Lecture 6 Timmons Chapter 12

Entrepreneurial Finance The Achilles’ Heel Three core principles of entrepreneurial finance: More cash is preferred to less cash

Entrepreneurial Finance The Achilles’ Heel Three core principles of entrepreneurial finance: More cash is preferred to less cash Cash sooner is preferred to cash later

Entrepreneurial Finance The Achilles’ Heel Three core principles of entrepreneurial finance: More cash is preferred to less cash Cash sooner is preferred to cash later Less risky cash is preferred to more risky cash

Exhibit 12.4

Entrepreneurial Finance The crux of it is anticipation What is most likely to happen? When? What can go right along the way? What can go wrong? What has to happen to achieve our business objectives and to increase or to preserve our options?

Entrepreneurial Finance The crux of it is anticipation What does it mean to grow too fast in our industry? How fast can we grow without outside debt or equity? How much capital is required to increase or decrease our growth by X percent? How much can be financed internally and how much will have to come from outside sources? What about our pricing, our volume, and costs?

Entrepreneurial Finance Shareholders Value Creation Customers Employees

Entrepreneurial Finance Allocating Risks and Returns Slicing the Value Pie Cash-Risk-Time

Entrepreneurial Finance Debt: Take Control Covering Risk Equity: Staged Commitments

Exhibit 12.3

Entrepreneurial Finance The Owner’s Perspective Cash flow and cash Cash flow and cash are King and Queen in entrepreneurial finance Time and timing In entrepreneurial finance, time for critical financing moves often is shorter and more compressed Capital markets Capital is one of the least important factors in success of higher potential ventures. High-potential founders seek not just capital, but investors who will add value, skills.

Entrepreneurial Finance The Owner’s Perspective Emphasis Non-economic factors are important in raising capital. Backers should add knowhow, wisdom, counsel and help. Strategies for raising Capital Maximizing amounts raised also increases risk. Therefore, effectuation and staged commitment. Entrepreneurs may turn down capital if valuation is less attractive and prospects are good. Downside Consequences Consequences of failure are much higher for entrepreneur than CEO of a larger business.

Entrepreneurial Finance The Owner’s Perspective Risk-Reward Relationships Capital markets are idiosyncratic and less efficient with these sorts of transactions. Valuation Methods Established valuation models tend to favor sellers. Conventional financial ratios Financial ratios are misleading when applied to most private entrepreneurial companies

Entrepreneurial Finance The Owner’s Perspective Goals Creating value over the long term, rather than maximizing quarterly earnings, is a prevalent mind-set and strategy among successful entrepreneurs

Entrepreneurial Finance Financial Strategy Framework The opportunity leads and drives the business strategy, which in turn drives the financial requirements, the sources and deal structures, and the financial strategy. Once the core market opportunity and strategy are defined, the entrepreneur can begin to examine the financial requirements in terms of operating and asset needs, and then pursue a fund-raising strategy.

Entrepreneurial Finance Free Cash Flow: Burn Rate, OOC and TTC The core concept in determining the external financing requirements of the venture is free cash flow. Three vital corollaries are the burn rate, time to OOC (out-of-cash time), and TTC (time to close financing).

Free Cash Flow The cash flow generated by a company or project is defined as follows: Earnings before interest and taxes (EBIT) Less tax exposure (tax rate times EBIT) Plus depreciations, amortization, and other non-cash charges Less increase in operating working capital Less capital expenditures

Operating Working Capital Operating working capital can be defined as follows: Transactions cash balances Plus accounts receivable Plus inventory Plus other operating current assets Less accounts payable Less taxes payable Less other operating current liabilities

Operating Working Capital Operating working capital can be defined as follows: Earnings before interest but after taxes (EBIAT) Less: Increase in net total operating capital (FA+WC) Where increase in net total operating capital is Increase in operating working capital Plus Increase in net fixed investments

Exhibit 12.5

Entrepreneurial Finance Raise Money When You Do NOT Need It.

Entrepreneurial Finance Crafting financial and fund-raising strategies Critical Variables affect availability of funds: Accomplishments/performance to date Investor’s perceived risk Industry and technology Venture upside potential and anticipated exit timing Venture anticipated growth rate Venture age and stage of development

Entrepreneurial Finance Crafting financial and fund-raising strategies Critical Variables affect availability of funds: Investor’s required rate of return or IRR Amount of capital required and prior valuations of venture Founders’ goals regarding growth, control, liquidity and harvesting Relative bargaining positions Investor’s required terms and covenants

Exhibit 12.6

Entrepreneurial Finance Financial life cycles Ex. 12.6 details the types of capital available over time for different types of firms at different stages of development Many equity sources are not available until firm survives early growth stages Upside potential of firm is a big part of availability

Entrepreneurial Finance Financial Life Cycles Foundation firms Will total 8-12% of all new firms; will grow more slowly but exceed $1 million in sales and may grow to $5 million to $15 million High-potential firms Grow rapidly; likely to exceed $20 to $25 million; strong prospects for IPO and have widest array of funding opts. Lifestyle firms Limited to personal resources of founders, and whatever collateral or net worth they can accumulate.

Entrepreneurial Finance Team Activity What are the key entrepreneurial finance issues that your IBP team will need to anticipate that are: Critical to the venture? Unique to the venture? Your team has 20- 25 minutes to prepare answers to these questions. Select a spokesperson and prepare an overhead with your responses to present to the class.