Convertible notes are not a recent invention. In fact, they have been used by investors and startup founders for a very long time and have been the reason for both the success as well as the failure of many startup firms.

In this article, we will have a closer look at what convertible notes are and how they are used in the process of funding startups.

What are Convertible Notes?

Convertible notes are instruments that offer early investors a mechanism to invest in very early-stage startups while reducing some of the risks related to such investments. Early-stage startups are considered to be very risky for equity investments. This is because there is a good chance that the value of the equity will turn to zero. Hence, angel investors use convertible notes to make an initial debt investment in such companies. This means that when the investment is first made, it has the characteristics of debt.

The startup company has to repay principal as well as interest applicable on this amount. This amount is generally not paid back in cash. Instead, the accrued interest keeps on adding to the principal. However, the convertible notes have a clause that when the startup company reaches a certain milestone, the debt will automatically be converted to equity.

For example, if the company has been able to generate revenue of more than $1 million for six consecutive months, then the convertible note debt will be automatically converted to equity. This means that the startup company will stop adding interest to the existing debt and any outstanding principal will be adjusted by issuing an equal amount of equity shares.

There is something called a conversion discount rate which is also part of the convertible notes agreement. Conversion discount rates are the amount of discount which is given to investors that hold convertible notes. In the above point, we have mentioned that debt is converted into equity. However, we have not mentioned the price at which this conversion happens.

The conversion discount rate is the discount that will be given to the holders of convertible debt. If this rate is 20%, then new shares will be issued at $8 per share to holders of convertible debt if the market rate is $10. The conversion discount rate signifies a premium that is paid to the holders of convertible debt for taking extra risks.

Hence, convertible debt can be extinguished in one of two ways. These notes have a maturity date specified in the contract. On this maturity date, the company can either repay the principal and the accrued interest in the form of cash or can issue equity shares at a discount. However, investors who choose to invest in convertible debt tend to take on significant risks. They generally want to obtain equity shares of the company and are not interested in receiving their cashback. Hence, investors often get disappointed if they are paid back in cash at the end of their tenure.

Who Issues Convertible Notes?

The issue of convertible notes is not suitable for all types of companies. There are some types of companies where convertible notes are more suitable. For instance, convertible notes are mostly used in the pre-seed-funding stage. This is because founders often want to raise cash at this stage to be able to expand further but investors are not looking to buy their risky equity.

Convertible notes are also issued by companies between two startup rounds. However, convertible debt can become quite risky when there are multiple parties involved. This is the reason that there should be a clearly defined agreement that explores the roles and responsibilities of each party in various scenarios.

Conclusion

Convertible notes are risky, however, they can also be rewarding to both founders as well as to investors. They offer companies a mechanism to raise funding before a concrete business plan is in place. From an investor’s point of view, they allow the investor to have a foothold in the company even though they do not have enough data to decide the valuation of the firm. Convertible debt allows investors to lock in their investments and then decide at a later date when they want to make a larger investment within the same firm.

Even though convertible debt can be quite useful, it should not be any founder’s first choice to raise money. Founders must explore all their other options such as SAFE notes, KISS notes and even revolving credit before they finally agree to issue convertible debt.

In this article, we will have a closer look at what a co-working business model is. We will try to understand the pros and cons of this model as well.

What is a Co-Working Business Model?

The availability of quality office space at a cheap price has been a pain point for most companies. Also, companies want the flexibility to increase and decrease the amount of office space that they rent out. The co-working business model provides this value proposition to its customers.

Co-working spaces allow the customer to rent out office spaces in a flexible manner which they can then use to facilitate work in a collaborative manner. Co-working spaces are especially useful for companies such as start-ups since they allow these companies to use well-developed office infrastructure even though they want to operate smaller teams.

Co-working spaces also have other infrastructure such as conference rooms which can be shared amongst the various occupants so that they are not a cost burden for any individual company.

Why do Customers Prefer Co-Working Spaces?

Co-working spaces have largely been preferred by smaller companies until now. Larger companies have started taking an interest in co-working spaces. However, they have not been able to build significant momentum until now. Some of the advantages which make customer prefer co-working spaces are mentioned below:

1. Co-working spaces support an asset-light business model. There are many companies that want to have an asset-light model. They want to utilize the limited funds at their disposal in a focused manner. This means that if the firm has access to certain funds, then they want to spend them building the right product instead of spending them on obtaining a plush office space.

   In the case of co-working spaces, start-ups have to spend very little money upfront. They operate on a pay-as-you-go basis which gives them a lot of flexibility. There are several businesses that are willing to pay a premium to have access to that kind of flexibility

2. Co-working spaces tend to bring a lot of different companies together. For start-up companies, this often leads to networking. There are many companies that have been able to obtain sales orders or even investment funding because of the networking opportunities they got from their co-working space.

3. Co-working spaces can be much more productive than a traditional start-up office setup. This is because co-working spaces have all the tools required to monitor the productivity of the workforce. The supervisors can use these tools to share feedback with their employees which helps further increase productivity.

Risks from an Investors Point of View

Large co-working space companies have been able to obtain significant investor attention. However, the multiples offered to these companies have been significantly lower as compared to other companies. This is because investors are averse to certain specific risks that this model has to offer.

• Timing Mismatch: The co-working business model is based on taking possession of an entire office, furnishing it, and then renting it out to short-term tenants at a higher price. However, there is a huge problem with this business model. The model is based on taking long-term obligations in the hope that the company will always be able to find short-term tenants. This creates a fundamental mismatch in the nature of cash inflows and cash outflows. This is the reason that many investors view the entire model as being risky.

