Posts Tagged ‘financial_plan’
Many entrepreneurs are “allergic to the numbers side of the business”. Part of the high failure rate of small businesses is due to avoiding and ignoring basic financial principals.
Ken Kaufman’s book explains the essentials of small business finance and how to easily apply them through the use of allegory. In other words, he uses “good ol’ fashioned story-telling” to make even the most finance-phobic business owner learn and appreciate the need for quantitative, financial management.
This is not just a story about Steve, a man struggling as a small business owner, a husband and a dad. It is a guide penned in a way we can all identify with. It goes beyond merely being clever about teaching financials.
For example, in Chapter 23, the protagonist (Steve) starts to see, from his own experiences, how anxiety and clarity are negatively correlated. This is a non-financial lesson we all must learn and respect. This book is full of well-articulated insights that we all face as business owners.
The first time you read it, Kaufman’s book is an enjoyable story that “hits home”. Then, it becomes a very useful reference guide for the next hundred times you’ll take it off your bookshelf.
Imagine an investment approach where you can fund an early stage company and not have to worry about – or wait for – a blockbuster IPO or acquisition many years out before realizing a return on your invested capital.
Angel and venture capital investments are traditionally defined as an equity stake in an early stage company where the investor provides funding when the business risks are high but the potential payout is also very large. While VC still is largely a “home run” investment approach, angels and some smaller funds are applying an innovative approach to early stage investing that still includes higher risk and reward, but is more of a “base hit” investment approach.
Royalty-based deals are not new, but the use of this funding approach for early stage companies is somewhat novel. For decades, oil and gas companies have used this deal structure to finance prospecting activities.
How It Works
In a nutshell, a royalty-based investment is more of a debt instrument (liability) instead of equity. While the actual financial structure may vary, the gist of the deal is a company borrows money and agrees to pay a royalty (percentage of its gross revenues) until a defined multiple of the original investment has been repaid.
One example: a company borrows $200,000 and agrees to pay 10% of its gross revenues to the lender until $800,000 has been repaid. This may take one year or ten years. The return of 4x may seem excessive to a borrower, but it may take many years to repay, so there is more risk to the lender than a typical commercial loan, and unlike a conventional angel investment, the company may not be giving up any or much equity (yes, an equity component could be incorporated into this structure).
Ideal Candidates (Early Stage Companies) for This Type of Financing
Royalty-based deals typically require the company to already be generating a reasonable stream of revenue. If a startup is still in the “pre-revenue” stage, most of the royalty-based venture financing firms will not be interested.
Royalty Capital New England (http://www.royaltycapital.us) from Boston does these types of deals
Revenue Loan (http://revenueloan.com) based in Seattle also does these types of deals
GigaOM Article from 2009 that talks about revenue based financing and coins the term “Class R Stock” (http://bit.ly/ClassR_Stock)
A video of a presentation from Growth Science International (http://www.growthsci.com) that discusses royalty-based financing:
Part Four of a Five-Part Series by ActSeed’s Dan Jacobson
In my previous article I provided an approach for creating integrated functional strategies and goals. This article describes how to use these functional strategies and goals as the input to define operational metrics and create a financial plan.
Spreadsheet software makes it easy for anyone to spin up a financial model and “show” interesting results. However, your credibility will be challenged unless you can communicate and defend your financial presentation and the reasonableness of your model’s underlying assumptions. I recommend that you follow the general approach outlined in the following graphic.
Assign one person with central coordinating responsibility. It may seem obvious to have your senior finance person take the lead. However, don’t hesitate getting someone from the outside involved if they have relevant experience, a general understanding of your business model, good spreadsheet modeling skills, and the ability to engage with your functional managers. Make sure you start off with the proper expectations. You may not need a full set of financial statements, or that need may be some time in the future. Think a step at a time and focus first on operational metrics and a cash view of profit and loss.
Key Inputs: Your coordinator should start with clear expectations for timeline and an understanding of the functional plans.
Step One: The coordinator should determine the time increments to be used for planning, for example monthly for 3 years or quarterly for two years, depending on the desired use for the final deliverables. Then the coordinator should work from functional plans to construct a basic metrics interpretation of the cost drivers and assumptions for each cost driver by major category. Major categories might include headcount by role, outside service or development costs, contract labor, equipment costs, raw material, purchase of partial or final assembled components, channel partner costs, IT infrastructure and services, commissions, training, etc. At this point, the coordinator should focus on the operational activities that will drive costs included in Gross Margin. In situations where functional plans describe alternatives, such as “build it ourselves” or “outsource”, these options should be included in the metrics model. Organize your model horizontally to display Units (for example headcount by role), Unit Costs (for example the monthly base salary for each Unit), and if the cost is fixed (a one to one basis to Unit increases), variable (relative to a relationship to another Unit such as production), or step variable (relative to Unit breakpoints such as sales thresholds). A simply conceived spreadsheet will allow you to efficiently engage each functional lead in the interpretation of their functional plan.
