Financial Management for start-ups

Most founders of start-ups want to end up in one of two places; Becoming a public company (by having its IPO) or being acquired by another company. Each of these scenarios has played out at 2 of the last three companies I’ve worked at. If, as an entrepreneur, you want to reach either of these goals, someone in your organization must have a good grasp of finance.

It's been about ten years since I completed my MBA, but all the lessons remain fresh in my memory. I majored in Finance, so I was fortunate to have studied with many, primarily US (my business school was in the USA) finance professionals from organizations like Blackrock, State Street, Fidelity, and Bain Capital. I was even more fortunate to have completed an internship at a New York Investment Bank, Bryant Park Capital. 

During my internship and studies, I learned a lot about - valuing companies, presenting financial data to investors, and PowerPoint (doh! I'm an MBA, of course!). Most importantly, I started to understand the special language that Finance professionals use; Market Cap, Fifo/Lifo, beta, default risk premium, arbitrage, hedging and so on..

Back at business school, I hit it off with one of my professors, Don Margotta, who is an expert on corporate governance and shareholder activism. I want to share a few of the ideas here, that ignited my passion for Finance.

He encouraged me to take a PhD in finance, specializing in Corporate Governance (using my Law degree from LSE). But the idea of starving for five years, straight after spending two years studying for an MBA, was a bit much for me.

Here are some of the finance books, that I've found inspirational; Liar's Poker, Barbarians at the Gate, and Black Swan (where Nassim Taleb proceeded to pull apart all the concepts I'd devoted hundreds of hours learning in my Statistics classes).

First, Time value of Money. This one is crucial. A pound today is worth more than a pound you get tomorrow, which is worth more than a pound you make the next day, and so on. The interest rate drives this value.

If I said all Finance calculations stem from this one idea, I wouldn't be far wrong. For example, you could get a good read on the value of a company by using this method to calculate the present value of all it's future cash flows.

Or if you thought the company had legs, you could use the perpetuity equation here:

PV of a Perpetuity = PMT/I

PMT = $1,000,000

Interest rate = 2.5%

Company Value = $40 Million

When they start negotiations, many Investment Bankers will use earnings multiples to value a company; these vary for industries and countries, one may be x 4, some may be x 20. You will use the EBITDA figure for a company - Earnings before interest, tax, depreciation and amortization, which is a standard measure of a company's operating performance. Here's an excellent example of one such valuation, using two parameters - High & Low:

At Bryant Park Capital, I began using Capital IQ, to find comparable public company data to estimate a Private Company's value. I also used Bloomberg, when I was at MFS Investments, for the same.

I hope I've given you some ideas about valuing your start-up.

I have concentrated on Financial value in this article. However, it's important to remember that a large company will sometimes buy a startup because of its strategic value rather than its financial value.