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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.
Now that you understand your buyer. let’s talk about revenue models. your pricing and your metrics. 6 .
Amazon Restoration Hardware. there are an infinite amount of revenue models and new models are constantly being created.REVENUE MODELS A revenue model simply outlines how you will bring money into the company. The last time I checked there were over 100 monetization strategies. more will have been created. Your pricing mechanics are determined by your buyers’ willingness to pay. Netflix 7 . Now. That is the wonderful thing about running a business. you will find a quick review of seven standard revenue models. Etsy AirBNB. 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. By the time you read this ebook. Once you understand basic revenue models. Twitter iTunes. you can begin to evolve them to your customers’ needs and wants. We will focus on seven standard revenue models and use four in our mock example. Lululemon Salesforce. it is commonplace. On the next page. Five years ago. Poshmark Facebook. but I strongly encourage you to explore co-mingling what exists and/or creating something new. nobody was renting their cars to strangers. LinkedIn Ebay.
we have moved away from a society that requires physical space to sell merchandise. Now that you understand revenue models. don’t be afraid to experiment with different forms of delivery. 8 . We have evolved to a society that creates virtual market places with digital goods and services. explore whether you could profitably deliver that.Let’s look at a history of revenue models. If your customers are interested in renting a tie instead of buying it. 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 move into the next decade. As you build your company. As we can see from the chart below. we can only imagine how our customers will purchase our goods and services. let’s talk about financial statements.
I want to change that. Below you will find a straightforward explanation of the key elements you will need to build your financial model. Our goal is to quickly assess the company’s performance and determine a financial strategy.the income statement. the balance sheet. Traditional financial statements include the income statement. This is the thrust of what we want to understand as business owners. Each of these three sections are interconnected. but we will not construct the full balance sheet. as it will allow you to develop and analyze your revenues and expenses. 9 .FINANCIAL STATEMENTS Most entrepreneurs dread building financial models. In Master the Finance Game. We will add cash from the balance sheet. The income statement is important. and the statement of cash flow. we create a streamlined version of the traditional financial model. as the process is rarely laid out in an easy-to-follow format. We focus on the most critical aspect -.
You can show revenue per square foot. In fact. the company spent $263 million on marketing alone. Each business is different and will be measured on different metrics.We will discuss generally accepted standards for reporting financials. you always want to make sure that your metric is based on logical assumptions. You can show number of customers acquired during a promotion. When used properly. which provides insight into the relevance of your promotions. but make sure it is based in reality. as metrics show the strength of your company. The measurement was based on the assumption that the company’s operating income should exclude several major expenses. let’s take a high level look at standard categories in the financial statements before we go into further detail. which shows how effective you utilize your space. 10 . which illustrates the amount of revenue that is derived from each user. including marketing and acquisition-related costs. It is okay to create a new metric. Expense Metrics You can show the number of users acquired per each marketing dollar. metrics can provide valuable insight. many companies attempt to create new measurements for their performance by creating their own metrics. but are critical to the life of the company. However. Now that we have that out of the way. However. You may recall Groupon’s attempt to convince people that their “adjusted consolidated segment operating income” was an appropriate measure of their performance. Think about that for a minute. Let’s look at a few common examples: Revenue Metrics You can show revenue per users. which highlights the strength of your marketing campaigns. As an entrepreneur you can already guess that marketing and acquisition costs are not only ongoing expenses.
This is where you list all costs associated with creating and selling your product or service. and Administrative (SG&A) This is where you list all cost associated with sales. Intangible . marketing.materials used to create the product or service. Gross Revenue Research and Development (R&D) Sales. general. List R&D salaries. equipment and materials expense used for R&D. Operating Revenue 11 . We assume that we have not added depreciation and amortization into the model See appendix for details. and office expenses for SG&A. Interest Expense or Revenue Taxes Net Income This is where you list any interest paid or interest received. travel. and administrative. List salaries. Subtract R&D and SG&A from Gross Revenue. Consult your tax authority for a tax schedule. Tangible . Tax rates vary by location. design and programming expenses. advertising. General.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.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. Subtract Interest Expense and Taxes (and add Interest Revenue) from operating revenue.
