You think you have found the ideal partner. You want to know if this is the right partner before you invest too much time, money, and other resources in the alliance. You have assembled the partnering team. You are ready to try the initial activity. Review the steps and tools in previous articles for starting the initial activity. You can build quality into the process by using the Plan–Do–Check–Act cycle. This can be accomplished by listing the tasks that need to occur in the Initiate stage below each step of the cycle. On the following pages are examples of what to do in each step. You may want to use these examples as is or modify them to meet your particular objectives. Either way, the process will help you accomplish the task in less time and with greater efficiency and higher quality.
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If none of these resources will work for you there is one final option. If you have valuables such as jewelry, antiques or stocks that are not a part of your retirement portfolio, and you are willing to part with them in order to fund your invention, you can sell them. We would only recommend this course of action if you have no other. Exhaust all other possibilities before selling off your valuables.
You can see that while there is funding available for Shoestring Budget™ inventors, there is no magic panacea. It is, instead, a common sense approach to creative ways to fund your invention. You can help to make up for limited funds by careful planning and cautious use of your limited resources.
Another potential professional partner is your prototype designer. Again, like the patent attorney and patent agent, this is something that is suggested to prototype designers with some regularity. Unless your invention is that one-in-a-million idea, your prototyper would probably prefer to be paid in money than to bet on the success of your invention.
Almost any professional whose services you will use in the development and marketing of your invention has the possibility of becoming a professional partner. If you choose to pursue this avenue, be cautious not to sign on too many professional partners. This is another area where you could find yourself in the position of becoming a minority investor/owner of your own invention.
In a growing economy, equity can still be threatened. Home equity does not deserve the same confidence as FDIC insured CDs. Neighborhoods can change, hurting home values. Residential neighborhoods become commercial, family neighborhoods get drug infested, single family homes are cut up and become multifamily units eliminating all the parking and reducing values. Soon there will be a massive exodus from family neighborhoods as baby boomers retire and move to retirement communities. Interest rate changes also threaten home equity. Higher mortgage rates make homes less affordable, which hurts home values. When homeowners hear or read about the Federal Reserve, most wonder how this will affect the value of their home. Higher real estate taxes also hurt home values.
Home equity is often disappointing as a savings vehicle. It lacks the utility of other savings systems. Unmanageability is a common occurrence. Just when you need your savings the most, home equity is likely to fail you. Laid-off workers often find they cannot tap their home equity with a second mortgage or refinance because they have no income to support higher mortgage payments. Retirees are often disappointed to find that the sale of their home after Realtor commissions and expenses leaves a much smaller nest egg than hoped for. Reverse mortgages often produce insufficient income for retiree living expenses. Savers relying on home equity must be prepared for sadness and grieving if their retirement plans are unreachable.
Though there are emotional quirks with true saving instruments, the frequency of trauma is low. Saving instruments are for investors who value predictability and are not troubled by jealousy, resentment, or regret when other investments produce spectacular returns and make headlines. Longterm returns on savings instruments are lower than for other investment classes. For those who value peace of mind, the price of lost returns is more than reasonable.
Savings instruments are also good for investors who do not want to spend time on their investments. Buy and ignore is a good philosophy for savers. Someone who needs to be out of the country for five years should leave her money in savings instruments. Blind neglect is often advocated for stocks, but in fact, there are too many five-year periods when stocks lose half their value.
Picking Treasury bonds requires a few hours each year. Higher yields can be found in agency issues and older bonds. Call provisions must be evaluated. The time requirements are minimal.
Investors looking for action should look elsewhere. If you enjoy lots of research, or want to interact with people such as tenants, other investors, or money managers, savings instruments are not for you. While you can create excitement trading bonds, you cannot create profits. High-energy investors should stay clear. Disappointment will follow.
Treasury bonds are also the only insurance against deflation. Savers who worry that current Japanese deflation may be exported to the United States or that there will be a return to deflation of the 1930s will feel safe here. Savers concerned with inflation will be comfortable with TIPs and money market funds.
Michael tinkers with his portfolio obsessively. In prior years, he read investment magazines and newspapers late into the night. Now he has a fast Internet connection and often signs off after midnight. Susan is freaked out by the paper gains and losses that routinely occur every month. The abstract nature of the account statements, reports, newspaper articles, and Web sites makes her nervous. Her mind cannot grasp what they really own nor does she understand why Michael is constantly playing with it. Ever since the decline of 1990, when they were new to the stock market, there has been a sense of impending doom over their financial security.
Interestingly, Michael and Susan would both be happier with a portfolio primarily consisting of single-family homes. Michael’s tinkering could cut costs and improve rents and tenant quality. He has no guilt about being a landlord. He and Susan have a nice house they are proud to own. They are now living in their third home together. Together they were able to buy two cute cottages in attractive neighborhoods, which they sold for much more than the purchase price. Michael is fair with the many employees he supervises.
