How to Think Like Benjamin Graham and Invest Like Warren Buffett

How to Think Like Benjamin Graham and Invest Like Warren Buffett
by Lawrence A. Cunningham

Chapter 6 - Apple Trees and Experience

If market price is the last thing an investor or manager should look
at in determining the value of a business or an ownership interest
in it, the first thing to consider is its fundamental economic characteristics.
There are so many approaches to appraising those fundamentals
that many people use the relatively lazy metric of market
price as a guideline in valuation, but that is a mistake. Of all the
approaches to appraising business value, just a few do virtually all
the hardwork, and those are the ones you need. A parable will
illustrate the basics, and the rest of this part will fill in the details.

Story of an Old man and his tree
Once there was a wise old man who owned an apple tree. It was a
fine tree, and with little care it produced a crop of apples each year
which he sold or $100. The man wanted to retire to a new climate,
and he decided to sell the tree.He placed an advertisement in the business
opportunities section of The Wall Street Journal to sell the tree for “the best offer.”

The first person to respond to the ad offered to pay $50, which, he
said, was what he could get for selling the apple tree for firewood
after he cut it down. “You don’t know what you are talking about,”
the old man chastised. “You are offering to pay only the salvage value
of this tree.You can’t see that my tree is worth far more than 50 bucks.


The next person who visited the old man offered to pay $100 for
the tree. “For that,” she opined, “is what I would be able to get for
selling this year’s crop of fruit, which is about to mature.” “You are
not as out of your depth as the first one,” responded the old man.
“At least you see that this tree has more value as a producer of apples
than it would as a source of firewood. But $100 is not the right price.
You are not considering the value of next year’s crop of apples or
that of the years after. Please take your $100 and go elsewhere.”


The third person to come along was a young man who had just
dropped out of business school. “I am going to sell apples on the
Internet,” he said. “I figure that the tree should live for at least
another 15 years. If I sell the apples for $100 a year, that will total
$1,500. I offer you $1,500 for your tree.” “Oh, no, dot-commer,” lamented the
man, “you’re even more ill informed about reality than
the others I’ve spoken with.” “Surely the $100 you would earn by selling the apples from the
tree 15 years from now cannot be worth $100 to you today. In fact,
if you placed$41.73 today in a bank account paying 6% interest,
compounded annually, that small sum would grow to $100 at the end
of 15 years. So the present value of $100 worth of apples 15 years
from now, assuming an interest rate of 6%, is only $41.73 not $100.
Pray,” advised the beneficent old man, “take your $1,500 and invest
it safely in high-grade corporate bonds and go back to business
school and learn something about finance.”

Before long there came a wealthy physician who said, “I don’t
know much about apple trees, but I know what I like. I’ll pay the
market price for it. The last fellow was willing to pay you $1,500 for
the tree, and so it must be worth that.” “Doctor,” advisedthe oldman, “you should get yourself a knowledgeable investment adviser. If there were truly a market in which
apple trees were traded with some regularity, the prices at which
they were sold might tell you something about their value. But not
only is there no such market, even if there were, taking its price as
the value is just mimicking the stupidity of that last knucklehead or
the others before him. Please take your money and buy a vacation
home.”


The next would-be buyer was an accounting student. When the
old man asked, “What price are you willing to give me?” the student
first demanded to see the old man’s books. The old man had kept
careful records and gladly brought them out.
After examining them, the accounting student said, “Your books
show that you paid$75 for this tree ten years ago. Furthermore, you
have made no deductions for depreciation. I do not know if that
conforms with generally accepted accounting principles, but assuming
that it does, the book value of your tree is $75. I will pay that.”
“Ah, you students know so much and yet so little,” chided the
old man. “It is true that the book value of my tree is $75, but any
fool can see that it is worth far more than that. You had best go back
to school and see if you can find a book that shows you how to use
your numbers to better effect.”

The final prospect to visit the old man was a young stockbroker who
had recently graduated from business school. Eager to test her new
skills, she too asked to examine the books. After several hours she
came back to the old man and said she was prepared to make an
offer that valued the tree on the basis of the capitalization of its
earnings. For the first time the old man’s interest was piqued, and
he asked her to go on.

The young woman explained that while the apples were sold for
$100 last year, that figure did not represent the profits realized from
the tree. There were expenses attendant to the tree, such as the cost
of fertilizer, pruning, tools, picking apples, and carting them to town
and selling them. Somebody had to do those things, and a portion of the salaries
paid to those persons ought to be charged against the revenues from
the tree. Moreover, the purchase price, or cost, of the tree was an
expense. A portion of the cost is taken into account each year of the
tree’s useful life. Finally, there were taxes. She concluded that the
profit from the tree was $50 last year.

“Wow!” The old man blushed. “I thought I made $100 off that
tree.”

“That’s because you failed to match expenses with revenues, in
accordance with generally accepted accounting principles,” she explained.
“You don’t actually have to write a check to be charged with
what accountants consider to be your expenses. For example, you
bought a station wagon some time ago and used it part of the time
to cart apples to market. The wagon will last a while, and each year
some of the original cost has to be matched against revenues. A
portion of the amount has to be spread out over the next several
years even though you expended it all at one time. Accountants call
that depreciation. I’ll bet you never figured that in your calculation
of profits.”

“I’ll bet you’re right,” he replied. “Tell me more.”
“I also went back into the books for a few years and saw that in
some years the tree produced fewer apples than it did in other years,
the prices varied, and the costs were not exactly the same each year.
Taking an average of only the last three years, I came up with a
figure of $45 as a fair sample of the tree’s earnings. But that is only
half of what we have to do to figure the value.”

“What’s the other half?” he asked.
“The tricky part,” she told him. “We now have to figure the value
to me of owning a tree that will produce average annual earnings of
$45 a year. If I believed that the tree was a ‘one-year wonder,’ I would
say 100% of its value—as a going business—was represented by one
year’s earnings.”

“But if we agree that the tree is more like a corporation in that
it will continue to produce earnings year after year, the key is to
figure out an appropriate rate of return. In other words, I will be
investing my capital in the tree, and I need to compute the value to
me of an investment that will produce $45 a year in income. We can
call that amount the capitalized value of the tree.”

“Do you have something in mind?” he asked.
“I’m getting there. If this tree produced entirely steady and predictable
earnings each year, it would be like a U.S. Treasury bond.
But its earnings are not guaranteed, so we have to take into account
risks and uncertainty . If the risk of its ruin was high, I would insist
that a single year’s earnings represent a higher percentage of the
value of the tree. After all, apples could become a glut on the market
one day and you would have to cut the price, thus increasing the
costs of selling them.”
“Or,” she continued, “some doctor could discover a link between
eating an apple a day and heart disease. A drought could cut the
yield of the tree. Or the tree could become diseased and die. These
are all risks. And we don’t even know whether the costs we are sure
to incur will be worth incurring.”
“You are a gloomy one,” reflected the old man. “There could also
be a shortage of apples on the market, and the price of apples could
rise. If you think about it, it is even possible that I have been selling
the apples at prices below what people would be willing to pay and
that you could raise the price without reducing your sales. Also,
there are treatments, you know, that could be applied to increase
the yield of the tree. This tree could help spawn a whole orchard.
Any of these would increase earnings.”

“The earnings also could be increased by lowering costs of the
sort you mentioned,” the old man continued. “Costs can be reduced
by speeding the time from fruition to sale, managing extensions of
credit better, and minimizing losses from bad apples. Cutting costs
boosts the relationship between overall sales and net earnings or, as
the financial types say, the tree’s profit margin. And that in turn
would boost the return on your investment.”

“I am aware of all that,” she assured him. “The fact is, we are
talking about risk. And investment analysis is a cold business. We
don’t know with certainty what’s going to happen. You want your
money now, and I’m supposed to live with the risk.
“That’s fine with me, but then I have to look through a cloudy
crystal ball, and not with 20/20 hindsight. And my resources are
limited. I have to choose between your tree and the strawberry patch
down the road. I cannot buy both, and the purchase of your tree
will deprive me of alternative investments. That means I have to
compare the opportunities and the risks.
“To determine a proper rate of return,” she continued, “I looked
at investment opportunities comparable to the apple tree, particularly
in the agribusiness industry, where these factors have been
taken into account. I then adjusted my findings based on how the
things we discussed worked out with your tree. Based on those judgments,
I figure that 20% is an appropriate rate of return for the tree.
“In other words,” she concluded, “assuming that the average
earnings from the tree over the last three years (which seems to be
a representative period) are indicative of the return I will receive, I
am prepared to pay a price for the tree that will give me a 20% return
on my investment. I am not willing to accept any lower rate of return
because I don’t have to; I can always buy the strawberry patch instead.
Now, to figure the price, we simply divide $45 of earnings per
year by the 20% return I am insisting on.”
“Long division was never my strong suit. Is there a simpler way
of doing the figuring?” he asked hopefully.

