The Audio Partners team has called a meeting to discuss financial matters and has asked you to prepare a slide presentation that explains the purpose of time value in money in finance and how time value of money concepts are used for financial purposes. Define these terms in your presentation and explain why the company should be concerned about them:
Present value
Future value
Introduction to the Audio Partners Portfolio Project
You will do a final Portfolio Project based on this company. By way of introduction to the Audio
Partners Portfolio Project, the final assignment and grading rubric are based on the SPOT
framework (Situation, Problem, Opportunity, and Tactics).
You will be presented with a business situation. Your task is to spot the problems, recommend
solutions, and rationalize your recommendations.
The situation is presented to you as a story. It describes a group of people who have a business
idea. It is not a business plan but a concept, but the story provides sufficient information to
serve as the point of departure for creation of detailed business plan for them—by you.
The story implies a number of problems (or opportunities) that echo issues encountered during
each of the six core courses in the CSUG curriculum. It also hints at issues related to the seven
Integrated Themes threaded through the MBA curriculum.
As you read the story, it will become clear that the founders need competent business advice to
transform their concept from an idea into a viable business plan—one with a high likelihood of
operational viability, attractiveness to investors, and sustainable competitive success.
You are to be that advisor.
YOUR ASSIGNMENT PART 1 — SPOT (Situation, Problem, Opportunity, and Tactics)
Viewing the story through the lens of your current MBA Core Class, the first part of your
assignment is to recognize and resolve each of the issues raised by the story—spot the issue,
recommend a course of action, and provide a supporting rationale.
The SPOT framework suggests a grading rubric:
1. Spot issues—3 points per issue
2. Recommend a course of action (opportunity)—2 points each
3. Support with a cogent Rationale—1 point each
See Appendix A for suggestions regarding how to approach this project using the SPRR
framework.
YOUR ASSIGNMENT PART 2 — Present a Plan
In addition to your critique and advice, Audio Partners needs a business plan to present to
prospective stakeholders—investors, suppliers, regulators, customers.
Viewing what’s needed through the lens of your current MBA Core Class, the second part of
your assignment is to use the information you have gained from the class AND the SPOT
exercise and present a plan.
Table of Contents
Introduction to the Audio Partners Portfolio Project ……………………………………………………… 1
YOUR ASSIGNMENT PART 1 — SPOT (Situation, Problem, Opportunity, and Tactics) ……………………1
YOUR ASSIGNMENT PART 2 — Present a Plan ………………………………………………………………………1
The Audio Partners Story …………………………………………………………………………………………. 4
Audio Partners Background ………………………………………………………………………………………………4
Dr. Darya Amiri, MD …………………………………………………………………………………………………………………………… 4
Mr. Kermit Duncan …………………………………………………………………………………………………………………………….. 4
Dr. Jeffrey Lee, PhD ……………………………………………………………………………………………………………………………. 5
Ms. Rebecca Mallory ………………………………………………………………………………………………………………………….. 5
Mr. Trevor Meredith …………………………………………………………………………………………………………………………… 6
Dr. Larry Novotni, PhD ………………………………………………………………………………………………………………………… 6
The Founding of Audio Partners ………………………………………………………………………………………..7
Audio Partners Business Description…………………………………………………………………………………..7
Current Status………………………………………………………………………………………………………………..8
Trevor’s Conversation with Jeffrey ……………………………………………………………………………………………………….. 9
Session Notes, Audio Executive Meeting, San Francisco Presidio ……………………………………. 11
Opening Remarks, Introduction to the Technology……………………………………………………………… 11
Topic 510: Marketing, Mr. Kermit Duncan…………………………………………………………………………. 11
Situation and Problem: Hearing loss, Stigma, Convenience, CAGR …………………………………………………………. 11
Topic 520: Accounting and Management Reporting, Dr. Darya Amiri and Dr. Larry Novotni ……….. 29
Forecasted 5-Year Financial Projection of Income and Expense …………………………………………………………….. 29
Recommended Form of Ownership to Supersede Partnership ………………………………………………………………. 29
Company Valuation ………………………………………………………………………………………………………………………….. 30
Assets & Liabilities ……………………………………………………………………………………………………………………………. 30
Costing & Financial Benchmarks ………………………………………………………………………………………………………… 31
KPI s & BSC ………………………………………………………………………………………………………………………………………. 31
Topic 530: Finance, Mr. Trevor Meredith…………………………………………………………………………… 32
Status Today, Completed Seed Goals, Fund Creation of MVP ………………………………………………………………… 32
Seed Stage is Complete …………………………………………………………………………………………………………………….. 33
Equity Investment & Funding Request Scenarios …………………………………………………………………………………. 33
Mission – Nanoscale Devices……………………………………………………………………………………………………………… 34
Osborning & Premature WOM …………………………………………………………………………………………………………… 35
Valuation, Partnership, Trevor’s Investment, Investors’ 25% Stake ………………………………………………………… 36
Valuation of Company Assets & Future Earnings ………………………………………………………………………………….. 36
S-Corporation, Start Date, Stock Issue, Call for a Financial Plan ……………………………………………………………… 37
Protection of IP/Trade Secret …………………………………………………………………………………………………………….. 40
Topic 540: Joint Session – Operations and Operations Strategy, Ms. Rebecca Mallory, Dr. Jeffrey
Lee, Dr. Darya Amiri ……………………………………………………………………………………………………… 40
Outsource Supplier Selection, Sensor Cost, and Yield Impact ………………………………………………………………… 41
Single Threaded, Supply Chain Risk Factors …………………………………………………………………………………………. 44
Volume Forecast, Fabrication, & Team Capacity Planning …………………………………………………………………….. 44
Warehouse Team & Customer Loyalty ………………………………………………………………………………………………… 46
Artisan Team……………………………………………………………………………………………………………………………………. 46
Capital Equipment and Labor Expense Benchmarking ………………………………………………………….47
Jewelry Operations Responsibilities ……………………………………………………………………………………………………. 48
Plating Variations & Mass Customization ……………………………………………………………………………………………. 48
Quality Management ………………………………………………………………………………………………………………………… 48
Plant Lease, Location, Build, or Outsource …………………………………………………………………………………………… 49
Jewelry Fabrication Facility, DFSS, Quality, Delivery to Promise …………………………………………………………….. 50
Price/Volume Fallacy ………………………………………………………………………………………………………………………… 51
Kimberly Certification ……………………………………………………………………………………………………………………….. 51
Business Operations, AWS, Business-Wide Integration …………………………………………………………………………. 52
Project Management ………………………………………………………………………………………………………………………… 52
Topic 550: Joint Session – Digital & Data Analytics and AI Strategy, Dr. Darya Amiri and Dr. Jeffrey
Lee ……………………………………………………………………………………………………………………………. 53
Topic 560: Strategy Wrap-up, Dr. Jeffrey Lee ……………………………………………………………………… 55
Sideline Conversations and Key Takeaways ………………………………………………………………………. 55
Conversation A: Jeffrey’s Note on IoT, BMI, and Audio’s Technology Competitors …………………………………… 55
Appendices ………………………………………………………………………………………………………….. 56
Appendix A: Suggested Approach to the Portfolio Project ……………………………………………………. 56
Situation………………………………………………………………………………………………………………………………………….. 56
Problem ………………………………………………………………………………………………………………………………………….. 57
Recommendation …………………………………………………………………………………………………………………………….. 57
Rationale …………………………………………………………………………………………………………………………………………. 57
Ambiguity………………………………………………………………………………………………………………………………………… 57
Take Risks………………………………………………………………………………………………………………………………………… 58
Customer Development Manifesto …………………………………………………………………………………………………….. 58
Appendix B: Online Research Resources …………………………………………………………………………… 58
Wearables / Hearables Business Landscape ………………………………………………………………………………………… 59
Wearables & BMI Technology Landscape ……………………………………………………………………………………………. 59
Business Plan Touch Points ……………………………………………………………………………………………………………….. 59
Regulatory Touch Points ……………………………………………………………………………………………………………………. 59
Financials & Features Benchmarks ……………………………………………………………………………………………………… 60
Jewelry Making Touch Points …………………………………………………………………………………………………………….. 60
The Audio Partners Story
Audio Partners Background
Audio Partners is a start-up owned in equal shares by six founders:
Dr. Darya Amiri, MD
Dr. Amiri received her BS in Biology from the University of Chicago, MS in Biomedical
Engineering from the University of Minnesota, and MD from Stanford University, After
completing her residency at Mayo Clinic, Dr. Amiri turned to research, and currently leads
the Critical Implant Technologies Group within Boston Scientific’s Institute for Advancing
Science, in Maple Grove, MN.
Persona
Darya is 35 years old. Married for three years, she resumed using her own name following
her divorce. Both of Darya’s parents emigrated from Iran, and she is very proud of her
Persian heritage, tracing her family back as far as 1720. She is an informal student of ancient
Persian culture, and she can be a little sharp with people who assume she is Arab. Like
Jeffrey Lee, Darya is a highly analytical strategic thinker. She stopped seeing patients to join
Boston Scientific when she discovered that she finds medical innovation more interesting
than medical practice. She continues to serve on the Advisory Board for the Future Grant
Program at the Mayo Clinic.
Mr. Kermit Duncan
Mr. Duncan received his BFA with a concentration in Media and Communication from Pratt
Institute, where he was an Apple Design Scholarship winner, and his MFA from the Rhode
Island School of Design. He rose in two years to Senior Creative Director at Ruckus
Marketing in New York City, established a new Emerging Brands practice at Landor & Fitch
in San Francisco, and now leads the AI Opportunities Group at Alphabet, in Sunnyvale, CA.
Persona
Kermit is 29 years old and lives with his husband Zachary, an account executive at Hubspot,
in a San Francisco Victorian house where they host dinner parties and cocktail gatherings
almost every weekend. One of his favorite things is to introduce new people to one
another; his friends call him “Yente” (the match maker) even at work. Traveling
internationally for Landor, he was often tapped to lead projects that presented crosscultural challenges: “Haha, that one we need to assign to Yente!” Kermit loves
improvisational comedy, and toyed with becoming a writer in Los Angeles or New York, but
decided he would rather woo an audience from on stage than work behind the scenes. His
exuberance, empathy, and genuine joy in the company of people, energize everyone
around him.
