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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.
your pricing and your metrics. let’s talk about revenue models. 6 .Now that you understand your buyer.
Amazon Restoration Hardware. We will focus on seven standard revenue models and use four in our mock example. The last time I checked there were over 100 monetization strategies.REVENUE MODELS A revenue model simply outlines how you will bring money into the company. it is commonplace. By the time you read this ebook. but I strongly encourage you to explore co-mingling what exists and/or creating something new. On the next page. Etsy AirBNB. Poshmark Facebook. Five years ago. Netflix 7 . Twitter iTunes. more will have been created. Naturally. 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. Your pricing mechanics are determined by your buyers’ willingness to pay. LinkedIn Ebay. That is the wonderful thing about running a business. you will find a quick review of seven standard revenue models. Now. Once you understand basic revenue models. Lululemon Salesforce. there are an infinite amount of revenue models and new models are constantly being created. you can begin to evolve them to your customers’ needs and wants. nobody was renting their cars to strangers.
we have moved away from a society that requires physical space to sell merchandise. As you build your company.Let’s look at a history of revenue models. don’t be afraid to experiment with different forms of delivery. we can only imagine how our customers will purchase our goods and services. let’s talk about financial statements. As we can see from the chart below. 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. 8 . We have evolved to a society that creates virtual market places with digital goods and services. If your customers are interested in renting a tie instead of buying it. explore whether you could profitably deliver that. As we move into the next decade. Now that you understand revenue models.
I want to change that. and the statement of cash flow. Below you will find a straightforward explanation of the key elements you will need to build your financial model. we create a streamlined version of the traditional financial model. as the process is rarely laid out in an easy-to-follow format. Our goal is to quickly assess the company’s performance and determine a financial strategy. the balance sheet. as it will allow you to develop and analyze your revenues and expenses. Each of these three sections are interconnected.the income statement. Traditional financial statements include the income statement. but we will not construct the full balance sheet. The income statement is important. We will add cash from the balance sheet. This is the thrust of what we want to understand as business owners. We focus on the most critical aspect -. 9 . In Master the Finance Game.FINANCIAL STATEMENTS Most entrepreneurs dread building financial models.
As an entrepreneur you can already guess that marketing and acquisition costs are not only ongoing expenses. In fact. You can show revenue per square foot. you always want to make sure that your metric is based on logical assumptions. the company spent $263 million on marketing alone. 10 .We will discuss generally accepted standards for reporting financials. When used properly. but are critical to the life of the company. Each business is different and will be measured on different metrics. Think about that for a minute. Now that we have that out of the way. which illustrates the amount of revenue that is derived from each user. metrics can provide valuable insight. let’s take a high level look at standard categories in the financial statements before we go into further detail. 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. including marketing and acquisition-related costs. However. which shows how effective you utilize your space. many companies attempt to create new measurements for their performance by creating their own metrics. You can show number of customers acquired during a promotion. You may recall Groupon’s attempt to convince people that their “adjusted consolidated segment operating income” was an appropriate measure of their performance. which provides insight into the relevance of your promotions. Let’s look at a few common examples: Revenue Metrics You can show revenue per users. as metrics show the strength of your company. which highlights the strength of your marketing campaigns. but make sure it is based in reality. However. It is okay to create a new metric.
general. This is where you list all costs associated with researching and developing new products or services. design and programming expenses. travel. Operating Revenue 11 . List salaries. marketing. and office expenses for SG&A. Tangible . Subtract Interest Expense and Taxes (and add Interest Revenue) from operating revenue. and administrative. Subtract R&D and SG&A from Gross Revenue.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. List R&D salaries. 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. Consult your tax authority for a tax schedule. General. Interest Expense or Revenue Taxes Net Income This is where you list any interest paid or interest received. We assume that we have not added depreciation and amortization into the model See appendix for details. Tax rates vary by location. advertising. This is where you list all costs associated with creating and selling your product or service. Intangible . and Administrative (SG&A) This is where you list all cost associated with sales. equipment and materials expense used for R&D.materials used to create the product or service.