“There is,” she assured him. “We can use an approach we Wall
Street types prefer, called the price-earnings (or P/E) ratio. To compute
the ratio, just divide 100 by the rate of return we are seeking.
If I were willing to settle for an 8% return, that would be 100 divided
by 8, which equals 12.5. So we’d use a P/E ratio of 12.5 to 1. But
since I want to earn 20% on my investment, I divided 100 by 20 and
came up with a P/E ratio of 5:1. In other words, I am willing to pay
five times the tree’s estimated annual earnings. Multiplying $45 by
5, I get a value of $225. That’s my offer.”

The old man sat back and said he greatly appreciated the lesson.
He would have to think about her offer, and he asked if she could
come by the next day.


When the young woman returned, she found the old man emerging
from behind a sea of work sheets, small print columns of numbers,
and a calculator. “Delighted to see you,” he said, enthralled. “I think
we can do business.
“It’s easy to see how you Wall Street smarts make so much
money, buying people’s property for less than its true value. I think
I can get you to agree that my tree is worth more than you figured.”
“I’m open-minded,” she assured him.
“The $45 number you came up with yesterday was something
you called profits, or earnings that I earned in the past. I’m not so
sure it tells you anything that important.”
“Of course it does,” she protested. “Profits measure efficiency
and economic utility.”

“Fair enough,” he mused, “but it sure doesn’t tell you how much
money you’re getting. I looked in my safe yesterday after you left
and saw some stock certificates I own that never paid a dividend to
me. And I kept getting reports each year telling me how great the
earnings were. Now I know that the earnings increased the value of
my stocks, but without any dividends I couldn’t spend them. It’s just
the opposite with the tree. “You figured the earnings were lower because of some amounts
I’ll never have to spend, like depreciation on my station wagon,” the
old man went on. “It seems to me these earnings are an idea worked
up by the accountants.”

Intrigued, she asked, “What is important, then?”
“Cash,” he answered. “I’m talking about dollars you can spend,
save, or give to your children. This tree will go on for years yielding
revenues after costs. And it is the future, not the past, we need to
reckon with.”

“Don’t forget the risks,” she reminded him. “And the uncertainties.”
“Quite right,” he observed. “If we can agree on the possible range
of future revenues and costs and that earnings averaged around $45
the last few years, we can make some fair estimates of cash flow
over the coming five years: How about that there is a 25% chance
that cash flow will be $40, a 50% chance it will be $50, and a 25%
chance it will be $60? “That makes $50 our best guess if you average it out,” the old
man figured. “Then let’s just say that for ten years after that the
average will be $40. And that’s it. The tree doctor tells me it can’t
produce any longer than that.

“Now all we have to do,” he finished up, “is figure out what you
pay today to get $50 a year from now, two years from now, and so
on for the first five years until we figure what you would pay to get
$40 a year for each of the ten years after that. Then, throw in the
20 bucks we can get for firewood.
“Simple,” she confessed. “You want to discount to the present
value of future receipts including salvage value. Of course you need
to determine the rate at which you discount.”



“Precisely,” he concurred. “That’s what my charts and the calculator
are for.” She nodded as he showed her discount tables that
revealed what a dollar received at a later time is worth today under
different assumptions about the discount rate. It showed, for example,
that at an 8% discount rate, a dollar delivered a year from
now is worth $.93 today, simply because $.93 today, invested at 8%,
will produce $1 a year from now.


“You could put your money in a savings account that is insured
and receive 5% interest. But you could also buy U.S. Treasury obligations
with it and earn, say, 8% interest, depending on prevailing
interest rates. That looks like the risk-free rate of interest to me.
Anywhere else you put your money deprives you of the opportunity
to earn 8% risk-free. Discounting by 8% will only compensate you
for the time value of the money you invest in the tree rather than
in Treasuries. But the cash flow from the apple tree is not risk less,
sad to say, so we need to use a higher discount rate to compensate
you for the risk in your investment.

“Let’s agree to discount the receipt of $50 a year from now by
15%, and so on with the other deferred receipts. That is about the
rate that is applied to investments with this magnitude of risk. You
can check that out with my neighbor, who just sold his strawberry
patch yesterday. According to my figures, the present value of the
expected yearly profit is $268.05, and tod ay’s value of the firewood
is $2.44, for a grand total of $270.49. I’ll take $270 even. You can
see how much I’m allowing for risk because if I discounted the
stream at 8%, it would come to $388.60.”

After a few minutes of reflection, the young woman said to the
old man, “It was a bit foxy of you yesterday to let me appear to be
teaching you something. Where did you learn so much about finance
as an apple grower?” The old man smiled. “Wisdom comes from experience in many
fields.”

Computation

First Five years

50 50 50 50 50
At 3% Inflation Adjusted 50(.97) 50(.97)(.97) 50(.97)(.97)(.97) etc.
48 47 46 44 43
Inflation adjusted price when Discounted at 15% 48(1/1.15) 47(1/1.15)(1/1.15) etc
42 36 30 25 21

Next Ten Years (Don't take inflation just take discounted value of 15%)
40 40 ......40 for the tenth year it is actually worth $10
So roughly $100 for all these years

Roughly the total Value of cash-flows is 42+36+30+25+21+100 = $254

“Nice try, you crafty old devil,” she rejoined. “You know there is
plenty of room for mistakes in your calculations too. It’s easy to
discount cash flows when they are nice and steady, but that doesn’t
help you when you’ve got some lumpy expenses that do not recur.
For example, several years from now that tree will need serious pruning
and spraying that don’t show up in your flow. The labor and
chemicals for that once-only occasion throw off the evenness of your
calculations.”

“But I’ll tell you what,” she bellied up. “I’ll offer you $250. My
cold analysis tells me I’m overpaying, but I really like that tree. I
think the delight of sitting in its glorious shade must be worth something.”
“It’s a deal,” agreed the old man. “I never said I was looking for
the highest offer but only the best offer.”

Introduction to Statistics

Introduction to Statistics - Fall 2006.
09:30-11:00 AM | Auditorium Wheeler
Instructor Fletcher Ibser







Tue 10/10 Probability I

Venn Diagram = Rectangle and the probability of the whole is 1

P(B/A) = Probability of B Happening Given that A has Happened.
e.g. Chance that a die rolls a 6 given that it has rolled an even number = 1/3




Multiplication Rule

Generic Case
P(A and B) = P(A) . P(B/A)
e.g. A red die rolls a 6 and a blue die also rolls a 6.
Think of it as a proportion. A large number of people do this so 6 will happen to 1/6th number of people.
Then a 6 will happen to 1/6th of that 1/6th group.

Special Case
If A and B are independent then
P(A and B) = P(A) . P(B)


Addition Rule
P(A or B) = P(A) + P(B) - P(A and B)

Venn Diagram makes it clear
This of two circles A and B overlapping so you will have to remove the overlapping portion which is what subtracting the P(A and B) does.

Words of Wisdom - Quotes

"The Unexamined Life is Not Worth Living" - Socrates

"Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime" —Author unknown


I hear...I forget
I see...and I remember
I do...and I understand
Ancient Chinese Proverb


Pilani :- Gyanam Parmam Balam - Knowledge is Power

Berkeley :- Let there be Light

Stanford :- Die Luft der Freiheit weht - "Winds of Freedom are in the Air"

MIT :- Mens et manus - "Mind and hand"



By Bernard Baruch


You have to lose money in order to better yourself


most people view the market as the place where the miracle of great and quick riches can be performed with little effort


a man who observes the future and acts before it occurs


if you get all the facts, your judgment can be right; if you don't get all the facts, it can't be right


Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.



Market speculation is "no different than trying to be a successful doctor or lawyer....you simply must devote yourself full time to the study of your craft."



