Problem Summary:
Using at least three tools/concepts in the Quantitative Analysis and Finance Chapter, decide how are you going to fund your start up and why.
Spend at least 30 minutes in your group, come to an agreement, upload 250-1000 words of your plan (mention the concepts/tools) to your learning journal. It is fine for each one to upload the same text, but variation and your own ideas are encouraged.
Further Definition of Company to Answer this Challenge:
(1) Company type
s corp. because we will not be responsible for double taxes, but we will have the liability insulation of incorporation. We may use stock to engage participants in our business, but we can reincorporate as a c-corp when we grow to a size that warrants that company type.
(2) Do we need to write a business plan to raise fund?
Revenue generating activities:
- Annual fees and expenses from certification and recertification:
reference ISO 9001 cert http://the9000store.com/ISO-9000-Tips-How-Much-Does-it-cost.aspx
- Consulting fees to address specific problems areas of members and applicants
- Referral fees for brokering new business deals with member businesses
Primary expenses to support revenue model:
- Marketing (brand building, lead pre-qualification, public relations): $200k/yr
- Staff (Experts, Administrators, Other): 5 founders + 1 FTE equivalent @ $80k/yr = $480k/yr
Questions:
- Do we need office space, or can we conduct business in other ways to streamline?
We will use executive office suites or meet at the client site for approximately $6k/year
- How should we approach launching the business? Begin with single industry, focused region, high-probability clients (such as those recovering from a recent negative PR hit).
(3a) How much will we charge for our services. $5,000-$50,000 (plus expenses) depending on the tier and complexity of certification. Paid annually for recertification.
(3b) How much funding will be needed for our venture “Society Trust”
Cost: Executive office suite (office space): USD 500 dollars average/month = $6K pa
Salaries: Staffs (5 founders + 1 accounting/MISC) average at 80K USD; So the total cost per year is 480K
Marketing costs: $200k for the first year
Contingency fund @ 5% = $34k
Total budgeted expenses: $720k
(4) How do we raise funds and who are our fundraising targets?
(4a) Obtain bank loan: see foundation grants -- PRIs include loans
(4c) Issue stocks: looking for angel investors and venture investors. Internal stock structure; If we look for venture investment, VC will look for higher return from the company. We will need to have a 15 or more clients paying full price to break even, venture capital seems unlikely due to relatively low potential for jackpot returns. Best option is to look for angel investment from an investor who has a particular interest/commitment to the social good that Society Trust does by certifying adherence to a triple bottom line standard.
(4e) Foundation grants:
http://grantspace.org/Tools/Knowledge-Base/Individual-Grantseekers/For-Profit-Enterprises/Business-funding [PRIs program related investments]
(4f) Donations? High profile/celebrity donors could have double impact of fund raising and testimonial marketing.
(4g) Lobby government to implement legislation that requires businesses to obtain a certification like (or explicitly) ours. Good business model like “Energy Efficient Mark” for most of the appliances. The certification company is a private company but the company work with government to gain public conscense.
(4h) Give the first few customers stock grants to engage them and build participation in our certification program. We can also provide free certification (and sell consulting service to get them up to certification level) to strategic partners that will help establish the brand and generate addition early adopter business.
(5) Which tools/concepts we choose to do number (4) funding our venture:
(a) Cash flow analysis: Investment, revenue, cost, and total cash flow
(b) Net Present value(NPV): our certification process creates an annual revenue stream from each participant, NPV allows us to calculate the current value of those income streams. Furthermore, using the probability of those clients maintaining participation in the program will allow us to calculate a weighted NPV and thereby establish a current valuation for the company.
(c) Using FRICTO to balance our risk/reward on an ongoing basis. Flexibility, Risk, Income, Control, Timing, Other.
(d) Regression analysis for forecasting/projections - we could identify relevant variables for the analysis once we get going.
(e) Strategic mergers and stock purchase/sales with other related businesses to form and solidify partnerships.
Monday, October 24, 2011
Quantitative Analysis - Additional Tools
Definitions of Quantitative Analysis (QA)
"A business or financial analysis technique that seeks to understand behavior by using complex mathematical and statistical modeling, measurement and research. By assigning a numerical value to variables, quantitative analysts try to replicate reality mathematically."