which are part of our current assets. If you construct your forecast and find that you will run out of cash in 2 months. you need to adjust your assumptions. We will look at cash in our financial model. inventory and A/R. Cash Inventory Accounts Receivable (A/R) List the amount of cash on hand. The twelve categories outlined above are the most important for our analysis. We are concerned with money coming in and out of the company. We are looking for a healthy runway of 6 to 12 months. If your company has A/R. Inventory and A/R help you understand cash flow. as well as current assets. capture this to analyze the speed of your payments. capture this to analyze your inventory levels. so it is helpful to have an understanding of these categories.The most critical elements of the balance sheet are cash. If your company has inventory. Remember: The number one reason startups fail is they run out of cash 12 .
Once you have constructed your financial model. 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 .
As you build your model. Now that we understand revenue models and financial statements. I believe that you do need a business model and a revenue model. keep in mind that revenue must be greater than expenses. our capital carries us through the first six months. This is why you will need some capital to start. most businesses run at a loss for the first few years. we can begin to build our financial model.It is critical that your company’s revenue model create sufficient cash flow to operate the business. We constantly hear that you don’t need a business plan to run a company.000 (you may change this assumption). The difference between good financial planning and poor financial planning is life and death for your company. 14 . Of course. The number one reason companies go out of business is that they run out of capital . In our model. In our financial model we will analyze how long we can operate with $500.
We explore these four models purely for simplicity. This will allow you to add new products. For Banjos. We look to Bonobos. ShoeDazzle. retail. In this example. We set our price based on research conducted in the market. subscription. we have decided we will start with pants and shirts. we price our goods at the going rate. as well as a few privately traded companies. As you can see. and modify growth rates by simply changing one cell. JustFab. Remember. and Bluefly Private Comparables: Bonobos. and Warby Parker The first tab you want to set up is the assumptions tab (see Assumptions tab in spreadsheet). and commission. For our mock company. Simply put. Public Comparables: e-Bay. for reference. we want to select a few publicly traded companies. we will explore etail. Always make your changes in this tab. 15 . We make assumptions on the number of units sold by looking at data from our private benchmarks. Let’s walk through the spreadsheets with our mock company. we are open to exploring any revenue model that our target audience (buyer) has expressed interest in using. to understand the volume of sales for an early-stage company. Banjos. Banjos Banjos sells men’s apparel using a patented avatar to customize the fit. you can begin to build and/or refine your financial model. Amazon. change prices. let’s assume that we are building an ecommerce site for men’s apparel.Building a Financial Model Once you understand your revenue model and the financial lingo. our private benchmark.
We can estimate that approximately 1.900 + 34. To get to this number. CEO.700 in 2009. However.By doing a basic search on the Internet. it is one thing to look at Bonobos’ numbers for guidance. We arrive at 5. but I will skew toward to the lower range of $115. The average price of the product is $138.000 pants since inception. Our calculation is: 55. All unit estimates are calculated by dividing revenue by our average price of $115. In February 2010. but we really want to look at our own customer growth.7k 2010 $12 mil $115 104. was quoted as saying that they have sold 55. we set out to launch our first campaign.3k Revenue Avg Price Units I want to stress that all of the data we are looking at comes directly from the public domain.400 pants were sold in 2007. Revenue was reported as $1. we derive the following facts: 2H: 2007 $552k $115 1. we subtract 5.400 I show this level of detail to illustrate that you can quickly find details on private benchmarks. You do not need to pay for any third party research.500. § § § § The company was launched in June 2007. as I know that their basic line is more popular.000 = 13. So.9k 2009 $4 mil $115 34.700 + 5.6 mil $115 13.000 units for the first two months of 2010. Andy Dunn.4k 2008 $1.000 + 1.000 units for 2010 by estimating 2009 per month units at 2. We estimate 13.900 pants were sold in 2008 and 34. 16 .6 million in 2008 and $4 million in 2009.