Self-reliance and "doing one's own thinking" is a must.


Most of the successful people I've known are the ones who do more listening than talking."




the stock market does not determine the health of the economy but "rather reflects it."




Having flexibility should not be underestimated.




"what we can try to do perhaps is to come to a better understanding of how to reduce the element of risk in whatever we undertake."





"better to have a few stocks and to watch them carefully."


good supply of cash on hand at all times in reserve is important




He liked to focus on "one thing at a time, perfect it, and do it well."







Same mistakes most investors make which are: 1) "they know too little about the company's management, earnings, prospects, and possibility for future growth," and 2) "they tend to trade beyond their financial capital capacity."


"Successful speculation requires staying on top of changes in industries and companies that either create new industries or improve on existing industries. The majority of your profits will come from these two.....




"Without control over your emotions, there is very little chance for profitable success in the stock market."



"Don't try to buy at the bottom and sell at the top. It can't be done except by liars."


"I made my money by selling too soon."



"Do not blame anybody for your mistakes and failures."


"Whatever failures I have known, whatever errors I have committed, whatever follies I have witnessed in private and public life have been the consequence of action without thought."



"follow what the market is currently doing as opposed to following what one might personally think the market should do."


Know your own failings, passions, and prejudices so you can separate them from what you see."



"The main purpose of the stock market is to make fools of as many men as possible."




He devoted lots of hours and effort to examining past trades to find out why he lost money.




"At times it is folly to hasten at other times, to delay. The wise do everything in its proper time." - Ovid







The market can stay irrational longer than you can stay solvent.

Successful investing is anticipating the anticipations of others.

It is better to be roughly right than precisely wrong.

When the facts change, I change my mind. What do you do, sir?


The difficulty lies, not in the new ideas, but in escaping from the old ones



You are neither right nor wrong because the crowd disagrees with you.You are right because your data and reasoning are right


Individuals who cannot master their emotions are ill-suited to profit from the investment process


Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble...to give way to hope, fear and greed


Warren Buffett, story from Benjamin Graham:
A story that was passed down from Ben Graham illustrates the lemminglike behavior of the crowd: "Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled—we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!” Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumor after all."

DRIP Plan

There's no need to do all that heavy accounting and itemizing. The IRS has at least a little common sense, and allows you to state "various" for the dates of acquisition, and report the sum total of the acquisition cost "basis" (although you still have to distinguish long term vs. short term holdings). See page 65 of Publication 550 ( http://www.irs.gov/pub/irs-pdf/p550.pdf) and the accompanying example.

So for anything held more than a year, all you have to come up with is the total of your purchase price (plus any reinvested dividends), which should be much easier to establish than all the individual purchases and dates. The reinvested dividends might be more painful to locate, but if you don't mind making an extra contribution to Uncle Sam, you can even choose to ignore those records -- you've presumably already paid taxes on the dividends; reporting them adds to your basis, lowering your current tax bill, so if you ignore them, you essentially pay taxes on the dividends twice -- but depending on the amount of the dividends and your situation, it might be less hassle.

Once upon a time it was expensive to buy stocks. Brokers charged retail commissions of several percent (really!) and charged extra fees on top of these for odd lots (less than 100 shares).

In the 70's there was a revolution wherein a new class of brokers called "discount brokers" appeared. These guys evolved and took over a huge chunk of the brokerage business.


DRIPs were created to get around the big broker commission problem -- a problem that no longer exists. Maybe in the 80's they were still useful to a significant fraction of the public. But now?

The discount brokers have lowered commissions until the commissions are so close to zero that they are hard to measure. Much smaller investors can now just buy stocks without resorting to DRIPs.

Stephen Hawking's Take on Black Holes

He gave us the big bang theory, he then realized that the birth of the star was Big Bang, so if we can look at the death of the star (black hole) we could get answers. Thus came the information paradox and Event Horizon
The Hawking Paradox
Part 2
Part 3
Part 4
Part 5

Susskind vs Hawking

Newton’s Laws of Stock Market Trading

Dr. Leonard Susskind's Course on Quantum Mechanics
Newton's First Law of Trading

“A Stock at rest tends to stay at rest and a Trending Stock tends to stay in trend unless acted upon by an equal and opposite reaction or an unbalanced force.”

If a stock is trending sideways, it tends to stay sideways until a powerful enough market force takes it out of its trend. If a stock is trending up or downwards, it will tend to stay moving up or downwards until drastic changes happen to the company or the market at large creating an “equal and opposite reaction”. We should therefore always trade in the direction of a trend and always be vigilant for signs of an ”equal and opposite reaction” or the “unbalanced force”.


Newton’s Second Law of Trading

“The acceleration of a stock as produced by a market consensus is directly proportional to the magnitude of that consensus, in the same direction as the consensus, and inversely proportional to the mass of the stock.”

This law teaches us that a stock moves up or down into a trend due to a force created by market consensus. How much a stock moves up or down that trend is determined by the magnitude of the market consensus and how “massive” a stock is. By “massive” we are talking about the price of a stock. The more expensive a stock is, the more well established the company has been and the lesser in percentage you will make out of the same move in absolute dollar versus a smaller, less massive stock.


Newton’s Third Law of Trading

"For every action, there is an equal and opposite reaction."

For every buying or selling, there must be an equal amount of buyers or sellers on the other side. The stock market is a zero sum game. For every buyer, there must be a seller and for every seller, there must be a buyer. The real question is, who is profiting from each of their buying and selling.


Links

Stock Dilution in a Startup

Let's say, for example, that you signed up to be COO of a startup company and the CEO founder offered you 5% of the company. The CEO says there's no funding in the bank yet, so you'll have to sign up for a low salary -- $50,000 per year.

But he assures you that he's had conversations with venture capitalists and there's a sense that if things go right, the company might one day sell for $100 million.

Hmmm, you think. 5% -- not bad. If we sell this thing for $100 million, I will walk away with $5 million.

WRONG!

Your math failed to take into account stock dilution. That's the effect the issuance of new equity shares has on the existing shareholders.

Let's go back to our example and see how stock dilution works in action.

You take the job and get 5% of the company.

Odds are you don't get it all at once -- it's probably subject to a vesting schedule and it might only be stock options -- but that's not really relevant to our equity dilution lesson.

How much is 5% of your pre-funding company worth?

Not much. In fact, until there's a funding round you don't really know what it's worth.

A funding round is important to entrepreneurs and their employees because it's a milestone that values the underlying stock of the company.

So, let's say that a year after you've been working as the COO of the company, you and the CEO are finally able to land a funding round.

The funders says they will give you $700,000 in capital for 35% of the company.

What exactly does that mean?

It means that the total valuation of the company after they put their money in will be equal to $700,000/.35, or $2,000,000.

In VC terminology, that's the post-money valuation. The pre-money valuation is therefore $1,300,000. That's the post-money valuation minus the value of the cash that is coming into the business as part of the funding round.

So, after the funding round, the valuation is $2,000,000 and you had 5% equity in the company, so now you're equity stake is worth $100,000, right?

WRONG!

Equity dilution knocks down your percentage stake in the business.

Here's how equity dilution works in this scenario.

Let's say there were 1,000,000 issued shares prior to the funding round. In order for the new investors to get a 35% equity stake, they need to be issued new shares.

How many shares?

It's a simple algebra problem. Let x be the number of new shares that need to be issued. The equation becomes:

x / (1,000,000 + x) = .35

Solving for x implies that 538,462 new shares must be issued to the investors.

The math says that it should be 538,461.5 but there's no such thing as half a share so we round up. Believe me, investors won't round down. If there's something on the table to be taken, they will likely grab it.

So, now the total number of shares in the company is 1,538,462. What your percentage equity stake in the company?

Well, you were allocated 5% of the 1,000,000 shares so you had 50,000 equity shares before the funding round.

After the funding round, you still have 50,000 shares.

So, now, your diluted equity stake in the company is 50,000/1,538,462, or 3.25%.

How much is it worth?

The answer is simply .0325 x $2,000,000. That's your percentage equity stake times the post-money valuation. As it turns out, your stake is worth $65,000, not $100,000 as you might have thought.

If the company were to sell for $100 million now, after the first round of venture funding is in the bank, you 3.25% stake would be worth $3.25 million, not the $5 million you thought you'd get before you learned about equity dilution.

