Business
Understanding the Big Picture
A Note on Advertising
Advertising on the Internet
• If you have user traffic, advertisers will pay
• Primary source of revenue for many free to
use services
– Google
– FaceBook
How to Make Money on the Internet
• Step 1: Generate traffic
• Step 2: Take cash from advertisers
• Step 3: Profit
• Simple enough
Twitter: > 300 million active users (over 1 billion accounts)
LinkedIn: about 400 million profiles
*These numbers don’t add up since interest income and expense are not reported on Google Finance.
Full details here:
https://investor.twitterinc.com/results.cfm
http://investors.linkedin.com/results.cfm
Selected Tech Valuations (11/1/2015)
Company
Market Cap
Apple
$666.25B
Google
$497.94B
Microsoft
$420.48B
Facebook
$287.31B
LinkedIn
$31.57B
Twitter
$19.25B
Types of Businesses
Types of Businesses
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Sole Proprietorship
Partnership
LLC (Limited-Liability Corporation)
Corporation
Sole Proprietorship
• Just start doing business
• The business takes your name
– Can file a DBA (Doing Business As) to use a
different name
• Business income and expenses are filed
annually on your personal taxes
• You can lose your house!
– You are the business
– If the business is in trouble, you are in trouble
– Your personal assets are fair game for lawsuits and
debt collectors
Partnership
• Similar to a sole proprietorship
• Must file a business name and any other state
forms
• Good idea to have a partnership agreement
• Can lose your houses!
LLC
• The business is its own legal entity
– Your house is safe
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Owners claim income on their personal taxes
Can have single or multiple owners
Great for R&D phase ideas
Forming an LLC
– Choose a name that contains LLC
– File the Articles of Organization (Simple form)
– Pay fees
• Operating Agreement
– Defines equity percentages, profit sharing, responsibilities, exit
strategy, conflict resolution, etc.
– Not required by all states
– Highly recommended even if not required
Corporations
• S-Corporation
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Similar to an LLC with shareholders
Income is claimed on shareholders personal taxes
Limited to 100 shareholders
Limited to 1 type of stock (everyone votes)
• C-Corporation
– More structure and regulations
– Easier to have share holders and investors
• Can go public
– The business is taxed separately
• Leads to double taxation
• Business income is taxed, then payments to shareholders is
taxed as personal income
Finance
Stock Price
• Great realization of supply and demand
• Liquid marketplace
– For heavily traded (high volume) stocks at least
• Stock price
– The last price a share of that stock sold for
• Market Capitalization
– Stock price * Number of shares
– This is the valuation of a company
– Difficult to value private companies
Investing Choices
• Stocks
– Buy low, sell high
• Stock Options
– Purchase the option to buy or sell a stock at specific price
until a set date
– Commonly used as an employee benefit
– Only costs the employer if the company is doing well
• Bonds
– Loan your money to an organization at a fixed interest rate
– Banks don’t have to give huge loans
– Crowd-sourced loans
Choosing an investment
• Risk vs. Reward
– Riskier investments have higher potential Return On
Investment (ROI)
• Safest investment is in Treasury bills, notes, and
bonds (T-Bills)
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Loan your money to the US government
Very low interest rates
Unlikely to lose your investment
National debt
The US government decided that it can get a higher
ROI by investing cash into the country that the interest
they will have to pay
• Maybe that’s optimistic, but I’d take those low interest loans
Present Value of Money
• The value of money is time sensitive
• $100 today ≠ $100 in 1 year
• At 3% interest
– $100 today = $103 in 1 year (100*1.03)
– $97.09 today =$100 in 1 year (100/1.03)
• $100,000 in five years?
– $100,000/((1+interest)^5)
– $86,260 present value @ 3% interest
– $78,353 present value@ 5% interest
Who Want to be a Millionaire?
• Yes, the trivia show
• Winning $1M
– Receive $250,000 after the show airs (30 days)
– 20 annual payments of $37,500
– http://millionairetv.dadt.com/official-rules/
• Present value of the $1M prize
– $863,179 @ 2%
– $714,964 @ 3%
– $562,555 @ 5%
• For prizes with a lump sum option
– Present value is awarded
– Who chooses the interest rate?
Return on Investment (ROI)
• ROI = (revenue – expenses) / expenses;
• Example
– Invest $10,000
– Returns $12,000
– ROI = 20%
Expected ROI
• Estimate the probability and magnitude of
success for an investment
• Possible ROI
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20% chance of no return
30% chance of $100,000 return
40% chance of $200,000 return
10% chance of $1,000,000 return
• Expected ROI = 0.2*0 + 0.3*100,000 +
0.4*200,000 + 0.1*1,000,000
• Expected ROI = $210,000
Bringing It All Together
Estimated Project returns
Revenue
25%
25%
50%
1 year
$100
$500
$2000
2 years
$500
$5000
$500
3 years
$2000
$1000
$0
Present Value
$2276
$1469
$2358
• Present Value of Expected Revenue
– .25*2276 + .25*1469 + .5*2358
– $3217
• If the project cost $3000
– ROI = 217/3000 = 7.2%
Choosing between projects
• Estimate the ROI of all possible projects
– Market Analysis (Estimate Revenue)
– Timeline (Present Value of Revenue)
– Feasibility
• Choose the project with the highest ROI
– Must also consider your risk tolerance
– Be mindful of cash flow
• Project cost $1M for a guaranteed $200M return in 40 years may
not be feasible in terms of cash flow even though it’s 2740% ROI @
5% interest
• Managers need to choose which projects survive based
on analyses like this
• VC’s and investors do this across organizations
VC’s and Angel Investors
• Convince them that you are their highest and
safest ROI option
• The riskier your startup, the higher the potential
payoff has to be
• 50% chance you’ll succeed
– You need to double their investment for them to
break even
– Even more once PV is computed
• Ultimately up to them how to invest
– It’s their money after all
Finance Summary
• Higher risk
– Lower expected return
• Longer wait for return
– Lower present value of return
• Significant number of parameters to estimate
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