VI

I’ve been deep into looking at convertible loans and option pools, and their impact on cap tables, dilutions and valuations.  The difference between an investment round and a round with converting convertibles or anti-diluting option pools, is the equivalence of the difference between Newton’s predicts of planetary orbit and Einstein’s. 

Its FAR too complicated and anal to delve into the difference between “nominal” and “real” pre-money valuation … beyond mind-numbing.  But if anyone is involved in a round that does include converting convertibles or option pool anti-dilution, please email me and I’ll step you through it.

It seems like there’s some difficulty getting started on a “pitch” so here’s a suggestion.

Rather than suggest another “template”, think about your pitch as “telling your story”.  Every business is unique – at least in some aspect – so there’s no “one-size-fits-all” template that is the best vehicle for telling your story.  However, the story should answer all or most of the following questions:

-          What’s the idea?

-          Does it solve a problem, or create an opportunity? (BTW, to a great extent an opportunity can always be expressed as the inverse of a problem J ).

-          Who has that problem?
Can you describe a typical customer?  Organization?

-          How many people/organizations have that problem?

-          What is your solution? Can you make money from it?

-          Would they be willing to pay to have the problem fixed?

-          How much would they pay? (If the answer is $0, then where will your revenue come from?)

-          Is there anyone else offering a solution to their problem? Who? How many are buying it? What’s the price?

-          Why would they use/buy your solution instead of one of these others?

-          How are you going to identify and reach these customers?

-          How are you going to convince them to use your solution rather than someone else’s?

-          How many will you sell, and how much revenue will you generate?

-          Finally, why is this team going to be able to achieve all of the above?

I like to think of pitches as a story that answers these questions.  The order is somewhat important, but only as an aid to the telling, and the uniqueness of every business will result is a uniqueness of the order.

Market Analysis

This area of business planning is always a quagmire of terms and definitions, but it’s not difficult if you step through it slowly and deliberately.

Ultimately a market is the interception of a product with a number of buyers – and exchange of value. And ultimately a market is just the prioritization of spending in one market to another.

To put this in “business” and “economic” terms:
• Total Market is the sum of all $, £, or € spent by all buyers of a product or a class of product..
• Value Proposition is the price a buyer is willing to give in return for the value they derive from the product.
• Competition is anything that prioritizes a buyer‘s spending on something other than your product.
• Competitive Advantage is a value proposition that prioritizes a buyer’s spending on your product rather than a competitors’, usually expressed in terms of Unique Selling Points.

I’ll carefully side step Available Market and Addressable Market for the moment, and simplify things for illustrative purposes.

So then, the Total Market are all those $, £, or € that could be spent on the class of product that you are selling.

For example, if your product is a new notebook computer, the market for it will be all potential buyers of notebook computers. And your share of that market will be those buyers you convince to reprioritize their spending away from the competition, with your value proposition and completive advantage. In this scenario the market size (the “pie”) is static and you are just taking a more market share (a bigger “slice” of the “pie”) from your competitors.

Your notebook may also have some very strong features that convince buyers of more powerful laptop computers to switch to your notebook. In this scenario you, and other notebook manufacturers, are increasing the market size (a bigger “pie”) by convincing this buyer that your notebook as enough value for them to switch.

There are two ways to think about market size; as the total $, £, or € spent (e.g. $10B to be spent of netbook computers in 2014), or the total number of purchases (e.g. 50M netbook computers will be sold in 2014). Of course the relation between those numbers is the Average Sales Price (ASP). If given the choice, I always prefer dealing with the latter.

So, when considering your market size, think about the following:
• How many buyers are there for your product? How many purchases?
• How much is being spent on similar products or services.
• How much is being spent generally in the space your product or service is in – remember it’s a zero sum game, if buyers spend money on your product, that’s $, £, or € that will not be spent somewhere else.
• Remember, if your competitive advantage is lower price (ASP), then the market size (in $, £, or € terms) is shrinking.

I’m toying with the idea of putting on two “Sales Survival” seminars.  Part 1 Sales and Part 2 Sales Management.

The objective would be to give some basic structure to the selling processing (sales script, process, objectives, closing)  and managing those that sell (sales cycle, pipeline management, forecasting).  It will also need to be generic in nature, so will never be a fit for your actual business.

I’d like to hear if this is needed and there is enough interest in putting this on?  And what specific concepts need to be covered?

This has come up on three different occasions in the past two weeks, so a brief overview ….

You can raise money for your business from getting an investment (equity) or taking a loan (debt).  Each is fairly clear.

With an investment, you sell equity in your business and the investor gets his/her return when the shares are sold.  Of course there is always the risk that may never happen.

With a loan you borrow money and are expected to pay it back over a specified period (term) at a specified interest (rate).  In theory its less “risky” than equity so earns less return to the investor.

A convertible loan is a hybrid instrument, that always starts out as a loan, but may be converted – at the lenders discretion – to equity.

Let’s suppose you needed $100,000 and that was best suited to a loan.  You could look at a “straight” loan (as opposed to a convertible loan) which would come with a repayment schedule (term) and interest (rate) attached.  Let’s say, for illustrative purposes, that the terms of the straight loan were 8% APR over a five year period.

A convertible loan would give the lender the ability to “convert” any of the unpaid principal into shares in the business at an agreed share price.

Why would the borrower or lender want to do that?

First, the lender.  Perhaps he/she would like “a piece of the action” – equity – but for a number of reasons isn’t willing to jump in with a straight investment.  Those reasons could include their intolerance to risk.  By using a convertible loan, they get their cake and eat it too.  The risk is reduced (in theory) and they can jump in with equity if they decide.  That’s a good option to have.

