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Copyright © 2013 by Lili Balfour All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in reviews and certain other noncommercial uses permitted by copyright law. Legal Disclaimer The author of this report and the accompanying materials has used their best efforts in preparing this material. The author makes no representation or warranties with respect to the accuracy, applicability, fitness, or completeness of the contents of this material. The information contained in this guide is strictly for educational purposes. To purchase the financial model, visit www.atelieradvisors.com/growth
PROLOGUE It’s been six years since I set out to build Atelier Advisors, a financial advisory firm focused on serving early-stage companies. Prior to Atelier Advisors, I spent fifteen years working for investment funds, law firms and investment banks, primarily focused on middle market companies. Over the past six years, I have been fortunate to advise leading early-stage brands across industries: from consumer goods to technology. By working with a broad range of companies, I have been able to amass a wealth of knowledge on revenue models. However, whether I am working with a brand that extracts value from a person (Eckhart Tolle and Erin Fetherston) or a product (Alpha Theory and Derivix) they all have one thing in common – they must monetize. Unfortunately, monetization is not the most exciting subject for most entrepreneurs. Let’s face it. Most people don’t enjoy finance. It is rarely laid out in an easy-tounderstand format. I want to change that. This ebook and spreadsheet explains financial concepts with easy-to-follow examples. Whether you are thinking about starting a company, or have already begun your journey, Master the Finance Game will give you the tools needed to succeed. My goal for developing the Master the Finance Game ebook, workshop, and online course is to teach the entire planet about entrepreneurial finance. As a native of Silicon Valley and a first generation Mexican American, I understand the importance of imparting wisdom learned in Silicon Valley to the rest of the world.
OVERVIEW Master the Finance Game will give you the tools needed to: 1) build a bottom up financial model based on your target audience’s needs, 2) value your company, and 3) secure the most appropriate type of capital. You can purchase the spreadsheets separately at www.atelieradvisors.com /growth or build from your own version. You will find references to the spreadsheets throughout the ebook. First, we will walk through the process of building financial models and metrics, using a mock company, in order to illustrate five popular revenue models. Second, we will construct a valuation for the mock company. This will help you assess the percentage of your company you will need to give away if you decide to issue equity to a partner or accept an equity investor. Third, we will review the different types of capital to determine which source is the best route for your company. What you will need to get started. Before starting, we want to understand the target audience or “buyer.” The best way to understand your target audience is to go directly to the source. Don’t be afraid to ask your potential or current customers about their needs and wants. Once you have researched the current market and have assessed the ecosystem, you will be ready to answer the following questions about your buyer, your pricing strategy and your metrics.
6 .Now that you understand your buyer. let’s talk about revenue models. your pricing and your metrics.
LinkedIn Ebay. it is commonplace. That is the wonderful thing about running a business. you will find a quick review of seven standard revenue models. Etsy AirBNB. Five years ago. By the time you read this ebook. Once you understand basic revenue models. Now. Model Etail Retail Subscriptions Marketplace Commission Ads/Sponsors Pay per Use Method Charge user for goods sold online Charge user for goods sold in a store Charge user on a regular schedule Charge merchant and user once item is sold Charge % of transaction when completed Charge advertisers or sponsors Charge user per asset usage or download Example Overstock. Naturally.REVENUE MODELS A revenue model simply outlines how you will bring money into the company. there are an infinite amount of revenue models and new models are constantly being created. nobody was renting their cars to strangers. We will focus on seven standard revenue models and use four in our mock example. Twitter iTunes. Lululemon Salesforce. but I strongly encourage you to explore co-mingling what exists and/or creating something new. On the next page. Your pricing mechanics are determined by your buyers’ willingness to pay. you can begin to evolve them to your customers’ needs and wants. more will have been created. Amazon Restoration Hardware. Netflix 7 . The last time I checked there were over 100 monetization strategies. Poshmark Facebook.
Now that you understand revenue models. As you build your company. we can only imagine how our customers will purchase our goods and services. We have evolved to a society that creates virtual market places with digital goods and services. explore whether you could profitably deliver that. we have moved away from a society that requires physical space to sell merchandise. don’t be afraid to experiment with different forms of delivery. 8 . If your customers are interested in renting a tie instead of buying it.Let’s look at a history of revenue models. let’s talk about financial statements. As we move into the next decade. Will you allow customers to rent your product and return it? Will you offer rent to own? Will you provide your product or service in both the physical and virtual world? The answer to these questions lies in your customer feedback. As we can see from the chart below.
