Entrepreneurial Finance Module 3


Hi; I’m Rana. Now, we’re going to start Module 3. Now, in Modules 3 and 4, we’re going to
actually construct a financial plan, and you’re going to understand how to construct a financial
plan in these two Modules. Now, this is pretty dense stuff, actually,
so we’ll go about it systematically, you and I, and here’s what I’m going to ask
of you. Be your good-researcher self. Be detail oriented. Be methodical. We’ll walk through it step by step together. Before we get started, let me offer two constraints. Constraint number one—that you have something
cool. I’m assuming you’ve got something cool
that you’ve made, meaning you’ve got a molecule or you have a device or you have
some really cool data, or you wouldn’t be watching this because you’re looking at
this and thinking, “This is pretty cool. How do I take this forward? I think I can do a lot for people.” That’s number one. Number two is that you have the answers to
three questions. One, what’s the need in the marketplace
for whatever you have that’s cool? Not the want, not the interest, not the cool
factor, but the need. You have identified who needs this. Number two—you’ve identified who your
customer is, who needs this—your customer—and all of the stakeholders around your customer. There are always other parties who are interested
in this coming to market. Number three is the value proposition. The value proposition is why somebody is going
to write you a check for your solution of whatever it is that you’ve made. Now, there’s a process called customer discovery. If you get on the web and type in customer
discovery, you’ll find books, articles, videos about how to engage in customer discovery
to answer these three questions. This is a very, very important process. And, by the way, it can take months. It should take months. It requires you to go out into the street,
talk to your customers and all of your stakeholders, and learn the answers to these questions. But what it does is it validates your hypothesis
because you think you know why people are going to need this, but the fact is it’s
an iterative process of revisiting your hypotheses and accepting or rejecting some of them to
determine why they really need it and what the value proposition is. Also, in so doing, you gather a huge treasure
of assumptions that are so valuable before you embark on your financial plan. So, three things—you need the need of the
marketplace, who’s the customer, and the value proposition. I’m assuming you’ve answered those three
questions. In Module 1, I introduced two words—time
and money—time and money constraints. So, now, those words are going to come back
and help us because now we’re going to calculate your burn rate. Well, a burn rate is the amount of money that
you spend in a given period of time. And what are we talking about? We’re talking about the obvious things of
your salary, travel, clinical trials, product development. All of these constitute your burn rate, which
we’re now going to calculate. What we’re going to do is identify different
points in your venture’s lifespan and find out how much does it cost to reach those various
points and add up those figures in order to find out what a monthly, quarterly, or annual
burn rate is. Now, classically, how do we do this? Well, classically, we do it one of two ways. One, as I just indicated, maybe open up a
spreadsheet and you say, “All right, here are my line items—salaries, clinical trials,
travel, etc.” And, by week or by month, you start filling
in those numbers until they march across the page. And then at the end of the year, you say,
“Oh, that’s how much we’re going to spend.” That’s one. Number two—all too often, we look at each
other or we look at the ceiling or we look at each other and we say, “What do you think?” “I think we’re going to spend $200,000
in the first half of the year, and, I don’t know, $400,000 in the second half of the year. What do you think?” Well, first of all, let me stop and say that
$200,000 and that $400,000—you just calculated an annual burn rate. The problem is, remarkably imprecisely because
you don’t really know what you’re going to achieve. They’re just a couple of numbers. Now, I will confide in you, when I taught
entrepreneurial finance and my students would hand in their assignment, and I would look
at them and I’d realize they just did one of those two things. And I’d say, “Here’s what you guys just
did.” And they’d look at me and they’d be like,
“Dude, were you in our study group last night?” And the answer is, yes, not too long ago,
I was in your study group last night. But then I learned the way to go about doing
this is by identifying milestones and by calculating the cost of how much it’s going to take
to achieve those milestones. So, what are we going to do here? What are we going to do differently? We’re going to write a milestone-driven
financial plan. By identifying the milestones in your plan
we can calculate your burn rate. Going back, we had four words that I introduced
in the beginning, which were constraints, plan, milestones, and assumptions. New word, though—process. The fact is, within your plan, there are multiple
processes. I’ll name a couple—product development,
clinical data. Okay, these are processes that are ongoing
throughout your life cycle, but what we’re going to do is identify the relevant milestones
within those processes, and others. Remember, a milestone-driven plan is the way
to calculate your burn rate because a milestone-driven plan is what investors want. Why? Investors are buying milestones. Why? Because with every milestone, you’re increasing
value and decreasing risk. By dividing your plan into processes and then
by identifying milestones along the way with those processes and quantifying those milestones
through assumptions to address constraints of time and money, we calculate your burn
rate. Now, also keep in mind that some of these
processes will be concurrent. Some of them will be in serial. And if that sounds like it’s really complicated,
