Entrepreneurial Manager Tool Kit Course Wrap-Up

1. Entrepreneurial Manager Tool Kit Course Wrap-Up The Entrepreneurial Manager Harvard Business School 1May 2001

2. The Entrepreneurial Manager Final Exam • Logistics - Section C • Friday, 4 May 2001 - 9:00am-1:00pm • Aldrich 10 (Aggarwal - Davis) • Aldrich 107 (De los Reyes - Tepperman) • Aldrich 108 (Terry - Zhao) • Print Labs - Aldrich 7 & 8 • Download Printer Driver! http://www.mba.hbs.edu/admin/tech/download/hp4050_win95.html • Computer Difficulties - Aldrich 7 • Diskettes Provided • Open Book / Open Notes

3. Entrepreneurial Manager Final Exam • Integrate Quantitative and Qualitative Analysis • What questions are you trying to answer? • How do the numbers inform your overall analysis? • Clearly state/defend your assumptions. • Be Specific in your Recommendations for Action • Support your recommendations with Analysis • Use Your Time Carefully.

4. What Pieces of “Analysis” Might You Encounter? • Understanding the Business Model • Assessing the Opportunity • Sizing the Market - How much market share does the venture have to get to meet the revenue targets? How will it do that? • Simple Diagnostics - e.g. “Taking the Company’s Temperature:” • Financial Ratio Analysis • How does the company make money? • Gross Margins • Asset Intensity • Cash Needs - Does the Company “Burn” cash or generate cash? How much will the company need to execute its plan? From whom should it raise money?

5. Additional Pieces of “Analysis” • Understanding Effects of Financing • Pre-Money and Post-Money Valuation • How much of the company must the entrepreneur give up? • How much of the company does the investor require to meet his/her required rate of return? • FV = PV(1+IRR)n => IRR = (FV/PV)1/n - 1 • Valuing the Company • Lifetime Value of Customers based on FCF • Customers we have today and those we expect to get. • FCF = EBIAT + Dep - CapEx - WC • CF = NI + Dep - CapEx - WC • Discounted Cash Flows (ke = rf + (rm-rf)) • EBITDA and/or Sales Multiples • Comparable Companies and Industries • IPO or M&A Transactions

6. EM - Three Broad Questions • What’s going on here? • How has the company gotten to this point? • What’s the business model? What kind of company is this? • Revenues, Costs, Financing… • What is the opportunity going forward? • What resources do they need to pursue it? • Cash? People? Customers? • What should they do about it? • Turn analyses into specific recommendations. • Not just the what but the HOW? • What are the risks? Anticipate consequences. • What can go wrong? What can go right? • How do we follow up? Measure the progress?

7. The Entrepreneurial Manager • Introduction - Welcome to the Territory 5 Classes • Fundamentals for the Entrepreneur 12 Classes • Recognizing Opportunity • Forecasting Cash Flows • A Venture as a Series of Experiments • Sources of Startup Funding • Building the Successful Venture 9 Classes • Starting Right • Building and Developing the Team • Managing Relationships • Alternatives for the Successful Venture 4 Classes • Achieving Liquidity & Sustaining the Enterprise • Summary - Pulling it all Together 2 Classes

8. What Did We Learn? e.g., term-sheets, pre- & post-money valuation, venture capitalists, IPOs New Knowledge e.g., evaluating an opportunity, reading a contract, unbundling risks Skills and Frameworks Action in the face of uncertainty. Entrepreneurial Point of View

