Wednesday, October 30, 2013

Linkedin Q3 earnings results

This post is part of a series of documenting the eventual implosion of Linkedin's stock price, updated on a quarterly basis.  Last quarter's post

Q3 results

  • It lost $3.4M in the quarter.  About what it guided last quarter.
  • While it beat its own revenue guidance by $20M, it provided no benefit to its income.
  • Page views and visitors dropped despite a 17M increase in members
  • Its slideshare subsidiary had an even sharper drop in visitors and page views..
Q4 guidance
  • It is guiding only 40% increase in revenue over last year for the last quarter.
  • The lowered guidance from Q2 for Q4 is restated.
  • It expects a drop in page views and visitors again.
  • It expects another loss in Q4
  • Full year earnings per share will be lower than last year, despite a >50% full year revenue increase.
  • It will have increased total diluted shares to over 120M, from 112M last year (~8%)
Speculating on why it remains unprofitable no matter its sales.
  • Many of its new members may be ghosts.  
  • Lawsuit this quarter alleges what is already widely known:  Linkedin hacks into your contacts and spams (sends) invitations on your behalf to everyone there.  
  • The spam can trick children into signing up with some difficult red tape to removing the account.
  • It has lowered its member standards to target 14 year olds so that they may link with colleges.
  • Even with its poor reputation for email ethics and privacy and systems safety, it has launched a mobile email service that grants linkedin full access to all of its users incoming and outgoing email
  • That it beats its own guidance for EBITDA but never for income effectively proves that it is either padding its revenue, or just pays its employees larger stock bonuses as a function of that increased revenue.
The shady marketing practises exposed this quarter would be a likely explanation for an increase in members without an increase in visitors and pageviews.  Arguably, assuming the 17M new members all were unique visitors during each month, then linkedin lost 17M unique visitors from its previous members.

Revenue per user dropped to $1.52 from the previous quarter.  That further supports the premise that they are running out of marketable new users, and perhaps just padding their user numbers with shady practices.

Market cap of $30B is impossible
120M shares at $250/share is not sustainable, because it presumes an evental $3B annual profit.  It previously stated its addressable member market as 500M members.  It is over 50% penetration.  While many of its members view it as legitimate as viagra penis enlargement ads, the first 50% penetration is necessarily easier and more potentially profitable than the last 50%, because the first 50% include those that find the service obviously useful.

There is still no evidence that the recruiting fees market worldwide is over $4B in sales.  This also acts as a significant barrier to its future earning potential.  Until proven otherwise, its sales potential should be limited to 2 or 3x current levels.  Even if it stopped paying its management so much, and tripled its non-GAAP profit, as profit available to shareholders, $600M per year, is $5/share in EPS.  A $50/share price target.

For the first time in their conference call last night, they mentioned thinking about the full 3B workers in the world as opportunity.  They are not making a profit on the core 250M people that currently find their service worthwhile enough to sign up, and are generally (higher paid) knowledge workers.  Theoretically these members should be more profitable than the marginal new member.  They currently earn $6/revenue (annual) per member, and 0 profit.  Acquring 3B users will be a significant cost, and continuous reinvestment of any contributions from profitable members into storing new accounts that are likely to just take up server space, and be annoyed by emails filling their viagra box.  It expects $135M in depreciation costs this year.  This is mostly computer and technology infrastructure costs.  Increasing users 10 fold will increase those costs 10 fold beyond LNKD's already steep user acquisition costs, and by doing so, it will arguably be chasing users that are even less profitable than its existing user base.  Furthermore any future reduction in costs/performance of future computers is offset by the database operation (computing time per operation) costs that will typically rise 100 fold with a 10 fold increase in database size.

EBITDA and NON-GAAP earnings is not a useful metric
Financial analysts that place any weight on non-GAAP earnings or Earnings Before Income Tax and Depreciation for linkedin make a grave error.

Unlike capital intensive companies such as airlines,  mineral extraction, or car plants, which generally pay a large amount to start a project whose costs get depreciated slightly each year, Linkedin's depreciation expenses is for ongoing computer upgrades and expansion, and these costs are generally depreciated very quickly, and in some jurisdictions are allowed to be expensed.  Unless we expect it to stop renewing its computer infrastructure, their depreciation costs should be a core part of their operations and earnings.

Linkedin also adjusts EBITDA to exclude the significant stock based compensation it awards itself.  Almost $200M this year, leaving profit for the year of a little over $20M.  The dilution this stock compensation creates directly harms any shareholder who is not receiving compensation from LNKD.  Because of the dual share structure that keeps solid control of the company with insiders, there is no possible pressure that would change its compensation policies.

Other anaylyses on LNKD
Commenting after LNKD issued over 5M shares in a secondary offering this quarter, was this detailed long term projection for the company and a resulting company value of $12B and $106/share.

Most of the numbers are quite fair and optimistic at the same time.  The one major error in the analysis is assuming only 112M shares outstanding over the next 20 years.  LNKD is already up to 120M shares, and an optimistically low number of new shares would be 1M per quarter, and that results in 200M shares outstanding in 20 years.  So a $12B eventual company value is only worth $60/share.

The other major issue with the $12B valuation is relying on operating income that excludes depreciation and stock compensation, and so for the next 5 years overestimates earnings by 7x.  So the $12B valuation relies on income that is likely to never be available to shareholders.

The major issue with social media valuations
Assumptions of $10B-$30B valuations on social media companies like LNKD or Twitter assume a world where users are monetized aggressively, and the users don't mind being monetized.  There also tends to be an assumption of a world where advertisers want to pay very high prices, and sell themselves on spending their money, and the social media company just has to staff enough people to answer phones and return email in order to collect all of that money.  Analyst valuations should be more considerate of the uncertainty of these assumptions.

A followup with Facebook (FB) confirming the above point
FB reported earnings a day after LNKD.  Impressive sales growth of over 60%, based on the strength of growth in its mobile advertising.  Much better than LNKD, However, they warned that there is not much more advertising that they can show users, and so their future growth is limited.

Friday, August 2, 2013

Linkedin in Q2, 2013 earnings (LNKD)

Linkedin reported Q2 results last night, and the results should be interpreted negatively considering that there is no improvement since the previous quarter.  This is an ongoing series of articles where each quarter I track LNKD's results in an effort to chronicle its eventual collapse.  Here was last quarter's article.

The one positive aspect of their results is that user growth and views was steady, and revenues were a few million higher than they told us to expect.

Real earnings vs. Adjusted EBITDA
Real earnings, GAAP net income, was about break even, and the same as last year: $0.03 per share.  The company, and analysts, like to focus on adjusted EBITDA instead of earnings, but depreciation is a real expense for the company as long as it will replace its computers one day, and the even bigger expense they "hide" through adjusted EBITDA is the massive stock based compensation.  Both its compensation program and depreciation are expected to continue, and they affect shareholders.  Only GAAP net income should be considered.

Of note, it had forecast a profit of 0 for the quarter.  With revenue of $16M higher than forecast, it only made $3.7M.  Another reason to consider only net income as relevant is that it is always possible to increase sales without making any money.  Income from operations was down 35% from 1 year ago.

Growth slow down
Year over year revenue growth dropped to 59%.  It was 72% the previous quarter, and 80% the one prior.  This type of slow down should be reason for a drop in stock market price.

Lowered guidance for rest of the year
The high end of its guidance for Q3 is for 48% year over year revenue growth.  The high end of their earnings expectations is a loss of $4M in Q3.  These are poor expectations that should reflect poorly on the stock price.

Linkedin lowered (slightly) its guidance for Q4 compared to guidance at the time of last quarter's results.  Previous top end revenue guidance was $1.46B, but after beating this quarter's revenue estimate by $16M, it raised its full year revenue guidance by "only" $15M to $1.475B.  Its forecast for Q4 is revenues of $413.7M is only 36% YoY growth.  Q4 top end expected profit is (Adjusted EBITDA is expected as $100M) $14.7M, with full year expected profit of $37M.  $14M of that profit will be from special tax rebates from Q1.

These are very poor forecasts compared to its valuation approaching $28B, and a very rapidly declining growth rate.

Under best scenario, LNKD is worth $10B ($90/share) in 10 years
If Linkedin is ever to deserve a market value of $10B, it will need to one day reach net income of $1B.  In 2023, that means 20 to 30 times its 2013 income.  To understand why that would be an exceptional success you have to ignore growth rates.  Using its peak growth rate, we could project that the roman empire would cover earth 20 bazillion times by now.

For Linkedin to triple its sales to $4.5B in 10 years would be a spectacular success.  Not only is that higher than the $3B total recruitment market estimated in 2011, which I addressed last quarter, there is a couple of other reasons to see it as a ceiling.

