Entrepreneurial Manager Tool Kit

Course Wrap-Up

The Entrepreneurial Manager

Harvard Business School

1May 2001

Logistics - Section C• Friday, 4 May 2001 - 9:00am-1:00pm

– Aldrich 10 (Aggarwal - Davis)

– Aldrich 107 (De los Reyes - Tepperman)

– Aldrich 108 (Terry - Zhao)

• Print Labs - Aldrich 7 & 8 – Download Printer Driver! http://www.mba.hbs.edu/admin/tech/download/hp4050_win95.html

• Computer Difficulties - Aldrich 7 Diskettes Provided Open Book / Open Notes

The Entrepreneurial Manager Final Exam

Entrepreneurial Manager Final Exam

• Integrate Quantitative and Qualitative Analysis– What questions are you trying to answer?– How do the numbers inform your overall analysis?– Clearly state/defend your assumptions.

• Be Specific in your Recommendations for Action– Support your recommendations with Analysis

• Use Your Time Carefully.

What Pieces of “Analysis” Might You Encounter?

• Understanding the Business Model– Assessing the Opportunity

• Sizing the Market - How much market share does the venture have to get to meet the revenue targets? How will it do that?

– Simple Diagnostics - e.g. “Taking the Company’s Temperature:”

• Financial Ratio Analysis • How does the company make money?

– Gross Margins– Asset Intensity– Cash Needs - Does the Company “Burn” cash or generate

cash? How much will the company need to execute its plan? From whom should it raise money?

Additional Pieces of “Analysis”• Understanding Effects of Financing

– Pre-Money and Post-Money Valuation– How much of the company must the entrepreneur give up?– How much of the company does the investor require to meet his/her

required rate of return?• FV = PV(1+IRR)n => IRR = (FV/PV)1/n - 1

• Valuing the Company– Lifetime Value of Customers based on FCF

• Customers we have today and those we expect to get.• FCF = EBIAT + Dep - CapEx - WC• CF = NI + Dep - CapEx - WC

– Discounted Cash Flows (ke = rf + (rm-rf))– EBITDA and/or Sales Multiples

• Comparable Companies and Industries – IPO or M&A Transactions

EM - Three Broad Questions What’s going on here?

– How has the company gotten to this point?– What’s the business model? What kind of company is this?

• Revenues, Costs, Financing…

– What is the opportunity going forward?– What resources do they need to pursue it?

• Cash? People? Customers?

What should they do about it?– Turn analyses into specific recommendations.

• Not just the what but the HOW?

– What are the risks? Anticipate consequences.• What can go wrong? What can go right?

How do we follow up? Measure the progress?

The Entrepreneurial Manager Introduction - Welcome to the Territory 5 Classes Fundamentals for the Entrepreneur 12 Classes

• Recognizing Opportunity• Forecasting Cash Flows• A Venture as a Series of Experiments• Sources of Startup Funding

Building the Successful Venture 9 Classes• Starting Right• Building and Developing the Team• Managing Relationships

Alternatives for the Successful Venture 4 Classes• Achieving Liquidity & Sustaining the Enterprise

Summary - Pulling it all Together 2 Classes

Entrepreneurial Point of View

Skills and Frameworks

NewKnowledge

e.g., term-sheets, pre- & post-money valuation,venture capitalists, IPOs

e.g., evaluating an opportunity,reading a contract, unbundling risks

What Did We Learn?

Action in the face of uncertainty.

What Did We Learn from theEntrepreneurs & Advisors We Met in Class?

