Entrepreneurial Manager Tool Kit Course Wrap-Up The Entrepreneurial Manager Harvard Business School 1May 2001

The Entrepreneurial Manager Final Exam 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

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

What Did We Learn? New Knowledge Skills and Frameworks e.g., term-sheets, pre- & post-money valuation, venture capitalists, IPOs New Knowledge e.g., evaluating an opportunity, reading a contract, unbundling risks Skills and Frameworks Action in the face of uncertainty. Entrepreneurial Point of View

What Did We Learn from the Entrepreneurs & Advisors We Met in Class? 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) 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)

Knowledge, Skills & Frameworks 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 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

Knowledge, Skills & Frameworks (Continued) 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? 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

Introduction R&R (Robert Reiss) R.R. Donnelley (Barb Schetter) 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.

Entrepreneurial Process: Exploit Act Harvest Never- Ending Process Identify Opportunity Marshal Required Resources Never- Ending Process Exploit Deals Act Harvest

Dimensions of Business Practice Promoter Trustee Entrepreneurial Administrative Strategic Orientation Opp. Driven Resource Driven Commitment to Opportunity Revolutionary Evolutionary Investment Multi-Staged Single-Staged Control of Resources Use or Rent Own or Employ Management Structure Networks - Flat Formal Hierarchy Compensation/Rewards Value/Team Individual

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... Driver 1 Driver 1 Revenues Driver 2 Driver 2 Driver 3 Driver 3 Profits Driver 1 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 Costs Driver 2 Driver 3

Dynamic Fit Management Change (Good & Bad News) People Context Opportunity Deal Pattern Recognition What can go wrong? What can go right? Risk/Reward Management Learning

Date of First Cash Flow Positive Maximum Financing Needs The Cash Flow Cycle for a Venture Cumulative Cash Flow in $ Date of First Cash Flow Positive Time Date of Cash Breakeven Maximum Financing Needs Burn Rate

Managing Risk and Reward What are the underlying assumptions and drivers of the decisions? What will change the odds? Probability of Occurrence Expected Value Probability of Losing 100% -100% +100% Goals in Managing Risk and Reward: - Increase Probability of Success - Increase Expected Returns +25% Return on Investment

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 SUCCESS Payoff - Investment INVEST NOW - Investment FAILURE Payoff - Investment - Cost of Test INVEST GOOD RESULTS - Investment - Cost of Test 1 ABANDON - Cost of Test RUN A TEST BAD RESULTS P S|G (1-P ) S|B S G

Staged Experiments Level of Commitment Commercialization Prototype Validation Mitigate Risks Idea Time

Phased Investment Decisions Abandon Invest Abandon Invest Second Abandon First Abandon Seed The option to abandon can be more valuable than the option to continue. Founding

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

Which Funding Source Do I Pursue? Ask Yourself… 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?

Sources of Financing Own Money/Customers/Suppliers Friends and Family 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

Alternative Sources of Funding 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: Contracts Knowledge, 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 Team Knowledge, 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 Dilemma Vision Yield Control to Others -Investors -Board -Top Managers Reduce Uncertainty Bring in Critical Resources -Money -Professional Management -Advisors

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 Relationships Knowledge, 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 Process Model Identify Opportunity Identify/Screen Potential Partners Structure Deal Manage Relationship Clearly Articulate Opportunity Evaluate Map needed resources/skills Decide which to do in-house and which outsource Identify potential partners Apply preliminary screen Evaluate finalists on key criteria Evaluate alternative forms -Licensing -Equity investment -Alliance -Joint-venture -Acquisition Structure contract to manage risks -Transfer -Reduce -Share Negotiate Deal Manage portfolio of ongoing partnerships -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

Achieving Disciplined Entrepreneurship Benefit of Discipline Benefit of Flexibility Level of Structure Start-up Established Firm

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 Guys from 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 Work with Entrepreneurs 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

On Effort and Failure and Continued Pursuit... 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. - 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 far from 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! Ernest Shackleton Will YOU Sign Up for the Entrepreneurial Adventure? MEN WANTED! FOR HAZARDOUS JOURNEY. SMALL WAGES, BITTER COLD, LONG MONTHS OF COMPLETE DARKNESS, CONSTANT DANGER, SAFE RETURN DOUBTFUL. HONOR AND RECOGNITION IN CASE OF SUCCESS. Ernest Shackleton 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

Setting off on the Journey There is little point in setting out for a place that one is almost certain to reach. - H.W. Tilman “Smooth Seas do not Make Skillful Sailors”