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Entrepreneurial Advisory

We advise entrepreneurs on

  • Life cycle and funding options
  • Business plan - purpose, elements
  • New venture strategy - Product, overall management strategy, financing strategy
  • Financial planning
  • Valuation methodology - VC and Entrepreneur
  • Funding options (warrants, converts)
  • Harvesting / Exit - Pros and cons of going public
  • Professional venture cycle
  • Cost of capital
  • Risk management
  • Assess if VC's add value.
What are the issues that Entrepreneurs are facing? How to be very sure of the reasons why you are going into your own business and realise the very reasons for doing so may not come to fruition straight away.
What are key Factors for Entrepreneurs?
Emotional stability is important as sometimes the roller coaster ride of an entrepreneur requires someone that can keep an emotional “even keel” to ensure that they can recover from the many setbacks that invariably will occur and also settle down from the high points to an operational level once again very quickly. What level and type of risk keep you awake at night? If entrepreneurial risk is one of those, then maybe being an entrepreneur is not your strong suit. There is SO MUCH uncertainty that it could drive an insecure, unmotivated person insane. Do your research and change “risk”: into a “calculated decision”
 
What could go wrong if I don’t understand cashflow vs. profit? Do I understand that they are very different animals? After careful consideration of your proposed venture, if the risks of serious downside are too great then do not proceed. You will need professional advice to review these options.
 
For the first year or two it is highly likely that your cash remuneration will be materially lower than your current situation. If this is a problem you must take steps before it happens. Your equity upside will take some time to forge upward momentum. Remember that the statistics on business failures are sobering. There is never enough money.

Tips for Entrepreneurs

  • Relationships suffer so make sure these are on good ground before you begin your venture.
  • Surround yourself with the right people.
  • Don’t get emotional – know when to cut your losses!!
  • Do not burn your bridges.
  • Have a plan B in case everything goes “South”.
  • Any work related benefits, or the loss thereof, need to be carefully analysed – extra superannuation, health plan, corporate car, group insurance, annual leave, long service leave, etc.
  • It’s not the glamorous existence that everybody believes it is.
  • Persistence builds resilience.
  • You need a strong resolve and a lot of personal fortitude to meet adversity head on.
  • Stay on top of the business obligations – PAYG withholdings, GST, Superannuation, etc.
  • Take some “Cash off the Table”.
  • Exit strategies – do you have one? 
Entrepreneurs and value 
  • Small companies have no access to markets, may seek investments by superfunds and VCs.  Impact of limited access to the financial markets on firm growth and valuation.  Concentrated ownership and non-diversifiable risk. Less liquidity means investors want to be compensated more, higher weighted average cost of capital (WACC).  How does this impact on the cost of equity capital and the investment value of the enterprise? How do you effectively communicate what you are worth? Define your cost of capital, as the risk free rate does not apply, and the market risk is not a benchmark as there is no diversification in a single asset
  • What can be done to ameliorate the situation? Managerial involvement of outside investors.  Is this a good thing? Why or why not?
  • Informational asymmetry and capital raising.  How can this be overcome?
  • Harvesting to realise value 
Sequence of New Venture Financing:
  • Seed financing
  • Development
  • Start-up
  • Early growth
  • Pre-IPO
  • Describe the need for financing to cover the various stages of a new venture being organised to develop, manufacture and market
Sources of Financing
 
Sources of Financing
 

Love Money

  • Self— house, credit cards, savings, bootstrapping
  • Family & friends

From the Business Itself

  • Trade credit from suppliers
  • Asset-Backed — including ST assets (receivables) and L T assets (mortgages) Pull capital back from mortgages which is generally a lower cost of funds. Factor receivables, discount them immediately to provide cashflow.
  • Vendor financining– set as much as possible 

From Government

  • Small business development grants and loans
  • (including soft loans with longer terms and without
  • personal guarantees)
  • In-kind support (advice, incubators, product
  • promotion/advertising, trade missions)
  • Export financing (export market development grants, working capital guarantee programs)

From Lenders

  • Straight loans (operating lines of credit; term 
  • loans; mortgages)
  • Leases (sale and leaseback; operating, financial)