capture this to analyze the speed of your payments. We are concerned with money coming in and out of the company. We are looking for a healthy runway of 6 to 12 months. so it is helpful to have an understanding of these categories. We will look at cash in our financial model. capture this to analyze your inventory levels.The most critical elements of the balance sheet are cash. The twelve categories outlined above are the most important for our analysis. Inventory and A/R help you understand cash flow. If you construct your forecast and find that you will run out of cash in 2 months. If your company has A/R. inventory and A/R. If your company has inventory. you need to adjust your assumptions. Remember: The number one reason startups fail is they run out of cash 12 . Cash Inventory Accounts Receivable (A/R) List the amount of cash on hand. which are part of our current assets. as well as current assets.
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.
I believe that you do need a business model and a revenue model.It is critical that your company’s revenue model create sufficient cash flow to operate the business. we can begin to build our financial model. As you build your model. our capital carries us through the first six months. In our financial model we will analyze how long we can operate with $500. Now that we understand revenue models and financial statements.000 (you may change this assumption). This is why you will need some capital to start. most businesses run at a loss for the first few years. 14 . The difference between good financial planning and poor financial planning is life and death for your company. keep in mind that revenue must be greater than expenses. The number one reason companies go out of business is that they run out of capital . We constantly hear that you don’t need a business plan to run a company. In our model. Of course.
In this example. JustFab. We explore these four models purely for simplicity. Banjos Banjos sells men’s apparel using a patented avatar to customize the fit. Let’s walk through the spreadsheets with our mock company. Always make your changes in this tab. let’s assume that we are building an ecommerce site for men’s apparel. Simply put. and modify growth rates by simply changing one cell. ShoeDazzle. For our mock company. we want to select a few publicly traded companies. As you can see. for reference. and Warby Parker The first tab you want to set up is the assumptions tab (see Assumptions tab in spreadsheet). as well as a few privately traded companies. and commission. you can begin to build and/or refine your financial model. Remember. We set our price based on research conducted in the market. Amazon. This will allow you to add new products. to understand the volume of sales for an early-stage company. we price our goods at the going rate. We make assumptions on the number of units sold by looking at data from our private benchmarks. retail.Building a Financial Model Once you understand your revenue model and the financial lingo. we will explore etail. Banjos. For Banjos. change prices. subscription. and Bluefly Private Comparables: Bonobos. we are open to exploring any revenue model that our target audience (buyer) has expressed interest in using. Public Comparables: e-Bay. We look to Bonobos. our private benchmark. 15 . we have decided we will start with pants and shirts.
000 = 13. The average price of the product is $138. To get to this number. but I will skew toward to the lower range of $115.700 + 5. it is one thing to look at Bonobos’ numbers for guidance.7k 2010 $12 mil $115 104.900 + 34. but we really want to look at our own customer growth.700 in 2009.000 + 1.9k 2009 $4 mil $115 34. Our calculation is: 55. CEO.400 I show this level of detail to illustrate that you can quickly find details on private benchmarks. we derive the following facts: 2H: 2007 $552k $115 1. we set out to launch our first campaign. In February 2010. However.500. We can estimate that approximately 1. So.6 million in 2008 and $4 million in 2009. You do not need to pay for any third party research. 16 . Andy Dunn. Revenue was reported as $1.400 pants were sold in 2007.6 mil $115 13.900 pants were sold in 2008 and 34.000 units for the first two months of 2010.000 pants since inception. was quoted as saying that they have sold 55. All unit estimates are calculated by dividing revenue by our average price of $115.3k Revenue Avg Price Units I want to stress that all of the data we are looking at comes directly from the public domain.000 units for 2010 by estimating 2009 per month units at 2.By doing a basic search on the Internet. as I know that their basic line is more popular. We arrive at 5. § § § § The company was launched in June 2007. we subtract 5. We estimate 13.4k 2008 $1.