• Work from Home Culture: Ever since the coronavirus pandemic broke out, the basic value proposition being offered by co-working business models has taken a massive hit. This is because of the fact that co-working companies generally own the top office spaces in the biggest cities of the world.

  After the pandemic, the world is seeing a rise in work from home as well as hybrid business models. Hence, the demand for office space is decreasing. Also, companies which do want to have an office are relocating far away from the city centers. Since co-working spaces have locked in their leases for a longer period of time, they might end up losing money as a result of these trends.

• No Technological Advantage: Lastly, there is nothing very technical about the co-working business model. One can view the business model as being a “retailer” of office spaces. Since the model is not technology-intensive, it is highly commoditized. Gaining a competitive edge that allows the company to maintain its premium pricing is quite difficult in such a market.

How Co-Working Spaces Make Money

1. Space Rentals: The first and most obvious source of revenue is space rental income. A co-working space leases out large office spaces. Typically, entire buildings at prime office locations are either leased out or purchased outright by these companies. They then offer the same space for rental on a retail basis.

   Co-working spaces offer small cubicle spaces for rent. They may also enclose some cubicles and sell that space as a private office within the co-working space. However, customers typically have to pay a higher price to obtain any kind of privacy.

2. Infrastructure Rentals: Some companies do not want to rent out only cubicle space. Instead, they want to rent out the entire office infrastructure. This means that they want to rent out office desks, chairs, computers, printers, and even servers. This equipment is quite expensive and can require a significant cash outlay. Hence, many companies prefer to rent this equipment from the co-working space as well.

   Co-working spaces have established vendors which provide this equipment to their customers. Since the co-working spaces require this equipment in bulk, they can take advantage of economies of scale. They can offer to lease the equipment at a lower price while still earning a decent profit margin on the same. Infrastructure rentals are the second most important source of revenue for co-working spaces.

   Also, co-working spaces tend to offer conference rooms, storerooms, and such other rooms to rent separately. In many facilities, companies can hire these rooms by the hour. Renting out conference rooms and other conference facilities also provides a significant source of revenue.

3. Virtual Offices: There are many start-up companies that have adopted the work from home model completely. However, even such companies have a small physical presence. There are many co-working spaces that offer such virtual office facilities.

   They allow the companies to use their office address as a registered corporate address in return for a fee. They also provide other facilities such as collection and forwarding of mail to alternate addresses. The popularity of virtual office spaces has also increased making it an important revenue option.

   

4. Commissions: There are a lot of facilities such as restaurants, cafeterias, cab services, facilities, printing and stationery, etc. which operate in conjunction with office spaces. These ancillary facilities can also act as significant sources of revenue.

   Many co-working facilities have their own subsidiary companies which provide a lot of these services. However, even if the co-working space owner is not able to provide these services on their own, they subcontract it to a third party in lieu of a commission.

   There are many different types of contracts structured between co-working spaces and third parties. Sometimes, the co-working spaces receive lumpsum payments whereas at other times they receive a percentage of the overall revenue.

5. Promotional Activities: The companies which operate on the premises of the co-working spaces are also consumers of a lot of products and services. For instance, every company requires a marketing agency or a public relations agency.

   Hence, co-working spaces are actually the perfect marketing venue for other companies that want to sell goods and services to start-ups that operate on the premises.

   There are other companies that want to sell products to the employees that work within a co-working space. For example, credit card companies may want to sell credit card products to the employees of the co-working space.

   Co-working spaces often lend out lobbies and other common areas to companies for performing promotional activities and below-the-belt marketing activities. The temporary lending out of such areas can also contribute a lot towards the overall revenue of the co-working space.

The bottom line is that co-working spaces have several revenue streams. It is possible for the co-working space to become even more creative and add new revenue streams to its revenue model. The multiple revenue streams help to enhance the basic return on investment. They also help diversify the risk inherent in having a single revenue stream.

To date, most startup valuation models suggest using a profitability metric such as profit before taxes and then assigning a multiple to it in order to derive a valuation. However, over the years this has changed.

New-age startup companies such as Facebook, Twitter, Airbnb, and Uber have negative cash flows. A lot of these companies have not seen any significant profitability. In fact, in most cases, these companies are losing money on a month on month basis. However, this loss of money is different from the loss which is realized during normal business transactions. This planned and controlled mechanism to strategically lose money is called a burn rate.

Over the years, the cash burn rate has become a very important metric in the startup ecosystem. In this article, we will explain some of the details related to the concept of the cash burn rate.

What is Cash Burn Rate?

Over the years, there has been a massive change in the collective wisdom of the entire startup community. Whereas earlier, the startup community was focused on “cash is king”, over the years, they have changed their belief to “growth at any cost”

Companies like Facebook and YouTube had a huge role to play in this attitude shift. Facebook and YouTube did not use their platform to generate money for a very long time. Over the years, these companies steadily lost money while focusing on the growth of their user base. It was only after these companies grew so large that they almost became monopolies in their own fields that these companies decided to monetize their platforms. Now, since users are hooked onto these services, companies can safely earn money from a larger base.

The cash burn rate is the result of a belief that gaining a strong and loyal user base is a bigger goal for a startup company as compared to the goal of short-term profitability.

For instance, if YouTube has started monetizing its videos before it became a behemoth, it would have left the door open for some of its competition. Till that point in time, the user base of YouTube was not so large. Hence, it was possible that a newer service could have provided competition to YouTube. By deliberately burning cash in a planned and strategic manner in the early years, YouTube virtually eliminated the competition and guaranteed itself a larger cash flow during the later years.

The cash burn rate is symbolic of a change in the investor mindset from short-term profitability to long-term market dominance and growth.

