Module 2 Entrepreneurship II:

Preparing for Launch

 Lesson 2-1 Financial Projections

Lesson 2-1.1 Projections: Financial

Projections
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Financial Projections for Startups - Slide 1

The slide contains an image of Yoda from Star Wars (© ®

Lucasfilm Ltd./Disney) [1]

Difficult to see ... always in motion is the future

Transcript

In this lesson, I'm going to talk about preparing financial

projections. Once you've decided on an appropriate revenue
model and pricing strategy to bring your idea to market, it's time
to start making assumptions about sales, income and expenses,
and cash flow. It's time to start building a model to forecast the
financial result that you and your stakeholders can expect from
the business. I frequently hear startup entrepreneurs complain
that they think the whole process of preparing financial
presentations is a waste of time. After all, nobody can predict the
future.

Most startup companies don't do as well as they predicted. A few

do much better than anyone could have expected. There are so
many variables and so much uncertainty. The only thing you
really know for certain is that your financial projections will turn
out to be wrong. But that's not the point. Nobody expects you to
be able to accurately predict the future. Financial projections and
the process of preparing them can still be very valuable.

What Good Are They? - Slide 2

Financial projections demonstrate:

 Your aspirations for the business
Your understanding of key drivers of profits and growth
Your understanding of key drivers of ROI for investors
Whether it fits an investor’s profile

Transcript

Even before you start, the work that you do to prepare financial
projections can force you to take an objective look at the
opportunity which will help you make an intelligent decision
about whether or not to proceed. That's the go or no-go decision.
For other stakeholders, including investors, key employees,
strategic partners, that you want to bring into the business, your
financial projections will tell them a lot. They demonstrate your
aspirations for the business. What are you really trying to build?
A fast-growth market-dominating company? A stable and
profitable lifestyle business, or something in between? What will
you as the founder of the company consider to be a success?
They demonstrate the extent to which you've thought through
and understand what the key drivers of growth and profitability
will be. Are you able to identify the areas in which you need to
invest in order to maximize the potential of the business, sales,
operations, technology, channel development, customer
support? Similarly, they demonstrate the extent to which you
understand the key drivers of return on investment for investors
in the company. They'll be trusting you with their capital. They
need to be confident that you have a plan to maximize their
returns. Finally, they help a potential investor quickly determine
whether or not the business fits their profile so that they can
quickly decide whether or not they want to learn more about you
and your opportunity.
Top-Down vs. Bottom-Up (1 of 2) - Slide 3

Top-Down Forecasting:

The slide contains the following quote overlaid with a red circle
with a line through it (the no symbol)

“It’s a huge market, so we only need a 1% market share to

be successful…”

Transcript

Here's some quick advice before you start. While it's perfectly
acceptable for you to use top-down thinking when you're
estimating your market size, it's not appropriate to build your
financial projections that way. Even though that's what a lot of
entrepreneurs do. This is one of the differences between a good
business plan and a bad business plan.

By top-down, I mean a financial projection that's based on an

assumed market share. There's a really big market out there,
and we're assuming that we're going to get a 1% market share
and that will result in millions of dollars in sales revenue per year.
This is a pretty big turn-off for most investors. I've also seen
some forecasters use a sales-based approach. This is a forecast
is based entirely on the number of salespeople that they can
hire. The projections will essentially say that each of our
salespeople will close a certain number of sales per month and
will grow the business simply by adding more and more
salespeople. The problem with both of these approaches is that
they completely lose sight of the customer and the value
proposition that you're offering.

Top-Down vs. Bottom-Up (2 of 2) - Slide 4

Bottom-Up Forecasting

“Our revenue projection is based on the number of

customers we think we can acquire with our go-to-market
strategy, and the amount that we think each customer will
pay”
Transcript

The best way to build a financial projection is to develop a

customer pipeline made up of potential early adopters, at first,
and then expanding into the broader market. Your business plan
has to explain the strategy that you've developed to convert
these prospects into customers and why you think your
assumptions about sales conversion rates and customer
acquisition costs are reasonable. If you can do that and base
your financial projections on those assumptions about customer
prospects and sales conversion rates, then you will have a solid
financial projection. As I said before, this is one of the
differences between good business plans and bad business
plans.

Estimating Future Revenue - Slide 5

What is your revenue model?

What price(s) can you charge?

How many customer prospects can you reach in your first

month, quarter, or year?
What sales conversion/closing rate can you achieve?

How fast can you grow in subsequent periods?

Transcript

So, let's get started. The first thing you need to do is build your
revenue projections. What is your revenue model and what's
your pricing strategy? How many customer prospects can you
reach in your first month, or quarter, or year? What percentage
of these prospects do you think you can convert into paying
customers? As your business gains traction and you learn more
about your customers, you should be able to grow your sales,
both by reaching more prospects and by improving your
conversion rate. How fast do you think you can grow your
revenues on a month-to-month, quarter-to-quarter, or year-to-
year basis?

