Friday, February 26, 2010

Don't Forget the Angels

To become a successful space entrepreneur, you need understand the process of securing funding. Most space business plans I have read lately start with funding from a rich Millionaire/Billionaire like Bezos, Branson, Bigelow, Musk, etc. Others assume Banks or venture capital firms will give them the cash they need. We need more entrepreneurs within the industry thinking about Business Angels. But what are business angels (BA’s) anyway?

As legend has it, before venture capital emerged as an industry, wealthy men met for lunch at the club at Harvard, MIT, Princeton, Cambridge and perhaps at the diner in your home town, inviting the local entrepreneurs to speak to their group. After the pitch, the entrepreneur would then be asked to step out of the room as these groups of high net worth individuals discussed whether to invest and if so how much. The term “Angel” was first used in the early 1900’s to describe the wealthy backers of Broadway shows, making speculative (“risky”) investments in these Broadway productions. We will define Business Angels (BA) as high net-worth individuals with significant potential to invest in private equity (PE) firms.

The takeaway from the above table is not the exact amount (since that varies by individual), instead note that Business Angels play a key role bridging the gulf between F&F and VC's.  As these Angel investment groups grew more sophisticated, some Angels hired professionals to manage their risk capital fund for them. The Venture Capital Industry grew out of the formalization of such an arrangement. Business Angels as a group invest almost as much as VC’s each year ($26B in 2007 vs. $30B for VC') but spread those investments over fourteen times as many companies (57,000 companies vs. 4,000 companies).

Contrary to popular lore, BA’s are not just interested in giving money away. BA’s investment portfolio is largely (over 90%) focused in stocks/bonds/real estate with only a small portion of their portfolio available to invest in risk capital like early stage private equity firms. BA’s usually invest in the early funding rounds. Every company was a startup at first: Google, Starbucks, Berkshire Hathaway (Warren Buffet’s company), and many other household names were initially funded by these wealthy individuals. Even Bill Gates received $280K from a business angel 30 years ago.

Over time, some Business Angels banded together, pooling their money to make larger investments. The management of these funds was gradually turned over to professional risk capital managers. Funds were established with different hurdle rates. Hurdle rates are the average financial return the fund was targeting to out-perform. Some closed Funds were established with a target exit date 10-15 years after the funds creation. Ever-Green Funds act more like a corporation with no pre-defined maturity date. Over time, Venture Capital began to be recognized as its own asset class entering the mainstream of public investing (the NASDAQ stock exchange helped with this too – more exit opportunities through IPO for many of the young startups that VCs have historically been interested in funding). For the first time, venture capital funds attracted institutional investors. This change increased the amount of money available to those creating new funds but reduced the tolerance for the high risk investments the sector had been known for. These new institutional investors demanded predictable results. Raising a new VC fund quickly meant recruiting a fund manager who had proven he could achieve returns in excess of that particular fund’s hurdle rate. Although performance above the hurdle rate is not significantly rewarded, performance below the hurdle rate is severely punished. As a result, more and more VC funds look to invest in the later rounds of funding where the risk is less.

VC funds usually have a more structured process for due diligence than the average BA. Statistics indicate the average VC evaluates 500-1,000 business plans annually but invests in only two to five PE’s per year.  Both BA’s and VC’s are interested in growing the Private Equity firms they invest in. They do this in at least three ways:
  1. Money – the cash
  2. Knowledge/Wisdom – many of the BA/VC’s are past entrepreneurs themselves
  3. Connections – these guys and gals share their relationships, connecting the entrepreneurs with key people they need to know.
Here is a great quote from Ron Conway, Super Angel investor in Google, Digg, and Twitter. Conway speaks about how he can help a company (more than just with his money) and why he is okay with owning a little slice of a big pie rather than a big slice of a little pie:

“If I invest in a company I open my Rolodex for them. I help them with business development introductions. I introduce employees. I give them credibility in the fund raising process. Let’s say the company was worth $1 million when I met them and I’ve helped them with both my Rolodex and my cash and they can now raise a round of venture capital at a valuation of $6 million. I would be hurting my own interests. A $500,000 investment at a 30% discount to a $6 million round is still priced and more than $4 million and is certainly worth much less than my investing at a $1 million pre-money where I could own 33% of the company.”
Do date, NewSpace companies have largely not looked appealing to these groups of investors. Here is a few reasons as to why:

