The document summarizes key points from a session on developing financial plans for a business. It discusses constructing pro forma financial statements, including income statements, balance sheets, cash flow statements and break even analysis. It covers assumptions for revenues, costs, and cash needs. Valuation of early stage companies and sources of funding such as angel investors are also summarized.

1. Welcome! Session 3 – July 20, 2004 Instructor - Kevin Hawley [email_address]

7. Building the Business Model Cost Projections Sales Projections Pro Forma Financial Statements Operating Plan Marketing Plan Financial Plan What will it cost to produce your product or service? What will it cost to sell any given amount of your product or service? How will your business make money? How much? For how long? Risks? Industry, Buyer & Competitor Analyses

8. Timing Example - Operations, Marketing, and Sales Interactions in the Financial Statements Operating Expenses Marketing Expenses Revenues (Sales) January February March April May June Fictional example for illustration purposes only! Sales Related Operating Expenses Fulfillment Related Operating Expenses

17. Gross Profit + Revenue - COGS = Gross Profit Margin (GPM) a/k/a Operating Profit = $ earned before overhead expenses

23. EXAMPLE: Startup Jewelry Distribution Business How much do they need? MONTH (82) (84) (80) (85) (73) (61) (53) (47) (38) (30) (22) (17) Cumulative (82) 2 (4) 5 (12) (12) (8) (6) (9) (8) (8) (5) (17) Cash Flow 220 40 42 33 19 19 11 9 9 8 8 5 17 Expend-itures 138 42 38 38 7 7 3 3 0 0 0 0 0 Revenue TOTALS 12 11 10 9 8 7 6 5 4 3 2 1 ($000)

29. - 10 Minute Break -

36. Venture Capital and Angel Investors Stage Primary Interest Control Level Assistance Provided Process Length Exit Timeline Where they Invest Later stage The Business Significant Control Executive Team Selection Financial Management 6 to 12 months 3 to 5 years Regional/National Early stage The Individual Support and Influence Hands-on Advisor Networking Help 2 to 4 months Up to 10 years Strictly local Venture Capital Firms Angel Investors Source: Ewing Marion Kauffman Foundation – www.emkf.org

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

38. Valuation of Pre-Start Companies Total amount of money raised Pre-start value of the company Amount of ownership (percentage) taken by Angel Investors Expected ROI in five years “ Real world” performance; how many Investments in start-up companies actually return between 10X and 30X? $250,000 to $1,000,000 (raised in total from multiple angel investors) $1,000,000 to $4,000,000 20% to 40% 30X return on investment About 10% The typical Angel Investor opportunity looks like this: Source: Ewing Marion Kauffman Foundation – www.emkf.org

39. Valuation Walk-through - Example 1 Total amount of money raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple* Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company * alternatively, does 1x revenue in Year 5 equal 30x investment? $250,000 5 $50,000 $7,500,000 (30X) $5,000,000 6 times earnings $30,000,000 25% $1,000,000 Here’s how a deal might be structured:

40. Where the Numbers Come From… Total amount of money needed/raised Total number of Angel Investors - Amount invested per Angel Investor Expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company $250,000 - Cash Flow Projections 5 - Based on avg. AI investment $50,000 - Specific AI profiles $7,500,000 (30X) – Roughly 100% ROI per year $5,000,000 - Income Statement 6 times earnings - Industry research $30,000,000 - multiply 25% - Projected 5-year value of the company divided by the AI’s expected 5-year return amount $1,000,000 - Amount of money raised divided by the AI’s required ownership percentage

41. Expected Return Depends on Time To Exit/Harvest… Expected 5-year return on initial $250,000 investment $7,500,000 (30X) Roughly 100% ROI per year End of Year 1 - $250,000 plus 100% return = $500,000 ( current value of investment) End of Year 2 - $500,000 plus 100% return = $1,000,000 End of Year 3 - $1,000,000 plus 100% return = $2,000,000 End of Year 4 - $2,000,000 plus 100% return = $4,000,000 End of Year 5 - $4,000,000 plus 100% return = $8,000,000 (32X) End of Year 6 - $8,000,000 plus 100% return = $16,000,000 End of Year 7 - $16,000,000 plus 100% return = $32,000,000 End of Year 8 - $32,000,000 plus 100% return = $64,000,000 End of Year 9 - $64,000,000 plus 100% return = $128,000,000 End of Year 10 - $128,000,000 plus 100% return = $256,000,000 And so on… every $1 invested 10 years ago turns into $1,024!!!

42. Valuation Walk-through - Example 2 Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company $250,000 5 $50,000 $7,500,000 (30X) $1,000,000 6 times earnings $6,000,000 125% -- Here’s an example of a “no go” for angel investors:

43. Valuation Walk-through - Example 3 Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company $1,000,000 40 $25,000 $30,000,000 (30X) $8,000,000 9 times earnings $72,000,000 41.67% $2,400,000 Can you find the potential problem in this example?

44. Valuation Walk-through - Example 4 Total amount of money needed Total number of Angel Investors - Amount invested per Angel Investor Total expected 5-year return on investment Pro forma 5-year EBITDA estimate Valuation (comparable) multiple Projected 5-year value of company Ownership percentage required by Angel Investors at five-year exit horizon Current (pre-money) valuation of company $300,000 4 $75,000 $9,000,000 (30X) $15,000,000 5 times earnings $75,000,000 12% $2,500,000 Can you find the potential problem in this example?

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