Subject line: [Flawless Financials] Quickly Creating A Great Financial Package Flawless Financials the Financial Forecasting Online Newsletter from Minotaur Financial and David Brode September, 2003 Please pass on Flawless Financials to those in your network. To leave Flawless Financials, follow instructions at bottom. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * This month: Quickly Creating A Great Financial Package * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Everyone wants to produce a great financial package for investors, but many companies fall short. While working with seed-stage companies over the past years, I've also found that even companies with effective packages spend too long getting the materials together. Since attracting capital requires a strong financial package, I thought we'd devote this month's newsletter to two inter-related topics: a) What are the characteristics of an effective package? b) What's the easiest way to develop it? I also describe how to systematically create a winning package with a relatively modest investment of time. I. What's in the Winning Package? 1. Investor Communications. This includes the numbers in the executive summary, and PowerPoint deck, and the verbal financial pitch. Investors screen based on these materials, so it's an important opportunity to use the numbers to convince them to stay interested. Figuring out what to show and what not to show can make all the difference. For example, saying you're in a $10B market that that if you only capture 1% then you'll be a $100M company is a certain turn-off. At this stage you must focus on sending the right messages regarding scale, business model, and investment savvy. 2. Financial Summary. This is the first level of detail you offer, and also your main tool for summarizing thoughts on the numbers. 3. Excel workbook with details. Eventually you need this for the due diligence phase, and it's where you develop the numbers for the other components. II. How to Develop the Package Quickly You can shorten the process and get better results by defining up-front what information you're trying to produce. To do this, create a Preliminary Financial Summary (more on this below) to guide the model building process. Because you will invariable develop keen insights through the detailed modeling exercise, loop back and revise the Summary. The process should look something like this: Preliminary Financial Summary drives Detailed Model which then drives Financial Package. III. Preliminary Financial Summary At this stage, you're looking to prepare little more than an "elevator pitch" about the financials. In tactical terms, this means creating a preliminary Financial Summary. (See http://www.brode.net/resources/Newsletter-2003-Aug.txt for the newsletter on this topic.) This document generally includes four sections: Investment, Use of Funds, Business Model, and Projections. Investment: For now, simply show how much money you plan to raise. In future iterations, make sure this meets investor return standards. Use of Funds: Outline the money-consuming categories, like particular pieces of equipment, acquisitions, headcount salaries, sales/marketing programs, working capital, etc. Use this section to identify areas for further inquiry. For example, if much of the funds are spent on headcount, you'll need a very detailed headcount growth plan with people/positions/salaries and when they are hired. If much is spent on capital equipment, show how it scales. Business Model: Describe the business model in its most basic terms, even if big parts can't be quantified quite yet. Projections: Set up a table for what summary projections you need to show, for example: Customers, Revenue, EBITDA, Cash over time. Draft the Executive Summary and PowerPoint deck leaving holes for this data. IV. Ready to Model! Now it's time for your detailed business model. The greatest time-saver here is a pre-built spreadsheet template that requires only minor modification to fit your business. Such a template is available on the Minotaur Financial website at www.brode.net/resources/entrepreneur-model.xls. Use a pre-built template to: - Ensure that all the parts are there: Income Statement with Revenue, COGS, Gross Margin, Operating Expenses, EBITDA, Depreciation/Amortization, EBIT, Interest, Taxes, Net Income; Balance Sheet with Current Assets, Fixed Assets, Intangibles, Current Liabilities, Debt, Equity Investments, Retained Earnings. - Ensure the pieces tie together: Net Income to Retained, Deprecation to Accumulated Deprecation, Amortization to Accumulated Amortization, Debt to Interest, etc. - Have complex calculations already built, e.g. Tax net operating loss carry-forwards. - Ensure the columns adding January-December into the annual total actually work! - Get great formatting without hours of effort. - Avoid forgetting standard items, like benefits and taxes as a percentage of salary. In the end, you want to understand how the business works in