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June 2003 How do we make money? Financial management, valuation and financing Douglas Abrams - Parallax Capital Management.

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Presentation on theme: "June 2003 How do we make money? Financial management, valuation and financing Douglas Abrams - Parallax Capital Management."— Presentation transcript:

1 June 2003 How do we make money? Financial management, valuation and financing Douglas Abrams - Parallax Capital Management

2 2 6XXXX Douglas Abrams - Parallax Capital Management How do we make money?  The business model  Financial management  Forecasting and valuation  Funding required and equity offered  ROI and exit strategy

3 3 6XXXX Douglas Abrams - Parallax Capital Management Determine the business model  How do we create value?  Who do we create value for?  How do we differentiate ourselves?  How will we make money?

4 4 6XXXX Douglas Abrams - Parallax Capital Management How do we make money?  The business model  Financial management  Forecasting and valuation  Funding required and equity offered  ROI and exit strategy

5 5 6XXXX Douglas Abrams - Parallax Capital Management Determine your needs  Think about your income and cash needs  Think about your sales and funding needs

6 6 6XXXX Douglas Abrams - Parallax Capital Management Two ways to look at your finances  Operating view - budgeting –Operating budget –Cash-flow budget  Accounting view - forecasting and valuation

7 7 6XXXX Douglas Abrams - Parallax Capital Management Expense and operating budget

8 8 6XXXX Douglas Abrams - Parallax Capital Management Cash flow budget

9 9 6XXXX Douglas Abrams - Parallax Capital Management The Path to Profitability (P to P)  What is profitability?  Startup can fund all operations from cash flow  How much investment needed until then?

10 10 6XXXX Douglas Abrams - Parallax Capital Management The burn rate and months remaining  Methods of calculating the burn rate –GAAP –EBIDTA (before interest, depreciation, taxes and amortization  Calculate months remaining –Remaining months liquidity –How many months worth of cash does the company have left?  Multiple burn rates may be required to reach milestones until startup can fund from its own revenues

11 11 6XXXX Douglas Abrams - Parallax Capital Management Principal financial statements  Balance statement - the company’s financial condition  Income statement (P&L) - the success of the business  Cash flow statement - cash availability and needs of the business

12 12 6XXXX Douglas Abrams - Parallax Capital Management Balance statements must balance  Economic resources of the company  Ability to provide future benefits to the firm  Cash  Inventory  Equipment Left side - Assets  Liabilities - creditor’s claims on the assets of the firm  Accounts payable, bonds payable  Shareholder’s equity - the owner’s claim on the assets of the firm  Contributed capital  Retained earnings Right side - Liabilities & Equity

13 13 6XXXX Douglas Abrams - Parallax Capital Management Why is financial information important to entrepreneurs?  No cash, no business  Financial information pulls together all information presented in the other segments of the business; marketing, manufacturing & management  It quantifies all assumptions & historical information concerning business operations

14 14 6XXXX Douglas Abrams - Parallax Capital Management How do we make money?  The business model  Financial management  Forecasting and valuation  Funding required and equity offered  ROI and exit strategy

15 15 6XXXX Douglas Abrams - Parallax Capital Management Forecasting requires predicting the future

16 16 6XXXX Douglas Abrams - Parallax Capital Management We predict using pro forma financials  Three to five years of:  Income statements  Balance sheet  Cash-flow statement  P&L

17 17 6XXXX Douglas Abrams - Parallax Capital Management Preparing your forecasts  Project from bottom up  Sales growth and market share are key  Project cash requirements

18 18 6XXXX Douglas Abrams - Parallax Capital Management What is the value of a firm?  Fundamental value?  Technical value?  Balance sheet value of assets?  Market value of assets?  Multiple of book value?

19 19 6XXXX Douglas Abrams - Parallax Capital Management Company valuation methods  Price to earnings (p/e)  Dividend yield  Multiple of book value  Comparables  Discounted Cash Flow (DCF)

20 20 6XXXX Douglas Abrams - Parallax Capital Management Comparables  Use value that has already been established either in public markets or through a sale for a comparable company  Difficulties –How to find comps –Accounting methods vary –Public versus private liquidity –Changing market conditions

21 21 6XXXX Douglas Abrams - Parallax Capital Management DCF Valuation Model  Firm value is discounted present value of future cash flows  Percent of sales forecasting  Tie income-statement and balance sheet figures to future sales  Variable costs and most current assets and liabilities tend to vary directly with sales  Only future sales require prediction; relationship between items can be calculated more easily

22 22 6XXXX Douglas Abrams - Parallax Capital Management Discounted cash flow  Project cash flow from operations for 3-5 years  Adjust the cash flow for factors such as non-recurring items of income and expense, depreciation, amortization, interest and taxes  Discount the cash flow as adjusted, using alternative assumptions for time and risk factors.

