What a difference a decade makes

Techno Utopia

Things can change fast. Big things. Real Fast. I think a lot about the cultural shift in the 1960s and how disorienting the cadence of change was. For me the significant barometer of change was the music of the sixties and the surrounding scene of fashion, sexual mores, civil rights, opposition to war and other serious social and cultural re-evaluations. These were, to a large degree, driven by the evolution of aesthetics and taste in music and the open mindedness that evolution engendered.

The band that stands out as modeling the aesthetic revolution was The Beatles. You can mark the time and interterm developmental stages by listening to their albums and looking at photos of the fab four. It is amazing in retrospect to see the morphology. A six-month span will show a complete developmental stage and paradigm shift. It is fascinating to check out in retrospect. Take a minute to think about how life currently seems pretty much the same along many of those aesthetic dimensions from six months, two years, even five years ago.

And at that time there was no guessing how far it could go and what extrapolating the trajectory would look like projected into the near future. The future looked bright.

The Beatles’ Boeing 707, Pan Am flight 101, left London Airport early on the morning of 7 February 1964 and landed in New York City. Sargent Peppers came out May 26, 1967. Think about that for a minute and what The Beatles looked like and sounded like over a little more than three years span. Is that even possible? You can’t blame people for thinking that if that kind of accelerated transformation continued we could be on the brink of something really transformative. It seemed their could be a tipping point in consciousness just over the horizon.

It is really remarkable when you think that only thirty years previous to that the popular music was centered on big bands and dancehalls. Bennie Goodman and others were huge. No wonder there was a generation gap. The new stuff must have really been difficult to comprehend much less love and enjoy and make the centerpiece of one’s life and outlook. Young people recognized it and youth culture was legitimized.

Another bellwether artist of that time that reflected and drove the change was Miles. Think about Miles circa 1958 and Miles in 1968. Very different. Radically different. And that is just a slice of his transformative career. He was at the cutting edge forefront from right after World War II through the eighties. He was an amazing chameleon that drove every modern jazz and fusion style for over four decades. Forty years is not long relatively speaking for tectonic cultural shifts.

The world failed to adapt and coalesce around the musical visions of utopia. Things got diluted and diffused and we have had many false starts and set backs since then. We still haven’t caught up to what they were intimating was just over the horizon. Musically, we stagnated. There has been lots of good music but it is bounded within the format created in the sixties. The form of the Beatles: drumkit, singers, Bass and guitars is still the standard format for pop bands. And Modern jazz still means the ensemble formats and tune structures developed in the 1950s.

Culture seems to transform in spurts and step functions. Our culture may have ossified aesthetically but we are in the midst of another set of changes now. Instead of driven by aesthetic evolution and discriminating taste, change is now driven by technology. Moore’s law and network effects have changed us and how we interact.

It has only been a decade since the mobile revolution was launched. The iPhone was released June 29, 2007. We all adapted and coalesced around that. And big new technologies like artificial intelligence and blockchain distributed ledgers are poised to radically alter how we act and interact going forward.

I hope the intimations of techno utopia are not a mirage. Are there things we should be doing to guide us into the light? As we confront the unintended consequences of social media platforms and cautionary specters of AI and automation driven unemployment, stagnation seems like a welcome plateau; a place where we could catch our breath. But that is not likely. This is more likely the slowest accelerated pace of innovation we will ever experience. It’s just going to get faster. Hold on to your seats!

To Be or Not to Be
Action vs. Inaction

 

Hamlet famously wrestled with whether to act or not. Its one of the biggest challenges we all face each and every day: what to do; when to do it; never enough time. And the plaguing questions about how will it be received, whether what we do is good enough or ready to be shared.

 

Doing anything, and completing any project we set out to do, is met with a series of obstacles. This is especially true of long-term projects. When we want to play the long game we are beset with doubts that feed our innate laziness. Inertia can take many forms along the arc: procrastination, preparation, the task itself, and deciding when it’s done.

 

Jazz musicians have a saying that the two most difficult parts of any tune are starting it and ending it.

