These are some basic funding concepts (including valuation, pre-money, post-money & dilution) for early startup entrepreneurs and others who haven’t been exposed to Business and Finance.
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Basic Funding Concepts for Entrepreneurs
1. +
Basic Funding Concepts for Entrepreneurs!
Alok Rodinhood Kejriwal
Founder – therodinhoods.com
January 2014
2. +
Background
I’m a crazy entrepreneur and have been involved in
running a truck company, trading drums, making socks
and currently produce mobile games.
During the journey, I’ve have picked up some
important funding concepts that I want to share!
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Disclosure
I am not a techie. I’m a Business guy, and these
funding concepts are for early startup entrepreneurs,
students, technical nerds, folks who haven’t been
exposed to Business and Finance but WANT TO
learn.
6. +
Valuation
What is valuation? Is it a science, is it an art, or is it both?
Let’s tackle this question with an example:
Let’s assume that you run a Car Rental Company that had
profits of Rs. 75 lacs (US$ 125,000) last year.
8. + Valuation – made simple!
At a very simple level, to understand valuation, all you
need to know is the basic Interest rate that you can
safely earn (typically in your country).
Now, this is the basic Interest rate that a reputed bank
would pay you, without ANY RISK. We aren’t talking
about loan sharks here
9. + Valuation – made simple!
In India, the ‘basic rate’ of Interest is 10% (Jan 2014)
- Remember that your last year’s profit was Rs. 75 lac
(US$ 125k)
Question: What is the amount needed to be
DEPOSITED in a safe bank in India to earn Rs. 75
lac in Interest per year?
10. + Valuation – made simple!
Obviously Rs. 7.50 crore in the bank! (10% interest on
this amount would earn Rs.75 lac per year in Interest)
11. + Valuation – made simple!
Therefore, Rs. 7.50 crore is the BASE
valuation of your Car Rental Business!
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Valuation – important points
The ‘Base’ valuation of your business being
established, what makes your valuation go HIGHER?
-GROWTH! Money in the bank doesn’t grow on its
own. Businesses do!
-The creation of tech, IP, tools, processes that will
result in ‘future earnings’.
- Talent, leadership, skills in a Company that will
enhance future earnings.
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Valuation – important points
Lots of startup companies have ZERO revenues and
hence NO profits and yet get acquired or massively
funded for mind boggling numbers.
Why?
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Valuation – important points
Case 1: Because the acquiring Company HAS the
Business to use the startup companies’ assets &
talent and generate additional profits. (See the case of
youtube acquisition by Google here - Slide 15)
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Valuation – important points
Case 2: The zero revenue company HAS the business
plan to generate substantial profits in the future that
justify high valuations in the present
(Case: Facebook’s multiple rounds of funding
BEFORE it began generating revenues)
(Case: Snapchat’s current rounds of massive
valuations with zero revenue – similar to Instagram
before acquisition by Facebook)
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Valuation Summary
Profits
-------------------
Interest Rate
= Base (Minimum) Value of a Company
+ Add FUTURE to valuation Everything else
that Dumb Money in a Dumb Bank account earning Dumb
Interest CANNOT do; that YOU can, being an Entrepreneur
in control of a great Business with a massive future
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Note on Valuation (for the experts )
I have NOT complicated the valuation discussion by
introducing concepts such as DCF, NPV, Black-
Scholes model, etc.
The reason is that the PRIMARY concept of ‘Value’
arises from the OPPORTUNITY cost of Capital
which is very simply captured by the ‘riskless rate of
return’.
I have also not added the element of RISK in this
valuation method because according to me, Startups
ARE 100% risky. Hence anyone investing in a
Startup invests with the assumption that her money
will be lost.
19. +
What is Pre-Money?
“Pre-Money” is the value of your Business BEFORE it
gets funded.
Assume that your Car Rental company, as valued in
the previous slides, is raising money.
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Pre-Money
Let’s say that you pitch your Car Rental Business to a
VC and claim the valuation of your Company to be
Rs.18 crore (US$ 3 million)
Note - This is much higher than the Rs. 7.50 crore
valuation calculated earlier because YOU are a super
hero (at least you think so) who will grow the business
spectacularly!
Rs. 18 crore IS your “PRE-MONEY” valuation of your
Company.
21. + Pre-Money
The VC is a very smart lady and accepts the Rs.18
crore valuation of your Company!
She further commits to give you Rs. 12 crore (US$ 2
million) as an investment to aggressively grow your
business!
23. + Post-Money
This just needs common sense!
Rs. 18 crores (US$ 3 million) is the value you pitched
(Pre-Money)
Rs. 12 crores (US$ 2 million) is the money that the VC
will invest (Investment)
Hence, Rs. 30 crores (5 million) IS the new valuation
of your business OR POST-MONEY.
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Dilution
What is “dilution”? Sounds a bit scary!
Dilution is the share you sacrifice in your business in
return for money (or other value) received from
someone else.
.
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Dilution
In the example in the previous slide, you accepted:
Rs. 12 crores investment (US$ 2 million) in your Company
The POST-MONEY valuation we learnt was Rs. 30 crores
(US$ 5 million)
So, what will be your dilution (share you will have to give
the VC)?
28. +
Dilution
Common Sense coming to the rescue again:
Dilution % Rs. 12 crore (US$ 2 million)
-------------------
Rs. 30 crore (US$ 5 million)
= 40%
Hence, 40 % is the DILUTION you will have to suffer
(give) as a share in your business to the lady VC.
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Topics that can be added
Depending on the response to this deck, I can add
the following topics:
- Cap Tables
- Price Earning multiples (relevant when Companies get
acquired by Operating Companies)
- Ratios that must be kept in mind
- ESOP pool calculations
Do mail me – alok@rodinhood.com if you would like these
to be added
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Connect with me!
e-mail - alok@rodinhood.com
Facebook -
facebook.com/rodinhood
Twitter - @rodinhood
My social network for anyone
enterprising!
therodinhoods.com
Presentations –
http:slideshare.net/rodinhood