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Correlating Innovation, Business Models, Development Plans & Private Financing GameON: Finance Conference Toronto, Canada October 28-29, 2008 Tom Sweeney [email protected] 514-865-2323

Correlating Innovation, Business Models, Development Plans, Private Financing

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Page 1: Correlating Innovation, Business Models, Development Plans, Private Financing

Correlating Innovation,Business Models,

Development Plans &Private Financing

GameON: Finance ConferenceToronto, Canada

October 28-29, 2008

Tom [email protected]

514-865-2323

Page 2: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney2

Discussion Topics

• Revisiting Innovation• Why Value Leadership and New Market innovation are better plays

for early stage companies (in Canada) than Sustaining and Low-End

• Business Models• The CEO’s #1 job is to actively manage reality• Read Confronting Reality by Larry Bossidy

• Business Plans & Pitches• Do plans with your team, not (just with) consultants• 20-minute rule for pitches and 2 minutes for micro-pitch

• Venture Economics & Development Plans• Not all companies are VC candidates• Use existing cash to achieve specific milestones that directly map to

a financing timetable based on your realistic access to capital

Questions or discussion anytime, please!

Page 3: Correlating Innovation, Business Models, Development Plans, Private Financing

Revisiting Innovation

Why IP is so important tobuilding sustainable

companies...

Page 4: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 4

Customers Pay for Perceived Value

• For every product-market category, including video games,Customers decide based on a set of established “ValueMetrics”, typically defined by the established players in thatmarket

• Example:• Bubble gum: chewing quality, size of bubble, smell, brand, etc

Established Customer Value

Metrics SetPe

rcei

ved

Valu

e

Price

Product - Market

• Pricing is a function of Perceived Value

Page 5: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 5

Value Innovation & IP’s Role

SustainingLow-End

Value LeadershipNew Market

Companies that go from a startup to market leadership have typicallyintroduced one of four forms of Value Innovation.

Page 6: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 6

Sustaining Innovation

Price

Customer ValueMix

Sustaining Innovation is when incremental improvements are made to one ormore components in the existing customer Value Mix. This is a tough space,particularly for Canadian companies. The market is dominated by theestablished companies.

Page 7: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 7

Low-End Innovation

Price

Low End Innovation is when similar value can be sold at a dramatically lowerprice that incumbents can’t or won’t easily match. This usually requireseither business model innovation or operational excellence to stay inbusiness. It’s also a tough space for Canadian startups. Think of IKEA andDell.

Customer ValueMix

Page 8: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 8

Value Leadership Innovation

Price

Customer ValueMix

New IPNew IP

Value Leadership Innovation is when new IP with proper protection isintroduced to an established market and one or more new Value Metricsbecomes the dominant reason why customers choose that product. Why doyou use Google?

Page 9: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 9

New Market InnovationNew Market Innovation is when a new product or service is introduced thatmakes it easier or more convenient for people to do what they previously hadto go to experts to do for them. California and its ecosystem leads the worldin repeatedly doing this. Steve Jobs is the master.

NewCustomerValue Mix

Price

New IPNew IP

New Product-Market

+

Page 10: Correlating Innovation, Business Models, Development Plans, Private Financing

Business Models

What are they?

Page 11: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 11

Business Models: Five People, Ten Definitions….

“An organized and rigorous way of looking at the health andprofitability of your business now and in the future. [A business

model] is a statement of the current reality and its likely – asopposed to hoped for – future direction. It is an early warning system

for real-world changes that pose threats or provide glimpses ofopportunities. The business model is a blueprint for taking action.”

“I can’t define it, but I know what it is when I see it.”US Supreme Court Justice, Potter Stewart

“Hire the world’s best athletes as spokespeople. Buy anenormous amount of advertising to get every sporting goodsstore to carry your products. Make the product overseas for

very little money. Charge very high prices.”Excerpt from Seth Godin’s, Bootstrapper’s Bible

Larry Bossidy & Ram Charan, Confronting Reality

Page 12: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney12

“Product-Marketing” is a Critical Concept thatNeeds a Remarkable Hyphen

Bootstrapper’s Bible• Great way to spend $5.00• Lighter approach to business

models but lots of pointers forbootstrapping!

Purple Cow• If your product is not remarkable

in its (niche) market ……

Blue Ocean Strategy• Deeper look at developing

compelling and sustainableproduct-market positions

Page 13: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 13

Confronting Reality

• Provides a very detailed lookat how to develop yourbusiness model, evaluate itand constantly adapt it toreality

• This book is the sequel toExecution: The Discipline ofGetting Things Done

• Talks about actively managingthe reality of a business

• Both books are excellent

Page 14: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney14

Business Models Have Three Main Components

Repeated Iteration and Actively Managing RealityProduces Tested, Actionable Business Models

External RealitiesFinancial history of your

industryOverall business environment

Customer baseRoot-cause analysis

Financial TargetsOperating margins

Cash flowCapital intensityRevenue growth

Return on investment

Internal ActivitiesStrategy

OperationsPeople

Organization

Source: Confronting Reality

Page 15: Correlating Innovation, Business Models, Development Plans, Private Financing

The Truth AboutBusiness Plans &

Investor Pitches

What purpose do theyserve….?