Revenue Forecasting Mistakes - Slide 6

Projections assume rapid customer adoption

Projections underestimate the length of the sales cycle

Transcript

As we've already discussed, most of your predictions about the

future will turn out to be wrong. Most projections are too
optimistic. So, where do entrepreneurs usually guess wrong
about their revenue? In my opinion, the biggest errors that
entrepreneurs make are about customer adoption rates and the
sale cycle. Your customers are busy, and it'll be hard to get their
time and their attention. The status quo can be your most
formidable competition. Even when you do have their interest, it
can take a long time to move a customer prospect through your
sales pipeline, especially when you're making a business-to-
business sale. Your end customer may not be the final decision
maker, and they may have to get a lot of additional people
involved before they can purchase. Even when you think the
purchase decision has been made, your contracts may be tied
up in a legal review for a long time. You should make sure that
you have a solid understanding of typical sale cycles in your
industry. The government, hospitals, and academia, for example,
are all notorious for having very long sale cycles.

Estimating Future Expenses - Slide 7

What will it cost to produce your product or service? Cost of
goods sold

How much will you spend on customer acquisition? Marketing

and sales

What will it cost to support the product or service and to operate

the company? General and administrative

Transcript

As you're building your revenue projections, you also have to be

estimating the expenses you'll have to pay. How much will it cost
you to make and deliver your product, acquire customers, and
maintain your business infrastructure? These are your cost of
goods, your sales and marketing expenses, and your general
and administrative expenses, or corporate overhead,
respectively.

Gathering Cost Information - Industry Comparables - Slide 8

Some costs may be easy to forecast based on information you

already have; other costs will be harder to anticipate
Industry comparables: Evaluate financial statements from
publicly traded companies that are competitors or are otherwise
comparable

Transcript

You should be able to get a pretty good handle on some of these

expenses. You can make accurate estimates of what you'll need
to pay for office rent, equipment, software, and so on. You can
estimate how many people you'll need, and what salaries you'll
need to pay to recruit and retain them. You can get quotes from
the suppliers of raw materials or finished inventory. You can
research what you'll need to pay for a website, online and offline
marketing and advertising, commissions to resellers, etc. For
other expenses, you may have very little information to work
with. Fortunately, there are places you can go for guidance. You
can look at financial statements for public companies that are
comparable to your business in some way. Same industry, same
business model, similar customer targets, etc. SEC filings are
available on both paid databases and free websites, like Yahoo
or Google Finance.

Gathering Cost Information - Slide 9

Industry averages

Library/online research
Small Business Development Centers
Paid databases such as Bizminer.com

Transcript

You can also look at published industry averages which you can
find in most business libraries, or by working with your local
small business development center. Risk Management
Associates, for example, publishes annual statements studies
which include dozens of financial ratios for over 500 lines of
business. These are taken from tax returns, and they include
both public companies and small and mid-sized businesses.

Expense Forecasting Mistakes - Slide 10

They underestimate their general and administrative (overhead)

expenses

They underestimate their selling expenses, the cost of

maintaining a sales force, in particular
Transcript

So, where do entrepreneurs usually go wrong when they

estimate their expenses? In my opinion, the two biggest areas
are general and administrative and selling expenses. You may
think you've identified everything you need to operate the
business, but things happen, and you'll need to be prepared.
Legal, accounting, travel, employee health care: these can all
add up quickly. You may also find that you need more people
than you thought or you may need to spend money to replace
employees that aren't working out. Entrepreneurs often
underestimate the cost of building and maintaining a direct sales
force in particular. Some salespeople will be more effective than
others, and it can sometimes take months before a new
salesperson is truly up to speed and meeting his or her goals. If
they aren't effective, you'll need to replace them and that starts
the whole process over.

Estimating Future Cash Flows - Slide 11

How long will it take to collect from customers? Average

collection period or days receivable

How much inventory will be needed? Inventory turnover

Will your vendors give you credit terms? Days payable

Transcript

Profits are nice, but ultimately, you and your investors care about
cash. So, how do you go about building a cash flow forecast out
of your revenue and expense projections? Here are some of the
things you need to forecast. Your average collection period. If
you're going to offer credit terms to your customers, you're going
to have to estimate how long it will take them to pay. Remember
that this is something that is outside of your control. You can't
write the check for them. Another name for the average
collection period is days receivable: the average number of days
that it takes to collect your accounts receivable from customers.
How much inventory will you need to carry, and how much will it
cost? It's not revenue until you sell it. Inventory turnover is a
measure of the number of times that you turn over your inventory
in a given year. The faster you sell your inventory, the less cash
you'll need to have tied up in it. Will your vendors offer payment
terms to you? They may very well not when your business is
new and lacks any sort of a credit history. If and when you're
able to get credit from your suppliers, you should be able to use
these terms to improve your cash flow. Days payable is the
average number of days that your accounts payable are
outstanding, the length of time that you're able to take between
purchasing and paying for your inventory. These short-term
assets and liabilities, accounts receivable, inventory, and
accounts payable will be the primary drivers of working capital in
your business.
Estimating Future Cash Flows - Fixed Assets and Capital
Expenditures - Slide 12

How much capital equipment (fixed assets) do you need to

operate the business?