and Delish Meal Delivery Service are the three most established companies in our area. To make our example easy. and a grocery service. We approach each company and ask if we can insert a promo card in their deliveries and list a promo code on their website. All in. Sparkling Maids. However. we spend $1. We decide to look for a dry cleaning service. we are ready to add growth assumptions. We learned that of the 1. based on Bonobos’ historical growth rate. let’s assume 1. 17 .000 with our paper campaign. only 1% (or 10) made a purchase. The cost for the promo card and the online ad are both 50 cents. so we made $1. We model E and F based on monthly growth rate and G through I based on annual growth numbers. The average purchase price was $100 for both campaigns.000 people click the ad. We now have 310 customers. We research the market and find that Polished Dry Cleaning. Now. You will replace estimated growth with actual growth as your company grows.Customer Acquisition We want to go to where our target market is. who made an average purchase of $100. a maid service. in rows E through I.000 with our online campaign and $30. Each company agrees to insert 1.000 who clicked the ad.000 for this campaign. so we will look for men who already demonstrate the desire to pay for online services that make their lives easier. 30% of the promo cards were redeemed and hence a purchase was made.000 promo cards with their deliveries and display an ad on their website.
Now. the changes will automatically populate all other sheets. you will see that on line 17 we have approximately 30. By reviewing the market size for men’s apparel. You may increase or decrease growth in column C. we learn that the men’s market is approximately 40% of the women’s market. we learned that buyers wanted to sign up for monthly subscriptions and receive a selection of dress shirts to complement their trousers. If you switch over to Income Statement. Similar to our etail revenue. have noted that they attract from 500. The model will automatically calculate the number of subscribers in C13. P&L and Metrics. Enter this data in Assumptions – cells C14 through C15. ShoeDazzle and JustFab. You will monitor the next 24 months of operations using this tab. 18 . To get started. it is set at 187. We use this data to estimate that our site will have a demand of approximately 40% of the sites focused on women. This is the tab that you will use for presentations. We researched the market and determined that we can profitably deliver a shirt for $50 per month. which focus on women.000 as our model matures.000 to 1 million members per month. As you change your data in the Assumptions tab. we want to start with our own bottom up assumptions. If you click to the Income Statement tab you will see that all of our assumptions and inputs are flowing to this tab. Remember our benchmark of 300.000 members? Our assumptions indicate that 10% of our subscribers are purchasing on a monthly basis. let’s go back to our assumptions. Okay. we review subscription sites. These sites. Currently. 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.We can see that the data is populating into the next sheet titled. This is a fair and conservative estimate. we will estimate that 30% of our member base will convert to our monthly subscriptions. We estimate 30% of our members will purchase $50 shirts on subscription. This is why we make all changes in the Assumptions tab.000 paying subscribers at the end of year two. We estimate our member number at the low range of 300. Therefore. Based on our customer research during the first few months. you could easily rationalize your projections to an investor. This tab will be used as your dashboard.
We agree to sell their $80 sweater and pay them 80% of all sales. Before we move on. 30% of our shoppers buy sweaters for $80 and we make 20% commission. Make sure all weightings add to 100% in the last cell (AF40). We estimate sales per square foot of $1.We also heard from our buyers that they prefer to try items on in person. We assume 30% of our member base will purchase the sweaters. We look to Warby Parker’s business model to assess their foot traffic. From their data. Retail sales automatically populate at row 39 in the P&L and Metrics tab.659. We add line 40 to weight sales based on standard retail traffic. make sure you understand the nature of each revenue line. For example. a pop up shop is a store within a store. We then look to Udan. You can adjust this to fit your industry’s standard. We have now completed all revenue assumptions for our business. Enter this data in Assumptions – cells C27 through C29. 19 .500 in 500 square feet. Our commission is 20%. Enter this data in Assumptions – cells C20 through C21. to determine the percentage of conversion from our member base.500 sales per square foot. We just heard from a free trade group who wants to sell their sweaters on our site. as their price point and target audience is similar to ours. It is commonly used as a way to quickly get in front of a new audience without the expense of actually building a store. We want to focus on a small space so we will set our store (or pop up) for 500 square feet at $1. we learn that their sales per square feet are $3.
