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Financial Viability@WisnuDewobroto

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Business Model Innovation is powerful to drive growth!

Assessing financial viability early – What’s this?

• Early assessment tool /process to test the financial viability of a business model

• Key outputs include pricing and volume: what do I have to do to cover costs and achieve breakeven (profitability)?

• The introduction of “risk” as a financial concept: Do the returns compensate for the risks I am taking as an entrepreneur?

• Provides early indication whether outside investment might be needed to get to breakeven

‘Sometimes there is a gap in the

market because there’s no market

in the gap’—Irene Bejenke-Walsh

MessageLab

Why?

To really be feasible, a business model must make sense

• not just strategically (where you have a compelling and competitive product offering and route to market),

• but also financially (so that you will earn more than you invest!)

• This also makes sense for a social/non-profit enterprise – you still need to break even!

Two paths...Financial viability has different parameters depending on

whether you intend to enter: 1. A market for products

2. A market for technology

Your choice of market might even depend on the respective financial viability of each option.

1. Market for Products Is there a ‘market in the gap’?

This section was co-authored by Irene Bejenke Walsh, MessageLab

1. Product MarketIf you aim to pursue a route to the Market for Products

(See ‘Clarysse model’ in Teece analysis slides in Business Model tool)

1. Value Proposition based on Product Offer (or standardised service) •Specific product / market niche •Control over the value chain •Diverse founding team with experience in industry •Funding from founders’ own capital, debt or possibly an Angel, followed by early revenues

-> Revenue Growth by selling standardised products to customer segments

Key questions to address

• Do the returns on investment compensate for the financial risks

involved?

• Can I make a product/ deliver a service which is competitive on a breakeven basis ?

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• Is the addressable market big enough to make commercial sense? (See Entrepreneurial Market Research in IE&D Toolbox)

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• How long before the business is self-financing and hence…..

• …will I need outside finance ?

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Copyright of Bart Clarysse and Sabrina KieferThe Smart Entrepreneur

TheComponents of a “Market in the Gap” Analysis• Addressable market: this needs to be

big enough, offer enough potential customers/revenues to make the company scalable (See also “Entrepreneurial Market Research” in IE&D Toolbox)

• A viable business model would satisfy all 3 components opposite

• “Return on investment” is used here as a conceptual term for a number of key financial issues entrepreneurs have to consider in the start-up phase, e.g. cash and time they are investing themselves, and how they want to be compensated for their investment.

Breakeven Analysis This is a rough test to work out how much we need to charge for our product or service (i.e. the lowest price) in order to at least cover our costs, i.e. get to breakeven.

•Once we have determined a breakeven price for our product or service, making a few basic volume and cost assumptions, we can answer the question: is our ‘breakeven price’ competitive in the market? •If my breakeven price is already higher than that of the nearest existing competitor(s), we are facing a competitive and financial challenge with different potential outcomes (or a negative business case). The idea is that the business model has to stand up at a minimum to this simplified P&L model to assess financial viability. •This is an interactive process, e.g. a negative business case result may cause us to review our assumptions and thus produce a new/ lower breakeven price. •Depending on our funding, we may be able to tolerate a negative business case in Year 1 provided we are confident that the cost base will improve in the near term (also known as ‘cost leverage’) – this is then an issue for a more detailed financial modelling exercise to determine when breakeven occurs and how viable this is for us.

Cost analysisFixed Variable

Explanation Costs that are the same regardless of how many items/ services you sell – sometimes described as the costs you need to incur before you are able to sell

Recurring costs that you need to pay with each unit you sell – naturally for some cost items (eg raw materials), the per unit cost will depend on volume

Example Development costs, property costs, marketing, IT costs, finance costs (though this depends on how the business is financed - debt or founders’ equity)

Cost of raw materials, distribution costs, product-based labour/ staff costs, royalties

Quantifying your risk & investment• Calculating risk and investment as an

entrepreneur are essentially subjective exercises.

• Two parameters to consider at this early stage are money and time invested and how you want to be compensated for these.