From the borrow’s side. He/she is giving up something here, by giving the lender the right to convert.  That’s worth something.  In general the value prepresented by the right to convert on the lenders side, is matched by better loan terms for the borrower – usually reduced interest rate or more favorable general terms.  In this case, the convertible loan may look like; $100,000 borrowed at 6% over a seven year period, with the unpaid principal converting to shares at $5/share.

Et voila.

/d

1381 The tower of London is stormed by rebels who enter without resistance.
1648 The first witch is hanged in Boston.
1775 The birth of the US Army.
1777 The Stars and Stripes is adopted as the US flag.
1789 The mutiny on the Bounty survivors arrive on Timor.
1807 Napoleon defeats the Russian army.
1822 Charles Babbage propose his “difference engine” to the Royal Astronomical Society.
1846 California is proclaimed a republic.
1919 The first non-stop transatlantic flight.
1937 The House of Congress passes the Marihuana Tax Act.
1940 Paris falls to Germany.
1967 Mariner V is launched towards Venus.
1982 The end of the Falklands War.
2010 StartVI starts.

Three questions came up after the last bootcamp session. The third is associated with general selling (this applies to both selling your product and selling an investment in your company – which can be considered as a product).

As a product manager, it was my job to provide sales training each quarter to the new sales reps.  I found that 25% of the time was spent training the reps on the product – but only it’s features, functions and benefits. The other 75% was spent on competition, competitive differentiation and customer objections.

Over time, I’d been called by sales reps with every customer objection imaginable.  (In sales management I’d never accept that a there even *existed* a reason for “not buying”, I’d always turn it around to ”we haven’t yet been able to establish the product’s value proposition”.

(Tip. Use that concept liberally when you are dealing with sales!!!!)

If I was pitching an investor for an investment in my business, I’d start by really understanding *all* of the value propositions that can constitute a “win” for an investor.

Obviously investment size, coupled with your (negotiated) valuation will serve as a basis for establishing the investors return. But I’d also look for all other “value” that can help create a “win”. Being the first, or the biggest, or the one with the most prestigous board, or even the company with the wildest launch parties may represent “value” to the investor, give them a “win” and help sell the deal.

Then I’d have someone try to sell me the investment.  I’d list every objection I could come up with, as to why I wasn’t going to invest. (You be surprised at how, with your inside knowledge, you’ll be able to come up with a very comprehensive list.)

I’d then reverse seats again, listen to the objections, and develop rebuttals to them.  You’ll never get all of them, trust me some really strange objections come out of the woodwork during sales negotiations, but you get a great start.

It also helps when you’ve been in the barrel a few times. Nothing develops sales experience like sales experience!!

Three questions came up after the last bootcamp session. The second is:

“I’ve been talking to potential investors, but keep getting surprised when I think we have a deal. What am I doing wrong?”

Whilst this (and the following post) are way beyond the scope of the bootcamp, it’s worth touching on a couple of points that may be helpful.

“Negotiating” is really just another way of saying “selling”. Selling (as opposed to taking orders) involves some exchange of value between a seller and a buyer, and an explicit or implicit win-win. If the seller can convince the buyer that the value the buyer is receiving is greater than or equal to the value they are giving, then it’s a win for the buyer. If it’s also a win for the seller, it’s a deal!!!

In an investment negotiation the entrepreneur is “selling” the risk-considered value of the return to the investor, and the negotiation is usually around differences in opinion of valuation and risk.  The entrepreneur is likely to have a higher view of the valuation and a lower view of the risks than the investor.

Now, when the investor is a VC, a win can mostly be created when (s)he has a favorable return on their investment, and the points of negotiation are usually valuation and equity position.

But, “win” can encompass more than “return”.

In any buying/negotiating situation, people “buy” for all sorts of reasons; ego, prestige, power, etc. And closing a sale is – to a greater or lesser extent – about understanding what constitutes a “win” for the buyer, that also enables a “win” for the seller.

In an investment negotiation, a “win” can be more that financial return for a VC.  In a down round or a down economy, a “win” maybe an egregious valuation – just because they can!!

Similarly, a “win” for an angel investor can be all sorts of things – power, publicity, position.

And sometimes a “win” for an entrepreneur that’s running out of cash is simply being able to stay afloat.

Three questions came up after the last bootcamp session. The first is regarding P&L’s and their role in business plans and operational plans.

P&L is a set of financials that are required for both the business plan and the operations plan. However they serve fundamentally different purposes in each plan.

In a business plan, the P&L is a 5-year overview of revenue and expenses. The goal is to create a financial picture for investment and exit valuations, and determine cash/investment needs. It’s a very much top-down approach, and I’m perfectly happy seeing it driven from market share acquisition rates. I’m also perfectly happy to see expenses “bucketed” in general accounting categories; like R&D, Marketing, Sales, and G&A and be derived as a percentage of revenue. To do this with credibility, it’s essential to have previous (and possibly extensive) experience with actual business operations to get really comfortable with operating expense percentages. Lacking that experience, an excellent proxy would be to look at the annual reports of your three closest competitors, or companies in the same industry space, and use *their* operating expense percentages as plugs for these values.

Just as a note, that exactly what I look at in due digence anyway.

On the other hand the P&L in an operations plan *is* a real budget!!!  It’s bottoms-up from the actual level you care about. Personally, I don’t care to breakout paper clips or pencils, but rather just lump those things into a general account of “Office Supplies”. And if that is less than 5% of you operating expense budget roll it up into a higher level category until it reaches that percentage. That gives you ~20 expense categories to manage, and ensures you are not majoring in minors.

BTW. Once you have a budget for four quarters, roll that into your business plan, and use it as a base to roll forward your projections for the next four years.

From a new report by Deloitte.