Wharton Strategic Business Planning Part 33785

STRATEGIC BUSINESS PLANNING

Welcome! Session 3 – July 20, 2004 Instructor - Kevin Hawley [email protected]

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING The Wharton SBDC is part of Wharton Entrepreneurial Programs and the Sol C. Snider Entrepreneurial Research Center. The Wharton Small Business Development Center is in part financed by a grant from the Commonwealth of Pennsylvania, Department of Community and Economic Development. The Wharton SBDC is funded under Cooperative Agreement No. 4-603001-2-0040-24 by the U.S. Small Business Administration. The support given by the U.S. Small Business Administration through such funding does not an expressed or implied endorsement of any of the co-sponsors’ or participants’ opinions, findings, conclusions, recommendations, products, or services. All SBDC programs are non-discriminatory and open to the public. Reasonable arrangements for persons with disabilities will be made if requested at least two (2) weeks in advance. Please contact Dr. M. Therese Flaherty, Director, Wharton Small Business Development Center, University of Pennsylvania, 433 Vance Hall, Philadelphia, PA 19104, (215) 898-8635.

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Agenda – Session 3      

Recap from Session 2 Where We Are and What’s Left Financial Plans Cash Flow Tying It All Together Preparation for Next Session Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Recap – Session 2 

Industry Analysis  



Competitor Analysis  



Number and types? Business performance data?

Sales Projections  



Were you able to identify your NAICS code? Research? Sources? Surprises?

Were you able to define your sales unit(s)? Can you describe the reasoning behind your projections?

Marketing Plans  

Do they closely tie in to sales projections? How did you select your “marketing mix”? Copyright © March 2004 Wharton Small Business Development Center

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Session 2 Homework Review  Develop a draft Operating Plan  Develop draft Sales Projections  Develop a draft Marketing Plan  How did you do?  Trouble spots?  How to move forward

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Where We Are and What’s Left          

Executive Summary – discussed in Session 1 Business Description – discussed in Session 1 Product/Service Description – discussed in Session 1 Marketing Plan – discussed in Session 2 and tonight Operations Plan – discussed in Session 2 and tonight Financial Plan – tonight Funding Your Business - tonight Attachments/Supporting Documents – next week Milestone Driven Planning – next week Finishing your Business Plan and Next Steps – next week Copyright © March 2004 Wharton Small Business Development Center

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Building the Business Model Industry, Buyer & Competitor Analyses

Operating Plan

Marketing Plan

Cost Projections

Sales Projections

What will it cost to produce your product or service?

What will it cost to sell any given amount of your product or service?

Financial Plan Pro Forma Financial Statements How will your business make money? How much? For how long? Risks? Copyright © March 2004 Wharton Small Business Development Center

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Timing Example - Operations, Marketing, and Sales Interactions in the Financial Statements January

February

March

April

May

June

Marketing Expenses

Sales Related Operating Expenses

Fulfillment Related Operating Expenses

Operating Expenses

Revenues (Sales) Fictional example for illustration purposes only! Copyright © March 2004 Wharton Small Business Development Center

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Book Recommendation The Interpretation of Financial Statements by Ben Graham “Highly practical and accessible, it is an essential  guide for all business people…”

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

The “Big Three” - Financial Statements 

Income Statement (aka “P&L”) 



Balance Sheet 



Lists your income, expenses, and net income (or loss) for a given period, usually one year. A “snapshot” of the net worth of your company, listing assets and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually December 31.

Cash Flow Statement/Plan 

Outlines the regular inflow and outflow of cash in your business on a month-to-month basis.

These sections make up your “pro forma” financial statements. Copyright © March 2004 Wharton Small Business Development Center

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Other Areas of the Financial Statement 

Break Even Analysis  



Sensitivity Analysis 



Shows the impact of unplanned results on your business (higher or lower costs, sales, etc.)

Funding Schedule 



Shows at what point your company begins to make money. Online calculator at “http://dinkytown.com/java/BreakEven.html”

Details the amounts of money you expect to need and when

Staffing Plans 

Details the titles, salaries/benefits, and timing of hiring for people you’ll be adding to the company. Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Financial Assumptions  Key sales and cost drivers  Basic information about the market and opportunities in the environment  Start with:  Unit sales projections  Prices  Cost projections – fixed and variable  Key drivers for each Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Financial Projections  “Pro Forma” financial statements  Income Statement – revenue minus expenses  Balance Sheet – assets and liabilities  Cash Flow Statement – actual cash on hand

   

Critical to you, essential to others Predictions of business performance Financing requirements Sources and uses of cash Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Constructing Credible Financial Statements  Important first step: educated assumptions  What are the key revenue drivers?  What are the key cost & expense drivers?