Jim Sharpe (Extrusion Tech) Robin Wolaner (Parenting) Rajath Chaudry (Lawyers & Leases) Matt Lieb (Kingsley Management) Sharon Ward, Paolo (Return Logic) Jim Fitzgerald (Balance) Barry Arnold (Retail Sports) Nick Lazaris (Keurig) Ginger Howard (Guidant) Tom & Tom (Nantucket Nectars) Alan Ellman (Screaming Media) Candace & Chris (Kendle) Louise Kitchen, Jeff Skilling (Enron) Katy, Andy, Elyce (kate spade) Rob Adler, Jeff Parker (CCBN)

Bob Reiss (TV Guide Game) Barb Schetter (R.R. Donnelley) Charles Ferguson (Vermeer) Chris Peters (Microsoft) Dr. V. (Aravind) Jeff Parker (Technical Data) Adi Cooper (Tracmail) Ann Meceda (PCC) Paul Ognibene (Clubtools) Sue Krukonis (Anasazi) Terry Opdendyk, Andy Swett (ONSET) Doug Macrae (Videoguide) Ralph Wagner (Walnut) Bob O’Connor (RBS - Walnut)

Knowledge, Skills & Frameworks Entrepreneurial Experiments

• Value of Information• Mitigating Risks by Staging

Experimentation and Funding• Due Diligence and Milestones

Financing • Term Sheets• Pre-Money, Post-Money• Sources of Financing• Interest Coverage• Deal Structure

Contracts• Leases, Term Sheets, Employment• Corporate Forms

– Managing Personal &Tax Liability• Working with Lawyers

– Questions to Ask– Structuring the Relationship

What is Entrepreneurship?• Approach to Management• Opportunity is the Driver• An Iterative Process

Opportunity Analysis• Reading Business Plans• Assessing Business Risks• Diagramming Business Models

– Fishbone Analysis• PODC Framework• Estimating Cash Flows and Drawing

Cash Curves• Risk/Reward Curves

– Probability of Failure– Expected Value of Returns– Robustness of Upside

Knowledge, Skills & Frameworks (Continued)

Building the Team• Interviewing Methods• Sharing Equity• Building the Board• Selecting Advisors• CEO Redeployment

Managing Relationships• Business Development Process

– ID Opportunity– Mapping the Business Network– Screen Potential Partners– Structuring Deal Forms

• Acquisition• Alliance• Equity Investment• Technology Licensing

– Managing the Relationship

Creating a Sustainable Venture• Preparing for Liquidity Events

– IPO– Private Sale– Strategic Investments

• Creating Structure and Designing Processes

– Flexibility vs. Discipline• Organizing the Team for the Next

Stage of Growth

Self Assessment?• Personal Propensities for Risk,

Uncertainty, Ambiguity?

• Desire for an Entrepreneurial Life?

Introduction R&R (Robert Reiss)

• An Entrepreneur follows Opportunity• An Entrepreneur spreads Risk and Owns very little

R.R. Donnelley (Barb Schetter)• Big Companies also have opportunities

Vermeer (Charlie Ferguson & Randy Forgaard)• A Visionary, A Technologist, still need A Manager• VC can help even if not a “friend”

Vermeer/Microsoft (Chris Peters)• Big Company seeking opportunity via acquisition

Aravind Hospital (Dr. Venkataswamy)• Grand Goal as an “Opportunity”• The Deal with People can be more than about Money

Introduction to Entrepreneurship

A way of managing rather than a specific economic function or a characteristic of an individual.

An approach to management that begins with OPPORTUNITY.

HBS working definition:• The pursuit of opportunity without regard to

resources currently controlled.

Exploit

Act

IdentifyOpportunity

MarshalRequiredResources

Deals

Harvest

Never-EndingProcess

Entrepreneurial Process:

Strategic OrientationStrategic Orientation

Control of ResourcesControl of Resources

Management StructureManagement Structure

Compensation/RewardsCompensation/Rewards

Commitment to OpportunityCommitment to Opportunity

InvestmentInvestment

Opp. DrivenOpp. Driven Resource DrivenResource Driven

EvolutionaryEvolutionaryRevolutionaryRevolutionary

Single-Single-StagedStaged

Multi-StagedMulti-Staged

Own or EmployOwn or EmployUse or RentUse or Rent

Formal HierarchyFormal HierarchyNetworks - FlatNetworks - Flat

Value/TeamValue/Team IndividualIndividual

Dimensions of Business PracticePromoter Trustee

Entrepreneurial Administrative

Fundamentals: Opportunity Recognition

Technical Data Corporation (Jeff Parker)• Build on Experience• Select Investors for more than just money• Don’t say No out of Envy

Tracmail (Adi Cooper )• Competing on Price is Tough • Seek Barriers that Protect• What are the barriers to Competitive Attack?