respectively. So. 20 . general.Expenses Now we want to create expense assumptions. labor. Use this data to calculate the dollar value of cost of goods sold. and administrative (SG&A) Cost of goods sold (COGS) includes materials. Enter this data in Assumptions – cells C34 through C35. simply determine who will manufacture your product and at what price. We estimate COGS for pants and shirts at 50% and 40%. research and development (R&D). and expenses directly tied to the revenue you produce. Our example uses % for simplicity. Expenses fall into three general categories – cost of goods sold (COGS). and sales. We will manufacture the same products for each distribution channel.
we determine who will do our web hosting (we estimate $250 per month for every 500. 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%. This will be minimal for an ecommerce site. Now let’s move to research and development. 21 . Next.000 users). so we assume we will invest heavily in R&D. 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%). but will normalize as we mature. 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. unless you decide to invest in your technical infrastructure.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. Research and Development (R&D) is expense related to developing existing or new products. These are generic estimates for illustration purposes only. We assume R&D will be extensive as we get started.
000. We look at our public benchmarks and we determine that SG&A is 35%. at $500 for clicks.000.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 estimate research and development costs will be $1. holding inventory can be a huge drain.000 Enter this data in Assumptions – cells C53 through C55.000 per month and check against our benchmark. We input real data. Note: if you use a portion of your office space for inventory. 22 . We estimate marketing. Remember. We know our first campaign cost $500 to produce promo cards. Advertising was in line with marketing.000 per month Enter this data in Assumptions – cells C48 Sales. $1. advertising and office at $5. allocate that square footage in COGS. 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.000 for future months. So let’s also set it at $5. so let’s budget $5. Remember this is where companies always underestimate. We choose 10% as our ecommerce site has a strong technical bent. Let’s see what we come up with on our own.
We believe we will spend $2. We set our annual salary increase at 5% and grow our personnel by 40% per year. 99% of the information you need is free. 23 .500 and communication at $1. We estimate computers at $2. You may find that this needs to be increased depending on the nature of your business. We have now completed our revenue and expense assumptions based on data that we have found in the public domain. Salaries are input manually on the Personnel Plan tab We estimate salary increase at 5% and personnel growth by 40% (yrs 3 – 5). through years three and five.500 on computer equipment and $1.000 on communication equipment.000 Enter this data in Assumptions – cells C56 through C57. Enter this data in Assumptions – cells C65 through C66.
Our goals go beyond simple benchmarks. 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. ShoeDazzle launched with a subscription only model.We can learn a lot from those who came before us. Teachers are required to wear casual pants as their work uniform. This is where all of your research will help you to make smart decisions about your SG&A dollars. but later learned that customers wanted the flexibility to buy when they wanted. This brings us to our next section. measuring performance. until they later realized that teachers were their prime targets. 24 . Yes. men in finance make more money. The best way to build solid company culture is to get everyone aligned with your company’s vision. We want to inspire our entire company to track goals and motivate each other. but they only wear casual pants on the weekends. The only way we will know if we are on track is if we set goals and measure our progress. Bonobos targeted men in finance.
We use 240 to indicate months. we are sectioning our cohorts based on methodology. We could categorize them by the campaign they came through. We look at the average purchase price of our customers. and commission is $100. Of course. we want to understand the Lifetime Value of Customers (LTV). the date of their purchase. Cohorts Let’s place our new customers in cohorts. respectively.000 The lifetime value of our etail customer is $48. 25 . the number of times they purchase per month and the standard duration of the customer. We enter all data in the P&L and Metrics tab beginning at Row 98 First.000. We will look at four methodologies: etail. As a general rule. This helps us understand how much we would be willing to spend. we can only estimate the duration of each customer. you want to make your cost back within a year. $50. and commission. subscription. retail. and $80. We enter the number of purchases at two based on observation. For this example. retail. to acquire one customer. This data is calculated by our spreadsheet in Column o. the more accurate your calculations. $75. The more customer data you have. $120 x 2 X 240 = $48. This will help us understand how each group of buyers interacts with our products and service. subscription. make your best guess and update with actual data when it is available. Let’s do this for each methodology: We see that the average purchase price for etail.METRICS Now let’s figure out how we can best measure our company’s growth. We can estimate that the standard duration of our customer is 20 years. We sell apparel to men within the 25 to 45 year range. or another variable that allows them to be tracked. If you are just getting started.