Dr. Jeffrey Lee, PhD
Dr. Lee received his BSEE, MS in Chemistry, and PhD in Physics from the University of
California at Berkeley. While an assistant professor working together with Larry Novotni,
then a Berkeley postdoc, Dr. Lee’s research explored techniques for the design and
optimization of nano-scale sensing and actuation devices that could achieve the technical
and economic (production cost and yield) performance suitable for high-volume
manufacturing and commercialization. In addition to delivering numerous articles and talks
in electrical engineering and device chemistry, Dr. Lee holds seven patents, including three
mask patents securing exclusive rights to the device architecture at the heart of Audio’s
product concept.
Persona
Jeffrey is 32 years old, married to wife Cynthia, with a three year old daughter, Xiang. Jeff
and Cynthia met at Berkeley, where is Cynthia is completing medical school preparing for
her residency. Both of Jeff and Cindy are highly analytical and share a love of ideas,
discussion, and debate. Jeff respects strategic thinking and believes people are responsible
for the future and, like Cindy, is less interested making his career a path to prosperity than
in devoting himself to making life better for people. Both are devoted to their daughter, and
Jeff even has a reputation for bringing her along when he teaches or speaks. Jeff and Cindy
also find time to be actively involved in the arts, as donors to the San Francisco Symphony
and the de Young Museum, and avid enthusiasts of the opera. They make it a point to
attend at least one cultural event each month, they always make an evening of it—formal
jacket and tie—and they always bring Xiang along.
Ms. Rebecca Mallory
Ms. Rebecca Mallory received her BA in Anthropology from San Francisco State University,
and an MFA from the Oregon College of Art and Craft (OCAC) where she continued as Artist
in Residence for jewelry design in metal and gemstone, and she holds a DFM Certificate
(Design for Manufacturability) from the University of Washington. She has been exhibited in
San Francisco, New York, Paris, Bangkok, and Arezzo (in Tuscany), and even before leaving
OCAC, her work had been recognized by houses including Cartier, Dior, Bucherer, and
Damiani, with whom she has since collaborated. Her designs are known for their complex
delicacy, softness, a graceful flow and transformation of light, and for exquisite
craftsmanship.
Persona
Rebecca is 28 years old, and lives on 12 wooded acres north of San Francisco, near the
California wine country, with two friends (also fine artists) with whom she shares studio
space, and jointly operates a community vegetable growers co-op. She enjoys long walks for
conversation with friends, always including her two Bernese Mountain Dogs, Bilbo Baggins
and Gandalf the Grey. She prefers soft color patterns and natural fabrics in her clothing, and
believes clothing becomes more beautiful as it ages with use. An informal follower of
Eastern philosophies, she feels a deep sense of connection with people, almost
experiencing their emotions along with them, and she strives to make herself, her
environment, and her art a source of positive, lighthearted harmony for the people around
her. Her signature greeting is to laugh and say, “Go placidly amid the noise and
haste, Kiddo. And hurry it up!”
Mr. Trevor Meredith
Mr. Trevor Meredith is a graduate of Olin College with a BS in Chemistry, and received his
MBA from Santa Clara University. He served as a senior executive vice president and general
manager at Philips Medical, and has held executive positions at Siemens Medical (where he
oversaw intellectual property matters and FDA approval / compliance matters), as well as
several Silicon Valley semiconductor companies, rising through marketing and sales
management.
Persona
Trevor is 73 years old and retired, although he prefers to say, “semi-retired” because he is
still active as a private equity investor and currently serves on the boards of three earlystage healthcare start-up companies. He provided much of the seed funding for Audio as an
angel investor, but he has refrained from active oversight of how the funds are used,
preferring instead to protect his status as a silent partner. Early in his career, he was
personally acquainted with Eugene Kleiner at Fairchild Semiconductor, and Tom Perkins at
Hewlett-Packard, and he is still well known at both Kleiner Perkins and Intel Capital.
Trevor is a highly analytical, systemic thinker, wants to understand the detail as well as the
big picture, and believes that, second only to making good hiring decisions, an executive’s
most important role is to ask lots of questions—most often “How do you know…” and
“What’s your plan if… ” Trevor respects hard work, diligence, intelligence, competence and,
especially, collaboration. He is frankly miffed when younger executives overlook his
expertise, insights, and suggestions. Although Trevor has very high standards, he also has a
sentimental and generous nature; he has forged many lasting friendships, some dating back
to college and even high school, and he takes his relationships with people seriously simply
because he considers that the right way to be. Although Trevor has a very substantial net
worth, he drives a modest car, lives in a lovely but unpretentious home, and follows a
modest lifestyle. Trevor and his wife, known by her friends as Jonny, maintain a vacation
home near Lake Tahoe, California, where he enjoys golf and hiking. They look forward to
resuming annual trips abroad when Covid passes. Trevor and Jonny especially take great
pride in their two children, and savor their career successes.
Dr. Larry Novotni, PhD
Dr. Novotni received the B.S. (Hons.) in Electrical Engineering and Computer Science (EECS)
from UCLA, and a PhD in Quantum Mathematics from Stanford University. He was recipient
of a Graduate Fellowship Award from IEEE, and the first recipient of the Directors Best
Thesis Research and Innovation Award from Cornell University, Solid-State Circuit Society
(SSCS). Dr. Novotni currently teaches part time at Stanford and leads research on resonance
physics in nanoscale semiconductor devices, on a fellowship at the University of California,
Berkeley.
Persona
Larry is 32 years old and lives in San Francisco. In his spare time, he is a champion triathlon
competitor, rock climbing instructor, and extreme ski enthusiast. He pushes himself and
enjoys achieving, in both his athletic and professional careers. Although he is disciplined and
deliberative in his thought process, he prefers experimentation to theory, and he is decisive
and action-oriented. “Short of life or death gambling, a go-for-it pitch summits faster than a
conventional one.” A well-liked leader, he is at his best under pressure, and has been
recognized “Most Trusted Expedition Leader” by board members of the American Alpine
Club for three consecutive years.
The Founding of Audio Partners
The initial founders of Audio Partners were Jeffrey and Larry, who developed the core
technology on which Audio’s products are based. They brought in Darya as an advisor and
Rebecca as the fine arts voice, and then it was Rebecca who enlisted Kermit. In each case, the
founders had either worked together before or were friends from school. Trevor, semi-retired,
is an angel investor, and has been a business mentor to the other founders, most of whom lack
business experience.
To bring their product idea to market, the founders thought it would be sufficient to set up
manufacturing and a website, and then perhaps also look into advertising, maybe in those
magazines everybody finds in the seat back pocket on airlines.
They were happy just to begin selling product and generating revenue and income with a view
to eventually being acquired if an interested buyer can be cultivated, or possibly become a
public company. Before they can accomplish any of that however they must raise funds to
establish production and selling capability, and so they are deciding how to prepare them and
present Audio to prospective investors.
With that in mind Jeffrey had written the following business description.
Audio Partners Business Description
Audio will design, manufacture, and sell what we call intelligent fashion accessories or “IA.”
Our initial product offering will be a line of hearables—earrings—designed to appeal to
American women 45 years or older, who have hearing loss. Our IA technology corrects
hearing loss in a manner that is more convenient and less expensive than conventional
hearing aid technology, and entirely unobtrusive — eliminating any embarrassing physical
evidence of a prosthetic in favor of a stylish fashion accessory: the earring.
This first product offering will be followed immediately by designs tailored to the tastes of
additional segments of the fashion market, and additional age groups, eventually ranging to
products designed to serve children.
Audio’s IA is made possible by a patent-protected set of semiconductor sensor technologies
developed by founders Jeffrey Lee and Larry Novotni at the University of California in
Berkeley, which enhances and extends so-called “smart dust” technology, developed at
Berkeley about 10 years ago.
The heart of Audio’s technology combines sensing, processing, and actuating capabilities in
a single semiconductor device that is smaller than a grain of salt. Placed close enough to the
ear, 8 to 13 of these devices (sometimes called dust “motes”) sense sound and then,
harmonically reinforcing one another, physically vibrate to amplify it. Further, AI technology
carried in an application on an intelligent mobile device, such as an iPhone, enabled the
wearer to adjust the frequency response of this harmonic group to amplify sounds the tonal
range she has most trouble hearing. Further, still the very low power requirement at this
tiny scale makes it possible to rely on ultrasonic stimulation to actuate the harmonic group,
entirely eliminating need for a large battery or recharging. Ultrasonic vibration (sound at a
higher frequency than we can hear) turns out to be sufficiently present in the ambient
environment around us to achieve this (In very quiet areas, sufficient ultrasonic energy may
not be available. However we believe the desire for hearing augmentation, which exists
especially in a noisy restaurant or airport conversation, exists little if at all in those quieter
circumstances).
This combination of IA and AI makes it possible to enjoy the benefits of hearing
augmentation without need of a doctor visit or post-purchase adjustment.
Our strategy is to lead in four critical areas: quality, delivery, cost, and innovation.
Current Status
Trevor read the description and advised that it will need to be expanded. It needs compelling
detail about the market, organizational plans, the specific planned uses of funds, the
credentials of the executives themselves, risks and expected returns, why now, who agrees—in
short, all the elements of a compelling business case to win investors. Trevor has suggested he
and Jeffrey meet.
Read the notes from Trevor and Jeffrey’s conversation:
Trevor’s Conversation with Jeffrey
TREVOR: “Jeffrey, I understand the nature of your idea and a few of the primary factors that
you believe will make it a success, but it is not clear what all of the different elements of your
business model are or how they fit together.”
JEFFREY: “Larry and I have had some initial discussion about that. We will make key decisions
collaboratively, but at the same time each member of the founding team will oversee one
function, get it organized and staffed, and then hire management talent to take over running
it.”