Private Communications Corp (Ann Meceda)• Not every Idea is an Opportunity• Understand your business model and experiment• Nothing goes exactly as planned

Fundamentals: Forecasting Cash Flows

Club Tools (Paul Ognibene)• Pick Investors Carefully• Cash Flow Forecasting Dilemma• Go big or start small

Anasazi (Sue Krukonis)• Going around the Distribution Channel is Challenging• Cash is King

Opportunity Analysis:Knowledge, Skills & Frameworks

• Reading Business Plans• Assessing Business Risks• Diagramming Business Models

– Fishbone Analysis

• PODC Framework• Estimating Cash Flows and Drawing Cash Curves• Risk/Reward Curves

– Probability of Failure

– Expected Value of Returns

– Robustness of Upside

Understand the Business Model...

Profits

Costs

Revenues

Driver 1

Driver 2

Driver 3

Driver 1

Driver 2

Driver 3

Driver 1

Driver 2

Driver 3

Using the Tool 1. Draw the key drivers of revenue and costs. 2. Identify key drivers and quantify assumptions. 3. Test sensitivity to changes in key drivers. 4. Analyze how reasonable key assumptions are. 5. Use the tool to surface key assumptions, logical inconsistencies, critical sources of uncertainty and important questions to ask

Dynamic Fit Management

PeoplePeople

DealDeal

ContextContext

OpportunityOpportunity

What can go wrong?What can go right?

Risk/RewardManagement

Change (Good & Bad News)

PatternRecognition

Learning

Cu

mul

ativ

eC

um

ulat

ive

Cas

h F

low

in $

Cas

h F

low

in $

TimeTime

BurnBurn RateRate

Date of First Cash Flow PositiveDate of First Cash Flow Positive

MaximumMaximum FinancingFinancing NeedsNeeds

DaDatete of Cashof Cash BreakevenBreakeven

The Cash Flow Cycle for a Venture

Managing Risk and Reward What are the underlying assumptions and drivers of the

decisions? What will change the odds?

Return on Investment+25%

Probability of Occurrence

Expected Value

Probability of Losing 100%

-100%

+100%

Goals in Managing Risk and Reward: - Increase Probability of Success - Increase Expected Returns

Fundamentals: Entrepreneurial Experiments

Value of Information Exercises• Experiments Pay when Cost and Probability of Failure are High. • Value of Information Depends on Alternatives

ONSET Ventures (Terry Opdendyk, Darlene Mann, Andy Swett)• Sequential Investment• Milestones, Objectives and Risk Mitigation• Venture Capital Model to Startups

Videoguide (Doug Macrae)• Product Driven (Field of Dreams)• Big Upfront Costs in Hopes of Lower Variable Costs Later• “Go Big or Go Home” Strategy May Send You Home Early

The Venture as a Series of Experiments:Knowledge, Skills & Frameworks

• Value of Information

• The Venture Capital Approach to StartUps– Mitigating Risks by:

• Staging Experimentation

• Staging Funding

– Due Diligence and Milestones

Running the Experiment

SUCCESSPayoff - Investment

INVEST NOW

- InvestmentFAILURE

SUCCESSPayoff - Investment - Cost of Test

INVEST

GOOD RESULTS - Investment - Cost of Test1 FAILURE

ABANDON- Cost of Test

1RUN A TEST

SUCCESSPayoff - Investment - Cost of Test

INVEST

- Investment - Cost of Test1 FAILURE

BAD RESULTS

ABANDON- Cost of Test

ABANDON0

P S|G

(1-P S|G )

P S|B

(1-P S|B )

P S

(1-P S)

(1-P G )

P G

Staged Experiments

Time

Level of Commitment

Idea

Validation

Prototype

Commercialization

Mitigate Risks

Phased Investment Decisions

Seed

Second

FirstAbandon

Invest Abandon

Invest Abandon

Invest Abandon

Invest

Founding The option to abandon can be more valuable than the option to continue.

