exam 2 content foundations of entrepreneurship fall 2012

Exam 2 Content

Foundations of Entrepreneurship

Fall 2012

Chapter 6

Building the Founding Team

The biggest challenge

“There’s plenty of entrepreneurs, plenty of venture capital. What’s in short supply is great teams. Your biggest challenge will be building a great team.”

John Doerr – Partner, Kleiner, Perkins, Caulfield, & Byers (kpcb.com)

http://www.kpcb.com/

Anchoring vision in team philosophy and attitudes

• The most successful entrepreneurs seem to anchor their vision of the future in certain entrepreneurial philosophies and attitudes:– What a team is– What its mission is– How it will be rewarded

• Unwritten ground rules, rewards, compensation, and incentive structures rest o these philosophy and attitudes

Anchoring vision in team philosophy and attitudes

“The capacity of the lead entrepreneur to craft a vision, and then to lead, inspire, persuade, and cajole key people to sign up for an deliver the dream makes an enormous difference between success and failure.”

Jeffrey Timmons

Extended network

Capacity for innovation

Moral support

Higher social level of support

Increased skill set

Feedback

Way To

Success

Advantages of having a team for a start-up

Things to keep in mind when creating a start-up

Evaluate your skills

Use your strengths

Ask for feedback of your actions

Building a powerful team

Create a staffing plan

Find people to fill positions

Your personal network

Your advisors’ Network

Your extended Network

FriendsFamily

ProfessorsAlums

Attributes of successful teams

• Cohesion – “We’re in this together”• Teamwork – make others’ job easier; no

individual heroes• Integrity – hard choices and trade-offs based on

what is good for the customer• Commitment to the long haul – no one benefits

by signing up now and bailing out early• Harvest mind-set – capital gain is the goal, not a

paycheck

Attributes of successful teams

• Commitment to value creation – making the pie bigger for everyone

• Equal inequality – democracy does not work well in start-ups (more on next slide)

• Fairness – rewards are based on contribution, performance, and results over time

• Sharing of the harvest – 10 – 20% of “winnings” is frequently set aside to distribute to key employees; characteristic of the most successful entrepreneurs

Equal inequality

• Company A - 4 employees

• 34% to president, 23 % each for marketing and technical VPs, 6% for controller

Equity distribution, Company A

34

23

23

6

Pres ident VP Mktg VP Tech Control ler

Equal inequality

• Company B – 7 employees

• 22% to president, 15% each for four VPs, 9% each to two other contributors

Equity Distribution, Company B

22

15

1515

15

9 9

President VP1 VP2 VP3 VP4 Other Other

Filling the gaps

• “Successful entrepreneurs search for people and form and build a team based on what the opportunity requires, and when.”*

• Team members contribute high value when they complement and balance the lead entrepreneur and each other

• The process of evaluating and deciding who is needed, and when, is dynamic and not a one-time event

* Timmons, 1975

Filling the gaps

• The founder

• Every team starts with the founder (aka, the lead entrepreneur)

• Founder determines whether team is needed, assesses talent, skills, track record, and contacts of possible members

• Founder needs to determine what the venture requires in order to succeed

Filling the gaps

• The opportunity• Whatever the team needs are depends on the fit

between the lead entrepreneur and the opportunity

• Entrepreneur must clearly define:– the value added and logic of business model

(revenues and costs)– Critical success factors – Extent to which s/he has access to critical resources

and relationships

Filling the gaps

• Outside resources• Gaps can be filled by external resources:• Boards of directors, accountants, lawyers,

consultants, etc.• Entrepreneur must consider:

– Whether need is specialized, one-time or part-time or a critical continuous need

– What trade secrets might be compromised if external expertise is used

External Team Members

Board of Directors

Board of Advisors

Accountants

Lawyers

Outside Investors

Virtual team

Do Nots of double employment• Do not use your employer’s resources

• Do not expropriate intellectual property from your current employer

• Do not solicit your employer’s customers until you quit the job

• Do not conceal the fact that you are founding your own venture

Compensation name Advantages Disadvantages

Founder Shares Attracts co-founders Dilutes owner’s equity

Option pool Ties employees’ goals to those of the company

Employees may leave the company if the price falls

Restricted stock Vested over time, expensed at current share price

Expensed at current price

Stock appreciation rights Low cost to the company Dilutes owner’s equity

Phantom stock Employees do not receive equity

Needs cash to be exercised

Types of Compensation

Problems that new venture teams face

Family Pressure

InterpersonalConflicts

Burn-out

Slicing the founder’s pie

• Making the pie as big as possible is the primary consideration

• The ultimate goal of any VC-backed firm is to realize a 5x to 10x ROI, usually via IPO or acquisition by larger company

