Reference no: EM132904393

Problem - VESTED INTERESTS IN VALUE: INVESTOR AND ENTREPRENEUR - Once Jim understands that his past efforts contribute to value only indirectly, through their influence on the ability of the business to generate future profits (and returns to investors), he sees the importance of business planning. To communicate effectively with potential investors he will need to formalize-and, to the extent possible, quantify-his vision and objectives.

If Jim had wished to remain local and sell only through the restaurant, a certain clientele of investors would have been willing to join him, vesting their hopes in the single brewpub. On the other hand, because his plan is to market his craft brewing nationally through normal retail stores and a chain of brewpubs, a different clientele of investors will consider partaking in the risk and return of the grander vision. Ascertaining the type of investor offering the $100,000 investment is critical. Communicating his vision effectively and attracting compatible investors (who share the same, or a highly correlated, view of the future) is one of the central purposes of a formal written business plan.

It is clear that investors are not going to share all of Jim's personal objectives for owning and operating a chain of brewpubs. For instance, in addition to having a national consumer base, Jim may wish to locate pubs in towns he likes to visit or where his relatives reside. He may want to employ a relative as chief financial officer (CFO). Similarly, Jim will not share all of his investors' objectives. It is common for upstream suppliers and downstream distributors to invest in order to solidify strategic relationships. Some of the objectives of strategic relationship investors may be at odds with Jim's objectives.

In this and other investment contexts, however, there is a financial objective that, other things being equal, both Jim and his potential investor can support: increasing the value of the ownership of Jim's operations. Rarely do investors and founders agree on exactly how to increase value. Nevertheless, there is almost always an unwritten agreement that, whatever the strategy (purchasing, operations, marketing, management), from the venture's viewpoint the fundamental criterion for evaluation is the strategy's contribution (directly or indirectly) to firm value. If Jim wants to appoint Dad as CFO, he will be asked to explain to the other investors why this enhances value relative to other choices for CFO. If the venture's hops supplier has invested and wants the business to increase its hops inventory holdings, someone will have to explain why this is a net financial advantage.

Jim and his potential investor have been debating two expansion strategies. Jim believes that, to affiliate his crafted ales with the brewpub experience, early customers should continue to purchase his ales primarily at a company pub. Such belief dictates that pub operations be expanded relatively rapidly, or that licenses be granted to existing pubs with the proper atmosphere to sell his draft ale. Jim's potential investor thinks it is better to go with a few destination pubs, no licensed pubs, and extensive advertising to create a brewpub affiliation as bottled versions of his crafted ales are distributed through normal distribution channels. While it is not clear how this debate will be resolved, it is obvious that one important criterion by which the strategies will be judged will be the bottom-line impact on the value of Jim's venture. Valuation is how visions of the future are translated, quantified, interpreted, and made relevant to current investor negotiations.

For those who are interested in why economists, finance professionals, and academics focus on the present value of owners' wealth to choose a firm's strategic direction, Learning Supplement 10A (at the end of this chapter) presents a nontraditional treatment of the traditional microeconomics argument for maximizing firm value as a unifying theme when evaluating investments. In such a context, it is easy to see how financial markets unify investor objectives for the firm without denying important differences in the way investors perceive a firm's investment (and harvest) opportunities. Recognizing the role of financial market signals, and incorporating them into decision making, can provide an important financial framework for investors and founders to use when evaluating the advantages and disadvantages of different expansion strategies. Agreement on an evaluation criterion is a first step toward agreement on the strategy itself.

How are Jim's and the investor's objectives related to venture value?