From Outside Investors

  • Angel financing (who they are, finding angels,
  • working closely with angels). 
  • Active private investors
  • Early winners ($10-$25m)
  • Professional investors – lawyers, accountants, bankers, etc.  They talk in multiples of capital return (e.g. “10 x bagger”). Under-pricing leads to losses. 
  • Venture capital (availability, cost, scale factors). These are Institutional investors. Superannuation funds participate in about 2% of deals
  • IPOs (availability, cost, likelihood) 
Startups and Venture Capital
 
What is Venture Capital? Venture capital (VC) is financial capital raised to invest into promising high growth start-up businesses. The structure of the deal can vary significantly with a mixture of debt securities or equity regularly used.
 
What do Venture Capitalists look for? In simplistic terms, the VC is typically looking for equity in the business and the venture capital fund makes its money from the capital gain of the equity value when the business is sold.
 
Venture capital is typically provided as growth funding for the expansion stage of a business and would typically come after early seed funding or angel investor funding rounds. Will your start-up be successful? Only extremely high growth potential start-ups will successfully access venture capital. It’s typical for VCs to invest in only 1 out of every 100 opportunities they see. In addition to just providing financial capital, the VCs themselves will often have deep knowledge and connections within their industry and will often take on advisory and directorship positions within the start-ups they invest in. 
 
Why should you use INKOM to reach your capital raising goals? Capital raising is an extensive process that can easily distract management’s attention from more important matters. Therefore a poorly planned capital raising process can cause a company’s performance to decline considerably and significant losses to be incurred. Therefore the introduction of a professional external capital solution at this delicate stage of business can be a strategic “saviour”.
 

The Deal

  • Allocates risk and returns and defines other rights and obligations between entrepreneur and outside investor
  • Term sheet setting out agreed valuation and sets out amount of investment, ownership claims, other principal conditions
  • Pre-money and post-money valuations
  • Representations and warranties, covenants
  • What factors are likely to govern the success of a new venture financing deal?
  • The Deal described who carries the risk, what share goes over, what happens if no success and dilution.
  • Convertible- we have assets after creditors and upside
  • How will it be paid out? What is the rate?
  • Rights- who sits on the board, who may veto, etc
  • Covenants – restrictions, limits, ratios, etc
  • Simplicity, robust, no deviations from projections. Must have incentives for all parties. Avoids future capital difficulties.
  • Valuation – is your stake in the company determined pre investment or post investment of capital injection? – it is only a very subtle difference but one that will have a material impact on your equity stake
  • Liquidation preference & Types of Share Capital – are you willing to forgo some rights as a shareholder to receive preferential distribution in the result of a return of capital? If preservation of capital is more important than voting and other rights then a strong consideration should be given to this matter
  • Pro rata rights – do your shares have the right to participate in further funding rounds from a preferential position. Many investors believe that since they had faith in the business form the initial stages that they should be preferentially entitled to other offerings that come along. It also is a valuable strategy to combat “equity dilution”
  • Options pool – important from several standpoints. Is it sufficient to attract and retain the right people in the business? The size of the option pool is important because they usually are exercised on a significant discount they can also cause a dilution in equity for the current stakeholders
  • Founder vesting – Very important considerations for those on both sides of the fence. How do you fairly treat the stock of founders and their rights as opposed to those remaining with the company and showing commitment to it. This subject is far too broad to warrant detailed discussion here so we are flagging it as an area that is important for any start-up business with significant non founder money invested
  • Anti-dilution – another broad topic but very important where a fluctuating share price is concerned. Will your equity position be protected if numerous further funding rounds are conducted at lower valuations that the initial rounds. This is a trap for the unwary.
  • Information rights – the dissemination of information in regards to unlisted entities is always an important issue. It needs to be well established what types of reporting will occur and how often the results are communicated to stakeholders
  • Caution - Obtain legal and financial advice not to give away value   

Seed startup finance

Funds required to initiate the production process to then enable the firm to generate revenues. The primary requirement of funds is towards initial capital expenditure and operating outlays. Seed financing is generally targeted towards ventures that already have a business plan and management team in place and is only in requirement of funds to initiate business. Apart from an entrepreneurs personal funds, funding can also be sourced from Angel investors and VC's.
 
