BU121 Study Guide - Final Guide: Discounted Cash Flow, Blue Ocean Strategy, Operating Cash Flow

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BU121 Exam Notes
Finance
Lecture
Venture life cycle
1. Development- feasibility stage- from idea to business- prototype, trial
- Seed financing: comes from your own pocket and family and friends- gives you
money to develop
2. Startup
- Startup financing: your/family money + angel investors and venture capitalists
3. Survival- revenues pay some but not all expenses- borrow or give up equity (Equity is
more popular)
- First round financing: venture capitalists, business operations, gov assistance,
commercial banks, suppliers and customers- important bc if you can get trade credit
and you can pay suppliers after the customers have paid you, that is a source of
funding
4. Rapid-growth- cash inflows>outflows- cash flow positive- value increases (before this,
investors wont see a lot of value, but they will when they see positive revenue)
- Mezzanine financing- det ith a euity kike- someone wants to invest but
they are still a bit uncomfortable- they want the opportunity to change their debt
into equity
- Second-round financing- Funds raised to finance expansion
- Liquidity stage financing
5. Early-maturity- growth slows, most value realized- consider exit (investor might leave,
and so might the entrepreneur)
- Business operations, commercial banks, investment bankers
- Bank loans, issuing bonds, issuing stock
Approaches to Valuation
1. Income approach- Based on assumption that value of business = sum of the present
values of any expected future benefits income stream and/or liquidity event
2. Market Approach- Value is determined based on comparisons to similar companies for
which values are known (not easy)
- Maket ultiple- that company sold for a certain times revenue (like 5 times
revenue)
3. Cost Approach- Value determined as measure of net cost of assets, original amount
iested o ost-to-dupliate (easy)
Income Approach Methods
1. Discounted cash flow
deteie fee ash flos
- = operating cash flow capital expenditures
- use cash surpluses from cash budget, + potential liquidity event
discount for risk and time value of money
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- investors will use high discount rate for risk involved (early development 50-70%,
market studies and testing 40-60%, viable product and established market 35-50%)
2. Risk adjusted net present value probability of occurrence
3. Venture capital method- works backwards- watch
https://www.youtube.com/watch?v=mqnZaswHI1g
- Exit value= How much your company is worth in future
- Exit multiple= Factor that multiplies revenues to get exit factor
- IRR= Return rate expected by venture capitalist )not always 100%)
- post money valuation= valuation of today
- post oey aluatio= todays aluatio – investment by VC
BUT...
- no rules for valuating early stage companies due to too many unknowns
- Valuation professionals need an income stream, growth rate and discount rate to
value any asset
- In early stages, 2 of those 3 are very uncertain
Considerations for Applying the Income Approach
- Because the development of projections depends on specific outcomes and
milestones, one scenario of cash flow is inadequate
- The risk of failure is likely higher than the present value discount rate
Venture capitalists consider portfolios of investments
- If losses are forecast in the first few years, it is likely that they will occur and even
greater ones
- Valuations are driven by subjective factors
Management team (most important), value proposition, intellectual
property, time to market (how long until I make $?), path to profitability
(bumpy or smooth road?), capital needs and burn rate, industry volatility
(attractive?), and deal structure
Structure of Venture financing
- Negotiation reached where entrepreneur determines acceptable amount of
ownership to give up in return for money and expertise, and the investor asseses
risks and rewards
- Most external capital is raised through the issuance of preferred stock with
provisions to provide protection for the investor
- Royalty arrangements becoming more common bc they are good for the investor
and entrepreneur
o Good for investor bc the investor can reduce some risk- they take a
percentage off each sale
o Good for entrepreneur bc they can give less equity and they only have to pay
the royalty if it sells
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Growth Strategies
- risk/reward trade-off
- better to grow slowly than too much
Intensive growth strategies
- Market penetration= Sell more of your current product to current customers
- Market development= Sell your current product in new markets
- Alternative channels= Pursuing customers through a different distribution channel
- Product development= Develop new products to sell to existing customers as well as
new ones e.g. dot eed a a to use a iPad
Integrative growth strategies
- Horizontal Integration= Acquire / merge with a competitor
- Backward Vertical Integration= Acquire / merge with a supplier (e.g. Capells soup
makes their own cans- they have become their own supplier)
- Forward Vertical Integration= Acquire / merge with a distributor (apple has their
own stores for control purposes)
- Why vertical integration? Cost effective, in demand supply that is hard to get and
you want to control it
Diversification= Acquire / merge with a company that is unrelated to your business
Blue Ocean Strategy
- seeking the white spaces (blue ocean) where no one is playing, where opportunity is
found at the intersection of value and cost
- 4 actions to find white spaces:
o ELIMINATE something that the industry has traditionally done
o REDUCE something below the industry standard
o RAISE something above the industry standard
o CREATE something the industry has never done
- Value innovation= creating value at a lower cost
Example: Amazon eliminated physical stores, reduced the margins created a barrier to
opetitos / thees ot a lot of oo to opete hee the agis ae lo, ut at the
same time it brings their customers back
Harvest and Exit Strategies
- The method the entrepreneur and investor use to reap the value of their investment
- For entrepreneur personal as well as financial considerations (set up to operate
without you)
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Document Summary

Venture life cycle: development- feasibility stage- from idea to business- prototype, trial. Seed financing: comes from your own pocket and family and friends- gives you money to develop: startup. Startup financing: your/family money + angel investors and venture capitalists: survival- revenues pay some but not all expenses- borrow or give up equity (equity is more popular) Mezzanine financing- (cid:862)de(cid:271)t (cid:449)ith a(cid:374) e(cid:395)uity ki(cid:272)ke(cid:396)(cid:863)- someone wants to invest but they are still a bit uncomfortable- they want the opportunity to change their debt into equity. Second-round financing- funds raised to finance expansion. Liquidity stage financing: early-maturity- growth slows, most value realized- consider exit (investor might leave, and so might the entrepreneur) Income approach methods: discounted cash flow, dete(cid:396)(cid:373)i(cid:374)e (cid:862)f(cid:396)ee(cid:863) (cid:272)ash flo(cid:449)s. = operating cash flow capital expenditures. Exit value= how much your company is worth in future. Exit multiple= factor that multiplies revenues to get exit factor. Post (cid:373)o(cid:374)ey (cid:448)aluatio(cid:374)= today(cid:859)s (cid:448)aluatio(cid:374) investment by vc.

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