Basic Funding Concepts for Entrepreneurs

+

Basic Funding Concepts for Entrepreneurs!

Alok Rodinhood Kejriwal Founder – therodinhoods.comJanuary 2014

+Background

I’m a crazy entrepreneur and have been involved in running a truck company, trading drums, making socks and currently produce mobile games.

During the journey, I’ve have picked up some important funding concepts that I want to share!

+Disclosure

I am not a techie. I’m a Business guy, and these funding concepts are for early startup entrepreneurs, students, technical nerds, folks who haven’t been exposed to Business and Finance but WANT TO learn.

+Topics covered

Valuation

Pre-Money

Post-Money

Dilution

+

Valuation

+Valuation

What is valuation? Is it a science, is it an art, or is it both?

Let’s tackle this question with an example:

Let’s assume that you run a Car Rental Company that had profits of Rs. 75 lacs (US$ 125,000) last year.

+Valuation

What is the valuation of your Car Rental Company?

+ Valuation – made simple!

At a very simple level, to understand valuation, all you need to know is the basic Interest rate that you can safely earn (typically in your country).

Now, this is the basic Interest rate that a reputed bank would pay you, without ANY RISK. We aren’t talking about loan sharks here

+ Valuation – made simple!

In India, the ‘basic rate’ of Interest is 10% (Jan 2014)

- Remember that your last year’s profit was Rs. 75 lac (US$ 125k)

Question: What is the amount needed to be DEPOSITED in a safe bank in India to earn Rs. 75 lac in Interest per year?

+ Valuation – made simple!

Obviously Rs. 7.50 crore in the bank! (10% interest on this amount would earn Rs.75 lac per year in Interest)

+ Valuation – made simple!

Therefore, Rs. 7.50 crore is the BASE valuation of your Car Rental Business!

+Valuation – important points

The ‘Base’ valuation of your business being established, what makes your valuation go HIGHER?

-GROWTH! Money in the bank doesn’t grow on its own. Businesses do!

-The creation of tech, IP, tools, processes that will result in ‘future earnings’.

- Talent, leadership, skills in a Company that will enhance future earnings.

+Valuation – important points

Lots of startup companies have ZERO revenues and hence NO profits and yet get acquired or massively funded for mind boggling numbers.

Why?

+Valuation – important points

Case 1: Because the acquiring Company HAS the Business to use the startup companies’ assets & talent and generate additional profits. (See the case of youtube acquisition by Google here - Slide 15)

+Valuation – important points

Case 2: The zero revenue company HAS the business plan to generate substantial profits in the future that justify high valuations in the present

(Case: Facebook’s multiple rounds of funding BEFORE it began generating revenues)

(Case: Snapchat’s current rounds of massive valuations with zero revenue – similar to Instagram before acquisition by Facebook)

+Valuation Summary

Profits-------------------Interest Rate

= Base (Minimum) Value of a Company

+ Add FUTURE to valuation Everything else that Dumb Money in a Dumb Bank account earning Dumb Interest CANNOT do; that YOU can, being an Entrepreneur in control of a great Business with a massive future

+Note on Valuation (for the experts )

I have NOT complicated the valuation discussion by introducing concepts such as DCF, NPV, Black-Scholes model, etc.

The reason is that the PRIMARY concept of ‘Value’ arises from the OPPORTUNITY cost of Capital which is very simply captured by the ‘riskless rate of return’.

I have also not added the element of RISK in this valuation method because according to me, Startups ARE 100% risky. Hence anyone investing in a Startup invests with the assumption that her money will be lost.

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Pre-Money & Post-Money

+What is Pre-Money?

“Pre-Money” is the value of your Business BEFORE it gets funded.

Assume that your Car Rental company, as valued in the previous slides, is raising money.

+Pre-Money

Let’s say that you pitch your Car Rental Business to a VC and claim the valuation of your Company to be Rs.18 crore (US$ 3 million)

Note - This is much higher than the Rs. 7.50 crore valuation calculated earlier because YOU are a super hero (at least you think so) who will grow the business spectacularly!

Rs. 18 crore IS your “PRE-MONEY” valuation of your Company.

+ Pre-Money

The VC is a very smart lady and accepts the Rs.18 crore valuation of your Company!

She further commits to give you Rs. 12 crore (US$ 2 million) as an investment to aggressively grow your business!

+ Post-Money

WHAT is the NEW valuation of your Car Rental Business?

+ Post-Money

This just needs common sense!

Rs. 18 crores (US$ 3 million) is the value you pitched (Pre-Money)

Rs. 12 crores (US$ 2 million) is the money that the VC will invest (Investment)

Hence, Rs. 30 crores (5 million) IS the new valuation of your business OR POST-MONEY.

+ Post-Money

Post-Money = Valuation + Investment by VC

+

Dilution

+Dilution

What is “dilution”? Sounds a bit scary!

Dilution is the share you sacrifice in your business in return for money (or other value) received from someone else.

.

+Dilution

In the example in the previous slide, you accepted:

Rs. 12 crores investment (US$ 2 million) in your Company

The POST-MONEY valuation we learnt was Rs. 30 crores (US$ 6 million)

So, what will be your dilution (share you will have to give the VC)?

+Dilution

Common Sense coming to the rescue again:

Dilution % Rs. 12 crore (US$ 2 million) -------------------

Rs. 30 crore (US$ 5 million)

= 40%

Hence, 40 % is the DILUTION you will have to suffer (give) as a share in your business to the lady VC.

+Topics that can be added

Depending on the response to this deck, I can add the following topics:

- Cap Tables

- Price Earning multiples (relevant when Companies get acquired by Operating Companies)

- Ratios that must be kept in mind

- ESOP pool calculations

Do mail me – alok@rodinhood.com if you would like these to be added

+Connect with me!

e-mail - alok@rodinhood.com

Facebook - facebook.com/rodinhood Twitter - @rodinhood

My social network for anyone enterprising! therodinhoods.com

Presentations – http:slideshare.net/rodinhood