• “Work backwards” from IPO capital structure to determine what will happen and who will get what

Chapter 8

Building Your Pro Forma Financial Statements

Underestimating time to secure

financing

Underestimating time to secure

financingTop-down versus

bottom-up forecasting

Top-down versus

bottom-up forecasting

Lack of comparables

Lack of comparables

Underestimating time to generate

revenues

Underestimating time to generate

revenues

Underestimating costs

Underestimating costs

Not understanding the revenue

drivers

Not understanding the revenue

drivers

Reducedsurvivalchance

Reducedsurvivalchance

Common mistakes entrepreneurs make

FinancialStatements

IncomeStatement

BalanceSheet

StatementOf

Cash Flows

Building Integrated Financial Statements

BUILDING YOUR PRO FORMA FINANCIAL STATEMENTS

Build-up Method

Comparable Method

Final Steps

BUILD-UP METHOD

Revenue Projections

COGS

Operating Expenses

Revenue Worksheet

COGS Worksheet

Operating Expense Worksheet

Preliminary Income Statement

COMPARABLE METHOD

Choose industry metrics

Compare your projections to othercompanies and industry average

Benchmark other companies in the industry

BUILDING INTEGRATED FINANCIAL STATEMENTS

INTEGRATED FINANCIAL STATEMENTS

Income Statement Balance SheetStatement of Cash Flows

Monthly forecastsfor years 1 and 2

Adjust monthly forecasts according to seasonality

Annual forecasts for years 3-5

Consider Accounts Receivable

Show outflow anddepreciate PP&E

ConsiderAccounts Payable

Focus on major infusions of cash

describe the nature of your

accounts receivables and payables

Mention PP&E expenses

PUTTING IT ALL TOGETHER

2-3 page explanation of your Financial Spreadsheets

Talk about revenue drivers

Talk about seasonality

Discuss the expense categories

Focus on major infusions of cash

Describe the nature of your cash flows

Accounts receivables and payables

Mention PP&E expenses

Talk about major asset categories, and any Liabilities that aren’t clear from the previous discussion

Discuss the Income Statement

Discuss the CashFlow Statement

Discuss theBalance Sheet

The Business Plan

Why write a business plan?

• Always when a new venture needs outside funding

• Early in the planning process when you are looking at a large-scale project

• Later or not at all when you are bootstrapping

Dollinger, 2008

Costs and benefits of planning

• Writing a plan takes considerable time, money, and energy

• Every plan deals with economic uncertainty and risks posed to new venture – founders may be uncomfortable confronting risks and uncertainties and avoid writing a plan

• Writing the plan helps founders confront risks and conflicts before they become serious problems

Dollinger, 2008

The plan demonstrates how you

1. Create or add significant value to a customer or end user

2. Solve a significant problem or meet a significant need for which someone is willing to pay a premium

3. Have robust market, margin, and money-making characteristics

4. Have a good fit with the founders, management team at time of market entry, and the risk/reward balance

Timmons, 1999

After you write the plan

• It becomes a point of departure for due diligence for potential investors and to determine risks of venture (technology, market, management, competitive, financial risks)

• This homework is crucial even if you don’t try to raise outside capital

• The most valuable investors will see weaknesses, even flaws, and will propose tactics and people to fix them

Timmons, 1999

Tips for business planning and raising outside funds

RE: Venture capitalists•There are a lot of them; don’t talk to all of them•Getting a “no” is as difficult as getting a “yes;” qualify your targets and force others to say no•Be vague about which other VCs you are talking to•Do not meet with an associate or junior member twice without a partner

Timmons, 1999


RE: The plan•Stress your business concept in the executive summary•The numbers matter less than the economics (value proposition and business model)•Make the business plan look and feel good w/o using “filler”•Be prepared to provide copies of published articles, contracts, market studies, purchase orders, resumes, etc.

