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Roadmap 04/11 (click here to expand/collapse)

Below is the Roadmap for select April 2011 website articles.    Please note  the website contains many more articles covering these same topics. For example, pre-game is integral to our program for attracting better R&D investment opportunities.

Provide Predictable Funding for Unpredictable R&D+
(Introduction to Franchise Capital Mgmt.)

Make funding more predictable (From Unpredictable R&D to Predictable Investor Returns)

  Attract and Retain Long-Term Investors

– Make a Market (You Have to See It to Believe It)

  Reinvest Interim Windfalls+

Make R&D success more frequent * (Execution is the Key to Success)

  Get Smarter at Tracking R&D Advancements+ and Transitions+ (Exits)
  Attract Better R&D-centric Investments
  Increase R&D Productivity (Execution is the Key to Success)

* Although it's still unpredictable

As funding agent+ we match investors and investments (owners of intellectual property+). Our role as funding agent (as middleman) is to keep investors happy, thereby ensuring steady funding for investments. We do this by packaging unpredictable R&D investments into an offering that is more attractive for investors (the perpetual fund). We do this by direct mediation into our unpredictable R&D investments (via franchise operations+), to ensure above-market productivity. Above-market R&D productivity is the only reliable means to ensure predictable funding.

Bringing It All Together - Franchise Capital Management

Summary: 

An expanded version of the patent application for Franchise Capital Management, a new approach to funding R&D

Note: Franchise Capital Management may come across as sterile and uninspiring without the benefit of its rationale and underlying intentions. First read this narrative for a different way to think about funding of R&D. The island nation of R&D Inc. sets the framework for the more conventional funding approach in this article.

 

This article is written from the standpoint where the Franchise Capital Management firm is up and running. How we get to that point has its own challenges.

This is a long article. A .pdf version is provided here for your convenience. Hotlinks (e.g., referenced articles) and scroll over features (e.g., glossary definitions) do not work with the .pdf version.

This article was excerpted from a U.S. provisional patent filed for Franchise Capital Management. The article enhances the patent application with additional exhibits and in-depth discussions on select topics.

Background for Franchise Capital Management

Franchise Capital Management provides continuous funding for unpredictable R&D+. Unpredictability is defined as uncertainty in knowing if, when, or where an R&D investment will develop into a major commercial success.1 R&D needs continuous funding for staff salaries, supplies, facilities, etc. for the period leading up to its commercial success, or failure.

  • Unpredictable R&D means not knowing whether a specific R&D investment will ever achieve commercial success.
  • Unpredictable R&D means it can take 3, 5, 7, 10 or more years to achieve commercial success, and the timing of that success is not knowable (and not statistically predictable by combining investments).
  • Unpredictable R&D means the path to commercial success is unknown. Commonly commercial success happens far afield from where an investment originally intends.

Unpredictable R&D is common to many industries, such as, pharmaceuticals, industrial chemicals, entertainment, and software. Attempts to-date to fund unpredictable R&D include the Industrial R&D model and the Venture Capital model.

The Industrial R&D model is an employer-employee relationship, where the employer gives employees continuous funding, the employer assumes the risk of failure, and in return the employer reaps the benefits of any success.

The Venture Capital model pools funds from many investors, and invests these funds across a mostly fixed number of R&D investments. Since R&D is inherently risky, venture capitalists place bets across many R&D investments with the hope one or more will succeed. If all investments fail then investors lose their money.

Industrial R&D has seen dramatically lowered productivity during the last decade (2000-2010). This is suspected to be the result, in the aggregate, of the industrial R&D model experiencing diminishing returns in the face of increasingly unpredictable R&D. The industrial R&D model is successful when R&D is more predictable. R&D has become more unpredictable, the industrial R&D model no longer is applicable and as a consequence its productivity has plummeted.

The Venture Capital model is largely a time-bound investment approach. Investors commit to a fixed time-frame. This time-bound approach flies in the face of unpredictability: setting of arbitrary deadlines means unpredictable R&D fails by definition. Further, venture capital management often insists on early selection of commercial paths for its investments. Early selection means promising research that doesn’t fit goes abandoned. The Venture Capital model per se increases rates of failure in unpredictable R&D.