The point of the above table is that you can create an Internet startup and bring your product to market for a only a few million dollars (or less).  NewSpace companies need more cash and will take longer to bring products to market delaying liquidity events (selling the company, IPO, merger, etc.).  As more suborbital firms start flying and as Bigelow and Musk reach higher and higher, interest will grow from Angels and VCs, but to become the darling of BA/VC’s, the industry may need to make some changes as it grows to look and behave more like a high-tech startup rather than an early state pharmaeceutical developer or computer chip designer (long R&D, huge cash needs, long product cycles, etc.). I will devote a full post to this topic of some practical things we can do make NewSpace more attractive to BA's and VC's. 

Here is a few definitions you should know (DISCLAIMER: super simplified definitions – there is way more nuance in is some cases then I include. Google for the details):

Pre-Money Valuation: The value of the company prior to an IPO. The general intent of both the entrepreneur and the investor is that the pre-money valuation of the company grows with each new funding round hopefully commensurate with the reduction of risk as the company accomplishes more of its business plan startup checklist. The growth in valuation from one funding round to another offsets some of the loss due to share dilution.

Investment Funding Rounds: Companies requiring significant cash to reach an exit (e.g. IPO/Sale), break the PE’s cash requirements down into the cash needed to reach the next company milestone (e.g. passing PDR, passing CDR, I&T, first product delivery, etc.). In the U.S., these funding rounds are typically referred to as rounds A, B, C, D, etc. with the share price increasing with each new funding round. Adroit VC’s will often time their investments in a PE immediately prior to the issuance of a new funding round, increasing their share price with the next round’s increased valuation. Since young space entrepreneurs will most likely have large cash requirements, they should anticipate requiring multiple funding rounds. They have enough to start but will need subsequent rounds to take them to the next milestone.

Dilution: The quote from Conway above hinted at how dilution affected him. Business Angels, especially, risk dilution of their ownership percentage if their PE requires more than one funding round and the BA is not able to make subsequent investments in those rounds to hold their percentage ownership. This loss of company ownership due to additional funding rounds is referred to as Dilution. The hope is the increase in pre-money valuation from one round to the next can partially offset this dilution.

Hurdle Rate: although mentioned before, it is worth repeating. VC fund managers are targeting a financial return above their hurdle rate. If the stock market doubles in 5 years, that is a 15% annual growth rate on investments. Target Internal Rate of Return (IRR) for BA’s and VC’s are between 30% and 100% per PE knowing that about quarter will end in bankruptcy. Thus most hurdle rates are between 20-40%.

Since Business Angels fill such an important gap between Friends and Family and venture capital, let’s spend a minute thinking about what could be done to increase the number of BA’s in general and increase their interest in making space investments:

  • Make it easy for individual BA’s to associate with other BA’s joining BA investment groups.
  • Make it easy for BA’s to quickly evaluate opportunities
  • Help BA’s by performing due diligence on their behalf. One idea would be for Business Incubators to expand their services to include business plan due diligence on behalf of BA groups – even due diligence for those PE business plans not currently represented by the incubator. In general, greater collaboration between BA groups and Business Incubators should encouraged and expanded. 
  • Each of these first three ideas are starting to coalesce at Angelsoft. Angelsoft is an electronic way to:
    • Organize BA investors
    • Organize entrepreneurs and their submissions (same formats across entrepreneurs)
    • Track results across all BA groups
    • 500 BA groups signed up to date
    • 1000’s of business plans submitted.
    • Not currently optimized for NewSpace but I have some ideas on this.
    • I will do a full post on Angel Soft soon with more details
  • Removal of Capital gains taxes on investment profits of this type.  If small business is the growth engine of the economy, then let’s get some more of it.
  • We need the NewSpace version of this
I would love to hear your ideas.  Add a comment.

Thursday, February 25, 2010

The Space Show's Classroom Series

David Livingston over at The Space Show is offering a wonderful space primer called The Space Show Classroom.  Dr. Livingston teaches graduate Space Studies courses at UND and has joined forces with Dr. John Jurist (Physicist and blogger) and Dr. Jim Logan (NASA, Life Sciences, Space Medicine) to create the Space Show Classroom series.  20+ audio sessions (1.5-2 hours each) providing a significant overview of rockets, space business, and the challenges of developing the frontier.  In addition to each audio program, you will find course materials at Space Show Classroom Blog.

