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EPSE Module 3—Session 2

EPSE Module 3—Session 2. Ken Liu March 19, 2012. Business Plan. Competition. Competition. There is no such thing as no competition!. Competition. Direct, indirect, substitute, complementary Customer DIY/NIH Fragmented vs. concentrated Top 3 >50% market share vs.

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EPSE Module 3—Session 2

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  1. EPSE Module 3—Session 2 Ken Liu March 19, 2012

  2. Business Plan Competition

  3. Competition There is no such thing as no competition!

  4. Competition • Direct, indirect, substitute, complementary • Customer DIY/NIH • Fragmented vs. concentrated • Top 3 >50% market share vs. • Hundreds w/no clear leader • Coopetition • Google vs. everybody • HP vs. IBM • Apple vs. everybody

  5. Substitute Indirect • Solar • Wind • Geothermal • Hydro • Oil • Gas • Coal • Nuclear • Concerts • Baseball game • Eating out • Piano lessons • Vacation • NetFlix • Pets Discretionary/ time & $$ BTU

  6. Complementary Products

  7. Direct Indirect Substitute Complement

  8. IP & Entry Barriers • Very few technologies are patentable or truly protectable • ICs • Life sciences • Materials • Software patents are rare with doubtful value • Need to measure benefits vs. very high costs of patent prosecution • Best protection: high market share + continuous innovation • New test: Can China break it in a month?

  9. Avoid the Frontal Assault Go around Go elsewhere Feed the beast Change rules of fight

  10. Holographix Story—1986-90 Technology Holographic discs (patented) Advantage Higher resolution (600 dpi) & cheaper (10-30%) than conventional lens Target Product 4-in-1 peripheral (printer, fax, copier, scanner) Market SOHO + SME Partner Targets HP, Canon, Xerox, Ricoh, Samsung, LG… Status Out of $$ Poor capital market (’87 crash) Unfinished prototype Technical issues

  11. Holographix—What’s broken?

  12. Holographix Mistakes • Technology overreach • Optical component >> systems integration • 10 yrs. ahead of market • Market leaders controlled product cycle & cannibalization • Direct competition with entrenched leaders

  13. Somewhat Happy Ending—2000 • Change plan to optical components licensing for printers • LG 1st licensee for laser printers • In & out of Chp. 11 • Got new VC funding • Evolved to manufacturing optical discs for various markets • Sold to Avanex for $90M in 2000 to supply their optical needs • Bought back from Avanex in 2003

  14. Business Plan Business Model

  15. What is Business Model? • How you make $$? • How much? When? • How to scale? • How much $$ you need? • How company structured? • Who to hire? • Valuation model & potential • Risk & return

  16. Business Model—the Essence “Let me get this straight on how this works: people pay you money at the beginning of the year, and at the end of the year you may or may not pay some of them back?” Investment banker: Yes. “That’s a good business.” --Warren Buffett on why he bought Geico

  17. Internet Business Model

  18. Enterprise Business Model

  19. HNC—Spring1991 • Founded in 1986 as spin-off from TRW • Leader in bleeding-edge neural network technology (son of AI) • $6M sales, 60 people • 4 BUs: • R & D • Tools • OCR • Financial decisions • Almost breakeven, ready for hockey stick • Just raised Series C in Dec. 1990

  20. HNC—Fall1991 • Tools sales dead due to recession • Big cost overrun on image processing chip development project w/Japanese partner • Bleeding $300,000/month • Management salary cut by 20% • Out of money by Spring 1992 • State of BUs • R & D—ongoing $2M projects • Tools—$1M business basically dead • OCR--$1.5M business, profitable • Financial decisions—initial successes with Equifax, Amex

  21. HNC—What to do?

  22. HNC since 1991 • One of largest software company in SD • 1995--$44M sales. 2nd best IPO behind Netscape. • Multiple financial markets • Credit card • Workers comp • Insurance claims • Retail • Bought by FICO in 2002 for ~$600M • Spawned analytics cluster in SD

  23. HNC Lessons • Technology in search of a problem is tough • Focus, focus, focus! • Disaster or fortune can change drastically very quickly • Many successes have near-death moments

  24. Business Plan Financing

  25. Cash is King! Control Burn!

  26. Financials—3 Years • By month for the first year • By quarter for subsequent years • Profit and Lost (P&L) statement • Balance Sheet • Cash Flow • Burn rate • Breakeven analysis • Funding required & Use of funds

  27. Funding Required • Total cumulative cash required before you generate cash sustainably • Operating losses • Working capital • Inventory/Receivables • Capital cost • For 18 months if possible • Add 50%+ for contingencies

