Basics of Startup Financial Planning

FINANCIAL PLANNING FOR STARTUPS

Tom Schryver, CFA Visi3ng Lecturer, Johnson Graduate School of Management

Execu3ve Director, Center for Regional Economic Advancement Cornell University

Why Create a Financial Plan?

•  Know when you’re running out of money •  Know how much money you need •  Enable you to describe your vision

–  To partners –  To employees –  To funders

© Tom Schryver 2014, All Rights Reserved

Why Pitch a Startup?


Why Pitch a Startup?

à Generate interest in the next conversa3on

•  Very very very rarely will anyone write a check based solely on a pitch

•  Uninformed investors are dangerous •  Tom’s rule of investors: they all add value, the ques3on is the +/-‐

sign


Financials In A Pitch – Audience View

•  Does the company have a good understanding of its poten3al market?

•  Does the company have a sense of how much of that market is obtainable? Are poten3al unit sales reasonable?

•  Are sales prices reasonable? Is there any evidence to back them up?

•  Are projected costs complete and reasonable? •  How much money will be required to start the business? •  How much money will be required to get the company to self-‐

sustainability? •  How profitable could the company be at maturity?


Financials In A Pitch – Ideas of What To Include

You choose what you think investors should be most interested in / know about / have as main takeaways about the opportunity: •  Details on target market: size, basis of es3ma3on, es3mate

on how much is obtainable by you •  Es3mate of startup costs with details on major items •  Projec3on of 3me to ramp up to cash flow breakeven and

total startup + losses to breakeven •  Projec3on of profitability at scale


Showing Returns To Investors

•  If you are pursuing a loan, demonstra3ng ability to service payments with a safety margin is cri3cal

•  If you are pursuing an equity investment, demonstra3ng ability to exceed required cost of capital is cri3cal

My opinion: •  Defining a poten3al exit is very difficult; only volunteer it if an exit is the

only way an investor can get their money returned (no possibility of dividends)

•  Calcula3ng an IRR or NPV on investment is not your job – it’s the investor’s: give them the informa3on they need around profit poten3al and allow them to do their assessment themselves


Financials In A Pitch – What To Avoid

•  $Trillion markets •  Magical thinking:

–  Unreasonably high net income margins (sofware and pharma rarely exceed 30%)

–  Revenue growing while other costs remain flat-‐line –  Revenue growth without marke3ng expense –  Free labor, free space, no insurance costs, etc. –  Ignoring 3ming impacts of acquiring inventory or capital items before revenue

•  Showing loan proceeds without interest expense or repayment •  Providing excessive detail that demonstrates lack of focus on key

performance indicators


Key Building Blocks

•  Revenue Model •  Key Resources •  Cost Model


Revenue Model -‐ Es3ma3on


Month 0 Month N

Units Zero Reasonable share of

TM (total? per loca3on / store?)

Price / Unit N/A Validated Price

Revenue Zero Units * Price = Revenue

Revenue Model -‐ Details


•  Experiment with reasonable growth rates •  Es3mate number of months to get to “N” •  Compartmentalize by product line, loca3on, store, etc. as

much as possible •  Must stack up to a reasonable share of reasonable market

Key Resources

•  What do our value proposi3ons require to happen? •  How do we support our channels? •  Do we need resources to have the customer rela3onships we

want? •  How about suppor3ng our revenue streams?


Key Resources are all the things required to open your business

Key Resources -‐ Types

•  Physical – buildings, cash registers, phones, trucks, etc. •  Intellectual – patents, databases, process knowledge •  Human – salespeople, customer service reps, store managers,

produc3on staff, R&D •  Financial – funds to pre-‐buy inventory, vendor financing


Key Resources -‐ Examples

•  Physical – Dean & Deluca store; FedEx trucks •  Intellectual – drug patent; process knowledge on how to

make beer •  Human – people to fill and cap toothpaste tubes; picking

orders and packaging goods for shipment; people to answer the phone

•  Financial – money to buy the product that will be sold in the store, or to buy raw materials to be made into finished goods; funds to cover gap between sending an invoice and receiving payment; vendor lease


Key Resources -‐ Es3ma3on


Month -‐N Month 0

Building

Equipment

Patents

Beginning Inventory

Etc.

Key Resources

•  What key resources will be required? •  What are a few hidden things that might otherwise get

forgoren? •  How much will it cost to get these in place?


Cost Model

•  What will your costs be when you are up and running? •  How will those costs change as you grow? •  What risks are inherent in your cost assump3ons?