Types of Cash Burn Rate

Even though the name suggests cash burn rate, it is possible for some entrepreneurs to refer to accounting burn rate when they discuss the issue. As an investor, it is important to clarify the type of figure which is being quoted.

An accounting burn rate uses the accrual principle. This means that it uses techniques such as capitalization, depreciation, and amortization in order to spread out costs during different periods. On the other hand, the cash flow-based burn rate does not believe in these principles. It simply considers the amount of cash inflow and the amount of cash outflow. If the outflows are greater than the inflows, then the resultant figure is called the cash burn rate.

Within the cash flow-based burn rates also, there are two different types of burn rates.

1. One of them is called a gross burn rate. This rate calculates the total amount of operating expenditures that lead to negative cash flows every month. This rate does not take into account any kind of cash flow.

2. On the other hand, there is another metric called net burn rate which measures the difference between the cash inflow and cash outflow. When investors refer to the cash burn rate, in most cases, they are referring to the net cash burn rate.

A Higher Burn Rate Does Not Have a Negative Connotation

Most entrepreneurs and investors have been primed to view negative cash flow as a negative event. However, this does not need to be the case. Over the years, investors have evolved to realize that a higher burn rate need not necessarily mean that the firm is incurring losses. Instead, it could mean the opposite.

A lot of investors view a higher burn rate as a positive occurrence if it is also accompanied by a correspondingly large increase in the user base.

A higher burn rate could mean that the company is acquiring a lot of customers and hence needs to pay the costs associated with this acquisition upfront. It could also mean that over the years, a relationship can be developed with these consumers in order to obtain stable cash flow from such customers.

All said and done, a burn rate is common in a lot of internet-based businesses. Companies find it very difficult to stop the competition from entering the market. Hence, they try to use network externalities to their advantage by creating a very large user base.

An individual user of a social network does not have much choice when most of their friends are on a particular social network. Hence, cash burn has been strategically used by companies to develop a strong user base before trying to earn a profit.

Investors tend to pay a lot of attention to who the team members are before they invest in any firm. However, there is almost no literature that speaks about how companies can achieve this goal.

In this article, we will have a closer look at the financial aspects of building a startup team.

The Problem with Hiring for Startups

Most of the startups that have come into existence today are high-tech startups. Hence, these companies require a lot of highly talented knowledge workers to grow and develop their business. The problem is that highly talented workers are found in competitive markets. This means that the same set of companies is approaching the same workers. Just like companies are selecting the candidates, the candidates are also selecting companies.

The problem is that startups lag behind more established companies in the labor market. On the one hand, established companies can offer more money upfront while on the other hand, they can also offer a well-defined career path. Startups do not have the luxury of offering either of these things. Hence, in a way, hiring for startups is like marketing on a budget.

The human resource team needs to get really creative in order to attract the right talent while being on a budget. The inability to attract the right talent can be a make-or-break deal for the startup company.

• Using Social Media: Before any company begins recruiting their candidates, it is important for the candidates to have some brand recognition. People are more inclined to work for companies they have seen or interacted with rather than working for obscure companies.

  Big companies often use the power of media to create brand recall. However, smaller startup companies do not have the big budgets required to use traditional media channels. It is important for them to use tools like social media to engage with prospective hires.

  Fortunately for startups, social media channels are absolutely free. The startup just needs to have a quirky persona in order to attract the attention of the target hires. Startup hiring managers will be surprised to see how much having a significant social media presence and brand recall can influence their candidates.

• The First Hires are Crucial: It is important for the company to realize that when it comes to startups, the importance of all hires is not the same. When the company grows from zero to ten employees, it needs to be very picky. This is because the first ten employees often form the leadership team of the company.

  The leadership team is quite crucial because they influence the other hires as well. A lot of the other new hires may have been a part of their network or may join the company because they believe in the vision of the leadership team. It is important for the startups to be reasonably generous in order to attract the best talent in the leadership team.

  When the company hires the next few employees, it can afford to be a little less picky and focus more on costs. Once the team size has already reached about a hundred, then the company may have enough infrastructure required to attract and retain good talent.

• The Bigger Picture: Startup hiring is like marketing to investors. If the candidate focuses too much on the current situation of the business, they may not be inclined to join the company. The startup hiring manager has to make sure that all candidates understand the full potential of the company. If the candidate believes in the company’s value proposition, they may be more than willing to take the risk.

• Target Other Shaky Startups: Hiring managers can be on the lookout for other startups where an adverse event has taken place. Companies which have witnessed the departure of key leaders, as well as those that have seen a recent down round, are likely to have employees which are looking at greener ventures. Employees who have already worked in startup companies can be convinced much more easily as compared to other employees.

• Hire Young: Startups tend to be highly risky ventures. People in their middle ages who have a lot of family obligations may not be suited for the high risk involved in such ventures. Startup ventures are more suitable for young students who have a few years of work experience.

  The typical startup employee is not happy spending years climbing the corporate ladder. Instead, they want to take on higher roles and responsibilities right away. Startup companies must position themselves to appeal to such employees.

• Equity Compensation: Last but not the least, companies must offer candidates an unlimited upside by making them an equity partner. However, equity partnership should form only a small portion of their compensation, or else it may feel like the company believes that their stock isn’t worth much and is transferring all the risk to the employees.

The fact of the matter is that hiring for startups can be quite challenging given the constraints. However, the ability to do so creatively and successfully can literally define the future of the company.

Hence, it is important to understand the advantages of this model in more detail. In this article, we have listed the most important advantages of the Product as a Service (PaaS) business model.