“I will be the CSO, Chief Strategy Officer, responsible for our business model and operations
strategy, and overall organization and management of Audio.”
“I will also serve as Chief Product Officer (CPO) responsible for our competitive strategy.
Overlapping me in this role, Rebecca Mallory, with her expertise in jewelry production and
industry contacts like Damiani will serve as our Chief Operations Officer (COO).”
“Kermit Duncan, who was brought in by Rebecca, will serve as our Chief Marketing Officer
(CMO). I should mention that Larry Novotni was not supportive of my decision to make Kermit
a full partner in equal shares with the rest of us who have been here longer. It was his view
that we do not need to fund a marketing function for a product as unique as ours. He has
already generated a lot of word-of-mouth interest in Audio through his social media contacts
with other innovators, and publication of some of our research work, as we were completing
development together at Berkeley.”
We thought you, Trevor, might be willing to serve as Chief Financial Officer (CFO) with the idea
that your main function will be to guide creation of a business plan and investment proposal
that will win the funding we need to turn our technology into a business.”
“With his technology expertise, Larry Novotni will overlap me in the role of CPO in the same
way Rebecca does with her fine arts expertise. Together, they represent Audio’s two most
important competencies. In addition, Larry will assume responsibility for setting up accounting
and management information functions for us. I thought we might designate him Audio’s Chief
Information Officer (CIO).”
“With her expertise in medical device design and regulation, Darya Amiri will also overlap with
me in my role as CPO. Darya will also take the lead on assuring Audio makes full use of digital
technology and analytics, across all functions from product design to operations to marketing.
We’re not sure what to call her role, but for now it will be Chief Business Science Officer
(CBSO).”
TREVOR: “OK, but I cannot serve officially as CFO. I am happy to advise, but it is important for
me to remain apart from any decision-making or operation of the company. Now, I assume
that each of the folks has, by now, thought through a plan for the function they are about to
organize, and identified the top 3 to 5 things that absolutely must go right for Audio to become
a success. So let’s do this. Get the whole team together for a weekend retreat. Have each of
them take the group through what they’ve got. We can all contribute. And I will bring an
outside expert in each of those functions, and invite them to give us their critique and
recommendations. You do the kick off and wrap-up, and we can take them in this order:
Jeffrey Introduction & Business Concept
Kermit Marketing
Larry Accounting, Reporting, and Organization
Trevor Finance
Rebecca Operations
Darya Digital & Analytics
Jeffrey Strategy
TREVOR: Your role as CSO will get you involved in most every one of those—certainly marketing
and operations. So will Darya’s role as CBSO.”
JEFFREY: Sounds good. We will do it at the Presidio in San Francisco.
Session Notes, Audio Executive Meeting, San Francisco Presidio
Opening Remarks, Introduction to the Technology
JEFFREY: Thanks for coming, everyone. For the guests Trevor has invited to join us from
Colorado State First, let me set the stage.
First, our sensor device is very small, which is to say unobtrusive in use. Unlike existing
technology, which can be packaged into a space perhaps a third of an inch cubed, our current
device is smaller than a grain of salt, and the future device we have in development now will fit
quite literally into a space no more and the diameter of a human hair. (This physical size has
already been proven feasible; remaining research needed now centers not on fabrication of the
device but on mathematical theory and the AI-enabled software to exploit its physics.)
Secondly, this requires no battery at all. And think about it. Your ear requires no battery but it
picks up and delivers sound to you, using energy developed biologically within your body.
Similarly, this device is activated by nothing more than ultrasonic energy which exists in the
ambient environment around us.
Third, this device is self tuning. That is to say it delivers good performance without the
requirement for a visit to an audiologist. Once again think of your ear. As long as it is
functioning and healthy, it to adapt to the sound around it.
We have built prototypes that work, 100 sets in a variety of design styles, which we have been
showing to jewelry houses.
REBECCA: Chartier and Damiani are both interested.
JEFFREY: Yes, Chartier and Damiani are both interested, and we think a dozen others might be
as soon as they see the product.
TREVOR: Investors are going to want to know same things that you want to know. How much
money is this going to take. How are you going to use it. How much money is available in the
marketplace to provide a return on the investment, how big is that return, and how hard will it
be to get it.
Topic 510: Marketing, Mr. Kermit Duncan
Session Notes
Situation and Problem: Hearing loss, Stigma, Convenience, CAGR
TREVOR: How much money is available in the marketplace to provide a return on the
investment, how big is that return, and how hard will it be to get it?
JEFFREY: The first thing to understand is that Audio will play at the intersection of two older
markets, a technology market and a fashion market. Of course, that’s what all wearables do.
We will be in neither the hearing aid market nor the fashion jewelry market, but in both.
KERMIT: Yes, and jumping ahead, this will come up as we think about creating channel
relationships, and whether to rely on them at all. If we enter the market by piggybacking with
an established company, that will be a market extension for them. Either it’s a hearing aid
company entering the jewelry space, or a jewelry company entering the hearing aid space.
Positioning and Penetration Strategy
REBECCA: There may be an opportunity here. The market seems confused about just how to
think about this. CES (the Consumer Electronics Show) segments the space into Health &
Wellness, Headphones & Personal Audio, and Wearable Technology. Arguably, we’re all three;
or perhaps a new category altogether. What that means is that we might be in a position to
teach the market how we want it to think about us, rather than inheriting somebody else’s
positioning framework.
TAM & SAM
KERMIT: We have 2019 data showing 37 million Americans over the age of 50 had mild to
moderate hearing loss, about half of those have annual incomes above the median household
national average, but only 27% owned a hearing aid. 16% of women over 45 years old
experience sufficient hearing loss to want to do something about it. It’s 22% of men that age,
around 4% for people in their twenties, and 60% for people in their 90s.
KERMIT: Well, no, not all of it. Hearing aids address a particular set of conditions that cause
hearing loss, but hearing loss can because by neurological and other problems that a hearing
aid cannot address. I think a big part of what goes on with audiology medicine is simply to make
that determination. In addition to 13,000 medical doctors who specialize in problems of the
ear. Nevertheless, age-related hearing loss is by far the bigger segment.
[Positioning, Stigma, DEAIME]
KERMIT: Apart from expense, there are two reasons they don’t do something about it. One is a
social stigma attached to hearing loss; it’s associated with aging or infirmity, and people don’t
want to wear something that attracts ridicule. The other is that hearing aids are and a real
nuisance to acquire. The way it’s done today entails is a lengthy, inconvenient and demeaning
series of in-clinic appointments with a licensed hearing professional for assessment, fitting,
programming, ongoing adjustments and maintenance. There are 7700 licensed “audiologists”
who provide these services, but even those prospective customers who are not reluctant to
undergo hearing tests don’t want to put up with all of that.
JEFFREY: What we would like to do is arrange things in such a way that prospective customers
can make the determination, and tune audio earrings all for themselves, and without any need
for fitting at all. One hurdle for us, though, is that age-related hearing loss in the United States
is predominantly addressed by FDA-regulated hearing aids.
TREVOR: Why? Is regulation foregone, or can product design make it unnecessary?
JEFFREY: That’s what we intend.
[TAM, CAGR]
KERMIT: We have data showing that in 2020 the worldwide market was $6.5B, and projections
that it will grow to $11.02B between 2021-2028. Compound annual growth has run between
7% and 8% for a period of at least 8 or 10 years. There is a question mark, though. CAGR
declined in 2020. It was negative 18%. We know the growth rate of American population overall
is declining, but that doesn’t seem to explain a drop like that.
DARYA: How sure are we of these market numbers. Is there a range of uncertainty, and what
happens if things turn out to be at the lower end of the range?
LARRY: If CAGR was stable before 2020, then that -18% looks like probably an anomaly or bad
data. Let’s ignore it. And population is huge; at this early stage we just need to get busy selling;
the population growth rate doesn’t matter. It’s not going to help us to worry prospective
investors by bringing any of it up.
Trends
KERMIT: Several market trends help us. There is an increasing prevalence of hearing loss in the
population. Like Audio, other brands are seriously working to incorporate digital and smart
technologies to boost demand. This An increasing share of the wearables market is moving to
hearables. There is buzz about the possibility of personalized audio-based solutions with the
help of an interface to software on a mobile phone. Some brands are considering extensions to
hi-fidelity audio and mobile communication. And there is interest in hearables that collect and
provide feedback on biometric data, specifically voice analytics, for audio-based wellness
solutions like sleep, stress, and anxiety management, and the pitch hear is that this can
augment or replace therapy, which is expensive.
[Product FFBS, Possible Variations, KANO]
TREVOR: OK, let’s get back to the product. What is out there now, and how is Audio going to be
special and different?
REBECCA: High fidelity is key. Hearing aid technology has improved, and I have seen data that
for following conversations in background noise there is a 7% improvement in the last five
years. Only 8% of hearing aid users are dissatisfied with sound quality. For hearing aids in the
workplace, satisfaction has gone from 65% in 2010 to 92% today, and for listening where there
is background noise (like in a restaurant) satisfaction goes from 27% for non-adopters to 76%
for hearing aid users. Signia Insio Charge&Go AX promotes a bluetooth-capable, rechargeable,
hearing aid with a split- processing architecture that enhances nearby important sounds while
reducing background noise. So our form factor is great, but we need to keep an eye on
performance.
[Differentiation]
DARYA: I looked at Signia. They seem to see the market through the lens of microprocessor
architecture. Their product features a load of AI based performance capabilities, self-optimizing
sound, mobile phone interface, Spotify, background noise reduction, and I think it can even
teach your cat so speak French. But it requires a rechargeable battery and it an in-the-ear
configuration that’s uncomfortable.
[KANO, AI Optimization, Software, HC]
KERMIT: That gets us to ease of use. One of the most innovative hearing aid brands now lets
you adjust volume and mute/unmute from an iPhone Apps, get more volume on sounds
(frequencies) you want to hear, and less on the sounds you don’t, adjust the bass, middle and
treble, and use AI to teach your hearing aids how you want to hear. At the same time, they
offer optimization recommendations based on how other people have tuned theirs. To be
successful, Audio is going to need to establish a software capability to do all that, or decide not
to compete on some of those features.