• Money: how much cash have I invested in the business, when do I want/need the money back and at what return? If I have re-mortgaged my house and invested £50K, personal finances might be tight and I will need a certain level of return to pay for the cost of finance.

• Time: How long will it take to get to breakeven point? How long can I go without a salary? If I have invested in “sweat equity”, i.e. unpaid time, how much is it worth and how much do I need/want to earn?

Note: typically, third-party investors require at least a 25% rate of return to invest in a start up business, this means that a business has to return 3x the original investment over 5 years.

The concept of return on investment • All businesses involve risk and some businesses are

riskier than others. • Higher risks are acceptable provided they bring the

prospect of higher financial returns. • At one level, a founder is an investor: someone

who invests his or her own time and/or money in a new business idea or venture.

• A venture is only viable , if it compensates the founder for the risks incurred, i.e…

• …if the founder’s return on investment exceeds the risks involved.

• For these purposes, the return in a venture and payback over time could be expressed as the equivalent annual interest rate you would receive on the same amount of money invested over the life of the venture

Question: would you expect to get back more money from a £100 investment in a business start-up or a £100 deposit in a domestic bank account? Now ask yourself why ?

2. Market for Technology

Technology business model – financial viability

1. Look at acquisition prices of comparable companies

2. Assess the stage of development those companies had reached when they were acquired

3. Assess what market conditions were like at the time

4. Estimate the potential value of your business at similar stages and market conditions

5. Evaluate the return on the effort and investment needed

Look at comparables – Steps 1 and 2

1. Look at comparable companies (similar industry/market) where early investors exited via a trade sale pre-revenue • What was the acquisition price?

2. At what stage of development was the comparable company when it achieved that price? e.g.: • Med/biotech: It had passed a stage 2 trial, or it had undergone full clinical trials • Engineering: It had achieved a certain stage of advanced prototype or pilot tests; it

had built a certain amount of infrastructure • Digital: it had a certain size of user base, a proven user growth trend, etc. • And generally: employee headcount, size of technical team, size of general

operations, number of years the company has existed, etc.

Typically, at a more advanced stage of development >> greater acquisition price

2. Stage of development - valueYou might try to extrapolate a value per asset ‘unit’ at those

comparable companies, based on acquisition value E.g. • Value per registered free user/paying customer (website) • Value per unit of infrastructure built (engineering) • Value of successful trial (medical), etc.

In other words, find a basis for comparison with your business

Look at Comparables - 3. Market conditions

3. What were financial market conditions like (esp. for private equity deals) at the time the comparable companies were acquired? • Greater risk appetite among investors >> greater price • Depressed financial market >> lower price

• How much competition was there on the market? • Was it a trendy sector? Investors trying to play catch-up to get into

the market >> price rises • Were there a lot of competing companies seeking acquisition?

>>price may fall

In short, what factors (stage of development and market) drove exit valuation at comparable companies?

Comparables and you – step 4

4. Estimate the potential value of your business at similar stages and market conditions • How long might it take you to achieve a comparable stage of

development to previously acquired companies, or comparable milestones? • What could your ‘value per unit’ be at that stage?

• Consider possible business value in a buoyant or depressed market .

The above will be speculative, but can offer a starting point for considering a future value range (depending on conditions).

5. Is the business model worth the investment?What kind of investment (£) would be needed for the co. to

reach a ‘sellable’ stage? How much work? • Develop Management team, Tech team, general staff • Infrastructure • Achieving regulatory compliance • etc.

Given the cost, time and risk, would the final payoff (sale) reward you sufficiently? • For the entrepreneur this may be subjective • For a financial investor less so – typically seek a 50-60% annual return

or 10 times initial investment • e.g. Imperial Innovations aims for exit sales of at least £100 million,

besides a high return on initial investment

Further Reading

Clarysse, B. and Kiefer, S., 2011. The Smart Entrepreneur. London: Elliot & Thompson, Ch. 7, 9 & 12.