What intangible assets are needed?

Look to industry comparables and industry average to learn what

is typical in your industry

Transcript

Moving beyond working capital, you need to estimate the

amount you'll have to invest in fixed assets or capital
expenditures. This includes real estate, including any
improvements you have to make to lease property, machinery,
office equipment, vehicles, and so on. Finally, do you need to
invest in intangible assets like patents or copyrights? For many
of these you can look to comparable companies and industry
averages for guidance.
Cash Flow Forecasting Mistakes - Slide 13

Underestimating the length of the cash-to-cash or operating

cycle

The time it takes to produce and sell your product or service,

plus the amount of time it takes to collect from your customers

Can be reduced somewhat if your suppliers give you time to pay

for your purchases of inventory

Transcript

Cash is king, and entrepreneurs often guess wrong about how

their revenue and profits will translate into cash. They
underestimate the amount of time that will elapse from the time
they purchase inventory to when they collect cash from the
customers that buy that inventory. This is the company's cash-to-
cash or operating cycle and it's an important metric to
understand.
Cash Flow Forecasting Mistakes - Operating Cycles - Slide
14

A long operating cycle means that a significant amount of cash

will necessarily be tied up in inventory and/or accounts
receivable

The need to invest cash in inventory and accounts receivable will

increase directly as sales increase

Transcript

A lengthy operating cycle means that the company will have to

have a lot of cash tied up in inventory and accounts receivable.
The need to invest in working capital, tying up cash in the
process will increase directly as your sales increase. You'll need
to plan for this to make sure you have enough cash available at
all times.
Creating the Model (1 of 2) - Slide 15

Linked Excel worksheets:

Key assumptions
Income statements
Balance sheets
Cash flow statements
12-month budget
Transcript

So, what will you ultimately have to have in your financial

projections package? Ideally, your projections can all be built in a
set of linked worksheets and Microsoft Excel, or some other
spreadsheet software. Keep it as simple as possible. You want
them to be easy for both you and others to review and
understand. You'll need at least 3 years' worth of projected
income statements, projecting revenues, expenses, operating
profits, and net income. You'll need to have projected balance
sheets listing assets, liabilities, and net worth, dated as of the
end of the same 3 years. You should also have projected cash
flow statements for 3 years. All of these, the income statements,
the balance sheets, and the cash flow statements should be
prepared in a format that's consistent with generally accepted
accounting principles. It's also a good idea to have a monthly
forecast of cash inflows and outflows for the first year, also called
a cash budget. This is what you use to determine your cash
runway and the amount of cash you need to raise from investors
or lenders in order to avoid running out of money.

Creating the Model (2 of 2) - Slide 16

Identify your assumptions

Keep the model as simple and flexible as possible

Transcript

Finally, you should have a separate list of the key assumptions

that are driving the most significant numbers in your projections:
sales, sales growth, profitability, cash flow, and so on. If you
prepare all of these projections with linked worksheets, you
should be able to quickly do a sensitivity analysis. That's where
you change a couple of key assumptions, keeping everything
else the same, and see what the bottom-line impact will be. A
sensitivity analysis is a good tool for helping you understand
which assumptions matter the most and where you should focus
if you want to maximize profits or cash flow.

Resources - Slide 17

SCORE (free templates)

Foresight (paid – templates plus tutorials)

Transcript

Fortunately, you don't have to build all of this from scratch. You
can download a free financial projections template from SCORE,
or you can buy a set of templates from vendors like Foresight.
Foresight also provides some great information on best practices
for financial projections even if you don't buy their templates.
 Lesson 2-2 Presenting Financial
Forecasts

Lesson 2-2.1 Projections: Presenting Financial

Forecasts
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Word Cloud - Slide 18

The slide contains a word cloud with words about financial

assumptions, including revenue, cash, growth, proceeds, and
projections. The image is from WordItOut.
Transcript

Hopefully, by now, you've started to pull together a reasonable

set of financial projections for your startup, and they're looking
pretty good. In this lesson, I'm going to talk about how you can
best present your financial projections to potential investors.
Investors are going to need to see your financial projections, but
it's just as important for them to understand the assumptions that
they're based on.

