Wharton Strategic Business Planning Part 33785

STRATEGIC BUSINESS PLANNING

Copyright © March 2004Wharton Small Business Development Center

Welcome! Session 3 – July 20, 2004

Instructor - Kevin [email protected]



The Wharton SBDC is part of Wharton Entrepreneurial Programs and the Sol C. Snider Entrepreneurial Research Center. The Wharton Small Business Development Center is in part financed by a grant from the Commonwealth of Pennsylvania, Department of Community and Economic Development. The Wharton SBDC is funded under Cooperative Agreement No. 4-603001-2-0040-24 by the U.S. Small Business Administration. The support given by the U.S. Small Business Administration through such funding does not an expressed or implied endorsement of any of the co-sponsors’ or participants’ opinions, findings, conclusions, recommendations, products, or services.

All SBDC programs are non-discriminatory and open to the public. Reasonable arrangements for persons with disabilities will be made if requested at least two (2) weeks in advance. Please contact Dr. M. Therese Flaherty, Director, Wharton Small Business Development Center, University of Pennsylvania, 433 Vance Hall, Philadelphia, PA 19104, (215) 898-8635.



Agenda – Session 3

Recap from Session 2 Where We Are and What’s Left Financial Plans Cash Flow Tying It All Together Preparation for Next Session



Recap – Session 2 Industry Analysis

Were you able to identify your NAICS code? Research? Sources? Surprises?

Competitor Analysis Number and types? Business performance data?

Sales Projections Were you able to define your sales unit(s)? Can you describe the reasoning behind your projections?

Marketing Plans Do they closely tie in to sales projections? How did you select your “marketing mix”?



Session 2 Homework Review

Develop a draft Operating Plan Develop draft Sales Projections Develop a draft Marketing Plan

How did you do? Trouble spots? How to move forward



Where We Are and What’s Left Executive Summary – discussed in Session 1 Business Description – discussed in Session 1 Product/Service Description – discussed in Session 1 Marketing Plan – discussed in Session 2 and tonight Operations Plan – discussed in Session 2 and tonight Financial Plan – tonight Funding Your Business - tonight Attachments/Supporting Documents – next week Milestone Driven Planning – next week Finishing your Business Plan and Next Steps – next week



Building the Business Model

Cost Projections Sales Projections

Pro Forma Financial Statements

Operating Plan Marketing Plan

Financial Plan

What will it cost to produce your product or service?

What will it cost to sell any given amount of your product or service?

How will your business make money? How much? For how long? Risks?

Industry, Buyer & Competitor

Analyses



Timing Example - Operations, Marketing, and Sales Interactions in the Financial Statements

Operating Expenses

Marketing Expenses

Revenues (Sales)

January February March April May June

Fictional example for illustration purposes only!

Sales Related Operating Expenses

Fulfillment Related Operating Expenses



Book RecommendationThe Interpretation of Financial Statements by Ben Graham

“Highly practical and accessible, it is an essential guide for all business people…”



The “Big Three” - Financial Statements Income Statement (aka “P&L”)

Lists your income, expenses, and net income (or loss) for a given period, usually one year.

Balance Sheet A “snapshot” of the net worth of your company, listing assets

and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually December 31.

Cash Flow Statement/Plan Outlines the regular inflow and outflow of cash in your

business on a month-to-month basis.

These sections make up your “pro forma” financial statements.



Other Areas of the Financial Statement Break Even Analysis

Shows at what point your company begins to make money. Online calculator at “http://dinkytown.com/java/BreakEven.html”

Sensitivity Analysis Shows the impact of unplanned results on your business

(higher or lower costs, sales, etc.)

Funding Schedule Details the amounts of money you expect to need and when

Staffing Plans Details the titles, salaries/benefits, and timing of hiring for

people you’ll be adding to the company.



Financial Assumptions Key sales and cost drivers Basic information about the market and

opportunities in the environment Start with:

Unit sales projectionsPricesCost projections – fixed and variableKey drivers for each



Financial Projections “Pro Forma” financial statements

Income Statement – revenue minus expenses Balance Sheet – assets and liabilities Cash Flow Statement – actual cash on hand

Critical to you, essential to others Predictions of business performance Financing requirements Sources and uses of cash



Constructing Credible Financial Statements

Important first step: educated assumptions

What are the key revenue drivers? What are the key cost & expense

drivers?