DEAIME
KANO classifies features as either the required minimum, the key differentiators, or the
occasional unexpected delighters. [Strategy]
Crowdsource AI SW Developers, Minimum Viable Business Network
REBECCA: Maybe we could we crowd source that, like Apple does. Create a business model that
includes enlisting app developers? Might get a lot wider and faster innovation than doing it
ourselves. We could consider offering grants to invite and stimulate development of technology
and software capabilities beneficial to us. Is there any risk with that?
JEFFREY: Apple maintains pretty tight control of branding image and selling. But I love the idea;
let’s think about it.
Differentiation, Niche, Market Disruption
KERMIT: Another ease-of-use advantage, and a capability that is absolutely unique to Audio, is
our form factor. Nobody else comes close to our imperceptible size and weight. And we entirely
dispense with a battery: no cost, no replacing, no recharging, no going dead just when you need
it. Audio’s product eliminates need for fitting, and it cannot hurt you. If we are “enhanced
jewelry” rather than “pretty hearing aid” then we might just bypass any FDA issues at all.
REBECCA: Based on what you said earlier, all that might make it possible to scrap the existing
BTB business model and sell direct to consumer.
Channel Structure, DTC
KERMIT: Yeah, and in fact, Eargo appears to do just that. Their business model eliminates need
for an audiologist, so it removes that incremental layer of cost in the channel, and it probably
frees them up to operate more independently, so they can influence sales, margins, as well as
innovation more easily. At least, that’s how it looks. Apart from the fact that it’s new and
untried, I am not sure I see a downside. FDA might eventually disagree.
DARYA: It’s probably worth saying that Eargo has invested a lot in its organization to achieve all
that. They have built a research and development organization with expertise in mechanical
engineering, product design, audio processing, clinical and hearing science, consumer
electronics and embedded software design. We sure do not have all of that, and whatever
funding we seek from investors ought to address it.
LARRY: What they don’t know won’t hurt us; let’s not set up hurdles we don’t need to
overcome. In any case, the feature that distinguishes us is that we’re a wearable—jewelry—so
let’s get to that market. Rebecca?
Differentiation
REBECCA: Well, it’s about appearance and comfort. We just eliminate the stigma problem
entirely. But jewelry does much more than eliminate an emotional negative; it creates a
positive. Our jewelry signals who we are and what we care about, it’s an expression of beauty
and creates a feeling of beauty. More than that, it reveals the self we love being. Just
completely opposite of trying to hide something embarrassing or humiliating.
LARRY: Fine, it’s about showing off.
Positioning
REBECCA: No! It’s much more fragile than that. It’s delicate, the same way our silicon devices
are delicate, but delicate emotionally. We need to nurture and protect the one as carefully as
we do the other. We don’t make wedding rings out of silicon. To your point, though, it’s also a
great investment. In 1975, one ounce of gold costs $79, and by 2020, it is averaging $1589. It’s
also fashionable. High-end fine jewelry continuously evolves over time, and jewelry makers
continuously pushing the boundaries of design, changing fashion.
Messaging
REBECCA: Technology such as 3D printing and casting is driving an explosion of creativity. We
can create exquisite, beautiful shapes that are simply too complex to be done by hand. That
said, high jewelry always will be a romantic endeavor. That’s what makes the most exclusive
jewelry special: it is not mass produced. Each piece is unique. Often the only time you see it is
at formal events and special occasions. Even so, with the current trends in fashion, where
casual outfits are percolating into formal events, high jewelry is also evolving to become more
versatile. But it must never give up its grace, elegance, and exquisiteness. That makes it a status
symbol. Regardless of the rest of your wardrobe, a single, elegant piece of fine jewelry might be
all you need to make a good impression and attract people.
DARYA: Well, that’s sure no hearing aid.
Differentiation
REBECCA: That gets to something else, too. Even if the big hearing aid brands have mechanical
engineering, product design, audio processing, clinical and hearing science, consumer
electronics and embedded software design, Audio will have talented in-house artists who can
channel creative innovation ideas on to paper, into production, and into reality. True artisans
who cherish delicate, soft and gentle jewelry that flows gracefully – capturing and transforming
light, creating stunning pieces of exceptional elegance and charm. This requires intense
attention to detail and quality control, meticulously carried out under microscopes, and a
masterful hand. In that way, making jewelry and making Audio’s silicon devices are the same.
Crowd Sourcing Design
KERMIT: We will need very good people in this role. Maybe that’s another kind of talent we
could attract by crowd-sourcing—cultivate a network of contributors, like Apply cultivates a
network of app developers.
Messaging and Media Selection
LARRY: A network of true artisans transforming light? Sounds a little overly passionate.
REBECCA: Well, it does when you talk about it. But when express it visually, it’s beautiful and
engaging. Van Cleef & Arpels does a good job with that. They don’t tell you the story, they show
you. Not that they’re the tone we should adopt, but they use visual expression.
KERMIT: They all do; Chartier, Chanel, Dior—it’s visual, evocative.
LARRY: Elizabeth Arden said, “I don’t sell cosmetics. I sell hope.”
KERMIT: Yes, that’s the story, and Charles Revson is supposed to have said, “Perfume is made in
the factory, but what we sell in the store is hope.” That thinking is a little out of date.
DARYA: A lot out of date…
KERMIT: OK, yes, a lot out of date, but the idea is right: we are focused on making earrings, but
what customers buy is the end-result benefits of having them. And those are emotional—
connection, self-esteem, acceptance, even agency and self-actualization.
JEFFREY: Well, physical, too—ability to hear better—and comfort, at least compared to in-canal
hearing aids.
Landscape – Hearing Aids, Jewelry, Semiconductors, Software
KERMIT: I agree, our messaging should echo all of that, and put it in terms that resonate with
women over 45. Now, as Jeffrey mentioned, Audio is going to play at the intersection of two
existing market landscapes that have never overlapped before. The first is the hearing aid
market. High-end brands are Phonak, Widex, Signia, Oticon, ReSound, and Starkey. They control
80% of the market. We have other data that says Demant Group has 30% market share, Sonova
31%, Sivantos /Widex 19%, GN ReSound 15%, Starkey 4%.
DARYA: How come Phonak is part of the 80% but it doesn’t show up in the second list?
KERMIT: There’s a proliferation company brands and product brands in this space. Oticon,
Rexton, Signia, Eargo, MD-HearingAid, Beltone, Miracle-Ear, Bernafon, Truhearing, and
Cros/bicros are hearing aids.
LARRY: OK, that’s confusing.
Branding, Purple Cow, DEAIME, Simplicity
JEFFREY: Our end game could be to merge with one of them, but in the meantime, how do we
make Audio stand out in that crowd?
Penetration Strategy
KERMIT: Well, we need to figure that out, but we can get some clues by learning from Eargo
and Dement, in particular. Eargo because they have the most innovative business model, and
Dement because they have the broadest business model. Eargo pays special attention to the
problems of stigma and purchase inconvenience, which is what we’re about, too. Dement
because they’re diversified; they appear to bet on technology leadership, and then deploy it
across applications in hearing health, hearing care, hearing aids, hearing implants, hearing
diagnostics, and now even premium audio and video solutions—if one market softens from
time to time, they have the others. Both publish financials from which we can infer financial
projection for Audio, but both still see their business as hearing aids, and not wearables, much
less jewelry, so that’s very good for us. We are at the intersection and they are just on one side
of it. But it’s a competitive space. Demant says there are several major players, intense
competition, and a high level of innovation, so its approach is to target underserved markets
opportunistically—a niche strategy.
Differentiation
JEFFREY: If you get down to it, that’s not unlike what we’re doing. Our big difference is patented
technology.
DARYA: That’s one way to look at it. But building a business model at the intersection is
innovative too.
KERMIT: Which brings me to our other landscape, which is the jewelry market. Many of them
cultivate a brand image that is unique to them; Tiffany, Cartier, Louis Viton (who is not just
jewelry but anything “luxury”). Some have a brand personality associated with where they are
located: Wempe, Wellendorff, and Bucherer in Germany; Bugary, Roberto Coin, and Damiani
(with whom we have a relationship through Rebecca) in Italy; Cartiet, Van Cleef & Arpels,
Chaumet, Boucheron, Bulgari, Chanel, Dior in France. Some jewelry manufacturing centers even
have a brand personality: Vicenza, Valenza, Arezzo, and Bassano del Grappa, in Italy, for
instance. It’s like fine wine—even a region can have cache. And in terms of just volume,
Thailand is a large producer and Thailand imposes no VAT (value added tax) on gold.
LARRY: So co-branding is a possibility?
KERMIT: It’s something to consider. Might be faster and easier to saddle a horse that’s already
on the track than raise one of our own from a colt. Of course, you have to decide how much
control of your brand you’re willing to give up.
LARRY: We could also co-brand with one of the hearing aid brands.
KERMIT: Possibly, but that might not be as advantageous.
US TAM, SAM & Volume Target
KERMIT: Earlier, I mentioned worldwide market size. My data says the U.S. hearing aids market
is projected to grow from $3.46 billion in 2022 to $5.86 billion by 2029, at a CAGR of 7.8% in
forecast period, 2022-2029. Keep in mind the large number of potential customers who are not
in that number, people whose needs are so imperfectly satisfied by what’s available to them
that the chose not to buy anything. Our entire competitive advantage is that we fill that niche.
TREVOR: Just how big is that potential?
JEFFREY: Well it’s never been tapped, so we don’t know. And we won’t really know until we get
out on the street, so to speak, and engage with people we’re talking about and learn a lot more.
