Entrepreneurial Financein Less than One Hour
Michael DearingStanford University 2010
Copyright 2008 Michael Dearing.
WARNING
• TONS of details are missing from this• You have to do a lot more reading and
learning• You should get a lawyer to help you• But you will know more than most people
at the end of this
Copyright 2008 Michael Dearing.
Promise
• This is mostly seventh grade math and basic common sense
• It's wrapped up in a vocabulary created by elites who like to stay elite by making this sound hard; it's not hard at all
• You will annoy the finance priesthood with your knowledge
• If you learn these concepts, read a few suggested books, practice with a calculator and spreadsheet, you can handle anything related to financing a new venture
Copyright 2008 Michael Dearing.
Agenda
• I. Five Basic Concepts
• II. Four Nouns
• III. Three Rules of Thumb
Copyright 2008 Michael Dearing.
I. Five basic concepts
• Cash is life• Cash comes from debt, equity, or operations • Growth eats cash• Risk goes down in chunks• Value = f (all future cash flows)
Copyright 2008 Michael Dearing.
Cash is life
CASH
ASSETS
SALES
BILLS
“PRODUCTS”
LEFTOVER CASH
Copyright 2008 Michael Dearing.
ACME Lemonade Stands
Copyright 2008 Michael Dearing.
Balance Sheet
=
AssetsLiabilities &
Shareholders' Equity
Where does the money come from?
Copyright 2008 Michael Dearing.
Balance Sheet
=
AssetsLiabilities &
Shareholders' Equity
Where does the money come from?
Cash + What we buy with the capital to be in business
Copyright 2008 Michael Dearing.
Balance Sheet
=
AssetsLiabilities &
Shareholders' Equity
Where does the money come from?
• Debt• Shareholders• Operations
Cash + stuff we buy with the capital to be in business
Copyright 2008 Michael Dearing.
Balance Sheet
=
AssetsLiabilities &
Shareholders' Equity
Where does the money come from?
• Debt• Shareholders• Operations
Cash + stuff we buy with the capital to be in business
• Lemons• Sugar• Water• Stand
Copyright 2008 Michael Dearing.
Profit & Loss2009Comment
Revenue $250# Glasses x price/glass
Cost of goods sold $125How much did you pay for the lemonade you sold?
Gross profit $125Left over to pay the bills
Operating expenses
$115The bills; other stuff you had to do to run the lemonade stand
Operating profit $10How much did you make on the business?
Taxes $4
Net income $6~Internally generated capital
Copyright 2008 Michael Dearing.
Financial Plumbing
RIGHT SIDE(where $ came from)
LEFT SIDE(the stuff we need) =
Sales
Gross profit
Expenses
Op profit
Taxes
Net Income
P&LBalance Sheet
Turn Net Income into Cash Flow*
* See Higgins for a great explanation of how to calculate cash flow from net income; we don't have time to do it now!
Copyright 2008 Michael Dearing.
Financial plumbing
• Cash raised on right side of balance sheet• Cash invested in stuff to make the business run
on the left side of the balance sheet• Humans use stuff on the left side of the balance
sheet to make revenue• Revenue pays bills• Profits turn into cash• Cash comes back to the balance sheet
Copyright 2008 Michael Dearing.
Growth eats cash
• Go back to the lemonade stand financial statements
Copyright 2008 Michael Dearing.
Growth Eats Cash?
RIGHT SIDE(where $ came from)
LEFT SIDE(the stuff we need) =
Sales
Gross profit
Expenses
Op profit
Taxes
Net Income
P&LBalance Sheet
Turn Net Income into Cash Flow*
* See Higgins for a great explanation of how to calculate cash flow from net income; we don't have time to do it now!
Copyright 2008 Michael Dearing.
Growth eats cash
• Go back to the lemonade stand financial statements
• If you grow sales, expenses or assets faster than you grow internally generated cash flow to pay for them you *must* raise cash from outside the company.(1)
(1) Robert Higgins, Financial Analysis for Managers, Chapter 4, "Managing Growth."
Copyright 2008 Michael Dearing.
Raising capital
• When?• How?• How much?
Copyright 2008 Michael Dearing.
Risk goes down in chunks
• Can I make lemonade?• Will anyone buy it?• Can I advertise to increase sales?• Can I produce enough to satisfy
demand?• Can I reduce my costs in order to
increase profits?• Can I expand from one stand to many?
t = 0
Copyright 2008 Michael Dearing.
Risk goes down in chunks
• Can I make lemonade?• Will anyone buy it?• Can I advertise to increase sales?• Can I produce enough to satisfy
demand?• Can I reduce my costs in order to
increase profits?• Can I expand from one stand to many?
t = 0 SEED
SERIES A
SERIES B
Copyright 2008 Michael Dearing.
Value = f (cash flows)
• Robert Higgins – Analysis for Financial Managemento Why cash drives valueo What is present value and the time value of moneyo How to incorporate these concepts into your plans and actions
Copyright 2008 Michael Dearing.
II. Four Nouns
• Convertible debt
• Preferred stock
• Angel investors
• Venture capitalists
Copyright 2008 Michael Dearing.
Back to the Balance Sheet (R)
• Debt financingo Trade credito Bank loanso Convertible debt **o Public debt
• Equity financingo Common stock o Preferred stock **
• Retained Earnings
Copyright 2008 Michael Dearing.
Convertible debt
• Borrow money from one or more entities• Converts to equity when equity is raised at
some future date• Converts at a discount to the price paid by
the new equity investors
Copyright 2008 Michael Dearing.
Preferred stock
• Ownership in the company in exchange for cash
• Price (value of the company) is negotiated: “pre” money
• “Post” = “pre” + new capital raised• Staged in series (seed, A, B, C …)• Better liquidation rights than common• A bunch of other terms – rights, resale,
conversion to common
Copyright 2008 Michael Dearing.
Angels
• Wealthy individuals• Range of sizes – small ($25-50k) to
large (up to $1 mil)• Some do notes, some do “priced
rounds” (preferred stock)• Some are active, some are passive• Silicon Valley has lots of them
Copyright 2008 Michael Dearing.
Venture capitalists
• Typically operate a fund made of other people’s money: pensions, endowments, rich people, institutions
• Focus on equity investments, rarely do convertible debt
• Invest larger sums than angels on average• Make money via carried interest and a
management fee on the fund
Copyright 2008 Michael Dearing.
Investor and security type
Convertible debt Preferred stock
Angels Often (smaller) Sometimes (larger)
Venture capitalists Rarely Almost always
Copyright 2008 Michael Dearing.
III. Three Rules of Thumb
• Match your financing to your milestones to your strategy to your values and dreams
• Know what is “market” – what has happened in other deals -- it will level the playing field and simplify the process
• You will make money by building great products and a great business – not by negotiating “great” terms on your financings (this goes for both sides of the deal!)
Copyright 2008 Michael Dearing.
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