Benefits for the Company

The Product as a Service (PaaS) business model is highly popular because of the advantage it offers to both parties. The details of the advantages have been mentioned below:

• More Eco-Friendly: The Product as a Service (PaaS) business model is more eco-friendly as compared to the traditional product-based model. This is because this model changes the revenue cycle of companies. Companies do not make money for every new unit produced. Instead, companies generate a profit from the same product. Hence, companies have an incentive to make products longer lasting. This ensures that companies utilize scarce resources in the best possible way since their incentives are also aligned with that of the overall environment.

• Higher Profitability: The Product as a Service (PaaS) business model also has higher profitability as compared to the traditional business model. This is because this model derives revenue from both products as well as services. Traditionally, services have a much larger profit margin as compared to products. Hence, if companies bundle the product and service, they also save costs related to customer acquisition. This cost advantage ensures that the bundled model produces a higher return on investment for the company.

• Preventive to Predictive Maintenance: Individual buyers are not in a position to buy sophisticated machinery which can monitor the health of their vehicle. However, large companies are able to do so.

  Advances in the “internet of things (IoT)” are making it possible to collect data from various kinds of machines and then analyze such data. Hence, companies are in a position to move from preventive maintenance to predictive maintenance. This means that companies can maintain vehicles and other equipment better than the end-users. They can use these economies of scale to make the model more affordable to the end-users without actually cutting down on their profitability.

• Higher Sales: Customers are hesitant in buying products and services which are expensive and require significant outlay. However, customers are comfortable agreeing to a small monthly payment that they can stop at a short notice without taking any loan. Since there is no liability that the customer has to take up, a larger number of people are willing to experiment with the Product as a Service (PaaS) business model. The end result is that the company witnesses higher sales than they would have witnessed if they had stuck to the traditional product-based model.

Benefits for the End-Customers

• No Capital Expenditure: The Product as a Service (PaaS) business model has a lot of merit from the customer’s point of view as well. Products that are typically purchased under the Product as a Service (PaaS) model tend to be expensive and require capital outlays. It is common for customers to borrow money from financial institutions to buy such products.

  With the advent of the Product as a Service (PaaS) business model, there is no need to borrow money and take on the liability. Instead of making monthly payments to the finance company, they can make the same payments to the manufacturer, and that too without any commitments or obligations! They can stop making the payment at a short notice and they will not owe the manufacturer any money since they were paying subscription fees and not loan installments.

• Flexibility: The Product as a Service (PaaS) business model provides a lot of flexibility to buyers. Buyers can upgrade or downgrade at any time without any hassles. They can also stop the subscription for a few months if they are not planning to use the asset during that time. Hence, the company is able to provide the same asset to different customers and earn revenue from them. This flexibility is the biggest reason that customers have started adopting the Product as a Service (PaaS) based business model in droves.

• Less Risk of Obsolescence: Another advantage for the consumer is that there is a lower risk of using an obsolete product. Since customers pay via monthly subscriptions, they can move on to a more advanced product or even to a different service provider if the product they are currently using is obsolete. Many customers find this to be an appealing value proposition since the service provider is bound to upgrade the product at periodic intervals.

Given the long list of advantages, it should come as no surprise that a lot of start-up companies are being built around this concept. Some of these companies have already gone on to become unicorns.

The largest and the most profitable companies of the world such as Microsoft, Google, etc. do not own any tangible assets.

It is important to note that this did not happen by coincidence. All this has happened because of a concerted effort of entrepreneurs to focus more on asset-light business models.

Asset-light business models have become a buzzword today. It is almost impossible for any new enterprise to get funded unless it classifies itself as an asset-light business model.

In this article, we will closely examine what an asset-light business model means and will also look at some of its salient features.

What is an Asset Light Business Model?

An asset-light business model, as the name suggests, is a business model where the company focuses on reducing the amount of capital that is invested in assets.

In financial terms, this would mean that the size of revenue generated by the company would be very high as compared to the amount of capital tied up in assets.

Finance enthusiasts will say that these companies have a very high asset turnover ratio.

Entrepreneurs carefully study the value chain of a business in order to identify the key functions which need to be kept in the house. Any other functions which are not mission-critical are outsourced to vendors in order to increase efficiencies.

For instance, in the case of Nike, manufacturing is generally outsourced. The company decides to focus on marketing.

On the other hand, in companies like Uber, the tech function is given a very high priority. Asset light business models are a smart way to deploy business capital to build a competitive advantage and then use that competitive advantage to run all non-critical functions efficiently.

Salient Features of the Model

Asset light business models are not really new. They have been in existence for many years. However, with the resurgence of tech-based businesses, asset-light business models have come to the forefront once again.

Here are some of the salient features of asset-light business models which have been mentioned below:

1. Focus on Intangible Assets: The whole focus of companies using asset-light business models is to gain a competitive advantage over the competition using intangible assets.

   For some companies, this intangible asset is in the form of a brand name. On the other hand, for some other companies, this intangible asset is in the form of patents, algorithms, software, or such other intellectual property rights.

   Instead of spending money on constructing factories and warehouses, the money is often spent on building intellectual property which provides a very specific value proposition that is difficult for the competition to replicate.

2. Focus on Customer Facing Side of the Business: It is also important to note that most of these asset-light companies focus on the customer-facing side of the business.

   Their business models are created in such a way that they solve a specific need for a business and acquire customers. The execution part of the business is then passed on to other service providers.

   It is the ability to acquire and pass on customers to service providers which allow these companies to earn a return on investment that is higher than the competition.

3. Creating a Lean Enterprise: The entire asset-light business model is based on the concept of lean enterprise. This means that these businesses conduct every activity in a manner that is not wasteful.

   Asset light business models are meant to redesign the entire process and eliminate any wasteful activity.

