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Part VIII: Less Damage Next Time > Financial Value Chain Influencers

Appendix B. Financial Value Chain Influencers

Table . Financial Value Chain Participants/Relationships
Value created for Value captured (getting paid) Business velocity Influence Risks
 How paid? Who pays? Incentive/dominant strategy Time horizon Scarce (limiting) resource Mechanisms of influence over others Key relationships Drivers of/Importance of reputation Legal exposures
Founders Self, customers, employees, investors, venture capital firms

Economy: act on an idea

Capital appreciation Build a large, lasting company. Usually long term; it may be a life's ambition Reputation, time, money, idea Can choose who its investors are, can insist on a strategy Customers, employees, investors Success of enterprise drives reputation; reputation important to be able to attract future investors Exists, although mitigated by corporate structure, directors' and officers' insurance
VC-installed management Investors, self, customers, employees; although loyalty may be stronger to the VC that installed them

Economy: represent liquid labor markets—bringing their expertise to a company

Options and salary May be regularly used by the VC to turn around struggling companies, so may have a bias toward VC. If VC-suggested strategy fails, VC is likely to help manager find another position. Shorter term than founder; once business is stabilized, or through IPO process, may move on to another venture the VC needs fixed Time, reputation Can try to influence strategy, but is not fully autonomous from VC VC Success of enterprise drives reputation; reputation not as important since VCs act as protectors, and will likely be in multiple companies during career Exists, although mitigated by corporate structure and directors' and officers' insurance
Internal investor relations (CFO/CEO) Management, investors, analysts, press, underwriters, customers

Economy: communicates with investors and customers

Salary, maybe options Be as positive as possible. Shorter term— goal is to achieve free advertising through media and keep investors happy Credibility Information provided to investors, the press, analysts Press, analysts Known that investor relations is not objective so reputation largely unimportant Liability if fraudulent
Accountants/auditors Management, investors, analysts, underwriters

Economy: maintains quality of financial information for those analysts

Fixed fee paid by the company; with some controversy, partners at certain of the accounting firms also became investors in their clients. Protective of reputation for objectivity while also maintaining relationships with the client company Long term Credibility Giving a qualified opinion would be very embarrassing to management and would create big problems in raising capital. Management, regulators Consistent objectivity; reputation is absolutely key to their business. Legal liability
Lawyers All parties, regulators

Economy: informs all parties of the requirements of the law and helps structure the relationships between key parties through contracting

Their client pays on an hourly basis. To strongly advocate the position of their own client Shorter term, transaction oriented, although with longer term reputation a concern Time (better lawyers can choose which clients to take), reputation Advice regarding previous transactions allows each party to be more sophisticated in dealing with the other. Lawyers often introduce entrepreneurs to investors and vice versa. VC, management Skill at advocacy and specific knowledge of relevant transactions drives reputation; reputation is important to securing clients. NS*
Public relations firms Management, press, investors, analysts, underwriters, customers

Economy: communicates with investors and customers

Fixed fee paid by the company Find creative ways to focus media attention on your company. Shorter term—goal is to achieve free advertising through media Reputation Manipulation of information received by the press, analysts, investors Press, management Creativity and effectiveness in getting free press drives reputation. This is important to gaining clients. NS*
Venture investors (LPs and selves)—identify markets, entrepreneurs, products or services to develop companies; self—option on external R&D, access to information flow, advantaged opportunity to fully acquire, option control potential emergent competitors, capital appreciation; entrepreneurs—provide capital and maybe advice, contacts; I-banks—groom next generation of IPOs and M&A; corporate—groom next generation acquisitions

Economy: screen and then provide risk capital and advice to unproven companies; allow established companies to exploit emerging technology; introduces companies to the public markets or acquirers.

LPs—management fee (2–3% of committed capital and 20–30% of gains); whoever acquires the portfolio company (public if an IPO, corporate if an acquisition)  Short as possible to maximize IRR (how funds are benchmarked against others); dictated by market conditions, sector popularity; typically 3–5 years VC time, possibly capital (depending on investor type); access to good deals; capital, relationships with active VC Entrepreneur—capital structure (subordinating execs' equity with VC's preferred stock, valuation and milestone ratchets, vesting, veto rights over sales and major changes in business, buy-back clauses, PIK dividends, liquidation preference with valuation multiples), operating advice; I-banks—choose where to do their IPO/M&A business; influence projects pursued by company, help attract VC investment Deal sourcing—entrepreneur community, other VCs;

Capital—LPs, other VCs;

