Prototyping Growth in Technology Ventures: A Practical Approach

• Author: Luis E. Pereiro
• Date: 01 November 2016
• DOI: http://doi.org/10.1002/jcaf.22207
• Published date: 01 November 2016

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© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22207

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Prototyping Growth in Technology

Ventures: A Practical Approach

Luis E. Pereiro

When model-

ing cash

flows for a

company approach-

ing stable growth, it

may be quite reason-

able to use a five-year

horizon. But such

length is way too

short for technology

start-ups—which

usually take decades

to realize their full

potential. Estimating

long-term, multiyear

forecasts, though, is no small

feat. Indeed, a favorite topic of

conversation among venture

capitalists and entrepreneurs is

the difficulty of estimating cash

flows for start-ups that will

operate in volatile, technology-

based industries—like biotech-

nology, software, or mobile

telecom equipment. How

does one figure out the future

performance of a high-tech

start-up over an extended time

frame? In this article, I sketch a

technique called growth proto-

typing, which goes a long way

toward solving the challenge.

PROTOTYPING: DEFINITION

AND IMPORTANCE

A prototype is a plausible

growth model based on empiri-

cal evidence—namely, a pat-

tern of evolution, rooted on

solid evidentiary basis, which

can be parameterized pre-

cisely along the dimensions

of time and money. Exhibit 1

displays an example—a cash

flow prototype for a private

equity fund of funds. The pro-

totype’s parameters are use-

ful, for example, to a general

partner who is trying to explain

to limited partners

(i.e.,the capital

providers) what pay-

ment schedule can be

expected from that

type of investment.

In the venture

capital industry, pro-

totypes of revenues

and cash flows (the

latter defined either

at the level of the

firm or the share-

holders) are the key

to answer four cen-

tral questions that arise in the

design of an investment deal

between entrepreneurs and

investors:

• Amount of funding. A cash

flow (CF) prototype tells

how much funding a new

venture will require—that

is, the cumulative invest-

ment until breakeven.

• Timing of funding. The

time schedule embedded

inthe CF prototype spells

out the precise dates at

which the funds will have

to be injected.

A prototype is a plausible growth model that can

be parameterized precisely in terms of time and

money. Prototypes can be used to determine how

much money is needed to fund a start-up, how

much the venture will be worth at exit time, and in

which way its ownership should be split between

entrepreneur and investor. This article explains

how prototypes are constructed and illustrates

how they are used in the financing planning of

technology ventures. © 2016 Wiley Periodicals, Inc.

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