Requirements - Slide 19

A three-to-five year financial projection

Income statements
Balance sheets
Cash flow statements
Additional worksheets with details (e.g., revenue build-up,
salaries, and headcount), as needed
Transcript

Before you have that initial meeting with a potential investor,

remember what the purpose of the meeting really is. It's not to
get the investment, it's to get a follow-up meeting. So, the
financial information that you present during your initial meeting
has to be concise and understandable, but it has to be backed
up by an appropriate level of detail. You will probably need to
have prepared at least 3 years' worth of projections, income, or
profit and loss statements, balance sheets, and cash flow
statements. Preferably, ones that are consistent with generally
accepted accounting principles, so that they're consistent with
your investors' experience and expectations. You'll also want to
have a worksheet or two that lay out the key assumptions on
which your projections are based, especially, the assumptions
behind your revenue and growth projections. You'll have to
defend these assumptions at some point. It can also be
productive to have a worksheet or two that provide additional
details, like the number of employees you're going to need to
hire over time.

Other Requirements - Slide 20

Cash budget for 12 months: cash inflows and outflows

Financing needs: the amount of capital you need to raise

Use of proceeds: how you plan to spend it

Transcript

You'll also need to have a monthly cash budget that forecasts

cash inflows, cash outflows, and your cash balance each month.
At least for the first year. This helps to show your cash runway,
how long you can operate before you have to raise additional
capital. Finally, you'll need to be able to discuss your financing
plan. How much money do you need to raise today, and how will
you spend it to create value in the company and for its
shareholders, including yourself?

Sensitivity Analysis (1 of 2) - Slide 21

A tool for determining how your projections would be affected if

key assumptions are changed

Lower or higher prices

Faster or slower sales growth
Longer or shorter sales cycles
Transcript

Entrepreneurs frequently ask if they need to be prepared to

present a sensitivity analysis. This is a tool for determining how
the business and its finances would be impacted if some of the
key assumptions underlying the forecaster changed. For
example, what happens to your profit margin if you lower your
price by 15%? What happens to your revenue growth rate if it
takes 30 days longer than you expected to close sales? Or what
happens to your cash runway if your customers take 40 days to
pay instead of 30?

Sensitivity Analysis (2 of 2) - Slide 22

Key assumptions listed on a separate worksheet

Best case, worst case, most likely

The investor presentation should include only the "most likely"

case; be prepared to discuss the others in follow-up meetings
Transcript

A sensitivity analysis is not that hard to prepare as long as you

have clearly laid out these assumptions in a way that makes
them easy to change in your models. Frequently, a sensitivity
analysis is a way for you to understand and share your best
case, worst case, and most likely projections. When you're
meeting with an investor for the first time, my advice is to focus
entirely on your most likely model. Your worst-case model may
not look good enough to get you to that second meeting, and
your best-case model might make the investor think you have
stars in your eyes. You can always dig into your sensitivity
analysis later and it will help you demonstrate to the investor that
you've clearly identified the assumptions that really matter.

What to Include - Slide 23

Highlights of your financial forecasts; enough to demonstrate:

The size and scope of the opportunity

The investment that is required
The potential return, if the company succeeds
The amount of time that it’s likely to take
Transcript

So, what should you include in your initial investor presentation?

At this early stage, you really only want to present highlights.
You want them to be enough for you to clearly communicate the
attractiveness of the opportunity, without getting either you or the
investor bogged down on the details. Remember, the purpose of
an investor presentation is to get a follow-up meeting. You want
him or her to be interested in learning more. At a minimum, you
need to present enough to communicate the potential size and
scope of the business. Is it a niche business that will steadily
gain market share, or is it a market-dominating company that
has the potential to disrupt an entire industry? Is it a lifestyle
business or a rocket ship to the moon? You also need to be clear
about the nature and size of the investment that's going to be
required, is it equity or debt? Do you need to raise tens of
thousands of dollars? Or tens of millions? If possible, it's good to
be able to give the investor clues about the potential return on
the investment if the company is successful. That's not to say
that you need to calculate the IRR for them, you certainly don't
want to do that.

A better way to do this is to discuss what you think the potential

liquidity options for your investors will be. Are you planning to
have the company throw off lots of cash in the form of
dividends? Do you think the company will eventually be
purchased by a larger company in your industry? If so, can you
point to similar transactions? Do you think the company has the
potential to go public in an IPO? How long do you think it will
take before your company will be ready for any of these options?
Make sure that you've done your homework so that you can be
credible when you discuss these alternatives.
Available as Backup (1 of 2) - Slide 24

Detailed financial projections—three to five years

Key assumptions:

Revenue forecasts and growth rates

Types of revenue (recurring vs. one-time; products vs.
services; etc.)
Gross profit margin

Transcript

Assuming that you're successful in getting that follow-up

meeting, that's when you should expect to review your full
forecast. You should also be ready to explain and defend the
assumptions behind your forecast, especially when it comes to
revenue growth and profit margins.
Available as Backup (2 of 2) - Slide 25

Selling and marketing expenses

Important administrative or overhead expenses

Significant capital expenditures

Detailed “use of proceeds” for the investment

Transcript

Of course, everything is fair game when you're digging through

your detailed forecasts. In addition to revenue and profit
margins, the questions you're likely to get will be about your
selling and marketing expenses, major administrative, or
overhead expenses, especially if they're not typical for a
company in your industry, your capital expenditures, and your
use of proceeds. That's the list of items you're raising capital to
pay for.
The Ask - How Much? - Slide 26

How much money are you trying to raise?