Assumptions – Revenue

Market size and opportunity Number of potential customers Your particular business cycle Product/service pricing Sales growth curve Avoid the “moving hockey stick”!!!



Assumptions – Cost of Sales/Goods Sold

Direct inputs to delivery of service Direct inputs to delivery of product Examples: materials, parts, labor,

shipping

a/k/a – variable costs

Not your expenses



Gross ProfitGross Profit

+ Revenue- COGS

= Gross Profit Margin (GPM)

a/k/aOperating Profit = $ earned before

overhead expenses



Expenses and Cash Flow

+ Operating Profit

- Expenses

= EBITDA

• salary • rent • utilities• telephone• marketing• legal

i.e., “keeping lights on”

a/k/a fixed costs



EBITDA

Earnings Before Interest TaxesDepreciation Amortization

• a/k/a Free Cash Flow• Businesses valued as a multiple of EBITDA



How Much Money Do I Need?

1. Prepare detailed Income Statement2. Then Balance Sheet3. Then Cash Flow Statement

Monthly negative Cash Flow = operating cash

Cumulative negative Cash Flow = total needed



Balance Sheet A “snapshot” of the net worth of your company,

listing assets and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually the end of the month or the end of the year.

Spreadsheet Exercise



Cash Flow Statement/Plan Outlines the regular inflow and outflow of cash in

your business on a month-to-month basis.




EXAMPLE: Startup Jewelry Distribution BusinessHow much do they need?

MONTH

($000) 1 2 3 4 5 6 7 8 9 10 11 12 TOTALS

Revenue 0 0 0 0 0 3 3 7 7 38 38 42 138

Expend-itures

17 5 8 8 9 9 11 19 19 33 42 40 220

Cash Flow (17) (5) (8) (8) (9) (6) (8) (12) (12) 5 (4) 2 (82)

Cumulative (17) (22) (30) (38) (47) (53) (61) (73) (85) (80) (84) (82)



Income Statement (aka “P&L”) Lists your income, expenses, and net income (or

loss) for a given period, usually one year.




Break Even Analysis Shows at what point your company begins to

make money. Online calculator at

“http://dinkytown.com/java/BreakEven.html”




Sensitivity Analysis Shows the impact of unplanned results on your

business (higher or lower costs, sales, etc.)




Funding Schedule Details the amounts of money you expect to need

and when Typically tied to milestones and achievements Allows investors to decide on a commitment level

January 2004 - $250,000 for start up expenses

June 2004 - $75,000 for advertising and marketing

March 2005 - $175,000 for expansion to 2nd location



Staffing Plans Details the titles, salaries/benefits, and timing of

hiring for people you’ll be adding to the company.

Title Hire Date Salary Benefits Bonus Total ExpensePresident January-04 $80,000 $26,400 $15,000 $121,400Machine Operator January-04 $35,000 $11,550 $2,000 $48,550Machine Operator April-04 $35,000 $11,550 $2,000 $48,550Shipping Clerk April-04 $24,000 $7,920 $1,200 $33,120Salesperson June-04 $30,000 $9,900 $3,000 $42,900Salesperson June-04 $30,000 $9,900 $3,000 $42,900Salesperson October $30,000 $9,900 $3,000 $42,900Totals $264,000 $87,120 $29,200 $380,320



- 10 Minute Break -



Funding Your Business Types of Investors

Venture Capital and Angel Investors

Valuation of Early Stage Companies

What You Give for What You Get - Examples

Alternative Sources of Funding for Your Business



Getting to the Investment Requirements and Pre-Start Valuation

Draft the business plan narrative sections – tell your story! Run the numbers – does the story hold up?

