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Collaboration strategies – how to partner right?

One of principle rules in attracting external resources to a starting-up enterprise is to make its expected profits highly plausible to interested parties, including investors. One of approaches toward de-risking planned activities is to bring attention to formal partnerships formed by the company. Having a right partner might increase chances for start-up’s commercial success and decrease its operational costs. So what are the most common dimensions of collaboration in starting up phase of business activity?

Crucial dimension for future commercial success of a start-up relates to its ability to interest, cooperate and receive orders for its goods, services, or solutions. One of the ways to make these aspects plausible is through working out and signing a document confirming pursued and shared declarations e.g. in form of letter of intent (LoI).

Purpose of LoI is to express in writing will of parties to explore together items they agreed to, and to declare officially that parties know each other and are negotiating. Usually final agreements resulting from LoIs take form of separate, legally binding contracts. LoIs are usually “soft” documents in terms of their legal power, can be general in terms of what they express, but still provide formal proof that parties are looking into more detailed ways of future cooperation.

You might find different examples and naming conventions for letters of intent, such as declarations of cooperation (DoC), memoranda of understanding (MoU), but what is common for all of them is that they are signed to declare intentions, which does not always have to  be finalized. Typical letter of intent should cover purposes for expressing intent by parties, scope and responsibilities of parties, organization and governance including representatives, and clauses such as non-binding effects, intellectual property, and confidentiality. You might find some examples of such documents in this place.

Letters of intent are not only signed with expected, future customers. Deriving from lean start-up approach we wrote about before, to lessen the costs of operations for start-up, letters of intent can also be signed with parties interested in running trials of products, services or solutions that are under development, parties expressing interest in testing a prototype, or parties interested in distribution of ready goods, services or solutions.

Depending on how advanced a start-up is, purpose section in letters of intent can range from exploration of joint business models, through detailed ways of cooperation in business development, even to declaring pre-orders once product, service or solution start-up is working on is ready (which is pretty strong confirmation of demand on start-up’s offering). LoI can also help a start-up to play the long game with big companies, which intent could be to find fit in cooperation model within agreed period of time.

To structure potential discussions on business models and to name them in your LoI you take a look into over 50 business models elaborated on by O. Gassmann, K. Frankbenberger and M. Csik in “The St. Gallen Business Model Navigator”, and also nearly 150 business innovation tactics shared by by L. Keeley, H. Walters, R. Pikkel and B. Quinn in “Ten Types of Innovation: The Discipline of Building Breakthroughs”.

Elaborated proofs can supplement another “stamps” looked for by investors such as certificates of attendance or completion a start-up acceleration programme or awards received from relevant communities or bodies. Altogether, they minimize perceived investment risk.

Having letters of intent signed by a start-up with couple of expected customers proves to potential investors that start-up’s offering raises interest, and demand for starts up’s value proposition is validated. These aspects might positively affect start-up valuation in its pre-market phase, which we wrote about some time ago.

Another way to demonstrate collaboration maturity of a start-up is to be able to license in part  know-how or technology needed, especially if it’s more beneficial than inventing new know-how or technology. Licensing-in, or in other words purchasing part of know-how or technology from existing entity can impact on perceived value of a start-up and foundations of its business (especially if part of know-how or technology is purchased from reputable entity). Finding entities offering know-how or technology of start-up’s interest should be part of state of the art analysis performed at early stage of product, service or solution development done with sources such as registered intellectual property databases we wrote about earlier.

Searching for a  right licensing-in partner through research queries in intellectual property databases can also lead to identification of potential customers and business partners. Licensing can also be done the other way around – in licensing-out form: from a start-up to external parties. It can make sense if a start-up has intellectual property, which is properly protected and can be licensed out without harm to future strategic position and profits of a start-up. Licensing out a part of know-how or technology can become separate stream of revenues needed at early development stage. Licensing agreements usually define fields of use of know-how or technology licensed out, rights which are granted, and rights which are retained (which ca be e.g. further research and development right to the subject of license). Therefore, rights to the same invention can be licensed out for multiple contexts and expected usages to many external parties. You can find supportive resources relating to licensing at website of MIT Technology Licensing Office in this place.

The last collaboration strategy we would like to briefly deliberate upon is outsourcing. Outsourcing usually relates to contracting out part of activities of an enterprise, which are not distinguishing in terms of capabilities represented by an enterprise itself. However in context of a start-up contracting out part of work to specialized organizations can again be a factor determining perceived value through teaming up with specialized partners. This can occur if parties contracted out demonstrate excellence in what they do and are responsible for resource-effective delivery of elements of product, service or solution offered by a start-up, belong to collective research organization (such as TNO, Fraunhofer, VTT), or specialize in rapid prototyping and production (such as RDLabs).

Collaboration strategies we have presented can take form of formalized expression of declared will, licensing-in and licensing-out agreements, outsourcing contracts, awards, certificates of attendance, or completion of relevant programs. Demonstrating ability to collaborate decreases risk of doing business with a start-up, impacts on chances to attract investors or being awarded a grant by grants awarding institutions. So which collaboration strategy is for you?

