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Five Points to Successful Projections

Most entrepreneurs struggle with financial projections, not wanting to commit to numbers they can't deliver, and having no clue what investors might consider reasonable. However, making no projections, or non-credible projections will get your startup marked as unfundable. Projecting the financials should be the last step of your business plan preparation, since it assumes you already know the opportunity size, customer buying habits, pricing, costs, and competition. Here are five basic "rules of thumb" that every private or venture capital equity investor uses to help you anticipate their reactions. The rules are obviously not absolute, but you must be prepared to explain to potential investors why your startup is the exception to these guidelines:

ONE
Five-year financial projections are the norm. According to a recent Dow Jones report, the average time to liquidity of an equity investment in a startup is now about five years. Thus most investors ask for 5-year projections, to get a sense of the opportunity and trajectory that you're envisioning while their money is tied up. Do the first year by months, second and third year by quarters and the forth and fith year annaully.

TWO
Aggressive revenue projections and growth rate. The first filter applied by most investors is to identify high-growth investable startups from ones that may be a good family business with organic growth, but could never generate a 10x return. Revenue in the fifth year should be at least $20 million, with a growth rate average of 100% per year.
But don't go crazy with this number. If your fifth year projection exceeds $100 million, that puts you in the rare category of the next Google, and probably won't be credible with investors, unless you have a track record in this range. In other words, revenue projections are not the place to be too conservative or wildly optimistic.

THREE
Gross margins greater than 50%. Most entrepreneurs, with no experience, believe that they can make good money with lower margins than competitors. The reality is that even if you eat Raman noodles and do survive with low margins, your growth rate will be stunted, yielding a low return for investors.
Financial projections for investors should always show an annual cost of goods sold and a gross margins line, as well as revenue. Low gross margins in the first couple of years are expected, but they better climb to the 60% range by year five.

FOUR
Show red ink to match your funding request. Financial projections shown to investors should always be pre-funding projections, to illustrate what revenues and expenses you think are possible, and how much your current funding falls short. Don't ask for funding if your projections imply you don't need it. Investors don't like their money used frivolously.
If you show a negative cash flow of $800 thousand before the business turns cash flow positive, it is fair to buffer that amount by 20% and ask for a $1 million investment, since we all know that there will be un-anticipated additional costs.

FIVE
Build a path to 10x return The only path to any return for equity investments is a liquidity event, like a merger or acquisition (M&A), or IPO. That's why investors want to hear about your exit strategy. If you don't have one, or intend to buy out investors with their own money, you probably won't get much interest.
What investors want to hear is that your company will demonstrate that high rate of growth to get you to $50 million in revenue in 5 years, making you a premium acquisition alternative to one of your partners, selling for 5 times revenue, for a total of $250 million. That makes their $1 million investment for 10% equity worth $25 million, or 25x.

Bottom Line - make your projections using reasonable well thought out with assumptions that fit the criteria set out above.

Adopted from an artilce by Marty Zwilling

Business Legal Structures

When you form a new business, you have a choice of four kinds of legal structures: a sole proprietorship, a partnership, a corporation, or a limited liability company. Each of these has its own distinct legal and tax differences, and you should use these to your personal advantage. Here's an overview of each:

Sole Proprietorship
A sole proprietorship is usually for a small business with few, if any employees. The biggest advantage is that it is easy to form and operate. All profits and losses flow directly to the "proprietor" (owner) and are reported on his or her personal Form 1040. The disadvantage is that the proprietor's assets, everything they own, is not protected from creditors. If the business gets into financial trouble, their house, car, toys and everything they own can be taken to pay the business bills. If the owner dies, the fair market valve will be included in their estate.
Start-up costs and ongoing expenses (tax-preparation) are minimal. If you intend to work only for yourself, with just one or two maybe even part-time employees, consider a sole proprietorship.

Partnership
Partnerships profits also flow directly to the partners/owners personal Form 1040. This means that if you have loses, they are directly deductible (up to the amount you have invested/contributed) to the partnership. (Invest $10,000, lose $12,000 and deduct $10,000 first year and carry-forward the $2,000 loss balance to next year.)
The disadvantage again is no legal protection. Each partner is responsible for all the partnership bills. Be sure to have a "buy/sell" agreement, which is a formal, legal plan to transfer ownership if one partner dies or withdraws from the partnership.

