1. The 2008-2009 University of Dayton Business Plan Competition Coaching Session four: Financial Tools

2. Some big dates coming up October 24 th : Coaching Session 5: Elevator Pitch November 5 th : Application deadline October 31 st, November 7 th, dress rehearsals November 15 th : Elevator Pitch

3. Goal for Today’s session—prep for the elevator pitch What are resources required? How are returns calculated? Understanding some key accounting concepts

4. A key point to remember You are writing fiction Your job is to convince investors that this deserves a Pulitzer prize! Your job is to convince an investor that these are reasonable and achievable numbers But they are still fiction!

5. A second key point to consider Writing a business plan will sharply refine these numbers What you are providing is a “back of the napkin” sketch of numbers If you have time, refine them. If not, take your chances with these.

6. Returns to investor In an elevator pitch you should provide 1. Projected Sales 2. Projected Profit Margins (Gross, maybe Net) 3. Projected RoA and when 4. Cash Flow positive (in time) Let’s consider each

7. 1. Projected Sales: back of the Napkin for the elevator pitch Figure out the size of your target market, and how it should grow in three years Identify market share for the top 4 firms in your target market Compare yourself on four attributes to those four firms – Peg yourself at 70% of the nearest competitor – So you might get 70% of their market size in 3-5 years Figure it takes you 3-5 years to ramp upto that 70% mark – 25% year one 45-50% year two, 70% year three

8. A quick example Suppose you find that your target market grows 10%, and is currently $1 million – Should be 1.21 million in year three You compare yourself to four top competitors, and find yourself equal to one with a 20% market share You are then looking at 14% (20% x 70%) if $1.21 million in year three, or $169.4k – Year one: $50,000 (20% of 20% of $1 million) – Year two: $ 99,000 (45% of 20% of 1.1 million) – Year three: $169,400 (70% of 20% of 1.21 Million) So, your year 3 sales ought to be about $170k (notice I rounded up a bit)

9. So now you have a reasonable and defendable sales estimate In the elevator pitch you don’t tell them how you arrived at the numbers, you tell them what you estimate sales and market share to be “We anticipate year three sales to be $170k, about a 14% market share”

10. 2. Profit margins But first a quick review : A Simple Income Statement Sales (minus returns) -Cost of Goods Sold (COGS) =Gross Profit Margin (GPM) -General & Administrative Expenses (G & A) = Earnings before Interest, Taxes, Depreciation & Amortization), AKA (EBITDA ) - Depreciation and Amortization = Earnings Before Interest & Taxes= EBIT -Interest =Earnings before Taxes (EBT) -Taxes =Net Income - dividends paid =Retained Earnings

11. Profit margins as a percent of sales Gross Profit margins are (sales-COGS)/sales Net Profit Margins are Net Income/Sales Report both as pct of sales

12. Using your sales forecast You estimate sales at $170k Maybe your COGS is $85k Your Gross Profit margin is $85k, or 50% Suppose all other costs equal $68k Your net income is $17k (85-68=17) Your Net profit Margin is $17k or 10%

13. What you would then say “We anticipate year three sales to be $170k, about a 14% market share”. That generates 50% Gross margins”.

14. 3. Getting RoA Concept one: ALE is A=L+E An asset is something of value within your business. Question: how did you acquire it? – Pay cash, swapped another asset, borrowed money Each time you add an asset, you account for how you acquired it, by increasing debt, equity, or both.