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Assumptions – Revenue  Market size and opportunity  Number of potential customers  Your particular business cycle  Product/service pricing  Sales growth curve  Avoid the “moving hockey stick”!!! Copyright © March 2004 Wharton Small Business Development Center

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Assumptions – Cost of Sales/Goods Sold  Direct inputs to delivery of service  Direct inputs to delivery of product  Examples: materials, parts, labor, shipping a/k/a – variable costs Not your expenses Copyright © March 2004 Wharton Small Business Development Center

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Gross Profit + Revenue - COGS = Gross Profit Margin (GPM) a/k/a Operating Profit = $ earned before overhead expenses Copyright © March 2004 Wharton Small Business Development Center

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Expenses and Cash Flow + Operating Profit - Expenses = EBITDA

• • • • • •

salary rent utilities telephone marketing legal

i.e., “keeping lights on” a/k/a fixed costs Copyright © March 2004 Wharton Small Business Development Center

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EBITDA Earnings Before Interest Taxes Depreciation Amortization • a/k/a Free Cash Flow • Businesses valued as a multiple of EBITDA Copyright © March 2004 Wharton Small Business Development Center

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How Much Money Do I Need? 1. 2. 3.

Prepare detailed Income Statement Then Balance Sheet Then Cash Flow Statement

Monthly negative Cash Flow = operating cash Cumulative negative Cash Flow = total needed

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Balance Sheet A

“snapshot” of the net worth of your company, listing assets and liabilities. Important to note that balance sheets don’t tell you about the ups and downs of the year, only how things were as of a certain date, usually the end of the month or the end of the year. Spreadsheet Exercise

Copyright © March 2004 Wharton Small Business Development Center

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Cash Flow Statement/Plan  Outlines

the regular inflow and outflow of cash in your business on a month-to-month basis.

Spreadsheet Exercise

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EXAMPLE: Startup Jewelry Distribution Business How much do they need? MONTH ($000)

1

2

3

4

5

6

7

8

9

10

11

12

TOTALS

Revenue

0

0

0

0

0

3

3

7

7

38

38

42

138

Expenditures

17

5

8

8

9

9

11

19

19

33

42

40

220

Cash Flow

(17)

(5)

(8)

(8)

(9)

(6)

(8)

(12)

(12)

5

(4)

2

(82)

Cumulative

(17)

(22)

(30)

(38)

(47)

(53)

(61)

(73)

(85)

(80)

(84)

(82)

Copyright © March 2004 Wharton Small Business Development Center

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Income Statement (aka “P&L”)  Lists

your income, expenses, and net income (or loss) for a given period, usually one year.

Spreadsheet Exercise

Copyright © March 2004 Wharton Small Business Development Center

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Break Even Analysis  Shows

at what point your company begins to make money.  Online calculator at “http://dinkytown.com/java/BreakEven.html”

Spreadsheet Exercise

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Sensitivity Analysis  Shows

the impact of unplanned results on your business (higher or lower costs, sales, etc.)

Spreadsheet Exercise

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Funding Schedule  Details

the amounts of money you expect to need and when  Typically tied to milestones and achievements  Allows investors to decide on a commitment level January 2004 - $250,000 for start up expenses June 2004 - $75,000 for advertising and marketing March 2005 - $175,000 for expansion to 2nd location

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Staffing Plans  Details

the titles, salaries/benefits, and timing of hiring for people you’ll be adding to the company.

Title President Machine Operator Machine Operator Shipping Clerk Salesperson Salesperson Salesperson Totals

Hire Date January-04 January-04 April-04 April-04 June-04 June-04 October

Salary $80,000 $35,000 $35,000 $24,000 $30,000 $30,000 $30,000 $264,000

Benefits $26,400 $11,550 $11,550 $7,920 $9,900 $9,900 $9,900 $87,120

Copyright © March 2004 Wharton Small Business Development Center

Bonus $15,000 $2,000 $2,000 $1,200 $3,000 $3,000 $3,000 $29,200

Total Expense $121,400 $48,550 $48,550 $33,120 $42,900 $42,900 $42,900 $380,320

STRATEGIC BUSINESS PLANNING

- 10 Minute Break -

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STRATEGIC BUSINESS PLANNING

Funding Your Business 

Types of Investors 

Venture Capital and Angel Investors



Valuation of Early Stage Companies



What You Give for What You Get - Examples



Alternative Sources of Funding for Your Business

Copyright © March 2004 Wharton Small Business Development Center

STRATEGIC BUSINESS PLANNING

Getting to the Investment Requirements and Pre-Start Valuation  Draft the business plan narrative sections – tell your story!  Run the numbers – does the story hold up?  Income Statement  Balance Sheet  Cash Flow Statement/Plan  Determine funding needs from the Cash Flow Projections  Examine “pro-forma” EBIDTA projections at 5 years  Determine if the ROI fits the Angel Investor targets  If so, begin “pitching your plan” to prospective investors!  If not, you can either rework the plan, or…  Go to alternative funding sources and/or self-fund the Copyright © March 2004 plan Wharton Small Business Development Center