KERMIT: But consider this. Suppose we decided to take a share of the existing $3.5B, without
even entering that untapped market where we have our best potential. Of course, we will enter
it, but worst case, if not one of those people ever purchased from Audio, we are still clearly
superior to every alternative available to the people who do purchase today. Is there seriously
any reason to doubt that our product could capture a slice of that existing market. Say it’s only
5%. What we are looking for is a plausible target. We won’t have a forecast until we have sales
success-rate data, after we get going. But it’s an operating target. Couldn’t we ramp up to that
in six years? At $2500 per pair, we already have $250K worth of earrings on the shelf. Ramping
up to just 400 in by next year gets us to $1.1M. We have had two years to get the kinks worked
out, so by the end of a third year it should be no stretch to increase volume to 4300. That’s
$11M in revenue. By then, Darya tells me, we will have optimized production processes and
enjoy the benefit of significant yield improvements, and be able to run to 17,000 sets ($43M.).
Then 34,000 ($85M), then 53,000 ($130M) and by the end of Year 6 arrive be able to run at an
annual rate of 70000 earring pairs and $175M in revenue. We start slow, then ramp fast, then
flatten out by Year 6 to a constant growth rate of, say, twice the market CAGR.
250K 100
1.1M 430
10.7M 4300
42.7M 17100
85.3M 34100
131.3M 52500
175M 70000
DARYA: Amazing. Can we execute?
KERMIT: Rebecca’s going to show us a rough capacity plan based on those run rates. Still need
Larry to cost it out and help Trevor take a look at cash and expense flows. We will need to add
production equipment and personnel as we go. Larry can talk a look at that, too.
LARRY: With some help, I can start with your numbers and Rebecca’s plan, and build a
projection based on those. We need a place to start so, be it ever so humble, that’s what we
can show investors. Separately, and in addition, we’ll critique the plan and see where it should
be improved, and we’ll keep that set of recommendations internal. Investors don’t need to see
it, but it will give us a head start on strengthening our business model.
TREVOR: OK, sounds like Larry has accepted the action responsibility.
Demand Generation, IMF, Media Selection
KERMIT: Now, the marketing task is to generate demand for those volumes. We will need a lot
more information about our target market so we can develop core messaging and an integrated
framework for mapping it to appropriate media. We don’t have a website, so we need to design
one. We’re not yet on social media, apart from Larry’s articles, and even those are probably not
on the media platforms that engage our women over 45. Visual appeal will be key, so all of this
will need to be to an upscale design standard, same as our earrings—maybe not Bergdorf’s but
certainly not Dollar Store. As we extend to other market segments, we will need to create and
deploy additional material targeting them.
LARRY: All of this is speculative investment. In other words, we need to pay for it in advance.
KERMIT: Exactly. So we need to monitor how well the decisions we make pay off, and pivot
quickly if they’re not.
BSC, KPIs
LARRY: More than that. How well Rebecca’s production activity is synchronized with your
demand generation success affects our margins. So we need a set of performance metrics that
link all of that, so we can keep an eye on it.
KERMIT: Sure, and we can add others as well. The classic is ROAS, which is just ROI for
marketing investments. But in the digital ecosphere, we can diagnose effectiveness right down
the level of individual web pages and messages, at each stage of the purchase decision process.
We need to do the same thing on social media. There are metrics for all of that, and what we
present to investors ought to spell them out.
TREVOR: Sounds like we’re on the right track, so what’s the budget to do what needs doing?
MARKETING 4-6%
KERMIT: Revenue follows resource, so once we’re running my suggestion would be to set each
year’s marketing budget as 10% of the following year’s revenue commitment. But we need to
jump start our first two years, so we can get to the $11M that I am proposing in year three.
LARRY: Wait, wait, wait; ten percent?? I looked into this a little, and even in companies with a
direct salesforce, the benchmark for sales and marketing is more like 4% to 6% of revenue.
KERMIT: Used to be, but it turns out that operating in the digital ecosphere costs more than
publishing advertisements and radio spots, or even paying a direct salesforce. The big
difference is that it’s two-way communication. We’re being engaging in dialog, not just
presenting our side of things. So, staying responsive to conversations on social media, keeping
any negatives from gaining traction, cultivating influential relationships, all of that takes
monitoring and participation.
DARYA: It can get us a lot of market information, too, beyond what we can get with traditional
market research and surveys. We can try out approaches online, see which visual designs work,
offer alternative user experiences, analyze patterns, and do it almost in real time. We could
split off that part of the expense, allocate 5% with Kermit for demand generation, and allocate
5% with me for monitoring and analytics. The people I will be hiring would probably greater
analytical depth than marketing professionals.
KERMIT: Either way works for me, but the expense will still be there.
KERMIT: I would add something here, too. As we consider opportunities to extend from our
first product and our first market to others, part of making good decisions about which to
comes next and what comes later depends on understanding not just the product but also the
personae of the new target segment, what messaging and positioning will work, how to keep
that consistent with the brand imagery we have already created. In part, that means the brand
we create now should be developed with our future uses for it in mind as well.
REBECCA: Thinking about it operationally, I suppose that means we should establish a formal
product roadmap; but not a “product” roadmap so much as a “strategy” roadmap. In other
words, a plan that doesn’t look exclusively at product and technology development, but looks
also at market and segment development—synthesis, neither perspective merely bolted onto
the other as an afterthought. Seems to me creating that would be something Jeffrey should
lead, as champion of Audio’s strategy function.
JEFFREY: Let’s come back to it after we get a look at Kermit’s list of possible market and product
extensions, but I agree we ought to have a roadmap, and I’ll be happy to set up the first
meeting.
REBECCA: Still keeping my operations hat on, I am thinking we probably need that kind of
formality for the entire outbound marketing suite: what materials and content are we going to
need, at what points in the decision process will prospects encounter a hurdle or hesitation that
we have to help them past, where should we be going and what media should we be using to
reach and engage them, how much can we rely on our website and social media activity, how
much should we outsource to agencies, and how much should we try to stimulate and earning
attention from people who aren’t on our payroll. That’s a lot of decisions, but more to my point,
how are we going to project manage all of that?
KERMIT: I agree, we have a lot to get done. And there’s really a good list of opportunities for us
to expand both products and markets. We will get to that in a little while, but I am stuck at an
even earlier step: we have not sketched out nearly enough information about presenting our
current product to our current market, women over 45. We know far too little about what we
should say to appeal to their attitudes, values, beliefs, purchase decision process, hot buttons
or triggers. And we know nothing at all about what not to say. That’s the role of marketing, of
course, but we need to start pulling all of that together now.
JEFFREY: Sounds good.
Segmentation
KERMIT: There’s no question that the group of “people with hearing loss” can be broken into
quite a few sub-groups. Age and gender are obvious, but even within the group of American
women over the age of 45, fashion preference, personal beliefs, economic status, proclivity to
luxury spending, and so on can map to a lot of different animating values and purchase
decision-making patterns.
LARRY: Just set up a website.
REBECCA: Personally, I probably would never even go look for a website you’d set up, Larry.
KERMIT: Haha, well I like you, Larry; maybe I would. But Rebecca’s raising the right question:
where do they go to get information, and when they get there what information do the need,
what information will lead them through a decision process that lands with purchase of Audio’s
product. And even after they experience all of that, what continuing interactions could we offer
to cultivate them as Audio advocates? All of that messaging and content needs to be in place
before we ever launch the product and trigger the conversation. Remember that we will
certainly engage thousands of prospective customers the moment we launch, and we don’t
want to be caught unprepared if it turns into tens of thousands in a few weeks.
REBECCA: I know we aren’t talking about operations yet, but we need to be prepared to deliver
right from the start as well.
LARRY: Well, Tesla wasn’t. They took orders.
REBECCA: OK, point taken.
TREVOR: Don’t give up too soon, Rebecca. Investors aren’t going to care that you guys have
thought about it. They’re going to want to know what you plan to do about it. We’ll come to
operations in awhile, I know, but we already have a question on the table. Given that you need
to be ready with marketing material and a message strategy before you ever launch, and
assuming you will not get funding to go after all subgroups at once, which subgroup are you
going to bet on first?
KERMIT: Thanks, exactly. Unless we get better information, let’s start with the assumption that
it’s going to be some segment of the women over 45. My instinct is that, so long as we stay in
the consumer mainstream, and avoid the fringes, most any economic and fashion profile will
work for us if—and this is a big if—if we define its persona carefully, and then create messaging
and make media selections that people in that group find hyper-relevant to their situation and
hyper-resonant with their values. I say “hyper” because, assuming again that we will not have
funding to waste, we can’t just get close; will need to make sure every dollar we spend on
creating a customer relationship returns a high-potential probability that it will convert to
revenue.
DARYA: So, what’s the answer?
KERMIT: Well, I think that’s it. We just say that to the investors, see what funding we can get,
and then decide what we can accomplish. Won’t that work, Trevor?
TREVOR: They’ll want a concrete plan. They might ask you to modify it, as a condition of
supporting you, and that’s fine. But they need to see a credible plan, and so far you don’t have
one.
Mission Pediatrics Synek
KERMIT: OK, well there’s more. It might be that women 24 to 36 prove more responsive to all of
the issues that make our product appealing. And there is a pediatric need that tugs at me
personally, too.
DARYA: Me too.
JEFFREY: Me too, but I cannot see our earring working for them. What Cindy and I hope, and
have hoped from the start, is that making Audio successful will fund the research that Larry and
I, with Darya’s advice, have already begun to get this technology to place where it can work
without a platform. Can you imagine how amazing that would be? Helping the people who are
most vulnerable to ridicule out of the trap they’re in: either be picked on for wearing something
that marks you as different, or be picked on for not hearing and engaging like other kids.
REBECCA: OK, please stop it! We really have to do something about that, even if we cannot fix it
with what we’ve got today, for most of us it’s clearly the reason that doing any of this is
important.
TREVOR: Guys, I sense that that is the reason for each and every one of you. Anybody say
otherwise?
LARRY: I could make a joke, but you’re right. That’s really why we’re doing this.
KERMIT: What if we get investors who don’t share that aspiration? They’ll fund us, but only if
we drop this starry-eyed pediatric mission and focus on the money? Do we say no?
JEFFREY: Could we try to convince them?
KERMIT: Maybe, but one of the first rules of market positioning is not to try bending the will of
a reluctant marketplace; do a better job of targeting and engage the people who are not
reluctant.
JEFFREY: Are you saying we need to segment and target prospective investors as well as
prospective customers?