Notice that there was an easier way to figure out your post-dilution equity stake. You gave away 35% of the company in the financing round, so your 5% was knocked down by a .65 dilution factor -- that's what you got to keep, in effect. So, 5% times .065 gives you the 3.25%. It's the same answer, but it's a quick way of calculating the effect of dilution on your equity stake.

Mind you, this is just your first round of dilution. If the company has to do a second round and gives away 40% of the company to new investors, then you've got to knock your 3.25% equity stake down by a .60 dilution factor. After that second round, your ownership stake will be down to 1.95%.

Is that good or bad? It depends.

If the post-money valuation on the second financing round is $1 billion, your stake is only worth $19,500,000. Not bad!

If the post-money valuation on the second round is $2,500,000, then your equity stake is only worth $40,950. Given the salary cut you took to get in on the action for this startup, this is a pretty miserable scenario.

Adding insult to injury is the fact that your equity stake's valuation is not real -- it's just a paper value. In a startup company there's usually no liquidity unless there's an exit event of some kind -- for example, maybe the company goes public or the company is sold to an acquiring company. At that time, you finally get to know what your stock is really worth.

What's the moral of the story?

Well, for starters, you can see that somebody who doesn't understand equity dilution is going to be overly optimistic about their likely take in a startup. They may be more willing to take a lower salary than they should be, or more willing to take a lower equity stake than they should be.

Now that you understand equity dilution, you won't make that mistake. You'll properly evaluate potential outcomes and likely funding scenarios and their dilutionary effect on your stake.

Based on your equity dilution analysis, we hope you'll make smart decisions. Good luck!

Courtesy

What is Lua?

Lua, an extension programming language (a language for extending applications). It supports procedural languages by using powerful data description facilities.

What does extension programming language mean?

There is increasing demand for customizable applications. As applications became more complex, customization with simple parameters became impossible: users now want to make configuration decisions at execution time; users also want to write macros and scripts to increase productivity. In response to these needs, there is an important trend nowadays to split complex systems in two parts: kernel and configuration.

The kernel implements the basic classes and objects of the system, and is usually written in a compiled, statically typed language, like C. The configuration part, usually written in an interpreted, flexible language, connects these classes and objects to give the final shape to the application.

Configuration languages come in several flavors, ranging from

a. simple languages for selecting preferences usually implemented as parameter lists in command lines or

b. as variable-value pairs read from configuration files (Windows .ini files, X11 resource files) or

c. as embedded languages, for extending applications with user defined functions based on primitives provided by the applications. Embedded languages can be quite powerful, being sometimes simplified variants of mainstream programming languages such as C.

Such configuration languages are also called extension languages, since they allow the extension of the basic kernel semantics with new, user defined capabilities. Lua is such a language.


What does powerful data description facilities mean?

Associative arrays are a powerful language construct for describing data used in an application.
Many algorithms are simplified to the point of triviality because the required data structures and algorithms for searching them are implicitly provided by the language.

Lua uses tabled for data description. Most typical data containers, like ordinary arrays, sets, bags, and symbol tables, can be directly implemented by tables.

Tables can also simulate records by simply using field names as indices. Lua supports this representation by providing a.name as syntactic sugar for a["name"].

Lua provides a number of interesting ways for creating a table. The simplest form is the expression {}, which returns a new empty table. A more descriptive way, which creates a table and initializes some fields, is shown below; the syntax is somewhat inspired in the BibTeX [13] database format:

      window1 = {x = 200, y = 300, foreground = "blue"}

This command creates a table, initializes its fields x, y, and foreground, and assigns it to the variable window1. Note that tables need not be homogeneous; they can simultaneously store values of all types.

A similar syntax can be used to create lists:

      colors = {"blue", "yellow", "red", "green", "black"}

This statement is equivalent to:

      colors = {}
     colors[1] = "blue";  colors[2] = "yellow"; colors[3] = "red"
     colors[4] = "green"; colors[5] = "black"

Sometimes, more powerful construction facilities are needed. Instead of trying to provide everything, Lua provides a simple constructor mechanism. Constructors are written name{...}, which is just syntactic sugar for name({...}). Thus, with a constructor, a table is created, initialized, and passed as parameter to a function. This function can do whatever initialization is needed, such as (dynamic) type checking, initialization of absent fields, and auxiliary data structures update, even in the host program. Typically, the constructor function is pre-defined, in C or in Lua, and often configuration users are not aware that the constructor is a function; they simply write something like:

      window1 = Window{ x = 200, y = 300, foreground = "blue" }

and think about ``windows'' and other high level abstractions. Thus, although Lua is dynamically typed, it provides user controlled type constructors.

Because constructors are expressions, they can be nested to describe more complex structures in a declarative style, as in the code below:

      d = dialog{
                hbox{
                     button{ label = "ok" },
                     button{ label = "cancel" }
                }
         }

What makes extension languages different?
They only work embedded in a host client, called the host program. Moreover, the host program can usually provide domain-specific extensions to customize the embedded language for its own purposes, typically by providing higher level abstractions. For this, an embedded language has both a syntax for its own programs and an application program interface (API) for communicating with hosts. Unlike simpler configuration languages, which are used to supply parameter values and sequences of actions to hosts, there is a two-way communication between embedded languages and host programs.

What are the requirements of extension languages?

• extension languages need good data description facilities, since they are frequently used as configuration languages;
• extension languages should have a clear and simple syntax, because their main users are not professional programmers;
• extension languages should be small, and have a small implementation. Otherwise, the cost of adding the library to an application may be too high;
• extension languages are not for writing large pieces of software, with hundreds of thousands lines. Therefore, mechanisms for supporting programming-in-the large, like static type checking, information hiding, and exception handling, are not essential;
• finally, extension languages should also be extensible. Unlike conventional languages, extension languages are used in a very high abstraction level, adequate for interfacing with users in quite diverse domains.

How does Lua become extensible?

In its design, the addition of many different features has been replaced by the creation of a few meta mechanisms that allow programmers to implement those features themselves. These meta mechanisms are: dynamic associative arrays, reflexive facilities, and fallbacks.

Dynamic associative arrays directly implement a multitude of data types, like ordinary arrays, records, sets, and bags. They also lever the data description power of the language, by means of constructors.

Reflexive facilities allow the creation of highly polymorphic parts. Persistence and multiple name spaces are examples of features not directly present in Lua, but that can be easily implemented in Lua itself using reflexive facilities.

Finally, although Lua has a fixed syntax, fallbacks can extend the meaning of many syntactical constructions. For instance, fallbacks can be used to implement different kinds of inheritance, a feature not present in Lua.

Where can we use Lua?
Currently, Lua is being extensively used in production for several tasks, including user configuration, general-purpose data-entry, description of user interfaces, storage of structured graphical metafiles, and generic attribute configuration for finite element meshes.

It took me 1 Hour and 10 mins to write this up on Nov 20th 2007 (9:30 am - 10:40 am). Just after bi-weekly HDK meeting.

More Information

KPP Seminars Attended

March 2006 The sun should never set on your investments - A primer on International investing

July 19th 2006 What it takes to stay ahead of the market

Oct 11th 2006 Happy New Year! – Stocks and Sectors that should shine in 2007

Nov 2006 Politics and profits - The Presidential Cycle

March 21 2007 Tough times ahead? - Prospering in a shaky market

June 21 2007 Back to the Basics - Improving your analytical skills

Free Courses Online

#1 UC Berkeley

Ranked as the #1 public school in the United States, Berkeley offers podcasts and webcasts of amazing professors lecturing. Each course has an RSS feed so you can track each new lecture. For printable assignments and notes you can check the professors homepage, which is usually given in the first lecture or google his name. Even though the notes, homework and tests are not directly printed in the berkeley website, as they are in MIT and other courseware sites, it's not a problem to find them. I personally tried to use it for John Wawrzynek's machine structures class and the nutrition courses.

Visit: Berkeley Webcasts
Visit: Berkeley RSS Feeds
Visit: UC Berkeley on Google Video

Getting The Most From Berkeley Webcasts

Berkeley Videos are in .rm format and real player can be a pain. It asks you to register real player, spawns on startup. Instead, download a free program called media player classic with the real alternative plugin. Media player classic is fully featured and much easier on the computers memory. The real alternative plugin download seems to come with an older version of media player classic, so updating media classic is optional.