 

 

 

 


We all have great ideas. It’s that pesky execution that’s troublesome. As T.S. Eliot said in The Hollow Men:

“Between the idea
And the reality
Between the motion
And the act
Falls the Shadow”

 

 

We have to take the leap and just start. A journey of a thousand miles begins with a single step; then one foot in front of the other. Start. Get a dart on the dartboard and iterate. Jump off the cliff and build the airplane on the way down.

 

Here is an inspiring quote by Goethe exhorting us to overcome inertia and begin:

“Then indecision brings its own delays,
And days are lost lamenting over lost days.
Are you in earnest? Seize this very minute;
What you can do, or dream you can, begin it;
Boldness has genius, power and magic in it.”

 

Then when the initial elation wears off, we find ourselves confronted with hard work of continuing the effort and not getting bogged down or distracted. We discover that the work is hard and a slog. We get caught in the doldrums or as Seth Godin calls it The Dip. Check out his great book by that name on the subject. It will give you lots of great advice about getting through the middle period.

 

Winston Churchill said: “ When you’re going through hell keep going.”

 

In entrepreneurship there is a similar problem of whether to Pivot or Persevere. Do you stay with your original concept or do you change based on the feedback you are receiving. There is a great Tim Ferris podcast on this subject where he has several super smart and talented entrepreneurs weigh in on the conundrum and how to deal with it. A lot of it has to do with asking the right questions of yourself and being radically honest in your responses.

 

These are the hurdles of inertia that we confront. A good way to look at them is as the stoic philosophers did and as Ryan Holiday lays out in his book The Obstacle is the Way. The perceived obstacles are what refine us and make our works better. Instead of bemoaning them, embrace them. We need support and strategies to face them and overcome, and shifting our perceptions of what they are can be immensely fruitful. The great industrialist Henry Kaiser said: “Problems are only opportunities in work clothes.”

 

 

Once we get the bulk of the project complete, and can see light at the end of the tunnel, comes the problem of deciding when something is complete, finished, done. The greatest artists have wrestled with this as an aesthetic question. When would Jackson Pollock decide one of his paintings was finished?

 

Or Beethoven decide a sonata was complete? If you have ever looked at his manuscripts they are so filled with sections crossed out and re-written and revised and it looks like a mess, but ends up sounding inevitable.

 

 

 

Voltaire, an incredible prolific literary figure, said in his Philosophical Dictionary: “Le mieux est l’ennemi du bien. (The perfect is the enemy of the good.)” That is a good thing to keep in mind when confronted with these competing imperatives.

 

Reid Hoffman, the founder of LinkedIn and one of the founders of PayPal and a legendary figure in Silicon Valley, said: “If you are not embarrassed by the first version of your product, you’ve launched too late.”

 

90% and done is better than 99% and incomplete. As Steve Jobs said: “Real artists ship.”

 

No-nonsense Harry Truman said: “Imperfect action better than perfect inaction”

 

 

Don’t get too balled up in making things perfect or ruminating over your “Art”. Just do it and get it out in the world and revise it based on feedback if you fell its valid. Picasso, another prolific creator said: “The less Art there is in painting the more painting there is.”

 

 

And even when we finally have the courage to call it a complete version 1.0, we run into something called Post-Completion Error. Post-completion error is an error where a user misses the steps of a task that are not directly related to the goal and have to be completed after the goal has been reached, like leaving the original in a copy machine after all the copying is done. Be aware of this tendency!

 

With all these landmines it’s amazing anybody gets anything done. Inertia is not our friend.

 

We do need to prepare: research, practice, training and whatever else gets us ready. Lincoln may have exaggerated but only by a bit when he said: “Give me six hours to chop down a tree and I will spend the first four sharpening the axe.” Maybe that is a good ratio for tree chopping, but I think we tend to get caught in a vortex of preparation and never get down to the task at hand.

 

Design Thinking is a set of principles and an action-oriented philosophy designed to help us get stuff done. One of its precepts is to adopt a more playful experimental mode of being; do then think, instead of think then do. Ready, fire, aim.

 

Focus, follow through, and when in doubt choose action. These are the things I try to remind myself and wanted to share with you.

 

I am now deciding this piece is finished.

 

If your work speaks for itself, don’t interrupt.