9. What Did We Learn from theEntrepreneurs & Advisors We Met in Class? • Bob Reiss (TV Guide Game) • Barb Schetter (R.R. Donnelley) • Charles Ferguson (Vermeer) • Chris Peters (Microsoft) • Dr. V. (Aravind) • Jeff Parker (Technical Data) • Adi Cooper (Tracmail) • Ann Meceda (PCC) • Paul Ognibene (Clubtools) • Sue Krukonis (Anasazi) • Terry Opdendyk, Andy Swett (ONSET) • Doug Macrae (Videoguide) • Ralph Wagner (Walnut) • Bob O’Connor (RBS - Walnut) • Jim Sharpe (Extrusion Tech) • Robin Wolaner (Parenting) • Rajath Chaudry (Lawyers & Leases) • Matt Lieb (Kingsley Management) • Sharon Ward, Paolo (Return Logic) • Jim Fitzgerald (Balance) • Barry Arnold (Retail Sports) • Nick Lazaris (Keurig) • Ginger Howard (Guidant) • Tom & Tom (Nantucket Nectars) • Alan Ellman (Screaming Media) • Candace & Chris (Kendle) • Louise Kitchen, Jeff Skilling (Enron) • Katy, Andy, Elyce (kate spade) • Rob Adler, Jeff Parker (CCBN)

10. Knowledge, Skills & Frameworks • What is Entrepreneurship? • Approach to Management • Opportunity is the Driver • An Iterative Process • Opportunity Analysis • Reading Business Plans • Assessing Business Risks • Diagramming Business Models • Fishbone Analysis • PODC Framework • Estimating Cash Flows and Drawing Cash Curves • Risk/Reward Curves • Probability of Failure • Expected Value of Returns • Robustness of Upside • Entrepreneurial Experiments • Value of Information • Mitigating Risks by Staging Experimentation and Funding • Due Diligence and Milestones • Financing • Term Sheets • Pre-Money, Post-Money • Sources of Financing • Interest Coverage • Deal Structure • Contracts • Leases, Term Sheets, Employment • Corporate Forms • Managing Personal &Tax Liability • Working with Lawyers • Questions to Ask • Structuring the Relationship

11. Knowledge, Skills & Frameworks (Continued) • Creating a Sustainable Venture • Preparing for Liquidity Events • IPO • Private Sale • Strategic Investments • Creating Structure and Designing Processes • Flexibility vs. Discipline • Organizing the Team for the Next Stage of Growth • Self Assessment? • Personal Propensities for Risk, Uncertainty, Ambiguity? • Desire for an Entrepreneurial Life? • Building the Team • Interviewing Methods • Sharing Equity • Building the Board • Selecting Advisors • CEO Redeployment • Managing Relationships • Business Development Process • ID Opportunity • Mapping the Business Network • Screen Potential Partners • Structuring Deal Forms • Acquisition • Alliance • Equity Investment • Technology Licensing • Managing the Relationship

12. Introduction • R&R (Robert Reiss) • An Entrepreneur follows Opportunity • An Entrepreneur spreads Risk and Owns very little • R.R. Donnelley (Barb Schetter) • Big Companies also have opportunities • Vermeer (Charlie Ferguson & Randy Forgaard) • A Visionary, A Technologist, still need A Manager • VC can help even if not a “friend” • Vermeer/Microsoft (Chris Peters) • Big Company seeking opportunity via acquisition • Aravind Hospital (Dr. Venkataswamy) • Grand Goal as an “Opportunity” • The Deal with People can be more than about Money

13. Introduction to Entrepreneurship • A way of managing rather than a specific economic function or a characteristic of an individual. • An approach to management that begins with OPPORTUNITY. • HBS working definition: • The pursuit of opportunity without regard to resources currently controlled.

14. Entrepreneurial Process: Identify Opportunity Marshal Required Resources Never- Ending Process Exploit Deals Act Harvest

15. Dimensions of Business Practice Promoter Trustee Administrative Entrepreneurial Strategic Orientation Opp. Driven Resource Driven Commitment to Opportunity Revolutionary Evolutionary Investment Multi-Staged Single-Staged Control of Resources Use or Rent Own or Employ Management Structure Networks - Flat Formal Hierarchy Compensation/Rewards Value/Team Individual

16. Fundamentals: Opportunity Recognition • Technical Data Corporation (Jeff Parker) • Build on Experience • Select Investors for more than just money • Don’t say No out of Envy • Tracmail (Adi Cooper ) • Competing on Price is Tough • Seek Barriers that Protect • What are the barriers to Competitive Attack? • Private Communications Corp (Ann Meceda) • Not every Idea is an Opportunity • Understand your business model and experiment • Nothing goes exactly as planned

