BUSINESS MODELS - The interaction b/w an organization and value; 1) Customers – who the value is created for; 2) Value
propositions – how the value is created thru
Performance – or the same activity but better; Cost – same performance but cheaper; Specifications/customization – newly segmented market offerings; Capabilities – truly new activities; 3) Pricing and Cost Structures – how the organization captures value thru Pricing Innovations – dell, subscription models (software as a service), and freemium (gaming); Cost Structures – economis of scale (fixed vs. variable costs) and econimes of scope… Business Models Types: 1) Platform – value created by connecting multiple groups either directly through transaction platforms or thru social networks, and indirectly thru ad networks and user base; 2) Blended – creating two distinct value props using same set of assets and capabilities (Costs increase modestly while rev increases sharply + Positive feedback possible on top of scale economies); 3) Segmented – different offerings for distinct customer segmets (Mass personalization – for example Uber options (UberAlternate and UberAlternateX) provides granularity and breadth); 4) Network - Direct Effect- Communication technologies => standards, devices, and social platforms… Indirect Effect – Platforms (entertainment) and commercials/transactions -> Ebay – buyers benefit from more sellers, and vice versa; 5) Disruptive Tech- tech that start; better in some important way, worse in other important ways (but improve rapidly), initially a nice market (who values the better? – people who can take risks, so wealthier people) and eventually pervasive; 6) Recurring Purchase – business models w/ recurring purchases (revenue) grow quickly as existing customers buy more and new customers are all incremental growth Bundled product that includes a consumable (razor/blade, medical diagnostic equipment), and subscriptions (network products); 7) Viral – Word of mouth is an inexpensive and powerful way for a company to grow Viral BM’s automate and turbocharge this effect; Current customers/users recruit new customers/users simply by using the product or service (Hotmail!); 8) Long Tail – Most businesses focus on a few dominant products, the long tail focuses on many nice products -> Have to be enabled – providing the tail to customers efficiently and effectively FINANCIAL MODELS: Steps – 1) Goals and Vision; 2) Products and Revenues; 3) operating Expenses; 4) Customer Acquisitin (although not exactly a linear path) = 1) Goals 3-5 year vision of what we’re going to do -> stated as concretely as possible and in operating terms (E.g. locations for a new restaurant, unit sales for a semiconductor company, or registered users for an app); 2) Revenue model – unit sales and pricing; quantifying value creation and capture; Translates goals into dollars by formalizing how much of what products the firm expects to sell at what prices w/ Unit volumes from goals and unit prices to determine revenues; 3) Operating model – operating costs; sustaining the business model -> Identify major operating costs to implementing the business model -> Project major costs over the model horizon (must be consistent w/ rev. projections) -> Combine with rev model to produce operating profit margin trajectory; 4) Sales model – customer acquisition costs; building the relationship w/ customers -> Identify major costs to aquire customers in the BM -> Project costs over the model horizon but Must be consistent w/ customer acquisition implied in rev. projections = Financial Model – given the BM goals, and combining the three above models, provides projected cash flows (including potential upside, capital required, as well as early losses and profitability – lifetime value of a customer) Uses -> 1) Quanitfy the opportunity – discipline and communication; potential value; 2) Understand resource requirements – assumptions imbedded in goals and capital requirements; capital to cover early losses; 3) Refine customer acquisitions strategies – customer acquisition vs. LTV; rationalize sales strategy; Fincanial Models -> Revenue Model = costs of operating model = LTVC of sales model = Sales effort/strategy of revenue model (cycle) - Building the sales model last is useful, but can lead to complications => Early revenue – accounts for revenue ramps in rev model while Early margins – discounts part of the sales model Model Concepts – OM = last years op cost/revenue = Eventual profitability; if cash flow negative, sum up then multiply 1.5-2x for cap needed VENTURE CAPITAL: VCs need explosive business models; the VC model – throw a bunch of money at a bunch of start ups, watch most of them burn through the money and fail; somehow end up with a lot more money than you started with…The winners better win big; To make the VC model work => Invest a small amount early in 20-30 explosive business models -> Generally 1-2% of their Fund (The amount is not even close to enough for the companies to execute on their business models) -> Learn Rapidly which business models are more likeyly to explode (in the good way) -> Invest more in these while the others perish =>Rinse and repeat until you find the big winners… Approach -> Embracing failure encourages swinging for the fences (failure isn’t personal); The need to learn rapidly creates urgency and discipline – need to fund the winners so cant fund the losers… What is standard reaction to one doing well/one