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Sam Ghosh Founder and SEBI Regd. Investment Adviser at Wisejay Private Limited Bangalore, Karnataka
Capital Investment decision making for entrepreneurs part 2: Stage wise value and return assessment
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11:20:26 AM, 6th July, 2019
  • Sam GhoshFounder and SEBI Regd. Investment Adviser at Wisejay Private LimitedBangalore, Karnataka
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    In the last post, we talked about the high-level considerations before even considering the project economics. So, should we just assume some numbers and calculate the returns?

    Wait!

    We cannot just “invent” numbers arbitrarily. We need a suitable framework to get to some reasonable estimates. Matured businesses generally have a wide experience of project implementations and understanding of expected economic output. For an entrepreneur often the case is different. Either the project is novel and has no comparable or it is a completely new field for the entrepreneur or both.

    To deal with the inherent uncertainty and novelty of projects entrepreneurs deal with, I am proposing the following framework which involves stagewise assessment of value creation and return opportunities. Without further adieu, let us get to it.


    STAGE WISE VALUE ASSESSMENT AND RETURN OPPORTUNITIES

    The framework depends on identifying the real options embedded in the project. Real options are choices at some stages of a project to expand, wait or abandoned etc. Anyways, the point of identifying the real options is to safeguard against rash exits when things get tough.


    1. Stage wise value identification

    In the last post in this series, we discussed the broad phases on project implementation –

    A. Set-up which involves product/facility development, legal and regulatory registrations.

    B. Validation which involves measuring project outcome with the stated objectives, and

    C. Operations involve user acquisition or integration with the existing processes etc.


    One can further divide these stages into substage depending on the project.

    Now, it is time to identify the value which is expected to be created in these phases or substages. For example, after the set-up stage, we will have some product and or facilities, some regulatory registrations and approvals etc. After the validation stage, we will have some market traction along with the assets created in the set-up stage.

    Note: Many entrepreneurs face this issue while raising capital from investors who claim that unless a business is generating profit it has no value. It is a fallacious notion at the least. Value has many different facets. An innovative product, intellectual property, market power, access to regulatory approval which are difficult to get – all can be valuable if someone is willing to pay for that. Keeping an open mind about what constitutes value is the key to this exercise.

    Now, that we have identified the value which is likely to be created in the different stages of sub-stages, it is time to identify the return opportunities at different stages.

    2. Return Opportunities

    A return opportunity means that at any stage if you decide to abandon how can you maximize exploitation of the value already created.

    For example, if you abandon the project after the set-up stage, a possible opportunity for return can be arranged with strategic investors (existing players in the market), licensing of intellectual property, licensing of regulatory approvals if allowed by law etc.

    Depending on the project, there can be various return opportunities and entrepreneur is suggested to be open-minded (and less emotional) about identifying those return opportunities.

    Also, only identifying those return opportunities is not enough, we need to judge the feasibility of those return opportunities as well. What kind of resources, connections and expertise required to manifest return at those opportunities? Do you have those resources, connections and expertise?

    3. Scenario-based return

    After we have a pretty good idea about the return opportunities based on stages and/ or substages, we can now get into the numbers.

    Based on different return opportunities, we can estimate the return amount. We can estimate the numbers based on the recent transactions in the market, interviewing the industry experts etc.

    It is also required that we understand the possible cost (both in terms of money and time) required to actually exploit the return opportunities. Depending on the project the costs cane be legal costs, commission charged by intermediaries, a requirement of regulatory approval etc.

    We need to arrive at the net return for all possible return opportunities.


    Next, we will move to actually appraise the project but first, we need to understand the cost of capital.

    ...to be continued

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