4. Fixed Costs to Variable Costs: Another important feature of the asset-light business model is the relentless focus on de-risking the business model by reducing operating leverage. Asset light businesses are famous for turning every fixed cost into a variable cost.

   For instance, companies can turn fixed salary costs into variable costs by hiring contractors and gig economy workers instead of full-time employees.

   Similarly, asset-light companies use cloud-based solutions to lower their costs instead of investing upfront in buying servers and other data center related expenses. The more any company can convert fixed costs into variable costs, the closer it is to having an asset-light business model.

5. Faster Response Times: Another important characteristic feature of asset-light business models is the ability to quickly respond to customer requests.

   Even though the requests are serviced by third-party services, the customer-facing business has to take ownership of the service delivery.

   This means that they have to create a system wherein they can quickly pass on the message to a nearby service provider and can also track their performance and service delivery process. The entire supply chain has to be linked by well-designed information systems that quickly and accurately transfer the required information to all stakeholders.

Asset light business models have transformed the way businesses function. These businesses are now present everywhere from grocery shopping to real estate brokers.

Asset light business models are able to utilize the existing setup that small and medium businesses already have in order to provide the last mile reach to the customers.

These companies are highly focused on their competitive advantage which is what makes them highly successful.

Advantages of Asset Light Business Model

1. Lower Upfront Investment: Asset-light business models can be started with significantly less capital. Most of the application-based business models only require the cost of application development and some customer acquisition costs, to begin with. This ability to generate higher revenues with lower investments allows the entrepreneurs and investors to begin small and hence dilute less equity at the founding stage.

2. Scalable: Asset-light business models are driven by intangible assets such as patents, brands, and other intellectual properties. Hence, when the business is expanded, the amount of money, as well as the time required, is very less.

   Asset light business models do not require the construction of factories or warehouses. Instead, they utilize the existing physical infrastructure by adding them to their service delivery network as and when required. This feature is very beneficial to investors. This is because venture capitalists generally provide a small amount of capital to a company.

   Once the company succeeds or shows signs of growing, more capital is pumped in. Venture capitalists are willing to pump in more capital to scale up the business of asset-light companies since the past records show that venture capitalists have gained greatly from this strategy.

3. Agility: The fact that asset-light business models can be scaled up quickly is also a testament to the fact that asset-light business models can be scaled down equally quickly as well. Hence, if a recession strikes and the revenue of the asset-light company starts to dwindle, the company can cut costs in order to stay competitive.

   The asset-light business model provides the entrepreneur as well as the investor with a lot of options to change the scale of the business and the resultant expenses at very short notice.

4. More Stable Profits: Investors are very inclined towards investing in businesses that can provide a stable cash flow. As we have mentioned above that the startup following the asset-light business model can change its expense structure at very short notice. Since most of the costs in the profit and loss statement of such startups are variable, the chances of loss are less.

   Startups lose a large amount of money if their business has a lot of overheads in the expense structure. In such cases, the revenues dwindle but the overhead expenses remain stable. This is unlikely to be the case with asset-light startup companies which is what makes them the darling of investors.

5. Higher Return on Investment: The asset-light business model focuses on controlling the business by having minimum ownership. Only the assets which are critical to the survival of the business are owned by the company. Lower ownership also means lower capital investment.

   Asset-light companies have a pay-as-you-go business structure. Hence, they are able to generate almost the same amount of revenue as companies with regular business models. However, since their ability to generate revenue is almost the same, these companies have a very high return on assets as well as return on investments.

   Asset light business models provide the company a form of leverage that they can use in order to maximize their profits. Investors and entrepreneurs are attracted to businesses with higher profit potential. Hence, they are keen on making investments in asset-light business models.

6. Avoids Diseconomies of Scale: When companies grow beyond a certain scale, management becomes quite difficult. For instance, when a company expands its last-mile connectivity, it is subject to a lot of issues.

   It is not easy to manage a network of hundreds or even thousands of points of sale. The management of these tasks can eat up a significant amount of resources of the company. However, asset-light business models can completely avoid this by delegating the task to the vendors. Managing vendors can also be difficult. However, the time and expense required are considerably less.

7. Transfer of Risks: The asset-light business model is based on the transfer of tasks from the business to external vendors. Companies tend to outsource their last-mile delivery, their computing requirements, and so on.

   It is important to note that whenever an activity is being transferred, the vendor is required to maintain a certain service level. Hence, the risk related to the activities is also transferred to the vendors. This is advantageous for the business since they are protected from many issues such as stockouts.

Disadvantages of Asset Light Business Models

1. Over-Reliance on Vendors: The biggest problem with asset-light business models is that companies that follow such models face an overreliance on vendors. Vendors are independent entities who are seeking profit and oftentimes their philosophy does not match the philosophy of the startup.

   Vendors are the face of the company to the end consumer and provide the final service. Hence, if they are not aligned with the values of customer service, they might resort to profiteering and other unethical means.

   As a startup company grows larger, it has high bargaining power with the vendors. This is because it redirects several customers to the same vendors. However, a smaller company does not have much leverage over its vendors. Hence, it is important for startup companies to be very careful when they select the final vendors who will actually provide the good or service to the customer.

2. Less Standardization of Services: The problem with having several vendors is that maintaining a certain standard of quality is often very difficult. This may not be because of wrong intent on part of the vendors. Instead, it may simply be due to the lack of availability of resources.

   For instance, different vendors providing different types of car repair services may have mechanics of different levels of expertise. In such cases, standardization of services is very difficult and it is quite possible that different customers might have very different experiences with the company which leads to dilution of brand image.