Angel investors are generally wealthy individuals who have past experience in the industry as well as the relevant capital to aid in the growth of the business. Angel funding is not as formal as VC funding.
 
Survival — First round finance
 
The survival stage in a venture's life cycle is the most critical stage as it is at this point when a firm decides if it is too continue its operations or shut shop. At this juncture, a firm has started to generate revenues but expenses generally are in excess. First round financing is funding required to bring a venture to its full operating potential. This round of financing is more formal and structured in nature.
Sources of finance: Venture cap; Business revenues; Suppliers (credit periods); Customers (Advance payments); Banks; Government grants and subsidies.
 
Rapid Growth — Second round finance
 
Firm's growth and increasing revenues call for additional capital expenditure to meet business requirements. Apart from capital expenditure a firm's increased order book also translates to increased working capital requirements such as inventory etc. Funding sources are: Commercial banks, investment banks, additional VC funding, revenues from business. Firms may also look at the IPO option.
 
Maturity — IPO
 
This is where the firm calls for large scale investments. Funding could take the form of long term debt; bonds, equity, preferred equity, debt with warrants etcetera.
 
 
Business Plan
 
A business plan is a document that clearly defines and states the objectives of a new venture apart from containing all necessary information on both internal and external elements that aid / hinder the venture from achieving its objectives.
 
The important sections of a business plan are:
  • Executive summary
  • Overall objective of the venture
  • Product description and background
  • Market analysis
  • SWOT
  • PESTLE
  • Porter's 5 forces
  • Overall business model and strategy
  • Operations
  • Marketing plans
  • Management
  • Financial information
  • Forecasted financials for 5 years
  • Funding requirements
  • Investments so far.
  • Conclusion
 
A business plan is critical to ensure the success of a new venture. The benefits of a business plan are:
  • It acts as a yard stick to the entrepreneur to ensure that the plans and procedures as laid out are in line with the firms overall objectives.
  • To communicates the venture's objectives to potential partners.
  • It acts as a financing tool as it communicates the profitability of the firm and the amount and periodicity of funds required.
  • Apart from the objectives of a firm, the business plan must ensure that the firm works towards generation of:
  • Revenue
  • Profit
  • Free cash flow to equity
 
Financial Planning for startups
 
Financial planning is the process behind the assessment of the current and future funding needs of the venture. The planning procedure stems out of the business plan and the firms overall objectives and marketing strategy. Steps in the financial planning process for startups:
 
  • Assessment of the firms objective and relative financial requirements
  • Plot revenue growth over the next 5 years
  • Assessment of the venture's financial drivers
  • Preparation of a pro forma set of financials for the next 5 years
  • The financials must include the amount of profit that would be ploughed back as retained earnings.
  • Basis the projected financials, plot the funding requirements — i.e details of external funding that may be required.
  • Risk assessment
 
The cash flow cycle:
  • Cash received from sources of funding
  • Cash converted into raw materials and working capital
  • Production process
  • Build up of inventory
  • Sale of inventory
  • Cash received from customers
  • Cash payments to suppliers
  • Balance of cash retained in business cycle
 
 
Valuation of a firm
 
Valuation of a firm
 
The valuation of a firm is a process whereby the entrepreneur or a potential investor asses the firm relative to the current market environment, the firms projected growth statements and subsequent financing requirements.
 
The valuation process can be looked at from four perspectives:
  • The entrepreneur
  • A potential partner
  • A potential investor
  • An existing investor
 
Entrepreneur: The valuation of a firm is essential as it gives him / her an idea as to the actual value of the firm relative to investments made so far and actual performance. A valuation also gives the entrepreneur an idea as to the potential amount of investment that may be required to ensure a sustainable growth of the company. If a valuation is not done, the entrepreneur would not be in a position to know how much is to be expected from future investors and partners.
 
Potential partner: Prior to investing in a venture, it is essential for the partner to understand the stakes at hand. This can only be done by reviewing the business plan and subsequently its financial position relative to the business plan.
 