Page 16: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 16

The Truth About Business Plans

• The exercise to produce one is fundamentally important

• VCs can spot plans done by consultants a mile away

• Most companies spend too much time on generating a“complete” (long) document

• Should be 12-15 pages that convey “deep and insightful” analysisbased on “bottom-up” assumptions and a solid grasp of the businessmodel

• VCs typically don’t read business plans to be able to say “no”

• Be ready with a clear and well thought-out summary• The first two or three paragraphs are critical

• Don’t assume investors have read anything you have sent• Plan on having 20 minutes to make your case with no more than 10-

12 slides and around a 30-point font

Page 17: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 17

BusinessModel

5 6

UnderlyingMagic

8

10

Team

Title& Speaker

Intros

1 2Elevator Pitch

CompanyOverview

3Problem

&Customer

4Solution

&Key Benefits

9

Projections

11Status

&Timeline

12

SummaryWhy Us?

Ten (+2) Slides, 20 Minutes, 30 Point Font

Competition&

Advantages

7

Marketing&

Sales

Obey the 10/20/30 rule. Stay high-level and hit the key points. Nobody writes acheque based on your presentation, but they do say “no”.

Page 18: Correlating Innovation, Business Models, Development Plans, Private Financing

Venture Economics,Development Plans and

Use of Cash

The core drivers of duediligence….

Page 19: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney19

Venture capital is a specialized form of private equity, characterizedchiefly by high-risk investments in new or young companies

Angels

Venture Capital

Early Stage Later Stage MezzanineCapital

BuyoutCapital

PRIVATE EQUITY

Public Equity Markets (TSX Venture, TSX, etc.)

Valu

e C

reat

ion

and

Paid

-In C

apita

l

Company Lifespan and Venture Capital Stage

1 Year

2-3 Years

3-4 Years

5-7 Years

Angel Seed Start-Up Early Stage Later Stage

Convertible Debt orCommon Shares

(<$500 K)

Preferred Shares“A” Round

($3-5 million)

Preferred Shares“B” Round

(>$5 million)

Preferred Shares“C” Round

(>$15 million)

Mezzanine IPO

TSXVentures

Page 20: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 20

Business Models and Venture Financing

• VC must generate high internal rates of returns to their LPs• Portfolio theory: winners cover the losers• Early stage VCs target high multiples (10X +) and IRRs of >50%

• A company’s development plan and its internal “clock-speed” must beobsessed to use investment cash to achieve specific milestones on acompetitive schedule

What is a “4X Multiple” ?• The increase in a VCs investment

when there is a liquidity event(M&A, IPO, MBO, RTO). “Weinvested $1M and made $4M.”

What is “30% IRR”?• Considers how much was returned by a

liquidity event and how long it took• Invested $1M and got $4M back in 3 years ~

59% IRR (great)• Invested $1M and got $4M back in 7 years ~

19% IRR (weaker)

Silicon Valley’s Entrepreneurial “Clock Speed”• The 10-year IRR for early-stage Silicon Valley VCs is 54.9%. The average in

Canada for the same period is -3%

Page 21: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney21

Start-Up Business Model: Bootstrap With a Planto Achieve Specific & Important Milestones

Due Diligence Milestone

Receiver’sWall

Director’sWall

The Idea New MoneyDeposited

VC Due Diligence Process

6-12 months

Family &Angels Grants SR&ED

TractionMilestone

Traction Milestone: achieve this key milestone before starting a financing round (gives investor confidence you’ve done something “important” already)

Due Diligence Milestone: achieve this second key milestone during financing(tell VC about it in “First Pitch”, hit the milestone, tell VC you did it)

First Pitch

Closing($$)

Under-funded company

Properly funded company

Bootstrap and Seed Syndicate

Page 22: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 22

Financing Stages & Development

Bootstrap First Round VC (Series “A”)

Second Round VC(Series “B”)

Acquisition

Tota

l Cas

h Pa

id-In

to C

ompa

ny

Shareholder Equity at Acquisition

38%

29%

33% Common

Series "A"

Series "B"

$1.5 on $2.0 million pre(two tranches)

$4.0 on $8.0 million pre(two tranches)

Example•Bootstrap to achieve working prototype prior to “A” round•Secure $1.5M participating preferred on $2.0M pre-money•Achieve product and early revenue•Secure $4M on $8M pre-money•“A” round VC participates in “B” round

Page 23: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 23

=XIRR is a Formula You Should Learn

T1 T2 T3 T4 T5

A2

Time

A1

B1

B2

C1

=XIRR((-A1,-A2,-B1,-B2,C1),(T1,T2,T3,T4,T5))

VCs want “C1” (their fully converted equity) to be large and “T5” (time to exit)to be as short as possible

Acquisition

“A” RoundFirst Tranche

“A” RoundSecond Tranche

“B” RoundSecond Tranche

“B” RoundFirst Tranche

Cas

h In

vest

ed

Page 24: Correlating Innovation, Business Models, Development Plans, Private Financing

© 2008. Tom Sweeney 24

Excellent VC Deal Terms Reference Book

Page 25: Correlating Innovation, Business Models, Development Plans, Private Financing

Correlating Innovation,Business Models, &Development Plans

with Private Financing

GameON: Finance ConferenceToronto, Canada

October 28-29, 2008

Tom [email protected]

514-865-2323