$6. 26 . We see that the cost for each methodology is $11. In this example. 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. subscription. if you spend your resources sending George Clooney free Banjos apparel for a photo shoot. but creating specific cohorts around campaigns will give you better insight. it may attract thousands of new customers. 180. marketing expense. we are adding sales expense. However you decide to review your lifetime value of customers against your customer acquisition cost make sure you are comparing apples to apples. There are several ways to calculate your customer acquisition cost. let’s look at our Customer Acquisition Cost (CAC) per methodology. This data is highlighted in our spreadsheet. we have a low LTV customer with a high referral value. $19. 600. That will give you a general view. Let’s move on to referrals. We use actual expense data to determine the cost of acquiring one customer over a set time period. For example. The number of customers acquired for etail. In this scenario. advertising expense. 187. and commission were 310.Now. and salary expense for each campaign. Keep in mind that some customers may be expensive to acquire and have a low LTV. yet serve as lucrative conduits for your business. Some companies calculate all relevant costs for one year and measure that against the number of customers acquired. and $19. you could measure the increase in traffic to your site to get a general sense of the impact. However. retail. This is only helpful if you have real data. respectively.
we want to measure the effectiveness of our campaigns. only 10% activate the account 100 x 10 = 1. Are there specific sites that refer traffic? Yes. This is generally a good benchmark for most companies. We are able to see that new traffic arrived at our site by referral from the magazine article and photo shoot. as each one recruits one. Google Analytics is the best free source. Are there certain key search words that potential customers use? Yes.of the 1. however. 27 .000 invited.100 invites are sent . our low LTV customer.000 who were invited. To do this. may have attracted 10. George Clooney. We are able to see that new traffic arrived at our site by searching for the product George Clooney was wearing in the ad. In our previous example. we look at the following data: . Do your blog posts generate strong interest in your site? Yes. we should always look to conduits that embody our brand’s message. As we think about viral campaigns. We will look to our viral coefficient to determine how many of our new customers are referring other customers. There are several paid services that will help you analyze traffic.000 new orders based on one pair of pants. We are able to see that new traffic arrived at our site by way of our company’s latest blog post. Traffic Sources Now. let’s see how new customers are learning about our site.each person invites 10 people . Set up a system to view where your traffic is generated.Viral Coefficient Now. 10% activate (or 100) Your viral coefficient is 1.
Don’t make it so complicated that you are not able to complete it on a weekly basis. keeping track of a few metrics gives you insight into your business. we simply create a few quick and easy methods to track our data to understand our customers. We now understand the best methods and channels for future customers. 28 .As you see. the viral nature of our campaigns. Put together a system that is easy for you and your staff to follow on a weekly basis. and sources of traffic. KissMetrics and Mixed Panel are two paid services that develop advanced tools to track this information. For our analysis.
When you assess whether or not your company would be attractive to a venture capital fund. we want to find revenue and valuation data for private companies similar to ours. Related Transactions To estimate value based on related transactions. Let’s discuss related transactions and public comparables before we walk through an example. and discounted cash flow. CB Insights. The three that I’ve used in the past are PrivCo. If you don’t want to spend the time to research valuation data. it is always a good idea to have data to support the valuation you propose. When you issue equity to partners or investors. 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.VALUATION There are several reasons why you would want to develop an understanding of your valuation. Once you find the data. and Venture Source. This will help you defend your valuation. 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. as discounted cash flow is rarely applicable to early-stage companies. you will need to set a valuation for your company. place a link to your source inside the spreadsheet. With privately traded companies. you want to understand if your company can achieve a high valuation in the near future. public comparables. there are paid services that collect this data. Regardless of your reason for building a valuation estimate. 29 .