 

The great industrialist Henry Kaiser, speaks to our tendency to over sell or over explain. Don’t let words get in the way and obscure good work.

 

The anthropologist Margaret Mead had this insight: “What people say, what people do, and what they say they do are entirely different things.”

 

An old adage in sales is: once you have made the sale: shut up. Don’t over sell. And at the end of the day, every time we attempt to persuade or convince someone of our point of view, it’s a sale.

 

Do good work. Actions speak louder than words; let them speak.

 

When, and when not, to explain our work is an artful balancing act. It doesn’t pay to remain totally silent. People need to be aware of our work before they can like it. So awareness campaigns are crucial.

 

Many times our work simply doesn’t speak for itself and some explanation and promotion are in order. Let people into the behind the scenes of your thought process and workflow. This can create a lot more interest in what you do and your finished product. The term for this type of behind-the-scenes look is “inside baseball”. Everybody loves to feel like an insider. Let them in.

 

Knowing when to elaborate and when to shut up; that’s the art. And when we decide it’s the proper time to shut up; listen. Listening is a crucial superpower skill that requires continuous cultivation. I try to be mindful of practicing active listening in each and every encounter, every day. We have two ears and one mouth; use them in that proportion.

 

As screenwriter Charlie Kaufman said: “Constantly talking isn’t necessarily communicating.”

 

I also strive to:

  • Be thoughtful
  • Be considerate
  • Be a fan
  • Be an open node
  • Be kind

 

Simple precepts go a long way.

 

About Henry Kaiser (I’m a big fan)

 

He was one of the great industrialists of the 20th century. He built the Hoover Dam, one of the greatest construction projects ever, that electrified the west and made Las Vegas possible. He was in charge of building the Liberty Ships during WWII and turned out ships in record number by creating innovative build processes with pre-fabricated sections. He salvaged trolley systems for his shipyards, that were bought up and destroyed by GM in an effort to eradicate public transportation and increase demand for their cars (an amazing tale in its own right).   He innovated healthcare and health insurance; to this day Kaiser is a big name in healthcare. He created a car company and the cult classic Henry J.

 

This guy’s work speaks for itself!

Startup Funding Rounds

The whole process of funding and developing startups has become more widespread because the cost of getting a product to market has dropped so precipitously in the past couple of decades from millions of dollars to typically anywhere from under $20,000 to $500,000.

The funding levels are relatively manageable by investors and the potential returns are huge. Potential. The risks are very high of any return, but the few startups that break out create legendary fortunes. That is why there are startup founders and startup investors.

A startup goes through a series of funding rounds on its journey from founder’s idea, through developing an MVP and customer discover, to finding Product/Market Fit, and scaling up operations and sales.

There are a lot of terms tossed around to describe the various rounds of funding that a startup can potentially receive.

These are the typical rounds encountered in an Angel and Venture-Backed Startup and not all startups receive all these rounds. Most small businesses don’t plan on scaling to become Unicorns and don’t pursue this funding journey.

The following rounds are presented in their evolutionary order relative to the development of a startup.

 

Sweat Equity

In the beginning of most startups, the founders will work on the idea for free. This is where things start. All the ownership resides with the founders at this point and they figure out how to develop the business concept using their own resources. This is where hustlers and builders push the development of their company forward without outside funding. Like Teddy Roosevelt said: “Do what you can, where you are, with what you have.”

If your idea is compelling enough, you can enlist the talents of others to work for sweat equity. This may take the form of paying a computer coder to help develop an MVP in exchange for stock in the company instead of cash.

 

Bootstrapping

Bootstrapping is taking early revenues from products and services developed with sweat equity and plowing it back into more development work. There is some outside money from early adopter customers, but not from investors. This is an important milestone because it signals that there is a need for what the company is creating. It is a signal that the founders are resourceful and committed to finding a way forward. This is the kind of grit investors look for in founders.

 

The 3 Fs

This is usually referred to as: Friends, Family, and Fools but I like to replace the last one with Fans. Once a fledgling startup has developed the concept and identified some preliminary customer interest and has a clearer idea of what the next steps should be then it is time to tap the founders’ personal network. This is risky because raising money from your grandmother or uncle and then throwing in the towel in six months can make for an uncomfortable Thanksgiving get-together. You want to be sure that you are on to something before hitting up loved ones and old college roommates. The first two stages move the idea along and also help develop discipline about how to parsimoniously deploy these precious funds in the most effective and efficient manner.