15. Why does this matter? This helps you track where your cash is going It helps you see what you have available Investors need this information. Remember: investors are like the “E” in ALE. Banks are the “L” in ALE

16. How are returns figured: RoA Return on Assets is Net Income/Total Assets – Re-write as Net Income/(Liabilities+Equity) Return on Equity is Net Income/Shareholder Equity – Re-write as Net Income/(Equity)

17. The “X” factor—condensed to multiples One way to consider RoA is to think of it in terms of “multiples” for the investor Suppose: – Investor pledges $10,000, for 25% of profits – In year five, you predict net income will be $100k – Investor gets 25%, or $25k Investors return is 2.5X ($25k/$10k)

18. Why use “X” in an elevator pitch? Investors do this mental math anyway, so provide it for them It’s also very quick, saving time – “Given our profit margins investors should earn a 2.5x return by year five”

19. Returning to our example You forecast a net income of $17k Suppose the investor invested $2k in return for 41% of the net income 41% of $17k≈ $7k $7k/$2k ≈ 3.5X

20. What would you say? “We anticipate year three sales to be $170k, about a 14% market share”. That generates 50% Gross margin”. This provides investors a 3.5X Return.”

21. 4. The tough one—when are you cash flow positive No easy rule here: here are rules of thumb – Ought to be between 1-3 years How much inventory do you plan to have? – Compare to firms in an industry – Look up inventory turn ratio for competitors How many turns does it take for your Gross Profit Margin to exceed inventory value? Add to one year

22. Continuing our example Suppose your average inventory is $20k Suppose inventory Turns is 6 (every two months) Suppose Gross Profit margins are 50% It takes two turns to pay for inventory out of Gross Profit Margins (4 months) Cash Flow positive in 16 months

23. Adding this to what we say “We anticipate year three sales to be $170k, about a 14% market share”, and cash flow positive in 16 months. That generates 50% Gross margin”. This provides investors a 3.5X Return.” Here is your returns to investors portion of the elevator pitch

24. What resources are required? You need three things – Estimate of COGS – Estimate of fixed expenses – Estimate to grow

25. COGS (Cost of Goods Sold) Maybe you have already identified this – If so, Great! If not, compare yourself to firms in the industry Use an average COGS, assume as a startup your margin is slightly worse – (buying power) You need enough inventory to handle a turn If industry average is 6 turns you need two months of sales in inventory

26. Example: Suppose sales are $170k and your COGS is $85k If Average industry inventory turns are 6 per year, you need two months of inventory on hand $85/6 ≈ $15k in inventory

27. Estimate of fixed expenses items to consider How many employees, their pay rate times 30% (fringe benefits) Cost of rent, utilities, phone, computer, internet access, legal and accounting Can you cut costs? Sum these and add to your minimum inventory

28. Estimate to Grow Simply a multiple of your fixed costs and COGS needs

29. What do you need the investor money for Building inventory? Hiring sales help? Infrastructure? Opening new locations? Working capital

30. For our elevator pitch, you ought to need between $50k and $250k Multiples may be the easiest way to get there Plus it shows growth. Judges like that What to say “We estimate we’ll need $100k from investors to build inventory and working capital. To do so we’ll offer investors 25% of the firm.

31. Finally some accounting concepts to consider

32. 1. Concept two: Recasted earnings You all know “the bottom line” is Net income Recasted earnings are net income before owner’s compensation. Recasted earnings takes away differences based on the cash owners take out of the business

33. 2. Retained earnings vs. cash (retained earnings are like a paycheck stub) Net income is a subjective number, that can be manipulated. – Your goal while courting investors is to manipulate NI upwards – Your goal while courting a spouse is to manipulate upwards – Your goal at tax time is to manipulate downwards Manipulating sounds unethical, but there are legal, ethical ways to do so. Do so with Ethics!

34. Why is this important? Because a business can be cash-flow positive, but showing no profit. This is okay! It’s where you’ll likely be in year one!

