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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)
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
Tips for business planning and raising outside funds
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
Tips for business planning and raising outside funds
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
Tips for business planning and raising outside funds
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Getting access to funds
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Getting access to fundsAfter using personal savings, start with Internal Sources
Home
Equity
Lines
Credit Cards
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Cash conversion cycle
Key Components
The Inventory CycleThe Accounts
Receivable CycleThe AccountsPayable Cycle
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Integrative Approach to Working Capital Management
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Chapter 12
Legal and Tax Issues
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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. ©
Choosing an attorney and accountant
Attorney
Choosespecialized
Accountant
Hireearly
Chooselocal
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Legal and tax issues in hiring employees
Equity Sharing
Employment Agreements
Other Employment Statutes
Employment Discrimination
Employees as Agents of the Company
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Insurance
Property
Liability
Key Person Life
Business Interruption
Group Life, Disability and Health Insurance for Employees
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Chapter 13
Intellectual Property
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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.
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Business Intellectual Properties
Trade Secrets
CopyrightTrademarks
Patents
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
International Protections for Intellectual Property
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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.
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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.
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
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
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
3 in 1
These “Bee Movie” Pez dispensers have all three types of intellectual property protections - patent, trademark and copyright.
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
Bygrave & Zacharakis, 2007. Entrepreneurship, New York:
Wiley. ©
You’re “dead!”
From USPTO.GOV, in the trademarks section…
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
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
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