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Olson’s Observations

Technology. Innovation. Science. VC. Media. :: by Eric Olson

Archive for April, 2006

Microfinance as a Business

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I was lucky enough to attend the microfinance conference at the University of Chicago recently where the topic was “Microfinance at a Crossroads.” There were many distinguished speakers at the conference who spoke about where microfinance is going and where it should be going. One theme that permeated the day’s discussions was microfinance as a business. Specifically, the thought was that we need to begin to think about growing, and possibly merging, microfinance institutions (MFIs) in order to make microfinance more efficient. The increase in efficiency would allow interest rates to be lowered making it possible to move down market and reach more of the poorest of the poor.

One of the panels during the day was geared toward talking about just that and focused on consolidation in the industry and the possibility of mergers ahead. However, Monica Brand of Accion brought up a great point. When mergers happen in the public markets the stock usually goes down. The reason for the drop is that mergers are hard. There are internal power struggles and management issues and the synergies that were seen as possible previous to the merger can sometimes never be obtained. Also, as opposed to “regular” businesses, MFIs are usually started with a very clear social vision in mind rather than a business vision. When the opportunity to merge comes up, especially if a commercial bank is involved, the social aspects will be what the MFI founders consider first and foremost. If they are not convinced their potential merger partners will uphold their social vision they will not merge or they will go forward with the merger only if their position remains preserved in the post-merger entity.

So, what can we do to obtain the synergies and take advantage of economies of scale that come when organizations grow or merge with others? One thing we can do is combine the data mining and CRM of organizations rather then merge them completely. Data mining and CRM are very expensive but the expense per action decreases as volume increases. MFIs can band together to form joint ventures that are designed specifically to run their back office operations. Combining operations not only saves costs, it also allows the MFI CEOs, founders and other personnel to keep their positions at the MFIs they run and maintain the integrity of their social vision.

Helping people is why microfinance exists and why all of us are so passionate about it but that doesn’t mean we shouldn’t think about it like a business. Business is not a bad thing. It values efficiency which is going to be critical in taking microfinance to the next level. The more efficient microfinance becomes, the more people we can ultimately help and the better we can serve the worlds poor. I personally look forward to the future of microfinance and to more ideas that will create a world in which everyone has access to basic financial services.

Written by Eric Olson

April 23rd, 2006 at 11:51 pm

Posted in Microfinance

Venture Capital Deal Pricing

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Throughout my high school and college days I learned many valuation methods. In fact, I have a book sitting on a shelf in my apartment called “Valuation” (convenient title, I know…) that is seriously two inches thick! With that said, these valuation methods make sense and can yield fairly good results when used in conjunction with each other to value a company and, in my case, it’s common stock. However, I always wondered how often I would use these models outside of the classroom.

Turns out, a lot of money managers that play in the public markets use these tools regularly and even modify them to yield better information. This is not the case in the VC game (nor should it be). I learned this fairly quickly after taking a job at Cambridge Associates right after school. Meeting VCs and hearing about how they do things was fascinating. I thought that they must have some pretty interetsting (read: hard to understand and complicated) valuation methods in order to value such brand new technologies and companies. Looks like I was off base. The valuation methods of VCs are actually, as Matt McCall put it in his post today, quite simple though subjective.

Before you can really understand why VCs value companies the way they do you first need to understand that the VC business is one of multiples. To quote Matt:

Early stage VC’s target 10x return of capital and expansion/late stage investors target 3-5x. Why 10x…seems a bit usurious? The classic venture portfolio looks like this. Of ten deals done:
– 4 crater
– 2 are breakeven +/- a little
– 3 are 2-5x capital
– 1 is 8-10x

The reason VCs need to target 10x is that they will have many losers and semi-losers in their portfolios. It’s just part of the game. Therefore, the winners not only need to provide a large gain, they also need to pay back the losses from the other investments in order to raise the overall portfolio return.

Matt goes on to describe how VCs price deals based on their target of 10x:

VC’s will then try to estimate a) what they think the company might be worth if successful in 3-5 years and b) how much more capital will be needed. In a simple case, let’s assume that the company is worth $100m in 4 years and will not take additional capital. Using the 10x rule, the VC will price the deal so that post-$ valuation of the deal is $10m. If the company is raising $2M and adds $1M worth of options to its pool, the VC will pay $7M pre-$.

Pretty straightforward, no? Determining the terminal value of the company and subsequently what the funding round in question should be valued at (in order for the 10x return) is really the wild card in all of this. Matt cranks out some simple math though which leads us right to some average pre moneys that look a lot like the 2005 VC investment statistics I mentioned yesterday on VentureWeek. The median pre moneys for 2005 were:

  • Seed: $2m
  • Series A: $5.4m

Matt suggests between 7 and 9 for series A and between 2 and 4 for seed stage deals from his quick math. These numbers are pretty much right on with what happened in 2005. (It should be noted that Matt’s numbers are averages and the VC stats are medians so all in all they are pretty much the same. Also, Matt says these numbers have a lot variance in them so be sure to use them more as examples to understand VC deal pricing than hard facts.) By combining the 2005 stats with Matt’s quick math we can come to the conclusion that most VCs are in fact valuing companies the way Matt suggests.

There you have it. VC company valuation in a nutshell. A big thank you to Matt McCall for putting a post out there explaining this! It really clears up a lot of misconceptions and I am sure a lot of entrepreneurs now see why VCs aren’t really interested in discounted cash flow model valuations.