KERMIT: Looking outward instead, initially we will be operating adjacent to many markets that
are not strictly “people with hearing loss” but never-the-less could be candidates for eventual
extension of our business.
LARRY: At this point, do we care?
KERMIT: I’m guessing investors will want to know what growth paths the company they’re
about to fund could follow, and which we think it should follow, after an initial success.
TREVOR: I think you’re right.
LARRY: If you’re going to talk about that, then can I take a break instead?
KERMIT: Think about Dement Group, for instance. They have been about hearing, but their
entry into video extends them into both a new product space and a new market space. It was a
matter of re-imagining their mission. With our technology, couldn’t we imagine extending
“hearing aids” to simply “hearing?”
JEFFREY: This is getting a little cerebral for me. What do you mean?
KERMIT: Why not consider taking a share of Apple’s earbuds market? Apple’s clunkey, clumsy
uncomfortable, stupid-looking white earbuds.
DARYA: Could we ever actually take on somebody as big as Apple? What new relationships
would that take? Seems to me Apple has virtually invincible brand power, not to mention
relatively unlimited resources and staying power.
REBECCA: Yeah. But if we have a more beautify solution. And they cannot match it… JEFFREY:
Hmmm… OK, I get it. What other extensions could be on our product roadmap?
Ansoff Extensions Master
KERMIT: Got an hour? We could take our existing product concept to other wearers, men,
pediatrics, age groups other than 45 and older. We could accelerate R&D for our nano-scale
sensor technology, to make earrings unnecessary, and begin preparing FDA. We could pursue
further development of AI-based software to enable background noise reduction,
personalization (so the wearer can select which frequencies to enhance or suppress), selfoptimizing sound (eliminating not only audiologists but even wearer adjustments), mobile
phone interfacing, entertainment services like Spotify, health data analysis and bio-feedback
(the hottest trend in wearables). High fidelity is probably expected, but we could move into
spaces adjacent to hearing aids (like medical products or ear buds) or into spaces adjacent to
earrings (like other sorts of jewelry or wearables). We could expand into additional sales
channels, or add channel partners, to increase our reach. We could adopt, or at least try out, an
outsource-network model to attract jewelry designers, or to attract software application
developers. And we could simply invest in our fabrication capability, improve yields and reduce
manufacturing cost.
JEFFREY: I like earbuds. Could we actually take market share from a powerhouse like Apple?
KERMIT: Maybe, but I was not making a suggestion. My point is that you can identify
opportunities just by how you think about it. Dement re-envisioned its “hearing aid” technology
as “Intelligent Audio Solutions” technology, and now its taking its technology into the video
space.
JEFFREY: OK, what we know about the marketplace is probably fairly complete but our analysis
ought to be formalized and formatted into analytical structures that are familiar to marketing
people and investors.
LARRY: Well I certainly agree with an analytical approach but I don’t have any idea what those
structures would be, is that something you can help with Kermit?
KERMIT: Well, yes of course, but formalizing might also benefit us by revealing things we don’t
know or have not thought about, so I suggest that we give this more than a lick and a promise.
TREVOR: I am sure investors will want to see at least a SWOT analysis and a market
segmentation graphic.
DARYA: In addition, this will help us zero in on which business development avenues to pursue
first, and which to defer. Especially, that will keep us from being distracted opportunistically
and squandering resources. We want to be sure to put all our wood behind one arrow.
LARRY: I see that there are lots of possible arrows but how do you decide which one to shoot
first.
DEAIME, WP Experience
JEFFREY: We don’t need to create the roadmap right here right now, but our investor
presentation should include at least our first thoughts on the matter. But let’s move on. Kermit,
what else have we got on marketing?
KERMIT: Something that’s adjacent to the extensions question. Marketing is not just media or
messaging—people confuse marketing with marcom—but I think the marketing role is to
understand each of the hurdles we need to guide the prospective customer through to
complete a successful journey to purchase.
LARRY: I think we’ve said that.
KERMIT: Yes, but beyond what can be accomplished online or with social media, earning trust
and removing hesitation can include things like a trial sample, a free consultation—and by the
way, “free” means no sales pitch. Perhaps a factory tour has value, especially, for instance, if
the support we’re trying to gain is from Chartier and Damiani. Technical information to support
integrating our product into their software environment, expertise such as medical advice or
assessments, receptiveness to co-development or customization, demonstrated credibility
maintaining the relationship after the sale is concluded or the joint venture agreement signed,
and so on. The goal is not merely to tell a compelling story, but rather to engage the prospect—
whether customer or partner, or app developer for that matter—engage them in taking on an
active role in the story.
REBECCA: And after you get all of that right, then you need to add the plus one—the
unexpected surprise that transforms the delightful experience into a memorable one.
LARRY: Let’s not over-fund post-sales support. We don’t even know that we are going to have a
problem.
JEFFREY: If ease-of-use is going to be one of our competitive differentiators, then I think that
needs to extend to the very first step in being easy to use, which is to quickly resolve any
questions or difficulties a new customer encounters first turning on and tuning in their earrings.
REBECCA: So that means we need to staff up sufficiently to make sure that any help they
request and receive from audio creates a favorable impression.
LARRY: I think we just make it online help, like an FAQ that people can navigate.
TREVOR: the risk is that the questions you anticipate, and even the number of help requests
you anticipate, could be wildly incorrect, and you won’t know until after you already go live.
DARYA: so it’s both things. If people are going to happy happy, we have to make sure that they
get the answer they need even if it’s a question we did not anticipate, and we have to make
sure they don’t wait so long for it so they become demoralized that it turns sour. For them.
JEFFREY: so how long is too long?
Customer Satisfaction, Staffing
KERMIT: Any wait at all is probably too long. As I recall the statistics, every second delay loading
a webpage loses you 7% of the prospects who came to the website. It’s really huge.
REBECCA: If our strategy is to cut out audiologists and make ease of use a differentiator, then I
think the kind of customer experience we’re talking about is almost impossible to achieve in a
low touch model. It’s got to be person-to-person. That said, I don’t think it’s too tough a
problem for us. Help calls won’t be the lion share of the workload. Even setting up a new phone
or computer typically only takes about 15 minutes of conversation. And it’s very repetitive so
you can probably do it with a decision tree-based chat, and bounce to a live person only for the,
say, 5% of people who cannot complete the process without a little additional help. I’m
guessing that most people don’t even need the help, but we all know some high maintenance
people who just want the help. What would you guess, are 5% of the people you know high
maintenance people, or maybe it’s even less?
LARRY: Well maybe more, but thinking about the target audience here, I imagine that a fairly
high percentage of our women over 45 are self-sufficient, seasoned professionals who don’t
require a lot of hand holding. So the webpage needs to be fast, the chat support needs to be
well scripted, and if we’re also going to back that up with phone support, what’s the right
staffing answer?
DARYA: Just to put a stake in the ground let’s say we want a call chat hold time of no more than
three minutes. If we are realistic about our anticipated sales volume, and our anticipated
problem rate, we can staff to achieve that level customer care for, say, the first six months.
After that we will have enough actual hard data to either add or lean out the investment there.
Organization
REBECCA: It would make sense to me to park the function with manufacturing and operations. I
know it’s a customer experience investment, but it’s also the most quality feedback we will get,
and it would make sense to me to vector that directly into operations without the intermediary
delay of a hand-off from marketing.
JEFFREY: OK so what plan are we going to settle on.
LARRY: I think we are over complicating this. We just don’t have enough hard information to
make a decision. Let’s defer it until we do.
JEFFREY: Maybe you’re right, but alternatively we could have Rebecca take her best run at an
estimate and plan for that headcount in our proposal.
LARRY: I’m worried that we keep inflating our funding request “just in case” and it’s going to
make investors harder to win.
REBECCA: It won’t take me long to run a calculation, and then we can see what the number is
and decide.
LARRY: we could make the additional help billable. That would keep us whole, and screen out
the people who can figure it out without help. If they’re not paying anything they shouldn’t get
anything.
Positioning, Branding, Reputation, Differentiation
KERMIT: We think presenting a piece of jewelry moves away from the stigma of a prosthetic,
but that’s just a start. We need to be thinking about our branding—not just the product but the
company—and designing the attributes we want it to have and convey.
Channels, DTC vs. Audiologists, Branding
KERMIT: The value of establishing a direct-to-consumer model is at least equivalent to the
avoided cost of maintaining a distribution channel through 7700 audiologists. That cost
amounts to 15% of revenue for an advising vendor, and probably 5% of revenue for
audiologist—or anyone else— who contributes nothing to closing sales beyond simply providing
a storefront. So, if the cost of creating and maintaining an online DTC infrastructure is less, then
maybe that’s the obvious choice.
DARYA: An advantage of maintaining the audiologist channel would be that prospective
customers who require the additional medical reassurance that an audiologist can provide
would be less hesitant to purchase.
JEFFREY: Selling jewelry through an audiologist? If we’re going to set up a channel model,
wouldn’t Cartier make more sense?
REBECCA: We have 100 sets to show in a variety of design styles. Chartier has expressed
interest in being first to market, although no firm commitment has been framed, and I am
talking with Damiani.
JEFFREY: Should we brand, co-brand, white label, brand at the company level and also the
product level, brand as product lines positioned differently for different target markets
Pricing
KERMIT: The average price of a set of hearing aids is right around say, $2500, and really highend high-performance products are as much as twice that, $4,000 to 6,000. Some private
insurance policies cover part, or all, of the cost of hearing aids, but Medicare doesn’t. On the
other hand, many states require private insurers to pay for hearing aids for children, and
veterans can get hearing aids at no cost through the U.S. Department of Veterans Affairs.
LARRY: Why not figure out our cost and then just double it to set our price? That guarantees a
50% margin and gets us moving. Let’s go to market with that now, and we can fix it later if we
need to.
REBECCA: Our costs are going to do down over time, so are you saying we would reduce prices
along with them?
LARRY: Sure. Lower prices are an advantage. And 50% margin is reasonable. If our costs go
down, it’s not fair to keep charging more.