17. Fundamentals: Forecasting Cash Flows • Club Tools (Paul Ognibene) • Pick Investors Carefully • Cash Flow Forecasting Dilemma • Go big or start small • Anasazi (Sue Krukonis) • Going around the Distribution Channel is Challenging • Cash is King

18. Opportunity Analysis:Knowledge, Skills & Frameworks • Reading Business Plans • Assessing Business Risks • Diagramming Business Models • Fishbone Analysis • PODC Framework • Estimating Cash Flows and Drawing Cash Curves • Risk/Reward Curves • Probability of Failure • Expected Value of Returns • Robustness of Upside

19. Understand the Business Model... Driver 1 Driver 1 Driver 2 Revenues Driver 2 Driver 3 Driver 3 Profits Driver 1 Using the Tool 1. Draw the key drivers of revenue and costs. 2. Identify key drivers and quantify assumptions. 3. Test sensitivity to changes in key drivers. 4. Analyze how reasonable key assumptions are. 5. Use the tool to surface key assumptions, logical inconsistencies, critical sources of uncertainty and important questions to ask Costs Driver 2 Driver 3

20. Dynamic Fit Management Change (Good & Bad News) People Context Opportunity Deal Pattern Recognition What can go wrong? What can go right? Risk/Reward Management Learning

21. The Cash Flow Cycle for a Venture CumulativeCash Flow in $ Date of First Cash Flow Positive Time Dateof CashBreakeven MaximumFinancingNeeds BurnRate

22. Goals in Managing Risk and Reward: - Increase Probability of Success - Increase Expected Returns Probability of Occurrence Expected Value Probability of Losing 100% +100% -100% Managing Risk and Reward • What are the underlying assumptions and drivers of the decisions? • What will change the odds? +25% Return on Investment

23. Fundamentals: Entrepreneurial Experiments • Value of Information Exercises • Experiments Pay when Cost and Probability of Failure are High. • Value of Information Depends on Alternatives • ONSET Ventures (Terry Opdendyk, Darlene Mann, Andy Swett) • Sequential Investment • Milestones, Objectives and Risk Mitigation • Venture Capital Model to Startups • Videoguide (Doug Macrae) • Product Driven (Field of Dreams) • Big Upfront Costs in Hopes of Lower Variable Costs Later • “Go Big or Go Home” Strategy May Send You Home Early

24. The Venture as a Series of Experiments:Knowledge, Skills & Frameworks • Value of Information • The Venture Capital Approach to StartUps • Mitigating Risks by: • Staging Experimentation • Staging Funding • Due Diligence and Milestones

25. SUCCESS Payoff - Investment INVEST NOW P S (1-P ) S - Investment FAILURE SUCCESS Payoff - Investment - Cost of Test INVEST P S|G (1-P ) S|G GOOD RESULTS - Investment - Cost of Test 1 FAILURE P G ABANDON - Cost of Test 1 RUN A TEST SUCCESS Payoff - Investment - Cost of Test P INVEST S|B (1-P ) (1-P ) S|B G - Investment - Cost of Test 1 FAILURE BAD RESULTS ABANDON - Cost of Test ABANDON 0 Running the Experiment

26. Staged Experiments Level of Commitment Commercialization Prototype Validation Mitigate Risks Idea Time

27. Phased Investment Decisions Invest Invest Abandon Invest Abandon Invest Second Abandon First Abandon Seed The option to abandon can be more valuable than the option to continue. Founding

28. Fundamentals: Sources of Financing • Walnut Venture Associates A (Ralph Wagner) • What do Angels want? • How do you find out about a company and its people? • Walnut Venture Associates D (Bob O’Connor) • What do Entrepreneurs want from Financial Backers? • An Angel Term Sheet Can Look Like a Camel • Extrusion Technologies (Jim Sharpe) • Banks as a Source of Funds • Sophisticated Experience Prevented Mundane Mistakes • Parenting Magazine (Robin Wolaner) • Experiment gave good results but didn’t raise $ • Corporate Partners have different needs • Career of the Entrepreneur (Each venture leads to others)