Timmons, 1999


RE: The Deal

•Make sure investors want you as bad as you want them

•Create a market for your venture

•Never say no to an offer price

•Use a lawyer with venture deal experience

•Don’t stop selling until the money is in the bank

Timmons, 1999


RE: The fund raising process

•It is much harder than you ever thought it would be

•You can last much longer than you ever thought you would

•The venture capitalists have to do this the rest of their careers

Timmons, 1999

Critiquing the plan – General criteria

• Comprehensiveness – use a template to help

• Analysis – resource, industry, competitor and product analysis; financial projections with percentages, returns, and comparisons with analogs

• Reasonableness – assumptions are comparable to benchmarks and facts

• Writing and presentation – well written and organized

Dollinger, 2008

Critiquing the plan – Specific criteria

• Management – experience, honesty, integrity

• Resources – rare, valuable, hard to copy, unique

• Projections and returns – all data must have solid foundation in reality, yet optimistic enough to attract investors

• Exit – how and when will investors recoup money?

Dollinger, 2008

Level 4Product/ svc fully developedMany users, established mkt

4/1 4/2 4/3 4/4

Level 3Product / svc fully developedFew users, mkt assumed

3/1 3/2 3/3 3/4

Level 2Product / svc pilot operable, not developed for production, mkt assumed

2/1 2/2 2/3 2/4

Level 1Product / svc idea but not operable, mkt assumed

1/1 1/2 1/3 1/4

EvaluationSystem

Level 1Single would-be entrep

Level 22 founders,

Level 3Partly staffed mgt team,

Level 4Fully staffed, experienced mgt team

Product / svc level

Management status and experience levels

Writing and editing the plan

• Steps: Prewriting, writing and rewriting/editing, editing – despite importance of good writing:

Research on 20 business plans in a competition:• 30% didn’t include specific strategy• 40% of teams had no marketing experience• 55% failed to discuss technical idea protection• 75% failed to identify details of competitor• 10% had no financial projections; 15% omitted

balance sheets; 80% failed to provide adequate details of the financial projections

Dollinger, 2008

Exercises

1. Draft an outline of your business plan– What information do you already have? – What information is still required? How will you get it?

2. Prepare as much of the executive summary as you can. Be concise and informative

3. Critique a business plan– How well does the plan address key issues?– What changes and improvements would you make to

the plan?– How well done is the presentation and writing?– Would you invest in this business? Why or why not?

Dollinger, 2008

Chapter 10

Raising Money for Starting and Growing Businesses

Ways of raising moneyTurning to family

and friendsApproaching

business angels

Going Public

Being Acquired

Looking for Venture Capital

Four basic ways of evaluating a business

Earning-capitalization valuation

Present value of future cash flows

Market-comparable valuation

Asset-based valuation

Earnings Capitalization Method:

Company value = Net Income/ Capitalization Rate

Present Value of Future Cash Flows:

PV = PV of the future free CF + the residual (terminal) value of the firm

Market-comparable Valuation (Multiple of earnings):

Total Equity Valuation = NI x P/E

Asset-based Valuation

Modified (adjusted) book value Replacement value

Liquidation value

External Financing

Customerfinancing

Customerfinancing

Reduced rentReduced rent

Governmentprograms

Governmentprograms

Leased equipment

Leased equipment

Vendor financing

Vendor financing

Services atreduced rates

Services atreduced rates

External Financing

External Financing

Finding business angels

1. Formal angel groups

Pros: Easy to findCons: May charge

you for presentation or even business plan submission;

Few in number (several thousand)

2. Individual angels

Pros: Several hundred thousand

Cons: Hard to find and approach – the best way is through your network

Types of Business Angels

Entrepreneurial Angels

Corporate angels

Professional Angels

Enthusiast Angels

Micromanagement Angels

Can be invaluableadvisors and mentors

Can take over or ruin yourcompany

Silent partners

Passive investors

Intervene in the business

Target Market

Business Plan

Management Team

Product/Service

Competitive Positioning

FinancialReturns

Top 6 factors according to VCsVCs may helpyou hire a Team

Fragmented,accessible, and growing rapidly

Better andprotected

No dominance, distribution channels are open7X return in 5

years

Competent written business plan

Assessing a VC

Value added Patience

Deep pockets Accessibility

Board ofdirectors

Harvesting (exiting) investments

• Initial Public Offering (IPO)