Jeff Weiner (LNKD CEO) said yesterday that the company has a 600 million user addressable market of knowledge workers.  That is its maximum number of users.  As of this quarter LNKD is already past the 1/3 point with 238M users.

MWW (Monster jobs) reported earnings in the morning, and though its revenue keeps dropping 10% YoY, it made 3 times the earnings of LNKD ($9M).  For what is likely the first time, LNKD's talent solutions revenue has surpassed MWW's revenue.  While its reasonable to hope that LNKD will continue to grow at the expense of MWW, that growth will get even more difficult and expensive.  If it already has half the market share, hoping that it can grow much more than double is too optimistic.

Even if it manages to increase sales 3 times, it would still need to increase profit margins another 6-10 times in order to successfully hit a $10B market value.  It would do so through some price increases, firing sales people, stopping its content purchases, user acquisition costs, server infrastructure, service improvements (development), huge stock compensation, and funding whatever mysterious force keeps their stock price up.

The problem that occurs for LNKD whenever it actually does make money, is that someone else can start a stock hype scam that offers recruitment services without making any money.  The someone else can be fired salespeople, and developers disgruntled they are no longer showered with stock option candy.

Its also possible to get an optimistic 3 times sales rate in 10 years by projecting LNKD's growth rate out.  A flat 30% annual growth from 2013 levels will hit exactly 300% in 10 years.  That is a reasonable projection of its ongoing growth decline.  Because LNKD has been spending so heavily to chase its existing growth profile, its hard to see it achieving these growth levels while also becoming profitable.

Linkedin's sales are almost 7 times what they were in 2010.  Its profitability this quarter was less than in Q2 2010, and its unlikely that next quarter will beat 2010 either.  Its fine to hope that the next 3x in sales growth leads to at least 3x income, but its hard to see LNKD's culture change to stop paying its insiders so much.  It needs to raise income by 30x, not just 3x, in order to justify a $10B market value.

Market reaction to results
All of the issues with LNKD's slowing growth (among others) were apparent last quarter, and the company provided no guidance of any improvement in the next 2 quarters.  After last quarter's results the stock fell to about $170/share.  So, there is no coherent explanation for it to trade near or over $200 after these results.

2013 may reach close to triple 2011 sales for LNKD.  Excluding the Q1 tax breaks it received, LNKD is projecting full year net income below that of 2011.  Just because it may beat low expectations doesn't mean its stock price should be rewarded when they are set that low, and fundamentally, we need to wonder what sales levels might lead to profitability.

DICE holdings
DICE (DHX) is also in the online professional communities business with a focus on recruitment.  It is about 1/7th the size of LNKD, but its Q2 profit was more than double that of LNKD ($8M).

The stock based compensation issue
LNKD had expected $49M this quarter, and came in just under that by less than $1M.  It expects Q3 stock compensation of $49M and Q4 of $52M.

The headline (non-gaap) earnings exclude these expenses and look better because of it.  But it is a cost paid by existing shareholders.  The $10B optimistic future market valuation worked out to $100/share just last year, when there were 100M shares outstanding.  Current shares outstanding are near 117M.  If somehow shares stop growing past 120M (around the end of this year), a $10B total value would mean $83/share.

There is reason to believe that stock based compensation will never come down.  Linkedin has a dual-class share ownership structure where only the insiders have voting power.  There is strong incentive to award themselves extra stock.  While the company is projecting stock compensation to grow slowly, this is still growth in stock compensation while the company's sales growth is rapidly declining.  The best we can expect from Linkedin's management is for stock compensation to plateau.

Tuesday, July 23, 2013

Mathematically splitting ownership (sharing) of a car/coffee maker or any other resource

Sharing a car can either be simple and unfair, or fair with any mathematical complexities managed through software applications.  This paper is using some simple every day sharing to illustrate important finance/organizational breakthroughs that apply and extend to the most complex organizational and social resource management purposes.

Principles of fair ownership of a resource
  • Equal partnership or decision power: Any minority or less than equal decision power is equivalent to no decision input
  • Paying to the partnership per use, with competition for use handled by a bidding process.
  • Sharing of proceeds when resource is sold.  Sharing of proceeds from use fees.
  • Sharing of fixed costs such as insurance, storage, repairs.
  • Minimum use fee related to depreciation, maintenance and fuel associated to use.
  • Process for adding/removing partners either through bidding or some other determination of value.
Issues with sharing a car
Sharing a car (or plane/tractor/house/TV) has many potential inconveniences (costs) with the main offsetting benefit of lower individual partner expenses.  The main issue is that Friday nights and weekend carry much more desired use than Monday's 2am-4am, or Tuesdays 10am to 3pm.  Bidding for access to a resource allows for perfect utilization of that resource.  Because everyone is an equal partner, then losers of a bid receive their share of a winner's bid.  People who can schedule trips at off peak times can likely be able to the minimum use fee for actual costs related to use.  Bidding provides a contractual solution to shared resource conflicts.  The alternative of allocating the resource to those who nag, complain or yell the most is not a contractual (deterministic) resolution process, and the alternative of fixed time blocks is less flexible, and doesn't account for individual (potentially shifting) desirability for certain time blocks.

Details of use bidding process
* bids exclude the cost per mile (minimum use fee)
* If someone wants to use the car from 2-5, while someone else wants it from 4-10, they need to outbid each other for the entire block.  Other bids from 5-7, and 7-10 would help the bid from 2-5.  Whichever adds up to more total revenue to the partnership would win.
* If someone absolutely needs to know that they have control of the car on the 3rd saturday of august, or next saturday, or tommorow, then they would pay a fee (to the partnership) based on the length of time that other bids are blocked.  The fee levels can be preagreed and/or reviewed by partner vote for exceptional cases.
* If someone wanted to take the car on vacation for 2 weeks, he'd need to outbid for the whole 2 weeks any bid for a single hour in that period, or make a proposal to the full partnership for the 2 week block.  Even if someone really wanted the car for a few hours in the period, there is likely significant revenue potential for the partnership in allowing the 2 week block rental, that the partnership would accept a reasonable offer.
* Every partner is assumed to have the alternative of commercial car rental options, and so there is a cap to how much anyone will pay the partnership for use, and there are opportunities for those deprived (outbid) for the use of the car.
* Partners would be allowed to resell their time slots/reservations.
* If a booking is to end with the car transferred to the next driver outside of normal dropoff locations, then those 2 drivers should make a joint booking covering the full time that the car is to be away from normal accessible pickup locations.  They agree among themselves on how to split the total costs.
* A policy to deal with drivers that are late in returning the car after use would include paying the partnership the higher of their hourly rental fee or the next partner's hourly rental fee, and pay the next partner the same amount for his inconvenience.
* The partnership might allow non-partners to rent the car.  Charging a higher per mile fee based on increased risk of irresponsible care or theft, and insurance.  Partners might be given a $2/hour or $10/day bidding advantage over non partners.
* If a partner is a victim of a crash while using the car, then regardless of whether he is at fault, he would be asked to pay the full share of any insurance premium increases, and a high portion of any deductible.  Some inner-partnership tribunal may reduce such penalties for instance out of fairness or partnership's failure if the cause of crash is say brake failure or worn tire blowout or zombie attack.  

Work/chores surrounding the car
Gas costs would be included in the per mile minimum use fee.  Filling up the tank might be an expected volunteer activity, or the partnership might pay any partner that chooses to refill the tank when it is under half full a fixed amount (say $1).  The actual cost of the gas would be treated as if the partner gave that amount to the partnership, and offset any use fees he has.

Changing oil or tires, cleaning the interior are all jobs that likely many partners would be qualified to do.  A bidding process among partners together with commercial non-partner alternatives if they seem better than the bids received would determine who gets to do the job.  The cost is paid by the partnership, using the per mile and rental revenue.

There may be a partner who is qualified to conduct advanced mechanical repairs.  And hopefully a few that are qualified to understand/supervise the process.  Bidding to supervise/approve repair jobs either from commercial outside or internal partners would be similar to bidding to do an oil change.

Motivation to share ownership of a car
A car can be useful, and you are unlikely to require it 24/7/365.  The main reason to share ownership is to have access while splitting the costs.  There can be several variations in individual motives, and these variations can cause conflicts or symbiotic benefits to partners.  One generality though is that every partner prefers that every other partner want to use the car in different ways than they do.

Investor:  Someone who doesn't use the car at all could make money from the ownership.  He only pays for his share of parking and insurance, and unexpected repairs.  If many other partners compete to use the car, the investor's share of those revenues could be well above  his costs.

Mechanic/worker: Like the investor, the car could be a source of work/income to a mechanic.  Other partners could subsidize their car use by ferrying the car to and from other partners.