Franchise Capital Management Overview

Franchise Capital Management provides predictable funding for unpredictable R&D. It does this by recruiting and retaining long-term investors. We attract these investors by repackaging unpredictable R&D into a more attractive investment vehicle: the perpetual fund+. The perpetual fund provides capital protection, steady prices, and a kicker in the form of unexpected extraordinary dividends. How we make this happen is described below, but keep in mind the real basis for how this works comes from increasing the frequency, if not the predictability, of success in our investments.

Franchise Capital Management relies on three main sources of funding: the perpetual fund, reinvestment of windfalls+, and derivative investment vehicles+. The perpetual fund is used to carry investments to their first windfalls. Reinvestment of windfalls carries investments to subsequent windfalls (and to eventual exit from the franchise). Derivative investment vehicles provide coverage in the event our timing is off for either of the other two funding sources.

Perpetual Fund

The Perpetual Fund doesn’t expire. We set up a ‘mutual fund’ so-to-speak of unpredictable R&D investments that is continuous. Investments may come and go, but the fund at any point in time can represent investments at any age or stage of development, from inception to billion-dollar enterprise. Likewise investors can be those who joined at the inception of the fund, or those who joined during our last open season+. Investments receive funding from investors past, present and future. Investors receive returns from investments past, present and future (Exhibit 1).

We seek long term investors for our perpetual fund. The intent for the fund is to provide predictable funding, and this is best achieved by attracting predictable investors. Funding to the first windfall for an investment can take 3, 5, 10, 15 or 20 years. Its success is unpredictable in timing. We reward investors who stay the duration to allow success to happen.

Exhibit 1. Perpetual Fund Concept, Profile View. The perpetual fund can be conceptualized as a pool of capital, into which new investments and windfalls are added periodically, increasing the total capitalization of the fund. Capitalization is the key factor in the calculation of share prices for the perpetual fund (adjusted for prices realized during open season). Funds used in franchisee operations are not shown as expensed since they are (essentially) capitalized at the moment we periodically revalue (upward) shares of the franchisees based on favorable progress. Drawing down the pool of funds are franchise operations and investor exits.
Investor retention+ is driven ultimately by increasing the quality of investments in the perpetual fund over time, which increases the frequency of success, which in turn increases investor share prices and the frequency with which we can disburse extraordinary dividends to investors. Increasing rewards over time are important for long term investor retention.

Reinvestment of Windfalls

We use reinvestment of windfalls to ensure capital protection and steady share prices to investors in the perpetual fund. We borrow against future windfalls or husband current windfalls to build a stabilization fund for the perpetual fund. We make a market in perpetual fund shares. In essence we are ‘pre-paying’ investors in the perpetual fund from future windfalls: extraordinary dividends are prepaid in the form of stabilized share prices.

We use reinvestment of windfalls to increase the frequency of success in our investments. Windfalls fund franchise operations+ (Exhibit 2), which are responsible for increasing the frequency of windfalls. Consider it a tax on windfalls to make windfalls happen.

Exhibit 2. R&D Certification and Oversight Infrastructure. Franchisees leverage expertise provided by the franchise in the form of franchise operations and Watchdog. See here for a detailed description of franchise operations. Watchdog includes formal decision mechanisms (e.g., Trial by Jury) for adjudication of most major financial decisions taken by or for the franchise (e.g., Advancements, Transitions). Watchdog also includes arbitration for disputes between franchisees, investors, and the managing partnership of the franchise capital management firm. See here for a detailed description of watchdog operations.
The perpetual fund provides financing for franchisees up to the first windfall. Reinvestment of windfalls provides financing up to subsequent windfalls. Windfalls are the largest source of funding and are used to fund the largest expenditures: late stage R&D. This is analogous to reinvestment of earnings in the corporate R&D model. The perpetual fund carries us to the first windfall; the windfall carries us to product commercialization+.

Derivative Investment Vehicles

We borrow against future windfalls to cover gaps in funding from either the perpetual fund or past windfalls. We do this using derivative investment vehicles. These are investments deriving their value from underlying assets+, but having only residual claim to those assets in the event of liquidation. Examples include unsecured loans, warrants, options and indices. These are typically short term time-bound investments for those more interested in a quick return. Consider these as insurance policies for predictable funding.