Please do not use this data while negotiating your valuation.sec.gov. Google and Yahoo! each have a finance section. for educational purposes only. You can find information on public companies on various sites. we have constructed faux scenarios. You can view detailed analyses of each company’s financials at www. In our spreadsheet.Public Comparables To estimate value based on public comparables. You should never have to pay for public company data. Search for S1. we want to find revenue and market capitalization for public companies with traits similar to ours. which details company data. 30 . and 10Q reports. 10K.
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. your company could sell at 10 times what the 409A valuation indicates. In fact. consult a corporate securities attorney. We are looking for a valuation estimate to assist us in negotiations. I am not an attorney. It is the value that is created for a set purpose. In the past. let’s walk through the valuation tab. to employees. In summary. so I will leave this discussion at a mere definition. such as stock options.Discounted Cash Flow To estimate value based on discounted cash flow. 409A You may have heard about Section 409A valuations. Most young companies have a net loss in the first few years. If you would like to understand Section 409A. This type of valuation is used to issue deferred compensation. similar to a home. Now that we understand why we are only looking for related transactions and public comparables. valuation is both art and science. which is illustrated on the previous page. we want to forecast company growth for five years to extract our free cash flow. yet does not affect the selling price. 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. This is similar to receiving an appraisal on a home. companies have been valued based on the number of engineers or the future growth potential of the company. 31 . You can probably already see why early-stage companies do not typically use this method. Discounted Cash Flow is generally used for later stage companies.
0x revenue. we would make it through six months. Now we understand our valuation estimate and financing strategy.000.000 in year five. We made sure to use data that was recent. Our proposed financing strategy is as follows: For the first six months. In month six.000 (C63 in our Assumptions tab). five related transactions through acquisitions. that we run out of money at this point. 32 . We pull our revenue from Row 10 of the Income Statement tab. and great strategic partners in our pipeline. if we used our initial startup capital of $500. as data that is more than eighteen months old may not be relevant. and five publicly traded companies. we have managed to negotiate a valuation of $6 million. our track record. This is important to us as we know from viewing data in Row 90 of the P&L and Metrics tab. based on our pipeline. we could take a convertible note from an angel investor (more on this in the next section) or use our own capital. we are ready to discuss various capital sources.000 range at our six month mark. Of course this would require us to look for the money in month one. Luckily. We see by looking at our calculations that we could reasonable get a valuation within the $1. We know that we have solid metrics that illustrate that we understand our buyer’s behavior. As you recall. Now.Valuation and Financing Strategy We have collected data on five related transactions through financing rounds.500.0x revenue to 6. Now we have a valuation range for our company. We believe that we would be attractive to a venture capital fund as our five year projections indicate we could sell for over $200.000. We simply multiply our revenue multiple by the revenue for the year we want to value the company. so it refreshes as our company grows. and our strong team. as some capital raises could take four to six months to complete.000 to $1. We see that the private company averages range from 2. we could secure additional capital at our six month mark valuation.
000. you may be better off seeking alternative sources of capital. Unfortunately. you will want to demonstrate that your company can be sold for a high multiple or file for an IPO.000.000 = $4.000. Let’s look at a few other financing options. our valuation is high enough to support the venture capital model. If your valuation points to a slow growth company. the return is what makes or breaks their fund.000.CAPITAL SOURCES Venture Capital Venture capital is the most widely publicized form of capital. When you develop a financial model.000 = $8. you can clearly see whether venture capital is or is not in your company’s future.000. Venture capital funds raise capital from pensions. We calculate this by adding our pre money valuation to the amount that was raised.000.000/$8.000 + $2.000. If you are looking for venture capital dollars. it is not the right type of capital for every company.000.000/$4.000 = 50% You would not want to give away 50% of your company in the first equity round.000 = 25% If your valuation were lower than $6. to get our post money valuation. In our example.000. foundations and high net worth individuals and invest this money for a return. so we can give away 25% of our company for $2.000 + $2.000.000 and $2. In fact. Don’t despair.000 and $2. For example.000. if your company is too early for venture capital. if your valuation was only $2. 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. there are other ways to finance your growth.000. 33 .000.000: $2.000. We have managed to get a valuation of $6. $6.000.000 it would be hard to justify accepting venture capital dollars.
