What’s My Trade, Asshole?
In June, 2007 my startup, Innovest, sent me on my first roadshow in Europe to present my investment analysis to some of the biggest fund managers on the other side of the Atlantic. My first meeting was with one of the most acclaimed, and most feared, investors in Europe, Eric Schott of APG.
Eric was a short, barrel chested man with a shaved head and a scowl (he looked like Don Rickles playing the pit boss in ‘Casino.’).
He walked into the boardroom, sat down, checked his Blackberry, and said, “Start.”
I started my presentation by talking about the economic trends affecting banks. He cut me off and said, “The market closes in 42 minutes. What’s my trade, asshole?”
I momentarily envisioned leaping out of my chair and drop-kicking him in the chest. But I kept my composure, fast forwarded to my last slide and said, “I think Lehman Brothers will fail and Citi will survive.”
“That’s what I think too,” he said. He then got up, shook my hand, and left the room. Meeting adjourned.
During my time in finance I presented to some of the meanest alpha males with the shortest attention spans. It was a brutal pressure cooker. I still sometimes wake up in the middle of the night with a revenge fantasy of what I should have done to some obnoxious, old, rich, white guy who treated me like shit.
But, despite my ongoing PTSD, I’m glad I went through it. It serves me well as an intrapreneur. Since my time on Wall Street I have helped Fortune 500 companies build 33 new ventures. Because of people like Eric Schott I’m always ready for someone to ask, “What’s my trade, asshole?” And while the wording is crass, the intention is totally legitimate: why would an innovation-agnostic investor care about what you’re building?
Why innovation matters to investors.
Every Investor in a large company needs to answer four questions about a company:
How will a company’s existing businesses grow?
How much growth will a company generate from new businesses?
How risky are new and legacy businesses?
How long will it take?
At its simplest level that’s pretty much it: Sustain old businesses, build new ones, and do it by taking smart risks in a reasonable time frame.
Every intrapreneur plays a critical role in helping their company fulfill these requirements for investors:
Are you using innovation to make an old business more efficient? How much will your work reduce costs and impact profitability, and how soon?
Are you generating new growth for legacy product lines? How much will sales grow and how quickly?
Are you building a new venture? What’s your best estimate of how big this venture can get?
Everyone’s answers to these questions are inherently imprecise. But we need to try anyway. And we need to have confidence that over time precision improves. We need to be able to put forward a best case, worst case, and median scenario about the expected impact for everything we create.
When you know your ROI, the people who fight you risk drawing the ire of the investors who own you if they obstruct you for stupid reasons. This is the only way an intrapreneur can fight through the inevitable politicized resistance that successful innovation triggers.
Here’s what you need to do to demonstrate return on innovation investment.
The Tools
Never value an idea. Value an outcome.
The first, second and third rule of intrapreneurship is never pitch an idea only pitch an outcome. This premise also extends to the economic valuation of innovation. You have to build and test a prototype before you start trying to predict how it will affect your company’s financial performance. Only then will you have credible starting assumptions about how it would affect sales, profitability, and stock performance once it’s fully grown. First, generate some small scale results, then make assumptions about how it will affect your company’s performance when and if it gets big.
Don’t Mistake Pundits for Practitioners
How can I put this delicately? It is total bullshit that you destroy innovation if you hold it to a standard of efficiently generating returns on investment. And the only people who promulgate that bullshit are pundits who have never fought in the trenches of launching a new business in an old company. It may sound good from the stage at Davos - but it’s a recipe for disaster in real life. It is the single biggest cause of innovation malpractice. Every veteran intrapreneur has a ‘die-on-the-vine’ story in which they built a product that gained traction with customers and was shut down because of political bullshit, rather than market invalidation.
The truth is that innovation ONLY works if the company needs it to work. Yes, a single product needs to be given permission to fail. But a portfolio of new ventures must be held accountable to deliver ROI. There has to be a system for quickly reallocating talent and money from invalidated ventures to new ventures and ventures that are gaining traction. Otherwise innovation lives in the soul-sucking purgatory of a cost center. It pulls from the same budget as the office christmas party. And you squander the talent of astounding entrepreneurs who then leave your company and become disruptive competitors. Yes, this is a raw nerve for me.
Your CFO Needs You. You Need Your CFO
CFOs suck at storytelling. Every CFO has suffered through the indignity of sharing an astoundingly good quarter with investors, but describing it in such bland jargon that investors don’t notice. The PR and communications people who help them are primarily there to ensure that they don’t get sued for saying something illegal.