Corporations
C Corporation
This is a separate legal entity that has its own assets (anything it owns) and liabilities (anything it owes). Individuals own stock in the company. It means that it is easy to split up or transfer ownership. If someone dies, the stock goes to their estate. If a stockowner/employee quits, they can either keep or sell their stock. Other individual investors or institutions can buy and sell the corporations' stock.
The primary advantage is that the shareholders have limited liability. If the business fails, goes bankrupt or is sued, the liability stops at the corporate level and the shareholders personal assets are generally not in danger. However, in closely held corporations (2-10 shareholders) the top executives may be held personally responsible for the actions of the corporation and in almost all lending situations, they will also have to personally sign the loan papers.
Double taxation is a disadvantage because the corporation has to pay takes on its profits and then if any of these profits are distributed to the shareholders, they also have to pay personal taxes.

S Corporation
A C corporation with less than 75 shareholders can elect to be classified as a "S" corporation. This allows both the profits and loses to be passed directly to the individual shareholders, in proportion the amount of stock they own, and avoids the double taxation of a C corporation. The S corporation can issue only one class of stock but preserves the limited liability for its shareholders.

Limited Liability Company (LLC)
This newer form of legal structure has two advantages. First, it is taxed like a partnership (all profits/loses flow through to the individuals) and second, it has limited liability similar to a corporation. It also offers flexibility in sharing of profits in that one person may control 25 percent of the LLC but receive 80 percent of the profits. Like a partnership, an LLC expires when an owner dies, so a buy/sell agreement is required.

There are other variations of all the above and it is strongly urged that owners engage legal and or accounting counsel to assist them in the determination of the best form for a particular situation.



Entrepreneurial Networking

Networking, in its simplest form, is meeting other people in a non-sales environment where you have the opportunity to exchange information.

As professionals, people donít like to do business with people they donít know. Getting to know each other is the first step in doing business with each other and networking is the first step in getting to know people. The networking objective is to exchange information, make an analysis of the information, and if appropriate, act on it.

Hereís a list on developing effective networking habits:

Sources. Use professional and social organizations in areas that could possibly be beneficial. Keyword here is "possibly." Reconnaissance each one, evaluate social events for business contacts and vice-versa. Networking is to exchange information and if appropriate, act on it!


Strategic Alliances

"Strategic" or the word "strategy," is a specific method to reach a goal or meet a need. It's both a science and an art and it involves a plan to reach a goal. Don't get strategies and tactics mixed up. Strategies are for long-term planning where "tactics" are for short-term goals."Alliance" is a formal pact of union in a common cause. It comes about because of an affinity or natural attraction between the parties involved.
So what we could be saying is that a Strategic Alliance is a specific method to reach a goal with an agreement with another. A key point for successful alliances should be that $money$ is not the key motivator.

Large and Small

Usually, a strategic alliance is a relationship between a large and a small company. The large company offers:

The small company offers:

It used to be that large companies looked for big ideas, sometimes internal like 3M which encourages development of new products internally, or IBM which founded "skunkworks" to get them into the PC business. Not true today. Today, large companies need a steady stream of innovations and they get these by strategic alliances, which often lead to acquisitions. -- Innovations equal alliances!

Pitfalls

One of the good ways to get you thinking about strategic alliances is a brief discussion on the potential pitfalls in putting together an alliance. Common pitfalls include:

CONSIDERATIONS

With all the industry consolidation and continuing downsizing going on in the large corporate environments, there are some subtle considerations for you to note. These fall under entrepreneurial due diligence requirements. Some can be accomplished prior to approaching a prospective alliance partner.

KEY ISSUES

Remember, seek strategic and operational synergies as well as cash. Money is NOT the key motivator to successful alliances.

How To Do It

You and your management team need to discuss and negotiate the basic deal. Don't bring your attorney along. However, bring your legal counsel into the behind the scenes discussions early on. Keep them posted on your progress so they understand your motivations and get a sense of the cultures involved. They can help you think through and develop some important points from the very start.



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2/02-2/16