  28. Fundraising • Full-time job (3 months+) • Lots of rejections • Lots of frustrations • How come they are not getting it? • “And they invested in that crap?” • Target, learn, adapt & repeat • Persist • All you need is 1! • It’s not done until $$$ clears bank

  29. Financing Considerations • How much? • Valuation/dilution • T & Cs • Value-add of investor • Mindshare with investor • Vision for business, value & exit • Degree of involvement • Control Love is grand… Divorce is 100 grand

  30. Financing Sources 200,000 35-50,000 Co. Stage $$$ Effort 2000 Vendor/ License/Grants Incubators Crowd Source 3Fs Angels VCs Strategics PE

  31. 3Fs: Friends, Family & Fools Stage Idea Purpose Build proof of concept/prototype Amount $25-250K Valuation <$500K FormCommon stock, loan Duration 3-6 mo. Their Goal Help you (emotional bondage) A return is nice but assume it’s lost—it’s play money Freedom High

  32. Incubators/Accelerators • Y Combinator, EvoNexus… • Free or investment • Office • IT • Mentoring • Service providers • Intro to $$ • 6-12 months to graduate Y Combinator Graduates

  33. Grants, Vendor & Licensing Stage Prototype onwards Amount $50K+ Duration Varies Form Cash for license, maybe warrants Grants w/o equity hit Vendor float, maybe warrants SBA loans Valuation N.A. Purpose Minimize dilution Their Goal Help you, spur innovation Freedom High

  34. Angels SV Angels, 500 Startups, TCA… Stage Prototype Purpose 1st customer; market validation Amount $50-3,000K Valuation <$500-5,000K, want 30%+ Duration <6-18 mo. Form Common or preferred stock, warrants, convertible note Their Goal Help you, giving back 3-5X return in 3-5 yrs. Freedom High

  35. Strategics Stage Revenue Amount $1 million+ Valuation $5M+ Duration N.A. (often part of licensing, joint development/marketing program) Form Stock, warrants, license Purpose Synergy Their Goal Technology, customers Competitive lock-up Prelude to buyout Freedom Medium

  36. VCs Stage Prototype onwards Revenue & breakeven w/in 18 mo. if enterprise Eyeball deals all about uniques & traffic Amount $2 million+ Valuation $3M+ Form Preferred stock + covenants Duration Initial rounds 12-18 mo. After that, up to exit Purpose Growth, solid financial base Their Goal 10X in 5 years Freedom Medium when meeting plan; can fire you if not

  37. Fund Structure • $$ from pension funds & endowments • 10-yr. funds with target investment areas • Done investing by 4th year, raise another round (if doing well) • Pressure to exit deals by 7th year. Potential conflict with company goals • Economics • 2% mgmt fees on funds managed—in tranches • Common to have 8% base return before profit split • 20-25% profit split (“carried interest”) • Example: $100M fund needs ~$150M before profit share • 1 partner per ~$40-50M to invest • Partners split “carry”, rest gets bonuses • Only partners count

  38. VC Mindset • Looking for specific profile • Market • Technology • Business model • Size of deal • Stage of development • Fund timing • Firm strategy/targets

  39. Term Sheet • Amt. invested, valuation • Tranches, milestones • 1x preference, fully participating • Dilution terms • Preference over other classes • Veto power • Board seats & rights • Syndicate

  40. VC Viability Debate • Liquidity squeeze • IPO way down • Strategic buyers consolidating • Companies need less $$ • Most Internet consumer plays need <$0.5M to start • Big plays too risky: cleantech, biotech, ICs • Competition • Angels & incubators on low end • Super angels can do $3-5M • Industry consolidation • 50% of firms going/gone. Top-tiers gaining. • Fund sizes down

  41. 2000-2010 VC ROI -10%

  42. Disappearing Money # IPOs 1990-2000 4,467 2001-2011 1,096 Source: Jay Ritter, Univ. of Florida

  43. VC Shrinkage New Funds Amt. Raised ($ Bil.) Source: VentureSource

  44. $1.3 million Bridge Note50% Warrant Coverage

  45. $3.7 million Preferred Stock$6 million Pre-$ Valuation

  46. It’s a Crap Shoot “We are bad at picking out the winners a priori. Despite doing extensive diligence…for every 10 deals we do, we lose all of our money on 5 to 6, we make a modest multiple on 2 or 3, but we make a lot of money on 1 or 2.” --Bill Bryant Draper Fisher Jurvetson

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