Here you want to have a plan to get to clear milestones and deliverables that will be inflection points of added value and reduced risk. This plan needs to include a detailed budget of how to get from here to there. An entrepreneur needs to be scrappy and capital efficient.

 


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Self-Funding

This is a select group that has the resources to fund the initial development. A serial entrepreneur who has sold previous startups are in this category. These are founders that want to focus on building an MVP without having the distractions of pitching investors before knowing whether the idea is feasible and customer interest is reasonable there.

These folks also realize that the further along the business is, the higher the valuation for the company and the less equity they need to give up in order to raise capital.

 


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Incubator and Accelerators

Incubators and Accelerators are formal programs that accept startups and put them through a program to help develop their idea and then present the graduates to an investment community during a presentation day.

Founders can get a modest amount of funding from these programs. They also get credibility because they have been scrutinized, vetted and accepted by the incubator program.

Y Combinator is one of the most popular incubators and they have had some great success stories come through their program like Dropbox and Airbnb.

 

Crowd Funding

Kickstarter, Indiegogo and others have made crowd funding a viable option for taking projects from ideation to execution and prove market validation. These website driven funding sites are attractive because the represent a funding vehicle that is non-dilutive. This means that the money raised is not in exchange for equity (ownership) in the company. Other incentives besides equity are offered such as exclusive access to the founders or early access to the product.

A crowd-funding project can also act as a way to gauge demand and interest in a concept early on.


This is an extract from my latest book Startups: A Guide to Entrepreneurship.  It’s available on Amazon.  Check it out!

http://amzn.to/2fc9mdC


Angel Investing

This funding round is also called Seed Funding and represents the first professional outside investment. Most founders get their seed round after successfully going through two or three of the early-stage funding strategies discussed above.

Angel investors are individuals who scout for great startup opportunities and generally make a lot of relatively small money investments in early-stage high-risk ventures. They are essentially buying lottery tickets on the character of the founder and the potential upside of a company breaking out into a huge success. They are look to make 100 times their money back if a company “exits” successfully by being acquired or going public.

Angels represent varying degrees of professional investor and they must be convinced of the potential of a startup to really scale and become hugely valuable.

 

Bridge Funding

The next significant round of funding is the Series A round where a company is funded by Venture Capital firms. But in many situations, founders underestimate how much time and money it will take to reach the milestones they need to achieve in order to warrant VC interest.

This gap between breakeven or profitability, or VC funding, is filled with a Bridge Round. It is designed to get the startup through to the next growth milestone. This follow-on funding round typically comes from the seed investors who are motivated to ante up or see the venture close down and their initial investment evaporate.

 

Series A

The Series A is the funding round where the company becomes a professionally organized entity: a corporation. Professional venture capital firms who as part of the deal join the board and create proper “governance” do this funding round. Proper governance means that the company is legally incorporated and holds regular board meetings and keeps a detailed record of board resolutions all designed to increase the share price of the company.

Prior to the Series A, founders run the show and answer to no one. Focus is on trying to find product/market fit. After Series A the CEO will spend a significant amount of time (25%) managing the board and the legal requirements of running a corporation.

 

Series B,C,D etc

These are the follow-on rounds once a company makes the transition to being a professionally managed operating entity.

 

Cap Table

The cap table is short for the capitalization table. It is the official list of all the shareholders in a company and how much they paid for their shares. The above funding rounds represent the people that make up the cap table.

 

Exit

This is the event that represents the big payday for early investors and founders. An exit is either an acquisition or an IPO Initial Public Offering. An IPO is where a company gets listed and traded on a stock exchange and sells shares to the general public. IPOs are relatively rare.

The more usual exit is an acquisition where the startup is bought by an established company to add to its portfolio of offering or for some other strategic reason.

The purchase price of the company is split among the various shareholders and the value of their pro rata portion is what determines their return on their original investment. The exit is the end game goal of venture-backed startups.


