Albedrio Partners, Inc.

Wealth Through Innovation v0.5

Prepared for:
Prepared by: Marcos Polanco, Principal

May 24, 2009

Albedrio Partners, Inc. 1607 Calle Colón #101, San Juan, PR 00911 787.529.5892 marcos@albedrio.com www.albedrio.com
 Albedrio Partners, Inc.

Introduction

“You need three things to create a successful startup: to start with good people, to make some-
thing customers actually want, and to spend as little money as possible. Most startups that fail
do it because they fail at one of these. A startup that does all three will probably succeed.”
- Paul Graham, founder of Viaweb (sold to Yahoo for $50M) and investor in 80+ startups

Entrepreneurs are not alone in their quest to realize their vision, and indeed stand on
the shoulder of giants who have outlined the path between entrepreneurial vision and
financial wealth. Albedrío partners with entrepreneurs to help them identify valuable
opportunities and remove as much risk as possible from their enterprises at the lowest
possible cost, thus maximizing the financial value of innovation.

This paper outlines the elemental risks faced by an innovative startup, how investors
(e.g. the founders) can target financing to remove these uncertainties, and the Customer
Development process to handle what is frequently the main risk: market acceptance.

Wealth through Innovation

A firm’s value to its shareholders is driven by its profit potential and braked by its risk
profile, in particular the risks associated with technology development, market accep-
tance, management capabilities and the business environment:

1. Technology Development means the risk that the technology under considera-
tion will actually fulfill the promised value proposition and satisfy clients. It is
important to note that technologies are almost certainly deployed in conjunction
with a family of consulting, training, financial and management tools to consti-
tute a complete solution to the business challenge faced by customers.

2. Market Acceptance refers to the number of customers efficiently reachable by the

enterprise through the chosen distribution channels, the length of the sales cycle,
the win rate for presented proposals, average deal size and the cost of customer
acquisition. The risk is that any one of these parameters will be “show-stoppers”,
unacceptable in order to generate the financial results sought by shareholders.

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3. Management Capability refers to the probability that a firm’s management team

has the competencies and motivation to guide the enterprise to the event that
will realize capital gains by the shareholders, typically through an initial public
offering, an acquisition or the declaration of a dividend distribution schedule.

4. Business Environment refers to the risks that political, technological, economic

or social changes will negatively impact the value of the enterprise’s business of-
fering. Recession, conflict, cultural changes, and scientific discoveries can render
offerings practically useless. This risk is managed through speed of execution
(thus granting less time for unexpected changes to occur) and continuous moni-
toring of the change drivers and the firm’s environmental exposure.

Example - Part 1: XPR Enterprises is developing a language translation device, targeting a $50M
global business market where they expect $10M in annual profits. They estimate that this line of business
could be sold for $20M, their objective. However:

1. There is a 60% chance that they can engineer a device weighing less than the required 1lb.
2. The product would require a new distribution channel (80% chance of success) and positioning as a
must-have item with a 3-month sales cycle (70% chance of success).
3. The management team is experienced in servicing national $10M markets, but has never sold glob-
ally. There is a 70% chance that they can build the competencies to reach the $50M mark.
4. It will take three years to launch the product, so there is a 70% chance that the business environment
will remain stable for these above assumptions and calculations to remain true.

Thus, to a first approximation, the nominal value of this business today = $20M x .6 x .8 x .7 x .7 x .7 =
$3.3M, only 16.4% of what the shareholders wish to sell at. It is management’s job to raise share value to
the $20M mark!

How to Finance Innovation

Given the above example, where the enterprise is only worth 16.4% of what sharehold-
ers are targeting, they are best served by a capital efficient risk elimination approach,
through which they ask the question, “What is the least amount of money we can invest
that will eliminate the greatest amount of risk in the enterprise?” Once they have elimi-
nated the greatest risks, they can reassess whether they are best served by continuing to

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fund the project. This is the fundamental logic of “venture capital rounds of funding”
utilized in Silicon Valley.

