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

*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.cfmhttp://investors.linkedin.com/results.cfm

LinkedIn: about 400 million profiles

Twitter: > 300 million active users (over 1 billion accounts)

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

• 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

• 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– 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)– 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– 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

• Present Value of Expected Revenue– .25*2276 + .25*1469 + .5*2358– $3217

• If the project cost $3000– ROI = 217/3000 = 7.2%

Revenue 25% 25% 50%

1 year $100 $500 $2000

2 years $500 $5000 $500

3 years $2000 $1000 $0

Present Value $2276 $1469 $2358

Estimated Project returns

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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