3. Low Barriers to Entry: Before the advent of asset-light business models, a significant amount of capital was required in order to begin any business. This high capital requirement used to act as a barrier to entry. Since a high amount of capital was required, very few people could actually enter into the market. Hence, there was lower competition and higher profits for the existing players.

   However, the possibility of using asset-light models has changed the game completely. It is now possible for small entrepreneurs to use bootstrapping techniques and enter the market. Once they do enter the market, they start using discounts as well as predatory pricing in order to gain market share. This creates a pricing war which ultimately negatively impacts the entire market.

4. Higher Cost of Operation: The entire asset-light business model is based on the concept of converting fixed costs into variable costs. Now, there is no doubt about the fact that this conversion provides the organization with a lot of flexibility. However, it must also be understood that this conversion can lead to more expensive products.

   The scalability is achieved by outsourcing to third-party vendors. These third-party vendors provide flexibility at a cost. For example, if a company has a high scale of operations, cloud-based computing services can prove to be much more expensive as compared to a fixed-price data center. Hence, if a company has a stable business with relatively stable sales, they are better off having a fixed cost-based cost structure instead of relying extensively on variable costs.

5. Lower Quality Human Resources: Most asset-light business models try to lower the cost of human resources. Companies like Uber and Airbnb are notorious for having very few employees. Most of the people working for them are not classified as employees. Instead, they are classified as contractors. Hence, they are not in the purview of employment laws.

   Startup companies are not required to provide benefits such as insurance or retirement funds to these contractors. This may seem like a great mechanism to cut costs in the short run. However, in the long run, high-quality human resources are unwilling to work under this model.

   Asset light business model-based companies generally have a hard time filling up positions across the various levels of the company. They generally face a high turnover of employees across all levels which ends up being more expensive.

6. Risk of Obsolescence: Finally, the entire asset-light business model is generally based on the superiority of some kind of intellectual property.

   Companies like Uber and Airbnb are at the top of their respective fields because they use the latest technology in their applications. Their success is predicated on the technological superiority of their mobile phone-based applications.

   However, it is quite possible that with the passage of time, a new startup may come up with another application that is more superior from a technological point of view. This is where the asset-light-based companies face the threat of obsolescence. They have to invest huge sums of money in research and development and have to constantly be ahead of the game at all costs.

The aggregator business model is a relatively new form of business model. Hence, it is not deeply understood by the average person. In this article, we will demystify the aggregator concept and try to explain it in layman’s language.

What is an Aggregator Business Model?

The aggregator business model is a by-product of the information age. With the internet boom, information became abundant. Many different types of service providers started providing their services online. However, customers did not have the time, inclination, or the know-how to search the internet in order to find the best deal for themselves.

As a result, the aggregator model came into being. The aggregator is simply a website that creates a brand and also creates partnerships with the actual service providers. The job of the aggregator is to collect information from various service providers, display them on their websites and sell the product. The actual job of providing the service is done by the service providers.

From the customer’s point of view, aggregators help them avoid the hassle of due diligence. Any service provider listed on the aggregator’s website has generally been vetted to ensure a basic level of service quality. It is common for aggregators to try to standardize various elements of service in order to provide a standardized experience. Hence, customers can be assured of a good service experience because of the brand association.

It is also important to note that all service providers on the aggregator’s website are actually independent entities. They are not employed by the aggregator. Hence, they are free to make their own choices. They generally decide to associate with the aggregator since they can provide more business. Some aggregators may allow service providers to continue their own independent business whereas other may require the service providers to exclusively serve their customers.

How does a Typical Aggregator Model Work?

1. When a founder tries to set up an aggregator business, the first thing they need is partnerships. Hence, the process starts with contacting as many service providers as possible. The aggregator then tries to convince the service providers that they can help their marketing efforts by bringing in more customers. The end result of this outreach is that a partnership agreement is signed between the service provider and the aggregator.

2. The founder has to build economies of scale. This means that they need several service providers to enroll with them before they pitch their service to customers. After all, the modern-day customer is spoilt for choice and hence is unlikely to spend money where they are not offered sufficient choice.

3. Once a certain scale has been reached with respect to the partnerships, the aggregator tries to create a brand. This is done by undertaking huge marketing campaigns. It is common for companies to deploy huge budgets for marketing. The idea is to make the brand name a trusted household name. This large-scale marketing allows the website to attract more customers than individual service providers could do.

4. Founders also need to build a system that allows them to enable seamless communication between the service providers and the customers while being in the loop themselves. Once the customer places an order, the entire service delivery process needs to be managed through the aggregators’ communication system.

5. Once the customer makes a payment after availing of the service, the money goes to the aggregator. The aggregator deducts a certain amount as commission and pays the rest to the service provider. Aggregators generally do not pay the money immediately to the service provider. Instead, they hold on to the money for some time and pay the service providers at specific time intervals.

How Aggregators Add Value?

Aggregators create value for two sets of customers. The details of both are as follows:

1. The first set of customers is the actual users i.e. the customers of the service providers. Aggregators create value for these customers since they promise good quality service delivery at a fair price. The customers have access to competitive quotes from several suppliers at the click of a button. Also, they have the assurance of quality guaranteed by the brand name. If the service is not of the expected quality, then they have a grievance redressal mechanism as well.

2. The second set of customers for the aggregators is the service providers. Aggregators add value to the service providers by marketing on their behalf. Aggregators allow the companies to focus on execution while outsourcing the marketing function. Also, aggregators are able to generate economies of scale. Since their advertising and marketing efforts are so huge, they draw in customers in large numbers. The service providers get access to these customers and are able to thrive if they provide good quality service.