Light flexible users: By scheduling their trips only when other partners don't request the car, they'd pay only the minimum use fees related to fuel and depreciation/maintenance costs of the car.  Car poolers who just want to use it to get to and from work in a common area of town receive a convenient and innexpensive means of travel to get there that they both subsidize for other owners, and have their use subsidized as well through bidding exchanges.

Heavy users: Those monopolising the resource by outbidding everyone else for prime time use, and blocking off entire days pay much more than other partners, but they pay much less than if they had to own the full car, and pay all of the parking, insurance and repair costs.  They also share in the revenue from the car when they are not using it.

Conflict and opportunities among motives
Heavy users will get frustrated if there are too many of them conflicting for the same time slots.  Investors may be delighted by this.  An obvious solution to the conflict that is in the interest of the heavy users is the partnership acquring a 2nd or additional car.  If the conflict persists, then the partnership will be collecting high rental fees, and so has the funds to acquire an additional car.  While it is possible that a majority of partners would have investor motives, and so it might seem wise to pre-agree conditions upon which the partnership would aquire additional cars, its actually unlikely to be necessary.

The primary motive for entering the car sharing is very likely to include some desired access.  There are likely  better pure investment alternatives.  The mechanic/worker motives would definitely favour acquiring a new car.  The light users if their motives are mainly "free" use of the car would also favour acquiring a new car if their access is getting crowded out by additional users.  A major advantage to the partnership of a 2nd car is redundancy in having a backup when the main car is being repaired.  If access to the car(s) is too conflicted, then the partnership is unable to attract new partners.  New partners inject cash directly into existing partners pockets by paying for (a share of) both the current worth of the car, and regular costs of parking/insurance/repairs.  Since the natural purpose of the partnership was to have access to cars, there is a very strong confluence of interests to maintain access to cars, and so have the partnership acquire an additional car when needed.

Another reason that pre-determining conditions for a new car acquisition may not be necessary, is that any group of partners can individually form an additional partnership for a new car using the funds from their share of the cash stash that is created in the partnership as a result of competitive use of the car.  Also, most of the existing partners are likely to want to join the new partnership anyway.  Even investment-motivated partners that want to block a new car acquisition on the grounds that it harms the profits of the existing partnership's intensely competitive car use, would see opportunity for the same to arise eventually in the new car's partnership.  Having a single partnership with 2 cars is more attractive to both existing users and potential new partners (compared to membership in either) because sometimes access to a van or pickup would be useful, and membership in 2 partnerships doubles the accounting, bills, voting for no reason.

Continuing with the additional partnership option, heavy users starting a new partnership because investors wanted to block the partnership from acquiring a new car would still welcome the same investment-motivated individuals in the new partnership.  Investors aren't parasites.  They'd help share in the acquisition and other fixed costs.  If they never bid on the time slots you want to use the car in, then you drive whenever you want, and only pay the actual operating costs.  

2 partners sharing 2 cars
Some people value convenience and access more than anything, and would have a general reluctance to sharing a car.  But one person who owns a pickup truck and one neighbour who owns a compact/electric car could come together to share both cars.  The compact car would likely have lower per mile costs and be preferred for some trips.  Adding a 3rd investment focused light user partner might be attractive to these partners because it offloads 1/3rd of the costs, and is unlikely to impede their full access.

Determining the minimum use fee
Users bid on blocks of time, but pay in addition to that the costs of operating the vehicle.  Those costs are definitely higher than just fuel costs.  The simplest way to measure "wear and tear" into a per mile cost is to take the estimated value of the car now (say a 2008 honda with 50k miles), the expected number of miles driven in upcoming year (say 20k miles), and then estimate future value by looking at the current value of a 2007 honda with 70k miles (with worn tires).  The next year a similar assessment would take place taking into account any surplus/deficit over the prior year's estimate. Fuel charges and wear and tear can be billed as separate items.  A driver that returns a car with a full tank would not be charged fuel costs.

Another guideline for setting the use fees is that they should allow generating a small surplus that avoids as much as possible the possibility of asking all of the partners for special contributions to repairs.  Most partners would appreciate the budgeting certainty that accompanies such a policy and predictable use fess over unpredictable demands for contributions.

The one source of conflict over use fee settings is that heavy users who not only pay most of the use fees, but also likely pay high time block bids to the partnership.  Their self interest would not only favour low use fees, but the proposal that some of the time block fees be used to offset use costs.  The philosophy of using time block fees to lower use costs would be wrong and evil.  The purpose of the bidding competition for time blocks of use is to compensate the partnership (other partners) for your temporal monopoly of the resource.  
While trying to use time block fees to subsidize and lower use fees is "evil", the time block fees do serve as a reserve for repairs, and so there is no need to inflate use fees just for the sake of protective anticipation of every expense (if there is a healthy stream of time block rental fees).

Partnership additions and subtractions
The topic of this paper extends concepts I developed in communal equity of businesses which mainly deals with adding and removing equal partners in a business setting.  The big difference when valuing a partnership in a resource ownership rather than a business, is that even if the partnership is receiving income from its resource, the value is purely tied to the market (resale) value of the resource.

In communal equity valuation, the main mechanism for setting the buy-in price or sell-out price is to have all of the partners list their dollar value, and then choose the median price as the buy-in price, and for the sell-out price either use a discount percentage from that value or have an independent vote for that price.  This process is also available for adding/removing partners in a shared car ownership.  

The process for buying in may involve considering who the buyer is in setting the price.  Someone mechanically skilled and wanting to contribute might be lured with a low price.  A heavy user with stereotypically irresponsible features might make some partners reluctant, but heavy users bring the partnership money, and the last 3 points of the "details of bidding" section deal with the risk of irresponsible behaviour.  The partnership has the security of a potential irresponsible partner's share, and if that partner is unable to pay restitution to the partnership, the share may be taken away.  If a car has 9 partners, then a new 10th partner pays 1/10th of the value of the car, and all the partners pay 1/10th of future fixed expenses.

The process for selling out can be determined prior to buy in by coding a "right to sell out".  The advantage of giving every partner a right to sell their share back to the partnership is that it enhances the value of joining the partnership.  A partner may move away and be unable to use the resource in the future, or become unable to pay his share of costs.  A partner may feel persecuted or strongly object to a partnership decision or attitude.  The right to secession/divorce solves all democratic/political conflicts.  A formula for determining a right to sell-out price should be based on a distressed sale price.  Blue book values less 20%-30%, or a craigslist or other internet search less 5%-10%.  The right to sell out is a unilateral right given to every partner to impose a demand for money on the partnership.  It doesn't have to be at a generous price to be valuable and generous.  The existence of the right doesn't preclude a proposal for partnership vote on terms for a specific sell out.

Software and technology
Software tools for a car sharing service are fairly critical to simplifying the process and minimizing its time sink.  Software tools include a bidding reservation system, a member credits and dues accounting system, and a partnership democracy and proposal review system.  A bidding system is a mathematical process that resolves conflicts in under 1 second by outbidding.  The alternative of strongly worded emails or tribunals where parties accuse each other of "you got to use it last time, and its my turn" have no unbiased resolution mechanism, and are time consuming.

Technology to account for miles driven, return of the car, could involve pictures of odometers, fuel gages,  GPS and clocks, but ideally it would be through an onboard car computer.  Lockboxes on the outside of the car could access keys, but ideally again, an onboard computer would require logins to authenticate who is driving, and track usage.

It is possible to avoid any hardware (such as lockboxes, and car computers).  This is easier if all of the partners share a narrow location, but even without it, a human chain of custody for keys is possible.  Exchanges between the next scheduled user would occur, and a signoff on miles, fuel would be made.  If there is a time lapse between the next scheduled use time and the previous user's return time, other partners might rent the car for the (short) period that it is free, returning the keys in time to the next scheduled user.  Hardware has the advantages of not using people's time or requiring their scheduling availability, and increasing partnership revenue by tracking all usage and encouraging full time block rentals.  Hardware has the disadvantage of costing something, and may not be able to verify external damage to the car.

I want to buy half your lawnmower, neighbour
The above lowtech chain of custody is especially applicable to relatively low value items such as a lawnmower.  After reading this article, you could go to your neighbour and offer to buy half of his lawnmower.  The costs to consider are tracking fuel use, who does the refueling, and picking up or delivering the lawnmower to the next user.  Standard fees for delivery would lead to the simplification that if all partners do their own pickup, then no costs change hand as a result of pick up and delivery.  Some partners can make money by delivering the mower to the next user, and "btw, can I mow your lawn?" can be another source of income.

After you buy half your neighbour's lawnmower, you can try selling 1/3rd of it to someone else, then 1/4 to another neighbour.