Topic 520: Accounting and Management Reporting, Dr. Darya Amiri and Dr. Larry Novotni
Forecasted 5-Year Financial Projection of Income and Expense
TREVOR: Let me get this part of our discussion started. The main thing we need to create and
show investors is a five-year financial projection.
LARRY: Darya and I have taken a run at that. I have been making notes of our discussions as we
go along, and Darya and I pulled together rough P&L and Cash Flow projections over lunch. The
Small Business Administration suggests that a cash flow budget ought to include an analysis of
trends and ratios, too, but we haven’t worked up any of those yet.
JEFFREY: We’re beginning from a standing start, so a balance sheet won’t have much news in it.
We need to set one up, but at the moment our only debt is the $200K loan from Jeffrey’s
parents, and our one potential liability is the option retained by U.C. Berkeley. We do have
some assets—a handful of finished goods inventory, and our IP—but no receivables or bank
credit relationships yet. You can argue that our own expertise as a founding team is an asset,
too.
Recommended Form of Ownership to Supersede Partnership
JEFFREY: The conversation we need to have next might change what we show as assets and
liabilities—and that has to do with deciding what form of business organization and ownership
we want to establish. We’ve all been just calling ourselves “partners” but that’s probably not
going to serve our needs as we bring in investors—they’ll want evidence of ownership in the
form of a credit lien or stock ownership.
DARYA: Can we borrow from a bank?
TREVOR: It is unlikely. What you can offer as security for a loan is far less than what you need
in funding. That leaves share ownership, and so you need to adopt a form of business
organization that facilitates creating and issuing shares.
KERMIT: I confess that I really don’t know how to even begin. I have heard of common stock
and preferred stock, but I have no idea what the difference is; and Trevor has said he does not
want to be a general partner in the firm and wants to remain a limited partner. But I don’t
know the difference between those, either.
REBECCA: It confuses me, too. I have heard LLC, LLP, corporation, S-corporation, Bcorporation. I hear friends talk about a 503, which I guess means non-profit.
LARRY: The one I always hear is LLC. And I have read it only costs about $100 to get that set
up. So, that’s my vote.
JEFFREY: But an LLC cannot issue shares of stock; or at least, not issue them to the public. It’s
more like a partnership.
LARRY: OK, well let’s get to work on our forecast, cash flow, and balance sheet, and come back
to this. We are going to need an answer and rationale to show investors.
Company Valuation
LARRY: Let’s just assume that we need $5 million to get the wheels rolling, and we know Jeffrey
doesn’t want to give up more than 25% of company ownership to investors, so $5 million is 25%
of 20 million, and we just tell him that the company is worth 20 million. That’s our valuation.
TREVOR: That’s one way to think about it, but if Audio fails, do you have enough physical assets
to be able to sell them all to recover the $5M so that you can return it to your investors?
Assets & Liabilities
Asset Valuation of IP, DARPA, Berkeley, Inventory Value
LARRY: We have some things. The sensor devices which we developed on our own would
otherwise have cost $800,000 or $900,000 in non-recurring engineering expense. We have
data from one of the ASICs that NRE for a military-grade analog bus driver/receiver is $225K,
and for a radiation-hardened space-grade analog power driver and sensing device $850k.
We’re at least that good, and since our NRE is already sunk, we have $225K to $850K of
inventory right there. Say it’s $1,000,000. Our patents must be worth something, so let’s say
another $1,000,000.
REBECCA: We have our 100 pairs of finished ear rings, our demonstration samples. At $2500,
that’s $250K. Can we just announce that price without ever having sold any? We have existing
inventory of sensor moats, too, but I have no idea how to put a value on that; we don’t have a
clue what the failure rate will be. It’s not many moats, though; a few hundred.
JEFFREY: Our research was funded by grants from DARPA and the University of California. In
return, DARPA requires only a secure disclosure of any innovation (and only to DOD), And UC
reserves an option to exercise the right to a royalty in the amount of 1/2% of EBIT as may arise
from commercialized of any patent protected innovation, at the discretion of the Regents of the
University of California.
DARYA: Thinking about liabilities, here, we need to pay attention to medical product liability. I
don’t know what the answer is, but I can tell you the risk is not trivial. We’re outside the ear,
but still easily viewed as a medical device. As we move into our next generation sensor, it will
almost certainly be classified as medically invasive. That’s not a bad thing—a pacemaker is
medically invasive—but it’s not something to overlook.
Trevor’s & Jeffrey’s Cash Contributions
TREVOR: I committed $300,000 and then another $150,000 because I already know you
personally and I know enough about the technology at work here to recognize the potential.
JEFFREY: That was my thinking too, so it’s why I invested $100K and invited my parents to lend
us $200K.
Costing & Financial Benchmarks
TREVOR: I am sure we all have faith in the future of Audio. Our investors are going to want us
to help them determine whether this is a good business. So benchmarks are part of the story.
LARRY: I know that Boston Scientific’s 2021 operating margin was 22% and EPS $1.60. Sonova
15000 employees generate $190K/employee, and Dement Group’s 18000 employees generate
$145K/employee.
KPI s & BSC
TREVOR: Those are good, and comparing favorably with statistics like that will build credibility
with investors. But comparing unfavorably ought to signal a warning to us that Audio is not
operating as efficiently as its competitors, so we ought to monitor those indicators just for our
own internal information, as well.
LARRY: We could do the same for other financial indicators: earnings yield, earnings growth,
return on capital, profit margin, and return on assets, come to mind right away, and there are
certainly others. We need to establish targets, monitor Audio’s performance against them, and
have corrective action processes in place to resolve any dangerous deviation.
REBECCA: I can see lots of operational KPIs to monitor for the same reason, to warn us if
anything we’re depending on starts drifting into danger. Process reliability, on-time shipment,
volume…
KERMIT: Marketing too: deteriorating or improving economic conditions, lost order rate, return
on advertising spend, and so on. But also monitoring and reporting on our competitors, and
probably on fashion trends.
JEFFREY: It’s obvious that every function in the company will have some set of KPI’s like that to
monitor. But the functions are interdependent, so I think we need consolidated reporting at
the top of the company as well.
TREVOR: I would think Accounting should take responsibility for managing that. I would expect
to see monthly financial statements, of course, but we also ought to see some evaluation of
Audio’s short term and periodic financial performance, as well as market performance and
operational performance—trends, early warning of changes in condition and proposals for
remediation. Accounting is going to be touching every function in the company, so that’s the
obvious focal point for consolidating and managing all of Audio’s monitoring activity.
LARRY: OK, I agree. To get that set up, then, the very first next step is to pencil out what those
metrics should be, and make at least initial suggestions as to a performance target for each.
Topic 530: Finance, Mr. Trevor Meredith
Status Today, Completed Seed Goals, Fund Creation of MVP
TREVOR: Let me introduce the finance discussion. Our goal is to create an investor
presentation that gains the funding needed to set up a company and lead it to profitable
growth. Investors are going to want to know how much money that is going to take, how we
are going to use it, how much revenue we can harvest in the marketplace, how hard it will be to
get it, why you are the team that can do it, how big a return they will get, and what could go
wrong.
Seed Stage is Complete
TREVOR: We have completed what investors call our Seed Stage. We ourselves provided most
of that money to fund those activities, and there was also some support from Berkeley and
DARPA. We have completed the research and development, proven product feasibility,
completed production of 100 prototypes, which we now have on hand to show. We have not
yet sold any, but we have validated market viability with Chartier, who has made a commitment
to explore establishing a sales channel relationship and possibly a co-branding relationship, and
we expect similar interest from Damiani soon. Key executive staff is in place, and we have
completed an initial marketing scan to size the opportunity, zero in, at least tentatively on a
target market segment, and begun nailing down competitive positioning strategy, and demand
generation messaging and tactics.
Equity Investment & Funding Request Scenarios
Scenario One—Fund Start-up & Emerge Stages
JEFFREY: So, we have the product and know how to make it. Now we need to set up a
company to produce and sell it, take it to market, ramp up, and start generating a profit. That
will require funding. Here are the key milestones that Rebecca and I have talked about.
1.
2.
3.
4.
5.
6.
Establish a product manufacturing capability—factory staff, plant and equipment
Establish a jewelry design capability
Establish a AI / software R&D capability, or a developer network
Create supplier relationships and supply commitments
Add marketing staff to prepare for demand generation
Establish sales channel relationships, possibly joint ventures, with one or more hearing
aid manufacturers to get access to their sales channels
7. Establish the same with one or more jewelry design houses, not only to get access to
sales channels, but also to get access to their design talent and material supply chains,
and possibly a co-branding opportunity
8. Turn on business operations
9. Turn on supply chains
10. Turn on manufacturing and ramp up to volume
11. Turn on sales & marketing and ramp up revenue
TREVOR: Some investors call the first seven the “Start-up Stage” and hold of funding those last
four steps, which they call the Emerging Stage, or Series “A” funding stage. We are going to
combine them in a presentation that show investors how we will go from a standing start to
profitable rapid growth.
Scenario Two—Fund Start-up & Emerge Stages AND add Ansoff Expansion Stage Now
JEFFREY: Once we are through those two stages, we can talk with investors about expanding
the business, and make a request for Series “B” or Expansion Stage funding. That is when we
can conduct further develop product enhancements—or business model enhancements, for
that matter—to strengthen our position in our market, to expand our share of the market, to
diversify into new products or new market segments, or even enter adjacent markets.
LARRY: So, you’re saying we should defer development of our nano-scale sensor, until after
we’re profitable?
TREVOR: That’s right. We should also be very cautious about pursuing any of the other product
or market extensions Kermit talked about.
LARRY: I am not so sure we ought to delay. That’s the real fun stuff, or at least the nano-scale
device is. That’s what’s going to redefine the market—something so small it requires no
platform at all, no ear rings, nothing. Let’s get funding for the whole package; I don’t see any
downside to including the R&D for the nano-scale device in our request.
TREVOR: I will give you this much. Investors certainly will want to know what out longer-term
opportunities are, and hear our assessment of their priority for attention and strategic value.