Exhibit 3. Perpetual Fund Concept – Top View. The funds pool can be subdivided, and derivative investment vehicles structured to derive their value based on the results of the subdivisions. We illustrate here subdivisions to leverage windfalls from initial public offerings (IPOs) and Commercial Success (shown as BB=Blockbuster).
Derivative investment vehicles can be based on almost limitless variations of slicing and dicing of the underlying assets. For example, investors may want to invest into new perpetual fund recruits, betting they will reach IPO+ within the next five years (Exhibit 3). Alternately, bankers may provide unsecured debt on the entire Franchise Capital Management enterprise.

Derivative investment vehicles may seem to increase the risk of Franchise Capital Management, but we pay down this risk as soon as the next windfall is achieved (Exhibit 4).

Exhibit 4. Share Price vs. Franchise Financial Risk. The franchise regulates share prices during the time leading up to windfalls. It does this by increasing the franchise overall financial risk, by selling derivative investment vehicles. This risk is later “bought down” when a windfall happens by using funds from the windfall to pay back investors in the derivative investment vehicles. When a windfall happens investors see a jump in share price, and the franchise sees a drop in financial risk.

Enabling Features of Franchise Capital Management

Reinvestment of windfalls is integral to making the above financial approach work (Figure 1). We use windfalls to reward investors in the perpetual fund. We use windfalls to increase the frequency of success of our investments. We use windfalls to fund investment operations post-windfall. But windfalls are the result of hard work by Franchise Capital Management partners and owners of intellectual property+. These parties also lay claim to these windfalls.

Figure 1. Reinvestment of Windfalls and Predictable Funding. The flowchart shows the logic for how reinvestment of windfalls contributes to predictable funding. They are used to finance activities which build greater predictability in funding.
Reinvestment of windfalls is contractual. Partners and owners sign up for the duration, and commit to reinvestment of all windfalls prior to the point when the franchisee achieves its second major commercial success (rationale here). Part of our branding as Franchise Capital Management is we launch successful multi-billion dollar firms, and before we launch these firms we want evidence of sustainability in the form of repeated commercial success. Franchise Capital Management commits to providing the funding to make this happen. Owners of Intellectual Property (and Franchise Capital Management partners) commit to reinvestment of interim windfalls until they make this happen.

In the normal course of events a first windfall (IPO) funds up to the second windfall (first commercial product). A second windfall funds up to the third windfall (second commercial product), at which point owners of intellectual property are free to exit the franchise. Franchisee owners (and Franchise Capital Management partners) only see cash after the final windfall – earlier windfalls are reinvested back into the general funds of Franchise Capital Management.

Instead of windfall cash payments, partners and owners receive i-shares+, or internal-shares issued by Franchise Capital Management. These i-shares represent ownership in the separate legal entity we call a franchisee. These i-shares are valued at the cash-equivalent of the recipient’s stake in the interim windfall. These i-shares can become worthless should the franchisee not achieve commercial success.

Exhibit 5

Franchise Ownership and Progress. Franchisees sell shares to obtain operating funds and lose ownership with each sale. Their ownership is replenished by the franchise as a reward for advancements (e.g., pre-game to mid-game) and windfalls.
Franchisee management sells i-shares to the Franchise Capital Management firm to obtain operating funds. Management in the franchisee essentially spends its own money, giving away ownership, to fund its research. At each windfall or advancement (advancements+ being viewed as an internal windfall) Franchise Capital Management replenishes ownership percentages for franchisee management by issuing and distributing new i-shares (Exhibit 5). These new i-shares are subsequently sold to obtain operating funds up to the next windfall or advancement.


We have three funding sources, and three funding instruments: perpetual fund shares, i-shares, and shares in our derivative investment vehicles. Each plays an integral role in enabling predictable funding for unpredictable R&D.

