then this reduces your revenue rather than increasing your cost. If you have indirect channel – do they do the jobs that need to be done completely, partly, or not at all?

See template spreadsheet.

Some expenses to think about InsuranceConsultants RentPatent costs Telecom costsHosting LegalSalaries AccountingBenefits TravelCommissions MarketingBonuses Trade shows

Financial projections –session 2

Things to consider (1) BMC sections are inter-dependent. A change in one section will impact other sections. Direct channel: higher revenue, higher cost. Indirect channel: lower revenue, lower cost. Self serve model: low service costs; consider cust acquisition cost. Hi touch model: high service cost. Luxury customers: likely hi-touch model. Hi margin. Commodity customers: lower cost model, higher volume, lower margin. Visible product: brand building costs. Embedded or licensed product: IP protection. Product design R&D. In house? Outsourced? Bloggers OEMs Manufacturing Hosting

Things to consider (2) Think of your costs being driven by revenue (not the other way around). –If you could double revenue by doubling salespeople, you’d just keep adding people until you employed the population of the world. Watch out for Butterfly Effect – where in your financial projection model will a relatively small change in assumption lead to a big change in results? –Investors will find these. It usually ends badly if you aren’t prepared to address them.

Financial projections - summary 1.Your financial projections must closely reflect your business model canvas. They tell the same story! 2.Investors look for growth rate, high margins, realistic and test-able assumptions. 3.Revenue should be built bottom-up from your business drivers. 4.Costs should be driven by achievement of revenue. 5.Understand the major sensitivities in your model.

Next up: Valuation

Valuation for Startups You need to raise money. How much of the company will you have to give an investor in exchange for funding? More??

Pre-money and post-money valuation Pre-money: the value of the venture before the investor’s money Post-money: the value of the venture immediately after the investor’s money Example: –Venture is worth $300,000 pre-money –Investor puts in $100,000 –Venture is worth $400,000 post-money –What percentage does the investor now own?

Valuation for Startups You are offering investors an opportunity to participate in your exciting new startup. What are investors buying when they invest in a raw startup?

Valuation for Startups What investors are buying in a raw startup: A good idea together with a good plan A committed team Founders with experience Founders with prior success Traction (users, revenue, channel…) The more of these you have, the greater the valuation you may be able to achieve. And of course, vice versa.

How much should investor take? Investor Takes:Considerations: >50% ~ 40% 20 – 30% 5-10%

How much should investor take? Investor Takes:Considerations: >50% Founder(s) lose control. Reduced incentive to work hard. ~ 40% Very little equity left for next financing round % Likely range for substantial seed investment 5-10% Small early investment

Valuation & Investment Examples Incubator 7% Angel 15% Super angel or group 30% $20K $100K$300K $290K $1,000K $665K Investment Post- money Valuation Ownership

Determining your valuation Valuation methods: Multiples of revenue, of EBITDA Hmm, you don’t have any. Discounted cash flow Don’t have any cash flow either. Comparables Maybe, but harder the more unique you are.

First-money-in valuation If this is the first money going into the venture, valuation is determined simply by: –The amount of money you raise –The ownership percentage it bought Among all the uncertainties, you must be able to show the minimum amount of money you need. What is the minimum amount of money you need in the first 18 months, to grow to the next stage?

First-money-in valuation Example: you’ve determined you need $150,000 in the first 18 months. –Consider the range of ownership you’ll (realistically) need to give away –At 15%, your valuation is $150,000/15% = $1,000,000 –At 30%, your valuation is $150,000/30% = $500,000 30% Worth $150K 100% Worth $500K

Team Valuation Exercise From your team financial projections: –How much cash do you need in the first 18 months? When you ask investors for money, this is how much you need. –What is your valuation range? –What percentage will you offer and why? Each team will present, first their elevator pitch (not an investor pitch!), followed by an explanation of the above valuation/percentage. You will have 120 seconds.