29. Sources of Financing:Knowledge, Skills & Frameworks • Term Sheets • Pre-Money / Post-Money Valuation • Dilution • Matching Opportunity to Source of Funding • Sequencing Financing • Calculating Interest Coverage • Negotiating Deal Structure

30. Which Funding Source Do I Pursue?Ask Yourself… • How much money will we need? • How deep is the cash trough? • What stage are we in the life-cycle of this opportunity? How close to break-even? • What are the exit options? • From whom should we raise money? • What do they provide in addition to funds? Expertise? Networks? Credibility? • What will be their impact on our future fund-raising efforts? • How will this deal influence our future flexibility? • What are my personal preferences? • How much control am I willing to give up? • Am I willing to make a personal guarantee? • What level of risk can I--and my family/significant other--live with? • Is this a good time to raise money? • What is happening in the broader capital markets right now? • Is the IPO market hot right now? Will it still be hot when we want to sell?

31. Sources of Financing • Own Money/Customers/Suppliers • kate spade, Kendle • Friends and Family • R&R, Technical Data, PCC • Angels • Walnut: RBS, Nantucket Nectars • Incubators • Clubtools, Peoplestreet • Venture Capitalists • Vermeer, Return Logic, Keurig, Anasazi • Asset Lenders (Banks) • Jim Sharpe • Corporations • Parenting Magazine, CCBN

32. Alternative Sources of Funding Financing Source Pros for Entrepreneur Cons for Entrepreneur

33. Building the Successful Venture: Contracts • Lawyers & Leases (Rajath Chaudry) • Seek Strong Professional Advice • Early Decisions Matter • Beware of Conflicts of Interests • Kingsley Management (Matt Lieb & Chris Jones) • Don’t be Too Clever about Financing • Fit Structure to Strategy • Return Logic (Sharon Ward, Paolo Motturo, Andrew Chan) • Dividing Equity has Repercussions • Terms in Each Financing Affect the Next Round • Decisions you Make Today Affect you Tomorrow

34. Building the Successful Venture: ContractsKnowledge, Skills & Frameworks • Leases • Term Sheets • Employment Contracts • Corporate Forms • Managing Personal and Tax Liability • Working with Lawyers • Questions to Ask • Structuring the Relationship

35. Building and Developing the Team • Cambridge Incubator: Peoplestreet (Mark Pitts) • Hiring is Critical and Can be Learned • Hiring Well is a Competitive Weapon • Hiring Mistakes are Expensive and Take a Long Time to Correct • Balance Inc. (Jim Fitzgerald) • Seek Advice but Don’t Compromise Personal Objectives • Don’t Hire People You Don’t Like • Use Board and Advisors for Recruiting • Retail Sports (Barry Almond) • Bad Things Can Happen to Good Entrepreneurs • “Should I Stay or Should I Go?”

36. Building the TeamKnowledge, Skills & Frameworks • Interviewing Methods • Sharing Equity • Building the Board • Selecting Advisors • CEO Redeployment

37. Reducing Risk in Hiring • Be clear in the job description • Stage your investment in rounds of interviews • Hire part-time or as consultant before full-time • Include different perspectives in the interviewing • Content-e.g., skills, fit, background • Interviewing approach • Interviewer perspective • Check references • Write an explicit employment agreement • Think about questions

38. Entrepreneurship is a Team Sport • Board of Directors • Experienced Investors (e.g. VCs) • Mentor or Coach for CEO • Industry Expert • Top Management Team • Functional Expertise • Experience (Start-up and Large Company) • Organizational Fit • Professional Advisors • Lawyers • Accountants • Executive Recruiters

39. Entrepreneur’s Dilemma Entrepreneur’s Vision Yield Control to Others -Investors -Board -Top Managers Reduce Uncertainty Bring in Critical Resources -Money -Professional Management -Advisors