35. 3. Concept four: Survival Stage— your goal is to be Where your working capital is positive, you are paying your loans, and have a little bit left over. You might be showing a loss, but that’s okay— less tax to pay You want to make a modest contribution towards covering your infrastructure goals

36. A Simple Income Statement Sales (minus returns) -Cost of Goods Sold (COGS) =Gross Profit Margin (GPM) -General & Administrative Expenses (G & A) = Earnings before Interest, Taxes, Depreciation & Amortization) = (EBITDA ) - Depreciation and Amortization = Earnings Before Interest & Taxes= EBIT -Interest =Earnings before Taxes (EBT) -Taxes =Net Income Immediate Costs Covering Operational Costs Covering Financing Costs Pull out your comp—so lenders can see Recasted Earnings

37. Stages to consider When GPM is positive, it means you’re covering immediate costs—if negative, you have BIG problems When EBITDA is positive, it means you’re covering operational expenses, but probably not infrastructure expenses When EBT is positive, you’re covering your debt obligations When NI is positive, you pay income taxes

38. Some income statement goals Even from the beginnings, GPM should be positive Within the first year, EBITDA should be positive Within three years Net Income should be positive

39. 4. What areas of a start-up require financing? Start-up infrastructure Start-up operations Working Capital Loan payments Owner’s comp

40. Types of Start-Up Costs Space to run your business (office, storefront, manufacturing, warehousing) Office equipment Office supplies Insurance Utilities (electricity, heat, water) Communications (phone, internet, mobile) Maintenance Advertising Labor (all the individuals it will take to run your business) Business licenses Raw materials/packaging materials Legal/Accounting

41. 5. ROA and DuPont ROA is Return on Assets. It is Net Income divided by total assets. This is the “return number” that people like to quote. When you earn $50 on a $1,000 deposit at the bank, your ROA is 5% Since A=LE ROA is also Net Income/L+E ROA is also GPM x Turnover

42. GPM times turnover margin Example: Suppose you lease boats to customers: Each sale earns you X GPM. The more rentals you have, the more turnover you have Multiple them, and you have your ROA Strategy: focus on increasing one or the other to improve profits and ROA

43. 6. Working Capital This is Current Assets-Current Liabilities This should be a positive number. Banks like to see that CA/CL > 2 (twice as many current assets as current liabilities)

44. 7. A/R and A/P are sources of cash A/R are loans you make to customers to buy your product – Take Visa or M/C to shorten this – Offer discounts for cash/quick payment – Dell’s Holy Grail: Collects A/R in 3-5 days, Pays A/P in 30 days A/P are loans your suppliers give to you – Can you buy in bulk? Negotiate better terms? I counseled a start-up who had limited working capital. A small $5,000 loan allowed him to build inventory, and cut shipping costs by 30%!

45. As you grow, let your customers and your suppliers help finance you. As sales grow, so will the amount you can finance from customers. Think of it as a “loan of goods sold”.

46. 8. Financing: where to go in order of priority Friends & Family Credit cards and house Vendors Banks Business Angels Private Investors VCs IPO Owner’s comp Start-up infrastructure Start-up operations Loan payments Working Capital

47. What three questions do banks ask? 1. Do you have the ability to repay? 2. Do you have the intent to repay? 3. What are our options if you don’t repay?

48. Do banks lend on start-ups? Yes if, The founder guarantees the loan, and has collateral for it The loan is for some securable, such as inventory Projections have great margins

49. Banks like three years of actuals So bank money is really a bit beyond where you are now.

50. Some helpful play tools for finance http://www.bplans.com/contentkit/index.cfm?s=to ols&affiliate=sba

51. An SBA micro-lender (loans under $35,000) Hamilton County Development Company, Inc. 1776 Mentor Avenue Cincinnati, OH 45212 Phone: 513-631-8292 Email: lawalden@hcdc.com Service Area: ADAMS, BROWN, BUTLER, CLERMONT, CLINTON, HAMILTON, HIGHLAND, WARREN Executive Director : David Main Microlending : Lou Ann Walden Fax: 513-631-4887

52. Capital Sources Percent of CEO’s who got some capital by these means:  Private Equity82%  Personal Loans19%  Bank Debt19%  Venture Capital 9%  Supplier Financing 5% Source: Inc Magazine