Would you buy 1/20th of a lawnmower that is worth $100 for $10?
I would.  Even if I am overpaying for my "real" share by double or $5.  The main alternative I would have would be to spend $100 instead of $10 for my mowing needs.  I actually don't have anywhere to store it, so I would happily make more money delivering it to the next user.  I also don't have an easy way of refueling it, or sharpening its blades, so that being taken care of is also a big advantage. I would be part of a network of partners that regularly produces offers to mow my lawn at a reasonable price without having me required to pick up or deliver the mower.  That 20 users instead of 1, reduces its life expectancy from 20 years to 1 or 2, doesn't bother me because it was probably going to get stolen or rust out before the 20 year period anyway, and we'll have a new better lawnmower within a couple of years as a result too, and I will only pay 1/20th the cost at that time.  If you asked me to pay $15 or $20 to join the partnership I would grumble, but would still say yes.

For you, who started the partnership with your neighbour by paying him $50 for half of his mower, you might have charged the next partners for their shares $40, $30, $25, $25, $20, $20, $20, $18, $16, $15, $14, $14, $13, $13, $12, $11, $10, $11, $10 and your share of all of those partner sales would be $20, $10, $6.25, $5, $3.66, $2.84, $2.50, $2, $1.46, $1.25, $1.07, $1, $.83, $.81, $.73, $.66, $.60, $.55, $.50 which leads to you making back your full $50 after the 9th partner (while keeping 1/9th ownership), and all of the mew partners up to 20th. provide you with proceeds from ownership transfers of over $61.

Natural sharing and consumer cooperatives
Continuing my laziness for naming concepts, natural sharing of resources is a fine label for this concept.  Natural is a reference to a solution for mathematical optimality.  This concept is also very closely related to consumer cooperatives.  The primary purpose of the partnership is centered around shared consumption of a resource.  In addition to work being created for the partnership, there is also a consumer networking effect where the partners can cooperate and trade with each other.  In addition to lawn mowing service, there are car pools, and delivery favours.  The accounting software that tracks amounts due and from the partnership also allows the partners to transfer balances among themselves through micropayments.

The office coffee maker
One way to get a coffee maker into your organization is to lobby the bossman to buy you one with company funds.  There is no clear economic rationale to the organization for making the purchase, and the vocal opposition will object that degenerate drug addicts should not be supported in engaging in drug use at company expense on company premises, and any funds that are proposed for this drug paraphanelia should instead by distributed to non-drug-addict employees as raises.  This war is something the bossman must resolve.  There are two heated sides to a fairly irrelevant issue, and difficulty in achieving a consensus.

There is a boring peaceful solution though.  Those employees that want a coffee maker should be able to pool together the funds to buy one, and the important point, without asking for permission.  They may come to a friendly agreement with the bossman for paying very little for use of organizational office space and electricity.  The argument for unmetered free access to electricity and office space is that it would cost the organization more in metering it, than ignoring it.

The clinching argument for organizational support in allowing a coffee maker cooperative within the organization is that of strategic investment.  Investment without control or concern for direct (profit) benefits made for the indirect benefits it will provide.  In the case of the organizational coffee maker, the indirect benefits are productivity levels improved by shorter trips outside the organization, and allowing the slaves/employees to confirm their "deserved" freedom of having a coffee maker without needing permission.  There are costs to suppressing the coffee maker coop.  While there may be no labour regulations guaranteeing access to coffee makers, and theft of electricity and office space is a fireable offense, there are more productive uses of time than suppressing coffee makers.  For those of you puzzled at the absurdity of this discussion, consider the suppression of electronic cigarettes and bitcoin, then add corporate coffee shop interests in suppressing private coffee consumption, and authoritarian anti-labour groups suppressing the right of anyone doing anything without obtaining permission.

The Office Pinball Machine
With the strategic investment argument winning you a coffee maker coop, it works to get a pinball machine for the break room too.  The strategic benefit to the organization is that it will distract the slaves from their 70 hour workweek, and the clincher... Pinball machines are awesome.  For the investors in the pinball machine, the machine should keep its investment value because they aren't made any more, and because it comes with a built-in usage meter (coin slot), non partners can be allowed to play it, and the revenue should cover maintenance.

Child Daycare
Though much more boring and useless than a pinball machine (joke), daycare can be a valued service.  Daycare might be facilitated by an employer though subsidized location rental, and by having computers tied to the organizational network, child monitors could have some of their wages/fees subsidized by the employer if they are doing/available for work.  Regardless of whether any assistance at all is provided by the employer, cooperative daycare among a group of employees can be attractive for the cost savings, and networking connections that allow finding child monitors.  A bidding process can be more flexible than requiring every coop member to provide equal time commitments.

Employee services without permission and lobbying
Lobbying for employee services to the bossman has several problems.  Bribes, remaining budget, biases, friendships of the bossman will have influence on the decision.  If the organization happens to be an equal partnership that vote and bind the full organization through majority, both a pinball machine and daycare, have no direct relationship to the organizational mandate, and so should not be a decision where the majority forces a decision on the rest.  Those who want a pinball machine pay for it, and those who want daycare pay for it.  The organization may provide modest support that is much easier for a majority to accept.  The benefit to everyone is that both a pinball machine and daycare service may be adopted without even considering an organizational budget only able to afford one.

The clearest example of this in city politics is when a developer or team owner proposes that a city pay for a sports stadium or casino.  The outcome is always bad.  Either an expensive crony development deal for the benefit of only those who will appreciate and use a sports stadium, or not having an awesome sports stadium.

Natural governance
Another commonality in the above partnerships are that all work is assigned based on a partnership vote for a package of a candidate, mandate and budget.  This is similar to my larger organizational/social governance model, I call natural governance, which suggests replacing elected kings and board of directors who then appoint all other positions, with the direct election of those positions, mandates and budgets.  The advantage is accountability in those positions.  A further refinement is that instead of electing heads of the FDA or EPA, we could "elect" (democratically determine) individual investigation projects within those agencies.

Natural sharing without equal ownership
Non owners can participate in the bidding process.  A single resource owner can still share it (or veto against sharing it).  The time rental bidding or agreed price and minimum use fee model still apply.  Unequal owners tend to create the same relationship as owner vs. non-owners.  There may not be much of a difference with commercial relationships, other than it can be more informal.  Worth noting is that when a partial owner has booked a block of time for the resource, then he is the exclusive owner of that block of time and can resell portions of it.

Shared ownership of a human resource
Freelance work can be imagined as self-owned.  Accepting a retainer is promising ownership of some of your hours to the one who pays your retainer, but maintains your freelance nature.  Accepting an employee position typically transfers ownership of your weekday 9-5 time to one employer, but it can also be viewed as a retainer for 35-40 hours per week.  A designer, engineer, or secretary can have multiple bosses within an organization in theory but this is considered difficult.

Natural sharing of an employee or human resource's retainer can be achieved by making all of the department's that might use the resource equal partner's in that resource.  They are equally responsible for the payment of the retainer, but the minimum use fee is the hourly rate corresponding to that retainer, and bids among the departments are made against each other with the partnership receiving the winning bid.  Any time used above and beyond the employee's full time obligations or human resource's retainer is negotiated directly with the human resource with payments going to him.

Generally, having multiple bosses instead of a single hierarchy in an organization is considered difficult because of the conflicts that can arise between bosses.  Natural sharing's bidding process solves all of those conflicts.  The human resource can have a share in his ownership in order to profit from competitiveness over the use of his time.  And/or the base salary can increase on a quarterly basis, based on how busy he is.  Those owners who are less busy, profit from the use of the resource by others.  There is no reason that shares in the human resource have to be from a single employer, as long as confidentiality among employers is respected.  If there is to be ownership of the human resource's time across multiple employers (as opposed to departments of a single employer) then it is important for the human resource, himself, to own a share of the resource, and allow, to his advantage, all interested partners to join in the partnership at the rate of his existing retainer fee.

One very useful aspect of this model of employment is in situations where post project availability in technology projects is required.  Implementation, installation, bug fixes, support can require unpredictable time requirements.  But it can also permit a partnership or hierarchy (delegating to and training of junior "employees") of human resources to make itself available for "customer ownership" of their time.

Interaction between work in shared ownership of resources and consumer coops
The mechanic function can be performed by one of the owners in a shared car.  Or, several car or car fleet ownership groups can share the human resource that is a mechanic.  The latter can make more sense for a professional full time mechanic, while the former makes more sense for amateur/apprentice/retired/part-time jack of all trades mechanics.

A co-owned mechanic resource can in turn co-own a set of tools and garage space housing those tools with other mechanics or tinkerers that need occasional use of tools.  A group of mechanics specializing in drive train repair and maintenance (most likely to be co-owned by customers due to eventual need) can in turn co-own one collision body and paint shop on the basis that those services require different tools.