let me remind you—going back to Module 1, and you do this all the time. Let me give you an example. Getting your child and you ready in the morning
and going off to school and work. So, first, you have two parallel processes
of getting yourselves ready. Then, you have a milestone of getting out
the door. After that, you have a single process of getting
your child to school, followed by another single process of getting yourself to work. I point out this simple example because you
know how to do this, and you know how to identify processes that are both in parallel and in
serial. So, let’s start with a simple plan. I’m going to identify a process and a single
milestone and a few assumptions. So, here’s an example for you. Let’s try product development. Okay, so, product development is an ongoing
process, probably throughout your venture’s life cycle—gen 1, gen 2, gen 3, product. So, that’s the process. Let’s pick a milestone of your first working
prototype. Okay, so, there’s your milestone. And let’s identify a few assumptions. Okay, assumption number one is you’re going
to have to buy some instrumentation. So, let’s say that you’ve identified that
the instrumentation is going to cost $350,000. Now, you need some people to build your prototype
for you. So, you’re going to have to hire, full time,
a mechanical engineer, and that person is going to cost $100,000. Then, you’re going to hire, part time, a
software engineer, and that person is going to cost $40,000. You’re also going to need, let’s say part
time, a manufacturing engineer to make sure you can scale this thing up, and that person,
part time, is going to cost $20,000. So, in order to get to this prototype, you’re
going to spend on people $160,000 in the course of the year. But you also are going to have to use a prototyping
house, an outsourced prototyping house. Now, they estimate that each iteration of
making a prototype for you is going to cost $30,000. Now, as much as you and I would love for one
iteration to succeed, let’s plan on four—four iterations of going to the prototyping house,
with each one costing $30,000, for a total of $120,000. When you add up all these numbers, we’re
looking at $630,000 to burn to achieve in one year the milestone of a working prototype. Let’s pick a second example. Let’s try clinical data. Okay—once again, probably an ongoing process
for the life of your venture. The first milestone you might want to achieve
is clinical validation. You have to run a small clinical trial. Okay, let’s look at some assumptions. You have identified four locations. You’re going to need four locations in which
to run the trial. You’ve also figured out that it’s going
to take a full nine months, so nine months of finding the patients and running the trial
with the patients. Okay, next thing—each location is going
to cost, you estimate, $300,000 to $450,000, for each location, four locations. So, for this milestone, which is clinical
validation, nine months, we’re looking at $1.8 million to achieve that milestone in
nine months. I just mentioned a couple of assumptions just
now. The fact is, you could find 20, 30, or 40
assumptions for each milestone that you have to reach. So, in this case, you’ve got to take those
assumptions to build the milestone and then weave those into your processes. And there’re going to be several processes
concurrently that are ongoing. For simplicity’s sake, just to be clear,
I just identified one assumption just now. Now, the next question you might ask is: Fine;
I understand. Where do I get all of this information? Well, remember I mentioned customer discovery
before? The first place you go, always, is back to
your customers. So, ask your customers and all those stakeholders
about these assumptions for you to achieve milestones—identifying milestones and what
are the assumptions to get there. After your customers, the next obvious place
to go is your vendors. Always go to your vendors. They’re selling into your marketplace. They’re probably selling right to your customers. Who knows? And they’re probably selling to your competitors
as well. And while we’re on the subject of competitors,
always talk to your competitors. You’ll find out so much. Don’t put your head in the sand. Talk to them. You’ll find out a great amount. Fourth—go to your investors. Your investors have an interest in what you’re
doing. They’re the ones that will actually help
you identify relevant milestones of what they want you to achieve. Fifth—this fifth source of information is
possibly the most rich of all. While you’re talking to customers, vendors,
etc., you’re also going to learn about companies to whom they compare you. We call those comparables. I know, not very creative. So, they’re going to say, “Oh, you’re
doing something like such-and-such company, which has maybe a similar device or is going
after a similar indication or has a similar business model to you. So, these comparables are other companies—they
could be still existing or they could have already been sold or maybe they even died,
but they have rich amounts of information. So, what you want to do is talk to these people
and gather the data for your assumptions—as many primary and secondary assumptions as
you can get your hands on. Fill in the gaps with tertiary if you have
to. But more importantly, also, identify the relevant
milestones for what you need to achieve, because by putting together all of your assumptions,
weaving them into milestones and then processes, you can calculate your burn rate. I’m going to identify another process. And we’re going to talk about one that researchers
really don’t like to talk about—sales. I know, eew, sales; nobody likes to talk about
sales, especially researchers. But the fact is, if you’re not selling anything,
you don’t have yourself a business, and sales is something that extends through the
life of your venture. So, if—let’s identify your milestone as
your first sale. When are you going to get to your first sale? What’s that going to take? Now, I can’t tell you when that’s going