I want to change that. Our goal is to quickly assess the company’s performance and determine a financial strategy. and the statement of cash flow. 9 . Each of these three sections are interconnected. We will add cash from the balance sheet. we create a streamlined version of the traditional financial model. as the process is rarely laid out in an easy-to-follow format. Below you will find a straightforward explanation of the key elements you will need to build your financial model. Traditional financial statements include the income statement. but we will not construct the full balance sheet. We focus on the most critical aspect -.the income statement. the balance sheet. as it will allow you to develop and analyze your revenues and expenses. In Master the Finance Game. The income statement is important. This is the thrust of what we want to understand as business owners.FINANCIAL STATEMENTS Most entrepreneurs dread building financial models.
the company spent $263 million on marketing alone. However. However. Now that we have that out of the way. Each business is different and will be measured on different metrics. including marketing and acquisition-related costs. 10 .We will discuss generally accepted standards for reporting financials. which highlights the strength of your marketing campaigns. you always want to make sure that your metric is based on logical assumptions. metrics can provide valuable insight. You may recall Groupon’s attempt to convince people that their “adjusted consolidated segment operating income” was an appropriate measure of their performance. which illustrates the amount of revenue that is derived from each user. It is okay to create a new metric. but are critical to the life of the company. which provides insight into the relevance of your promotions. The measurement was based on the assumption that the company’s operating income should exclude several major expenses. Expense Metrics You can show the number of users acquired per each marketing dollar. which shows how effective you utilize your space. You can show revenue per square foot. as metrics show the strength of your company. Think about that for a minute. Let’s look at a few common examples: Revenue Metrics You can show revenue per users. many companies attempt to create new measurements for their performance by creating their own metrics. In fact. When used properly. As an entrepreneur you can already guess that marketing and acquisition costs are not only ongoing expenses. but make sure it is based in reality. You can show number of customers acquired during a promotion. let’s take a high level look at standard categories in the financial statements before we go into further detail.
general. design and programming expenses. Tax rates vary by location. Intangible .materials used to create the product or service. Gross Revenue Research and Development (R&D) Sales.Revenue Cost of Goods Sold (COGS) or Cost of Sales (COS) This is where you list all revenue. This is where you list all costs associated with researching and developing new products or services. General. advertising. Tangible .all other expenses directly related to creating and selling your product or service Subtract cost of goods sold or cost of sales from revenue to calculate gross revenue. Interest Expense or Revenue Taxes Net Income This is where you list any interest paid or interest received. Subtract Interest Expense and Taxes (and add Interest Revenue) from operating revenue. We assume that we have not added depreciation and amortization into the model See appendix for details. Operating Revenue 11 . List salaries. and Administrative (SG&A) This is where you list all cost associated with sales. List R&D salaries. equipment and materials expense used for R&D. marketing. and office expenses for SG&A. This is where you list all costs associated with creating and selling your product or service. Subtract R&D and SG&A from Gross Revenue. and administrative. travel. Consult your tax authority for a tax schedule.
The most critical elements of the balance sheet are cash. which are part of our current assets. capture this to analyze your inventory levels. so it is helpful to have an understanding of these categories. We will look at cash in our financial model. If you construct your forecast and find that you will run out of cash in 2 months. Cash Inventory Accounts Receivable (A/R) List the amount of cash on hand. If your company has A/R. Remember: The number one reason startups fail is they run out of cash 12 . Inventory and A/R help you understand cash flow. you need to adjust your assumptions. We are looking for a healthy runway of 6 to 12 months. capture this to analyze the speed of your payments. We are concerned with money coming in and out of the company. as well as current assets. inventory and A/R. If your company has inventory. The twelve categories outlined above are the most important for our analysis.
you should determine the answer to the following five questions: Q: How much cash is available at any given time? Q: How long does it take for inventory to arrive? Q: How long is your sales cycle? Q: How quickly do customers pay? Q: What % of sales is refunded? 13 .Once you have constructed your financial model.
keep in mind that revenue must be greater than expenses. The difference between good financial planning and poor financial planning is life and death for your company. Now that we understand revenue models and financial statements. The number one reason companies go out of business is that they run out of capital . our capital carries us through the first six months. In our model.It is critical that your company’s revenue model create sufficient cash flow to operate the business. Of course. 14 . As you build your model.000 (you may change this assumption). In our financial model we will analyze how long we can operate with $500. most businesses run at a loss for the first few years. I believe that you do need a business model and a revenue model. We constantly hear that you don’t need a business plan to run a company. we can begin to build our financial model. This is why you will need some capital to start.