Even if they elect not to fund those, yet, the need to be revealed, if not featured, in our investor
proposal.
Mission – Nanoscale Devices
TREVOR: So those are the detail “how-to” questions that need to be answered, but what we
need to show investors also need to see is “why you.” They’re going to be looking for an
opportunity that has the potential not just to grow but to grow into a business worth hundreds
of millions of dollars. Some investors will also have a social mission in mind some something
that they want to accomplish with their money, like advancing medical research or advancing
education or the arts or whatever it might be. In other words they’re going to want to know
why you’re doing this, and see if it lines up with why they would do it. And they’re going to
want evidence not only that is your plan rock solid yet flexible, but also that you members of
the executive team you, and your partners, have the skills and the mindset to follow through
and make it work.
JEFFREY: Well, getting comfortable financially is certainly a goal, although there are lots of
other ways I could do that. For me, it’s some combination of wanting to be involved in work
that makes life a little better for people, but work that also keeps me in contact with interesting
technology and interesting people. Rebecca feels the same way.
JEFFREY: There’s another reason, too. I believe we can take this capability and refine it so that it
no longer requires any kind of platform at all, allowing us to place small swarm of smart-dust
motes directly inside the ear canal. That is, it can be deployed into use like an implant, or
something a person would apply like fingernail polish. That’s why I feel so strongly that Darya’s
experience with Boston Scientific and her medical expertise makes her a critical member of the
team. But to fund the research needed, and to make that mode of care work, and to get
through the process of FDA approval—which can take a very long time—we’ve got to bring
down the price of producing our sensor devices. It seems to me the way to do that is to create
high volume demand, the levels of volume you can only generate in a consumer market. That’s
what got us to Audio.
KERMIT: I’m not sure I would call it a swarm of dust mites. In my ear? I wouldn’t recommend
that.
LARRY: Well, it’s dust mote, not mite. It’s accurate terminology, and I am already using it in my
publications about the size of these devices and where we think the technology is going. Not
just in scientific papers, but my blog and some talks I have given. People get it. They love it!
Osborning & Premature WOM
KERMIT: A couple of you guys are pretty excited about the technology, as you should be, but
you’re already talking about next generation enhancements to outsiders before we’ve even got
our first generation to market. More than a few observers believe that’s what bankrupted
Osborne Computer Corporation. Osborne did it to himself not just once but twice.
REBECCA to KERMIT (leaning over to speak privately): You’re not wrong, but you’re a new
member of the team, so be careful you don’t poke the bear. Be your Yente, Yente.
JEFFREY: Ultimately, commercializing what we have now, to reduce cost and fund
development, will bring us right the the cusp of an authentic BMI brain machine interface. We
eliminate the earring platform entirely.
DARYA: Commercialization of the technology by means of jewelry as the means to a longerterm strategic end is probably OK. Deployment of the technology in the form of jewelry
satisfies a legitimate market need, a legitimate people need, and that business need never be
abandoned if we chose not to. But the longer-term strategic intention is to drive down the cost
of sensor devices, and to fund further research and refinement of our technology, by creating
consumer demand for it. The goal of further R&D is to obviate the need for a carrier platform
at all, enter permit implementation of the devices, and the benefits they create, by applying
them directly on the skin surface of the outer ear much as fingernail polish is applied to the
outer surface of a fingernail.
LARRY: In fact, a limited version of the Samsung actuating technology has already been proven
feasible as inks, or tattoos. And Elon Musk’s Neuralink is already getting there, although it
depends on sophisticated robotic surgical technology to implant it. In any case, I believe the
technical capability to eliminate a platform is within 3 to 5 years of realization. There only real
risk factor is that FDA review and approval might take longer, or even stall.
Valuation, Partnership, Trevor’s Investment, Investors’ 25% Stake
TREVOR: How about the end game. Do you want to spin off, merge, cell to a larger
organization, or pass this on to your kids?
I committed $300,000 and then another $150,000 because I already know you personally and I
know enough about the technology at work here to recognize the potential. And there was no
great deal of discretion about where that money would be spent; essentially all of it would go
to activities in the electronic design lab and the semiconductor foundry facility that Berkeley
maintains with IBM down in San Jose. But you’re going to be asking for, I expect, several
millions of dollars, and it will be allocated to a wide variety of functions. That leaves a lot of
room for losing track of the strategic-necessity-test that every investment ought to pass before
it is made. Every dollar expended needs to be moving us a full dollar closer to the next stage of
profitability and rapid growth. Your investors are going to insist on sufficient ownership stake
to assure them the control to oversee those expenditures commensurate with the investment
risk they are taking.
JEFFREY: You mean an investor is going to want to become a partner.
TREVOR: Well, you know, I have refrained from using that term about myself and my
relationship with the rest of you. There are several forms of business organization, and so one
decision for you to consider now is whether partnership is the right one for you.
JEFFREY: What difference does that decision make?
TREVOR: Well, we were just talking about control of decision making. That’s one difference.
Taxation is another.
JEFFREY: I really do not want to give up 25% equity, and I absolutely detest the idea of an
investor putting somebody on the Board of Directors who can exercise control or even interfere
with our control of strategy and direction. I might relent if the board member could be
somebody who’s even smarter and more ambitious than we are, but just not going to let that
happen without some sign-off that the addition is OK with us.
LARRY: I feel the same way. We’ve put our lives into this project.
Valuation of Company Assets & Future Earnings
LARRY: Well let’s just assume that we need $5 million to get the wheels rolling, and we know
Jeffrey doesn’t want to give up more than 25% of company ownership to investors, so $5
million is 25% of 20 million, and we just tell him that the company is worth $20 million. That’s
our valuation.
TREVOR: What investors are going to want to know is why you think it’s $20 million.
LARRY: Because we need $5 million. Or at least, that’s my best guess. It feels like enough.
TREVOR: Of course. But using a book-value approach, what investors will want to know is
whether, if Audio fails, there are enough physical assets to sell to pay back the $5 million.
LARRY: We have some assets. The sensor devices which we developed on our own would
otherwise have cost $800,000 or $900,000 in non-recurring engineering expense. We have
data from one of the ASICs that NRE for a military-grade analog bus driver/receiver is $225K,
and for a radiation-hardened space-grade analog power driver and sensing device $850k.
We’re at least that good, and since our NRE is already sunk, we have $225K to $850K of
inventory right there. Say it’s $1,000,000. Our patents must be worth something, so let’s say
another $1,000,000.
JEFFREY: I like that our patents are worth $1,000,000. Are you saying that we could get that
much in royalties if we let somebody else use them?
LARRY: I don’t know that we couldn’t, right?
S-Corporation, Start Date, Stock Issue, Call for a Financial Plan
DARYA: You said $1.00 per share, Trevor. Of course, it will grow to more, but I am not sure I
see how that reflects the value of the company.
KERMIT: We might want to set a share price target for Audio. That would give us a metric, or
more of a focal point for setting other financial targets, like earnings per share. We need to be
thinking about how Audio will look to investors who are watching financial ratios.
DARYA: All right. Thinking about it that way raises lots of similar questions. What’s the right
interest to offer lenders on the purchase of bonds? Why borrow at all rather than just selling
more stock?
JEFFREY: I would expect the stock to appreciate in value more than simply what’s necessary to
retire the loan with interest, and by holding onto stock we keep more of that growth for
ourselves.
DARYA: But there’s a risk, right? When we issue stock, we also distribute the risk of things
going badly. If we borrow, our lender bears none of that risk, and we’re obligated to pay the
loan no even if it drives us into bankruptcy.
LARRY: As I understand it, when stock is sold, we get cash; when stock is retained or bought
back, it’s carried on our balance sheet as if it were a cash value, but that cash value is called
goodwill. So, to pursue this line of thinking about managing ratios and investors, the challenge
of issuing and repurchasing stock will be to optimize the amount of goodwill we show, in order
to balance our statement of net worth—which is to say shareholder equity—against our
credibility as a borrower or investment target. Is that right?
DARYA: Where do bonds fit into this? Are those just a kind of loan? And how about taxes—are
stocks, bonds, loans treated differently? I started out thinking we were just trying to float
operations, but I am no longer even sure what kind of funding we should seek.
JEFFREY: Not to mention whether we should approach private investors, institutional investors,
investment banks…
DARYA: Or family, friends and fools?
TREVOR: The investors themselves will tell you pretty quickly whether Audio is the kind of
investment they want. I think we’re looking at private equity for now.
TREVOR: Let me make a suggestion. I have hinted that partnership is not the best form of
business organization for Audio, but the group has seemed reluctant to get into a discussion of
alternatives forms of organization or their pros and cons. So, if you are comfortable with just
accepting a recommendation, let me offer one. Most of our funding is coming from the several
of us who are “in the family” so to speak. We’re talking about a few owners, not thousands. So
I suggest we simply decide organize as an S-Corporation and leave it at that.
LARRY: Does that lock us in forever?
TREVOR: No, we can reorganize Audio in the future. But deciding now gives us a working
model and answers any questions taxation, control of decisions, and legal liabilities.
DARYA: Sounds fine to me.
JEFFREY: Thanks, Trevor, that sounds good. So how does ownership work, then—do we each
get stock?
TREVOR: Yes, exactly. I thought we might simply allocate shares based on the “skin in the
game,” so to speak, each of us has already invested. I have invested $450K. Jeffrey has invested
$100K of his own money in what we’re doing, and his parents have also made a loan of $200K
loan at 7% a year to help get Audio started. At a dollar a share, 450K shares to me, 100K shares
to Jeffrey. We can invite Jeffrey’s parents to accept shares as repayment of their loan. Of
course, they can decline that alternative, and preserve the right to repayment according to the
terms of their loan.
LARRY: I haven’t written a check, but I think the value of my contribution to the research must
be equivalent to Jeffrey’s. Rebecca’s indispensable, and so is Darya. Does this mean we all lose
our places at Audio if we cannot come up with cash?
DARYA: Actually, I could provide $50K but that’s about all.
KERMIT: I could swing $2…
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