The series is still new. David is planning to mix in these programs in with the other Space Show content, about two per month.

So far, he has tackled:
  1. An Introduction (you could probably skip this one and read the syllabus.)  His main point in this episode: the Classroom series would be more structured and on-topic than a typical program - structured similar to a graduate level course.
  2. The Rocket Equation - Paul Breed as guest.  Go to this post of mine and play with the rocket equation spreadsheet if you are new the Rocket Equation.  Then listen to this Space Show.  The team does a GREAT job explaining.  The course material on the blog is also helpful!
  3. Flight Dynamics - NASA's Dan Adamo as guest. 
I will try to listen to each one as they are available and will post comments germane to space business on this site.  But I highly encourage you all to get smart...even on this engineering stuff!

Thursday, February 18, 2010

Fred Wilson, a New York City venture capitalist over at A VC is at it again.  This week's finance topic is on Compound Interest.  I think the real value of these posts is the rich comment section.  Each of Fred's MBA Monday posts has over 100 comments each...they are well worth reading.  also, if you have not read his other MBA Monday posts, probably worth reading from the beginning.  They do build on each other.
  1. Return on Investment
  2. Present Value of Cash Flows
  3. Time Value of Money
And as a teaser...Fred's venture capital focus inspired me.  In a coming post, I plan to lay out the differences between Angel Investing, Venture Capital and its implications to NewSpace.  I admit, the research for this post has changed some of my assumptions.  Yay for new learning.  Stay tuned.

Saturday, February 13, 2010

Suborbital Cargo Agent

With the Next-Generation Suborbital Researchers Conference (NSRC) next week in Boulder, CO, I wanted to share an idea for a “near-term”, “low-cost”, suborbital business venture.  The graph below shows price points for suborbital research payloads.  To achieve these price points while still offering a healthy profit for the business owner, demand needs to grow.  Here is a business concept that may both make money and grow demand. Let me explain...