Alternate definition of QA in Chemistry (wikipedia.org)
"In chemistry, quantitative analysis is the determination of the absolute or relative abundance (often expressed as a concentration) of one, several or all particular substance(s) present in a sample."
Alternate definition of QA in Behavior Science (wikipedia.org)
"Quantitative analysis of behavior is the quantitative form of the experimental analysis of behavior. This has become the dominant scientific approach to behavior analysis. It represents behavioral research using quantitative models of behavior."
Methods of QA
Matching Law (QA of Behavior)
"In operant conditioning, the matching law is a quantitative relationship that holds between the relative rates of response and the relative rates of reinforcement in concurrent schedules of reinforcement. It applies reliably when non-human subjects are exposed to concurrent variable interval schedules; its applicability in other situations is less clear, depending on the assumptions made and the details of the experimental situation."
Mathematical Principles of Reinforcement (QA of Behavior)
"Mathematical principles of reinforcement (MPR) are a set of mathematical equations that attempt to describe and predict the most fundamental aspects of behavior. The three key principles of MPR, arousal, constraint, and coupling, describe how incentives motivate responding, how time constrains it, and how reinforcers become associated with specific responses, respectively."
Behavioral Momentum (QA of Behavior)
"Behavioral momentum is a theory in quantitative analysis of behavior and is a comparative metaphor based on physical momentum. It describes the general relation between resistance to change (persistence of behavior) and the rate of reinforcement obtained in a given situation."
Algorithmic Trading (QA in Finance)
"In electronic financial markets, algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading, is the use of computer programs for entering trading orderswith the computer algorithm deciding on aspects of the order such as the timing, price, or quantity of the order, or in many cases initiating the order without human intervention."
Stochastic Calculus (QA in Finance)
"Stochastic calculus is a branch of mathematics that operates on stochastic processes. It allows a consistent theory of integration to be defined for integrals of stochastic processes with respect to stochastic processes. It is used to model systems that behave randomly."
Chapter 6: Finance Outline
·
Accounting – information, trends and facts
o “There is no chief accounting officer, just controller”
· Finance – strategy, decision
o External – investment (dealing with other people’s money)
§ Valuation
§ Cash flow
o Internal – financial management (dealing with own company’s money)
§ Dividends
§ Merger and acquisition
o Business structures
§ Proprietorships
· Individual owner (or husband and wife)
· Direct accountability for company debts
· Easiest form of business to own and operate
§ Partnerships
· Two or more owners who share liability
· Limited or unlimited versions
o Limited partnerships cannot be sued for their own personal property (LLP = limited liability partnership)
o Individuals pay taxes, not the company
o Company makes decisions
§ Versus unlimited liability where individuals in the company all make decisions
o Must have a record of working as a group, so the group is responsible.
§ Corporations
· S-corporation versus C-corporation
o C-corporation
§ Most companies are C-corps
§ Minimum cost of $800 corporate taxes per year in CA
· Must file annual report of CEO, CFO, secretary
§ Double taxation
· Corporate taxes (~15%), plus personal income tax (~25%).
o Ends up with only 60% of profits paid to shareholders.
· Interest is tax deductable.
§ Delaware has two protective laws
· Does not show the public who is the CEO
· Has a court system to deal with business disputes so expedites business issues.
§ Nevada is similar.
o S-corporation
§ Only up to 100 stockholders, cannot sell stock on the open market.
§ No double taxation.
· Limits personal liability
· LLC is a limited liability corporation, but it can have shareholders. Not public.
· Affords the rights of an individual to the company
§ Investment
· Risk vs. Return
o Example: CD and oil exploration
o Systematic versus unique
§ Systematic – whole market has risk
§ Unique – risks associated with a specific investment
o Diversified portfolio?
o Beta 1, 0, -1, etc.
§ Variability in the valuation of a company relative to market indices (measure of risk)
· Coca-cola is Beta=1, so it follows the market
§ Going against the market is a negative beta.
· Allows you to balance out your risk.