The costs to the owners of the mechanic are his fixed expenses including any compensation he wants for 0 work.  If the mechanic shares ownership of space and tools, then his co-owners only pay a fraction of those costs, and a fraction of the fixed costs associated with a partial ownership in a body shop.  When someone uses the mechanic service, the mechanic receives an agreed hourly rate, and payment for his share of the garage and tool use fees, and his costs if any for body shop services.

The bidding system for mechanic services would primarily be based on jumping ahead of the queue.  Bids would still primarily be payments among the co-owners of the mechanic, but an associated bid for tool and space rental must also be covered by the customer-owner.  The bidder might also optionally offer a bonus to the mechanic for quick turnaround.  It makes sense to have a maximum bid which guarantees queue position, and a fairly chunky interval among bids.  For example there may be a $50/hr maximum rental bid that guarantees a position in queue (behind only other $50 bids).  A $5 interval between bids would permit a limited number of classes for work.  Work that was currently bid at $25/hr or higher would be permitted a 2 hour wind down time before being put aside to work on higher bid work.  If the shop is free for the next few hours, then a bid of $5 or $10 might guarantee that a job that takes 1 or 2 hours is completed without getting bumped for higher bid work.  When dealing with outside non-owner customers, any costs normally paid by owners when the facility is idle would be covered, and a fee equivalent to a bid provided to the partnership.

Advantage for customers in co-owning a service
Because the workers face no risk since all of their fixed costs are paid for, they can charge lower prices than if they had to buy space and tools upfront, and hope that they get enough business to pay for their fixed costs.  So the total amount paid to the worker-service by the customer owners is lower than it would be if a risk-adjusted price or profit margin was built into the prices.

For a truck fleet owner that might be able to afford 1 full time mechanic, co-owning part of 3 mechanics might not only be cheaper, but provide them with the capability of fixing 3 trucks at a time.  Furthermore, its business focus is likely on making and shipping things, and so managing a mechanic or garage operation is a needless distraction.  In the same vein, such a company would likely prefer co-owning a shipping service rather than maintaining its own.

Co-ownership also substantially reduces risk to the partners.  If they are not consuming the resource due to slowness in their business, then the co-ownership produces revenue for them.  If competition is very high, and a surplus generated for the partnership, then the surplus facilitates expanding the service.

Advantage for worker in being co-owned
A unionized position is likely to either pay more or offer better perks and vacations.  If the worker has a unionized position, he would not see much benefit in pursuing having his work co-owned, but unionization is increasingly difficult as technology advances and work is more competitive.  One popular alternative becoming fashionable for those underemployed is worker cooperatives, where the workers own an equal share of the business.  While that may be attractive, compared to being co-owned, the workers will need to raise startup capital somehow.

A worker coop and co-owned worker can be compatible in several ways.  Several mechanics can co-own a garage and tools, where some or all of the partners are co-owned by different groups.  A group of co-owned workers can expand into a worker cooperative by reducing the hours available as a co-owned retainer.

A group of mechanics sharing the same place is a source of networking, where people getting jobs can subcontract to others to complete or assist with the work.

The one disadvantage of co-owned worker is potentially needing several customer-owners before starting.  Like the landmower ownership, starting as a single owner employee simplifies the process.  It may be in both the employee and employer's interest to obtain additional partners.  Approaching an existing garage can be an attractive partnership for people wanting to invent/build something, or private car partnerships that would repair their own car on weekends and late night.

Worker's wages can go up more rapidly when more customers want to co-own and use his time compared to traditional employment.  It works essentially like having multiple competing job offers on his ability to negotiate salary.

The relationship with basic income
Political conflict between the left and right too often focuses on the question "Does labour or capital better deserve to oppress consumers?".  Consumer's having the right to organize production seems obvious.  They still need the help of capital and workers, and natural sharing or consumer coops still compensate for those roles.  Basic income (cash paid unconditionally directly to adult citizens) frees people from the requirement of a slavemaster as the motive for work.  Basic income also enables sharing as a consumer coping strategy because all of the partners will have the income available when dues are due, and it enables workers assisting partnerships and cooperatives for supplemental income if they are not otherwise busy. Basic income also enables starting businesses without immediate revenue opportunities, by relying on the income support.

Global climate and environmental sustainability
We can consider all humans equal owners of the planet's climate and ecological sustainability.  But we should also separate climate issues into distinct ownership plans.  Atmospheric carbon dioxide concentrations, ocean acidification, methane releases associated with permafrost thawing, desertification, and sub-arctic and antarctic glacier melting are all distinct climate challenges that require addressing, but not necessarily have a single solution.  The latter problem of polar glacier melting can be addressed narrowly.  We can block out the sun near the poles to cool them.  This might be considered an act of war by the few people that inhabit sub-arctic regions such as Greenland, and so a peaceful solution could involve the near billion people that would be affected by massive sea level increases, to chip in to the polar cooling dislocation fund.  A general problem with global warming discussions is that some people, organizations, and nations, would benefit from it, and a discussion model that allows them to "extort" a modest fee for their lost opportunities would be more productive than a model that permits their obstructionism under a facade of agreement.  Acknowledging the right to rape and destroy the environment is probably necessary to implement policies to save the environment by addressing compensation for the rapists, or at least excusing them from paying for their share of the solution costs.  It appears as though human-political nature requires calamitous circumstances before acting, but using a model of shared ownership could allow some of us to pay more for the costs of prevention, including the possibility of compensating those that might be opposed to action.

Friday, May 3, 2013

Linked in Q1, 2013 earnings (LNKD)

Linkedin reported earnings last night, and I plan to write an article after each quarter for now on as a diary tracking how an impossibly valued company adjusts to its real valuation, and how the financial industry may attempt to distort and manipulate that valuation.

Core maximum future value remains below current price
The total recruitment market was last measured 2 years ago, at $3B.  Even if that grows to $4B, linkedin is suited to only the higher end job portion of that market.  If it is paid $200 per job, it needs to place 15M jobs per year in order to generate $3B in sales.  A couple of months ago (end of article), I estimated worldwide online job postings at below 8M with many of the postings having fees much lower than $200 including free.

So it is hard to understand how LNKD could ever reach as high as $3B in core sales, and $1B in annual profits, and so a maximum corporate future value of $10B, which is a maximum future share price of below $90.  Considering the risk of failing to reach that maximum, a $45/share or below current price is appropriate.

The lack of takeover or dividend potential
The true value of a share of stock can only be measured by the payments that share is entitled to receive:  Dividends and takeover bids.  If a company is too large, and too highly valued, with no real cashflow stream then it cannot be taken over at a price near its current value.  Similarly if its structure discourages ever paying a dividend, its stock value can only be measured based on significant deterioration in stock price that is necessary before management considers selling or issuing a dividend, and a price that buyers can rationally consider the whole company based on cashflow.

LNKD meets all of these overvaluation criteria, as it has tightly controlled dual class shares.  A related issue is that it uses that concentrated control to issue extremely generous stock compensation to itself (and employees).  Its irresponsible for the financial analyst and media industries to ignore that compensation in its results.  That compensation has a real effect on the valuation of shares for both takeout and dividend purposes as well.  The below $90/share ($86.65 = 10B / 115.4M shares) maximum future value is based on current shares outstanding of 115.4M.  Just 18 months ago, that same $10B maximum total future value translated to over $100/share because the shares outstanding were 98.8M.

Linkedin estimates that it will award its insiders $195M in shares this year, and that number excludes the 512k shares it is giving out for its acquisition of Pulse.  The share issues are the main reason it has never been profitable, and there is no reason for it ever to stop issuing nearly all operating profit to insiders, because it has complete insider control of the company, the support of the financial analyst community, and the support of state of Delaware.  That future stream of insider share giveaways further reduces any maximum future share value estimate.  There is no reason for LNKD's management to ever pay all shareholders through a dividend when it can be applauded by the analyst community for paying itself.

Linkedin forecasts
For the next quarter, Linked in is forecasting year over year sales growth of about 55%, and core (after depreciation and stock compensation) earnings ranging  from a loss -$6M to 0.  For the next 3 quarters, it is also forecasting year over year sales growth of 55%, and core earnings range of $-21M to $4M.  A significant slowdown in growth is occurring in non-US markets.

Declining sales growth
Even if LNKD beats its own estimates considerably and achieves 60% growth, it would be a significant drop from 2012's year over year growth of 81%, and this quarter's 72% yoy growth.  It would also make the most reasonable optimistic estimate for 2014 growth to be 45%, and 2015 growth nearing 30%, even if you make the mistaken assumption of an infinite addressable targetable sales market for Linked in, instead of it approaching its potential penetration cap.