Potential Investor: If a VC firm or any investor is to invest capital into an enterprise, it is essential that the investor value the firm to asses both the pre money as well as the post money value of the entity. A valuation would provide an accurate assessment of the amount of funds being asked for vies-a-vie the actual funding requirements. Apart from an assessment of current value it also provides a potential owner an understanding of the performance of the firm till date as well as possible future returns that may arise out of an investment.
 
Existing investor: Valuation may be looked at either from the perspective of exiting or the business or to bring in additional capital. Should an existing investor seek to exit the business, a valuation generates the current standing of the business hence it also shows the investor how much the original capital investment is now worth.
 
 
Valuation methods
 
 
The primary methods used in evaluating a firm are:
  • Discounted cash flow
  • Multiples
  • First Chicago - apart from the pure financial valuation, VC's also use the First Chicago method where three possible business scenarios are created and the firm is run through each scenario to arrive at a possible outcome of the investment. The three scenarios under the First Chicago method are:
    • Black hole
    • Living Dead
    • Utopia
A standard probability matrix is employed to arrive at the possible outcome of the investment.
Apart from the pure financial valuation techniques, investors also decide on an investment basis a number of qualitative factors such as interview with key personnel, business plan and market conditions and SWOT analysis.
 
VC's also use a scoring matrix called a VOS (venture opportunity score) which rates a venture across 4 verticals and finally classifies it as either High, average or low. A venture that returns a score >2.33 is classified as a high. 
 
Events that can impact valuation:
  • Performance below expectation
  • Performance or prospects being significantly below or above expectations
  • Business substantially and consistently behind or ahead of plan
  • Business has met or missed its milestones such as clinical trials, technical developments, divisions becoming cash positive, or restructurings being completed
  • Deterioration or improvement in level of budgeted performance
  • Whether business has breached any banking covenants, defaulted on any obligations
  • Existence of off-balance sheet items, contingent liabilities and guarantees
  • Existence of a major lawsuit
  • Evidence of fraud
  • Disputes over commercial matters such as intellectual property rights
  • Existence of fraud
  • Change in management or strategic direction of business
  • Significant adverse or favourable change in company's business in technical, market, economic, legal or regulatory environment
  • Significant changes in market conditions (indicated by movement in share price of same sector businesses)
  • Underlying business is raising money and there is evidence that the financing will be made under conditions different from those prevailing at the time of the previous round of financing 
Funding options
  • Primary funding options are:
  • Debt
  • Equity
 
Debt or Equity?
 
Australian companies typically derive their business funding from a broad range of sources. In addition to equity capitals, debt issues and/or business loans typically form an integral part of operational funding. In Australia, non-financial entities typically have a 50:50 equity (listed and unlisted) and debt/loans split.
 
INKOM can advise on capital management issues including the capital structure question of Debt vs. Equity and provide access to both including hybrid instruments. With our strategic partners we can facilitate the debt facilities with a wide range of debt providers.
 
Debt
 
Funding via debt usually pertains to long term debt funding from VC, commercial banks or non finance institutions. Debt funding from banks and financial institutions is largely dependent on the credit worthiness and analysis of the borrower. The 5 C's that characterize credit worthiness are:
  • Capital required
  • Capacity to repay
  • Collateral offered
  • Conditions of loan
  • Character and market reputation of borrower
 
At times debt funding from venture capitalists, typically in the form of convertible notes, are accompanied with sweeteners such as warrants and call options. A call option is a right that can be exercised to buy certain asset(s) at a specified price. If the assets are the company's' stock, existing stock is sold to the party in question.
 
Warrants are call options where, if utilized, the debt provider is issued fresh equity at a certain pre-defined price. The disadvantage of this method is that it dilutes the stakes of other equity holders.
 
Equity
  • Common stock
  • Preferred stock
  • Convertible debt
 Harvesting and Exit strategies
 
 

Harvesting and Exit strategies

Options available for an investor to exit a firm are:
  • Systematic Liquidation
  • Outright sale
    • Mergers and Acquisitions
    • MBO
    • Sale to founding family
    • Sale to employees
  • IPO 
     

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