This is an extract from my latest book Startups: A Guide to Entrepreneurship.  It’s available on Amazon.  Check it out!

http://amzn.to/2fc9mdC

 


If you found this interesting and helpful, check out my book Understanding Entrepreneurship and Startups 

This is a quicker read to assimilate the key 20% that will give you 80% of the results ASAP!




Oh Behave! Behavioral Economics

 

Behavioral Economics is a method of economic analysis that applies psychological insights into human behavior to explain economic decision making.

 

Behavioral Economics: We are not Spock.

 

Behavioral Economics is a heroic attempt to get classical economics to get more real when it comes to actual human behavior. We are not always rational and calculating the optimal solution to what is best for us. Sometimes we misbehave. Economics should take that into account.

 

Economics made great strides in becoming a reputable science by abstracting human behavior relative to how we make decisions. It made the math easy to simply say that we all optimize our decisions to give us the maximum satisfaction and benefit, all the time. Well guess what, it ain’t necessarily so.

 

Physics is a pure science that sometimes has a similar relationship to everyday events. There is the story of the dairy farmer who enlisted a physicist to analyze his cows and milk production. The physicist reviewed the farm and the operation, went away for six months, and returned with his analysis. He began: “assume a spherical cow of uniform density…”

 

Simplification, reductionism, and abstraction are the methods of generating theory. Economics made great strides by developing analytical tools based on the simplified assumption that we are completely rational actors. In theory.

 

In practice, not so much. For over two centuries the ideology of free markets has dominated the world, bending politics as well as economics to its core assumption that market forces produce the best solution to any problem. Any problem. These days we are exploring more nuanced versions of capitalism and economics.

Behavioral Economics is a method of economic analysis that applies psychological insights into human behavior to explain economic decision-making. Traditional economics assumes that people are completely rational actors and are always optimizing their decision-making.

 

If that were a true and accurate description of our behavior, then supermarkets wouldn’t have impulse purchase sections by the check out line and their would be no advertising industry or influence selling tactics. Behavioral Economics attempts to paint a more nuanced portrait of our decision-making behavior, our heuristics, and our cognitive biases. To paraphrase Leonard Nimoy: we are not Spock.

 

 

 






 

 

 

One of the big breakthroughs in thinking about our decision-making abilities came from looking deeply at the short cuts we use to quickly size up a situation and act. These shortcuts are called heuristics. Heuristics it turns out are highly practical problem solving techniques especially when one has to make a quick decision, like the fight or flight type we used to have to make on the savannah a couple hundred thousand years ago. They are not guaranteed to be optimal or perfect, just sufficient for the immediate circumstances. Nowadays, they can lead us into temptation and be manipulated by savvy marketers and hucksters.

 

 

Behavioral Economics can teach us about who we really are. Like Morpheus says in the Matrix: “You take the blue pill, the story ends. You wake up in your bed and believe whatever you want to believe. You take the red pill, you stay in Wonderland, and I show you how deep the rabbit hole goes.”

 

Check out this list of what I think are the very best books on Behavioral Economics. Take the red pill…

 

 

Net Present Value

 

Net Present Value (NPV) is the gold standard analytic technique used in financial analysis and investment decision-making. And spreadsheets like Excel make it super easy to use. Lets talk about what NPV is, how its derived, and how to employ it.

 

 

 

In business we invest in projects that make money in the future. We pay now and intend to reap the rewards in the future. Usually a project or asset will make money as a stream of revenues and profits over years. It could also be a project whose main benefit is savings. We need the ability to calculate whether that stream of future cash flows is worth more than the money we need to invest to buy it or build it. NPV is the tool we use to make that analysis.




 

The way we look at decisions about whether to fund a project or calculate the value of an asset is to turn that stream of future dollars into today’s dollars.

If you need a primer on the time value of money, check out these two blog posts:

 

 

Then we compare that sum of present values to the cost; if the cost is more than the total present value, we don’t do the deal; if it is less, it is considered a good deal.

This is the way projects are analyzed and assessed as go or no go, and how income producing assets and acquisitions are valued for sale, purchase, merger or acquisition.

