The Basic Function – ROI
A common phrase echoes in the conference halls of the ABLC: “My biofuel technology has a great ROI.” Entrepreneurs base their claims on a pro forma, a projection of future cash flow calculated on spreadsheets. Even though the business planning process starts with the pro forma, the value of the ROI, itself, does not mean very much, despite the optimism of the project owner. A business case must be described in the pro forma which yields an ROI that exceeds the risk of the project. The pro forma analysis is simply an initial screening tool for investors to quickly learn if the new-technology project is worth their time and trouble (and, potentially, investment of funds).
Navigating the Technology Valley of Death
The ROI is just the tip of the iceberg of the pro forma. Entrepreneurs (and investors) wish they had a road map to identify the safest route through the proverbial technology valley of death (Figure).
Figure. The Technology Valley of Death for Emerging Biofuels
(white line – # of ventures; yellow line – cash flow; common sources of funds at each stage of development – founder, F&F [Friends & Family], Grants, Angel investors, Venture Capital)
The pro forma is a teaching tool for entrepreneurs to learn how to navigate through the treacherous valley by providing guidance to critical questions, including:
- Is the project viable?
- What are the risks?
- What should be done next?
- Where should R&D and technology development efforts be focused?
- Is there a better way to be spending limited resources?
- How much can the process afford to pay for the biomass?
- How much capital can be supported by the cash flow?
- How much debt can be handled?
- What scale is necessary for the technology to be profitable?
- Where should the first plant be built?
- What is the fastest route to positive cash flow?
The Design of the Pro Forma
A common format is a static pro forma, where the financial results are displayed only as values, or formulae with locked input cells (i.e., the entrepreneur cannot change the input values). The results are restricted to one scenario by the design of the spreadsheets. On the other hand, a dynamic pro forma has the financial results displayed as formulae, which grab data from unlocked input cells (i.e., the entrepreneur can change the input values).
When do you produce a pro forma? It should be prepared very early in the development of the project. Afterwards, it is updated continuously, which is easy to do in a dynamic pro forma, a living document to:
- Change inputs when new information becomes available
- Examine a What-if Analysis
- Perform a sensitivity analysis.
An analysis of the dynamic pro forma does not simply look at the numbers, but at what is behind the numbers. What then emerges is a map on how to avoid some of the hazards of the technology valley of death, which increases the odds of project success.
About the Author
Gerald Kutney is a Director of Lee Enterprises Consulting and Managing Director of Sixth Element Sustainable Management in Ottawa. He has a Ph.D. in chemistry and over two decades of executive experience with global corporations and entrepreneurial enterprises in the forest bioeconomy. He specializes in dynamic pro forma design and analysis.
The opinions expressed in the report are those the author and do not necessarily reflect the views of Lee Enterprises Consulting.