With declining sales growth and no real earnings, even with the mistake of assuming an infinite potential market, valuing the company at over 14 times 2013 sales ($202/share) is not close to reasonable.

Comscore vs. Alexa metrics
Another peculiarity of Linked in results is that it reported a healthy 13% quarter over quarter increase in comscore internet metrics for use and pageviews, but Alexa's more transparent internet monitoring service shows no change in the last 6 months for Linked in's pageviews, time spent on site, and reach.

I can't explain the difference, but someone should be explaining it.

The future of employment and robotics
Relevant to linked in's value 10 years from now, and so its real value today, is how robotics might transform employment.  General purpose personal robots are closer than we think, and it not only ends many types of employment, it ends the need for most types of factories.  The main reason personal robots will arrive soon is that they are cost effective if they can be transformed into self-driving electric cars as one of many potential transformations, and widespread adoption of standardized components makes programming and sharing the programming of the robots cost effective and easier, much like computer and phone apps are easier and cheaper because there is a large market available to share them.

Thursday, April 25, 2013

Improving economy by eliminating corporate tax revenue

Anger against corporations and their tax avoidance is not necessarily misplaced, but I will show how eliminating corporate tax revenue can increase overall tax revenue and economic benefits such as income and income equality.

This is a less math heavy article on my concept of natural tax policy

Natural tax policy for corporations
Corporate tax policy can be greatly simplified by taxing cashflow instead of income.  At a 50% tax rate, a company that goes from a cash balance of 0 to $50M in one year would owe $25M in taxes.  If its cash balance 5 years later was also $25M, then it should not have owed/paid any other income net taxes in that time.  It does not matter what its profits were, how much it spent on machinery or salaries, how much additional investment it received or how much it repaid investors.  Only what its cash balance is at the end of any period.  If its balance goes up then back down to $25M, it would receive a refund equal to past income taxes paid.

In addition to simplicity, the great benefit of this is that it provides high incentive to spend cash like a hot potato.  Cash would flow directly to people, since if a company pays another company, the receiver also wants to get rid of it in order to avoid a corporate tax bill.

If a company is out of good ideas for spending, it would repay its shareholders with dividends.  Companies no longer need any complex tax avoidance schemes, because its owners (shareholders) would likely prefer being repaid to the company "wasting" money on other matters.  This solves the issue of corrupt corporate governance that avoids repaying investors.

The key benefit of taking money out of corporations, and sending it towards people, is that it increases business activity  and employment in order to go collect that money back as revenue.

The key problem with existing corporate tax policy is that very little tax revenue is collected from corporations because they know how to avoid taxes.  If you follow the links to the more detailed natural tax policy article, it focuses on a particular current problem of corporations keeping cash abroad to avoid US taxation, and, in general, doing business in tax haven countries.  Natural taxation solves the corporate tax avoidance problem by no longer expecting any tax revenue from the corporate sector, but funneling cash into the individual sector where avoidance is more difficult.

Natural tax policy for individuals
The core absurdity of existing tax policy is the preferential treatment for certain investment income, and the surtaxes on employment income (social security/payroll taxes).  There is no need to encourage investment by taxing it less, because investment tends to require no real effort, and is attractive or unattractive independently of its tax rate.  There are several changes to individual tax policy needed to coordinate with the corporate tax changes:

Roll up payroll taxes into marginal tax rates:
If people currently pay a 40% income tax rate and 10% in payroll taxes, then simply change the tax rate to 50% with 0% payroll tax.  Any employer share of payroll taxes can be turned into an automatic raise for the employee.

Every individual receives an investment tax sheltered account
Like Canadian RSPs, every individual should be able to deduct taxable income by adding money to their investment account, and increase taxable income whenever they withdraw money from their investment account.  Up to 70% of employment (non-investment) income for the year could be deferred/sheltered in this  manner.

A 10% surtax on investment income
Though investment income in the sheltered account is not taxed until it is withdrawn, all investment sales, interest, and dividends received would be taxed 10% immediately.  When an individual places an investment, he would receive a 10% tax credit.  So overall, the 10% tax would apply to investment profits.  This creates no disincentive to investing, because most people like to save for the future anyway (especially if they have the freedom/luxury to do so), and if they simply prefer to leave money in the bank, and pay less taxes, the bank will invest the funds.  The biggest investment incentive that remains is the tax deduction created by adding to your investment account.

Allow income splitting through personal loans from investment account:
An individual can provide income to any one he chooses by giving them a loan from his investment account.  The recipient counts the loan as taxable income, and future repayments as reductions of taxable income.  The lender will pay 10% tax on repayments received, but defers any other income taxes until he withdraws funds from his investment account.

To summarize, tax revenue increases occur due to the 10% investment income surtax, and replacing payroll taxes with the equivalent increase in income tax rates, but then applying that tax rate to all income instead of just employment income.  Tax deferral and income splitting opportunities are not a major loss of tax revenue.   Tax deferral likely results in more tax revenue later.  The loss of revenue created by income splitting is only the difference in marginal tax rates between the lender and recipient.

Economic benefits
Flow of cash away from corporations is needed in order to create demand for what businesses sell.  That leads to further investment and employment to meet that demand.

The richest people have had most of their wealth untaxed because it is typically held as corporate shares that is not subject to tax until they are sold.  Even if they continue to shelter most of their wealth, forcing them to accept dividends and pay 10% tax on that will help everyone else's tax burden.

The income splitting opportunity will allow people to pay for personal services (gardening, childcare) with 0% loans thereby creating income opportunities for low skilled people.  The type of spending being tax deductible encourages more of that spending, and it may cause increased tax revenue if it replaces previously undocumented income.

These tax changes increase overall tax revenue and employment and economic activity.  Through income splitting opportunities, income equality will also be enhanced.

Rich and middle class individuals will have their lives enhanced as a result of easy income deferral and splitting opportunities.  The poor and middle class will have their lives enhanced through greater income opportunities from business and personal service employment.

Basic income funded by increased tax revenue
While economic benefits are created through the increased flow of funds of natural tax policy, tax revenue is also enhanced by the flows, and tax revenue is enhanced additionally due to the increased economic activity.

The fairest, and most economically productive, spending of tax revenue is on basic income and social dividends.  Giving every citizen an equal cash amount from any surplus tax revenue, and also funded by cutting any redundant social services or any other government program.

Although rich and poor receive the same basic income as a taxable benefit, it is fundamentally a transfer from those lucky enough to be able to extract a successful living from society, back towards the entire society and including, gratefully, to those less lucky in having society value their contributions.

Basic income further creates economic activity and opportunity by creating more potential consumers for business to employ to extract funds from those consumers.  Replacing social services with unconditional cash payments removes all disincentives and traps that discourage social service recipients from risking the loss of any social benefits through employment or other income.

Solving the bitcoin taxation problem
Bitcoin is some where between a digital commodity and digital currency.  The distinction is critical for current tax policy implications.  It has clear and obvious benefits for transactions and is a medium of exchange (like a currency), but its users might prefer to label it a commodity because then exchanging something for bitcoin is barter and non-taxable.  The commodity status further complicates tax matters when converting bitcoin to cash because it may be preferred to consider it as a capital gain (preferential tax treatment) instead of income.  Loss of tax income as a result of a useful barter medium will aggravate governments and societies that depend on tax funding.

Natural tax policy solves all of these issues.  When bitcoin is turned into cash, it is taxable income just as any other investment or other income.  No matter how popular, and ubiquitous, bitcoin becomes its convertibility to cash will always be relevant, if only to pay income taxes.

Bitcoin critical mass, greed, and new digital currency

Bitcoin is the most popular cryptocurrency.  While extremely volatile these past weeks, I believe it is on the verge of reaching critical mass.  It is not perfect, and I will discuss those issues, but the success of bitcoin brings interesting insight into the emotion of greed.