The bottom line is that aggregation-based start-ups are available in almost every industry and in every part of the world. There are companies that aggregate all types of products and services right from household cleaning services to complex medical services.

The poorly managed start-ups face severe cash flow issues during such recessions. A lot of these start-ups end up closing down during such recessions.

It is important for the founders to understand that the external economic climate can change at very short notice. Therefore, it is important for them to build a recession-proof start-up.

In this article, we will have a closer look at the various steps that start-ups can take in order to ensure that their start-ups are able to survive the downturn.

1. Structure a Scalable Business: It is often said that a successful business is built even before there is a business. The same can be said about a resilient business as well. There are certain types of companies that are better at surviving downturns as compared to other companies. These companies begin their operations with very low overheads. All their costs are related to the actual manufacture of products. Hence, in a downturn when production is reduced, the costs also go down.

   Start-up founders must find creative ways to ensure that overheads are kept very low. Nowadays, a lot of start-ups have started embracing the work-from-home culture. This allows them to avoid the costs of renting a large office space in an upscale building. Similarly, many other techniques are used to ensure that the business remains asset-light and does not have any debt payments.

   There are many start-up companies that do not deploy full-time employees. Instead, they use the services of freelancers till the time the company does not have stable revenue. This might seem like a wastage of money when the going is good. However, the company is not obligated to pay freelancers. They can terminate the services of freelancers whenever they want. This flexibility helps founders perform better during the downturn.

2. Cut the Cash Burn Rate: There are many start-up companies that focus on growth instead of profitability. They want to capture the market share before their competitor is able to do so. However, this strategy can cause failure during a downturn.

   During a recession, all the players in the market are generally short of cash. Hence, it is unlikely that any of these players will try to capture more market share. Hence, start-up companies should try to focus on improving per-unit profitability. This will allow them to reduce the rate of cash burn. If the company is burning cash at a slower pace, then it can use the same amount of money for a longer time duration. This helps the company survive longer without receiving any funding during the downturn.

3. Survive with Downrounds: It is important to realize that a stock market crash generally accompanies a recession. This often means that a lot of the funds are trying to sell their holdings in order to cover their positions in the market. This leads to an overall outflow of funds from the equity and debt market.

   The market for investment in start-ups is even more impacted because of downturns. Investors are not looking to make further investments. This can be detrimental to a start-up that may require more cash just to pay its bills. Start-ups cannot wait for a long time and hence they do not have sufficient bargaining power.

   Hence, start-up founders must be more flexible. They should be willing to accept a lower valuation and give more equity to investors if they want to survive. Being fixated on previous valuation numbers can jeopardize the survival of start-up corporations.

4. Use Alternative Funding: It is common for start-up funding to reduce during an economic downturn. Start-up companies must try to survive without going in for a funding round. There are some sources of alternate funding such as revenue-based financing which can be considered by start-up firms during such stages.

   It is important to note that the interest rates will generally be high during this period. Hence, it is possible that the start-up may have access to debt. However, it is of utmost importance to ensure that the debt is utilized sparingly. Many start-up companies have taken on a lot of debt during an economic downturn only to go bust at a later stage.

5. Cut Costs: Last but not the least, start-up companies may have to cut costs to stay afloat. However, companies need to be careful which costs they cut. If they reduce the perks of all employees, the company may not face such a big backlash.

   However, if the company tries to lay off a large number of people, it may attract a lot of negative publicity. The same company may find it difficult to attract quality human resources at a later stage. Hence, the company must try cutting all other costs first. Layoffs must only be done if there is no other alternative left.

A recession can be the litmus test for a start-up. Companies that were not built on a solid foundation will fail whereas those that were built on a solid foundation will survive and prosper. In fact, in many cases, an economic downturn can turn out to be a catalyst that can spur growth.

For many years, participants in the real estate market have had to deal with this uncertainty. However, Zillow saw an opportunity in this uncertainty.

Zillow created a business model which helps buyers, as well as sellers, crack better deals. As a result, Zillow has now become a household name in all of America. Even though the company began in the year 2004, it has quickly gone on to become a $12 billion company.

In this article, we will have a closer look at what Zillow is as well as the story behind the Zillow model.

What is Zillow?

Zillow is a real estate marketplace that aims to provide buyers, sellers, and other intermediaries, with accurate information about the real estate market.

Zillow maintains one of the most comprehensive real estate databases in the United States of America. Zillow has also spent a lot of money on technology. As a result, Zillow is able to use this vast database as well as big data technologies to provide the most accurate data related to the market.

Zillow provides a proprietary tool called Zestimate on its website. This tool is used by buyers and sellers to determine the price of a property. Over the years, the tool has become so accurate that the Zestimate value is considered to be a benchmark and is used as a data point to start the bidding process.

Zillow provides several different facilities to its users. Some of these facilities have been listed below:

• Zillow allows users to view properties from foreclosures and other such distressed sales. This makes it possible for the buyer to obtain better deals.

• Zillow also maintains a database of agents that they have already vetted. Hence, if buyers want to deal with a real estate agent in a particular zip code, they can use the ones suggested by Zillow since a background check has been performed on those agents

• Zillow also provides leads for several other service providers such as mortgage brokers, packers and movers, and other such service providers.

  The end result is that four out of every five homes which are listed on the real estate market in America have been viewed by buyers on Zillow! Zillow knows the pulse of the American real estate market. They also create detailed annual reports for property trends in various neighborhoods across the country.

How does Zillow Generates Revenue?

Zillow has been quite innovative when it comes to revenue generation as well. Zillow has several revenue streams which it uses to generate cash flow. The details of some of these revenue streams have been mentioned below:

• Zillow generates a significant portion of its revenue from the rental section. Zillow allows landlords to place listings on their websites. Landlords can then accept applications through this website.

