Why Finance? A need for a financial brain in any kind of business

Innovative and unique firms serving different interest areas of customers are being conceptualized and executed everyday. From Uber for airplanes to Airbnb, entrepreneurs are exploring new ideas, unexplored before. They create needs, unfelt before. But the theme of all those firms serve a common purpose, making your customers life easy.

However, firms must not just be limited to this purpose. Firms serve another important group of people – their own shareholders. After all they are the people who provided the company with money when it was in need. And after all, shareholders own the company. So how do we serve interest of the shareholders – A large group of people representing different income group in addition to including institutional investor?

One thing I can tell you, being a finance major, we the finance people have differing variables, conflicting theories and own personal assumptions. It will be rare to find two finance people agreeing on a given model. But I can assure you one thing that we all agree upon. That is all company should have a goal to “maximize the wealth of a shareholder by maximizing the long term intrinsic value of the company”. Yes, this is one of the rare areas in textbook that holds true in practical world. And this gives answer to the question previously raised, “How do we serve interest of the shareholders?”.

Now not all entrepreneurs have done a finance coursework and not all know that “Maximizing the long term intrinsic value of the company” will be an all-inclusive goal that serves every purpose that an organization believes in and thereby keep all stakeholders contented.

This is one of the reason activist run campaigns against corporation that they should get a seat on the board. And I see this as a fair demand because having an activist in the board, in addition to bringing all the positives (with few negatives), they bring concepts of finance with them.

And why do we need concepts of finance in the board? Let me explain this with a simple example. Currently I am working on a project about a Fortune 500, industry leading company. I can tell you with a good confidence level that the company should increase its debt to increase its long term intrinsic value. Although the percentage of debt in relation to its equity that I would suggest can be argued, but I can assure you that increasing debt from its current level is more than likely to increase the firm’s intrinsic value. In addition, I can give you names of few companies that can add value by repurchasing shares. And what purpose does increasing debt or repurchasing share serves? The all-inclusive purpose of creating wealth to the shareholders.

My point is being someone, who has relatively few years of experience in finance can come up with such conclusion, how beneficial would it be for every board to have a finance expert that has wealth of finance expertise. Not just that. To all those young entrepreneurs thinking of running your own venture, always keep a seat open for a finance mind, as finance is not just about collecting and paying money.

Can decacorns retain its attractiveness?

Ten years ago, a startup being valued over a billion dollar was a rare event. But now unicorns have become so common that to regain an exclusive status for a startup, people came with a new buzzword – Decacorn – A startup valued at ten billion dollars or more. Uber, Xiaomi, Pinterest, Snapchat, SpaceX are few names that have been valued over ten billion dollars. These firms may seem as, or in fact are big names with big prospects. But from an individual investor’s perspective, are those firms worth investing: through mutual funds or in an IPO?

To analyze this scenario, let’s understand how startups are valued. Take a hypothetical example that Uber is looking for funding and a venture capitalist decides to give Uber ten million for a 1 percent stake, thereby valuing Uber at a billion. The amount of investment and the percentage of stake is decided by a series of negotiation between the founders and venture capitalist. The key determinants of the outcome of negotiations are growth potential, founder’s expectations and earnings of the company (if any). Even if the company may have negative earning, positive future earnings are expected along with supernormal future growth. Thus, a unicorn or maybe a decacorn is created. This paper value, the higher it is, the favorable reception it will receive during its IPO or during its further valuation rounds, thereby rewarding early investors at the cost of later investors.

Another perspective to look into it is the difference in the value per share of these startups. A recent WSJ article, “Mutual funds flait at valuing hot startups like Uber”, states how mutual fund firms vary in the valuation of private stocks. As per WSJ, tech unicorns had 12 instances where a same firm was valued differently on the same day. So which value should an investor look at? Closely related with this perspective is the recent IPO of Square, a mobile payment platform by Jack Dorsey – CEO of both Twitter and Square. Private valuation for Square was 6 billion, but then its IPO placed its value at $3.9 billion. Seriously? A difference of 1.1 billion!

IPOs are a window of opportunity for the founders to cash in on their idea/s. No one knows the firm and its perceived value better than its founders. Hence, founder can choose a time whereby they can receive the highest possible price for its stocks to maximize their returns, thereby reward the time and effort they have put in for the firm. But on the other hand, the loser is the general investor who buys its stock in the IPO.

Given how well tech stocks are performing after its IPO, the idea of those stocks being overvalued may seem absurd. But, it was absurd to believe that holding “dot-com” stocks was a bad idea, during late 90’s and early 2000’s.