12–18 months of cash runway

To achieve product, customer, and/or financial milestones

Transcript

You should have a slide near the end of your presentation called,
"The Ask," or "Financing Requirements," or something like that.
This is your call to action, and any presentation that doesn't
include a call to action has the potential to be a waste of
everyone's time. So, be specific. What do you need and how can
they help? How much money are you trying to raise right now? It
should probably be enough to last you for at least 12 to 18
months so that you have enough time and resources to
accomplish the key milestones that you've set for the company
before you have to go out and raise money again. If you don't
achieve the milestones, it'll be very hard for you to raise that next
round on the favorable terms that you're probably hoping for.
The Ask - For What? - Slide 27

Use of proceeds

What will the money be used for?

Will it create value?

Transcript

I've said this before, but I think you really should describe how
you intend to spend the money that you raise. Investors will want
to see that it's really creating value. Company overhead is not a
very exciting use of proceeds. They're going to want to see that
you're spending as much of the money as possible to advance
your technology, get real actionable feedback from customers,
grow your sales, and improve your profit margins.
The Ask - Slide 28

Understand your audience and their capacity to invest

Don’t propose valuation or deal terms!

Are you asking for anything other than money?

Transcript

Make sure that you understand your audience and their capacity
to invest when you're asking for money. It makes very little sense
to talk with an angel investor about a multi-million-dollar
investment unless they're going to be just one of many investors.
It makes even less sense to talk to a $500 million venture capital
fund about a $25,000 or $50,000 investment. Have you already
raised any of the money? If you've already got an investor on
board, make sure they know that. It's so much easier to raise
money if new investors can see that there's already smart
money in the deal.

A word about valuation. I think it's a mistake for you to mention

the valuation you think you deserve in an initial investor
presentation. Most venture capital firms and most sophisticated
angel investors expect that they'll be the ones who proposed the
valuation, and that will come only after they've decided that they
want to invest in the business. If you lead off by proposing a
valuation that they think is too high, they may lose interest
because they think they'll never be able to come to terms with
you. If you lead off with a valuation that's too low, you're going to
leave money on the table because they'll never agree to a higher
valuation after you've basically said you'll accept a lower one.
There's plenty of time to discuss valuation and other important
deal terms later once it looks like you've got a real thing going.
The only time when I think you should be the first to bring it up is
if you already have a lead investor on board. The terms have
been agreed to and you're just trying to bring on some additional
investors to fill out the financing round.

Example #1 - Spreadsheets - Slide 29

The slide contains an image of a spreadsheet overlaid with a

large red circle with a line through it (a no symbol).
Transcript

So, now, let's look at a few examples. There are lots of ways to
present financial information in an investor presentation. Let's
start with what not to do. Don't just copy and paste your
spreadsheets into your slide presentation. For one thing, it's not
even close to being legible. For another, it does nothing to
highlight the numbers that matter. The investor has to try to pick
them out on their own. Less is more. There's almost never a
reason to present monthly or even quarterly revenue or cash
projections like this. There's also no reason to include more than
a few line items. Remember, you can get into the details in a
follow-up meeting. If the investor asks you to send your detailed
projections after the first meeting so that they can review them,
that's a win for you. You want them to be interested enough to
ask for more.

Example #2 - Tables - Slide 30

Financial Projections
($000) 2014 2015 2016
Headcount 28 44 59
Revenue $3,655 $10,196 $24,931
Net ($1,987) $1,246 $11,769
Transcript

Here's a bare-bones approach. Many of the investors that you

meet will have financial backgrounds, and this may mean that
they relate better to numbers than they do to graphs. So, give
them what they want. The key numbers, revenue and profits,
with the dollar amounts in thousands so that they're easy to
read. Maybe throw in an additional metric to provide additional
context, the employee headcount forecast in this example. You
really don't need a whole lot more than this. This bare-bones
table has the same information from the squint chart on my last
slide, a company growing from 4 million to 25 million in 2 years
with a really strong profit margin by year 3. It's a software
company, so one would hope that the profit margins would be
high. You can also see that the headcount is growing but not
nearly as fast as revenue, hence, the dramatically improving
profit margins.

Example #3 - Graphs - Slide 31

The slide contains a line graph representing the information

presented in the table on Slide 30 - Example #2 - Tables. Time in
years is listed along the x-axis and dollars along the y-axis.
There is a line representing revenue and a line representing net
income; both lines show a gradual increase from 2014 to 2015
and a rapid increase from 2015 to 2016.