Written by Eric Olson

April 18th, 2006 at 10:32 pm

Posted in VC

Banker to the Poor

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I just finished reading Banker to the Poor this weekend which was written by Muhammad Yunus, founder of the Grameen Bank. The book chronicles Yunus’ discovery of microfinance and readers get to see the idea move from its humble beginning (a spontaneous $27 loan from Yunus’ own pocket) to the poverty fighting powerhouse Grameen is today ($5.34 billion in loans distributed with a 98.45% payback rate). However, it wasn’t easy getting there.

Yunus faced many issues while building up Grameen. The first of those issues what that of purdah. Purdah is a tradition in Bangladesh (where Grameen started) that basically says women should stay inside the home and not leave or converse with other men unless their husband is present. This tradtion caused Yunus and his team much trouble in the early days since women, the primary microfinance borrowers, were to scared to talk to them and especially to borrow money without their husbands permission. Even if Yunus could talk to these women while their husbands were around their hubands wanted to know why they couldn’t have the loan.

I should take a side bar here and note that women are the primary focus of Grameen because Yunus and his team found that money made by women affected poverty the most since they would put the money back into their home and buy food, etc. so, econmically, women with money will provide more on an impact on poverty.

Through shear perseversence and cultural awareness Yunus and his team were able to win over the people and the bank was formed. The problems didn’t stop there though. The government was not as fond of Grameen as they should have been, natural disasters sometimes wiped out the borrowers assets and even the World Bank caused Grameen some troubles. However, the concept and the people behind it were too strong to be cast aside and I, for one, am greatful for that.

Many of you who are long time readers know that I am strong advocate of microfinance lending (I even produced a podcast on it which you should check out if you are interested). I believe that microfinance makes the most economic imact per dollar spent in terms of helping the poor. The impact is so great because credit empowers people to take control of there lives and use their natural creativity to pull themselves out of poverty. Many programs out there now, while still doing a lot of good (and I applaud them for that so please don’t take this as a knock), think that training is the answer and that without it people won’t move above the poverty line. Microfinance shows just the opposite. It shows that everyone is an entrepreneur and can/will survive on their own merit if just given some start-up capital.

I urge anyone who is somewhat interested in microfinance to read Banker to the Poor. While reading you will feel the passion Yunus has for the idea and you will see, through examples, that it works. I am willing to bet that, after reading the book, you will feel as strongly about the concept as I do.

Additional Info: I will be attending the Chicago Microfinance Conference on April 21st at the University of Chicago (you can register and attend too - just click on the link for more info). I am really excited about it and will undoubtedly have some interesting things to report on after so stay tuned!

Written by Eric Olson

April 9th, 2006 at 10:24 pm

Posted in Books, Microfinance

No Music = No Internet

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Provocative title isn’t it? However, new research could actually prove this to be true. Music permeates all human cultures and there is strong evidence that the brain comes prewired with music circuits making it a product of human evolution. The question is: If music is a product of human evolution than what is music for?

Many scientists, including Darwin, wrote music off as a method early man used to try to attract mates. This was a solution that made sense at the time because no scientist was ever able to link music to survival. The thought was that if music couldn’t be linked to survival than it had to be linked to the propagation of the species since a trait will persist generation after generation only if it is linked to one of those two needs. However, Steven Mithen’s new research may indicate that music was, in fact, a survival mechanism for early man (source: Science Journal article).

Here is how Mithen imagines things:

…the small band of Neanderthals gathered 50,000 years ago around the caves of Le Moustier, in what is now the Dordogne region of France, were butchering carcasses, scraping skins, shaping ax heads — and singing.

One of the fur-clad men started it, a rhythmic sound with rising and falling pitch, and others picked it up, indicating their willingness to cooperate both in the moment and in the future, when the group would have to hunt or fend off predators. The music promoted “a sense of we-ness, of being together in the same situation facing the same problems,” suggests Prof. Mithen, an archaeologist at England’s Reading University. Music, he says, creates “a social rather than a merely individual identity.”

Mithen believes that “language may have been built on the neural underpinnings of music” and that, before language, music actually helped man communicate and survive. Recent discoveries that suggest music has a particular place in our brain may back up Mithen’s hypothesis. In fact, Mithen even points out that, because language impairment does not lead to musical impairment, music must have been around longer.

Music, as we all know, is strongly tied to emotions and that is why Mithen believes it helped early man survive. For example, one man could start to “sing” and the others would know how he was feeling from his tone and could then join in to “sympathize” with him. Music can also be used to manipulate peoples emotions so early man could have, for example, used “happy” tunes in order to keep people cooperating and forging ahead on a long day of hunting or gathering.

As a musician (haven’t updated the site in a while), and as a human being, this theory fascinates me. I have been known to say that music is the only universal language but I never really thought about it more than just thinking that notes are written the same way regardless of where one is. I had never really thought of the emotional ties we all have to music because they are so natural and tied to our subconscious. This may be why a song can sometimes express things in a way that words just can’t or why, when a certain tune pops up on the iPod, one immediatley enters into a specific emotional state. Professor Mithen’s research is very interesting and I, for one, will be watching and reading as he moves forward knowing that, if he is correct, there would be no internet without music.

Source Info: I found this article within a weekly e-newsletter I receive from the great folks over at StonePages.com. If you are interested in archaeology and ancient cultures you should absolutely subscribe or at least visit their site frequently. You won’t regret it!

Also: In the spirit of this post I thought I would share some of my Pandora stations so all of you could see some of the new music I am discovering at the moment. Enjoy!

Rock Radio
Depeche Mode Radio
Jazz Radio
Singer/Songwriter Radio

Written by Eric Olson

April 5th, 2006 at 10:48 pm