Download: Real Alternative Plugin
Download: Media Player Classic For Windows XP/2000
Download: Media Player Classic For Windows 98/ME

#2 MIT Open Courseware

The Massachusetts Institute of Technology is ranked 7th nationally in the United States. Many of the courses do not have video lectures. Instead, they have notes in PDF format along with tests and homework.

Visit: MIT OpenCourseware Course Listings
Visit: MIT OpenCourseware Online Textbooks
Visit: MIT Courses With Video Lectures
Visit: MITWorld Public Videos
Visit: MIT Pocast: ZigZag

Getting the Most Out of MIT OCW

Since MIT OCW is heavily based on opening PDF files it's recommended you download FoxIt Reader, a freeware PDF reader that's many times faster than the bulky and slow adobe acrobat. Also Ghost Script in combination with GSView is able to read pdfs, and post scripts files.

Download: Foxit Reader

#3 Carnegie Mellon's Open Learning Initiative

Carnegie Mellon is a private research university ranked equal with Berkeley. Though registration is not required they have a registered user mode that allows you to keep track of your scores and progress. Currently 11 courses are offered. The courses are basically ebooks in a frame-based easy to use navigation system with an occasional powerful interactive Java Applet for practice and testing.

Visit: Carnegie Mellon OLI

#4 Utah State OpenCourseWare

Utah State has a very familiar structure as MIT OCW with large available course listing.

Visit: Utah State Course Listings

#5 Tufts OpenCourseWare

Tufts University in Massachusetts has a very familiar structure as MIT OCW with large available course listing.

Visit: Utah State Course Listings

#6 Openlearn

European site called Open University's OpenLearn supported by The William and Flora Hewlett Foundation. Contains many online course and a different style content management system. I was unable to find anything interactive or any streaming media, though it does have forums for each course. Appears to function mostly as a large educational ebook library.

Visit: OpenLearn

2 #7 JHSPH OCW

Johns Hopkins University Bloomberg School of Public Health offers health based lecture notes and assigments. You'll find the JHSPH OCW website uses the same familiar navigation structure as MIT OCW. The notes are formatted much more cleanly but I haven't seen exams, and their search bar seems to be broken.

Visit: JHSPH OCW Course Listings
Visit: Johns Hopkins University Podcasts

#8 Connexions

CNX.org is an open-content library of course materials developed by Rice University. It has a huge database of content which is very useful for people who know what they're looking for. It does have ebook style higher level courses courses you can choose from.

Visit: Connexions
Visit: Connexions Course List

#9 Sophia

Initiative is led by Foothill College which contains 8 free courses.

Visit: Sofia

#10 University of Washington Computer Science & Engineering

Contains posted lectures and classnotes. Some of the courses even contain video lectures.

http://www.cs.washington.edu/education/course-webs.html

Notre Dame OpenCourseware

Just found out about this one.

http://ocw.nd.edu/

Wikiversity

From the creators of wikipedia, Wikiversity describes itself as being a community seeking to create and use learning materials and activities. Wikibooks is also incredibly powerful already containing everything from a detailed guide to learning French to Organic Chemistry and Nanotechnology.

Visit: Wikiversity
Visit: Wikibooks

Archive.org Education

Contains 1354 educational resources at the time of posting.

Visit: Archive.org Education

Honorable Mention: Peoi.org

Visit: Peoi.org

Barnes and Nobles University

Free online courses given as long as you buy the required reading material. Unfortunately barnes and nobles university is now barnes and nobles book club.

More University Video Sites

http://globetrotter.berkeley.edu/conversations/
http://graduateschool.paristech.org/?langue=EN
http://www.researchchannel.org/prog/
http://mitworld.mit.edu/
http://www.princeton.edu/WebMedia/lectures/
http://ci.columbia.edu/ci/
http://www.law.duke.edu/webcast/index.html
http://www.hno.harvard.edu/multimedia/video_mm.html
http://www.law.georgetown.edu/sci/sls.html#Presentations
http://athome.harvard.edu/archive/archive.asp
http://www.ksg.harvard.edu/multimedia/videoarchive.html
http://www.law.harvard.edu/news/webcasts/
http://webcast.oii.ox.ac.uk/?view=Default
http://www.princeton.edu/WebMedia/lectures/
http://www.gsb.stanford.edu/news/audiovideo.html
http://shc.stanford.edu/events/archive.htm
http://www.oid.ucla.edu/Webcast/
http://www.yale.edu/yale300/democracy/mediatranscripts.htm
http://yaleglobal.yale.edu/video.jsp



http://freescienceonline.blogspot.com/
Jimmy Ruska
http://freevideolectures.com/

How to issue Shares to Partners

Why Do You Need a Partner?

If you are very bright, very tenacious, and financially well endowed, then you can start a company which you own in its entirety and in which you can hire a bright, capable, highly motivated and well-paid management team. However, if you do not fit this description entirely (I might add that, if you do not possess at least one of these attributes, you might want to re-think starting your own business), then you will likely have to bring "partners" into your company by giving them equity, i.e. some share ownership. Obviously, investors who bring money to fuel the growth of your company deserve some ownership. Similarly, key people who join you on your team, or who start the company with you, will want some form of ownership if they are making a valuable contribution for which they are not being fully paid in cash. Others who contribute their skills, experience, ideas, or other assets (such as intellectual property) may be given shares in your company in lieu of being paid in cash.

How do you deal in New Partners?

Valuation is the issue. What is the new partner's contribution worth in relation to the whole pie? At that moment in time, what is the company worth and how is that worth determined? Bringing in new shareholders always means "dilution" to the existing shareholders. If a new investor is to receive a 10% stake in the company, then a shareholder who previously held 40% of the equity, will now hold 36% (i.e. 90% of 40%). You never actually never give up your shares when new people are dealt in. You simply issue more shares (the same way governments print money). Issuing more shares is what causes the dilution. If you have 100 shares and you want to give someone 10%, you'd have to issue 11 new shares (11/111 x 100 = 10%, approximately).

Unless you are greatly concerned about control issues, each time you dilute you should be increasing your economic value. If you dilute your ownership from 40% to 36%, you still hold the same number of shares, but the per-share value should have increased. For example, if you entice Terry Mathews (of Newbridge and Mitel fame) to your board by paying him 10%, it is quite likely that your shares will double or triple in value (i.e. market value for sure and hopefully also intrinsic value because of strengthened leadership). If your 40% was worth $1 million, your resulting 36% may now be worth $3 million!

If you bring in a new VP of Marketing and give her 5% as a signing bonus, how do you know that her contribution will be worth 5%? How do you measure someone's reputation? Unless the person is well known or has a proven record, it may not be so easy. That's why vesting (described later) may be appropriate.

There is only one way to bring in new partners: carefully and with deliberation. A partner may be with you for life. It may be more difficult to terminate a business partnership than it is to obtain a marital divorce. So think about it!

Who Should Get What?

What percentage of the company should each partner in a new venture receive? This is a tough question for which there is no easy answer. In terms of percentage points, what's an idea (or invention or patent) worth? What's 5 years of low salary, sweat and intense commitment worth? What is experience and know-how worth? What's a buck worth? "Who should get what" is best determined by considering who brings what to the table.

Suppose Bill Gates said he'd serve on your Board or give you some help. What share of the company should he get? Just think about the value that his name would bring to your company! If a venture capitalist thought your company was worth $1 million without Gates, that value would increase several-fold with Gates' involvement. Yet, what has he "done" for you?

Often, company founders give little thought to this question. In many cases, the numbers are determined by what "feels good", i.e. gut-feeling. For example, in the case of a brand-new venture started from scratch by four engineers, the tendency might be to share equally in the new deal at 25% each. In the case of a single founder, that person may choose to keep 100% of the shares and build this venture through a "bootstrapping" process, in order to maintain total ownership and control by not dealing in other partners. It may be possible to defer dealing in new partners until some later time at which point the business has some inherent value thereby allowing the founder to maintain a substantial ownership position.

The answer to the question "who should get what" is, in principle, simple to answer: It depends on the relative contributions and commitments made to the company by the partners at that moment in time. Therefore, it is necessary to come up with a value for the company, expressed in either monetary terms or some other common denominator. It gets trickier when there are hard assets (cash, equipment) contributed by some parties and soft assets (intellectual property, know-how) contributed by others. Let's look at a some examples for illustration.

