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Power Equations
Recently I was asked to speak at a TechAlliance / Ernst & Young event in London, Ontario about valuations. I was speaking after Bill Armitage who was clear and understandable so there seemed little point in my getting in an arm wrestle over the finer points of valuation theory. I thought I would try to address some of the questions that I perceived these and many other entrepreneurs have been asking these days: 1. How do I find money? and 2. How do I get the best price.
To shed some light on these questions I directed the audience to the slide below which I have titled the Murphy Balance of Power Equations after the originator and my partner, Jacqui Murphy. I will allow that these formulae may not have the mathematical rigor of those presented by Fischer Black and Myron Scholes for which they were awarded a Nobel prize. But I think you may find them more intuitive.
As Murphy points out, the entrepreneur can find money and maximize price by shifting the balance of power in his/her direction.
No Revenue = No Power: Pre revenue transactions are hard to get done at the best of times. However, even today these deals can get done if there is something special about them… A brand name management team or a locked down go to market channel are two examples of what that pixie dust might be. Having said that, even these entrepreneurs will be price takers.
A Little Revenue = Less Power: The second formula may be somewhat counter intuitive. There are a couple of reasons for this. First, in all likelihood the company will have under performed relative to their initial budget which hands a huge negotiating chip to the investor. Second, there is a huge gap between first revenue and a sustainable business model. Most investors know that the way you generate first revenue is not ultimately how you will be selling to scale. However, they don’t know how long it will take you to find that secret. It is a bit like being in a taxi cab, the meter ticks away while you are stopped at the light. This isn’t new, it has been commented on by many. Geoffrey Moore’s Crossing the Chasm presents one formulation: Hitting first revenue with no cash is no fun!
Self Sustainable = Oh the Power!: Being able to present investors with a sustainable business is like holding a pair of aces. There is no doubt that you will attract attention. Be careful not to over play your hand as it is still way easier to say no to a deal than to say yes.
All this makes me wonder, why is it exactly that we are focusing on the finer points of valuation rather than the finer points of sales…which brings me back to a prior TCP blog post: Stop Pitching and Focus on Building
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June 18th, 2009 at 8:47 am
[...] She believes that not only is it the new order — it’s also the way to establish a power position when you do go to raise money with VCs. I agree and invite you to check it out and let us know your [...]
June 25th, 2009 at 12:34 am
True for dealing with new money in; financial success is the upper hand.
As a founder involved in internal power struggles, however, I find my personal time investment and commitment to the company detracts from the leverage (aka “Power”) created by business success. The controlling shareholder(s) seem to hold stronger cards during internal discussions, regardless of how successful the company. In your experience, when and how does this power balance begin to shift?
Great post Andrew, Ronald.