40. Managing Relationships • Keurig Coffee (Nick Lazaris) • R&R Revisited - Setting up the Virtual Company • Assembling a Complex System of Stakeholders • Guidant Radiation Therapy (Ginger Howard) • What do you Have? What do Need? What Deal gets you There? • Finding the Next Big Thing • Nantucket Nectars (Tom & Tom) • Be Willing to Do the Laundry, if Necessary • Distribution is Not Obvious • Achieving Liquidity while Preserving a Role

41. Managing RelationshipsKnowledge, Skills & Frameworks • Business Development Process • ID Opportunity • Mapping the Business Network • Screen Potential Partners • Structuring Deal Forms • Acquisition • Alliance • Equity Investment • Technology Licensing • Managing the Relationship

42. The Business Development Process Develop Business Model Identify Opportunity Identify/Screen Potential Partners Structure Deal Manage Relationship Clearly Articulate Opportunity Evaluate Opportunity Map needed resources/skills Decide which to do in-house and which outsource Identify potential partners Apply preliminary screen Evaluate finalists on key criteria Evaluate alternative forms -Licensing -Equity investment -Alliance -Joint-venture -Acquisition Structure contract to manage risks -Transfer -Reduce -Share Negotiate Deal Manage portfolio of ongoing partnerships -Key metrics -Individual and portfolio level Manage relationships -Ownership -As they evolve -Multiple points of contact

43. Managing Relationships • Ongoing management is required because reality is too complex to fully contract. • Guidant’s Approach - Ginger Howard: • Identify an Owner on each side responsible for the contract, negotiation and deliverables. • Philosophical Alignment of People and Business Processes. • Formal Reviews - Milestones, etc. • Constant Communication - Talk every day… • Ruthless Honesty.

44. Creating a Sustainable Venture • ScreamingMedia (Kevin Clark) • Moving from Chaos to Structure • Having Cash in a Downturn is a Strategic Advantage • Kendle International (Candace and Chris) • Build Organization for Next Stage of Growth • Valuations in Private vs. Public Markets • Enron (Louise Kitchen & Jeff Skilling) • Is there Entrepreneurship in Large Organizations? • Can you Develop Processes that Maintain Flexibility and Foster Pursuit of Opportunity? • kate spade (Katy, Andy, Elyce, Pamela) • Money to Grow vs. Money to Compensate for Past Efforts • CCBN (Jeff Parker) • Is Entrepreneurship Learnable?

45. Creating a Sustainable Venture Knowledge, Skills & Frameworks • Preparing for Liquidity Events • IPO • Private Sale • Strategic Investments • Creating Structure and Designing Processes • Flexibility vs. Discipline • Organizing the Team for the Next Stage of Growth

46. Achieving Disciplined Entrepreneurship Benefit of Discipline Benefit of Flexibility Level of Structure Start-up Established Firm

47. Taking it to the Next Level.. • Can you scale up the business model, especially cash? • Can the management team make the next step? • Who do you bring along to the next step? Who do you leave behind? Who gets on board? • Management • Investors • Customers • Partners

48. Avoiding the Flat-Line... • Actively search for opportunities • Obsess about your customers • Frame crises as opportunities not threats • Frame action as experiment • Don’t fire scientist when experiment fails (except if he runs same experiment twice) • After you raise the money, avoid the temptation to bet it all on one hand or roll of the dice.

49. What’s Stopping the Big Guysfrom Doing It? • Attackers’ Advantages • Innovative Business Concept • Sense of Urgency • Start-Up, Speed-Oriented Culture • Opportunity focused • Network of Relationships • Shareholder Value Focus • Defenders’ Dilemma • Cannibalization fears • Channel conflicts • Resource driven • Curse of the deep pocket • Current income focus • Conventional mindset

50. Entrepreneurial Point of View • Make Decisions Today and in the Future to Ensure that: • What can go right, goes right. • What can go wrong is avoided or will not critically wound the company. • How can I make the future that I want to happen actually happen? • Knowledge, Skills, and Frameworks Mean Little without Action. • The great end of life is not knowledge but action. • T.H. Huxley • An ounce of action is worth a ton of theory. • Friedrich Engels