1. Business Models and Funding Startups (Class 12.1 – April 9, 2013) CSE 3316 – Professional Practices Spring 2013 Instructor – Bill Carroll, Professor of CSE

2. Guest Speaker – 4/11/2013 Jeff Smith, Chief Innovation and Technology Officer, Numerix Entrepreneurship 2020 Location – Rady Room, Nedderman Hall

3. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-1 Part IV: Start-up Financial Strategy Chapter 10: The Business Model

4. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-2 Chapter Overview Understanding business models Developing a business model Understanding why business models fail

5. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-3 What is a Business Model? A way to create and capture economic value Convert new technology to economic value and deliver that value to the customer Business model characteristics –Creates new value –Difficult to replicate –Based on accurate assumptions about the customer

6. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-4 Business Model is the Implementation of Strategy

7. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-5 Strategically Position the Company in the Value Chain Location is a function of: –The company’s capabilities –Whether the technology is licensed or forms the basis for a start-up –What kind of business the entrepreneur wants to operate

8. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-6 The Value Chain Production Marketing & Distribution Raw Materials Product Development Manufacturing Marketing & Selling Logistics Warehousing Wholesale/Retail

9. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-7 Value Chain Characteristics Warehousing of inventory –Hold or outsource Ownership –Allow ownership in the channel? Financing and payments –Credit to smooth out cash flow variances Risk management –Mitigate with insurance carriers Member power –Degree that strong members control the system

10. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-8 Factors in Market Coverage Distribution: methods and processes used to take a product from manufacturer to customer –How much control over the product does the entrepreneur want? –Will the distribution strategy force customers to change the way they acquire and use the product? –Do customers regularly use the channel?

11. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-9 Sources of Opportunity for New Business Models

12. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-10 Identify Cost Drivers Components/processes involved in developing the final product –Supply –Production, –Fulfillment –Distribution How do critical success factors (sales team, marketing strategy, occupancy, etc.) drive revenues, costs, and cash flow?

13. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-11 Other Factors to Consider Capture value with pricing, cost, and financing –Premium v. lower pricing –Purchase orders, credit cards, PayPal Test for weaknesses in the business model –Launch in limited markets to test –Get feedback from customers and stakeholders –Conduct ongoing sensitivity analysis on the critical success factors

14. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-12 Business Models Change Expanded geographically, new markets, different product offering Selling new products/services to existing customers Taking current business model into new product/service areas Expanding through acquisition or strategic alliances Leveraging existing capabilities to develop new business models

15. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-13 Metrics for Success Does the business model –Inspire complementary products and services? –Increase network effects among customers?

16. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-14 Why Business Models Fail? Predictions based on faulty logic Does not create and capture value The customer has not been identified

17. Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall 10-15 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

18. 11-1 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Part IV: Start-up Financial Strategy Chapter 11: Funding the Technology Start-up

19. 11-2 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Chapter Overview Risks and stages of funding The cost of raising capital Government funding sources Seed capital Start-up funding Funding biotechnology

20. 11-3 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Risks and Stages of Funding

21. 11-4 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Risk Points Seed capital stage –Funding for product development and business launch –Risk associated with technical feasibility and manufacturing Early stage or start-up –Secure first customer –Risk associated with capturing enough customers for product acceptance Growth stage –Focus on managing growth –Risk associated with systems and controls

22. 11-5 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Cost of Raising Capital Up-front costs: preparation of financial statements, business plan, prospectus, legal advice, marketing to potential investors Back-end costs: investment banking fees, legal fees, marketing costs, brokerage fees, state and federal fees. Total costs can be as high as 25% of total amount raised

23. 11-6 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Bootstrapping Borrow, partner, lease Get into business quickly to prove the concept Hire as few employees as possible Lease or share as much as possible Use other people’s resources –Favorable terms from suppliers –Customers pay a portion up front

24. 11-7 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Government Funding Sources Small Business Innovation Research Grants (SBIR) –Phase 1: up to $100,000 –Phase 2: up to about $750,000 Small Business Technology Transfer Research Program (STTR): partnerships between research institutes and small technology companies Small Business Investment Company (SBIC) –Private VC firms licensed by SBA, provide long-term loans The Small Business Administration (SBA) –Partners with commercial banks to guarantee 75% of loan value

25. 11-8 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Seed Capital Friendly money – people you know –Money from strangers will require a private placement memorandum and prospectus to meet “blue sky” laws Debt Financing –Banks typically do not lend to start-ups –Credit cards, commercial finance companies Equity arrangements –Be careful of trading equity for services because it is more expensive at this stage –Difficult to get rid of a person who doesn’t work out Strategic Partnerships and Intermediaries –Associating with a successful large company can give a stamp of approval –R&D partnerships share the risk of development

26. 11-9 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Start-up Funding Risk factors for investors –Degree of uncertainty –Asymmetric information in favor of the entrepreneur –Asset base is principally intangible (e.g. IP, know-how) –Market conditions are often erratic

27. 11-10 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Angel Investors & Networks Private investors who are the principal source of informal capital Fund up to about $1 million Invest in people first, technology and market second Major risks include moral hazard and information asymmetry Invest in familiar industries Seek annual returns greater than 20%

28. 11-11 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Unlikely Angel Deals

29. 11-12 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Funding Biotechnology Challenges –7-9 years to bring a new drug to market –Technology is typically unproven at early stages –Most biotechnology is licensed from universities and research institutes, not owned by company –Difficult to calculate the value of biotech firms because of intangibles

30. 11-13 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall Stages of Biotech Funding Seed stage –Typically government grants to fund research –Investor capital sought on basis of technical strength and initial market research First-round Funding: FDA Phase I Testing –Assess safety of drug, procedure, or device –Typically $15-$20 million required Second-round Funding: The Business Model –FIPCO: Fully Integrated Pharmaceutical Company Difficult entry and depends on IPO –Licensing Model Focus on development and testing, then licensing develop of applications and clinical trials to large pharma

31. 11-14 Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

32. Crowdfunding (Riedl, “Crowdfunding Technology Innovation,” Computer, March 2013, pp. 100-103) Crowdfunding – small-scale “investors” pledge money to a project, funds collected through various websites – Kickstarter, RocketHub, GoFundMe, Appbackr, … Kickstarter (founded in 2009) – 86,000 projects (44% fully financed) – 3.3M “investors” – $480M in funding Example Kickstarter projects – Pebble watch ($100K goal; $10M+ raised; 68,929 “Pebblers”) – Sun Come Up Oscar-nominated documentary movie ($14K goal) – Form 1 low-cost 3D printer ($100K goal; $2.9M+ raised; 2,068 backers) “Investors” – No ownership stake – T-shirts – Product samples – Credits, etc. Legal issues – Allowed under US law? – Intellectual property