June 2003

1. June 2003 How do we make money? Financial management, valuation and financing Douglas Abrams - Parallax Capital Management

2. How do we make money? • The business model • Financial management • Forecasting and valuation • Funding required and equity offered • ROI and exit strategy

3. Determine the business model • How do we create value? • Who do we create value for? • How do we differentiate ourselves? • How will we make money?

4. How do we make money? • The business model • Financial management • Forecasting and valuation • Funding required and equity offered • ROI and exit strategy

5. Determine your needs • Think about your income and cash needs • Think about your sales and funding needs

6. Two ways to look at your finances • Operating view - budgeting • Operating budget • Cash-flow budget • Accounting view - forecasting and valuation

7. Expense and operating budget

8. Cash flow budget

9. The Path to Profitability (P to P) • What is profitability? • Startup can fund all operations from cash flow • How much investment needed until then?

10. The burn rate and months remaining • Methods of calculating the burn rate • GAAP • EBIDTA (before interest, depreciation, taxes and amortization • Calculate months remaining • Remaining months liquidity • How many months worth of cash does the company have left? • Multiple burn rates may be required to reach milestones until startup can fund from its own revenues

11. Principal financial statements • Balance statement - the company’s financial condition • Income statement (P&L) - the success of the business • Cash flow statement - cash availability and needs of the business

12. Left side - Assets Right side - Liabilities & Equity • Economic resources of the company • Ability to provide future benefits to the firm • Cash • Inventory • Equipment • Liabilities - creditor’s claims on the assets of the firm • Accounts payable, bonds payable • Shareholder’s equity - the owner’s claim on the assets of the firm • Contributed capital • Retained earnings Balance statements must balance

13. Why is financial information important to entrepreneurs? • No cash, no business • Financial information pulls together all information presented in the other segments of the business; marketing, manufacturing & management • It quantifies all assumptions & historical information concerning business operations

14. How do we make money? • The business model • Financial management • Forecasting and valuation • Funding required and equity offered • ROI and exit strategy

15. Forecasting requires predicting the future

16. We predict using pro forma financials • Three to five years of: • Income statements • Balance sheet • Cash-flow statement • P&L

17. Preparing your forecasts • Project from bottom up • Sales growth and market share are key • Project cash requirements

18. What is the value of a firm? • Fundamental value? • Technical value? • Balance sheet value of assets? • Market value of assets? • Multiple of book value?

19. Company valuation methods • Price to earnings (p/e) • Dividend yield • Multiple of book value • Comparables • Discounted Cash Flow (DCF)

20. Comparables • Use value that has already been established either in public markets or through a sale for a comparable company • Difficulties • How to find comps • Accounting methods vary • Public versus private liquidity • Changing market conditions

21. DCF Valuation Model • Firm value is discounted present value of future cash flows • Percent of sales forecasting • Tie income-statement and balance sheet figures to future sales • Variable costs and most current assets and liabilities tend to vary directly with sales • Only future sales require prediction; relationship between items can be calculated more easily

22. Discounted cash flow • Project cash flow from operations for 3-5 years • Adjust the cash flow for factors such as non-recurring items of income and expense, depreciation, amortization, interest and taxes • Discount the cash flow as adjusted, using alternative assumptions for time and risk factors.

23. What are our time, scope and size ambitions? • Subsistence model • Income model • Growth model • Speculative model

24. Scalability and its costs • Scalability necessary for VC investment • $300MM gross profits within 5 years • Scalability is expensive - marketing, infrastructure, etc. • Demonstrate need and value of product or service with $3MM? Get to break even with less than $20MM with yearly revenues of $100MM in 5-10 years

25. How do we make money? • The business model • Financial management • Forecasting and valuation • Funding required and equity offered • ROI and exit strategy

26. What are sources of funds? • Profits/Retained earnings • Equity • Debt

27. Funds needed • How much does the company need? • What percentage does the company want to sell? • Often too much or too little • This is the wrong question • Set performance and fund-raising milestones • How much money do you need to achieve the next milestone? • Divide defensible firm value by funds needed to determine percentage to sell

28. Sources of funds • Own money (OM) • Friends and Family (F&F[and Fools]) Angels • Incubators • Corporations • Customers, suppliers, lessors and strategic partners • Government grants and investments • Banks for VC loans

29. Uses of funds • Be detailed • No big salaries for founders • How will these funds be used to fuel necessary growth? • Sufficient funding to reach next financing milestone

30. Funding stages • Founder’s capital • Seed/Angel • Series A, B, C • Mezzanine • Pre-IPO • IPO

31. Pre-money valuation • Worth of the business before VC investment • Amount invested by VC divided by • Agreed pre-money value of business + • Amount invested by VC = equity owned by VC • VC receives equity share based on post money total • $3MM pre + 1 MM VC = 25% VC equity

32. How do we make money? • The business model • Financial management • Forecasting and valuation • Funding required and equity offered • ROI and exit strategy

33. VC hurdle rate • Minimum yearly compounded rate of return VC expects from investment (risk assessment) • Seed stage 60-100% • Early stage 60% • Late stage with profits 40% • Bridge financing to cash out 20%

34. Why are VC’s hurdle rates so high? • VCs must deliver above-average returns to their investors • Percentage of winners and losers • 20/80 at best • Overall return required by VC investors 30/40% • Do the math

35. Post money valuation • Used to estimate the price the business must command at the liquidity event • If liquidity event is sale in 5 years, and hurdle rate is x%, can calculate sale price required • $4 million post money; 50% hurdle rate • Sale price must = $30 MM

36. Calculate VC’s Projected ROI • Take projected earnings from DCF model in exit year • Multiply by comparable P/E multiple for industry to calculate price • Multiply by VC’s equity percentage at exit to calculate VC’s share • Divide VC’s share by original investment

37. Exit strategy and market conditions • Liquidity event • Convert private equity to cash or freely tradable stock • Sale or IPO • Merger with public company • Back-door listing, • Reverse merger • Within 3-5 years • Only 10-15% of liquidity events

38. Contact us • Douglas Abrams • Managing Director • Parallax Capital Management • dka@parallaxcapital.com • www.parallaxcapital.com • 65-6238-3492, 65-9780-5381 (hp) • 390 Orchard Road, #11-01 Palais Renaissance, Singapore 238871