Financial viability

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Financial Viability
@WisnuDewobroto

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Business Model Innovation is powerful to drive growth!

4. Assessing financial viability early – What’s this?
• Early assessment tool /process to
test the financial viability of a
business model
• Key outputs include pricing and
volume: what do I have to do to
cover costs and achieve
breakeven (profitability)?
• The introduction of “risk” as a
financial concept: Do the returns
compensate for the risks I am
taking as an entrepreneur?
• Provides early indication whether
outside investment might be
needed to get to breakeven
‘Sometimes there
is a gap in the
market because
there’s no market
in the gap’
—Irene Bejenke-Walsh
MessageLab

5. Why?
To really be feasible, a business model must make sense
• not just strategically
(where you have a compelling and competitive product
offering and route to market),
• but also financially
(so that you will earn more than you invest!)
• This also makes sense for a social/non-profit enterprise –
you still need to break even!

6. Two paths...
Financial viability has different parameters depending on
whether you intend to enter:
1. A market for products
2. A market for technology
Your choice of market might even depend on the respective
financial viability of each option.

7. 1. Market for Products
Is there a ‘market in the gap’?
This section was co-authored by
Irene Bejenke Walsh, MessageLab

8. 1. Product Market
If you aim to pursue a route to the Market for Products
(See ‘Clarysse model’ in Teece analysis slides in Business
Model tool)
1. Value Proposition based on Product Offer
(or standardised service)
•Specific product / market niche
•Control over the value chain
•Diverse founding team with experience in industry
•Funding from founders’ own capital, debt or possibly an
Angel, followed by early revenues
-> Revenue Growth by selling standardised products to
customer segments

9. Key questions to address
• Do the returns on
investment compensate
for the financial risks
involved?
• Can I make a product/
deliver a service which is
competitive on a
breakeven basis ?
entrepreneur
business
• Is the addressable market
big enough to make
commercial sense?
(See Entrepreneurial
Market Research in IE&D
Toolbox)
market • How long before the
business is self-financing
and hence…..
• …will I need outside
finance ?
finance
Copyright of Bart Clarysse and Sabrina Kiefer
The Smart Entrepreneur

10. TheComponents of a “Market in the Gap” Analysis
• Addressable market: this needs to be
big enough, offer enough potential
customers/revenues to make the
company scalable
(See also “Entrepreneurial Market
Research” in IE&D Toolbox)
• A viable business model would satisfy
all 3 components opposite
• “Return on investment” is used here
as a conceptual term for a number of
key financial issues entrepreneurs
have to consider in the start-up phase,
e.g. cash and time they are investing
themselves, and how they want to be
compensated for their investment.

11. Breakeven Analysis
This is a rough test to work out how much we need to charge for our product or
service (i.e. the lowest price) in order to at least cover our costs, i.e. get to
breakeven.
•Once we have determined a breakeven price for our product or service, making a few basic
volume and cost assumptions, we can answer the question: is our ‘breakeven price’
competitive in the market?
•If my breakeven price is already higher than that of the nearest existing competitor(s), we are
facing a competitive and financial challenge with different potential outcomes (or a negative
business case). The idea is that the business model has to stand up at a minimum to this
simplified P&L model to assess financial viability.
•This is an interactive process, e.g. a negative business case result may cause us to review our
assumptions and thus produce a new/ lower breakeven price.
•Depending on our funding, we may be able to tolerate a negative business case in Year 1
provided we are confident that the cost base will improve in the near term (also known as ‘cost
leverage’) – this is then an issue for a more detailed financial modelling exercise to determine
when breakeven occurs and how viable this is for us.

12. Cost analysis
Fixed Variable
Explanation Costs that are the same
regardless of how many
items/ services you sell –
sometimes described as
the costs you need to
incur before you are able
to sell
Recurring costs that you
need to pay with each unit
you sell – naturally for some
cost items (eg raw
materials), the per unit cost
will depend on volume
Example Development costs,
property costs,
marketing, IT costs,
finance costs (though this
depends on how the
business is financed -
debt or founders’ equity)
Cost of raw materials,
distribution costs, product-
based labour/ staff costs,
royalties