Income Statement Balance Sheet Cash Flow Statement/Plan

Determine funding needs from the Cash Flow Projections Examine “pro-forma” EBIDTA projections at 5 years Determine if the ROI fits the Angel Investor targets If so, begin “pitching your plan” to prospective investors! If not, you can either rework the plan, or… Go to alternative funding sources and/or self-fund the plan



Comparing Venture Capital and Angel InvestorsVenture Capital Firms Typically do not

invest in start-ups Responsible for

about 10% of all start-up funding

Angel Investors Provide about 90%

of the seed and early stage outside equity capital for start-up entrepreneurs

Source: Ewing Marion Kauffman Foundation – www.emkf.org



Comparing Venture Capital and Angel InvestorsVenture Capital Firms Operate like mutual

fund companies General partners

such as managers, analysts,etc.

Limited partners are pension funds, corporations, etc.

Angel Investors Loosely formed

groups or wealthy individual investors

“Tried and true” entrepreneurs

Typically have invested in several companies




Comparing Venture Capital and Angel InvestorsVenture Capital Firms Typically invest in

rounds valued at $7MM or more

Average investment in the $2MM range

Later stage interest

Angel Investors Typically invest in

rounds valued between $250K and $2MM.

Average investment per individual of $25K to $250K




Comparing Venture Capital and Angel InvestorsVenture Capital Firms Invested ~$20B in start-

ups last year About 3,000 deals About 700 investors Averaged about $7MM

per round 2 or 3 investors per

round

Angel Investors Invested ~$30B in start-

ups last year About 50,000 deals 400,000 investors Averaged about $750K

per round 6 to 10 investors per

round




Venture Capital and Angel Investors

Stage

Primary Interest

Control Level

AssistanceProvided

Process Length

Exit Timeline

Where they Invest

Later stage

The Business

Significant Control

Executive Team SelectionFinancial Management

6 to 12 months

3 to 5 years

Regional/National

Early stage

The Individual

Support and Influence

Hands-on AdvisorNetworking Help

2 to 4 months

Up to 10 years

Strictly local

Venture Capital Firms Angel Investors




How Angels Evaluate Start-ups…

Quality of the management team…………Size of the opportunity……………………..The product or service……………………..Sales channels……………………………..What stage the business is in…………….How much money you’re trying to raise…..Need for funding in future rounds………….Quality of your business plan………………

0-30%0-25%0-10%0-10%0-10%

0-5%0-5%0-5%

The Management Team’s experience, intelligence, drive, and personalities are typically the most important criteria for AngelInvestors, followed by the overall size of the opportunity.




Valuation of Pre-Start Companies

Total amount of money raised

Pre-start value of the company

Amount of ownership (percentage)taken by Angel Investors

Expected ROI in five years

“Real world” performance; how many Investments in start-up companiesactually return between 10X and 30X?

$250,000 to $1,000,000(raised in total from multiple angel investors)

$1,000,000 to $4,000,000

20% to 40%

30X return on investment

About 10%

The typical Angel Investor opportunity looks like this:




Valuation Walk-through - Example 1

Total amount of money raisedTotal number of Angel Investors - Amount invested per Angel InvestorExpected 5-year return on investment

Pro forma 5-year EBITDA estimateValuation (comparable) multiple*Projected 5-year value of company

Ownership percentage required by Angel Investors at five-year exit horizon

Current (pre-money) valuation of company* alternatively, does 1x revenue in Year 5 equal 30x investment?

$250,0005

$50,000$7,500,000 (30X)

$5,000,0006 times earnings

$30,000,000

25%

$1,000,000

Here’s how a deal might be structured:



Where the Numbers Come From…Total amount of money needed/raisedTotal number of Angel Investors - Amount invested per Angel InvestorExpected 5-year return on investment

Pro forma 5-year EBITDA estimateValuation (comparable) multipleProjected 5-year value of company


Current (pre-money) valuation of company

$250,000 - Cash Flow Projections

5 - Based on avg. AI investment $50,000 - Specific AI profiles

$7,500,000 (30X) – Roughly 100% ROI per year

$5,000,000 - Income Statement

6 times earnings - Industry research

$30,000,000 - multiply

25% - Projected 5-year value of the company divided by the AI’s expected

5-year return amount

$1,000,000 - Amount of money raised

divided by the AI’s required ownership percentage



Expected Return Depends on Time To Exit/Harvest…

Expected 5-year return on initial $250,000 investment

$7,500,000 (30X) Roughly 100% ROI per year

End of Year 1 - $250,000 plus 100% return = $500,000 (current value of investment)