1. Professor Goldblum has developed a new product for decreasing the cost of automobile fuel consumption. He decides that in order to bring this innovation to market, he will need a business partner to help him with a business plan, and then manage and finance a new company formed to exploit this opportunity. He recruits Sam Brown, aged 45, who has a good record as a local entrepreneur. They agree that Sam will get 30% of the company for contributing his experience, contacts, and track record plus the fact that he will take a $50K/year salary instead of a "market" salary of $100K for the first two years. Furthermore, they agree that Sam will commit his full-time attention to the firm for 5 years and that should he leave, for whatever reason before the full term, he would forfeit 4% of the equity for each year under the 5 year term. The Professor takes 60% for contributing the intellectual property and for providing on-going technical advice and support. The Professor "gives" the University a token 10% because according to University policy, the University is entitled to "some share" of his intellectual property because of its contribution of facilities even though, under its policy, the intellectual property rights rest with the creator. Although these numbers are somewhat arbitrary, they are seen by the parties as being fair based on the relative contributions of the parties. As a taxpayer, one might suggest that the University got the short end of the deal, but that's a moot point.

2. Three freshly graduated software engineers decide to form a new software company which will develop and sell a suite of software development tools, bearing in mind the paucity of software talent plaguing the industry. They all start off with similar assets, i.e. knowledge of software, and comparable contributions of "sweat equity". Heidi takes on the role of CEO of the new venture and they divide the pie as to 40% for Heidi (because of her greater responsibilities) and 30% each for the other two. They are happy campers for now. Some time later, they decide to recruit a seasoned CEO with relevant experience and bring in a Venture Capital investor to fund the promotion of their then-developed and shipable suite of software products. They will then have to wrestle with the issue of what their company is now worth and how much ownership they will have to trade for these new resources. This will be determined by the venture capital suitor(s) in light of current market investment conditions and the attractiveness of this particular deal.

3. Four entrepreneurs who have recently enjoyed financial windfalls from their businesses, decide to get into the venture capital business. They decide to form a company with $10 million in investment capital. Harry provides $3 million, Bill provides $2 million, and the other two each provide $2.5 million. How much of the new company will each of them own? (This isn't a trick question.) For assets as basic as cash, it is easy to determine "fair" percentages.

In the case of the second example above, we have a situation in which a company is established and has some value by virtue of its products and potential sales in the market. The company's Board decides to bring in an experienced CEO (this also makes the venture capitalist happy) to develop the business to its next stage of growth. Although it may be possible to hire such a person and pay him/her an attractive salary, it probably makes more sense to bring in such a person as more of a partner than a hired hand. In this case a lower-than-market salary could be negotiated along with an equity stake. One way of doing this is to apply the difference between market rate and the actual salary over a period of time, say 5 years, to an equity position based on a company valuation acceptable to the founders. If a venture capital investment has been made or is being negotiated, this may set the stage for such a valuation. For example, Louise was earning $125,000 per year working as the CEO of an American company's Canadian operations. She agrees to work for $75,000 per year for 5 years. She is essentially contributing $250,000 up front (in the form of equity that does not have to be raised to hire her). If the company has been valued at $2 million, she ought to receive something in excess of 10% of the company. However, her shares would "vest" over 5 years meaning that each year she would receive one-fifth of the shares from "escrow". She would forfeit any shares not so released should she break her commitment or should her employment be terminated for cause. In this example, Louse's salary is really $125,000 per year but she is investing a portion of this in the company's equity (on a tax-advantaged basis, I might add!).

For more mature companies and especially for publicly-listed companies, it is possible to provide managers with incentive stock options as an additional incentive in the form of a reward if the company performs well and if the stock price reflects this performance. However, this is not the same as ownership and should be viewed as part of a salary package.

Important Point: Don't confuse equity (i.e. investment and ownership) with income (i.e. salary)!

Shares vs Percentage Points

Sometimes people will get hung up on percentage points. For example, if a new company is created which consists of many people, it may not be possible to divide that fixed 100% into 20 or 30 meaningful chunks of 10%. It just won't work. Some people may receive only 3% and may feel slighted by what appears to be an insignificant amount (although I sure would like to have had 1% of Microsoft when it got started). It's too bad that only 100 percentage points are available. However, there is no limit on the number of shares which can be issued. So, let's issue 10 million shares and give our 3% person 300,000 shares. We all know that someday these shares might be worth $5, $10, or $50! Work it out! It suddenly becomes more palatable.

So, how many shares should be issued? Small public companies usually have between 5 and 15 million shares outstanding. Larger public companies may have 100 million or more shares issued. Private companies, large or small, have fewer shares issued - anywhere from 1 to perhaps a few million. The number is not really important for private companies because these shares do not trade in a public market. When companies go public, i.e. list their shares for trading, there are often stock splits such that 5 or 10 new shares are traded for each existing share in order to give a company a "normal" number of shares and a "normal" price range.

The number of shares which you will issue when you first start out should be determined by how many partners you wish to have. If only a handful, then you could simply issue 100 shares with the percentage points being equivalent to the number of shares. It might make you and your partners feel better to increase this number by a few orders of magnitude. That's OK, too. If you have many partners, it helps to have many shares - even if only for psychological reasons.

Novice entrepreneurs may think, "Gee, it would be nice to own 5 million shares in a company." True, but it may cause complications if you have too high a number. For example, if you start with 10 million shares and then deal others in so that you end up with 15 million shares and then you decide to go public, resulting in over 20 million shares, this may be too large a number and you may have to do a roll-back or consolidation (see next paragraph).

Stock Splits and Stock Rollbacks

You have probably heard of a "stock split". This happens often with publicly traded companies when their share prices become "too high". Microsoft, for example, has split many times. That's why Bill has 270 million shares. Microsoft does this when the share price appears too expensive for the average investor. After all, who wants to pay $500 for one share? If you split 2 for 1, then the price per share would be $250, but if you split 5 for 1, the price per share would now be $100. When companies split their shares, they do so simply by exchanging new shares for old shares with all the shareholders.

Stock rollbacks or share consolidations as they are sometimes called are the reverse of stock splits - but with one notable difference. When a rollback is done, 1 new share is issued for 2 or 3 (or whatever the Board decides) old shares. However, the new shares are issued under a new corporate name meaning that the company must change its legal name. Often the change is minor, such as from Acme Corp to Acme Inc or from Acme Corp to Acme 2000 Corp. This is done so that the new shares are not as likely to be confused with old shares. This is not the case for splits, assuming that shareholders will want to trade in their old shares for new shares whereas in the case of consolidations shareholders will not be eager to trade their old for their new.

Why a rollback? If a share price is too low, the company may appear like a "penny stock" or nickle-and-dime outfit. So, if a stock is trading at $.10 per share a 1 for 10 rollback, will give the stock a more respectable dollar appearance. Also, if a smaller, more junior company has 500 million shares outstanding (which can happen), it may be better, for market reasons, to have a tigher "float" (i.e. number of issued shares trading on the market).

In terms of what is appropriate, here are some ballpark numbers to consider. Private companies, closely held (i.e. few shareholders) would have a small number of shares, regardless of their size. Private sompanies with a larger number of shareholders (say up to 50) could have a few thousand or even a few million shares issued. Small public companies (with annual sales below $10 million) such as those trading on a junior stock exchange, like Vancouver, would have between 5 and 10 million shares issued. Senior companies (with annual sales in excess of $100 million) such as those trading on Toronto, might have more than 50 million shares issued. The really mammoth corporations with sales in the billions of dollars will likely have more than 100 million shares issued. Microsoft has about 600 million shares issued as at March, 1997.

Implications of Ownership

Ownership means sharing risks and sharing rewards. It implies a certain degree of control (i.e. risk management) insofar as the shareholders appoint the management team and it implies a sharing in the value of the company - however measured (i.e. profits, the net worth, market value, etc). These are two distinctly different concepts. The astute entrepreneur might ask herself if she wants to be a wealthy, independent owner or if she wants to be a very busy manager! Most owners, especially founders appoint themselves as the senior managers. And, they have this right. But, I'd rather be rich than busy or poor. The most important aspect of share ownership is that as the value of the company increases, one's share of the value also increases. Bill Gates doesn't really have billions of dollars. What he has is a fraction (one-quarter, roughly) of a business worth many billions of dollars. Your risk is the investment you put in, other forgone opportunities, and possibly reputation (if the deal sours). But the reward may be unlimited. That's why equity is so attractive. It is not uncommon for a founder of a high tech venture to own a million shares (which cost him very little in the form of cash) and see these shares appreciate to a value of several million dollars in a relatively short time frame. There are literally thousands of examples of this - Gates being the most prominent one.

