Is Your Business Model Sound?

“If it’s a penny for your thoughts and you put in your two cents worth, then someone, somewhere is making a penny.”  – quote from Steven Wright.
I love to listen to entrepreneurs and advisors talk about the value of a new venture.  Even more enlightening to me is the discussion that centers around the proposed business model.  Of particular interest is when the conversation moves to potential funding and the steps one must take to be successful at this difficult task.  One slant I have heard a number of times is a common theme about the difference in approach between West Coast and East Coast investors. There seems to be a pretty consistent “myth” which goes something along the lines of “West Coast investors are more likely to invest in an idea / concept whereas those on the East Coast want to see models and projections.”  It almost comes across as requiring you to develop a viable business model for those on the East Coast but you can “coalesce the vapors of human experience into a viable and meaningful comprehension” to win over West Coast money. (My thanks to Mel Brook’s character, Comicus, from History of the World; Part I for this quote.)

Well, I hate to bust this myth but I believe nothing can be further from the truth. Trust me, unless an investor is totally in love with either your management team or the social cause you are touting, you need a viable business model to obtain meaningful financing. Now some of the models I hear touted sound a bit like this quote from Stephen Wright – they appear to be based on the belief that “there has to be money in there somewhere.”  While this might be true, investors look for you to show them the map and tell them where.

When some talk about their model, I still hear about the number of “eyeballs” a site will attract and the resulting impact of generating advertising revenue. This isn’t Warby Parker – – I am not discouraging this approach but you have to consider how many uses FB had to get to before it could generate meaningful ad revenue. Though they may convey it at different times in the evolution of an early stage company, the message from investors from both Coasts is always the same – – the more pain your product / service eases and the easier it is to use, the more people will pay; and if it is better yet if that payment happens at the time of a purchase (like a transaction fee.) They invest in aspirins not vitamins (see my earlier blog on this.)

So a word to the wise; while I would certainly agree that I have seen some West Coast investors fund companies earlier in their life cycle, I would not extend this to include the concept that there was not a solid business model behind that decision. Earlier involvement does not translate into the fact that they will fund a concept without a business model.  Stay focused on that solid business model no matter where your target investors reside.

The Liquidity Option for Equity Based Plans

“Winner must be present to win.” – common note on many raffle tickets

How many times have you participated in a raffle and noticed this “condition” boldly printed on your ticket?  I have been at more rubber chicken events than I care to acknowledge and I always cringe when I notice this warning.  My immediate reaction is always the same – is this event so bad that they have to bribe me to stay until the end?  We all know the winner is never announced before the very end of the evening – and once that lucky person stands up, we all head for the exits.

I think the parallel in business is ownership liquidity and in particular, the quandary many owners face to provide some cash to minority shareholders as they exit the business.  I have advised many long established enterprises and it does not matter what life cycle stage they are in, there is always this “Sword of Damocles” hanging over their head.  What happens if one of the owners leaves or passes on?  The remaining shareholders feel burdened by the commitment to buy out the departing party and it is this very concern that causes many shareholders to be silent about liquidity in their buy/sell agreements or not establish an equity sharing plan in the first place.  Perhaps the uncertainty as to growth and/or success also plays a role here.

Up until a few years ago, I had only seen this issue and mindset at more established businesses; usually in legacy type industries. Enter the current tech early stage growth phase (one of a few in my lifetime) and equity sharing is back with a vengeance.  However, this round, I have seen a different mindset sprinkled in with the plethora of discussions on stock options, restricted stock, etc.  There have been a good number of equity based schemes that really only have value upon a defined liquidity event.  No vesting or granting of ownership – simply stated – the holder of the ownership instrument must be present at the time of the liquidity event to benefit.  In essence the “winner must be present to win.”

Now, I do not mean to imply that equity in an early stage growth company is like a raffle ticket (actually, I think the raffle odds may be better) or that such an instrument should be seen as a bribe to keep you someplace that you do not want to be.  But, many would espouse that it is the team that creates the true value and unless the team stays until the end (liquidity) there may be no value.

So, if you are a young entrepreneur, you may want to think about this approach as one of the alternatives you consider.  As usual, please consult your professional advisor before reaching a conclusion.  While there might be some tax cost involved, think about the time, effort and expense you may have to endure to address that equity owner who has vested and now wants to leave and get fair value for what they feel they contributed.