End of Year 2 - $500,000 plus 100% return = $1,000,000End of Year 3 - $1,000,000 plus 100% return = $2,000,000End of Year 4 - $2,000,000 plus 100% return = $4,000,000End of Year 5 - $4,000,000 plus 100% return = $8,000,000 (32X)End of Year 6 - $8,000,000 plus 100% return = $16,000,000End of Year 7 - $16,000,000 plus 100% return = $32,000,000End of Year 8 - $32,000,000 plus 100% return = $64,000,000End of Year 9 - $64,000,000 plus 100% return = $128,000,000End of Year 10 - $128,000,000 plus 100% return = $256,000,000

And so on… every $1 invested 10 years ago turns into $1,024!!!




Total amount of money neededTotal number of Angel Investors - Amount invested per Angel InvestorTotal expected 5-year return on investment




$250,0005

$50,000$7,500,000 (30X)


$6,000,000

125%

--

Here’s an example of a “no go” for angel investors:








$1,000,00040

$25,000$30,000,000 (30X)


$72,000,000

41.67%

$2,400,000

Can you find the potential problem in this example?








$300,0004

$75,000$9,000,000 (30X)


$75,000,000

12%

$2,500,000

Can you find the potential problem in this example?



Finding Angel Investors…Starting points for finding Angel Investors and other resources…

Wharton SBDC Websitehttp://whartonsbdc.wharton.upenn.edu

Innovation Philadelphiahttp://www.IPphila.com

Inc.com (“Inc. Magazine”) Website http://www.inc.com/guides/finance/20797.html

Google Search EngineEnter these terms - “angel investors” Philadelphia



Alternative Funding Sources…

Suppliers and Customers Personal Funds and “Bootstrapping” Friends and Family Private Equity Debt



Suppliers and Customers

Suppliers allowing deferred payments A “float” from suppliers Customers offering advance payment Advance ordering and order guarantees

If you don’t ask, you won’t know if you can get it!



Personal Funds and “Bootstrapping”

Cash savings Converting assets “Sweat equity” The “apple cart” approach

Try to think like an impartial investor even when ESPECIALLY when using your own money!



Friends and Family

Traditional startup funding sources The investment they make is in YOU! Business metrics usually less important Usually a higher tolerance for problems

Written agreements still very important! Consider the potential impact on relationships if the business is not successful and the investment is lost!



Private Equity Sophisticated “Angel Investors” Professional investors – typically take a

sole investor position in startups Minimal margin for error and a low

tolerance for underperformance Generally reserve the right to replace the

management team if projections aren’t met! Contracts tend to be complex with lots of strings

attached to investment

Talk with other companies they’ve invested in!



Debt Financing

Local banks Small Business Administration loans Credit cards Borrowing against home equity Borrowing against insurance policies Borrowing against your retirement IRA

Be aware of the risks and consequences!



Rules for External FinancingRule # 1 – Try to use other people’s money (OPM)

Rule # 2 – Let your customers and suppliers finance the business to the greatest extent possible

Rule # 3 – Use money you can afford to lose or can emotionally handle losing

Rule # 4 – Get money as inexpensively as possible

Rule # 5 – A smaller percentage of something big is worth more than 100% of nothing!

Rule # 6 – Seek advice from advisors, i.e. lawyer, accountant, consultants, family, etc.



Homework Assignments Develop a draft Financial Plan

Use the discussions from this evening to build a integrated financial plan for your business.

Revise and refine Financial Projections Based on your operating, marketing, and sales expenses,

how much money will the company need to get started, what are your cash flow projections, and how much money will the business make and when?

Complete the Operating Plan Go back into your narrative plan and adjust your story based

on the realities of your financial plan.

Questions about the assignments?



Next Session (Session 4) Attachments and Supporting Documents

Other things to include in your blockbuster plan

Milestone Driven Planning How to stay on track and build confidence among investors

Bringing It All Together We’ll walk through plans from participants in our class, discuss

strength’s and weaknesses, try to highlight areas that need additional work. We’ll use the templates from Sessions 1-3 to evaluate the plan.

Next Steps Staying focused, accessing additional SBDC resources, finding and

using an expert advisory board.

See You Next Week!