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Comparing Venture Capital and Angel Investors Venture Capital Firms  Typically do not invest in start-ups  Responsible for about 10% of all start-up funding

Angel Investors  Provide about 90% of the seed and early stage outside equity capital for start-up entrepreneurs

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

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Comparing Venture Capital and Angel Investors Venture Capital Firms  Operate like mutual fund companies  General partners such as managers, analysts,etc.  Limited partners are pension funds, corporations, etc.

Angel Investors  Loosely formed groups or wealthy individual investors  “Tried and true” entrepreneurs  Typically have invested in several companies

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

STRATEGIC BUSINESS PLANNING

Comparing Venture Capital and Angel Investors Venture Capital Firms  Typically invest in rounds valued at $7MM or more  Average investment in the $2MM range  Later stage interest

Angel Investors  Typically invest in rounds valued between $250K and $2MM.  Average investment per individual of $25K to $250K

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

STRATEGIC BUSINESS PLANNING

Comparing Venture Capital and Angel Investors Venture Capital Firms  Invested ~$20B in startups last year  About 3,000 deals  About 700 investors  Averaged about $7MM per round  2 or 3 investors per round

Angel Investors  Invested ~$30B in startups last year  About 50,000 deals  400,000 investors  Averaged about $750K per round  6 to 10 investors per round

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

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Venture Capital and Angel Investors Venture Capital Firms

Angel Investors

Later stage

Early stage

The Business

The Individual

Significant Control

Support and Influence

Executive Team Selection Financial Management

Hands-on Advisor Networking Help

6 to 12 months

2 to 4 months

3 to 5 years

Up to 10 years

Regional/National

Strictly local

Stage Primary Interest Control Level Assistance Provided Process Length Exit Timeline Where they Invest

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

STRATEGIC BUSINESS PLANNING

How Angels Evaluate Start-ups… The Management Team’s experience, intelligence, drive, and personalities are typically the most important criteria for Angel Investors, followed by the overall size of the opportunity. Quality of the management team………… 0-30% Size of the opportunity…………………….. 0-25% The product or service…………………….. 0-10% Sales channels…………………………….. 0-10% What stage the business is in……………. 0-10% How much money you’re trying to raise….. 0-5% Need for funding in future rounds…………. 0-5% Quality of your business plan……………… 0-5%

Copyright © March 2004 Wharton Small Business Development Center

Source: Ewing Marion Kauffman Foundation – www.emkf.org

STRATEGIC BUSINESS PLANNING

Valuation of Pre-Start Companies The typical Angel Investor opportunity looks like this: $250,000 to $1,000,000

Total amount of money raised

(raised in total from multiple angel investors)

Pre-start value of the company

$1,000,000 to $4,000,000

Amount of ownership (percentage) taken by Angel Investors Expected ROI in five years

20% to 40% 30X return on investment

“Real world” performance; how many Investments in start-up companies actually return between 10X and 30X? Copyright © March 2004 Wharton Small Business Development Center

About 10%

Source: Ewing Marion Kauffman Foundation – www.emkf.org

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Valuation Walk-through - Example 1 Here’s how a deal might be structured: Total amount of money raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple* Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company * alternatively, does 1x revenue in Year 5 equal 30x investment? Copyright © March 2004 Wharton Small Business Development Center

$250,000 5 $50,000 $7,500,000 (30X) $5,000,000 6 times earnings $30,000,000 25% $1,000,000

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Where the Numbers Come From… Total amount of money needed/raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment

$250,000 - Cash Flow Projections 5 - Based on avg. AI investment $50,000 - Specific AI profiles $7,500,000 (30X) – Roughly 100% ROI per year

Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon

Current (pre-money) valuation of company

$5,000,000 - Income Statement 6 times earnings - Industry research $30,000,000 - multiply 25% - Projected 5-year value of the company divided by the AI’s expected 5-year return amount

$1,000,000 - Amount of money raised divided by the AI’s required ownership percentage

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Expected Return Depends on Time To Exit/Harvest… Expected 5-year return on initial $250,000 investment