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How to Valuate a Start-up?

Have you founded a company, and don’t know how much it could actually be worth? Or are you maybe  a Business Angel considering investment into newly founded business, who needs to estimate its value?

Start-ups valuation methods I’d like to share with you can be supportive in both of the   situations. I will focus on valuation of early stage technology start-ups, and so called pre-seed valuation, which refers to the stage of a company before it attracts any external funding such as Business Angel, or Venture Capital. For later stage start-ups, especially those which attracted funding, you should use a different valuation methods . By technology start-ups I mean start-ups, which build their value thanks to owned intellectual property rights, which consists of non-obvious know-how, industrial designs, and patents.

For applicable purposes of this post let’s assume you are a CEO of a start-up, who prepares to meet with its potential investors. The question you ask yourself is how much your company is  worth, and how much you should ask for, which always will be a derivative of your company’s valuation.

Whereas old, good, and favored by Venture Capitalists multiplies method, or Discounted Cash Flows (DCF) method needs to base on solid or well educated market size and your sales projection, it cannot be used in all examples, and sometimes it’s just inadequate to use. Such cases include creating new product or service entering new market of unmet needs, which you cannot back up with any solid benchmark. For sure you can make your own assumptions, do primary and secondary market research,and check flexibility of demand of your product or service against proposed price, however it’s good to have back up valuations, especially when your DCF is challenged by investors you negotiate investment with.

Seriously thinking investors can check value of your company against couple of pre-seed valuation methods, which are currently in use. One of my favorite methods, which I learned from serial entrepreneurs Prof. Malte Brettel from RWTH Aachen in Germany, and Prof. Tony Warren from Pennsylvania State University in the US, is Berkus valuation model.

Berkus valuation model comes from the US, and is especially valuable when you lack financial history, your business plan is uncertain, and still you need to determine value of your company. According to Berkus valuation model you need to check the existence of, and add up values for the following elements, which your start-up might consist of:

1) Sound idea your start-up represents (creation of basic value)  – add up to USD 500 k

2) Having prototype (reduction of technology risk) – add from USD 500 k to USD 1 mln

3) Having good management (reduction of execution risk) – add from USD 500 k to USD 2 mln

4) Having strategic relationships (reduction of marketing risks) – add from USD 500 k to USD 2 mln

5) Having good quality of the board, incl. advisors (reduction of governance risk) – add up to USD 1 mln

6) Having ongoing sales (reduction of production risk, doesn’t apply in very early stage) – add up to USD 1 mln

Berkus valuation model originates form Dave Berkus, early stage private equity investor, who made over 140 technology investments. Original Berkus method assumes fewer factors and sums tan provided in method above, and if you are conservative entrepreneur, you can stick to orthodox approach of Berkus presented here.

You can make Berkus method even more pragmatic if you combine it with Kawasaki method, also used for early stage start-ups valuation. In a nutshell  Kawasaki’s method introduces additional element you can add to Berkus, this is value you add for each engineer on board of your start-up  – USD 500 k, and value you subtract for every full-time MBA on board (such as top management consultants) – USD 250 k. In that context it’s always better to ask full-time MBAs to join the advisory board of your start-up, and present them as non-core staff, as they cost a lot, and increase the monthly burn/run rate of early stage venture. It doesn’t mean that full-time MBA start-up founder by definition decreases value of the venture of course.

You can complement both Berkus’ and Kawasaki’s valuations with Cayenne Valuation Method . Cayenne Valuation Method is based on 25 questions, which High Tech Start-up Estimator of Cayenne Consulting consists of.

Other early stage start-up methods include angel’s standard method, rule of thirds method, start-up advisor method, or virtual CEO method, however these I detailed above seem to be the most substantial in terms where the numbers you present comes from.

If you’re determined and not afraid to learn it’s good to master basic DCF method. Sooner or later you’ll need it, especially when you start growing in a way requiring investments more serious than from Business Angels. I’ve learnt DCF from Principles of Corporate Finance by R. Braeley, S. Myers and F. Allen therefore I can recommend it to you. You can find some basic information about DCF here

However if you are real entrepreneur you should find someone who is DFC-literate to support you, including your peers who graduated from economics, finance, or business studies, worked for top management consulting or valuation practices in other consulting companies.

Don’t start valuation of your company with DCF if you don’t have thorough business plan of your venture in the first place,  especially including industry, market forecast, and marketing plan detailing targeted market segment, envisaged pricing of your products, and/or services, promotion, distribution, first five years sales projection, and also production and operations plan. You’ll need this data as assumptions for state of the art DCF valuation every potential investor thoroughly investigates.

In that context you might find supportive basic financial model template and early stage pitch deck template prepared by Amplify, which is one of US start-up accelerators I researched for my Master Thesis at MBA Entrepreneurship and Innovation in WU Executive Academy.

Dzida!