The benefit of angel investors is that they are typically using their own money. As you develop your funding strategy. and can set their own time horizon. a convertible note is the best approach if you have a low valuation. you want to be mindful of future rounds of funding. Angel investors invest for themselves or within an angel group. There are several organizations that aggregate data around angel investors. if you don’t want to sell your company or file for an IPO.000 in revenue. You will also want to speak with experts in your industry. The requirements range from no revenue to $1. This allows them to invest without strict requirements regarding future returns. like venture capital funds. Let’s discuss several ways you can raise capital. In theory. Not all money is equal. as well as capital. There are some angels who will demand equity. Angel investors are as easy to find as venture capital funds. you may find that you have very little equity to give to new investors. a convertible note is simply a loan that converts into equity. depending on the industry.000. However. Gust and Angel List are the three best sources to find angel investors in your sector and geographical area. There are some angel investors who will not require you to sell within a three to five year time frame. Angel Capital Association. As we saw in our previous example. if you don’t want to sell your company or file for an IPO ever. Naturally. Remember.Angel Investors Angel investors will invest in companies that are too early for venture capital. Angel investors. In my opinion. If you dilute your company too soon. are looking for a return. This will give us the opportunity to grow our valuation prior to issuing equity. 34 . there are other options for you. we accepted a convertible note from an angel investor. this gives them more flexibility on terms and time horizons. you want to take money from people who deeply understand your industry and can provide guidance.
There have been several crowd funding projects in which the product was not delivered in time. There is one additional area to note regarding crowd funding. By building a sound financial model. there has been at least one lawsuit due to the failure to deliver a product. This highlights the importance of creating a financial model for your company. I could create a profile on a crowd funding site to target women who are interested in purchasing my dress. Please refer to my blog at www. You may not have investors to answer to with a crowd funding campaign.atelieradvisors. As I write this ebook. At the time of this writing. This allows me to raise the capital needed to produce the line. crowd funding sites are not allowed to issue equity. Crowd funding’s simplicity is a strength and a weakness. without diluting my company’s equity. but your product may cost you $2 million to produce and deliver. 35 . For example.com/think for the latest on equity crowd funding. but there is definitely a need to have some due diligence on the viability of the products. At this point. but 1.Crowd Funding Crowd funding has become increasing popular over the past few years. It is critical that you understand the expenses involved in creating any type of company. the SEC has yet to finalize the regulations around issuing equity in a crowd funding campaign. There are several sites that provide the platform for this type of funding. You may be able to get $1 million on Kickstarter. Crowd funding allows individuals to market their product or service before they create it. you can set a price that will allow you to deliver the product on time. if I want to create a line of dresses. It is great that we can get products we want to develop quickly funded. Kickstarter and IndieGoGo are the two most popular.000 angry customers may be worse.
000 to $2. you may not want to accept capital for equity. Please consult an attorney before accepting any type of investment. There is a common misconception that convertible debt is free money.000 / $1. Remember. It is rare to have a valuation of over $2. getting you from one point to the next.500. you will receive a term sheet that explains your legal obligation. If you are looking for $500.000. The term sheet will indicate your liability in a range of scenarios.000. $500. 36 . pre-revenue companies range from $750. When you pursue a convertible note. If you pursue a convertible note. you may be forced to pay the interest and debt.Debt Debt is rarely discussed and sometimes despised.000 = $1.000. we always want to be mindful of the amount of equity we are giving away at each round.000 for a seed stage company. Valuations for seed stage. 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. They allow budding companies to accept money in exchange for a (legal) promise to issue future stock at a discounted price.000.000.000. This is controversial and should be discussed with an attorney. are popular with the startup community. $500. Keep this in mind as you develop your valuation estimate and funding strategy. I believe it can be a useful resource for a growing company if used the right way.000.000 + $1. as we discussed.500. Debt can operate as a bridge. which is too high for your seed round. Let’s look at several types of debt instruments: Convertible Notes Convertible notes. Timing – if you are not able to raise an equity round in a set period of time.000 = 33% The investor would own 33% of your company.000 and your valuation is only $1.