our private benchmark. We explore these four models purely for simplicity. In this example. Public Comparables: e-Bay. change prices. JustFab. to understand the volume of sales for an early-stage company. as well as a few privately traded companies. This will allow you to add new products. you can begin to build and/or refine your financial model. We make assumptions on the number of units sold by looking at data from our private benchmarks. Banjos Banjos sells men’s apparel using a patented avatar to customize the fit. and modify growth rates by simply changing one cell. For Banjos. Simply put. retail. let’s assume that we are building an ecommerce site for men’s apparel. we price our goods at the going rate. Banjos. Always make your changes in this tab. we will explore etail. As you can see. Remember. and Warby Parker The first tab you want to set up is the assumptions tab (see Assumptions tab in spreadsheet).Building a Financial Model Once you understand your revenue model and the financial lingo. we want to select a few publicly traded companies. we are open to exploring any revenue model that our target audience (buyer) has expressed interest in using. For our mock company. Let’s walk through the spreadsheets with our mock company. and commission. Amazon. We set our price based on research conducted in the market. We look to Bonobos. we have decided we will start with pants and shirts. subscription. ShoeDazzle. for reference. 15 . and Bluefly Private Comparables: Bonobos.
000 + 1. Andy Dunn. We estimate 13. we derive the following facts: 2H: 2007 $552k $115 1.6 million in 2008 and $4 million in 2009.9k 2009 $4 mil $115 34. Our calculation is: 55. but we really want to look at our own customer growth. we subtract 5.900 pants were sold in 2008 and 34.000 units for the first two months of 2010.400 pants were sold in 2007. However. CEO. We arrive at 5. was quoted as saying that they have sold 55. it is one thing to look at Bonobos’ numbers for guidance. In February 2010. All unit estimates are calculated by dividing revenue by our average price of $115.500. § § § § The company was launched in June 2007. 16 .4k 2008 $1.3k Revenue Avg Price Units I want to stress that all of the data we are looking at comes directly from the public domain. The average price of the product is $138.000 units for 2010 by estimating 2009 per month units at 2.400 I show this level of detail to illustrate that you can quickly find details on private benchmarks.700 + 5.7k 2010 $12 mil $115 104. To get to this number. we set out to launch our first campaign.900 + 34.000 = 13.700 in 2009. We can estimate that approximately 1. Revenue was reported as $1. So. as I know that their basic line is more popular.6 mil $115 13. but I will skew toward to the lower range of $115.By doing a basic search on the Internet.000 pants since inception. You do not need to pay for any third party research.
so we will look for men who already demonstrate the desire to pay for online services that make their lives easier. so we made $1. we are ready to add growth assumptions.000 who clicked the ad. who made an average purchase of $100. The average purchase price was $100 for both campaigns. 17 . we spend $1. in rows E through I.000 with our paper campaign.000 people click the ad. and Delish Meal Delivery Service are the three most established companies in our area. The cost for the promo card and the online ad are both 50 cents. 30% of the promo cards were redeemed and hence a purchase was made. let’s assume 1.000 with our online campaign and $30. We decide to look for a dry cleaning service. only 1% (or 10) made a purchase. To make our example easy. You will replace estimated growth with actual growth as your company grows. However. Sparkling Maids. We research the market and find that Polished Dry Cleaning. Now.Customer Acquisition We want to go to where our target market is. and a grocery service.000 for this campaign. a maid service.000 promo cards with their deliveries and display an ad on their website. We learned that of the 1. We model E and F based on monthly growth rate and G through I based on annual growth numbers. We approach each company and ask if we can insert a promo card in their deliveries and list a promo code on their website. based on Bonobos’ historical growth rate. We now have 310 customers. All in. Each company agrees to insert 1.
We estimate 30% of our members will purchase $50 shirts on subscription. let’s go back to our assumptions. you could easily rationalize your projections to an investor. Therefore. We researched the market and determined that we can profitably deliver a shirt for $50 per month. This is a fair and conservative estimate. If you switch over to Income Statement. These sites. Currently.000 paying subscribers at the end of year two. We use this data to estimate that our site will have a demand of approximately 40% of the sites focused on women. Now. Similar to our etail revenue.000 members? Our assumptions indicate that 10% of our subscribers are purchasing on a monthly basis. By reviewing the market size for men’s apparel. If you click to the Income Statement tab you will see that all of our assumptions and inputs are flowing to this tab. This is the tab that you will use for presentations. Based on our customer research during the first few months.000 to 1 million members per month. Enter this data in Assumptions – cells C14 through C15. Okay. Remember our benchmark of 300. we will estimate that 30% of our member base will convert to our monthly subscriptions. You will monitor the next 24 months of operations using this tab. you will see that on line 17 we have approximately 30. we learned that buyers wanted to sign up for monthly subscriptions and receive a selection of dress shirts to complement their trousers. This tab will be used as your dashboard. have noted that they attract from 500. P&L and Metrics. we review subscription sites.We can see that the data is populating into the next sheet titled. The model will automatically calculate the number of subscribers in C13. we want to start with our own bottom up assumptions. which focus on women. ShoeDazzle and JustFab.000 as our model matures. The etail data on row 12 in our Income Statement tab is in line with our private benchmark’s historical data and the assumptions we have discussed. As you change your data in the Assumptions tab. it is set at 187. 18 . we learn that the men’s market is approximately 40% of the women’s market. the changes will automatically populate all other sheets. To get started. This is why we make all changes in the Assumptions tab. We estimate our member number at the low range of 300. You may increase or decrease growth in column C.