  Zillow provides all the information about the tenants on the same interface. Zillow also provides an option for landlords to accept rental payments via Zillow. This service is free for the landlords. However, tenants have to pay a $29 fee to access this service. Since all the best rental listings are available on Zillow, tenants do not mind paying the $29 fee!

• Zillow also generates revenue by offering its space to property management companies for advertisement. As mentioned in the point above, Zillow has a significant number of prospective tenants on its website. Hence, companies whose main business is to rent out apartments are willing to buy advertisement space at high prices on this website. This helps Zillow generate significant revenue

• Zillow also has a premier real estate agent program. Real estate agents have to pay a fee to Zillow in order to join this program. Zillow suggests customers to use the services of a premier agent. This helps the agent obtain more business which is why they are willing to pay a higher fee.

  Zillow also guarantees a certain number of views per listing for premier agents. These views are targeted views and belong to a specific zip code. Also, Zillow charges these premier agents based on the number of views that they have provided.

• Since Zillow is a huge platform for home sales, mortgage lenders also find it to be a good place to advertise their products and services. Zillow charges these mortgage lenders on the number of clicks as well as views that it generates. Since clicks and views translate to sales, mortgage lenders are willing to pay top dollar to advertise on Zillow.

• Zillow also offers software solutions for landlords, premier agents, and other players involved in the real estate ecosystem. Zillow sells these facilities as a cloud-based service. Hence, users have to pay only when they use the service.

• Zillow has taken over a mortgage lending company. They have rebranded the company to Zillow home loans. As a result, Zillow originates some of the loans for properties sold on their website. Loan origination is also another source of revenue for Zillow!

The bottom line is that Zillow was once an obscure start-up. However, after several rounds of funding and an initial public offer, Zillow has now come to dominate the American real estate market! This is the reason that Zillow acts as an inspiration for many entrepreneurs in the United States and across the globe.

Ideally, when a company becomes a unicorn i.e. achieves a valuation of $1 billion, then there shouldn’t be any chances of failure. However, surprisingly even unicorn companies fail. Many times, they end up causing a lot of damage to the investor’s funds as well. Hence, it is important for investors to understand the reason why unicorn companies fail.

Why do Unicorns Fail?

It is important to understand the common reasons behind the failure of unicorns in order to be able to predict these failures.

1. Overvaluation: The number one reason behind the trouble faced by unicorn companies at later stages is overvaluation at early stages. There is a glut of investors in the private market who are willing to buy in the hype and invest huge sums of money in startups that do not have a proven track record. A lot of times, this leads to unicorns succumbing below their own weight.

   Companies often try to convince investors that they will achieve dramatic growth in a very short span of time. It is not uncommon for unicorns to claim that they will grow the company at the rate of 15% per week. This immense speed comes at a cost. Often this leads to large-scale mismanagement in the company. Of course, scalability is an important aspect of the business model of startups. However, there should be reasonable assumptions, or else the growth process can turn into an operational disaster.

2. Increased Cost of Acquisition: A lot of startup companies are working on very thin margins. This is because they price their products abnormally low in order to gain customers. At earlier stages, they tend to incur a loss. However, at later stages, the company tries to raise prices to recoup its losses. Companies still do not have pricing power and hence keep the price of their products abnormally low. Such companies are dependent upon keeping the cost of customer acquisition low. If the cost of customer acquisition rises even a little bit, then the company tends to go underwater. Also, if the market is close to saturation, then it is normal for the cost of customer acquisition to rise. Hence, these companies are prone to financial turmoil at later stages.

3. Difference in Investor Mindset: A lot of unicorns fail since they are not able to make the transition from privately-owned companies to publically owned corporations. The world is full of examples where the stocks of privately-owned companies have tanked after their public listing. This is because public investors evaluate investments in a completely different manner as compared to private investors.

   Public investors tend to focus on value which is found in the financial statements. On the other hand, private investors tend to focus more on the future. They believe more in the dreams being sold about the potential that the company has to change the world. Startup companies need to go public only after the transition is complete. If the company is not able to justify its valuation based on the numbers in the financial statement, then its stocks will be pounded in the open markets.

Predicting the Failure of a Unicorn

It is common for unicorns to list on the stock exchanges. However, some of them succeed whereas the others fail. Investors need to look out for some of the symptoms which are an indicator that a startup might fail.

1. Stagnating Employee Counts: Investors need to keep an eye on the employee count of the startup company. It is very difficult for a startup company to grow at 15% per week with a stagnant workforce. Hence, a rapid increase in the headcount is often an indicator that things are going well. If the company stops hiring people or slows down the rate of hiring, it often means that the company has run into some kind of trouble. This fact can be used by an investor as an indicator to predict the success of startup companies.

2. Declining Social Media Attention: The brand value is a large part of the overall value proposition of a startup company. This is largely because startup companies are generally customer-facing corporations and hence need to be continuously connected to customers. Declining social media attention could often be the result of budget cuts. Since lesser customer engagement is often bad news for a startup company looking at rapid growth, budget cuts in this area often mean that the company is heading for trouble.

3. Secured Excessive Funding: As a company obtains a higher amount of funding, it should actually be close to becoming profitable. However, if a company has already raised millions of dollars and is still no closer to turning profitable than it was on the first day, then the company is surely headed for trouble. Hence, investors must try to steer clear of such companies.

The fact of the matter is that all types of companies are prone to failure and unicorns are no exceptions. Investors must be aware that sometimes the hype surrounding a unicorn can turn out to be just hype that is not backed by any substance.