 

In those previous blog posts we analyzed and calculated the value of future cash flows and brought them back to present value. Net Present Value (NPV) takes this idea a step further and accounts for the transactional aspect.

 

We must “purchase” the future cash flows either by:

  • Buying a bond or stock, or
  • Acquiring a company, or
  • Purchasing an income-producing asset, or
  • Undertaking a project and incurring the costs of developing or building the income-producing asset.

Net present value “nets out” the cost of acquiring the future cash flows. NPV compares the cost in today’s dollars to the present value of projected income or benefits also in today’s dollars. The deal is only worth doing if the price is less than our assessment of the future benefits.

 

NPV is the main tool used to value assets and make decisions about projects, purchases, mergers, or acquisitions. The spreadsheets can get pretty complicated when they are populated with all the costs, revenue and expense projections, and assumptions about timing and risk, but the basic idea is always to compare the costs to the future benefits and compare them apples to apples by taking into account the time value of money.

 

NPV answers a simple question: does the present value of all the money coming in over the life of the project outweigh how much money we have to spend in order to receive it? Net present value is just that, it’s the net between the present value of these two streams: the money going out and the money coming in.

We need to determine whether NPV is greater than 0. If it’s greater than 0, then the costs are less than the benefits and we should do the project or make the investment.

 

The decision rule is whether NPV is bigger than 0 or less than 0. We can construct the formula for NPV by following along very closely with what we did in the prior blog post discounting cash flows. NPV is the gold standard but using it along with IRR makes for even better analysis and decision making.  I will talk about IRR (internal rate of return) in a future blog post.

 

NPV is equal to the present value of what’s coming in off the project as cash flows minus the initial cost.

 

This formula is set up as the initial cost, which has a minus sign in front of it, plus Cash flow in period 1, discounted one period back, plus the cash flow in period two, discounted two periods back, plus the cash flow in period 3, discounted back three periods, you get the idea, plus all the other cash flows coming in discounted by their period.

 

What we are doing is taking the initial cost and weighing it against the present value of all the cash coming in. We “net” the two numbers. There’s a minus sign on the costs, and plus signs on all of the present value cash flows.

We are essentially looking at how all the money going out weighs against all the money coming in.

 

Think of it like a balance. If we know the initial investment and the stream of money coming in from the project in the future, we can measure the NPV as the difference between the two; its the net between those two streams.

 

As the initial investment becomes larger, the NPV become smaller. You can see that the NPV, whether it’s bigger than 0 or less than 0, depends on that balance between the money going out and the money coming in. Let’s work a problem and compute an NPV in practice.

 


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NPV in Practice

Analyze the stream of cash flows and compute the NPV if the discount rate is 15%

 

EXAMPLE PROJECT

Today

Year:           0             1             2       Sum (NPV)

-$3,000     $1,500   $1800       $300

 

Let’s think about whether it’s worth it to do this project.  In period 0, today, we need to spend $3,000 in order to receive the future cash flows. Is it worth it to spend that $3,000? What do we expect to get in return?

 

What are the cash flows coming in off the project? We have a cash flow of $1,500 coming in at the end of year one. And we’ve got a cash flow of $1,800 coming in at the end of year two. If we just sum up the cash flows, a minus 3000 (it is minus because it is a cost) plus 1500 plus 1800, we get an answer of $300. This project is generating cash. It’s profitable in this sense. The money coming in is bigger than the money going out.

 

That’s the sum of all the cash flows, but that’s without any discounting. We haven’t accounted for the fact that we have to wait a year to get the $1,500, and then wait another year after that to get the $1,800. Remember: to use money you have to pay; there is a cost of capital. So what do we have to pay? In this case, we have to pay that 15% discount rate.  That is the cost of capital in this example.

Today

Year:     0                   1                 2         Sum (NPV)

-$3,000           $1,500        $1800         $300

Present

Value:                 1500/(1.15)1   1800/(1.15)2

NPV

@15% -$3,000 + $1,304.35 + $1,361.06 = -$334.59

 

We need to adjust the cash flows for the time value of money by discounting them to the present value.  We take that $1,500 and discount it one period at 15% and we get $1,304.35. Then we take the $1,800 and discount it two periods at 15% and we get $1,361.06.  Now when we sum the present value of all those cash flows, we get minus $334.59, which tells us that the project destroys value. It’s not worth doing.