we spend $1. we are ready to add growth assumptions. Sparkling Maids. We research the market and find that Polished Dry Cleaning. We model E and F based on monthly growth rate and G through I based on annual growth numbers.000 with our online campaign and $30. a maid service. However. The cost for the promo card and the online ad are both 50 cents. and a grocery service. based on Bonobos’ historical growth rate.000 promo cards with their deliveries and display an ad on their website. You will replace estimated growth with actual growth as your company grows. so we made $1. The average purchase price was $100 for both campaigns. All in. Now. who made an average purchase of $100.000 who clicked the ad.Customer Acquisition We want to go to where our target market is.000 for this campaign. only 1% (or 10) made a purchase. We now have 310 customers. 17 . and Delish Meal Delivery Service are the three most established companies in our area.000 with our paper campaign. We decide to look for a dry cleaning service. To make our example easy. We learned that of the 1.000 people click the ad. 30% of the promo cards were redeemed and hence a purchase was made. so we will look for men who already demonstrate the desire to pay for online services that make their lives easier. in rows E through I. let’s assume 1. We approach each company and ask if we can insert a promo card in their deliveries and list a promo code on their website. Each company agrees to insert 1.
000 members? Our assumptions indicate that 10% of our subscribers are purchasing on a monthly basis. 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. which focus on women. We estimate 30% of our members will purchase $50 shirts on subscription. 18 . Now. As you change your data in the Assumptions tab. To get started. By reviewing the market size for men’s apparel. we review subscription sites. you could easily rationalize your projections to an investor. 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. we learn that the men’s market is approximately 40% of the women’s market. Okay. Currently.000 to 1 million members per month. we want to start with our own bottom up assumptions.000 paying subscribers at the end of year two. let’s go back to our assumptions. Similar to our etail revenue. If you click to the Income Statement tab you will see that all of our assumptions and inputs are flowing to this tab. If you switch over to Income Statement. Therefore. ShoeDazzle and JustFab. the changes will automatically populate all other sheets.We can see that the data is populating into the next sheet titled. The model will automatically calculate the number of subscribers in C13. This tab will be used as your dashboard. Remember our benchmark of 300. This is why we make all changes in the Assumptions tab. it is set at 187. P&L and Metrics. Based on our customer research during the first few months. have noted that they attract from 500. We researched the market and determined that we can profitably deliver a shirt for $50 per month.000 as our model matures. We use this data to estimate that our site will have a demand of approximately 40% of the sites focused on women. This is a fair and conservative estimate. Enter this data in Assumptions – cells C14 through C15. We estimate our member number at the low range of 300. you will see that on line 17 we have approximately 30. This is the tab that you will use for presentations. You may increase or decrease growth in column C. we learned that buyers wanted to sign up for monthly subscriptions and receive a selection of dress shirts to complement their trousers. These sites.
Enter this data in Assumptions – cells C27 through C29. a pop up shop is a store within a store. From their data. We estimate sales per square foot of $1. We add line 40 to weight sales based on standard retail traffic. Make sure all weightings add to 100% in the last cell (AF40). as their price point and target audience is similar to ours.500 sales per square foot. We look to Warby Parker’s business model to assess their foot traffic. We have now completed all revenue assumptions for our business. It is commonly used as a way to quickly get in front of a new audience without the expense of actually building a store. make sure you understand the nature of each revenue line.We also heard from our buyers that they prefer to try items on in person. For example. 30% of our shoppers buy sweaters for $80 and we make 20% commission.500 in 500 square feet. Before we move on. Our commission is 20%. You can adjust this to fit your industry’s standard. We want to focus on a small space so we will set our store (or pop up) for 500 square feet at $1. Retail sales automatically populate at row 39 in the P&L and Metrics tab. We then look to Udan.659. 19 . We assume 30% of our member base will purchase the sweaters. We agree to sell their $80 sweater and pay them 80% of all sales. we learn that their sales per square feet are $3. We just heard from a free trade group who wants to sell their sweaters on our site. to determine the percentage of conversion from our member base. Enter this data in Assumptions – cells C20 through C21.
