Investment Decision - Do Not Invest. I would not invest for the following three reasons: (1)
unproven proof of concept, (2) outsourcing risk is not truly addressed (3) revenue and market
share capture assumptions lack support and appear unreasonable without any primary research
evidence.
(1) Unproven proof of concept: The plan outlines a technology that has only been proven in a
simulated environment. While the technology boasts of 15-30% drag reduction, they have yet to
provide evidence they can actually achieve this under real world conditions. The results from the
preliminary trials are not confirmation and an expectation to achieve 30% for a $2.5M
investment is not compelling enough alone. The claim that DARPA cannot achieve the same
results is equally unsubstantiated. Additionally, the objective of 30% drag reduction for
subsurface admittedly states they need additional R&D to account for increased complexities. I
would be far more willing to invest given a conclusive proof of concept anticipated in 2005.
Going from a $130,000 research grant to a $2.5M investment is a leap of faith I am not willing to
embrace. The assumption that the patent process will proceed smoothly compounds the issue.
(2) Outsourcing risk: Whereas the management team identifies the outsourcing risk, the
recommended countermeasure is not sufficient enough to mitigate concerns. Outsourcing
reduces the ability to effectively manage quality control as well as customer response time in the
event of an issue. Managing costs and schedule will be critical in the early phases to establish
credibility with the greater marketplace. I agree with the strategy of targeting the WSF in order to
establish a beachhead, but relying on the lowest-cost alternative to achieve the optimal results in
order to “immediately” scale elevates the level of risk considerably to the out years. EBIT
margins do not reach positive numbers until year 4 in the financials and controlling COGS will
be critical to meeting the projections. A $7.98/sq ft price point may appear small but any
variance when considering the overall size of the vessels and volumes required could easily
balloon in the wrong direction.
(3) Revenue and market share capture assumptions: The Company is seeking $2.5M in June
2005 and then forecasts $660,000 in revenue by EoY 2005, increasing to $6.1M in 2016, 830%
YoY growth with subsequent YoY growth rates of 220% and 73% respectively. Given the
assumptions of $800K for a large solution and $200K for a medium installation, they would have
to guarantee 6 large and 6 medium installations in the first 18 months. That would be almost
half of the WSF fleet or some combination depending on the size of their vessels.
By 2007, the
company would need to acquire 90% of the WSF market share alone in the first 2.5 years. While
the plan suggests secondary research supports the possibility, there is no documentation of any
primary research available. Outside of discussions with WSF, there is no validation the
marketplace is interested in LoDrag. Also, a 2 year lifespan seems short and does this timeline
coincide with ship retrofits? Again, no validation that companies would find this agreeable. The
plan promotes the idea the Company can establish alliances, but is vague on who the alliances
would be other than the notion of the America’s Cup.
Attempting to raise $7.5M of capital in a little over a calendar year for significant R&D while
trying to earn greater than $26M in revenue over a similar time period does not align. Without
any actual primary research evidence, I would not invest in this plan.
LoDrag is not worthy of investment. The LoDrag business plan is lacking in four specific ways.
(1) The ask is tremendous ($2.5 million) given the flimsy justification of the technology’s
claimed efficacy. (2) The analysis makes broad market assumptions on buying factors/behavior
on the part of target customers. (3) LoDrag founders operate on the prediction that fuel costs will
perpetually remain high. (4) LoDrag is giving a best case scenario in terms of ongoing product
development, which could see significant boosts in cost to produce.
(1) The qualification and quantification briefed for the effectiveness of LoDrag quotes realistic
and best case scenarios for efficiency gains. A computer simulation is the single piece of
evidence cited for the claim of a 30% efficiency gain. 15% is the cited statistic for realistic
increase in energy efficiency for ferry operators. All these claims are predicated on the idea that
the technology will always work as designed, that the retrofits will be successful and cost
effective, and the technology endures in a field environment where it has yet to be tested. An
investor looking at a plan of this nature would certainly note that the best case scenario presented
has a 5x return over the course of roughly 6-7 years. Such thin reasoning and even a lack of
proof of concept undercut the grandiose claims made in the business plan. A modest ask to fund
proof that the technology works would be more feasible and could serve as demonstration to
potential customers.
(2) In the course of the business plan, LoDrag cites only a modest reference of “preliminary
contact” with WSF officials who provided a “welcome reception” to their technology. No other
citations exist in the business plan stating that the team had interviewed other potential
customers. They base their potential market and customers on research and data in efficiency and
assume that their technology would be adopted by these potential customers. This indicates that
the LoDrag founders did inadequate primary research with their key segment. Even the primary
potential customer, WSF, has made no commitment to purchase the technology or a tentative
agreement to purchase upon completion. This is a product that could be funded and hit the
market with zero commitments or orders. One based entirely on the technology premise and not
on direct research of potential or real customers. To understand the spending priorities and
decision-making criteria of potential customers is critical for market validation. For example,
would WSF be interested in taking each boat out of their fleet for a period of time (losing
income) to retrofit to a new technology that may require upkeep or replacement for what could
amount to a modest gain in efficiency?