detail while still keeping the model metric-driven. Start the model with historical details for both Income Statement and Balance Sheet. Have headcount and customer counts for historical periods in the model. Then create the forecast, focusing on the holes you need to fill in the Investor Communication documents. VI. Reworking the Financial Summary The model is done to support the Financial Summary. As we dive into details, sometimes the results change and we need to change the numbers in the Financial Summary. You can quickly identify which parts of the model matter and which don't. In one recent engagement with two lines of business, we saw that the revenue quickly became 90%-10%. So we assumed the smaller business would maintain current EBITDA margins and turned our attention to scrutinizing the cost structure of the larger business. At this point you're ready to craft the verbal pitch. This is different from the Financial Summary in that it's not so much about the numbers, but it's more about how you describe the business model/value proposition so that prospective investors get it. Develop three points that demonstrate the economics are good and what the critical assumptions are. For example, one recent client had awesome Gross Margins with little additional G&A. So it was basically a question of whether Sales & Marketing expenses can drive Revenue efficiently. For other businesses it's critical to understand the potential variability in cost factors. With one client we wanted to estimate the impact of outsourcing one job position. Since we knew that job was 1/3 of the total headcount, we assumed 50% outsourced at 50% of the cost and could quickly estimate a 5% EBITDA improvement; this verbal analysis bounded the problem for all involved and allowed us to take it in or out of the story as needed. VII. Start Your Numbers So get out there and create (or for you VCs, demand) a great financial package. The clarity you gain in creating a Financial Summary will pay off handsomely down the road. Until next month, all the best, David Brode – Minotaur Financial Removing Financial Issues as a Deal Roadblock * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * WHAT I'M READING OzGrid.com (www.ozgrid.com) is a massive website all about Microsoft Excel. Yes, there are many sites about Excel, but this one is special. - Password recovery products - Charting tools - An incredible number of add-ins - Options of how to put Excel on the web * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * NEWSLETTER ARCHIVE AVAILABLE Make sure to visit the Minotaur Financial website for the Newsletter Archive at http://www.brode.net/resources/ * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * http://www.brode.net mailto:David@Brode.net 1919 14th Street, Suite 510 Boulder, CO 80302 (303) 444-3300 * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * ABOUT DAVID BRODE I’m a financial modeling specialist. Over the last fifteen years I’ve completed dozens of models and certainly thousands of versions to support corporate development, M&A, strategic planning, and debt and equity transactions. These models have raised over $1B in debt and $100M in venture capital and private equity. Over time I’ve consistently revised software tools and work processes to get the job done quickly and well. If you have a financial forecasting issue, I’d love to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * (c) 2003 Minotaur Financial, All rights reserved. You are free to use material from the Flawless Financials newsletter in whole or in part, as long as you include complete attribution, including a live web site link. Please also notify me where the material will appear. The attribution should read: "By David Brode of Minotaur Financial. More articles on financial forecasting can be found at http://www.brode.net " * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Are you struggling to convince others to do a deal which you think is a no-brainer? To discuss how you can take numbers off the table as a deal roadblock, call (303) 444-3300. I'm very accessible and glad to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * DO YOU LIKE THIS NEWSLETTER? You are welcome to share this email with colleagues who would benefit from better numbers. Your feedback is always welcome and appreciated. Write in to mailto:feedback@brode.net. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * PRIVACY POLICY: I never rent, trade, or sell my email list to anyone for any reason whatsoever. You'll never get an unsolicited email from a stranger as a result of joining this list. To SUBSCRIBE FREE to this newsletter, send an email to mailto:subscribe@brode.net. And you'll get Minotaur's Financial Forecasting White Paper in the deal. To be REMOVED from this list, send an email to mailto:remove@brode.net. (Please note that this message needs to come from the email address that originally subscribed. If you need help determining this, please email mailto:David@Brode.net.)