We will manufacture the same products for each distribution channel. and expenses directly tied to the revenue you produce. Expenses fall into three general categories – cost of goods sold (COGS). respectively. research and development (R&D). simply determine who will manufacture your product and at what price. Our example uses % for simplicity. and sales. 20 .Expenses Now we want to create expense assumptions. Enter this data in Assumptions – cells C34 through C35. We estimate COGS for pants and shirts at 50% and 40%. labor. Use this data to calculate the dollar value of cost of goods sold. So. and administrative (SG&A) Cost of goods sold (COGS) includes materials. general.
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. we look at our public benchmarks and we observe that cost of goods sold is 35%.Next. Research and Development (R&D) is expense related to developing existing or new products. so we assume we will invest heavily in R&D. we determine who will do our web hosting (we estimate $250 per month for every 500. 21 . Next. This will be minimal for an ecommerce site. These are generic estimates for illustration purposes only. Are our numbers inline with the norm? Expect COGS to be high in the first few years of growth and stabilize near your benchmarks. 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%). unless you decide to invest in your technical infrastructure. Now let’s move to research and development.000 users). Banjos has a digital avatar to assist with customized fit. but will normalize as we mature. We assume R&D will be extensive as we get started.
000. So let’s also set it at $5. We estimate marketing. General & Administrative (SG&A) is going to be a bit more extensive. holding inventory can be a huge drain. We know our first campaign cost $500 to produce promo cards. allocate that square footage in COGS. Let’s see what we come up with on our own.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. We input real data. $1. We look at our public benchmarks and we determine that SG&A is 35%. Remember. at $500 for clicks. We estimate research and development costs will be $1.000 Enter this data in Assumptions – cells C53 through C55. so let’s budget $5. We have researched our local real estate market and determined our monthly office space will be $5.000 per month and check against our benchmark. Advertising was in line with marketing. advertising and office at $5.000 per month Enter this data in Assumptions – cells C48 Sales. Remember this is where companies always underestimate. Note: if you use a portion of your office space for inventory. 22 .000 for future months.000. We choose 10% as our ecommerce site has a strong technical bent.
99% of the information you need is free. Enter this data in Assumptions – cells C65 through C66. We set our annual salary increase at 5% and grow our personnel by 40% per year. through years three and five. We estimate computers at $2. We have now completed our revenue and expense assumptions based on data that we have found in the public domain.We believe we will spend $2. You may find that this needs to be increased depending on the nature of your business. Salaries are input manually on the Personnel Plan tab We estimate salary increase at 5% and personnel growth by 40% (yrs 3 – 5). 23 .500 on computer equipment and $1.500 and communication at $1.000 Enter this data in Assumptions – cells C56 through C57.000 on communication equipment.
Our goals go beyond simple benchmarks. This brings us to our next section. ShoeDazzle launched with a subscription only model. but later learned that customers wanted the flexibility to buy when they wanted. men in finance make more money. until they later realized that teachers were their prime targets. but they only wear casual pants on the weekends. The best way to build solid company culture is to get everyone aligned with your company’s vision. measuring performance. Yes. We want to inspire our entire company to track goals and motivate each other. Teachers are required to wear casual pants as their work uniform. 24 . Bonobos targeted men in finance. The only way we will know if we are on track is if we set goals and measure our progress. This is where all of your research will help you to make smart decisions about your SG&A dollars. 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.We can learn a lot from those who came before us.
subscription. we want to understand the Lifetime Value of Customers (LTV). If you are just getting started. the number of times they purchase per month and the standard duration of the customer. We look at the average purchase price of our customers. and commission. This data is calculated by our spreadsheet in Column o. subscription. or another variable that allows them to be tracked. As a general rule. This helps us understand how much we would be willing to spend. For this example. $75. we are sectioning our cohorts based on methodology. $50. the date of their purchase. retail. We enter the number of purchases at two based on observation. make your best guess and update with actual data when it is available. We sell apparel to men within the 25 to 45 year range.000 The lifetime value of our etail customer is $48. $120 x 2 X 240 = $48. We will look at four methodologies: etail. 25 . We could categorize them by the campaign they came through. respectively. Cohorts Let’s place our new customers in cohorts. We use 240 to indicate months. We can estimate that the standard duration of our customer is 20 years.000. to acquire one customer. and commission is $100. Of course. The more customer data you have. Let’s do this for each methodology: We see that the average purchase price for etail. you want to make your cost back within a year. We enter all data in the P&L and Metrics tab beginning at Row 98 First. retail. and $80.METRICS Now let’s figure out how we can best measure our company’s growth. This will help us understand how each group of buyers interacts with our products and service. we can only estimate the duration of each customer. the more accurate your calculations.