lagging? What is the typical advice when things are not working well? Staged Investmen -> Initial investment of 1-2% of the Fund; A-Round – own 20-30% of the company; Pro-rata follow on investment (20-30% of B-round) => Requires new lead investors which means almost unlimited resources can be available.. A-Round – investment at a negotiated valuation, which determines ownership-> Pre valuation + investment = post valuation; Common stock owns pre/post; investor owns investment/post => Company can sell and investors and common shareholders win or nobody wins COMMON STOCK OWNERSHIP -> VC Investors: Weed out crazy ideas, invest in big ideas and spread their bets to start; Concentrate their bets over time, and selectively larger investments based on what they learn; Successful Venture Fund – portfolio -> 10% success rate -> three winners each returning portfolio; Valuation works by considering investment amounts, valuations, staging and ownership (dilution); Dilution - Adding new shares reduces the fraction of the young firm owned by current shareholders; Adding new shares brings in resources that enhance the value of the young firm (money and people), As long as the value grows rapidly, current shareholders end up w/ a smaller piece of a larger pie Convertible notes: The time and legal cost of an equity round make small convertible notes attractive; Notes typically convert to equity at a discount in a subsequent round => Conversion example – 200k convert note w/ 20% discount; A-round 6m invested for 30% ownership (20m post value) -> Company now has 80m shares after a- round and before conversion (24m a-shares; 56m common shares)… so, A-shares sold for .25/share (6/24) -> Notes Converts at a discounted prce of .20/share (.25 *(1- .2)) -> n’holders receive 1m A-shares (Own 1.235% 1/81) INVESTMENT TERMS -> Negotiating Primary terms: 1) Investment size – easy to negotiate -> How much company needs to make meaningful progress? Necessary to get next investment round; investors want to learn at low cost (dump laggards and focus on winners); Founders want to prove themselves at low cost; future rounds are likely to be less dilutive; 2) Valuation – harder -> investors prefer lower, Founders prefer higher; What value you assign to young company?.. Higher = more ownership with founders; Lower = more ownership with investors therefore Number is arbitrary but not random; 3) Common stock terms -> pool easy to negotiate, vesting harder; investors prefer longer while founders prefer shorter; Pool – founders and investors both want to recruit and retain top employees; Vesting – founders value their past work, and investors value their future effort; 4) Preferences for investors -> harder to negotiate; Some harder – liquidation prefence; Some easier – dividend preference; Some in between – anti-dilution protection; Type of Liquidation Preference (most important); 1) Simple – investors get the larger of their investment and their share of the company’s value (not both); 2) Multiple – Investors get the larger of X times their investment and their share of the company’s value (not both); 3) Participating – investors get their investment plus their share of the remaining value -> Not capped Term Sheets – document summarizing rough terms; Not legally binding, terms often change; Purposes – set expecttaions and start negotiations that have a reasonable chance of success Capped Participat. Pref. – cap is a multiple of investment; participating preference cannot pay more than cap; (invest 10 cant get more than 3x; or can take half) Binding cap – preference cannot pay more than cap; multiple rounds – investors with senior preference make decision first; later rounds tend to have preference -> C – shares over b-shares- over a-shares over common shares (alternative is parity, not early rounds have preference) Example – serie A, inv 5 post 15 (33%); series B invest 10, post 40 (25%) -> if sell for 24m w/ basic preference; series b can take 10m investment or 25% of 24 = 6m; SERIE B takes 10 leaving 14m; Serie A can take 5m investment or 33% of 14m = 4.67m, takes 5m payoff leaving 9M for COMMON (37.55% of 40 post) Example – participating preferred – same as before; 36m exit => Serie B 10m investment plus 25% of residual; Series A gets 5m investment plus 25% of residual; Residual is 21m (36-10-5); common only gets 50% of residual = 10.5m (29% of 36m); if only one series participates the lower series investment doesn’t eliminate shares – remain as common shares (A would only get 25%, not 33%) -> preferences align incentives -> no liquid pref. entrepreneur gets rich, participating -> VC $$ PROBLEMS – Participating across the board with troubled start up; company sells for 40m participation gives 82% of rest leaving shareholders with 720k Problems – retaining employees; recruiting employees, or raising c-round; Muliple pref. even worse -> suppose 1.5x investors entitled to 54m, common gets nothing VCs concern for common => Success requires great employees; Start-ups offer low wages, long hours, and little job security; Upside from equity is essential Problem for common = Problem for investor -> Not enough ownership; Too much preference; Preferences are generally reasonable -> When a company stumbles but gets a second chance, existing investors take a hit; Converting early rounds to common; Eliminates preference overhang or Refreshing stock/option pool; Adds to common, dilutes existing shares; New common shares used selectively