Step Two: The coordinator should meet with each functional manager responsible for the completed functional plans. Given top management’s plan for sales and production, the coordinator should engage the functional manager in the build-out of the metrics model for their functional plan. The discussion should focus on refining the list of cost drivers, estimating the units relative to the sales and production targets over the planning timeline, and expectations for direct costs (but not yet fringe benefit or other corporate overhead) for each cost driver. The coordinator should challenge the functional manager so that the units and costs are reasonable given the sales and production targets. Also the challenge whether the model is complete and captures all inputs and costs. The functional manager needs to understand that this rough metrics model will become a basic budget for their operations and adjustments, and that this is not just an academic exercise. Finally, the model should include referenced footnotes that describe basic assumptions that drive the metrics model.
Step Three: After completing the function-level metric model, the coordinator should create a consolidating spreadsheet tab that portrays a company-level view of the sales and production targets, units, and units costs on a cash basis for the specified time increments. This spreadsheet tab should also include a quarterly or annual summation of units and costs. As a second effort, the coordinator should create an additional corporate tab for costs such as management, space, utilities, employee acquisition or fringe benefit costs, insurance, and other overhead. Some of these overhead items (for example employee fringe benefits) can then be allocated back to the functional models (for example as a percentage of direct labor). If distinct functional options exist (for example “build it ourselves” or “outsource”) two or more consolidated tabs should be created and marked accordingly. The summary model(s) and updated functional models will be easier for the coordinator to model the impact of changes in assumptions.
Step Four: The next step is a review of the rough cut model with management. This discussion should begin with a review of the functional metrics models, assumptions, and the summary model(s). The key questions for management should be “Are we capturing all cost drivers?”, “Are our assumptions reasonable?”, and “Does this model accurately represent our business and expectations for operations and expenditures?” Responses might lead to some refinements in how the model captures and consolidates metrics and costs.
Step Five: After the model is determined to be workable, the next step is to seek management challenge for key assumptions and impacts on targets and costs. This is essentially the real “what if” phase of refining the model. A few examples of challenges here might include “What if we slow down our timeline for market introduction?”, “What if we use more contract labor?”, and “How can we reduce our pre-breakeven cash burn to the funding level we have or anticipate?”. Each of these macro questions will have impacts on assumptions for each functional model. This step enables management to refine or model alternatives and challenge the functional managers.
Step Six: Next is a second round of discussions with functional managers to answer questions and focus on how the functional plans can be reasonably refined to meet the modeling objectives of management. In other words, “Given management’s refined plans and constraints, what is the level of activity and costs that will allow you to achieve these targets?”. Functional managers need to understand that this step in the process will require them to make commitments for reaching targets and operating within constraints. In some situations this may result in push-back to management, indicating with supporting justification, that “This is the most efficient plan and use of all resources to achieve company-wide targets”.
Step Seven: Input from functional managers should be incorporated into the functional and consolidated models. Care should be taken to maintain version control over all models. In my fifth and final article I will present some ideas for managing documents, collaboration, editing, and approvals.
Step Eight: The new iteration of the model should be reviewed with management to demonstrate the impacts of changes and the commitment and input from functional managers. This may be done in a meeting where functional managers present their refinements and assumptions. There may be additional iterations, but the end product should be a dynamic model that can be used in budgeting, operational projection, and financial presentation. Management needs to declare that one version of the model is “official” and that the underlying assumptions will be the standard for budgeting and projection. And as plans change, this model will be the basis for modeling current and future state for these changes.
Develop Deliverables – Operational and Metrics: The coordinator can now interpret the final model into performance targets, budgets, and metrics for each function and also for the company. This deliverable can remain in spreadsheet format or be incorporated into a formal budget and financial management system. Then each functional manager can be accountable for monthly and annual performance to plan. And as circumstances change, these changes can readily reflected in the functional and company level models.
Develop Deliverables – Financial Model: The coordinator should work with the senior finance officer or outside resources to make the model adjustments required for the desired set of financial projection deliverables. These adjustments might address cash to accrual basis for accounting, capitalization, depreciation, valuation of intellectual property, estimates of tax liability, or a myriad of other topics that do not directly impact the scope of influence for functional managers. In many situations, an accurate projection of cash sources and cash uses may be adequate. In the other extreme, a full set of independently reviewed financial projections (profit and loss, statement of changes in cash, sources and uses, and balance sheet) might be required. Once again, it is critical that you begin this exercise with a clear definition of the final financial deliverables required.
This structured approach will deliver many benefits to your company. Even if you do not need a full set of projected financial statements you will have developed a clear and shared company-wide view, commitment among management and functional managers, and mechanism for review and refinement. Stakeholders outside of your company will appreciate and value this analytic interpretation of your company’s plans.