Keep in mind that some customers may be expensive to acquire and have a low LTV. However you decide to review your lifetime value of customers against your customer acquisition cost make sure you are comparing apples to apples. and $19. if you spend your resources sending George Clooney free Banjos apparel for a photo shoot. In this example. we have a low LTV customer with a high referral value. $19. The number of customers acquired for etail. and salary expense for each campaign. 600. In this scenario. Some companies calculate all relevant costs for one year and measure that against the number of customers acquired.Now. Let’s move on to referrals. That will give you a general view. However. retail. 180. you could measure the increase in traffic to your site to get a general sense of the impact. 187. but creating specific cohorts around campaigns will give you better insight. subscription. let’s look at our Customer Acquisition Cost (CAC) per methodology. For example. 26 . it may attract thousands of new customers. we are adding sales expense. This is only helpful if you have real data. respectively. This data is highlighted in our spreadsheet. and commission were 310. advertising expense. There are several ways to calculate your customer acquisition cost. yet serve as lucrative conduits for your business. We use actual expense data to determine the cost of acquiring one customer over a set time period. marketing expense. 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. $6. We see that the cost for each methodology is $11.
Traffic Sources Now.each person invites 10 people .100 invites are sent . let’s see how new customers are learning about our site. however. In our previous example. There are several paid services that will help you analyze traffic. Do your blog posts generate strong interest in your site? Yes. may have attracted 10.000 who were invited. We are able to see that new traffic arrived at our site by searching for the product George Clooney was wearing in the ad.000 new orders based on one pair of pants. As we think about viral campaigns. George Clooney. Are there certain key search words that potential customers use? Yes. Google Analytics is the best free source. We are able to see that new traffic arrived at our site by way of our company’s latest blog post. This is generally a good benchmark for most companies.of the 1. Set up a system to view where your traffic is generated. we want to measure the effectiveness of our campaigns.Viral Coefficient Now. 10% activate (or 100) Your viral coefficient is 1. we should always look to conduits that embody our brand’s message. only 10% activate the account 100 x 10 = 1.000 invited. We will look to our viral coefficient to determine how many of our new customers are referring other customers. 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. our low LTV customer. as each one recruits one. we look at the following data: . 27 . To do this.
Put together a system that is easy for you and your staff to follow on a weekly basis. we simply create a few quick and easy methods to track our data to understand our customers. For our analysis. keeping track of a few metrics gives you insight into your business. and sources of traffic. KissMetrics and Mixed Panel are two paid services that develop advanced tools to track this information.As you see. the viral nature of our campaigns. Don’t make it so complicated that you are not able to complete it on a weekly basis. 28 . We now understand the best methods and channels for future customers.
CB Insights. Let’s discuss related transactions and public comparables before we walk through an example. you will need to set a valuation for your company. Once you find the data. public comparables. you want to understand if your company can achieve a high valuation in the near future. There are three common ways to estimate the value of your company: related transactions. When you assess whether or not your company would be attractive to a venture capital fund. and discounted cash flow. it is always a good idea to have data to support the valuation you propose. as discounted cash flow is rarely applicable to early-stage companies. there are paid services that collect this data. When you issue equity to partners or investors. Regardless of your reason for building a valuation estimate. We will focus on the first two in our spreadsheet. This will help you defend your valuation.VALUATION There are several reasons why you would want to develop an understanding of your valuation. and Venture Source. If you don’t want to spend the time to research valuation data. We can typically find revenue and valuation data in press releases and blogs. The three that I’ve used in the past are PrivCo. With privately traded companies. we want to find revenue and valuation data for private companies similar to ours. you will need to cast a wide net and piece together information as you find it. 29 . place a link to your source inside the spreadsheet. Related Transactions To estimate value based on related transactions.
