BERKONOMICS – Business insights from Dave Berkus

Archive for November, 2009

A compelling vision drives innovation.

by on Nov.24, 2009, under Ignition! Starting up

Companies that innovate new products, services and methods of delivery are the ones that stand out in a crowded business world, especially when attempting to gain recognition beside competitors on the web. 

Innovation is valued by our society, by investors and certainly by consumers.  It is the focus for state and federal governments worldwide, many finding ways to reward innovators with tax incentives or investors with tax credits to finance innovative new enterprises.

As a keynote speaker, I often start presentations with a short history of innovation in the United States, using the twist of examining innovation through the lens of 150 years of cyclic bursts of bubbles, leading to subsequent recessions and depressions.  It is not hard to find strands of gold in the carnage left by failed businesses lost when a bubble bursts, such as in 1857, 1902, 1929 and 2001.

Innovators make use of golden strands of opportunity left when the unfinished vision of another cries for completion, or when a genuine new concept changes the very way people think about their lives.

[Email readers continue here...] Leonard Kleinrock and a few of his UCLA computer lab students worked to send the first several characters from UCLA to Stanford in 1969 over a direct line established for the test.  They were able to send only the “LO” of “LOGON” before recording the very first crash of the Internet.  And I’m sure they had no idea what they were fathering with that effort which eventually became ARPANET, and then of course, the Internet itself.  They had no mantra, and a limited vision to connect mainframe computers to share academic information.

How many entrepreneurs used that infrastructure to create an expansive vision of what could be?  Tim Burners-Lee wanted to use this new infrastructure to create a friendlier web of pages, sharing data like the pages of a massive library of books extending throughout the world.  The result was the worldwide web, upon which Mark Andreeson and his crew in Chicago build the Mosiac browser to make this data more available to anyone.  Which in turn allowed innovators worldwide to create applications inside a browser, share detailed information previously locked inside libraries and corporations, and ultimately to change the world by making the exchange of information frictionless.

We can look back to Edison, Ford and Bell as great innovators of their time.  But perhaps the most impressive invention of recent times is the result of hundreds of people, firms, and institutions, each adding a new brick to the building of the Internet.

Now we have the infrastructure for innovators to create applications with free software on computers used for many purposes simultaneously.  And millions of innovators are at work extending the capabilities of the Internet.

What opportunities are next?  Perhaps it is the remaking of the world through green technologies, clean technologies, new medical technologies, new home entertainment products, new mobile communications products and services, and more.

Who said that “Everything that can be invented has been invented?”  Ah yes. That was Charles H. Duell, U.S. Commissioner of Patents in 1899.   Oops.

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Address ten vision tests for success.

by on Nov.17, 2009, under Ignition! Starting up

A vision must be solid and flexible enough to pass a number of critical tests if it is to guide a business enterprise to greatness.  Here in brief are ten tests for a successful vision.  Try these on for size, and test yourself for attractiveness to the marketplace, to investors and to history.

Ten tests for a successful vision

1.  Is your market identifiable and accessible?    Test yourself as to whether you can identify the size of your market niche, and whether you can overcome the many barriers to access customers within your niche.

2. Where in industry life cycle?     If your vision is for a product or service that fills a need in a mature industry, you may be flying against the prevailing winds as a market shrinks over time, taking your business with it.  Conversely, a fast growing industry lifts most all good participants, making excellent companies excel even more and grow even faster, like a small plane flying at 150 knots with a 75 knot tailwind.

3. How large a total market?    If the total market for your niche is under $100 million per year, it is going to be difficult to build a $50 million business, even if not impossible.  If the market is ten times that size, there is probably room for competitors to fight for dominance and still succeed if you are not number one.

4. Can you dominate that market?    The dominant player in any niche controls pricing for all those under it, and often sets the risk profile for new entrants into the niche if the dominant player’s products or services fill the needs of customers at reasonable prices and quality.

5. Have you created high barriers to entry?    If your business is a “me too” entrant into any market niche, even the smallest success will soon attract competitors that will sap some degree of your potential growth. What can you prove as a barrier to entry for competitors?  Is it the advantage of time – years of development ahead of any competitor? A core patent or “thicket” of patents protecting your offering?  A strategic relationship with one or more of the largest customers?

6. Are margins high enough?     Some great ideas just can’t make money and ultimately die for lack of profit potential.  Profit margins are higher for unique products or services early in the life of an industry niche, or for products protected by patents that prevent others from undercutting you simply by releasing a cheaper product.  High profit margins are a sign of high barriers to entry and attract investors and ultimately good buyers for your business.

7. Can this business grow to above $20-50MM?     This is a basic test for investors, separating your business from those with smaller visions.  There is nothing wrong with a vision for a smaller enterprise if not in need of professional investors to make it a reality.

8. Do you have a world-class management team?     The best way to protect against failure is to attract a team with members who have experienced success and failure and can recognize the ways to manage toward success and avoid the pitfalls previously experienced from past failures.  From a professional investor’s perspective, the team should be able to be flexible, coachable and experienced enough to get a business through breakeven and beyond the next level of outside investment, greatly reducing execution risk.

9. Can you translate an idea into a compelling product?    Some great ideas just cannot be made into a product at a reasonable enough prices to attract customers.  And some attract early adopters but cannot pass into the mass market.  Sometimes, an idea is just too early for the available technology to make it attractive.  Early cell phones were large bricks that required a large carrying case and cost up to a dollar a minute to use.  As technology caught up, allowing miniaturization and light weight, mass adoption drove the price down and allowed the building of infrastructures everywhere to support the use of inexpensive minutes.  Do anything you can to develop compelling products or early prototypes as proof of ability to reduce technology risk.