Ownership does not imply any additional obligations nor liabilities. Once an equity stake is purchased, or "vested", it belongs to the owner forever. It also entitles the owner to vote for the company's board of directors, its governing body. Depending on the relative shareholding, a shareholder may have very little control as in the case of a large public company or very substantial control as in the case of a small company in which he has more than 50% of the votes or in which he may have less than 50% of the votes, but still have great influence by virtue of a shareholders' agreement.

A very successful founder once said, "I'm not really very smart, but I sure do have a lot of smart people working for me!". This person understood the difference between ownership and management.

What's a Company Worth? (and When?)

How is value added to a business over a period of time? All companies start off being worth only the incorporation expense. As soon as people, money and assets are added or developed, a company will appreciate in value. If the management team comes up with a breakthrough technology, that may be worth millions of dollars! The development of products and customers adds value. The management team itself is worth something by virtue of its aggregate experience, skill, contacts, etc. Value is best measured in terms of potential, not in terms of historical earnings or financial track record - but in terms of future performance possibilities. Value increases both through internal actions and growth as well as through external contributions (e.g. cash and people) which facilitate such growth.

For founders and early investors, the upside potential is the greatest. In its early stages of development a company may be worth very little, especially to outsiders. All of the value may be dormant within the team - awaiting development. Those who contribute at this early stage deserve to enjoy enormous gains because they are the ones who are bold enough to take the initial risks. An "angel" investor who provides a University faculty member with a small amount of start-up funding, say $50,000 to prepare an invention for exploitation, may easily deserve 10 or 20% of that business. After a concept is more fully developed, this initial position may be viewed as a "steal", but then again, most such "steals" end up being worthless deals!

It is both unhealthy and unrealistic for an entrepreneur to begrudge the stake held by his or her early backers. Sometimes there is a tendency towards seller's remorse. For example, an entrepreneur who sells 20% of his firm for $50,000 may feel cheated one year hence when a serious investor is willing to pay $500,000 for 20%. This is flawed thinking. Without that intial $50,000, this company may never have survived its first year. In this illustration, the founder initially had 100%, then 80%, then ended up with 64%. The angel had 20%, then ended up with 16%. The rich investor ended up with 20% - at least until the next round at which time they will all again suffer a dilution. Ideally, as time marches on, the value of the company increases dramatically such that subsequent dilutions become less and less painful to existing stakeholders. Sometimes, when milestones are not achieved, the early investors and founders must swallow a bitter pill by enticing new investors with large equity positions with major dilutive consequences. But, that's business!

The value of a business is best ascertained by what an investor is willing to pay for it (i.e. its shares) or what a potential strategic acquisitor (i.e. an investor (or competitor) who wants to buy it for strategic business reasons) is willing to pay for it.

It is prudent management philosophy to always be thinking in terms of making a business attractive to such suitors by building a solid foundation and by nurturing and growing it. The business should always be in a condition to sell it.

Other Alternatives

Let's be creative. You don't always have to give up shares in your company if you can't pay cash. Also, it gets messy (from a corporate governance perspective) having too many, especially small, investors. You might be able to negotiate a deferred payment arrangement, possibly with interest. If you need to acquire a tangible asset, you can likely obtain bank or third-party financing. For soft assets like intellectual property, you could consider entering into a royalty arrangement, i.e. for every unit sold embodying said intellectual property, you pay a 5% royalty on sales to the provider of the asset. And remember, equity is expensive. Giving someone a 5% stake, means that that party owns 5% of your firm's net worth and profits forever! So, tread cautiously.

Summary

Dividing the pie is not easy. In the end, or to put it more correctly - in the beginning, it is important that all equity partners accept the deal. Each shareholder would like to own a bigger percentage - that only makes sense. But, unfortunately, all the "percents" have to add up to 100. That's why it's nice to be able to issue 10 million shares. It sounds a lot better to own 100,000 shares in the next hot software deal, than to only own a mere one percent!

At the time you sell some or all of your shares in the company, remember that it is dollars which you put into your bank account, not percentage points.

Link One

Link Two

CFA Institute Webcasts

Here is the Link

Private Equity in India

The top 20 private equity investors in the country have invested $5.4 billion over 551 deals in the past 15 years. Leading the pack are Warburg Pincus (80 deals worth $1.1 billion), ICICI Venture Funds (158 deals worth $542 million) and Carlyle (21 deals worth $510.8 million).

In terms of number of deals, India’s largest PE fund ICICI Venture has struck the highest number of deals, followed by Warburg Pincus, IL&FS Investment Managers and Intel Capital, according to data compiled by research outfit Thomson Financial.

This data do not, however, include the recent investments made by buyout fund Blackstone in Intelenet ($109 million), Eenadu group ($275 million), Nagarjuna Construction ($150 million) and Gokaldas Exports ($165 million). If these figures are added, it will put Blackstone among the top three PE investors in the country and take the cumulative investments by the top 20 PE majors to beyond $6 billion.

“The bulk of the PE deals in India have been struck in the last two to three years. Though number of deals struck by Indian funds has been higher, foreign funds have also become prolific and are cutting more deals now,” said Carlyle India MD Rajeev Gupta.

Among the foreign funds, Warburg Pincus was the first to start making investments in India and has struck the maximum deals. The fund bought stake in UTV Software Communications for $2.4 million in October 1996.

While Intel Capital and Actis made their first investments in India in 1998, Morgan Stanley’s first investment was in the year 1999. PE funds JP Morgan and Carlyle began investing in India during the tech-boom in 2000.

IDFC private equity, Actis, IL&FS Investment Managers, Citigroup Venture Capital, Singtel Ventures, Morgan Stanley Private Equity and ChrysCapital Management are the other funds in the top 10 by value of investments in India.

Though the period taken in the data has been the past 15 years, experts agree the bulk of PE investments in India were in two tranches — one during the internet boom when most investments were in tech-related companies and the other in the last two years due to the current economic boom.

Interestingly, the oldest recorded PE deal has been struck by ICICI Venture in October 1991. The fund bought stake in Hyderabad-based contract research and testing organisation Vimta Labs for $14,000.

“Though PE investments from foreign funds have been flowing into India for a decade with Warburg Pincus being the first to start investing, the current economic boom has witnessed unprecedented flows. There is still a lot of money chasing deals in India and all sectors look attractive,” said Mahesh Chhabria, director, growth capital, 3i India.

In the last two years, there has been a huge flow of private equity funding into India. Thomson Financial data say in 2006, Indian companies received PE funding worth $1.6 billion and during January-July 2007, $2.49 billion worth of PE investments have been made.

Experts say with many buyout funds and global PE majors looking to get more exposure in India, the average deal size for the industry as a whole has risen. “The deal size has risen in the last one to two years and will continue to rise and number of deals struck will also reduce,” said India head of a global PE fund.

What is Business Intelligence?

Business Intelligence is nothing but intelligence about business. Mainly it is related to the performance of your company. Intellectual information about your company's performance.

If a CEO wants to know about his company's performance for the past 3 years? BI can answer it.
If CMO wants to know which marketing strategy worked effectively? BI can answer it.
If Sales head wants to know which product sold with the best margin? BI can answer it.

What is practical about it?
The numbers..scorecards...dashboard...presentation...analytics...performance...

BI enables senior managers to take informed decisions..

http://www.b-eye-network.com/home

What causes Trade Deficits

Part One
Part Two

How a Country is Run?

Legislative branch

The United States Congress is the legislative branch of the federal government. It is bicameral, comprising the House of Representatives and the Senate.

Executive branch

The day-to-day enforcement and administration of federal laws is in the hands of the various federal executive departments, created by Congress to deal with specific areas of national and international affairs. The heads of the 15 departments, chosen by the President and approved with the "advice and consent" of the U.S. Senate, form a council of advisors generally known as the President's "Cabinet". In addition to departments, there are a number of staff organizations grouped into the Executive Office of the President. These include the White House staff, the National Security Council, the Office of Management and Budget, the Council of Economic Advisers, the Office of the U.S. Trade Representative, the Office of National Drug Control Policy and the Office of Science and Technology Policy.