10K. and 10Q reports.gov.Public Comparables To estimate value based on public comparables. You should never have to pay for public company data.sec. 30 . Please do not use this data while negotiating your valuation. Search for S1. You can find information on public companies on various sites. which details company data. we have constructed faux scenarios. we want to find revenue and market capitalization for public companies with traits similar to ours. In our spreadsheet. You can view detailed analyses of each company’s financials at www. Google and Yahoo! each have a finance section. for educational purposes only.
In the past. such as stock options. consult a corporate securities attorney. to employees. companies have been valued based on the number of engineers or the future growth potential of the company. Now that we understand why we are only looking for related transactions and public comparables. yet does not affect the selling price. In summary. It is the value that is created for a set purpose. If you would like to understand Section 409A. similar to a home. valuation is both art and science.Discounted Cash Flow To estimate value based on discounted cash flow. so I will leave this discussion at a mere definition. This type of valuation is used to issue deferred compensation. 409A You may have heard about Section 409A valuations. This is similar to receiving an appraisal on a home. 31 . Discounted Cash Flow is generally used for later stage companies. your company could sell at 10 times what the 409A valuation indicates. which is illustrated on the previous page. let’s walk through the valuation tab. Most young companies have a net loss in the first few years. I am not an attorney. 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. we want to forecast company growth for five years to extract our free cash flow. You can probably already see why early-stage companies do not typically use this method. We are looking for a valuation estimate to assist us in negotiations. We determine the free cash flow by adding back all non-cash items to net income. Once you have free cash flow you apply a discount rate to discover the present value of the free cash flow streams. In fact.
000 in year five. We simply multiply our revenue multiple by the revenue for the year we want to value the company. we are ready to discuss various capital sources. Now. we have managed to negotiate a valuation of $6 million. our track record. Of course this would require us to look for the money in month one. In month six.Valuation and Financing Strategy We have collected data on five related transactions through financing rounds. and our strong team. as some capital raises could take four to six months to complete. five related transactions through acquisitions. we could take a convertible note from an angel investor (more on this in the next section) or use our own capital.000. We made sure to use data that was recent. Luckily. We see by looking at our calculations that we could reasonable get a valuation within the $1. so it refreshes as our company grows. as data that is more than eighteen months old may not be relevant. As you recall. based on our pipeline.000 to $1. Our proposed financing strategy is as follows: For the first six months.500.0x revenue.000. we could secure additional capital at our six month mark valuation. and five publicly traded companies. if we used our initial startup capital of $500. 32 . We know that we have solid metrics that illustrate that we understand our buyer’s behavior. that we run out of money at this point.0x revenue to 6. Now we have a valuation range for our company. This is important to us as we know from viewing data in Row 90 of the P&L and Metrics tab. We pull our revenue from Row 10 of the Income Statement tab. We see that the private company averages range from 2. and great strategic partners in our pipeline. we would make it through six months.000 range at our six month mark.000 (C63 in our Assumptions tab). We believe that we would be attractive to a venture capital fund as our five year projections indicate we could sell for over $200. Now we understand our valuation estimate and financing strategy.
In fact.000 = $4. our valuation is high enough to support the venture capital model.000 and $2.000. there are other ways to finance your growth. if your valuation was only $2.000. foundations and high net worth individuals and invest this money for a return.000. For example.000 + $2.000. to get our post money valuation. Venture capital funds raise capital from pensions. If your valuation points to a slow growth company. it is not the right type of capital for every company. We calculate this by adding our pre money valuation to the amount that was raised. Unfortunately.000. Let’s look at a few other financing options.000.000.000 and $2.000.000 = $8.000.000.000.000/$8. Don’t despair. if your company is too early for venture capital. the return is what makes or breaks their fund. 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/$4. you will want to demonstrate that your company can be sold for a high multiple or file for an IPO.000.000.000 it would be hard to justify accepting venture capital dollars.000. you can clearly see whether venture capital is or is not in your company’s future. We have managed to get a valuation of $6.000.000.000: $2. 33 .000 = 50% You would not want to give away 50% of your company in the first equity round. If you are looking for venture capital dollars. In our example. so we can give away 25% of our company for $2. you may be better off seeking alternative sources of capital.CAPITAL SOURCES Venture Capital Venture capital is the most widely publicized form of capital.000 + $2. When you develop a financial model.000 = 25% If your valuation were lower than $6. $6.