Bitcoin is worth more than 0 because:

  • There is a fixed supply currently of 11M, and it cannot grow past 21M coins.  
  • It has provable scarcity.  Cannot be counterfeit.
  • There is a verifiable public ledger of all transactions and coin creation in history.
  • It costs electricity and equipment in order to create new coins, and so that effort is only made if there is belief that the value is greater than the cost.
Bitcoin is worth $100-$10k each (critical mass) because:
  • Its relatively difficult to make new ones today.
  • It is the most convenient form of value transmission, since it can be sent instantly from home or phone to anywhere, at low or no fee.
  • At over $1B in market capitalization, and $40M+ daily exchange volume, and $70M+ in daily transactions, there is sufficient value to let any one person "buy" most things (that cost under $1M or $2M).
  • If there is enough total value to support one person's transactions, then the value needs to go up as more people use it for transactions.  This is the critical mass point, and arguably occurs well below $1B in market capitalizaion.
  • As more people find bitcoin useful for transactions, more people find it useful as a store of value, anticipating that more other people will find it useful either for transactions or as a store of value.
  • Even if other crypto currencies exist, valuing them in bitcoin, as the leading cryptocurrency, makes the most sense, and this is another source of transaction and store of value for bitcoin.
Disadvantages of bitcoin:
A bitcoin wallet is like a wallet or briefcase full of cash or gold.  It can be convenient to pay for some things with a briefcase full of cash, and bitcoin is quicker and doesn't risk authorities confiscating it when travelling accross borders, and it is divisible to 8 decimal places.  But like a cash wallet, there is no recourse if it is destroyed (without backup), and it is extremely difficult to obtain restitution if it is stolen, and even difficult to have a clue who stole it.  Because a bitcoin wallet is typically stored on a computer, it is susceptible to hacking, viruses, and other electronic theft that would not threaten your briefcase(s).

The banking system does a good job in protecting from and tracing fraud and theft.  While holders of state currencies are not protected from losing value as a result of currency printing, on balance, it would seem more valuable to more people to be protected from theft and fraud, through some tracing of transactions and an "undo" feature/process than they risk losing from political action.  The banking system's imperfection came to light with the April Cyprus events.  Previously most people assumed that when the banking system loses your (depositor) money for whatever reason, your money doesn't disappear.  That confidence, whether factual or not, is critical to the validitity and usefulness of the banking system.

This is the only real disadvantage of bitcoin as a trade currency.  If you are not trading face to face with your cash briefcase, then you have to trust some intermediary, or even your briefcase manufacturer/provider, to temporarily hold your wallet/coins.  

Greed's effect on bitcoin:
Although I am not criticizing, people looking to acquire and hoard bitcoin make it more scarce for people that would like to use it as currency.  But the hoarders are likely eventual spenders, and if the value of the currency goes high enough, the hoarders will sell it back to spenders or other speculators.  Speculation is healthy because higher market capitalization is healthy.  Higher market capitalization is what sustains higher transaction (spending) volume in the long run.  If the value of the US Dollar dropped in value by a factor of 1000 to other currencies, then spending levels of Americans would tend to drop by a factor of 1000 as well.

Greed allowed the decentralized development of bitcoin.  By not requiring central control, early adopters were able to get a head start in accumulating (mining) bitcoin, and invest in software and hardware that allowed them to grab more bitcoin for themselves, and through sharing of software breakthroughs, shared with other early adopters.  Decentralized greed democratized (enabled a wide number of people to participate in) to evangelize, and form a social connection around, bitcoin.

The noteworthy insight on individual greed is that it can be maximized through shared social belief in ideas.  Shared faith in Santa Claus, bitcoin, the dollar, and the banking system leads to a healthier and happier society than if that faith is broken.  Similarly, if people understand that taxing their income benefits them individually by allowing them to work and earn more income, and so is in their interest.  Similarly, we can understand that a fairer, less corrupt, society is in our interest, even if we are not personally at risk of being abused, because a fairer society motivates other social members into contributing to society, and thus assisting you in some way (you might consume their work, and benefit from their share of tax burdens).

New crypto currency design
I have a design for a new crypto currency which I will share with anyone that gives me $20k.  The $20k would be a deposit for future value and promises high returns (the $20k is similar to a loan and has some similarity to this concept).  The design does reward greed through early adoption and investing.  It keeps a predictable limited money supply, but does away with mining lotteries.  Most importantly it provides personal account security, while retaining the option of anonymity.

It incorporates almost all innovations I have previously developed on this site.  For hints (consider it a scavenger hunt) on the implementation, look at this and get through to the grocery store example on this article

As another hint, think crypto society instead of crypto currency.

Saturday, March 30, 2013

Natural Finance competitive advantage for startups

This is part 5 in the series of comparative advantages of natural finance over traditional finance tools.  Part 1 and 2 focused on traditional small businesses that frequently finance through loans.  Parts 3 and 4 focused on capital intensive companies that frequently finance through equity/shares.  Although startups also typically rely on equity financing, they differ from traditional capital intensive companies in that they need relatively little funds, and offer a much more speculative business proposition.

Natural Finance Soft Loans are business loans without fixed repayment terms.  Instead, they are repaid when business cashflow materializes.

 the major advantages of natural finance:
Advantages for borrowers,
  • Cashflow from investment similar to equity investments in that repayments are only made when revenue/income permits.
  • Control of the organization and incentives for profitability and success are retained by borrower/founders.
  • Open loans, and queued priorities, make it simple for a successful business to reduce its borrowing costs by inviting lower interest loans, ultimately achieving a perfect competition market from lenders by facilitating loans from the most willing bidders.
  • Permits continued expansion project financing without causing existing investor objections.
Advantage for lenders,
  • Being more attractive to borrowers means that buyers are more likely to accept higher loan rates.
  • Many risks and types of fraud or lapsed insurance can be eliminated.
  • Loan payment priority can never be supplanted or diluted.  It is impossible for traditional finance debt covenants to fully anticipate or satisfy objections to future dilution.
  • Risk profile of investment is much more clearly assessed at time of loan.  Much fewer things can go wrong.  For instance, generous management salaries, bonuses and perks cannot be implemented at greater risk to lenders.

Startups as one of the few paths to great wealth
Technology startups have created significant wealth for some founders and initial investors.   Some have even created that wealth without creating a profitable company.  The primary reason for the wealth success stories of startup founders is their relative strong bargaining power in both needing very little funding, and having good business stories suitable for IPOs (Initial public stock offering).  The bargaining power permits founders to retain control of the company, and the IPO prospects allows them to conspire with initial investors and IPO sales partners to prevent takeovers and dividend payments.

The issues with traditional financing of startups
Many startup businesses will never generate profits to pay anyone but its founders, and many more startups do not even achieve that level of success.  Since there is a high failure rate, investors typically require a story that allows them to hope for a 10x or 100x return on investment, and so traditional loans is not a possible option since startups could not possibly afford an interest rate that provides those returns.

The key comparative advantage of natural finance for startups
Compared to the traditional finance goals of turning a startup into an IPO, the founders of a company using natural finance must have confidence in making eventual profits, because they will need to repay investors in order to collect those profits.  The IPO game just needs a story to be successful, and establish an empire for the founders.  The reason for founders to prefer natural finance is that investors are idiots or corrupt to prefer an IPO.  Public markets exist to trade minority stakes in companies which are always worth less than the company itself, and the empire of majority control of the company.

Natural finance tools for startups
The main natural finance tool is soft loans.  It is recommended that a total cap on interest of 100% be in place, and that the interest rate never exceed 30% per year.  The reason for the total cap is to permit predictability of repayment for all lenders, and prevent runnaway indebtedness that prevents future investment.  When a loan reaches its cap, the cap acts as distress-limiting function that would help the company survive and repay its investors.

Another key feature of natural finance is its encouragement of communal partnerships.  The ideal organizational structure a business should aim to eventually accomplish is that of ownership by equal partners.  The advantages are the prevention of abuse by majority owner(s), and the power of shared supervision to prevent any other abuse.

The tool most handy for startups is deposit options which allows one (or communal partnership of) owner(s) to promise a future equal share at a locked in buy-in price in exchange for monthly payments.  The buyer of the option has the right to abandon it at anytime, by not making the next monthly payment.  The "strike price" (buy in price) of the option is based on a specific total value of the company divided by however many partners happen to exist at the time it is exercised.  The strike price is adjusted down based on the monthly payments made and/or dividends paid.

Very early stage financing
Deposit option premiums of $1500 or $10k per month  paid to the startup founder act as a salary that the business need not pay to the founder.  The lack of expenses by the business means greater financing flexibility (capacity for new loans) for it.  Whether the strike price is in the millions or billions, for very little investment, the founder is "sponsored" for further research/development, and the investor can hold a future claim on the business which he can materialize in value by further assisting the company.

Deposit call option premiums of $4000/month buy a much lower partnership share strike price than does an $2000/month premium.  These premiums are paid directly to the founder and not to the company.  The founder might accept both offers if the lower immediate "salary" justifies a much higher future partnership share sales price, and he is confident in achieving that future value.

Another option that necessarily suits the founder, and likely is more attractive to the potential partner is a call option premium of $4000 with the added condition that $2000 of that premium received by the founder be reinvested as "low interest" loans to the business to cover sales, travel, and other investment acquisition expenses.  The re-investment condition ensures that the founder is focused on generating revenue so that he may have those loans repaid.  Compared to a $2000 option premium and a $2000 additional monthly loan investment into the company, the investor is much more likely to prefer a lower future purchase price of a partnership share over the potential small returns on small monthly loans.