as their price point and target audience is similar to ours. a pop up shop is a store within a store. You can adjust this to fit your industry’s standard. Retail sales automatically populate at row 39 in the P&L and Metrics tab. We estimate sales per square foot of $1. Before we move on.500 in 500 square feet. Our commission is 20%. From their data. Enter this data in Assumptions – cells C20 through C21. make sure you understand the nature of each revenue line. We add line 40 to weight sales based on standard retail traffic. We look to Warby Parker’s business model to assess their foot traffic.500 sales per square foot. we learn that their sales per square feet are $3. We then look to Udan. It is commonly used as a way to quickly get in front of a new audience without the expense of actually building a store. 30% of our shoppers buy sweaters for $80 and we make 20% commission. We just heard from a free trade group who wants to sell their sweaters on our site. 19 . We agree to sell their $80 sweater and pay them 80% of all sales. Enter this data in Assumptions – cells C27 through C29. We have now completed all revenue assumptions for our business. Make sure all weightings add to 100% in the last cell (AF40).We also heard from our buyers that they prefer to try items on in person. to determine the percentage of conversion from our member base. We want to focus on a small space so we will set our store (or pop up) for 500 square feet at $1.659. For example. We assume 30% of our member base will purchase the sweaters.
Use this data to calculate the dollar value of cost of goods sold. 20 . We estimate COGS for pants and shirts at 50% and 40%. simply determine who will manufacture your product and at what price. and expenses directly tied to the revenue you produce. and administrative (SG&A) Cost of goods sold (COGS) includes materials. We will manufacture the same products for each distribution channel. general.Expenses Now we want to create expense assumptions. and sales. So. labor. Enter this data in Assumptions – cells C34 through C35. respectively. Our example uses % for simplicity. Expenses fall into three general categories – cost of goods sold (COGS). research and development (R&D).
21 . Banjos has a digital avatar to assist with customized fit. we look at our public benchmarks and we observe that cost of goods sold is 35%.000 users). but will normalize as we mature. Research and Development (R&D) is expense related to developing existing or new products. Next. so we assume we will invest heavily in R&D. unless you decide to invest in your technical infrastructure. Now let’s move to research and development. This will be minimal for an ecommerce site. we determine who will do our web hosting (we estimate $250 per month for every 500.Next. Are our numbers inline with the norm? Expect COGS to be high in the first few years of growth and stabilize near your benchmarks. we assess which other expenses are required to sell within each channel Fees Salaries Web hosting Credit card fees Payment gateways Commission/Affiliate Shipping Storage/Rent Etail Yes Yes Yes Yes Yes Yes Yes Sub Yes Yes Yes Yes Yes Yes Yes Retail Yes No Yes Yes Yes No Yes Now. how we will process payments (most credit card fees are close to 3% and gateways are 2%) and how much we will pay in commission (a standard rate is 10%). We assume R&D will be extensive as we get started. These are generic estimates for illustration purposes only.
22 . Let’s see what we come up with on our own. We input real data.000. Remember. allocate that square footage in COGS.000 for future months. at $500 for clicks.000 Enter this data in Assumptions – cells C53 through C55. $1.000 per month and check against our benchmark. so let’s budget $5. Note: if you use a portion of your office space for inventory. Advertising was in line with marketing.000. We know our first campaign cost $500 to produce promo cards. We estimate marketing.After reviewing our public benchmarks we ascertain that the range is 0% to 10% of revenue is a good allocation for an e-commerce site.000 per month Enter this data in Assumptions – cells C48 Sales. We estimate research and development costs will be $1. We look at our public benchmarks and we determine that SG&A is 35%. We have researched our local real estate market and determined our monthly office space will be $5. General & Administrative (SG&A) is going to be a bit more extensive. advertising and office at $5. holding inventory can be a huge drain. Remember this is where companies always underestimate. So let’s also set it at $5. We choose 10% as our ecommerce site has a strong technical bent.