There are also independent agencies such as the National Aeronautics and Space Administration, the Central Intelligence Agency, and the Environmental Protection Agency. In addition, there are government-owned corporations such as the Federal Deposit Insurance Corporation.

Judicial branch

Federal Judicial Branch
The highest court is the Supreme Court. Below the Supreme Court are the courts of appeals, and below them in turn are the district courts, which are the general trial courts for federal law.

State Juducial Branch

Separate from, but not entirely independent of, this federal court system are the individual court systems of each state, each dealing with its own laws and having its own judicial rules and procedures.

The supreme court of each state is the final authority on the interpretation of that state's laws and constitution. Here is a hierarchy for California State Supreme Court. The State supreme courts are well above the Superior Courts like the one for San Diego County


Constitution of California
Constitution of USA

Principles for a Good Life

1) The Bodybuilding Principle - You only grow and develop when you work against significant resistance, lifting more than you can comfortably handle. Hard workouts, then rest: a formula followed by all fine athletes.

2) The Process Principle - Work on doing things well and the outcomes take care of themselves. Focus on outcomes and you interfere with doing things well. Process goals spur improvement; outcome goals create pressure.

3) The Feedback Principle - Turning feedback about how you're doing into concrete goals for further work channels your development. Work without goals is like exploring without a map: you spend much time wandering aimlessly.

4) The Strengths Principle - You reach your greatest potential by making the most of your distinctive strengths, not by incrementally improving your weaknesses. What you're good at will fuel your greatest passion and stimulate your highest efforts.

5) Maslow's Principle - You cannot meet your higher level needs for success and fulfillment if your more basic needs go unmet. Achievement at work cannot substitute for love, security, and well-being, but the absence of these can interfere with achievement.

Traits of a trader

1) The Constant Desire to Improve - Continuing education, keeping up to date with what's happening in the areas.

2) The Ability to Press Their Advantage - The very successful traders keep their risk management, but don't hesitate to become more aggressive when they see opportunity. They remind me of boxers who, seeing opponents hurt, will go for the kill. The less successful traders seem to lack that killer instinct.

3) Emotional Resilience - A trade with an edge that doesn't go their way either tells them something important about the market, or it tells them something about their execution. Either way, it's a potential learning experience.

4) Creativity - They find edges in the most unlikely places.

Getting Started with Investing

I use WSJ Online and Barron’s online for information.



One of my first books I read on investment was by Andrew Tobias.. I liked it. Then I read Peter lynch’s books.. later they seemed too basic and I liked book’s on investment strategies.. One of the good one’s is “Automatic Millionaire”.. He writes about investing with a discipline.. Also, 4 pillars of investing is an interesting book. The book types that you can read are :

a) Books that explain how stock market works (4 Pillars of investing or Random Walk the wall street)

b) Books that explain how to invest is stock market (Automatic Millionaireor One up the wallStreet etc)

c) Books that explain how to evaluate Stocks ( Graham Dodd’s book “intelligent investor”)


These days you can listen to Podcasts as well. My favorite podcasts are again from WSJ and “The Displined Investor” (called TDI).. you can google them to get the links.


So in short here is my recommended ways to gain investment knowledge:

a) Read lots of books: Read above mentioned books .. also you can go to Barnes & Noble or Public library.. they have good books that you can look through. Couple of books would match your level and you can take off from there.

b) Read magazines: They give information in sensational way but you can get the underlying information. My favorites are Barron’s & Smart Money

c) Read Blogs: My favorite is Kirkreport.. I also browse a few at times..but I stick with this one

d) Browse through financial websites: I like Morningstar & barron’s online

e) Read journals: My favorite journal is “Financial Planning Journal”. It has academic information but does give some good information.. this is slightly advanced though

f) Listen to Podcasts: In Itunes you can get good reviews. Start with “The disciplined investor” podcast. It shows other links that are useful. I also get Kiplinger’s and Fidelity personal finance podcasts.

g) Watch TV: (yes TV J ) Jim Cramer’s Mad money is one way to learn. His theatrics apart, he does throw in some sagacious advice once a while. I like it.

h) Ask questions: In lists like this or in Morningstar discusson boards etc.


Once you have sufficient understanding, then you can make investment Plan. In that plan, you can decide how much to invest in different types of investments. I use below methods to evaluate types of investments

a) Morningstar.com evaluate mutual funds & some stocks

b) Value line to evaluate the stocks .

c) Your brokerage may provide research reports. I use Fidelity and they give good research reports from many companies. My favorites are Lehman, NDR & Argus. From Etrade I get “CSFB” research.



Once you evaluate the stocks/funds you can start investing in them.




A few things I read that I thought were particularly useful:

"The Small Investor" - Jim Gard
"The Only Investment Guide You'll Ever Need" - Andrew Tobias
"The Intelligent Investor" - Benjamin Graham
"The Essays of Warren Buffet: Lessons for Corporate America" by Lawrence Cunninghan. it is gem. personal opinion.




This is a great source for financial advice geared towards Indians:

http://www.r2iclubforums.com/clubvb/forumdisplay.php?f=3

13 Steps to investing foolishly
http://www.fool.com/school/13steps/13steps.htm

Cramer
http://www.youtube.com/watch?v=rOVXh4xM-Ww




Here are some I like:
Jim Rogers
John Templeton
James Grant
Warren Buffett
Mark Faber
Kurt Wulff

Most of these guys are not in the business of making stock recommendations, but when they have, they have been good 'uns. I look to these guys for "ideas", rather than instructions to buy. I'm happy to have many sources of ideas, because I can't look in every nook and cranny of the markets, and many of these guys' ideas would never come to my attention unless I they told me about 'em.

John Templeton seldom made specific stock recommendations. In his public appearances he usually simply explained his views that investing should be global and have a long term perspective. He sometimes gave his view of which countries stocks were overpriced etc. However he once recommended MACSX. About the same time Faber recommended MACSX and APB. I bought and both have worked out well for me. Whenever Templeton spoke I listened.

About 5 years ago story came out that Warren Buffet had made a large investment in PTR. I think he wrote about it in his annual letter to his shareholders. No doubt that PTR was a low priced oil stock (vs assets). Question was the risks of investing in a company run by the Chinese government. With Buffet's judgement that those risks were acceptable, I jumped in. Its up 454% since then, about 49%/year. Still cheap according to Wulff (see below). Buffett writes an annual letter to his shareholders that is worth reading www.berkshirehathaway.com Its purpose is to tell shareholders about things going on at the company, but there are always useful comments about the state of the economy, the markets, trends that look stupid to him, etc. Always very plain spoken.

James Grant publishes a very expensive newsletter, but he also writes a column in Forbes. www.grantspub.com About 30% of his columns identify a stock idea, as do about 30% of his newsletters. Usually a deep value idea or comparison.

Jim Rogers is investing in commodities these days. Says he's out of stocks except for short positions in real estate I think. See some of his past writings (blog like) on www.jimrogers.com . He hasn't published anything new there in last few years. The web site does have an up-to-date list of his speaking engagements, and some of them are webcast. Read his books too. "Investment Biker" and "Adventure Capitalist". These books are each about a trip (literally) around the world, where he explains the economic situation and investment climate he found in each country along the way. Learn how to bribe border guards and how to trade money on the black market. Someone once asked him what was different about these two trips. He said "Took each trip in a different decade, in a different vehicle, and with a different woman." He has a new book on investing in China due out in a few months. Used to be able to see him every Saturday morning on a roundtable on Fox network, but he's not there anymore. I think that's because he has moved to China. Hell, if I were that show I'd pull him in by satellite. He was the only reason I watched the show.

Mark Faber writes a very expensive newsletter, but you can read his thoughts and a list of recommended stock positions twice a year in Barron's experts roundtable. This is the guy who first got me interested in Thai stocks. www.gloomboomdoom.com

Kurt Wulff writes oil/gas stock analysis that he publishes to subscribers (institutions) and then puts them up on his web site for free public access after a short delay. www.mcdep.com All this guy does is evaluate the relative merits of oil/gas stocks by looking at their price vs reserves. Useful info tho! Updated every week.

Every writer fills some niche. That doesn't mean their ideas or advice are the full story, or even something you can use.