(3) LoDrag’s business model hinges on demand driven by the high cost of fuel. As of the writing,
fuel costs were high. However, in the interim, oil prices remain low and relatively stable. A
persistently low-cost economic environment for fuel will inevitably reduce the demand for
efficiency products. A good example of this is the direct correlation between hybrid sales and
fuel prices. Hybrid demand falls as fuel prices fall. In addition, technological advances in
engines are consistently producing higher rates of efficiency. The threat of a current or future
innovation in boat engines could further undermine the LoDrag business model and render it
moot.
(4) In outlining the plan forward, the study notes that additional refinement at minimum is
necessary for the technology to reach market. The risk matrix notes that supplemental funding
might be required beyond the huge $2.5 million initial ask in the event that research and
development overruns. Other risks, including issues with maintenance, resourcing, and wear also
contribute to the impression that this product relies on the massive ask providing for all the
upfront costs with minimal problems. Past precedent from industry renders this supposition
unlikely at best. Investors are assuming high risk just for a product to reach market, to say
nothing of its viability.
After reviewing the LoDrag business plan, I would not recommend investment in LoDrag Inc.
The primary factors driving the recommendation include (1) an overall lack of support for the
product and market claims, (2) complicated cost factors that would discourage a rapid rate of
adoption, and (3) a financial model that is misaligned with the plan.
1.
Product and Market Claims
The overall description of LoDrag’s opportunity is believable, but there is zero quantitative
support for the market conditions. Claims of a potential 30% reduction in drag are based only on
proof-of-concept computer simulations and no product specs have been shared. There are
existing solutions available to the market that can reach 30% and the competitive advantages
listed are more similar to potential specs and are not unique to LoDrag. No data was shared on
the market share or penetration rates of any competitive solutions, so it is impossible to validate
the competitive conditions. The choice of targeting Ferries is confusing since the vessels are
typically custom made in small quantities. The installations would therefore need to be custom,
limiting efficiency through standardization. LoDrag states that it would plan to perfect the
product on its first customers at WSF which would be concerning to any operator and lacks
confidence. The military and VLT vessel segments look to be more attractive given their
high-levels of fuel consumption and standardized vessels. Strategic alliances that include a
sailboat racing series are misaligned with the market opportunity. Other alliances that I would
expect to include skilled labor unions, environmental associations and shipyards are not
described.
2.
Cost Factors:
The projected cost and installation of LoDrag appears to be very costly for boat owners without
validation that the boat owners would actually carry the costs. The installation process has to be
conducted in dry dock and repeated every two-years. There is no information on how long the
installation would take and may not be feasible for larger verssels. The company plans to lead
R&D of the highly complex systems internally, to outsource manufacturing and to offer custom
installations that require highly skilled labor. There is an estimated 10% license fee to consider.
The business will also be dependent on a large sales team that will need to educate customers
throughout a long sales cycle. All of these factors limit potential margins and increase the risk of
the investment. There is no data shared on how competitive the sales environment is. There will
be a low diffusion rate given the product sits under water, so a costly $500,000 free installation
as a marketing strategy seems misguided.
3. Financial Model:
The five-year growth rate from $660k to $100m seems aggressive without validation as to how
they will achieve this growth. There are basic estimates on the cost to manufacture and deliver
the product, but there is risk in using this data because the product is still in concept stage. The
personnel expense appears low considering the revenue and number of customers needed to
achieve the aggressive revenue goals. It is unlikely that a sales staff working on long-term deals
will work on a high commission ratio. There is almost no support for the financials in the
business plan narrative other than cost estimates. I would also need validation for how the costs
would be broken out to understand what is fixed and what is variable.
Because of these factors, among others, I am not recommending an investment.
Based on my review of the LoDrag business plan, I would not invest in this venture. The primary
reasons I would not invest are: 1) the LoDrag business plan has no clearly defined product
journey combined with a reliance on high R&D costs without a clearly defined target market; 2)
the LoDrag business plan has disproportionate spending ratios for both cost of production and
fully burdened cost of customer acquisition; 3) the lack of clarity in the financial projections and
assumptions.
High R&D Costs: The first reason not to invest is the reliance on a proof of concept as a viable
business opportunity. The business plan is focused on preliminary evidence of product
capabilities using computer simulation which is not proof that it actually works in a real-world
environment given all the variables associated with ocean-going vessels. Additionally, although
the patent process has begun, and the business plan makes mention of a comprehensive strategy
to protect the patent if and when it is granted; there is no appendix with documents supporting an
actual strategy. Finally, manufacturing based startups are difficult to justify for venture capital, so
the investment in research and development is too risky without any real product. Even if the
product was in actual production, the company is not sure which application of the product
would be entered into a viable market. There is only a statement of the annual fuel consumption
by the ferry boat industry. There is no actual description of any market validation to confirm the
pain for the ferry boat operations associated with those fuel costs. There is just an assumption
that this is something the ferry boat operators would be willing to pay for to reduce fuel
consumption. Additionally, other than plans to partner with the Washington State Ferry system as
an R&D partner there is no actual evidence of conversation with the operators of the system to
meet any defined needs in terms of reducing fuel consumption.