• An acquisition

• A buyback of the investor’s stock

Very Unlikely

Pros and Cons of an IPO

FinancingFinancing High Expenses High Expenses

Follow-On FinancingFollow-On Financing Public Fish Bowl Public Fish Bowl

Realizing Prior InvestmentsRealizing Prior Investments Short-Term Time Horizon Short-Term Time Horizon

Prestige and VisibilityPrestige and Visibility Post-IPO Compliance Costs Post-IPO Compliance Costs

Compensation for Compensation for EmployeesEmployees

Management’s Time Management’s Time

Acquiring Other CompaniesAcquiring Other Companies Takeover Target Takeover Target

Employee Disenchantment Employee Disenchantment

Upsides Downsides

Advantages and disadvantages of an acquisition for the seller

Management Founderand CEO

Company Investors

Convertingstock

EmploymentAgreement Culture

Expenses andCommissions

Bygrave & Zacharakis, 2007. Entrepreneurship, New York:

Wiley. ©

Chapter 11

Debt & Other Forms of Financing


Wiley. ©

Getting access to funds


Wiley. ©

Getting access to fundsAfter using personal savings, start with Internal Sources

Home

Equity

Lines

Credit Cards


Wiley. ©

Cash conversion cycle

Key Components

The Inventory CycleThe Accounts

Receivable CycleThe AccountsPayable Cycle


Wiley. ©

Integrative Approach to Working Capital Management


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Sources of short-term cash: More time for Payables & less for Receivables

Tightening upAccounts

ReceivableCollections

Seasonal Business

Credit TermsTrade Credit

Negotiating with Suppliers

Short-term Bank Loans

Sources of Short-term

Cash


Wiley. ©

Obtaining Bank Loans

though Accounts Receivables

Obtaining Loans against

Inventory

Obtaining Financing

from Customer repayments

Choosing the Right Mix of Short-term Financing

Obtaining SBA-guaranteed

Loans


Wiley. ©

Chapter 12

Legal and Tax Issues


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In this chapter we study

• Issues related to leaving your current employer to start your own company

• How to choose an appropriate attorney and accountant

• Issues related to the legal form for your business• Shareholder relationships• Insurance• and issues related to selling stock to investors


Wiley. ©

Corporate opportunity doctrine

Identify the opportunity

Notify thecompanyabout it

Look for anotheropportunity

You can usethe opportunity

The com

pany use

s

the opportu

nity

The company doesn’t

use the opportunity


Wiley. ©

Consider when leaving a company…

Recruitment offellow workers

Proprietaryinformation

Non-competition

You may be held liable for

persuading people to leave the firm.

You may not be allowed to compete

with your former employer.

Make sure that the information you

learned from your previous job is not protected before

using it.

Bygrave & Zacharakis, 2007. Entrepreneurship, New York: Wiley. ©

Choice of legal formForms available Brief description

Sole ProprietorshipOwned and operated by one owner who is in total control

Partnership Two or more persons go into business for profit, as co-owners, sharing profits and losses

CorporationSeparate legal entity, with legal existence apart from its owners, the stockholders

Limited PartnershipOne or more general partners, who conduct the business and take on personal risk, and one or more limited partners, who act as passive investors

Limited Liability Company

Owned by “members,” who either manage the business themselves or appoint “managers” to run it for them

Bygrave & Zacharakis, 2007. Entrepreneurship, New York: Wiley. ©

Comparative table of entitiesForms

availableControl Liability Taxation

Administrative obligations

Sole Proprietorship

Owner has complete control

Unlimited personal liability

Not a separate taxable entity

Only those applicable to all businesses

Partnership Partners share controlJoint and several unlimited personal liability

Not a separate taxable entity

Only those applicable to all businesses

CorporationControl distributed among shareholders, directors and officers

Limited personal liability

Separate taxable entity unless subchapter S selection

Some additional

Limited Partnership

General partners control, limited partners do not

General partners: joint and several unlimited personal liability, limited partners: limited liability