Transcript

Here's another example, same numbers but we've added a

simple line graph for those who aren't so numerically inclined.
You can see revenue growing. In fact, you can see that the rate
of growth is improving from the way that the revenue line gets
steeper, which is something that was a little harder to get from
the last example. Profits are going from negative to positive and
the rate of increase is also getting better. The numbers are
provided in a small table at the bottom, as it's sometimes hard to
determine the actual amounts without squinting at the graph for
a while.

Example #4 - Detailed Tables - Slide 32

Detailed Projections
2014 2015 2016
New Users 48 145 327
New Users/FTE 2 3 6
Revenue($000) $3,655 $10,196 $24,931
Gross Profit 2,843 8,367 21,408
% 78% 82% 86%
Expenses 4,831 7,122 9,639
EBITDA $(1,987) $1,245 $11,770
% −54% 12% 47%
Cash $4,082 $4,313 $14,340

~$25M Revenue by Year 5

3× increase in New Users/FTE

Gross Profit Margin over 85%

EBITDA Margin over 45%

Attractive target for acquisition by 2017

Transcript

Finally, for those of you who absolutely insist on having busy

presentation slides, here's an example of a way to communicate
a lot of information. The revenue and profit projections are here,
as they were in the previous examples, but we've added gross
profits and percentages for both gross profits and net profits.
We've also added the projected cash balances, which can be
pretty important after all. And some revenue growth and
efficiency metrics, new users per year and the number of new
users per full-time employee. The cash totals help to
demonstrate that this company may not need to raise any more
money from investors after this round. There are even some
highlights over there to the right to make absolutely certain that
the investor understands that we're talking about a company
that's expected to grow fast while significantly improving its sales
efficiency and profit margins over time. Finally, “attractive target
for acquisition by 2017” is all you really have to say to tell the
investor when and how you think they'll be able to realize a
return on their investment.

Resources (1 of 2) - Slide 33
The Capital Network. (2012, September 19). Financial
projections for presentations [slide deck]. Retrieved from
https://www.slideshare.net/thecapitalnetwork/financial-
projections-presentation

Fernandes, S. J. (2013, July 6). The best startup investor pitch

deck & how to present to angels & venture capitalists [slide
deck]. Retrieved from https://www.slideshare.net/Sky7777/the-
best-startup-pitch-deck-how-to-present-to-angels-v-cs

Transcript

There are quite a few blogs and websites out there that offer
really good advice for entrepreneurs about preparing and
presenting their financial projections.

Resources (2 of 2) - Slide 34

Kawasaki, G. (2012, January 17). How to create an enchanting

financial forecast #OfficeandGuyK. Retrieved from
https://guykawasaki.com/how-to-create-an-enchanting-financial-
forecast-officeandguyk/
Davidson, T. (n.d.). How to pitch your financial projections.
Retrieved from https://foresight.is/learn/presenting-financials

Transcript

I definitely recommend Guy Kawasaki's blog, as well as these

other sites. Good luck.
 Lesson 2-3 Financing Options

Lesson 2-3.1 Startup Financing

Media Player for Video

Word Cloud - Slide 35

The slide contains a word cloud about equity, including assets,

company, financing, cash, operating, and investors. The image
comes from WordItOut.

Transcript

Welcome back. In this lesson, I am going to talk about financing

the startup company. The word cloud for this lesson is focused
on equity. I am going to speak mainly about why startups need
equity financing to pay for assets they need to acquire and to
pay for company operations.
Necessary Evils (1 of 2) - Slide 36

Assets: What the business must own in order to create/deliver

its products and operate/manage the company

Necessary because without them, the business could not

function

Evil because they consume cash that could otherwise be used

to pay bills or dividends

Transcript

I want to start at the very beginning. Let's discuss assets. As an

entrepreneur, I want you to think about the assets that your
business owns as being necessary evils. Clearly, they're
necessary. Without them, you don't have a business. You don't
have the ability to manufacture a product. You don't have the
ability to deliver a service. And you don't have the ability to
operate the company. But they're evil because assets are going
to consume cash that you could otherwise use to pay bills or to
pay dividends to yourself and to the other shareholders of your
company. And that's really why you're in business.
Necessary Evils (2 of 2) - Slide 37

More assets = less cash available!

Less assets = more cash available!

This is a strategic decision that the entrepreneur must make as

the company is launched and grows over time

Outsourcing—a “virtual company”

Vertical or horizontal integration

Transcript

The more assets that you have in your business, the less cash
you're going to have available for yourself and your
shareholders. If you can get by with fewer assets, all else being
equal, you should have more cash available at the end of the
day, month, or year to pay out to yourself and to your
shareholders. I want you to think about this as a strategic
decision. A decision about how you design, organize, and
operate your company in order to maximize the amount of free
cash flow that it can generate. Not just to pay out to yourself, but
also to pay the bills that are going to come due from time to time.
At one end of the spectrum, your strategy could be to operate as
what's called a virtual company. In a virtual company, you
essentially outsource all of your corporate functions to outside
vendors or partners. You could hire a manufacturer's rep to be
your sales force. A contract manufacturer could make and even
ship your products. An HR contractor could handle your
recruiting, if you have any, and pay your payroll. You get the
idea. You could hire vendors to handle almost every business
activity leaving you to set the strategy and manage the company
from your desk. A virtual company has very few assets.