Liquidation— I-banks and corporate
Returns over time key source of reputation; affects all key relationships, especially capital raising, also attracting entrepreneurs and investing with them on favorable terms; returns important to attract LPs, credibility with I-banks Nearly none. Sophisticated LPs and coinvesting VCs, companies responsible for own legal counsel, acquiring corporates are sophisticated, I-banks are sophisticated.
Limited Partners (LPs) in VC funds Their larger portfolio, of which VC is probably a small part

Economy: provide capital to those with expertise in identifying opportunities

LPs receive their funds from various sources like pensions and often act as fiduciaries; LPs' objective is capital appreciation. Spread investments into various quality VC funds, which allows diversification and gives option to invest in their next fund Long term, the life of the fund into which they invest (7–10 years); they may receive distributions returning capital and appreciation as early as within a few years; typically are unable to sell their interests in VC funds Percentage of their overall portfolio allowed to be allocated to this risky, illiquid asset class; administrative burden could be a minor constraint. Threat not to reinvest in VC's next fund; once invested, legally an LP cannot take any role in influencing investment decisions lest he lose his LP status and thereby limited liability. VC, the most popular of which can choose to exclude LPs from oversubscribed funds Returns benchmarks for pension/ endowment administrator who makes the decision how to allocate among asset classes and which funds within asset classes Fiduciary responsibility to those who have given them the funds to invest
Investment Banks
Underwriters Entrepreneur/VC—raising capital on their behalf in the capital markets; money managers/public investors—with whom they place the equity

Economy: introduces companies to the public capital markets

Company pays a percentage of proceeds at time of offering. Make sure equity issued finds buyers on the day of the IPO; incentive to price stock as low as the company will accept without hurting underwriter's reputation; wants to hype (market) the deal, so they will not be required to support the price of the stock Day of IPO and short period after when they will support the price; reputational concerns might suggest a longer term interest in the stock's success. Reputation, sales force “bandwidth” to sell new equity to its institutional and other investors; receptivity of markets that can rapidly change and make an offering undoable Terms of offering (lockup periods restricting VC and entrepreneur's ability to sell stock for a period after the offering), sense of market appetite for types of companies; influences what VCs will invest in or advise their portfolio companies; ability to affect equity analyst's compensation VC, entrepreneurs, money managers, public reputation Balance between conflicting reputations to get the best price for the company, and selling to money managers and investors stock that will appreciate after the offering Various regulatory requirements, but generally offering documents are careful to minimize risks by maximizing disclosure
Sell-side equity research Money manager/public investors—rely on equity research to evaluate public companies' business prospects; underwriters—help promote an IPO and then continue to cover it; entrepreneurs—a means to efficiently communicate their story to the wider public

Economy: supposed to synthesize for investors the impact of changing industry and company conditions; has analytic expertise and access to best information

Paid from other, profitgenerating parts of the bank, particularly the underwriters; sometimes based on the number of IPOs the analyst has helped market Balancing reputation with investors against underwriter and company pressure to be positive Follows companies long term, establishing a reputation Reputation, access to management for information, time Communicates to the public through the press, tries to persuade money managers and investors, companies try to please the analysts, can try to influence which companies the underwriters take public Management, money managers, the press, underwriters Reputation driven on ability to correctly predict stock price movements, also charisma; reputation is key to having influence over investors and being an asset to underwriters. New regulations around their relationship with management; recent class action lawsuits have failed to assign liability for wrong predictions.
Mutual Funds
Money managers (buy-side) Smaller investors; underwriters—place large blocks of IPO stock with them, who tend not to churn it as much as day traders

Economy: supposed to synthesize for investors the impact of changing industry and company conditions; has analytic expertise and access to best information

Percentage of money managed; their funds attract more money when they have performed better than the average within their risk category. Better relative performance; may lead to imitative investing to be sure to not significantly underperform peers; may also encourage riskier investing so long as staying within the loose boundaries of the “risk category” Quarterly reporting; ultimately, long-term performance is important, but also engage in short-term trading into and out of positions Reputation, access to information Decision to buy IPO stock, hold it, sell it Underwriters to get IPO stock, equity analysts to get insight and information, trust of smaller investors Returns over time; reputation is key to attracting capital to invest Very little; investors invest at their own risk
External Factors
The press Public/its shareholders; investors, analysts

Economy: collects and distributes generally nonfinancial information about companies to interested parties; not necessarily experts