We have now completed our revenue and expense assumptions based on data that we have found in the public domain. 99% of the information you need is free.000 on communication equipment.We believe we will spend $2. Salaries are input manually on the Personnel Plan tab We estimate salary increase at 5% and personnel growth by 40% (yrs 3 – 5). You may find that this needs to be increased depending on the nature of your business.000 Enter this data in Assumptions – cells C56 through C57. We estimate computers at $2. Enter this data in Assumptions – cells C65 through C66. through years three and five. We set our annual salary increase at 5% and grow our personnel by 40% per year. 23 .500 and communication at $1.500 on computer equipment and $1.
men in finance make more money. The best way to build solid company culture is to get everyone aligned with your company’s vision. Our goals go beyond simple benchmarks. This is where all of your research will help you to make smart decisions about your SG&A dollars. but they only wear casual pants on the weekends. Bonobos targeted men in finance. but later learned that customers wanted the flexibility to buy when they wanted. Remember our questions? Who is your “buyer?” How do they want to buy from you? Use the data you gather to create effective advertising campaigns directed at your precise market. until they later realized that teachers were their prime targets.We can learn a lot from those who came before us. This brings us to our next section. 24 . ShoeDazzle launched with a subscription only model. Teachers are required to wear casual pants as their work uniform. We want to inspire our entire company to track goals and motivate each other. Yes. The only way we will know if we are on track is if we set goals and measure our progress. measuring performance.
We sell apparel to men within the 25 to 45 year range.000. This will help us understand how each group of buyers interacts with our products and service. and commission. and commission is $100. to acquire one customer. We use 240 to indicate months. $50. We look at the average purchase price of our customers. and $80.METRICS Now let’s figure out how we can best measure our company’s growth. The more customer data you have. the number of times they purchase per month and the standard duration of the customer. Cohorts Let’s place our new customers in cohorts. make your best guess and update with actual data when it is available. subscription. subscription. we want to understand the Lifetime Value of Customers (LTV). This helps us understand how much we would be willing to spend. you want to make your cost back within a year. retail. $120 x 2 X 240 = $48. the date of their purchase. We enter the number of purchases at two based on observation. We will look at four methodologies: etail. 25 . the more accurate your calculations. we can only estimate the duration of each customer. For this example.000 The lifetime value of our etail customer is $48. This data is calculated by our spreadsheet in Column o. Let’s do this for each methodology: We see that the average purchase price for etail. Of course. retail. or another variable that allows them to be tracked. respectively. we are sectioning our cohorts based on methodology. $75. We can estimate that the standard duration of our customer is 20 years. We enter all data in the P&L and Metrics tab beginning at Row 98 First. We could categorize them by the campaign they came through. As a general rule. If you are just getting started.
retail. we have a low LTV customer with a high referral value. The number of customers acquired for etail. it may attract thousands of new customers. yet serve as lucrative conduits for your business. respectively. but creating specific cohorts around campaigns will give you better insight. let’s look at our Customer Acquisition Cost (CAC) per methodology. $19. However. This is only helpful if you have real data. Some companies calculate all relevant costs for one year and measure that against the number of customers acquired. if you spend your resources sending George Clooney free Banjos apparel for a photo shoot. However you decide to review your lifetime value of customers against your customer acquisition cost make sure you are comparing apples to apples. Keep in mind that some customers may be expensive to acquire and have a low LTV. 600. subscription. It may be hard to understand the exact number of new users who are coming to your site due to the sleek photo shot they just read. we are adding sales expense. Let’s move on to referrals. you could measure the increase in traffic to your site to get a general sense of the impact. advertising expense. and salary expense for each campaign. In this example. and $19. That will give you a general view. There are several ways to calculate your customer acquisition cost.Now. $6. We see that the cost for each methodology is $11. In this scenario. We use actual expense data to determine the cost of acquiring one customer over a set time period. 180. marketing expense. and commission were 310. 26 . For example. This data is highlighted in our spreadsheet. 187.
27 . Do your blog posts generate strong interest in your site? Yes. only 10% activate the account 100 x 10 = 1. 10% activate (or 100) Your viral coefficient is 1. as each one recruits one.Viral Coefficient Now. George Clooney. Traffic Sources Now. may have attracted 10.each person invites 10 people . We are able to see that new traffic arrived at our site by searching for the product George Clooney was wearing in the ad. We are able to see that new traffic arrived at our site by referral from the magazine article and photo shoot. Are there specific sites that refer traffic? Yes.000 new orders based on one pair of pants.of the 1. however. Set up a system to view where your traffic is generated. we should always look to conduits that embody our brand’s message. To do this.100 invites are sent . let’s see how new customers are learning about our site. Are there certain key search words that potential customers use? Yes. This is generally a good benchmark for most companies. We are able to see that new traffic arrived at our site by way of our company’s latest blog post.000 invited. There are several paid services that will help you analyze traffic. In our previous example. As we think about viral campaigns. our low LTV customer.000 who were invited. we want to measure the effectiveness of our campaigns. Google Analytics is the best free source. We will look to our viral coefficient to determine how many of our new customers are referring other customers. we look at the following data: .