Fundamentals: Sources of Financing

Walnut Venture Associates A (Ralph Wagner)• What do Angels want?• How do you find out about a company and its people?

Walnut Venture Associates D (Bob O’Connor)• What do Entrepreneurs want from Financial Backers?• An Angel Term Sheet Can Look Like a Camel

Extrusion Technologies (Jim Sharpe)• Banks as a Source of Funds• Sophisticated Experience Prevented Mundane Mistakes

Parenting Magazine (Robin Wolaner)• Experiment gave good results but didn’t raise $• Corporate Partners have different needs• Career of the Entrepreneur (Each venture leads to others)

Sources of Financing:Knowledge, Skills & Frameworks

• Term Sheets

• Pre-Money / Post-Money Valuation

• Dilution

• Matching Opportunity to Source of Funding

• Sequencing Financing

• Calculating Interest Coverage

• Negotiating Deal Structure

How much money will we need?• How deep is the cash trough?

• What stage are we in the life-cycle of this opportunity? How close to break-even?

• What are the exit options? From whom should we raise money?

• What do they provide in addition to funds? Expertise? Networks? Credibility?

• What will be their impact on our future fund-raising efforts?

• How will this deal influence our future flexibility? What are my personal preferences?

• How much control am I willing to give up?

• Am I willing to make a personal guarantee?

• What level of risk can I--and my family/significant other--live with? Is this a good time to raise money?

• What is happening in the broader capital markets right now?

• Is the IPO market hot right now? Will it still be hot when we want to sell?

Which Funding Source Do I Pursue?Ask Yourself…

Own Money/Customers/Suppliers• kate spade, Kendle

Friends and Family• R&R, Technical Data, PCC

Angels• Walnut: RBS, Nantucket Nectars

Incubators• Clubtools, Peoplestreet

Venture Capitalists• Vermeer, Return Logic, Keurig, Anasazi

Asset Lenders (Banks)• Jim Sharpe

Corporations• Parenting Magazine, CCBN

Sources of Financing

Alternative Sources of Funding

Internally GeneratedFunds

Retain Control Minimize Oversight

Need Positive CF May Limit Growth

Friends & Family Quick Due Diligence Retain Control

Lack of Assistance Personal Conflicts

Angels Higher Valuations Retain Control

Varied Sophistication Can Turn off Future Funding

Incubators Mix of Services Access to Networks

Unproven Model Expensive Services/$$

Venture Capitalists Professional Investors Access to Future Capital

Aggressive Terms Loss of Control

Bank Debt Retain Equity Fixed Obligations

Corporate Partners Higher Valuations Access to Resources

Bureaucratic Limits Liquidity Options

Financing Source Pros for Entrepreneur Cons for Entrepreneur

Building the Successful Venture: Contracts

Lawyers & Leases (Rajath Chaudry)• Seek Strong Professional Advice

• Early Decisions Matter

• Beware of Conflicts of Interests

Kingsley Management (Matt Lieb & Chris Jones)• Don’t be Too Clever about Financing

• Fit Structure to Strategy

Return Logic (Sharon Ward, Paolo Motturo, Andrew Chan)• Dividing Equity has Repercussions

• Terms in Each Financing Affect the Next Round

• Decisions you Make Today Affect you Tomorrow

Building the Successful Venture: ContractsKnowledge, Skills & Frameworks

• Leases

• Term Sheets

• Employment Contracts

• Corporate Forms– Managing Personal and Tax Liability

• Working with Lawyers– Questions to Ask

– Structuring the Relationship

Building and Developing the Team

Cambridge Incubator: Peoplestreet (Mark Pitts)• Hiring is Critical and Can be Learned

• Hiring Well is a Competitive Weapon

• Hiring Mistakes are Expensive and Take a Long Time to Correct

Balance Inc. (Jim Fitzgerald)• Seek Advice but Don’t Compromise Personal Objectives

• Don’t Hire People You Don’t Like

• Use Board and Advisors for Recruiting

Retail Sports (Barry Almond)• Bad Things Can Happen to Good Entrepreneurs

• “Should I Stay or Should I Go?”