$7,500,000 (30X) Roughly 100% ROI per year

End of Year 1 - $250,000 plus 100% return = $500,000 (current value of investment) End of Year 2 - $500,000 plus 100% return = $1,000,000 End of Year 3 - $1,000,000 plus 100% return = $2,000,000 End of Year 4 - $2,000,000 plus 100% return = $4,000,000 End of Year 5 - $4,000,000 plus 100% return = $8,000,000 (32X) End of Year 6 - $8,000,000 plus 100% return = $16,000,000 End of Year 7 - $16,000,000 plus 100% return = $32,000,000 End of Year 8 - $32,000,000 plus 100% return = $64,000,000 End of Year 9 - $64,000,000 plus 100% return = $128,000,000 End of Year 10 - $128,000,000 plus 100% return = $256,000,000 And so on… every $1 invested 10 years ago turns into $1,024!!! Copyright © March 2004 Wharton Small Business Development Center

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Valuation Walk-through - Example 2 Here’s an example of a “no go” for angel investors: Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company Copyright © March 2004 Wharton Small Business Development Center

$250,000 5 $50,000 $7,500,000 (30X) $1,000,000 6 times earnings $6,000,000 125% --

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Valuation Walk-through - Example 3 Can you find the potential problem in this example? Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company Copyright © March 2004 Wharton Small Business Development Center

$1,000,000 40 $25,000 $30,000,000 (30X) $8,000,000 9 times earnings $72,000,000 41.67% $2,400,000

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Valuation Walk-through - Example 4 Can you find the potential problem in this example? Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company Copyright © March 2004 Wharton Small Business Development Center

$300,000 4 $75,000 $9,000,000 (30X) $15,000,000 5 times earnings $75,000,000 12% $2,500,000

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Finding Angel Investors… Starting points for finding Angel Investors and other resources…  Wharton SBDC Website http://whartonsbdc.wharton.upenn.edu  Innovation Philadelphia http://www.IPphila.com  Inc.com (“Inc. Magazine”) Website http://www.inc.com/guides/finance/20797.html  Google Search Engine Enter these terms - “angel investors” Philadelphia Copyright © March 2004 Wharton Small Business Development Center

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Alternative Funding Sources…     

Suppliers and Customers Personal Funds and “Bootstrapping” Friends and Family Private Equity Debt

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Suppliers and Customers    

Suppliers allowing deferred payments A “float” from suppliers Customers offering advance payment Advance ordering and order guarantees

If you don’t ask, you won’t know if you can get it!

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Personal Funds and “Bootstrapping”  Cash savings  Converting assets  “Sweat equity”  The “apple cart” approach Try to think like an impartial investor even when ESPECIALLY when using your own money! Copyright © March 2004 Wharton Small Business Development Center

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Friends and Family  Traditional startup funding sources  The investment they make is in YOU!  Business metrics usually less important  Usually a higher tolerance for problems Written agreements still very important! Consider the potential impact on relationships if the business is not successful and the investment is lost! Copyright © March 2004 Wharton Small Business Development Center

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Private Equity  Sophisticated “Angel Investors”  Professional investors – typically take a sole investor position in startups  Minimal margin for error and a low tolerance for underperformance  Generally reserve the right to replace the management team if projections aren’t met!  Contracts tend to be complex with lots of strings attached to investment

Talk with other companies they’ve invested in! Copyright © March 2004 Wharton Small Business Development Center

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Debt Financing  Local banks  Small Business Administration loans  Credit cards  Borrowing against home equity  Borrowing against insurance policies  Borrowing against your retirement IRA Be aware of the risks and consequences! Copyright © March 2004 Wharton Small Business Development Center

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Rules for External Financing Rule # 1 – Try to use other people’s money (OPM) Rule # 2 – Let your customers and suppliers finance the business to the greatest extent possible Rule # 3 – Use money you can afford to lose or can emotionally handle losing Rule # 4 – Get money as inexpensively as possible Rule # 5 – A smaller percentage of something big is worth more than 100% of nothing! Rule # 6 – Seek advice from advisors, i.e. lawyer, accountant, consultants, family, etc. Copyright © March 2004 Wharton Small Business Development Center

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Homework Assignments 

Develop a draft Financial Plan  Use the discussions from this evening to build a integrated

financial plan for your business.

 Revise and refine Financial Projections  Based on your operating, marketing, and sales expenses,

how much money will the company need to get started, what are your cash flow projections, and how much money will the business make and when?

 Complete the Operating Plan  Go back into your narrative plan and adjust your story based

on the realities of your financial plan.

Questions about the assignments? Copyright © March 2004 Wharton Small Business Development Center

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Next Session (Session 4)  Attachments and Supporting Documents  Other things to include in your blockbuster plan



Milestone Driven Planning  How to stay on track and build confidence among investors



Bringing It All Together  We’ll walk through plans from participants in our class, discuss

strength’s and weaknesses, try to highlight areas that need additional work. We’ll use the templates from Sessions 1-3 to evaluate the plan.



Next Steps  Staying focused, accessing additional SBDC resources, finding and

using an expert advisory board.

See You Next Week! Copyright © March 2004 Wharton Small Business Development Center