Put together a system that is easy for you and your staff to follow on a weekly basis. the viral nature of our campaigns. we simply create a few quick and easy methods to track our data to understand our customers. and sources of traffic. We now understand the best methods and channels for future customers. keeping track of a few metrics gives you insight into your business. KissMetrics and Mixed Panel are two paid services that develop advanced tools to track this information. 28 . For our analysis. Don’t make it so complicated that you are not able to complete it on a weekly basis.As you see.
When you issue equity to partners or investors. as discounted cash flow is rarely applicable to early-stage companies. Let’s discuss related transactions and public comparables before we walk through an example. we want to find revenue and valuation data for private companies similar to ours. there are paid services that collect this data. it is always a good idea to have data to support the valuation you propose.VALUATION There are several reasons why you would want to develop an understanding of your valuation. place a link to your source inside the spreadsheet. This will help you defend your valuation. With privately traded companies. you will need to set a valuation for your company. and Venture Source. public comparables. When you assess whether or not your company would be attractive to a venture capital fund. Related Transactions To estimate value based on related transactions. Once you find the data. and discounted cash flow. you want to understand if your company can achieve a high valuation in the near future. Regardless of your reason for building a valuation estimate. We will focus on the first two in our spreadsheet. you will need to cast a wide net and piece together information as you find it. The three that I’ve used in the past are PrivCo. There are three common ways to estimate the value of your company: related transactions. We can typically find revenue and valuation data in press releases and blogs. 29 . If you don’t want to spend the time to research valuation data. CB Insights.
and 10Q reports.Public Comparables To estimate value based on public comparables. You can view detailed analyses of each company’s financials at www. we want to find revenue and market capitalization for public companies with traits similar to ours. for educational purposes only. Google and Yahoo! each have a finance section. You should never have to pay for public company data. Please do not use this data while negotiating your valuation.sec. 10K.gov. 30 . You can find information on public companies on various sites. In our spreadsheet. which details company data. Search for S1. we have constructed faux scenarios.
If you would like to understand Section 409A. We are looking for a valuation estimate to assist us in negotiations. valuation is both art and science. which is illustrated on the previous page. similar to a home. I am not an attorney. to employees. Most young companies have a net loss in the first few years. such as stock options. In fact. Discounted Cash Flow is generally used for later stage companies. 31 . 409A You may have heard about Section 409A valuations. We determine the free cash flow by adding back all non-cash items to net income. This type of valuation is used to issue deferred compensation. In the past. In summary. your company could sell at 10 times what the 409A valuation indicates. Once you have free cash flow you apply a discount rate to discover the present value of the free cash flow streams. It is the value that is created for a set purpose. Now that we understand why we are only looking for related transactions and public comparables. so I will leave this discussion at a mere definition. companies have been valued based on the number of engineers or the future growth potential of the company. Our goal is to find a lower range that we would not want to go beyond and a higher range that we hope to negotiate for our term sheet. consult a corporate securities attorney. we want to forecast company growth for five years to extract our free cash flow. This is similar to receiving an appraisal on a home.Discounted Cash Flow To estimate value based on discounted cash flow. yet does not affect the selling price. You can probably already see why early-stage companies do not typically use this method. let’s walk through the valuation tab.
Now we understand our valuation estimate and financing strategy. we would make it through six months. Luckily.000. Now. we could secure additional capital at our six month mark valuation.000 to $1. and our strong team.000 in year five.Valuation and Financing Strategy We have collected data on five related transactions through financing rounds. Our proposed financing strategy is as follows: For the first six months. In month six. based on our pipeline. as data that is more than eighteen months old may not be relevant. five related transactions through acquisitions. Now we have a valuation range for our company. we could take a convertible note from an angel investor (more on this in the next section) or use our own capital.500. Of course this would require us to look for the money in month one. We know that we have solid metrics that illustrate that we understand our buyer’s behavior. we are ready to discuss various capital sources. This is important to us as we know from viewing data in Row 90 of the P&L and Metrics tab. We simply multiply our revenue multiple by the revenue for the year we want to value the company. and great strategic partners in our pipeline. We believe that we would be attractive to a venture capital fund as our five year projections indicate we could sell for over $200. that we run out of money at this point. our track record. We pull our revenue from Row 10 of the Income Statement tab. if we used our initial startup capital of $500.0x revenue to 6. We made sure to use data that was recent. We see by looking at our calculations that we could reasonable get a valuation within the $1. As you recall.000 (C63 in our Assumptions tab).000 range at our six month mark. We see that the private company averages range from 2. 32 .000. so it refreshes as our company grows. as some capital raises could take four to six months to complete.0x revenue. we have managed to negotiate a valuation of $6 million. and five publicly traded companies.