Building the TeamKnowledge, Skills & Frameworks

• Interviewing Methods

• Sharing Equity

• Building the Board

• Selecting Advisors

• CEO Redeployment

Reducing Risk in Hiring Be clear in the job description Stage your investment in rounds of interviews Hire part-time or as consultant before full-time Include different perspectives in the interviewing

• Content-e.g., skills, fit, background

• Interviewing approach

• Interviewer perspective

Check references Write an explicit employment agreement Think about questions

Entrepreneurship is a Team Sport Board of Directors

• Experienced Investors (e.g. VCs)• Mentor or Coach for CEO• Industry Expert

Top Management Team• Functional Expertise• Experience (Start-up and Large Company)• Organizational Fit

Professional Advisors• Lawyers• Accountants• Executive Recruiters

Entrepreneur’s DilemmaEntrepreneur’s

Vision

Bring in Critical Resources -Money -Professional Management -Advisors

Yield Control to Others -Investors -Board -Top Managers

Reduce Uncertainty

Managing Relationships

Keurig Coffee (Nick Lazaris)• R&R Revisited - Setting up the Virtual Company

• Assembling a Complex System of Stakeholders

Guidant Radiation Therapy (Ginger Howard)• What do you Have? What do Need? What Deal gets you There?

• Finding the Next Big Thing

Nantucket Nectars (Tom & Tom)• Be Willing to Do the Laundry, if Necessary

• Distribution is Not Obvious

• Achieving Liquidity while Preserving a Role

Managing RelationshipsKnowledge, Skills & Frameworks

• Business Development Process– ID Opportunity– Mapping the Business Network– Screen Potential Partners– Structuring Deal Forms

• Acquisition• Alliance• Equity Investment• Technology Licensing

– Managing the Relationship

The Business Development ProcessIdentifyOpportunity

DevelopBusinessModel

Identify/ScreenPotential Partners

StructureDeal

ManageRelationship

Clearly ArticulateOpportunity

Evaluate Opportunity

Map needed resources/skills

Decide which todo in-house andwhich outsource

Identify potentialpartners

Apply preliminaryscreen

Evaluate finalistson key criteria

Evaluate alternativeforms -Licensing -Equity investment -Alliance -Joint-venture -Acquisition

Structure contractto manage risks -Transfer -Reduce -Share

Negotiate Deal

Manage portfolioof ongoingpartnerships -Key metrics -Individual and portfolio level

Manage relationships -Ownership -As they evolve -Multiple points of contact

Managing Relationships Ongoing management is required because

reality is too complex to fully contract. Guidant’s Approach - Ginger Howard:

• Identify an Owner on each side responsible for the contract, negotiation and deliverables.

• Philosophical Alignment of People and Business Processes.

• Formal Reviews - Milestones, etc.• Constant Communication - Talk every day…• Ruthless Honesty.

Creating a Sustainable Venture ScreamingMedia (Kevin Clark)

• Moving from Chaos to Structure• Having Cash in a Downturn is a Strategic Advantage

Kendle International (Candace and Chris)• Build Organization for Next Stage of Growth• Valuations in Private vs. Public Markets

Enron (Louise Kitchen & Jeff Skilling)• Is there Entrepreneurship in Large Organizations?• Can you Develop Processes that Maintain Flexibility and Foster Pursuit of

Opportunity? kate spade (Katy, Andy, Elyce, Pamela)

• Money to Grow vs. Money to Compensate for Past Efforts CCBN (Jeff Parker)

• Is Entrepreneurship Learnable?

Creating a Sustainable Venture Knowledge, Skills & Frameworks

• Preparing for Liquidity Events– IPO– Private Sale– Strategic Investments

• Creating Structure and Designing Processes

– Flexibility vs. Discipline

• Organizing the Team for the Next Stage of Growth

Level of Structure

Benefit of Discipline

Benefit ofFlexibility

Start-up Established Firm

Achieving Disciplined Entrepreneurship

Taking it to the Next Level.. Can you scale up the business model,

especially cash? Can the management team make the next

step? Who do you bring along to the next step?

Who do you leave behind? Who gets on board?• Management• Investors• Customers• Partners

Avoiding the Flat-Line...