· Stock and stock market
o Stock Indices: S&P 500 (big companies), Wilshire 5000 (largest 5000), Nikkei 225 and Dow Jones 30 (oldest and most famous, but not representative of the whole market)
o Standard IPO is $10/share to make return historically about 10% using P/E ratio.
§ Since DJ started tracking the total return for all companies is ~7.6%
§ Average P/E ratio is 16.
§ Also need to know growth rate.
· Could not be earning money but still valuable.
· Book value assets (real estate, equipment, reputation) could represent value
o Buy and liquidate to get money back
§ What is the challenge of continuing to sell stock?
· Take over potential
· Diluted value of shares
· Alternatives:
o Borrow money
§ Have to pay interest
§ Must be able to “service the debt”
§ Need collateral
o Issue Corporate bonds
§ Sells your debt to the public
§ Issue coupons at a “par value” but they can be resold at a different price.
§ Interest rate on bond is fixed, outside interest rate and bond price are negatively correlated.
o Options
§ Pay for option to buy by a defined date “CALL OPTION”
§ “PUT OPTION” is an option to sell.
§ Chicago option exchange, minimum 100 shares, keep 50% for processing fee.
o Stock options
§ Must pay taxes on exercised gain on stock options, even if you hold the stocks and it goes down in value.
§ Works differently than founder’s stock.
· Founder’s stock has a “nominal price” and you pay taxes when you sell on the appreciated value from the nominal price to the sale price.
o Mergers and Acquisitions
§ Why?
· Diversify
· Improve sales and earnings
· Purchase an undervalued company
· Lower operating costs with economies of scale
§ Mergers are friendly, acquisitions are hostile
· Absolute power is 51% but could take much less to elect your people to the board.
o If you buy more than 10% must inform the SEC
· Poison pill
o Protects against takeover
o Use all cash and borrow from bank to buy shares back, share price goes up and you take on debt so makes the company less attractive.
o New contract to employees, if company sold to new company everyone get a significant raise (25% in Yahoo’s case in defending against Microsoft)
o Can also fight in court.
· After M&A
o Reduced wages
o Layoffs
§ Typical layoff strategy is layoff half, give other half a raise to signal no more layoffs. Otherwise everyone looks for jobs.
o Lower cost
o Reduce working capital needs
o Gain access to pension fund
§ Laws against it but it does happen
o Sell assets (real estate, patents, divisions)
§ Leveraged buyout
o Mutual funds and hedge funds
Chapter 5: Quantitative Analysis Outline
Quantitative analysis (QA) is one of the most important tools in a business curriculum and is used principally in finance, accounting, marketing and operations. QA helps individuals to remain objective when solving complicated problems. Important topics in QA include:
o Decision tree
§ Simplifies decision making based on conditional probability
§ Start a business, etc. look at data or other people’s research to get probability
o Cash flow analysis
§ How much does an investment cost and how much cash will it generate each year?
§ Too much cash? What to do with it?
· Invest/Reinvest in company
· Acquire other businesses (strategically)
· Pay dividends
o NPV – Net Present Value
§ A dollar tomorrow is almost always worth less than a dollar today.
· Depends on the interest rate, inflation rate, opportunity costs
§ To compare different investments, convert them all to today’s dollar.
· Called the discount rate, and it is different for different risks – very subjective.
o IRR – Internal Rate of Return
§ Based on NPV
§ IRR of an investment is the interest rate that makes the sum of the net present value of an income stream equal zero in today’s dollars.
· 7% for 7 years will double your money.
o Normal distribution – Bell Curve
§ Determined by the mean and standard deviation
§ Variance is the distance between sigma and negative sigma, or within one standard deviation.
o Regression analysis and forecasting
§ Linear regression
· Uses historical data to extrapolate the relationship between variables
· Does not hold in the extreme
· Excel data table – completes a table based on a relationship and givens
o Business world does not tend us go as far as academics in finding the right curve for the data, usually just a straight line
· R Square – if too low it doesn’t fit the data too well (70% very high, 30% not bad)
· T Test – how strong X affects Y (-2<T<2 = data is significant)
· Both T and R have to be high for the equation to be a good forecasting tool.
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