At the other end of the spectrum, you could choose to build a

vertically and horizontally integrated business, where you do just
about everything in-house. You do your own product
development, you own your own factory, you manage your own
human resources and your own internal sales force, you pay all
of your own bills. A company like that would have to have a lot of
assets. In the long run, it might be more profitable than a virtual
company because it doesn't have to make room in its strategy
for all of those outside vendors and their own individual profit
margins. However, those assets are going to consume a lot of
cash that could otherwise be used elsewhere. Most startups are
better off operating with fewer assets, at least until they reach
the point where their sales are high enough, and predictable
enough, to justify the additional investment. That's because cash
is king in a small business. Managers sometimes have to be
more focused on cash flow than they are on profits.
Financing the Startup - Long-Term Assets - Slide 38

Why do early-stage ventures need outside cash?

1. To pay for long-term assets

Used to produce or deliver the products or operate the

business
Will be used for at least several years

Transcript

So, let's talk about why startup companies need to raise money
from outside investors. The first reason is to pay for long-term
assets. These are pieces of equipment or machinery, vehicles,
buildings, and other assets that you are going to use for several
years in order to produce or deliver the products that your
company is providing.
Financing the Startup - Working Capital - Slide 39

2. To finance working capital (short-term assets)

Inventory, accounts receivable, etc.

Needed if you stock inventory or offer customers time to pay

Transcript

Then there are short-term assets or working capital. That's

mainly inventory and account receivable. These are assets that
are short term in nature. You should be able to sell your
inventory fairly quickly and collect your account receivables fairy
quickly. But in the meantime, they're going to consume cash. If
you can get away without having to have accounts receivable or
inventory in your business, you can free up some, or all, of that
cash.
Financing the Startup - Operating Losses - Slide 40

3. To cover operating losses

Whenever the company is not breaking even

Which can be several years for startups

Transcript

The third reason is to cover operating losses whenever the

company is not breaking even. That can happen in an ongoing
company when it has a bad month or year, or if it's a seasonal
business. For a startup company, it may take several years to
build up enough of a customer base for the company to be
profitable.
Debt vs. Equity - Slide 41

Debt vs. Equity Table

Debt Equity
Provided by Lenders Owners
Repayment Schedule Specified Indefinite
Investors' Risk- Moderate to
Little or none
Tolerance high
Participation in Can be very
Little or none
Management active
Principal and
Type of Return Expected Capital gain
interest
Cash flow from
Source of Repayment Liquidity event
profits
Transcript

Let's switch channels now to discuss the differences between

debt and equity financing. Debt comes from lenders. While
equity comes from shareholders, who are the real owners of the
business. Debt has to be paid back at a specific point in time and
on a specific schedule, while equity has no definite repayment
schedule. It may never be paid, or it could be paid back many
years from now, depending on how long it takes for the company
to be successful. Lenders have very little tolerance for risk. They
need to know that they're going to be repaid because the only
return on their investment they’ll get is the interest on the loan.
Equity investors can accept more risk because they have the
potential to get a much higher return if the company succeeds.
Lenders don't participant in the management of the business. If
your banker doesn't like the way you're running your business,
he or she has no alternative other than to call the loan. Equity
investors do participate in management. Even small
shareholders get to vote to elect the company's board of
directors, and that's who hires and fires the management team.
Large equity investors, like venture capital firms, may actually
have a seat on the board and the right to approve budgets and
management salaries. Lenders expect to get their principal and
interest repaid out of the company cash flow from profits over
time. Equity investors are shooting for a capital gain, a multiple
of their original investment that comes from a liquidity event.
More on this later.
Long-Term Assets (1 of 2) - Slide 42

Types of long-term assets

Real estate
Machinery & equipment
Office furniture and equipment
Vehicles
Intangible assets

Transcript

Let's circle back to how you want to finance the cash needs that
we discussed earlier. These are some of the long-term, fixed,
and intangible assets that your business may need to own.
Long-Term Assets (2 of 2) - Slide 43

Should be financed with long-term debt, so they can be paid for

over their useful lives, rather than all up front

Startup companies cannot demonstrate that they will have the

cash flow to repay the loan, so they will have to finance most of
these with equity

Transcript

If you need to own long-term assets, you'd like to be able to

finance them with long-term debt, so that you can pay for them
over the period of time that you're using them in your business.
The problem for startup companies is they can't demonstrate to
a lender with certainty that they have or ever will have the cash
flow necessary to repay the loan. Without some outside
guarantee, most startups will have to finance the long-term
assets they need with equity instead of debt.
Working Capital - Slide 44

Inventory: Must be sufficient to cover the time needed for

production/stocking.