13. Quantifying your risk & investment
• Calculating risk and investment as an
entrepreneur are essentially subjective
exercises.
• Two parameters to consider at this early stage
are money and time invested and how you
want to be compensated for these.
• Money: how much cash have I invested in the
business, when do I want/need the money back
and at what return? If I have re-mortgaged my
house and invested £50K, personal finances
might be tight and I will need a certain level of
return to pay for the cost of finance.
• Time: How long will it take to get to breakeven
point? How long can I go without a salary? If I
have invested in “sweat equity”, i.e. unpaid time,
how much is it worth and how much do I need/
want to earn?
Note: typically, third-party investors
require at least a 25% rate of return
to invest in a start up business, this
means that a business has to return 3x
the original investment over 5 years.

14. The concept of return on investment
• All businesses involve risk and some businesses are
riskier than others.
• Higher risks are acceptable provided they bring the
prospect of higher financial returns.
• At one level, a founder is an investor: someone
who invests his or her own time and/or money in a
new business idea or venture.
• A venture is only viable , if it compensates the
founder for the risks incurred, i.e…
• …if the founder’s return on investment exceeds the
risks involved.
• For these purposes, the return in a venture and
payback over time could be expressed as the
equivalent annual interest rate you would receive
on the same amount of money invested over the life
of the venture
Question: would you
expect to get back more
money from a £100
investment in a business
start-up or a £100
deposit in a domestic
bank account?
Now ask yourself why ?

15. 2. Market for Technology

16. Technology business model – financial viability
1. Look at acquisition prices of comparable companies
2. Assess the stage of development those companies had
reached when they were acquired
3. Assess what market conditions were like at the time
4. Estimate the potential value of your business at similar
stages and market conditions
5. Evaluate the return on the effort and investment needed

17. Look at comparables – Steps 1 and 2
1. Look at comparable companies (similar industry/market)
where early investors exited via a trade sale pre-revenue
• What was the acquisition price?
2. At what stage of development was the comparable company
when it achieved that price? e.g.:
• Med/biotech: It had passed a stage 2 trial, or it had undergone full clinical trials
• Engineering: It had achieved a certain stage of advanced prototype or pilot tests; it
had built a certain amount of infrastructure
• Digital: it had a certain size of user base, a proven user growth trend, etc.
• And generally: employee headcount, size of technical team, size of general
operations, number of years the company has existed, etc.
Typically, at a more advanced stage of development >>
greater acquisition price

18. 2. Stage of development - value
You might try to extrapolate a value per asset ‘unit’ at those
comparable companies, based on acquisition value E.g.
• Value per registered free user/paying customer (website)
• Value per unit of infrastructure built (engineering)
• Value of successful trial (medical), etc.
In other words, find a basis for comparison with your business

19. Look at Comparables - 3. Market conditions
3. What were financial market conditions like (esp. for
private equity deals) at the time the comparable companies
were acquired?
• Greater risk appetite among investors >> greater price
• Depressed financial market >> lower price
• How much competition was there on the market?
• Was it a trendy sector? Investors trying to play catch-up to get into
the market >> price rises
• Were there a lot of competing companies seeking acquisition?
>>price may fall
In short, what factors (stage of development and market)
drove exit valuation at comparable companies?

20. Comparables and you – step 4
4. Estimate the potential value of your business at similar
stages and market conditions
• How long might it take you to achieve a comparable stage of
development to previously acquired companies, or
comparable milestones?
• What could your ‘value per unit’ be at that stage?
• Consider possible business value in a buoyant or
depressed market .
The above will be speculative, but can offer a starting point
for considering a future value range (depending on
conditions).

21. 5. Is the business model worth the investment?
What kind of investment (£) would be needed for the co. to
reach a ‘sellable’ stage? How much work?
• Develop Management team, Tech team, general staff
• Infrastructure
• Achieving regulatory compliance
• etc.
Given the cost, time and risk, would the final payoff (sale)
reward you sufficiently?
• For the entrepreneur this may be subjective
• For a financial investor less so – typically seek a 50-60% annual return
or 10 times initial investment
• e.g. Imperial Innovations aims for exit sales of at least £100 million,
besides a high return on initial investment

22. Further Reading
Clarysse, B. and Kiefer, S., 2011. The Smart Entrepreneur.
London: Elliot & Thompson, Ch. 7, 9 & 12.