23 23 6XXXX Douglas Abrams - Parallax Capital Management What are our time, scope and size ambitions?  Subsistence model  Income model  Growth model  Speculative model

24 24 6XXXX Douglas Abrams - Parallax Capital Management Scalability and its costs  Scalability necessary for VC investment  $300MM gross profits within 5 years  Scalability is expensive - marketing, infrastructure, etc.  Demonstrate need and value of product or service with $3MM? Get to break even with less than $20MM with yearly revenues of $100MM in 5-10 years

25 25 6XXXX Douglas Abrams - Parallax Capital Management How do we make money?  The business model  Financial management  Forecasting and valuation  Funding required and equity offered  ROI and exit strategy

26 26 6XXXX Douglas Abrams - Parallax Capital Management What are sources of funds?  Profits/Retained earnings  Equity  Debt

27 27 6XXXX Douglas Abrams - Parallax Capital Management Funds needed  How much does the company need?  What percentage does the company want to sell? –Often too much or too little –This is the wrong question  Set performance and fund-raising milestones –How much money do you need to achieve the next milestone? –Divide defensible firm value by funds needed to determine percentage to sell

28 28 6XXXX Douglas Abrams - Parallax Capital Management Sources of funds  Own money (OM)  Friends and Family (F&F[and Fools]) Angels  Incubators  Corporations  Customers, suppliers, lessors and strategic partners  Government grants and investments  Banks for VC loans

29 29 6XXXX Douglas Abrams - Parallax Capital Management Uses of funds  Be detailed  No big salaries for founders  How will these funds be used to fuel necessary growth?  Sufficient funding to reach next financing milestone

30 30 6XXXX Douglas Abrams - Parallax Capital Management Funding stages  Founder’s capital  Seed/Angel  Series A, B, C  Mezzanine  Pre-IPO  IPO

31 31 6XXXX Douglas Abrams - Parallax Capital Management Pre-money valuation  Worth of the business before VC investment  Amount invested by VC divided by –Agreed pre-money value of business + –Amount invested by VC = equity owned by VC –VC receives equity share based on post money total –$3MM pre + 1 MM VC = 25% VC equity

32 32 6XXXX Douglas Abrams - Parallax Capital Management How do we make money?  The business model  Financial management  Forecasting and valuation  Funding required and equity offered  ROI and exit strategy

33 33 6XXXX Douglas Abrams - Parallax Capital Management VC hurdle rate  Minimum yearly compounded rate of return VC expects from investment (risk assessment)  Seed stage %  Early stage 60%  Late stage with profits 40%  Bridge financing to cash out 20%

34 34 6XXXX Douglas Abrams - Parallax Capital Management Why are VC’s hurdle rates so high?  VCs must deliver above-average returns to their investors  Percentage of winners and losers –20/80 at best  Overall return required by VC investors 30/40% –Do the math

35 35 6XXXX Douglas Abrams - Parallax Capital Management Post money valuation  Used to estimate the price the business must command at the liquidity event  If liquidity event is sale in 5 years, and hurdle rate is x%, can calculate sale price required  $4 million post money; 50% hurdle rate  Sale price must = $30 MM

36 36 6XXXX Douglas Abrams - Parallax Capital Management Calculate VC’s Projected ROI  Take projected earnings from DCF model in exit year  Multiply by comparable P/E multiple for industry to calculate price  Multiply by VC’s equity percentage at exit to calculate VC’s share  Divide VC’s share by original investment

37 37 6XXXX Douglas Abrams - Parallax Capital Management Exit strategy and market conditions  Liquidity event –Convert private equity to cash or freely tradable stock –Sale or IPO –Merger with public company –Back-door listing, –Reverse merger  Within 3-5 years  Only 10-15% of liquidity events

38 38 6XXXX Douglas Abrams - Parallax Capital Management Contact us  Douglas Abrams  Managing Director  Parallax Capital Management    , (hp)  390 Orchard Road, #11-01 Palais Renaissance, Singapore


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