Cost Types

•  Fixed costs – remain the same (mostly) regardless of volume •  Variable costs – vary propor3onally based on how many you

make

Consider: •  Economies of scale – savings as you grow in volume •  Economies of scope – savings as you grow in breadth


Fixed Costs

•  Management and overhead compensa3on •  Buildings •  Machinery •  Permits and licenses


Variable Costs

•  Direct labor •  Raw materials •  Shipping •  U3li3es


Economies of Scale

•  Buying in bulk •  Shipping in larger volumes •  More efficient use of machinery •  More efficient use of labor (ie: specializa3on)


Economies of Scope

•  One store selling many products •  Mul3ple value proposi3ons for a single customer •  Mul3ple revenue streams from the same transac3on (product

+ extended warranty)


Categorizing Expenses by Type: COGS

•  Cost of Goods Sold (COGS) are the direct costs associated with providing the product or service. Examples: –  Direct labor –  Raw materials –  Warehousing –  Produc3on equipment

•  Revenue – COGS = Gross Profit


Categorizing Expenses by Type: SG&A

•  Selling, General and Administra3ve expenses (SG&A) are the indirect costs associated with opera3ng a business. Examples: –  Adver3sing –  Sales salaries and commissions –  Management salaries –  Fringe benefits –  Office rents –  Insurance

•  Revenue – COGS = Gross Profit •  Gross Profit – SG&A = Opera3ng Profit


Categorizing Expenses by Type: Non-‐Opera3ng

•  Non-‐Opera3ng Expenses are business costs that do not impact regular opera3ons. Examples: –  Interest –  Income taxes –  One-‐3me revenues and expenses (ie asset sales) –  Foreign exchange gain / loss

•  Revenue – COGS = Gross Profit •  Gross Profit – SG&A = Opera3ng Profit •  Opera3ng Profit – Non-‐Opera3ng Expenses = Net Income


Expense Checklist


q  Rent q  Furnishings q  Computers

q  Sofware! q  U3li3es

q  Electric q  Internet

q  Payroll q  Payroll taxes q  Workman’s comp q  Unemployment

insurance q  Gen. liab. Insurance q  Key man Insurance q  Banking and Credit Card

fees q  Patent fees

q  Professional services q  Cleaning services q  Lawn care q  Lawyers q  Accountant q  Bookkeeper q  Recrui3ng q  Other freelance

q  Marke3ng expenses q  Web development q  Print q  Conferences q  Memberships q  Ads q  trademarks q  Other

q  Travel q  Discounts

q  Sales taxes q  Shipping

q  Customs q  Supplies

q  Toner! q  Misc

q  Repairs and Maintenance q  Facili3es q  Equipment

q  Licenses q  Royal3es

Use this as a guide and apply the level of detail that matches your business

Cost Model -‐ Es3ma3on


Month 1 Month N

Raw Material / Unit Costs at Low Volume Costs at Full Volume

Labor Divide total by units / mo Divide total by units / mo

Produc3on Equipment Divide total by units / mo Divide total by units / mo

Total COGS / Unit

Adver3sing Startup Run-‐Rate

Other SG&A Startup Run-‐Rate

Non-‐Opera3ng Expenses

Cost Model -‐ Es3ma3on

•  Start to link revenue growth with costs •  Keep in mind 3ming of costs compared to revenues! •  Use unit growth to drive breakpoints in cost decreases as you get to scale


Building Your Cash Basis Financial Model


Startup Costs: Acquire Key Resources

Revenue: Units * Price

Cost of Goods Sold: Units * COGS / Unit

Selling, General, Administra3ve

Non-‐Opera3ng Expenses (Including Costs of Financing!)

Net Income (Cash Basis)

Pre-‐Revenue Startup Growth Profitable Maturity

Source of Cash: Investments

PLUG N’

CHUG

“I have no idea what the poten3al financial performance of my business is”

>

“I don’t know what these numbers signify, there’s lirle thinking behind them – I just have

them because I was told I have to” “I don’t know what this model does – I just filled

out someone else’s form”

Cash vs. Accrual Method: When To Go Accrual


•  Do you have significant 3ming risks? •  Inventory •  Holding other peoples’ money •  Other people holding your money •  High upfront capex

Hypothesis Tes3ng


Fundamental principles: •  The financial plan you just created is made up of a large number of

hypotheses •  It is cri3cal to maintain your plan as a living document to reflect new

knowledge •  Your financial plan should help you iden3fy key areas of risk – which is

made up of: 1.  Areas of high magnitude: large profit drivers, big capital expenses 2.  Areas of high uncertainty: shaky es3mates, factors with a large number of

con3ngencies

What Do You Do About It?


•  If an item is substan3al and you are es3ma3ng, dig to ensure no cheap / free informa3on is available that could help you refine

•  Treat revenue model, key resources, and cost model as areas of testable hypotheses

•  Iden3fy key data, test, and measure

What to Present


•  How much will it cost to get started – and how long •  How long will it take you to become self-‐sustaining •  What does the sunny, happy future look like (how profitable)

•  Choose metrics and graphs based on industry norms

Q&A


Basics of Startup Financial Planning

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