The second reason not to invest is the lack of clear evidence for the two most important financial
considerations for any startup: cost of production and cost of customer acquisition. The
outsourced manufacturing costs of goods sold is way above the 40% COGS expected for the
U.S. manufacturing industry. In addition, the expenses for sales and marketing of LoDrag are
way out of proportion for manufacturing companies who usually spend approximately 15% of
revenues. They would be spending a disproportionate amount of the equity position on direct
sales staff without any defined market segmentation or validation.
The third reason not to invest is lack of clarity for which market LoDrag intends to focus to meet
their lofty projections. The business model focuses on a variety of potential market segments
totaling $1.8 billion, however, there is no clear plan how they will establish dominance in any
one segment, and only vague mention of potential markets with no details of how they plan to
enter these markets in any systematic fashion. The plan starts with the vague mention of the
potential $30 million market for ferry boats and a mention of 100% ROI for the boat owners
without any financials details to explain how that return would be achieved. Additionally, the
financial projections for revenues do not have any basis in how those revenues would be
achieved. The financial assumptions state prices for the different installation sizes, but there is no
evidence of a strategy on how to reach those segments, who they would specifically target, or
even how they created the revenue assumptions for each installation size. Furthermore, without
any clear market validation there is no clear indication of the price any assumed customers
would be willing to pay. Finally, these vague financial assumptions do not offer any details on
the expected market share LoDrag plans to acquire which means I have no way to tell if the year
three revenue projections are projected to reach a ten percent market share.
Based on the given data and assumptions presented in this case, I would not choose to invest the
requested $2.5M at this time. Although the competitive advantage of the technology and
opportunity initially appeared attractive, there are three key factors influencing my decision.
First, there was very little market validation performed. Second, the current state of
development is not far enough long to justify the proposed deployment and revenue timelines.
Third, the list of key potential risks has not been fully developed, leaving the company
vulnerable to many unintended circumstances.
Market Validation. One of the most important steps in determining the overall viability of a new
technology’s success is market validation from industry experts and potential customers. This
requires extensive interviewing. Although the LoDrag team identifies the Washington State
Ferry System (WSF) as the biggest and most attractive potential customer it wants to target in its
initial segment, they give little indication that any meaningful relationships have been formed to
date. Although the preliminary contact with officials at the WSF produced positive feedback on
the LoDrag technology and its drag reduction capabilities, a more in-depth analysis of needs is
needed. There is no indication of what specific criteria would be needed for the WSF to
seriously consider adopting the LoDrag technology. Other potential segments and strategic
partnerships are later mentioned, but there has not been a concerted effort to interview any of
them to the degree needed for meaningful analysis here. Without extensive market validation
performed, it is hard to quantify the interest or potential of the LoDrag technology’s adoption.
This process determines all subsequent assumptions made in their business plan.
State of Development. Another relevant concern is the overall state of development of the
LoDrag technology and how this affects the team’s proposed production timeline and revenue
generation. Although they have identified and talked to a Chinese manufacturing company about
the price of outsourcing the tiles, there is no indication that this source is a truly viable business
partner. There needs to be at least several more potential partners listed as backups here. This
would give would-be investors more definition around variable costs and how it will influence
LoDrag’s production and distribution schedule. Since a significant amount of the proposed
funding is needed for prototype development ($500,000), this is cause for some concern. It is
also not clearly defined what specific materials are needed for production. There are probably
multiple suppliers and distributors that will need to be identified and locked down before this
part of the business is deemed viable. This process could significantly increase the projected
cost of goods sold.
Underestimation of Potential Risks. There are a number of subsequent potential risks outlined at
the end of the plan that are not clearly explained to the level of depth needed. Most importantly,
there is the reality that the LoDrag retrofit may increase the frequency of maintenance needed for
the ships. This would be no small inconvenience to the ship operators if it negatively affects
logistics and their transportation scheduling timelines. Frustrated from losing money while
waiting longer for the maintenance and repairs, they could choose to cancel the retrofits all
together. In this situation, losing just one contract could mean the difference between generating
enough revenue and having the business going under. This table also speaks to the other two
major factors outlined in more detail above.
In conclusion, I believe the lack of substantiated market validation, uncertainties around product
development and partners needed, and the overall undervalue of risks makes this an unattractive
investment opportunity. The LoDrag business plan simply provides too many unjustified
assumptions to back it with investment dollars.