Example - Part 2: XPR Enterprises estimates that product launch will cost $10M; however, they choose
to approve only $1M of funding to fulfill the following objectives within six months:

1. Identify the specific technology breakthroughs required to solve the weight issue through a survey
of the leading academic researchers on potential solutions.
2. Conduct a study to determine whether and how to sell the product in less than three-months.
3. Identify the absolute minimum set of features that customers would be willing to pay for, thus
reducing the original three years needed to launch to only two years.

They choose to retain the existing management team for the moment, as they are perfectly capable
of conducting the above tasks, and not to mitigate the distribution channel risk, which would cost
and additional $1M. Here’s the before-and-after risk profile sought from their $1M investment:

Risk Before After

Product 60% 90%

Distribution 80% 80%

Sales Cycle 70% 90%

Management 70% 70%

Environment 70% 80%

Valuation $3.3M $7.3M

Therefore, the shareholders raised the value of the company by $4M with only a $1M investment.
That is a good return! But if they had been unable to succeed then they must identify the root
causes and decide whether to cut their losses at the $1M or continue investing.

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The Role of Customer Development in Financing Innovation

Customer Development is a four-stage process focused on eliminating market accep-

tance risk at minimal cost through early engagement with potential customers. The four
stages are:

1. Customer Discovery, wherein the enterprise ensures that there exist customers
who attest that the offering actually solves a top problem, and that the way in
which the offering is acquired is compatible with their business practices. Only
the pain of top problems causes customer purchasing action, and the complete
solution must be compatible with organizational and industry workflows.
2. Customer Validation, wherein the enterprise develops a repeatable sales process
with customers who are willing to accept business startup risks along with company
founders. Customers are not only paying the purchase price, but they are also
changing internal processes and accepting the possibility of startup failure,
which would negatively impact their organization and personal reputation. A
successful customer validation exercise must produce the first customer orders.
3. Customer Creation, wherein the enterprise identifies scalable demand-creation
channels for new customer acquisition at acceptable costs.
4. Company Building, wherein the enterprise successfully exits the development
stage and articulates a mission to dominate a given market segment.

Albedrío teams with founders on a capital-efficient traversal of the discovery and vali-
dation stages. The first step is to size & type the addressable market, developing hy-
potheses of the customer problem, minimum viable solution concept, demand creation
channel, competitors, pricing model, sales roadmap, whole team competencies, and cus-
tomer workflow (both before & after product implementation). The second step is to ac-
tually perform the investigation of whether the hypotheses are correct, stopping as soon
as we find conclusive customer data. The process repeats until it succeeds.

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Albedrío Leadership

Marcos J. Polanco is a proven innovator with diverse experience in technology devel-

opment, entrepreneurship and public policy. Mr. Polanco holds a bachelor’s degree in
Computer Systems Engineering from Stanford University, a Master Certification in Pro-
fessional Management from the Institute for Generative Leadership and an Executive
Certification in International Marketing from the Thunderbird School of Global Man-
agement.

Mr. Polanco began his career performing object database research at Hewlett-Packard
Laboratories in Palo Alto, California, and went on to both technical and managerial
leadership roles at a number of Silicon Valley startups before co-founding Imana, Inc. to
commercialize a social search technology he co-invented and patented.

Mr. Polanco served as advisor to the Government of Puerto Rico in the implementation
of its Information & Communication Technologies strategic public policy roadmap and
in the design of the Puerto Rico Science, Technology & Research Trust, the Island’s in-
novation policy instrumentality. He thereafter entered government service to launch an
investment promotion business unit at the Puerto Rico Industrial Development Com-
pany (PRIDCO). The unit quintupled the size of the aerospace industry in Puerto Rico
(from 400 to 2,075 committed professional career positions) in the span of three years,
including the launch of Lockheed Martin, Honeywell Aerospace and HCL Axon, as well
as a major expansion by Pratt & Whitney. These successful negotiations positioned
Puerto Rico as a talent source for federal innovators and added $70 million in annual
payroll income to Puerto Rico’s economy.

At PRIDCO, Mr. Polanco launched the “PRIDCO for Entrepreneurs” program which
included funding for two technology incubators, technical assistance in winning federal
Small Business Innovation Research awards, technical assistance in winning federal
procurement contracts, lean manufacturing training for the aerospace supply chain,
federal patent protection assistance, and commercial missions to various aerospace &
federal information technology conferences.

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