Not a separate entity unless affirmatively chosen

Some additional

Limited Liability Company

Members share control or appoint managers

Limited personal liability

Not a separate entity unless affirmatively chosen

Some additional


Wiley. ©

Shareholder and operating agreement

Negotiating employment terms between you and

the investor

Disposition of equity interests

Distribution of company profits

Redemption provisions

Each party’sobligations

-Redemption Agreement-Cross-purchase Agreement

Provisions toresolve votingdeadlocksbetween owners

Protection forinvestors againstbeing left behind


Wiley. ©

Legal and tax issues in hiring employees

Equity Sharing

Employment Agreements

Other Employment Statutes

Employment Discrimination

Employees as Agents of the Company


Wiley. ©

Insurance

Property

Liability

Key Person Life

Business Interruption

Group Life, Disability and Health Insurance for Employees


Wiley. ©

Legal issues in the sale of securities to investors

Two securities offerings that donot have to be registered with

government authorities

Intra-stateoffering exemption

Offering under $1,000,000

Public placement

Private placement


Wiley. ©

Chapter take-aways

• Pay attention to issues related to leaving your current employer to start your own company

• Choose an attorney who specializes in your industry and an accountant who specializes in your local area

• Pick the legal form that’s most appropriate for your business

• Manage shareholder relationships• Get the right insurance• Know when you don’t need to register stock sales


Wiley. ©

Practical Reasons for Protecting a New IdeaInvestors are loath to put money into a venture that cannot establish a unique product niche.

Stockholders will challenge a corporation's investment of its resources in a program that can be easily copied once it is introduced to the market.

All the time, effort, and money people invest in perfecting a product, as well as advertising and promoting it, may be wasted if imitators can enter the market easily.

Moreover, the imitators can cut prices, because they have not incurred the startup expenses the company had to endure to bring the idea from conception to a mass-producible, reliable, and appealing product or service.


Wiley. ©

Licensing and Technology TransferCommon concerns and clauses

Defining the property being licensed

Limitation on licenses

Assigning value to a license

Royalty rates

Negotiating license agreements

Foreign licenses


Wiley. ©

Software Protection

All manner of software could be protected by patent regardless of how it is perceived, and many patents have been issued on software.

Software specific to the operation of the computer itself is patentable.

All forms of computer programs could be protected by copyright.

Companies can also protect software through a trade secret approach.


Wiley. ©

The InternetUploading and downloading of copyrighted material on the internet can be copyright infringement.

Copyright infringement has also been found in some cases against bulletin board operators and administrators who have received and stored such material.

Domain names are taking on some of the characteristics of trademarks.


Wiley. ©

IP AgreementsPreparing employment contracts

Transfer of employee rights to company innovations

How employee moonlighting might compromise confidentiality

Non-competition clauses

Preventing employee raiding

Employee ownership of copyright

Rights of prior employees

Consultant contracts

Confidential disclosure agreements


Wiley. ©

3 in 1

These “Bee Movie” Pez dispensers have all three types of intellectual property protections - patent, trademark and copyright.


Wiley. ©

Protecting trademark names

Seek non-descriptive words

• The purpose of the mark is to distinguish between products, not to describe the products

• “Celestial Seasonings” is OK

• “Tasty Seasonings” would be difficult to protect

Search for any other users

• Do so both before applying for registration and after registering

• Go after imitators as soon as you learn about them

http://www.applerecords.com/

Register the mark

• Register at the state level

• When it becomes clear you’ll be interstate, register at federal level

• Renew it six months before it lapses

• * Registration is not required to prove ownership of a mark, but it gives better protection

Use the mark as registered

• Do not alter it

• If change is needed, register a new mark

1994

2002Now

Pre-1961

Refer to the trade name as brand

• Scotch “Brand”

• Kleenex “Brand”

• Xerox “Brand”

• Google “Brand”

Why? See next slide

Do not use the name as a verb

• Using the brand name as a verb poses a challenge to protection of the trade name / trademark– Xerox does not use the term Xeroxing, which

could make the term generic– Do Google employees “google?”

License mark to others carefully

• If others fail to maintain the quality the mark represents, it may lose its identity

• The “dark side” of brand licensing– Long-term impact. Consumers have

expectations when they buy a product with your (brand) name on it - need to use quality monitoring or case auditing

– Day-to-day issues. Call centers, customer contact points

Flaunt the mark

• Otherwise, it may be judged to have become abandoned

• Put it on the product, advertisements, displays, tags, and manuals

exam 2 content foundations of entrepreneurship fall 2012

Documents

team philosophy

team iswhat

team members

company aequity distribution

gapsthe founderevery

company bfilling

attitudesanchoring vision

comanchoring vision