Actively search for opportunities Obsess about your customers Frame crises as opportunities not threats Frame action as experiment

• Don’t fire scientist when experiment fails (except if he runs same experiment twice)

After you raise the money, avoid the temptation to bet it all on one hand or roll of the dice.

What’s Stopping the Big Guysfrom Doing It?

Attackers’ Advantages– Innovative Business Concept– Sense of Urgency– Start-Up, Speed-Oriented Culture– Opportunity focused– Network of Relationships– Shareholder Value Focus

Defenders’ Dilemma– Cannibalization fears– Channel conflicts– Resource driven

• Curse of the deep pocket

– Current income focus– Conventional mindset

Entrepreneurial Point of View

Make Decisions Today and in the Future to Ensure that:• What can go right, goes right.

• What can go wrong is avoided or will not critically wound the company.

How can I make the future that I want to happen actually happen?

Knowledge, Skills, and Frameworks Mean Little without Action.• The great end of life is not knowledge but action.

– T.H. Huxley

• An ounce of action is worth a ton of theory.– Friedrich Engels

The Entrepreneurial Manager and You:Questions to Ask

Do I want to be involved in an early stage venture at some point in my career?

Do I want to be involved as a supplier of financing to early stage ventures?

What early career experiences will best prepare me? What is my risk profile? Can I tolerate ambiguity and uncertainty? Am I motivated by the love of a product, being in

control, creating something new, making money?

Career Choices

Be an Entrepreneur• Strategy 1 - Go For It Now• Strategy 2 - Learn Best Practices First

Work with Entrepreneurs• Private Equity• Consulting• Banking• Corporate Manager• Non-Profit• What Else?

Attitudes are Essential... There is no one “type” of entrepreneur Success is not forever, and failure is not fatal.

• Failure is the opportunity to begin again more intelligently. - Henry Ford

At the end of the day, what do you have?• Relationships• Reputation

Make every day an adventure• Just as in life, business is about development and growth. Each

is equally exciting. • Courage is doing what you are afraid to do. There can be no

courage unless you are scared. - Eddie Rickenbacker

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, and comes short again and again; because there is not effort without error and shortcoming; but who does actually strive to do the deeds; who knows the great enthusiasms, the great devotions; who spends himself in a worthy cause, who at the best knows in the end the triumphs of high achievement and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who know neither victory or defeat.

On Effort and Failure and Continued Pursuit...On Effort and Failure and Continued Pursuit...

- Theodore Roosevelt, 1910 at the Sorbonne

Is it Luck or Hard Work?

I find the harder I work, the more luck I seem to have.

– Thomas Jefferson

Opportunity is missed by most people because it is dressed in overalls and looks like work.

– Thomas Edison

You Decide - Is the View Worth the Climb?“The view we enjoyed from the summit could hardly be surpassed in sublimity and grandeur; but one feels farfrom home so high in the sky, so much so that one is inclined to guess that, apart from the acquisition of knowledge and the exhilaration of climbing, more pleasure is to be found at the foot of the mountains than at their frozen tops. Doubly

happy, however, is the many to whom lofty mountain-tops are within reach for the lights that shine there illumine all that lies below.”

--John Muir

Exercise and recreation are as necessary as reading. I will say rather more necessary because health is worth more than learning.

--Thomas Jefferson

MEN WANTED!FOR HAZARDOUS JOURNEY.

SMALL WAGES, BITTERCOLD, LONG MONTHS OFCOMPLETE DARKNESS,

CONSTANT DANGER,SAFE RETURN DOUBTFUL.

HONOR AND RECOGNITIONIN CASE OF SUCCESS.

Ernest Shackleton

Will YOU Sign Up for the Entrepreneurial Adventure?

Recruiting Advertisement for Shackleton’s 1914 Trans-Antarctic Expedition aboard the Endurance - 5000 Men (and 3 Women) Applied - 27 Set Out on the Journey -27 Returned Safely

“Smooth Seas do not Make Skillful Sailors”

There is little point in setting out for a place that one is almost certain to reach. - H.W. Tilman

Setting off on the Journey