 

It’s a profitable project, but we don’t want to do it. Why would we ever not want to do a project that’s profitable? It all comes down to the 15% discount rate. That 15% indicates what the hurdle rate is for the profitability of the project. This project might be profitable, but it is not profitable enough to justify the required 15% return. If we, our bosses, or our investors require a 15% return to take the risk of that project, we’re not going to be able to deliver it to them with a project like this.

 

 

Let’s examine what some of the main drivers are in that net present value calculation. First is cash flow. Obviously, more cash is better than less. The second is the timing. The further the cash flow is out in the future, the deeper it gets discounted.

 

And the third driver is the discount rate. The higher the discount rate, the deeper the cash flows get discounted and the lower the NPV. The lower the discount rate, the less discounting, the better the project. Lower discount rates, higher NPV. Higher discount rates, lower NPV.

Here is another example on the white board:

 

 

Net present value is the benchmark metric. It is our best capital budgeting tool. It incorporates the timing of the cash flows and it takes into account the opportunity cost, because the discount rate quantifies, in essence, what else could we do with the money.

 

The fact that we’re discounting implicitly incorporates the opportunity cost. And it incorporates risk. If we think the project is a lot riskier, what can we do? We can increase the discount rate to reflect that risk.

 

NPV is objective in the sense that, if we have good forecasting and good discount rates, we can lay this out and calculate it in a way that is presentable and explainable to anybody. It’s an arm’s length metric. NPV is transparent, we could sit down together with a spreadsheet and go over it and explain all of the assumptions to each other.

 

Net present value weighs the costs and benefits of cash coming in versus cash going out, and gives us an objective, arm’s length, and transparent metric for capital budgeting.

Spreadsheets like Excel make implementing NPV analysis a breeze.  Here is a screen shot of NPV laid out in Excel:

 

 

To sum it all up:

Here is the formula laid out in general terms:

 

NPV = -C0 + C1/(1+i) + C2/(1+i)2 +…+ CT/(1+i)T

-C0 = Initial Investment

C = Cash Flow

i = Discount rate

T = Time

 

Remember the main drivers of NPV are:

  • Cash Flow. Obviously, more cash is better than less.
  • Timing. The further the cash flow is out in the future, the deeper it gets discounted.
  • Discount Rate. The higher the discount rate, the deeper the cash flows get discounted and the lower the NPV. The lower the discount rate, the less discounting, the better the project. Lower discount rates, higher NPV. Higher discount rates, lower NPV.

 


This blog post is excerpted from my book MBA ASAP Understanding Corporate Finance.  It is available from Amazon as a paperback, eBook for Kindle, and audiobook.  The audiobook is also available from Audible.

 

 

 

 


 

Ex Nihilo

 

 

Ex nihilo is a Latin phrase meaning “out of nothing”. It often appears in conjunction with the concept of creation, as in creatio ex nihilo, meaning “creation out of nothing”.  This is an ancient religious and philosophical concept.

 

 

 

 

 

It is also what entrepreneurship and startups are all about: creating something out of nothing. As entrepreneurs, we are looking to create something that fits a need, something of value. Some “thing” that does not yet exist but can be conjured.

 

 

In startups, we devise business models that do it for a profit so that the process is scalable, meaning it can sustainably grow.

 

 

 

Peter Thiel, the co-founder of PayPal and the first outside investor in Facebook, wrote a book about entrepreneurship called Zero to One based on this premise of going from nothing to something; that the act of creation is singular and incredibly worthwhile.

 

 


Related:  Top Startup Entrepreneur Books


 

 

This may be the most exhilarating part of entrepreneurship: taking an idea, a product of mind, and making it tangible, useful, valuable.

For more, check out my new book MBA ASAP 10 Minutes to Understanding Entrepreneurship and Startups.

 

 

 

 

 

Seven Good Reasons to read biographies and autobiographies:

They provide a sandbox for role-play and rehearsal

 

Biographies allow us to test our mettle by trying to figure out how best to navigate and negotiate situations in a risk free environment. Because history tends to repeat itself and human behavior follows relatively predictable patterns, we can learn from other’s circumstances and mistakes. Complex situations can be unpacked into component parts for future actionable reference.