to happen, but here’s where we can make some assumptions, which is this. The average sales cycle from the first time
you meet a customer until that customer writes a check—that can take 18 months. Okay, so, there’s one assumption. Next assumption—who’s going to actually
do the sales? Well, you’re going to have to hire a salesperson. Let’s say that person costs $80,000 a year
plus a commission to be determined. But you know the base salary is $80,000 a
year. Second, you’re going to have to send a technical
person, a technician perhaps, from your lab to those meetings with the salesperson to
help close the sale. That’s another person. That person is going to cost, let’s say,
$100,000 a year. Third—a very subtle point here—your lawyer,
your corporate counsel, may have to draft the contracts that you’re going to have
to write for each one of those sales. And, usually, with each one there’s a little
bit of language and negotiation, so you’re going to need your counselor, and let’s
say your counselor costs $400 an hour. Now, you have a mish mash of talent here. Maybe you have a dedicated salesperson, but
let’s say that technical person also works in the laboratory. Okay. A couple of other assumptions you’re going
to have to figure out: How many sales calls, how many meetings, how many emails is it going
to take to close one sale? Another assumption you’re going to have
to figure out: How many customers in the pipeline can your salesperson handle at once? Two, five, a hundred—remember, customers
are going to come and go from your pipeline. What I want to point out is that the sales
process is not as linear as, say, the product development process. It’s more complex. There are many more moving parts. Now, what’s going to happen is this. Actually, as it evolves, that sales process
is going to evolve into a sales plan. I know; I just said sales plan and you’re
thinking, “Hold on. How many plans am I writing?” Well, today, you’re writing one with several
processes. But the fact is, as your venture matures,
you’re going to end up writing a sales plan, an operating plan, and a marketing plan. But, today, to keep it simple, at this level
of just getting started, we’re just going to call them processes. Now, I identified just now three processes. These are ongoing processes that go on for
the life of your company. And we’ve also learned that within each
of those processes, we’re going to segment into milestones. And the goal here is to calculate the burn
rate to achieve each of those milestones. But, now, here’s what you can do with that
information. Let’s say you want to answer the question
of: What’s going to be my burn rate for a given quarter, let’s say 2018—second
quarter 2018? What’s going to be my burn rate that quarter? Well, by looking at this, you can look at
the ongoing processes, overlapping ongoing processes, during that quarter. And you can add up the burn rates of each
of those processes in the course of that quarter, and by summing them up, you get a total burn
rate for second quarter ’18. Let me point out one of the most powerful
aspects of this approach. All entrepreneurs want to know how much money
to raise. So, usually, what we do is we ask, “How
much money should I raise?” Well, the answer is in your milestone-driven
plan. Let your milestones guide you to determine
how much money you should raise. Here’s how you do it. Talk to your investors. Your investors and you will identify what’s
the top milestone, perhaps what’re the top three milestones that they value most. Knowing that, you can calculate how much money
you should raise. Keep in mind, the first draft of anything
is never the final draft. So, you’re probably going to have to rewrite
this a few times. It’s a collaborative process with you and
your investors. You’ll show them a draft, and they’ll
refine it with you, and you’ll go back and bring it to them again. Now, for my current company, I actually had
to write four financial plans. The first three times, I showed them to my
investors. In very technical financial talk, they said,
“Naw, we don’t like this.” But they told me what they didn’t like,
so I refined it and brought it back to them. And the fourth time was the charm. What’s an example of what might change? Well, let’s say one investor values customer
validation. That’s the milestone the investor wants
you to meet. Another investor may say, “Well, actually,
I value clinical validation,” and that’s the milestone for that investor you want to
meet. A third investor may say, “I don’t have
as much money as those guys,” so you’re going to want to identify an interim milestone
for that investor to buy. So, whether you’re shifting priorities,
whether you’re shifting milestones, whether you’re shifting timelines, your milestone-driven
plan allows you to be flexible with understanding and calculate how much money to raise to meet
the demands of your investors. What’s our objective for these Modules? Our objective is to set you up to succeed. Today, I outlined three processes. For each one, I named one milestone and a
few assumptions. By no stretch was this designed to be comprehensive. It was designed to focus your attention on
just how much work goes into making a comprehensive, rigorous financial plan. The fact is, you may identify 5 or even 15
different processes for your venture, but by implementing these systematic and repeatable
steps that we used today to quantify assumptions in order to calculate milestone burn rates,
you can apply that methodology across all of the processes that you’ve identified. And you could even do it with something as
complex as your sales process.

One thought on “Entrepreneurial Finance Module 3

  1. Hi! I am begging you. Please! Help me. I need to finish one assignment on entrepreneurial analyse of business model. Pleeeease! I do not have a background on Finance. At least on what conditions you will help. Please! Sorry for being emotional

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