The Problem: Suborbital companies are not prepared for customers – they don’t know retail. This is not an oversight on the part of these young companies. Launch operators have spent the last five years designing, building, and testing launch vehicles, why would they needed retail experience?  But with paying customers around the corner...this problem has to be solved.
  • Suborbital firms launching people are solving this problem by hiring travel agencies to interface with customers and coordinate sales activities.
  • Suborbital firms launching cargo have yet to solve this problem. Using existing travel agents will probably not be effective as the cargo customer base is focused on scientific research instead of human entertainment. Developing the sales/customer service talent in house is a possible solution, and although not fully avoidable, would be expensive and distracting from the firms' focus of flying rockets.
The Solution: Firms launching cargo need their own class of travel agent, their own outsourceable sales force – a Suborbital Cargo Agent (SCA). This agent would:
  • Interface with the customers, 
  • Integrate experiments into flight racks, and
  • Deliver integrated flight racks to launch operators for flight. 
  • After flight, the SCA would deliver payloads and data back to each customer.
Benefits to Customers:
  • One customer-focused interface to address all questions and coordinate payload, launch logistics, flight payment, etc.
  • More flight opportunities – by the SCA signing agreements with multiple launch operators, a crash, delay, or full manifest from one launch operator, would not delay flights as cargo could be switched to alternate providers as needed
  • Perhaps lower cost if the SCA could leverage her buying power when purchasing flights from the launch operator.  These savings could be passed on to the customer.
Benefits to Launch Providers:
  • Allow launch operators to focus on their core competency – launch operations. Outsourcing Sales and Customer service responsibilities and the associated costs both in time and money. Even if the operator chooses to develop a sales force of their own, an SCA would still allow an operator to increase demand at a lower cost.
  • Increase flight rates. Since the variable cost for a suborbital flight is low, the key to success for an operator will be high flight rates.
I was intrigued as I considered the possibilities for a venture that addresses this need. My next step was to do a little primary research. I talked to three groups: University professors from Cal Poly, MIT, and St. Louis University currently active in either university satellite development or active in space research of some kind, Contacts at NASA’s Commercial Reuseable Suborbital Research (CRuSR) program, and contacts at the Suborbital Applications Research Group (SARG) . Here is a brief summary of their comments about research payloads:
  • Low Cost: current CubeSat-sized payloads cost a university $50-100K to orbit. This is too much for most college programs which is why you see many universities unable to sustain a program of launching even cubesat-sized payloads. Although a market will continue for orbital payloads, universities would welcome a cheaper alternative that would bring the cost down while offering many of the same benefits to a university Aerospace engineering department. A preferred price point would be under $20K since that would allow many universities to include the launch price in Govt grants and research applications.
  • Frequent Launch Opportunities: according to one professor, his current wait time to launch a cubesat-sized payload 7 years. The students who developed that payload will have graduated many years before this payload ever flies.
  • Inter-departmental Cooperation: To date, most university work on satellite and related Aerospace projects have originated from the Aerospace engineering department (or Physics department if a university lacks an Aerospace engineering department). For universities to gain maximum value from suborbital research programs, they would need to develop cross-disciplinary teams. Aerospace Engineering, Physics, and other disciplines (Biology, Medicine, etc.) would need to work together for the benefit of all departments. The professors admit this level of ongoing collaboration is not regularly seen between university departments and may be a challenge to maintain.
  • Payload standardization in the form of CubeSats have been a great benefit to university engineering programs. The university participants would benefit from a similar standard for suborbital research.
  • Multiple Sizes: The CubeSat size is too small for some larger experiments.  Multiple sizes would be welcome.
  • Two forms of experimentation: Manned and Unmanned. Some research programs can be conducted remotely. This is great news for universities wanting the value of such a hands-on program at low cost since automated experiments avoid the weight and volume human tended experiments take up. But manned experiments will play a leading role as well for those focused on life sciences research or whose larger experiments cannot currently be automated. The professors I spoke with saw both types of experiments flourishing on suborbital vehicles.
  • Advocates. The industry is new (heck, we are not even flying to 100km yet), but SARG’s Dr. Alan Stern estimates an “imminent” market of 1000 missions per year. Whether such a large market estimate is hyperbole for the sake of the sound-bite or an actual belief is up for debate. But such a claim is an interesting nugget of how bullish some are about suborbital opportunities.
  • Suborbital experiments are a gateway to orbital experiments. Researchers may test their hardware and gain experience in suborbit and graduate to orbital efforts when the time is right.  Offering such a tier of services (suborbital and orbital) should grow both markets.
I have also been in contact with Jeffrey Manber and NanoRacks after I read of their plan to build a business transporting cubesat-sized standard experiments to the ISS. NanoRacks has developed a standard rack that plugs into an MDL on station. NanoRacks worked with Bob Twiggs (co-creater of the CubeSat) from Kentucky Aerospace to build a standard experiment module called the CubeLab. Still 10cm-cubed, and plugs into their rack via a standard USB port. Very plug-and play! I like this. NanoRacks and Kentucky Space intend to offer this CubeLab technology as open-source for the benefit of the industry. One important nugget: the CubeSat has already passed significant ITAR hurdles, and since the CubeLab is based on similar technology to the CubeSat, a business using this open-source technology should have a significantly easier time attracting and working with international customers.  NanoRacks goal is to offer Micro-gravity research opportunitis on the ISS, but I think the technology ports very well into the suborbital arena as well.

So with this background research, let’s build a business case ( or at least the fun spreadsheet stuff). Here is what I have in mind for such a venture:
  • Focus exclusively on the automated cargo market. 
  • Fly only CubeLabs.
  • Work with Kentucky Space to develop a series of standard CubeLab sizes:
    • CubeLab1: current 10x10x10cm bus (16 per rack)
    • CubeLab4: 20x20x20cm bus (4 per rack)
    • CubeLab8: 20x20x40cm bus (2 per rack)
    • All compatible with the current NanoRack rack design
  • Negotiate low costs per flights and preferred provider status from the available suborbital launch operators
  • Consider partnering with Kentucky Space for integration services.
Provide the following services to customers:
  • Educate: Suborbital Research Evangelist - how suborbital research can benefit you, the customer
  • Book Flights
  • Ongoing rebooking as schedules of experiments and launch vehicles slip
  • Payload integration coordination
  • Integrated Rack delivery to launch provider (two to sixteen experiments integrated into one "ready-to-launch rack" making it easy for launch operators to load the rack onboard their rockets)
  • Payload return to customer
  • Launch data download from rack to secure Internet site for customer
So now the numbers. I have prepared two extreme pro formas: one optimistic view of launch prices and market demand and one more pessimistic view. And let me admit this right now, I have NOT done my due diligence on these figures. Instead these are meant to establish the trade space and start the discussion. Feel free to download these spreadsheets adjusting the inputs as desired.



