Business, Law, and Innovation Business 101 Lecture 3 Spring 2011 Professor Adam Dell The University of Texas School of Law

2 - Business Models / Economics - Finance / Accounting - Strength of Business Models - Market Niches - Changing Markets 2 Big Themes:

3 Business Models / Finance How much can you sell your WIDGET for? (Sales) How much does it cost you to make the WIDGET? (COGS) How much margin is left over? (Gross Margin) What expenses (rent, employees, etc.) do you have? (SG&A) What is left after that? (EBITDA) What percentage of sales is that? (Operating Margin) How much do you need to invest in the plant? (Cap Ex) What is left after that? (Net Operating Cash Flow) If this doesn’t work…..nothing will. You can quote me on this: “Finance is often a lot of fancy B.S. designed to hide the ball.” 3

4 Business Model / Finance – Income Statement 4

5 Strength of a Business Model We’ve got something no one else has (intellectual property) and it’s really valuable to customers (they’ll pay a lot for it). We’ve got a position that has entrenched us in a market and it’s hard for anyone to compete against us (MS Windows). We have a big “MOAT” (Warren Buffett). This thing we sell, its really cheap for us to make additional copies of it and sell it millions of them (software). Strength of the business model translates into a high valuation multiple in the public markets. - Businesses that are growing fast - Have a great big MOAT - Have great Operating Margin (Operating Income / Sales) 5

6 Market Niches 6 Think of every company competing in a given market (for $s) as a single plant competing for space in their niche of the canopy of the forest. Many never get to see the light. The strength of the business model will define how large and strong the enterprise becomes. But remember: Trees don’t grow to the moon.

7 Markets are Not Static 7 You can be certain of one thing: THINGS ARE GOING TO CHANGE….remember CREATIVE DESTRUCTION. Markets There are more middle class people in China than there are people in US. More people speak English in China than there are people in the US. There are more people in China on the Internet than there are people in US. Technologies Alta Vista -> Google Home Phone -> Cell Phone Customer needs / expectations 411->Google SMS Competitors MS -> Google Docs This constant roaring machine gives rise to new opportunities every day.

8 Lawyers and Business 8 Business people make deals. Lawyers “paper” them. A big knock against lawyers is their lack of a fundamental understanding of business. It would serve you well to try to understand the underlying business models of your future clients. It’s important to strip away the “noise” in transactions, contracts, partnerships and businesses. Focus on the key drivers of success. The rest will take care of itself.

9 Lawyers, Business & Negotiation 9 Virtually every interaction in business is a negotiation. It would serve you well to read and understand: “The Art and Science of Negotiation” by Howard Raiffa

10 Lawyers, Business & Negotiation 10 1) You must be willing to walk away 2) Know in your mind what you want / need; don’t be so clear to the other side. 3) Remember that everyone wants to “feel” like they got a good deal. 4) Do not give up something without getting something of equal value. Always work in the context of the entire transaction. 5) If you think you got an extraordinary deal, you probably didn’t. 6) If there are not realistic & fair incentives on both sides, things will likely go bad. 7) Working with great people is more important than working with a great contract. 8) Put yourself in the shoes of the opposite site before you sit down. - Try to understand their alternatives - Try to understand what is important to them - Do not empathize; focus on objective facts - Try to anticipate their arguments - Look at the prism from all sides