Accounts receivable

Must be sufficient to cover the collection period (typically

longer than the payment terms)
Hard to avoid if competitors offer credit
Transcript

Working capital is mainly short-term assets, inventory and

accounts receivable in particular. As we discussed earlier, you'll
probably need to invest in these if you're selling a physical
product and you're giving your customers time to pay their bills.
The amount you have to finance must be sufficient for you to
cover the amount of time it takes for you to produce, stock, and
sell your inventory. And the time it takes for you to collect from
your customers. Note that your average collection period will not
necessarily be the same as the number of days that you give
your customers to pay. Collections are somewhat outside of your
control. They will pay when they will pay, and you can't force
them to pay on time. All you can do is stop selling more products
to them if they don't pay their bills on time. And it's hard to avoid
having accounts receivable if your competitors are offering
payment terms to the same customers that you're trying to
attract.

Financing Working Capital - Slide 45

Should be financed with short-term debt

Startups have not demonstrated that they can deliver products or
collect from customers, so this will have to be financed with
equity

Transcript

Ideally, you'd like to finance working capital with short-term debt,

perhaps a line of credit. But again, startups haven't
demonstrated that they can consistently deliver products or
collect from their customers, so most of the time startup
companies will have to finance their working capital with equity.

Incurred Operating Losses - Slide 46

Incurred whenever the company is operating below its break-

even point

Salaries
Professional services (legal, accounting, consultants, etc.)
All company overhead expenses
Transcript

And now let's talk about the third category, operating losses.
These are the costs of paying your administrative, sales and
marketing, research and development, and all other expenses
during the period of time when your company's sales are not
high enough for you to be breaking even.

Operating Losses - Slide 47

It could take several years for a startup company to break even

Operating losses must be financed with equity, as there is no

cash flow that can be used to repay a lender

Transcript

It could take several years for your startup to break even. So,
this could be a lot of money. Operating losses must be financed
with equity because there is no cash flow that could be used to
repay a lender, and there is no collateral that the lender could
take as a secondary source of repayment.
Debt vs. Equity - Slide 48

The slide contains the same Debt vs. Equity table presented in
Slide 41 - Debt vs. Equity with the last row emphasized.

Transcript

So, let's come back to our debt versus equity table. Let's focus
on the source of repayment. Lenders expect to be repaid out of
cashflow from the profits that your business is generating or will
generate in the future. Equity investors are fundamentally
different. They want to see a liquidity event. What does that
mean? It almost always involves the sale of the company. This
has big implications for you as your setting your goals as an
entrepreneur and your aspirations about the kind of future you
want to have for yourself in your company.
Implications for Fundraising - Slide 49

Startups will almost always require equity

Equity investors will become participants in managing the

company

Appointing the board of directors

Approving strategic decisions
Approving budgets
Approving future rounds of financing

Transcript

As we've discussed, startups will almost always require equity

capital if they need to raise outside capital at all. The investors
who provide that equity capital will be active participants in
managing the company with you. They'll probably have a seat on
your board of directors, which will be able to hire and fire the
company's management team. They'll also have a say in
strategic decisions like acquisitions, new financings, budgets and
spending plans, and the like.
Implications for Fundraising - Repaying Investors - Slide 50

Equity investors expect to be repaid in a future liquidity event

Usually a sale of the business

Entrepreneurs and the investors must agree on this
If not, the entrepreneur will have to try to grow the company
without raising outside capital

Transcript

There'll also be very focused on driving toward a liquidity event

so that they can get their return on their investment. And as I
said before, this probably involves a sale of the company. You
need to be on the same page if this is the case. If your goal is to
build a company that you'll manage for 20-30 years and maybe
even pass it on to your children after you're gone, then you
should not be trying to raise equity capital from outsiders. You'll
be better off trying to bootstrap the company, operating with few,
if any, investors and very few assets, at least until you've
reached the point where the business is profitable and able to
produce enough consistent cash flow to finance those assets on
its own. Or by raising debt financing from lenders.
Equity Financing Sources - Slide 51

Personal savings

Friends and family

Angel investors

Venture capital firms

Equity crowdfunders

Strategic partners

Transcript

Here's a list of the sources that startups generally turn to in order

to raise equity financing. They include the founder's personal
savings, friends and family members, angels, venture capitalists,
crowd funders, and strategic partners. In our next lesson, we're
going to focus on angel investors and venture capital firms.

References
1. Lucas, G. (1980). Yoda [digital image]. Star Wars: Episode V -
The Empire Strikes Back, Lucasfilm Ltd./Disney [1 ↩]