In 1993 I co-wrote a book (with Grant Thornton colleagues) titled “How To Prepare A Results-Driven Business Plan”. At Grant Thornton we observed that most clients seeking bank or investment funding took either a cookie cutter or overly academic approach to preparing their business plans and supporting documents. These business plans typically took a great deal of time to prepare, yet seldom “closed the deal” when presented for financing. In many cases, the “worst” business plans were prepared by a third party. The objective behind our book was to provide models and a leading practice approach that closely integrated business concepts and strategy to defendable finance and operating details – hence the “results-driven” premise.
So, with more than 15 years of water over the dam have the fundamentals of ‘results-driven” business planning changed? What can you do to fine-tune your business plan in order to obtain funding and support in today’s world?
I’d like to work from the basic premise of the Grant Thornton book and provide some new perspective based on my experiences as a consultant and entrepreneur. My focus will primarily be on business plan components used for funding or external support. I also assume that you have developed a basic business concept and strategy. For a broader primer on business planning I’d suggest that you take a look at some of the primer resources in the ActSeed Marketplace.
The topics I’ll cover include:
- Understanding Your Audience
- Organizing the Process and Assessing Your Environment
- Strategy and Goal Setting by Function
- The Financial Plan
- Assembling and Refining the Components
The first topic is addressed in this article. The others will be addressed in weekly articles at ActSeed.com.
1. Understanding Your Audience
The business planning process should begin with the identification of your audience and the evaluation of their interests. By translating their interests into a set of business plan “deliverables” you can efficiently organize the efforts your team efforts in translating your strategy into goal setting and planning. First you need to identify your audience segments and determine your objectives for meeting and presenting your business concept. Second, you need to define the information and level of detail they need. Then you need to use that information to develop a work plan and timeline to develop specific deliverable “components” according to your priorities. Through interaction with your team (as I will describe in a later article) you can bring together and integrate the components. Having interim, or in some cases draft, materials is valuable for early stage meetings and web content.
Most of us would like to think that our great business idea could be grasped by anyone with modest intelligence. After all, we’ve developed it to the point that we are convinced it is airtight. What many underestimate is the fact that securing money, talent, organization, and outside support requires an overt and sustained communication to key constituent groups. The interests of these groups can vary widely, so it is apparent that no one document or level of detail is appropriate to meet all needs:
The primary interests of the internal audience – management, employees, advisors
- Integrated and actionable operational details
- Financial planning and forecasting
- Performance management
Primary interests of external audience – investors, vendors, and acquirers
- Viability of product or service in the market
- Achievability of goals
- Organizational capacity and discipline to execute
- Mitigation of risk
While the needs of these two groups might appear reasonably distinct, the growing integration of discontinuous supply and distribution channels has created a hybrid party – the business or channel partner that acts as an operational extension of your company as well as an investor. This hybrid might help you quickly access new markets or distribution channels, reduce operational costs, and fund the costs of expansion or systems development.
Primary interests of channel hybrid audience – supplier/distributor/funding source
- Operational synergy and cost avoidance
- Elimination of channel redundancy
- Deeper, more real-time market “insight” and increased sell-through
Add to this the opportunities to out-source, off-source pieces of operations, or have third parties host or integrate information systems and data. Clearly, today’s operational environment can be much more enabling, but also much more complex and integrated. But, a non-linear business model and supporting plan can be powerful if explained properly.
I suggest preparing a simple matrix with the horizontal axis representing the stakeholders or “audiences” for your business plan, and the vertical access representing the functional topics to be addressed. After preparing this straw model, get your team and/or advisors involved in a discussion regarding the level of detail required for each stakeholder. Individual team members will be responsible to prepare drafts for their functional area of responsibility, so a clear definition on the level of detail, timelines to complete, and the process to integrate components is an important step. Also you’ll want to achieve agreement on the format and method for collecting and keeping version control over draft documents. The use of software collaboration tools (to be addressed in the next article) can be incredibly valuable, particularly if team members do not reside in one physical location. After agreement on formats and responsibilities, the next stage of your discussion should address the level of detail required for each stakeholder.
The following graphic depicts a simplified and iterative approach to developing and refining a set of business plan components. Stakeholders and key business functions are identified. A sequence for completion is defined, and the level of detail appropriate to the stakeholder is specified. The logical sequence for completing and integrating each component into the overall deliverable for each stakeholder should be clear.
Perhaps the most important thing to consider is that each of the functional components will go through many changes and levels of detail as they are prepared. There is no such thing as a static business plan, but if you are able to work from solid draft deliverables it will be much easier to make and integrate comprehensive changes. When changes, such as the opportunity to work with a new channel partner, unfold it is best to re-assemble your team and have a discussion on the implications of the change to each of the business plan components.
It is easy enough a few copies of business proposal formats used by investors. However, your business plan will be much stronger and focused if you borrow some of the concepts of Customer Experience Management – beginning with the needs of your customer or stakeholder, then working backwards to efficiently produce the component deliverables that will address their interests and needs. This will help you avoid time spend on non-relevant topics and allow you to prepare “just in time” content. It will also enable you to tell a compelling story about your planning process.
More ideas on the planning process and assessment of your environment will be included in my next article.