there are other options for you. if you don’t want to sell your company or file for an IPO. Angel investors. The benefit of angel investors is that they are typically using their own money. Angel investors invest for themselves or within an angel group. like venture capital funds. This will give us the opportunity to grow our valuation prior to issuing equity. Not all money is equal. are looking for a return. As you develop your funding strategy.000 in revenue.000. you want to be mindful of future rounds of funding. Remember. you may find that you have very little equity to give to new investors. Naturally. if you don’t want to sell your company or file for an IPO ever. As we saw in our previous example. Angel Capital Association. If you dilute your company too soon. The requirements range from no revenue to $1. as well as capital. In theory. There are some angel investors who will not require you to sell within a three to five year time frame. a convertible note is the best approach if you have a low valuation. this gives them more flexibility on terms and time horizons. Gust and Angel List are the three best sources to find angel investors in your sector and geographical area. In my opinion. Angel investors are as easy to find as venture capital funds. you want to take money from people who deeply understand your industry and can provide guidance. a convertible note is simply a loan that converts into equity. However. There are some angels who will demand equity. 34 . depending on the industry.Angel Investors Angel investors will invest in companies that are too early for venture capital. There are several organizations that aggregate data around angel investors. and can set their own time horizon. Let’s discuss several ways you can raise capital. we accepted a convertible note from an angel investor. This allows them to invest without strict requirements regarding future returns. You will also want to speak with experts in your industry.
if I want to create a line of dresses. Crowd funding allows individuals to market their product or service before they create it. but 1. There are several sites that provide the platform for this type of funding. You may be able to get $1 million on Kickstarter. It is critical that you understand the expenses involved in creating any type of company. Crowd funding’s simplicity is a strength and a weakness. Kickstarter and IndieGoGo are the two most popular.com/think for the latest on equity crowd funding. crowd funding sites are not allowed to issue equity. there has been at least one lawsuit due to the failure to deliver a product.Crowd Funding Crowd funding has become increasing popular over the past few years. without diluting my company’s equity. It is great that we can get products we want to develop quickly funded. I could create a profile on a crowd funding site to target women who are interested in purchasing my dress.000 angry customers may be worse. you can set a price that will allow you to deliver the product on time. For example. but there is definitely a need to have some due diligence on the viability of the products. There is one additional area to note regarding crowd funding. 35 . As I write this ebook. By building a sound financial model. At this point. Please refer to my blog at www. At the time of this writing.atelieradvisors. This highlights the importance of creating a financial model for your company. the SEC has yet to finalize the regulations around issuing equity in a crowd funding campaign. but your product may cost you $2 million to produce and deliver. There have been several crowd funding projects in which the product was not delivered in time. This allows me to raise the capital needed to produce the line. You may not have investors to answer to with a crowd funding campaign.
000 and your valuation is only $1. you may not want to accept capital for equity.000. When you pursue a convertible note.000. pre-revenue companies range from $750.500. as we discussed. The term sheet will indicate your liability in a range of scenarios.000. you will receive a term sheet that explains your legal obligation. 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.000 for a seed stage company.Debt Debt is rarely discussed and sometimes despised.000 to $2. Debt can operate as a bridge.000. 36 . $500. Timing – if you are not able to raise an equity round in a set period of time. are popular with the startup community. I believe it can be a useful resource for a growing company if used the right way.000.000 + $1. Please consult an attorney before accepting any type of investment. which is too high for your seed round. If you are looking for $500. you may be forced to pay the interest and debt. There is a common misconception that convertible debt is free money. getting you from one point to the next.000.000 = $1. Valuations for seed stage. we always want to be mindful of the amount of equity we are giving away at each round. It is rare to have a valuation of over $2.000 / $1.000 = 33% The investor would own 33% of your company. If you pursue a convertible note. This is controversial and should be discussed with an attorney. Keep this in mind as you develop your valuation estimate and funding strategy.500. Let’s look at several types of debt instruments: Convertible Notes Convertible notes. $500. Remember. They allow budding companies to accept money in exchange for a (legal) promise to issue future stock at a discounted price.000.