Journalists are trying to build their own reputation; the media firm is trying to increase consumers of its media so as to increase the value of the firm. Attract consumers of its stories, could lead to a bias toward sensationalism. Pressure to produce a great volume of stories may also lead to going with “easy” stories—reporting on fads (what others are reporting) and being uncritical of PR and management spin. Very short term; the deadline for printing tomorrow's paper/magazine/television report Story ideas, expertise Can attract investor and customer attention to a company as well as publish stories on the successes and failures of all involved parties (investor gains, auditor mistakes, etc.) PR firms, analysts, sometimes management Depends on the media organization, but can be entertainment value of stories or depth of analysis. Importance of reputation also depends on the audience. None—strong constitutional protection
Forecasting/ analysis firms (Gartner, Jupiter) Management, investors, underwriters, analysts; press

Economy: gains access to the best available market data and uses sophisticated analytic techniques to make forecasts

Paid semifixed fees for detailed reports on a subject Balance between reputation for accurate forecasts and a need to market their own research in sensationalistic ways Medium term; forecasts tend to change over time, and they are not necessarily held responsible for misforecasts, however, reputation will suffer if they are consistently wrong. Reputation Their predictions form the basis of business plans, investor decisions, analyst predictions, press accounts. These reports often are the starting point of investment fads. Management, press, investors, analysts Not necessarily held responsible for misforecasts, however, reputation will suffer if they are consistently wrong. None
SEC The public; investors, analysts, underwriters who rely on the accuracy of financial information

Economy: sets standards for the quality of financial information provided to the public and analysts

Not for profit Accommodation between efficiency of markets and necessary regulation to created a trusted market environment Long term Time and financial resources Jail, fines, ability to ban individuals from financial services jobs Financial industry, politicians Reputation for fairness and practical accommodation of market efficiency and adequate protections for investors; has monopoly on its function with the United States (financial activity could migrate elsewhere) None
Federal Reserve The public, everyone in the economy

Economy: stimulates and restrains the economy as necessary to maintain orderly growth

Not for profit Avoid damage to banking industry; avoid a recession, avoid inflation Long term Has all resources it needs Interest rates, money supply, bank capitalization requirements Financial industry, politicians Reputation for fairness and practical accommodation of market efficiency and adequate protections for investors, but has monopoly on its function with the United States (financial activity could migrate elsewhere) None
FASB Accountants, everyone who relies on the consistency of financial information

Economy: sets standards for the quality of financial information provided to the public and analysts

Industry support Provide transparency to financial reports Long term Time and personnel Sets GAAP rules Financial industry, accountant firms, companies Reputation for fairness and practical accommodation of market efficiency and adequate protections for investors, but has monopoly on its function with the United States and increasingly GAAP is used internationally None
Class-action lawyers Investors, self; the SEC, whose enforcement is aided by lawyers' pursuit of wrongdoing

Economy: bolsters regulators' enforcement of law and discourages law breaking by other players

Paid a percentage of the awards won for clients Pursue the largest, most easily proven cases of law breaking by parties with deep financial resources Short term Time and personnel Lawsuits require a lot of resources to defend against and when lost can result in very large financial penalties and reputational damage. Relatively independent actors, not coordinating activities with other parties but opportunistically pursing “deep pockets” Frequently winning cases; credibility with the courts helps None
The Public
Pension/401(k) investors Employees, benefits administrators; funds are aggregated for and often invested by money managers, VC funds often have Pension Fund LPs

Economy: Exploits economies of scale to allow small investors less expensive access to financial expertise; is a vessel through which private savings are cycled back into the economy.

Percentage of funds under management and perhaps a bonus based upon performance Offer brand-name funds to plan participants, receive highest possible returns Long-term retirement Number of funds that can be offered and administered Where it chooses to invest its funds (which money managers it offers to its participants, into which VC firms it becomes an LP) Money managers, VC firms, management, employees Competent administration of a reasonable number of choices for 401(k) plans, good returns for a defined benefit pension plan ERISA obligations
Stock-holding investors Self, consumers of press, provide liquidity to private investors (VCs)

Economy: collectively provide capital and make judgments on the relative merits of companies

Capital gains and dividends Depends on risk appetite of the investor; known for bouts of greed and fear Depends on the investor Capital, time and financial expertise Chooses which stocks and funds to purchase and sell Money managers, regulators, press N/A None
Day traders Self, consumers of press, fee-charging exchanges, provide liquidity to private investors (VCs) and other market participants

Economy: arbitrage, quick incorporation of market information into stock price

Capital gains Anticipate momentum and quickly buy and sell Extremely short Capital Chooses which stock to buy and sell None N/A None
NS = not significant



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