33 . you may be better off seeking alternative sources of capital.000/$8.000. if your company is too early for venture capital. For example. you can clearly see whether venture capital is or is not in your company’s future. foundations and high net worth individuals and invest this money for a return.000.000/$4.000.000.000.000. In our example. In fact.000 = $4.000. if your valuation was only $2. Unfortunately. you will want to demonstrate that your company can be sold for a high multiple or file for an IPO.000.000. there are other ways to finance your growth. so we can give away 25% of our company for $2. Let’s look at a few other financing options. If you are looking for venture capital dollars. our valuation is high enough to support the venture capital model.000.000. Don’t despair. Venture capital funds raise capital from pensions.000: $2.000 + $2. the return is what makes or breaks their fund.000 and $2. We calculate this by adding our pre money valuation to the amount that was raised.CAPITAL SOURCES Venture Capital Venture capital is the most widely publicized form of capital.000.000 and $2. If your valuation points to a slow growth company.000 it would be hard to justify accepting venture capital dollars.000. When you develop a financial model.000 = 25% If your valuation were lower than $6. $6.000. We have managed to get a valuation of $6. Venture capital funds look for companies that have the potential to reach at least $50 million in sales within a five year time frame and desire to sell or file for a public offering.000 + $2.000 = $8.000 = 50% You would not want to give away 50% of your company in the first equity round. it is not the right type of capital for every company. to get our post money valuation.000.000.
There are several organizations that aggregate data around angel investors. if you don’t want to sell your company or file for an IPO. However.000 in revenue. Remember. As you develop your funding strategy. Let’s discuss several ways you can raise capital. This will give us the opportunity to grow our valuation prior to issuing equity. You will also want to speak with experts in your industry. Angel Capital Association. Angel investors invest for themselves or within an angel group. are looking for a return. Gust and Angel List are the three best sources to find angel investors in your sector and geographical area. If you dilute your company too soon. This allows them to invest without strict requirements regarding future returns.000. you want to be mindful of future rounds of funding. as well as capital. if you don’t want to sell your company or file for an IPO ever. a convertible note is simply a loan that converts into equity. you may find that you have very little equity to give to new investors. and can set their own time horizon. Angel investors. depending on the industry. like venture capital funds. Naturally. In theory. There are some angel investors who will not require you to sell within a three to five year time frame. As we saw in our previous example. you want to take money from people who deeply understand your industry and can provide guidance. 34 . The benefit of angel investors is that they are typically using their own money. there are other options for you. we accepted a convertible note from an angel investor. Angel investors are as easy to find as venture capital funds. a convertible note is the best approach if you have a low valuation. this gives them more flexibility on terms and time horizons.Angel Investors Angel investors will invest in companies that are too early for venture capital. There are some angels who will demand equity. In my opinion. The requirements range from no revenue to $1. Not all money is equal.
without diluting my company’s equity. By building a sound financial model. It is critical that you understand the expenses involved in creating any type of company. There have been several crowd funding projects in which the product was not delivered in time. This highlights the importance of creating a financial model for your company. Kickstarter and IndieGoGo are the two most popular. As I write this ebook. but 1. There is one additional area to note regarding crowd funding. It is great that we can get products we want to develop quickly funded. You may be able to get $1 million on Kickstarter.000 angry customers may be worse. Crowd funding’s simplicity is a strength and a weakness.Crowd Funding Crowd funding has become increasing popular over the past few years. There are several sites that provide the platform for this type of funding. I could create a profile on a crowd funding site to target women who are interested in purchasing my dress.atelieradvisors. Crowd funding allows individuals to market their product or service before they create it.com/think for the latest on equity crowd funding. but your product may cost you $2 million to produce and deliver. This allows me to raise the capital needed to produce the line. you can set a price that will allow you to deliver the product on time. crowd funding sites are not allowed to issue equity. For example. At this point. Please refer to my blog at www. there has been at least one lawsuit due to the failure to deliver a product. the SEC has yet to finalize the regulations around issuing equity in a crowd funding campaign. At the time of this writing. but there is definitely a need to have some due diligence on the viability of the products. You may not have investors to answer to with a crowd funding campaign. 35 . if I want to create a line of dresses.