There is no reason he would be a poor landlord. Michael is also not likely to trade properties. While he is able to justify many small commissions to a discount broker, having never added them all up, the idea of giving 6 percent of his property to a Realtor every time he sells a building does not appeal to him. Susan could drive by and look at their properties any time she needed reassurance. The children could help out cleaning and fixing up between tenants. Though Michael may lose a major topic of conversation at the office, he would sleep better and be more productive at work. He would also be wealthier. If, in each of the last 10 years, he had bought a new single family home with $50,000 down, putting nothing in his 401(k) or anywhere else, he could potentially have equity of $1,000,000 today.
There are two basic types of interest that every person who uses debt or credit cards needs to understand: simple interest and compound interest. Over time, there is a significant difference between these two methods of calculating your interest on a debt. Part of your strategy to eliminate debt will probably involve getting rid of debts that use compound interest first.
Often, the rate you’re quoted on a loan or a savings account is not what you actually pay or earn. Depending on how often the actual interest due to you or the lender is calculated, your rate may be noticeably higher than the “nominal” or stated rate. APR stands for annual percentage rate, and refers to the actual cost of borrowing the money based on the frequency of the interest calculation. For example, a 6% loan may have an APR of 6.15%, depending on the calculation period. APY is identical to APR, except that it calculates the actual rate that our savings earns, instead of the interest we pay on a loan.
We have yet to take into consideration market risk. Using a Black-Scholes model, a volatility of 50 percent (characteristic of DuPont and Dow stock today), and an overall chance of success of 10.4 percent, the value of the Polyarothene project is $3.57 million versus $1.67 million based on the decision tree alone.
This result does not consider the option to abandon at each of four stages; it is based on a straight 10.4 percent unique risk. So it is the rifle shot, but it takes into account the volatility of the marketplace. This result is also interesting—because of market volatility alone, it might still pay to do this rifle shot project, just as it would pay to drill the exploratory well in Chapter 5. NPV gave the wrong answer for another reason!
Of course, we should take into account both kinds of risk.
This requires us to work backward from the end result, using the probabilities of success cited in the previous section. First, value an option of entering stage 4 with an 83 percent chance of successful commercialization, using Black-Scholes. With this value in hand, go back a stage: Value the option of entering stage 3 with a 75 percent success rate and the reward (underlying security) being the value of the stage 4 option, discounted for the probability of success.
Do it twice more until you are back to the beginning of the process, stage 1. We have created a series of linked, nested, compound options. Although the detailed calculations are beyond the scope of this book, the result is interesting: $4.75 million.
In effect, we have now moderated the negative impacts associated with unique risk using multiple options to abandon and have taken full advantage of the positive values associated with market risk.
To summarize, without the option to abandon, the project has an NPV of –$2.60 million. With four options to abandon, which relate only to unique risk, it is worth $1.67 million. Adding market risk to the equation improves the value to $4.75 million. In relative terms, each step in risk management represents an enormous increment in value. Note also that these results depend critically on the systematic reduction of risk at each stage and the acceleration of costs from stage to stage. But that is how R&D should be managed.
A second critical tool in risk management is hedging, which is greatly facilitated by the global banking system. In the commercial world, if one wishes to buy a fermentation plant from a Swiss supplier with 10 percent down and 90 percent due on delivery 12 months hence, one considers a currency hedge. If the price is quoted in U.S. dollars, the Swiss manufacturer may buy a forward option on dollars. If it is quoted in Swiss francs, the U.S. customer may buy a forward option on Swiss francs. In either case, for a small price, their business plans are not exposed to currency risk. When I joined W. R. Grace & Co. in 1982, I found just such a contract on a fermentation pilot plant in place. In fact, the dollar strengthened dramatically, so we bought the plant far more cheaply than expected, while being fully protected if the currency had moved in the opposite direction.
The bankers offering these hedges can reduce their risks substantially, for example, by finding a counterparty, perhaps a Swiss firm buying computers from a U.S. supplier in the same time frame. This activity is classic hedging. Note that the hedge is against market risk.
Economics is conventionally divided into two types of analysis: microeconomics and macroeconomics. Microeconomics studies how individuals and firms allocate scarce resources, whereas macroeconomics analyses economywide phenomena, resulting from decision-making in all markets. One way to understand the distinction between these two approaches is to consider some generalised examples. Microeconomics is concerned with determining how prices, values and rents emerge and change, and how firms respond. It involves an examination of the effects of new taxes and government incentives, the characteristics of demand, determination of a firm’s profit, and so on. In other words, it tries to understand the economic motives of market participants such as landowners, developers, occupiers and investors. This diverse set of participants is rather fragmented and at times adversarial – but microeconomic analysis works on the basis that we can generalise about the behaviour of these parties. A particular branch of economics known as urban land economics is concerned with the microeconomic implications of scarcity and the allocation of urban property rights. Ball et al. (1998) in the preface to their book state that: ‘The microeconomics of commercial property, proved to be the most difficult [area] to draw together. There simply does not exist an adequate and complete general microeconomic theory of urban property markets.’ This is true and an attempt to develop such a theory is not attempted here! Instead this section brings together and explains the key microeconomic concepts and theories that have a bearing on urban property markets and the important work of authors such as Harvey (1981), Fraser (1993) and Myers (2006) in relating classical economic concepts and theories to urban land and property markets is acknowledged.