In other words, CFOs get excited when someone cool invites them to the cool kid’s party. They appreciate it when they can go into the product studio and help explain how user validation translates into financial value. They help extrapolate how it would impact the firm if it gets huge. And they can give you very smart advice about when you should walk away and redirect your investment toward something else. The Punk-Pinstripe alliance between the CFO and the intrapreneur is the Holy Alliance of Innovation ROI. Build that alliance. Build it with all your heart and soul.
If you can multiply and divide you can build a valuation model.
Valuation is not inherently hard - it’s just explained badly. If you made it through 7th grade math you’ve got what you need to run a valuation model. The most important element of valuation is to be clear about your assumptions.
What conditions need to be true for your best case scenario to become real?
What conditions would lead to a massive, expensive clusterfuck?
What would happen to your project if all the conditions today were to continue in perpetuity?
The other cardinal rule is that valuation models love instant gratification. The longer you have to wait for an investment to work, the more risky, and less valuable it becomes.
When you’re focused on increasing efficiency or generating new growth from a legacy business you should calculate the net present value (NPV) of your project. NPV calculates how much you should be willing to invest today for a project that will make money in the future. The value of the investment declines the longer you have to wait. Net present value is the basic building block of investment math. If you have some track record of previous yearly profitability and cashflow, then you can project into the future and you’re ready to build an NPV model.
The OG, Jedi Master of valuation, (and a wonderful, empathetic, plain-spoken, self-aware human) is Aswath Damodoran. His book, The Dark Side of Valuation, is a masterpiece. His blog, Musings on Markets is also stupendous. His smaller, simpler book is The Little Book Of Valuation. I recommend that you read them all.
For a super easy model to get you started with valuation this article in Forbes by Bobby Grajewski is extremely helpful. But, please take your CFO out for a slice of pizza, and ask them to help you populate the model with credible numbers.
Another great resource is the blog ‘Mergers & Inquisitions.’
WARNING: If you are building a new venture from scratch DO NOT USE THE NPV MODEL!! It will backfire terribly. New ventures do not have a track record of data that can reliably predict future performance. Instead, use the innovation options model. David Binetti (another wonderful, empathetic, smart, approachable man) is the architect of innovation options.
What entrepreneurs call ‘disruption’ investors call ‘industry decline’
Way before Facebook destroyed the newspaper industry, business strategists were thinking about why companies move from maturity to decline. A mature, big business starts to decline when it cannot generate new growth from new businesses and legacy businesses become less profitable. When the reason for a company’s decline is the meteoric rise of a new entrant we call this ‘Disruption.’ Intrapreneurs have to formulate a hypothesis of how their company might decline. When intrapreneurs can position innovation as an effective countermeasure to decline, they become the most important person in their company. They earn the power and autonomy to build impactful, epic shit that customers and investors love.
Every intrapraneur needs to formulate a plausible scenario of how their company and industry might decline if they don’t innovate. You don’t have to look very far: Sears, Blockbuster, Nokia, Kodak, and the entire hotel, newspaper, and big box retail industries offer abundant examples of companies collapsing because of new, high speed innovations entering the market.
With the lens of valuation you can go back through the financial performance of companies that have gone extinct and start to see when and how the first cracks started to appear. You can then start to look for ‘look-alike’ cracks in your own company and industry. A financially modeled scenario is always more credible than a bold headline screaming ‘disruption is imminent.’ Damodoran, in his book ‘The Dark Side of Valuation’ goes into great detail about how to model a company that is transitioning from ‘maturity’ to ‘decline.’
‘So, what’s your trade, asshole?’
One company that is in decline is Deutsche Bank.
I believe that the slow decline of the once-great Deutsche Bank is not an anomaly - but a harbinger of the impending disruption of the entire industry of Big Finance. (I explained some of the reasons why in this article, ‘Why Fintech Falters In Big Finance.”) I believe Citi, HSBC, Morgan Stanley, Bank of America, Wells Fargo, JP Morgan, and Goldman Sachs will all eventually catch Deutsche-Bank Disease with different symptoms, mortality rates, and recoveries. Some of those banks will decline like Sears, others will persevere and rebound like Walmart. I’m currently writing my next book, Pinstripe to Punk, in which I explore the startups that I believe will do to Big Finance what Amazon did to Big Box Retail. I’m working through a valuation model to forecast how much might be lost by Big Banks and Gained by New Entrants. My current (imperfect) forecast is that Big Finance will decline by $864 billion over the next seven years.
And THAT is my trade, asshole.