10. Is there an exit strategy for the investor(s) over time?     There are many professional services businesses that make fine lifestyle opportunities for architects, doctors and dentists.   But these types of businesses are not attractive to potential buyers willing to pay a premium for businesses that are worth millions more than their asset value.  Building a great business to create wealth for the entrepreneur at exit, means thinking of the exit strategies from the beginning.  Who or what type of buyer would be attracted to this business if successful?   Great wealth is made from selling great businesses at immense profit for the entrepreneurs and investors who took the journey.

Depending upon your stage of development, if you are at the initial creation stage of your business, you might now revisit the earlier posting, “The Berkus Method” (under “Raising Money” in the contents index for this blog) for determining early stage enterprise value for investors.  However, these ten tests certainly apply to all stages of a business’ development as entrepreneurs then professional management work to ctreate extraordinary value for the enterprise.

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Vision is everything.

by on Nov.11, 2009, under Ignition! Starting up

I love absolute statements. And this is one of my favorites.  You’re at the ignition stage of a new business venture.  Of course you have a vision for what that business will do to change the world.  And this insight is directed to you in an attempt to stress test that vision and sharpen it further to help insure your success.

Let me address those whose vision may be limited and who will be happy with a successful local dry cleaning enterprise or small restaurant around the corner.  Although many of these insights will help you succeed, you are not the target for this epic effort to help entrepreneurs build great businesses that do change the world.  Take what you can from these bursts of insight.  I wish you well in your endeavors.

For the rest of you who want to change the world, I am with you and happy to offer all the help I can to reinforce your opportunities for success.

To you, let me repeat: vision is everything.  A great vision for a new enterprise drives innovation. It serves as the rallying cry for all future employees, investors, customers and even suppliers.  It sharpens the understanding of those new to the enterprise and moves them to follow and even to become unpaid advocates for the business. 

[Email readers continue here...]  Think of some of the great visions from the past that did change the world.  “Absolutely, positively overnight” made FedEx an indispensible name in supply chain management.  “A computer on every desk” made Microsoft a partner in the growth of most every business.   You can think of many more, visions expressed so clearly that the enterprise became critical to your own success.

There are other, less dramatic ways to express a vision.  “Be the largest supplier of laser toner in North America”, or “Make dining into a five star experience.” 

Years ago, as a panelist at an entrepreneurial seminar, I watched as over fifty aspiring young entrepreneurs filed past a microphone, each tasked with making a thirty second pitch to the panelists of professional investors.  About halfway through this painful exercise, one man walked up to the microphone and said, simply, “We move oil through the Internet” and then he moved on.  Immediately after the panel presentation, I found that one entrepreneur and began a conversation that led to my investing $100,000 in his vision of a supply chain enterprise based upon perfect knowledge of oil delivery systems, precise timing of delivery and coordination of resources to move oil from source to customer using the Internet as a frictionless tool for communication and coordination. 

Although that business ultimately failed, I still speak with that entrepreneur as he uses his experience in a new field, better off as a result of his learning experience.  I carry no rancor as a result of the loss, since I bought into the vision, helped as I could with the execution, and came to the realization along with the entrepreneurial team that the number of uncontrollable elements far exceeded those which could be controlled by any third party at that stage of development of the Internet.

We will explore vision in more depth in recognition of its importance to success.

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The Berkus Method – Valuing the Early Stage Investment.

by on Nov.04, 2009, under Raising money

             For those of us who’ve invested in early stage companies, especially technology start-ups, we have confronted a universal problem.  There are many ways to project the value of a company for purposes of pricing an investment, but all rely upon the revenue and profit projections of the entrepreneur as a starting point.  Many formulas then discount those projections according to some set percentage or by assigning weight to elements of the enterprise.

             And in my opinion, all fail to take into account the universal truth – that fewer than one in a thousand start-ups meet or exceed their projected revenues in the periods planned.

            Years ago, confronted with the same conundrum, in the middle 1990’s I came up with a method of assessing the value of critical elements of a start-up without having to analyze the projected financials, except to the extent that the investor believes in the potential of a company to reach over $20 million in revenues by the fifth year of business.

            First published widely in the book, “Winning Angels” by Harvard’s Amis and Stevenson with my permission in 2001, the method has undergone a number of refinements over the years, particularly in the maximum assigned to each element of enterprise value, reducing those amounts as the investment market adjusted from the craziness of the bubble to more logical values in the years that followed.  Because the Internet has such a long memory and documents from the distant past can be found with ease, a search the “The Berkus Method” today will yield a number of conflicting valuations culled from the many subsequent publications of the method over the ensuing years.

[Email readers continue here...]  Here is the latest fine-tuning of the method. You should be able to adopt it to most any kind of business enterprise if your aim is to establish an early, most often pre-revenue valuation to a start-up that has potential of reaching over $20 million in revenues within five years:

If Exists: Add to Company Value up to:
Sound Idea (basic value) $1/2 million
Prototype (reducing  technology risk) $1/2 million
Quality Management Team (reducing execution risk) $1/2 million
Strategic relationships (reducing market risk) $1/2 million
Product Rollout or Sales (reducing production risk) $1/2 million
 

                Note that these numbers are maximums that can be “earned” to form a valuation, allowing for a pre-revenue valuation of up to $2 million (or a post rollout value of up to $2.5 million), but certainly also allowing the investor to put much lower values into each test, resulting in valuations well below that amount.

                There is no question that start-up valuations must be kept at a low enough amount to allow for the extreme risk taken by the investor and to provide some opportunity for the investment to achieve a ten times increase in value over its life.

                Once a company is in revenues for any period of time, this method is no longer applicable, as most everyone will use actual revenues to project value over time.

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