Price Point Backup Data (from the graph at the start of this post):

Monday, February 8, 2010

Net Present Value & Time Value of Money

Each Monday, our Venture Capitalist friend, Fred Wilson, over at tackles an important term from business school. To get us caught up, I will post the first two MBA Monday posts below:

  • The Present Value of Future Cash Flows: A business is worth all of the cash that business will ever generate discounted by the fact the business has not generated the cash yet (it is still in the future). In a spreadsheet, use the formula NPV.
  • Time Value of Money: Money you have is worth more than money you will earn in the future. Thus, earnings in the future are discounted to account for the risk and delay.

Thursday, February 4, 2010

The Rocket Equation

Although this is essentially a business blog, some basic engineering knowledge will be required to evaluate potential space business concepts. The rocket equation is one such concept which must be understood. This interactive spreadsheet should give you better idea about how the rocket equation works. The spreadsheet should also give you the formulas which you can use in your own calculations. I have included multiple versions of the rocket equation, solving for: specific impulse, dry mass, propellant, and delta-v. In layman's terms, here is a brief definition of each rocket equation components:
  • Specific Impulse (Isp): The efficiency of the engine. The higher the value, the greater the efficiency. Measured in seconds.
  • Dry Mass: The mass of the spacecraft. Measured in kilograms.
  • Propellant: The mass of the propellant. Measured in kilograms.
  • Delta-V: The standard unit of measure for the cost of movement in space. The higher the maximum delta-v for a spacecraft, the more movement that spacecraft can perform. You are out of gas if you run out of delta-v.
  • Gravity: Constant for LEO/GEO.

Tuesday, February 2, 2010

MBA Mondays - ROI vs. IRR

Fred Wilson, Venture Capitalist over at is starting a great series on Business School lessons for those new to business terminology.  He got the inspiration for the series from the comments he got on this post about the difference between Return on Investment (ROI) and Internal Rate of Return (IRR). 

I am reminded of David M. Livingston's 1998 paper, "The Business of Commercializing Space."  In the paper, David survey's 600 venture capital firms asking them about about their expectations when completing an investment.  This quote from David's paper should give you an idea of the kind of IRR these VC's are looking for:
"Ten to one returns as a minimum; Returns ranging from >30% to >100% IRR; Greater than 30% IRR; Time period of 3-6 years needed; Hundreds of times the return of a normal business."
What I love from Fred's lesson on IRR - Fred actually imbeds his spreadsheets (complete with formulas).  I firmly believe you understand the concept better after you have built the formulas.  I am considering doing the same spreadsheet imbedding for some of my upcoming posts.  Great idea Fred!

Monday, February 1, 2010

A Free-Market NASA Budget?

America has always performed best when promoting free markets and competition. President Obama's new direction for NASA holds the potential to transform our space agency from supplier to customer and significant market potential for our nation's brightest entrepreneurs and engineers. The budget changes include:
  • Dropping Orion and Constellation (no more "near-term" manned moon focus)
  • Keep ISS supported through 2020
  • Extra $6B over five years
  • Transition to Commercial LEO services (NASA now a customer instead of a supplier)
  • Dollars for Robotic exploration
  • Dollars for Technology demonstration to raise TRLs of some near-term technologies like automated rendezvous and docking and depots (for a crash course on depots – check out Jon Goff’s work – search depots on his blog)
  • Dollars for basic research for some more long-term technologies.
Doug Messier has a nice summary of the proposed NASA budget over at Parabolic Arc. Let the Congressional battles begin!  And here is a fun quote from earlier today by NASA Administrator, Charles Bolden:

"Today we are launching a bold and ambitious new space initiative to enable us to explore new worlds, develop more innovative technologies, foster new industries, increase our understanding of the earth, expand our presence in the solar system, and inspire the next-generation of explorers..."