you may not want to accept capital for equity.000 and your valuation is only $1.Debt Debt is rarely discussed and sometimes despised. Please consult an attorney before accepting any type of investment. Let’s look at several types of debt instruments: Convertible Notes Convertible notes. If you pursue a convertible note. we always want to be mindful of the amount of equity we are giving away at each round. There is a common misconception that convertible debt is free money. as we discussed. you may be forced to pay the interest and debt. It is rare to have a valuation of over $2. you will receive a term sheet that explains your legal obligation.000. $500. which is too high for your seed round.500.000 = $1. 36 . Keep this in mind as you develop your valuation estimate and funding strategy.000 = 33% The investor would own 33% of your company. Remember.000. getting you from one point to the next.000.000.000 to $2. This is controversial and should be discussed with an attorney.500.000. I believe it can be a useful resource for a growing company if used the right way.000 + $1. are popular with the startup community. When you pursue a convertible note. Debt can operate as a bridge. If you are looking for $500. They allow budding companies to accept money in exchange for a (legal) promise to issue future stock at a discounted price.000.000 / $1.000. $500. there are several terms you will need to think about: Valuation Cap – some investors will ask you to place a cap on the valuation at conversion. Valuations for seed stage.000 for a seed stage company. Timing – if you are not able to raise an equity round in a set period of time. The term sheet will indicate your liability in a range of scenarios. pre-revenue companies range from $750.
if you don’t have strong revenue. The benefit to paying the loan off sooner. you are borrowing money with a promise to pay it back as a percentage of future revenue. or extend it out for several years.Revenue-based Loans Revenue-based loans have recently surfaced in the startup community with the help of Lighter Capital. a revenue-based loan may not work for you. of course. One of the main benefits of revenue-based loans is that the interest on the loan is tax deductible in most states. Unlike a bank loan. If your scheduled monthly payment is 2% of revenue. Let’s take a look at asset-based loans. With this type of capital. which may seem high. royalty-based loans. as the loan is repaid as a percentage of the company’s revenue. Please consult with an attorney in your area to determine your state’s tax laws regarding revenue-based loans. you would pay more when revenue is high and less when revenue is low. However. Unlike a bank loan. this rate is comparable to an expensive credit card. This type of capital has been used for decades under the name. a company may pay off the revenue-based loan after a set period of time. In fact. the revenue-based loan does not require a set monthly payment. This can be a great source for a company that has strong revenue and can pay back the money within a year. 37 . This helps companies who may not have smooth revenue streams. Similar to a bank loan. However. is a decrease in expense. one should also weigh the fact that they may not be able to get funding elsewhere due to lack of credit or other variables. which most entrepreneurs end up using when they are attempting to reach profitability. the standard interest rates are 15% to 30%. A revenue-based loan requires the company to have a history of solid revenue.
The one thing that all asset-based loans have in common is the underlying need for collateral (read: assets). Select a capital source that is aligned with your long-term vision. if you manufacture clothing but need capital to produce the line. but find that your valuation and growth trajectory are not appropriate for a venture capital fund. If you know that you don’t want to give away equity or sell your company in the near future. don’t pursue venture capital dollars or angel investors who are looking for a return. 38 . which is the exchange of invoices to allow for better cash flow. They purchase invoices from customers who need capital to manufacture merchandise that has already been ordered and invoiced. you will need to look for a short-term source of capital to get you to the next stage. If you do want to give away equity. In summary. The rates for factoring range from 2% to 15%. and asset-based loans may be the right type of capital for your company. revenue-based loans. they repay their loan. Naturally. You want to make sure that you are taking the most appropriate type of capital for your business. Once the companies deliver the merchandise and receive payment from their client. Crowd funding. Rosenthal and Rosenthal is a commonly used firm in the fashion industry. you may be a candidate for factoring. A commonly used asset-based loan is factoring. For example. companies with stronger credit will receive favorable rates. there are several types of capital sources for early-stage companies.Asset-based Loans Asset-based loans have also been around for decades and have a wide variety of offerings. based on the health of the company.
com/think If there is a specific area you want to know more about.atelieradvisors. 39 . tweet me at @atelieradvisors or message me at www.com/atelieradvisors I will create future blog posts based on your feedback.RESOURCES I hope you enjoyed my first ebook! My goal is to teach entrepreneurs around the world about finance.facebook. do not hesitate to contact helpdesk@atelieradvisors. If you have any questions about the material.com I will continue to blog on this topic at www.
we use Operating Revenue. and amortization. the computers in our example could have been amortized. These four items do not reflect the financial health of the company. You pay $10. You purchase a machine for $10. you will allocate $2. EBITDA is earnings before interest. You will depreciate it based on a 5year straight-line schedule.000 each year. This is why you will commonly see non cash items removed from the calculations. However.000 in year one. Notice that this expense is not a cash expense. For our streamlined version of the financial model. In other words.Appendix Depreciation and Amortization As you purchase equipment for your company. We will amortize using a standard straight-line depreciation for a simple example. The rationale behind depreciation schedules is that you do not use the machine all at once. we completely ignored depreciation and amortization. for simplicity. depreciation. you will start to create depreciation schedules. 40 .000 for the machine in year one.000 every year for five years. If you are wondering. You use it over time. not EBITDA. tax. you don’t pay $2.
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