if you don’t have strong revenue. as the loan is repaid as a percentage of the company’s revenue. However. One of the main benefits of revenue-based loans is that the interest on the loan is tax deductible in most states.Revenue-based Loans Revenue-based loans have recently surfaced in the startup community with the help of Lighter Capital. this rate is comparable to an expensive credit card. Unlike a bank loan. The benefit to paying the loan off sooner. a revenue-based loan may not work for you. This helps companies who may not have smooth revenue streams. If your scheduled monthly payment is 2% of revenue. which most entrepreneurs end up using when they are attempting to reach profitability. the standard interest rates are 15% to 30%. or extend it out for several years. you would pay more when revenue is high and less when revenue is low. is a decrease in expense. Similar to a bank loan. one should also weigh the fact that they may not be able to get funding elsewhere due to lack of credit or other variables. 37 . This type of capital has been used for decades under the name. you are borrowing money with a promise to pay it back as a percentage of future revenue. A revenue-based loan requires the company to have a history of solid revenue. This can be a great source for a company that has strong revenue and can pay back the money within a year. However. Please consult with an attorney in your area to determine your state’s tax laws regarding revenue-based loans. Let’s take a look at asset-based loans. a company may pay off the revenue-based loan after a set period of time. royalty-based loans. the revenue-based loan does not require a set monthly payment. which may seem high. Unlike a bank loan. With this type of capital. of course. In fact.
companies with stronger credit will receive favorable rates. based on the health of the company. but find that your valuation and growth trajectory are not appropriate for a venture capital fund. A commonly used asset-based loan is factoring. Select a capital source that is aligned with your long-term vision. In summary. Naturally.Asset-based Loans Asset-based loans have also been around for decades and have a wide variety of offerings. Once the companies deliver the merchandise and receive payment from their client. they repay their loan. If you know that you don’t want to give away equity or sell your company in the near future. If you do want to give away equity. which is the exchange of invoices to allow for better cash flow. 38 . For example. You want to make sure that you are taking the most appropriate type of capital for your business. you will need to look for a short-term source of capital to get you to the next stage. revenue-based loans. Crowd funding. don’t pursue venture capital dollars or angel investors who are looking for a return. They purchase invoices from customers who need capital to manufacture merchandise that has already been ordered and invoiced. if you manufacture clothing but need capital to produce the line. The rates for factoring range from 2% to 15%. there are several types of capital sources for early-stage companies. and asset-based loans may be the right type of capital for your company. The one thing that all asset-based loans have in common is the underlying need for collateral (read: assets). Rosenthal and Rosenthal is a commonly used firm in the fashion industry. you may be a candidate for factoring.
If you have any questions about the material. tweet me at @atelieradvisors or message me at www.com I will continue to blog on this topic at www. 39 .facebook.atelieradvisors.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.com/think If there is a specific area you want to know more about. do not hesitate to contact helpdesk@atelieradvisors.
EBITDA is earnings before interest. we completely ignored depreciation and amortization. 40 . the computers in our example could have been amortized. You purchase a machine for $10. This is why you will commonly see non cash items removed from the calculations. depreciation.000 in year one. If you are wondering. You pay $10. For our streamlined version of the financial model. tax. These four items do not reflect the financial health of the company. You will depreciate it based on a 5year straight-line schedule. and amortization.Appendix Depreciation and Amortization As you purchase equipment for your company. We will amortize using a standard straight-line depreciation for a simple example. you don’t pay $2. for simplicity. You use it over time.000 each year. Notice that this expense is not a cash expense.000 for the machine in year one.000 every year for five years. not EBITDA. In other words. However. The rationale behind depreciation schedules is that you do not use the machine all at once. you will allocate $2. we use Operating Revenue. you will start to create depreciation schedules.
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