which may seem high. of course. the revenue-based loan does not require a set monthly payment. as the loan is repaid as a percentage of the company’s revenue. Similar to a bank loan. a revenue-based loan may not work for you. a company may pay off the revenue-based loan after a set period of time. you are borrowing money with a promise to pay it back as a percentage of future revenue. if you don’t have strong revenue. Unlike a bank loan. you would pay more when revenue is high and less when revenue is low. or extend it out for several years. A revenue-based loan requires the company to have a history of solid revenue. the standard interest rates are 15% to 30%. is a decrease in expense. 37 . Let’s take a look at asset-based loans.Revenue-based Loans Revenue-based loans have recently surfaced in the startup community with the help of Lighter Capital. Unlike a bank loan. this rate is comparable to an expensive credit card. One of the main benefits of revenue-based loans is that the interest on the loan is tax deductible in most states. If your scheduled monthly payment is 2% of revenue. royalty-based loans. This helps companies who may not have smooth revenue streams. This type of capital has been used for decades under the name. This can be a great source for a company that has strong revenue and can pay back the money within a year. which most entrepreneurs end up using when they are attempting to reach profitability. Please consult with an attorney in your area to determine your state’s tax laws regarding revenue-based loans. The benefit to paying the loan off sooner. In fact. However. one should also weigh the fact that they may not be able to get funding elsewhere due to lack of credit or other variables. With this type of capital. However.
there are several types of capital sources for early-stage companies. 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. don’t pursue venture capital dollars or angel investors who are looking for a return. they repay their loan. If you know that you don’t want to give away equity or sell your company in the near future.Asset-based Loans Asset-based loans have also been around for decades and have a wide variety of offerings. If you do want to give away equity. you may be a candidate for factoring. Once the companies deliver the merchandise and receive payment from their client. The one thing that all asset-based loans have in common is the underlying need for collateral (read: assets). Crowd funding. 38 . based on the health of the company. The rates for factoring range from 2% to 15%. They purchase invoices from customers who need capital to manufacture merchandise that has already been ordered and invoiced. A commonly used asset-based loan is factoring. revenue-based loans. companies with stronger credit will receive favorable rates. Rosenthal and Rosenthal is a commonly used firm in the fashion industry. Naturally. and asset-based loans may be the right type of capital for your company. For example. which is the exchange of invoices to allow for better cash flow. You want to make sure that you are taking the most appropriate type of capital for your business. Select a capital source that is aligned with your long-term vision. you will need to look for a short-term source of capital to get you to the next stage. In summary.
com/think If there is a specific area you want to know more about.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 I will continue to blog on this topic at www. If you have any questions about the material. do not hesitate to contact helpdesk@atelieradvisors. tweet me at @atelieradvisors or message me at www. 39 .facebook.
you don’t pay $2. If you are wondering. You use it over time. These four items do not reflect the financial health of the company. The rationale behind depreciation schedules is that you do not use the machine all at once. you will allocate $2. you will start to create depreciation schedules. and amortization. we completely ignored depreciation and amortization. the computers in our example could have been amortized. You will depreciate it based on a 5year straight-line schedule. we use Operating Revenue. In other words. tax. You pay $10.Appendix Depreciation and Amortization As you purchase equipment for your company. EBITDA is earnings before interest. not EBITDA. However. For our streamlined version of the financial model. You purchase a machine for $10. Notice that this expense is not a cash expense. for simplicity. We will amortize using a standard straight-line depreciation for a simple example. 40 .000 in year one.000 for the machine in year one.000 each year. This is why you will commonly see non cash items removed from the calculations.000 every year for five years. depreciation.