 

They allow us to invert the harsh lessons of experience

 

The Cy Young winning baseball pitcher for the Pittsburgh Pirates Vernon Sanders Law said, “Experience is a hard teacher because she gives the test first, the lesson afterwards.” Pitchers must have a lot of time in the dugout between starts to think profound thoughts.

Tweet: Experience is a hard teacher because she gives the test first, the lesson afterwards. https://ctt.ec/O1ew6+

Reading biographies let’s you reverse the chronology and absorb the lesson first.

They help us practice and develop empathy and emotional intelligence

 

Emotional Intelligence is the capability of individuals to recognize their own, and other people’s emotions.

We use emotional information to guide our thinking and behavior. We need to be able to manage and adjust our emotions to adapt in different settings. In short we need to be appropriately social to get on in the world and achieve our goals.

Empathy is the ability to understand and share the feelings of others. Empathy is our ability to project into the situations of others and really experience their trials and tribulations as our own.

It is easy to read a biography and gloss over the trials and tribulations of the subject and those in their circle. We read of how they were ostracized and criticized and ignored or ridiculed; had diseases and illness; poverty and financial hardship, or were surrounded by war and death. We read these things and put them into the category of the stuff they had to overcome. Because we know the end of the story: that they triumphed either in life, or after with fame and glory, we diminish the immediate impact of these things that they must have felt.

Taking a moment to feel that impact allows us to develop our capability for empathy and understanding of others in our lives.

They help us see further

 

In February 1675 Sir Isaac Newton wrote to his good friend and colleague, the great polymath Robert Hooke, “If I have seen further, it is by standing on the shoulders of giants.” Reading biographies captures that experience. They allow you to see further by vicariously experiencing what others have gone through and achieved. The practice is an efficient way to gain life lessons.

This idea of standing on the shoulders of giants didn’t originate with Newton. The original attribution of this is from Bernard of Chartres in the early 12th Century as recorded by John of Salisbury:

“Bernard of Chartres used to say that we [the Moderns] are like dwarves perched on the shoulders of giants [the Ancients], and thus we are able to see more and farther than the latter. And this is not at all because of the acuteness of our sight or the stature of our body, but because we are carried aloft and elevated by the magnitude of the giants.”

Obviously Newton was an avid reader.

 

We are reminded of the cyclical nature of events

The philosopher George Santayana wrote, “Those who do not remember the past are condemned to repeat it.” There is not much new under the sun and we risk repeating mistakes others have made before us if we are not aware of them. If we make ourselves aware, we can hopefully avoid them.

A cautionary tale can help us recognize and avoid potentially bad situations. And biographies allow us to rehearse navigating these challenging situations in a riskless way from the safety and comfort of our armchair while sipping herbal tea.

This kind of foresight may help us but I want to temper this point with the fact that sometimes events are outside of our control and may proceed even if we are aware of the probable outcome. It’s like watching an accident unfold in slow motion. “Those who don’t study history are doomed to repeat it. Yet those who do study history are doomed to stand by helplessly while everyone else repeats it.” When events take this type of turn, it’s probably better to read philosophy and swap the tea for scotch.

 

They promote and encourage self-discovery

 

Biographies are chock full of teachable moments; some positive, inspirational and aspirational, and some that are cautionary. Ideas and approaches to life will reveal themselves through biographical narratives. Experiential learning is more impactful and satisfying, and thus more memorable, than reading a list of normative steps in a self-help or textbook.

They help us look at the world from novel angles

We need diversity of ideas and experience in order to break out of our creative ruts. Transformative ideas and revolutionary innovations come from lateral thinking; transposing a concept from one field to another or combining ideas in new and non-obvious ways. Biography is a resource for developing this super power.

 

They provide us with world-class mentors

 

When you read a biography or autobiography you get a glimpse into the subject’s mind and gain the advantage of “knowing” them. They become mentors as we ponder about what advice they offer related to the situations we face.


Related: Curated list of Best Biz Bios


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