The April 2011 articles are organized around two major topics: 1) make funding predictable, and 2) make investment success more frequent. A roadmap for these articles is found as a collapse-expand link at the top of this and other articles for this month (online).
Table 1 – Key Features of Franchise Capital Management
(Click each item to expand and view its description)
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The Franchise Capital Management Mechanics

Exhibit 6. Franchise Capital Management Mechanics (Process Flows). Shows steps from initiation of the franchise to the next open season, when new entrants are enrolled into an existing perpetual fund. Scroll over each process step to pop up an abbreviated description of the step. Click on each process step to be taken to a link with the full description of the step.


 

 

Table 2 – Descriptions of Process Steps
(Click each item to expand and view its description)
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The Investment Algorithm

The investment algorithm refers to the database of financial information and analyses needed to manage the franchise. The investment algorithm accepts raw data and processes it to allow for planning, tracking and analysis of measures of success for the franchise (see Table 3 for illustrative measures). The investment algorithm tracks actual measures, projects future measures, and allows what-if analyses based on various market, competitive and regulatory outlooks.

Table 3. Franchise Capital Management Measures of Success. Illustrative measures of success for Franchise Capital Management firms by category of measure. 
Category Franchise Capital Management Measures of Success
Growth
  • Projected fund share prices increase steadily over time
  • Franchisee i-share prices increase steadily over time
  • Franchisee advancement rewards increase steadily over time
  • Projected fund share price growth outpaces market comparables
Reliability
  • Quality of imputed share prices increases over time
  • Windfalls increase in frequency and value
  • Targeted open season share prices and volumes consistently realized
  • Increasing operating funds availability reduces the need for funds from derivative investment vehicles
Robustness
  • Accepted petitions backlog for membership increase over time
  • Investor retention increases over time
  • Derivative investment vehicle lines of credit increase over time
  • Franchisee transition outs are proving to be smarter over time
  • Successful franchisees increasingly continuing membership on a voluntary basis
Security
  • Operating fund reserves increase over time
  • Franchisee and managing partner re-investments from windfalls increase over time
  • Fund growth projections are consistent with reasonable financial risk projections

Measures of success influence the design of the investment algorithm. For example, to increase investor retention, the investment algorithm might track investor profiles+, investor profile retention vs. fund share price growth rates, investor profile retention vs. expenditures on retention programs, etc. A similar line of reasoning is followed for each measure of success, resulting in a complete database design for the investment algorithm, tailored to the goals of each Franchise Capital Management firm.

Notice the categories. Both investors and owners of intellectual property are interested in growth, reliability, robustness and security of the franchise. Any franchise can get it right once. Since we’re interested in continuous funding potentially spanning decades, we need measures of success which can weather any economic storm or change in risk profile for investors.

The measures of success in Table 3 do not assume any timing for windfalls, advancements or commercial successes (a type of windfall). We will not have access to this data from franchisees, even estimated, as stipulated in the R&D Bill of Rights & Obligations. We prohibit explicit forecasting of unpredictable R&D results for our investment algorithm (i.e., forcing franchisees to guess). However, guesses for advancements and windfalls should be incorporated into what-if analyses. Windfalls represent potentially the largest contribution of funds to the franchise over time and it would be financially imprudent not to have financial analysts take a guess at their financial impact. We just don’t plan on them as a source of funding, but we do plan ahead in case they happen.

Conclusion

The above financial approach comes from careful consideration on how funding impacts the achievement of World Class R&D status. The approach is not comprehensive, and is not the only way. However, any approach for funding unpredictable R&D must take into account the R&D Bill of Rights and Obligations, as does this approach. This Bill stipulates the baseline design criteria for continuous funding of unpredictable R&D.

This financial approach targets R&D-centric investments for firms in Phase 1 of the industrial cycle. This is 'new money' for 'new men' willing to do whatever it takes to turn promising intellectual properties into a string of successful commercial products or services. The model will fail when applied to firms in Phase 2 or 3 of the industrial cycle. Only in Phase 1 firms do men have the sense of ownership and commitment that comes from going where no one else has gone before. These men will encounter every imaginable obstacle, rebuttal and even acts of sabotage as they do their daily work. They don’t need a funding agent pestering them with arbitrary notions of how long or in what direction the work should proceed. They need a funding agent who factors the inherent unpredictability of the enterprise into the financial approach itself.


Home Page April 2011

  • 1. We use the term unpredictable R&D synonymously with discontinuous discovery+. See here.
Further Reading