Recent post on communal equity options is most focused description of communal equity options.  Deposit options are most likely to help design-type startups, and does so without hampering the company's borrowing capacity. 

Organizing a company with external sales and investment agents
While traditional companies favour keeping sales, marketing and investment acquisition functions in house, there is no obvious requirement that they be so, since the performance and compensation of such departments is relatively independent of the actual operations.  Natural finance facilitates that separation mainly through its comptrollership function which ensures that payments owed, are made when able to.

While sales and investment functions can be separated from a company, it is not completely clean to do so.  Both sales and investment have a tendency to over-promise on what can be delivered, and the concern is amplified if sales and investment teams are external to the company.  There is also often the need to get the operations department involved in a sale to both negotiate on what is possible how fast, and help close the sales or investment.  The only other major issue in using external sales agencies is you likely need that they are not involved in any competitive companies.

To control the investment sales over-promising tendency, its compensation can be based on investor repayments.  Natural finance can completely align the interests of investors and their solicitors by ensuring they are paid by the same transaction.  It should provide the investor with confidence knowing that a soft loan he "buys" only results in a payment to the salesman when the investor himself is repaid the loan with interest.

To form a closer partnership with marketing sales agents, you likely want them to intend to become partners in the business through deposit call options, and/or reinvestment of sales fees into soft loans for the business.  The benefit to the sales agency for such arrangements can include territorial exclusivity or other favours.  To handle the involvement of the operations department in closing and negotiating sales, the sales agent can "hire" the operations department (with fees conditional upon closing sale).

The benefit of external agents is lower fixed costs, which tends to be important for a startup.  The benefit of having the function in house is tighter control over people's lives and behaviour.

How a 30% interest initial loan for almost any venture is profitable
30%/year interest loans are very expensive and usually unsustainable.  Natural finance makes such loans possibly sustainable in 2 important ways.  First, there is a 100% total interest cap, so the amount owing on a 30%/year loan will stop growing after a little more than 3 years. Second, all natural finance loans are open, meaning that anyone who offers a lower interest rate can replace the loan.

For someone that invests in a natural financed startup at a 30% interest rate, he has an immediate interest in becoming an investment agent for the company, and needs no formal agreement with the company to do so.  This is fundamentally the same conflict of interest that exists within the traditional financial industry: creating hype for what they own.  But, the behaviour benefits the startup, and the financial promoter's help is likely much needed.

The advantage of accepting exploitative and onerous loans from investment or sales agencies is that you get their services for free.  They become instantly motivated to promote your startup so that they may be repaid their high interest loans.

If the company takes a few years before earning revenue, then whether a loan is at 30% or 10% won't matter too much because of the total cap of 100% interest.  The importance of the cap is detailed here

Hiring a first employee
The example near the bottom of the paper on communal equity put options shows how using natural finance securities can lower the cash compensation costs of employees by over 70%.  Providing employees with deferred compensation (soft loans), deposit call options to become a partner, shares, and put options on those shares, replaces the cash costs.  Lower cash costs in a startup business enhances its sustainability and investability.

Closer partnerships with suppliers
If your startup is ever likely to pay one company $1M or more for products or services, then that supplier is a good candidate to invest in your business, by becoming a full partner or participating in soft loans.  For soft loans, it may be possible to tie lower interest rates to continued purchases from the supplier.

Part of ongoing operations of a natural finance company is to fund large projects with new financing rounds that are placed in last payment priority.  Getting the people and companies that will receive what the funding will be spent on to help fund the project provides benefit to both the buyer and sellers.

Partnerships with customers
Kickstarter is a popular crowdfunding site that lets people fund art and gadget startups by letting them buy advanced copies of merchandising, promotional meetings, or the gadgets themselves.  The problem with the service is that customers have no guarantee of ever receiving what they supported.

While getting a product among the first is likely the most compelling reason for a customer to fund a startup, natural finance loans can provide the same features as kickstarter pledges by allowing lenders the option of redeeming their loans for products, collectable gimmicks and promotions.  While that practice can slightly violate the natural finance rule of always repaying investors at the head of the queue before repaying those behind them, it is excusable if the profit margin on redeemable loans for products is high, and it is fully justifiable if the intent of the loan was for a specific product redemption at the time the loan was made, and if not, also fully justifiable if replacement financing is obtained to produce what is necessary to honor the loan redemption.

Natural finance loans, in addition to providing any kickstarter ability, also allows business customers that may be able to profit from your product to help support and improve it.  It further provides customers compensation for delays in developing the product, and the opportunity to withhold product redemption until the next generation product is released, or otherwise change their product redemption intentions based on new collectibles or promotions offered.

(see the grocery cooperative example near end of paper)

Partnerships with society
If your startup wants to develop an AIDS medication that doesn't cure patients but requires a daily dose to keep them alive, and you gain monopoly power to charge whatever people will pay to stay alive, then even if you are improving society by giving it an option it did not previously have, its a stretch to think you deserve social approval, support or funding.  Pure financial interests can support you.  If on the other hand, you want to research the effectiveness of a natural or unpatentable AIDS remedy that cures patients, with say a mixture of grasses, aspirin and red wine, then there is great social interest in the success of the research or any future effort based on the research.  Health insurers, patients, wine marketing associations, people at risk of being patients and humanity, all have reason to support such research without any serious concern for a financial return of their investment.  In fact the social interest is usually best served if the support keeps prices down, and the returns on investment are in kind, but for supporters higher prices and/or moderate prices means that the net cost is kept low due to the refund of profits on top of a reasonable priced cure..

I define strategic investment as investment for the benefit of seeing something accomplished rather than out of concern for the direct profits possible, or their distribution, from that accomplishment.  Helping a company get oil or copper out of the ground has the strategic benefits of lowering the price of oil and copper.  Helping society build roads gives me the strategic benefit of customers and myself getting to my place of work easily.

We often think of proposals with social strategic benefits as worthy of petitioning government to assist with.  In the case of developing an affordable cure for AIDS, government can be corrupted against such a social interest, by the financial interests of an expensive life prolonging established solution.  

Social sponsorship of projects whether they are high profit, low profit, or non profit is made easier through natural finance.  "Donors" can treat their contribution as a donation, but if the project is successful they will receive a direct benefit from that donation whether it is through cheap social distribution of the innovation, or their share of the financial benefits from a not so cheap distribution of the innovation.

Another way to invite social commitment for your project is to grant a permanent right for any social institution to purchase your company at a fixed price.  It may or may not be generous to allow society the right to purchase your company for $100M or $20M, but it is still an explicit gift, than can be judged simply on its merits, and is unlikely to discourage the efforts required of you that might make society consider this opportunity.

The great benefits of many partners
Having 20 or 20 million partners in your company provides energy for product, process and investment ideas, and creates an army of people with a vested interest in the company to help promote it.

As more partners join, the affordability of a partnership share improves.  For 1000 partners, every 1M in company valuation costs $1k for a new partner.  If it is affordable for more people interested in the viability of the company, then there is more demand for a partnership share, and part of the investment may become justifiable through intangible benefits of influence and status.

For the original owner(s), 20 or more partners means selling 95%+ of the shares in the company.  No matter how many partners or how long ago the founder gave up authoritarian control over the company, odds are that the founder's ideas and direction are still likely to be valued in some role, even if perhaps the huge salaries and perks he might be able to bestow on himself if absolute control were denied to him.

One advantage of large partnerships is decentralized governance where partners bid for the right to lead projects or perform functions rather than have them bestowed through a hierarchy.  Its similar to my natural governance principles for wider society, and creates competition within the enterprise that benefits all partners.

The control freak's guide to starting a commune
Even if you are sure of the best decisions needed for "your" company, and sure that having to listen to other input will be tiring and unproductive, partners can still benefit you greatly.  The best way to ease your concerns over having to deal with partners, is to make a condition of initial partnership, the protection of any key roles that you want to keep, for up to 5 years.

The benefits to future partners is that relief from your tyrannical ways is eventually assured, and so the attractiveness of a partnership share greatly enhanced, and so the rewards (monetary partnership share value) of selling future partnership shares greatly enhanced for you.  You gain the protection to make the right decisions for the company for the next 5 years so as to further enhance partnership value, and will continue to have significant advantages in having your ideas heard after your 5 year reign.

A company, and partnership share in that company, is always more valuable without a monopoly over ideas, including a monopoly on deciding the leadership's salaries.

The Power of the comptrollership function
The 3rd party comptrollership function permits much of the creative cooperative arrangements discussed in this paper by creating trust.  Investors and stakeholders are assured of being paid when revenue and cashflow materializes, without requiring audits, inquiries for payment, or management's discretion on whether to follow up on its promises.  Financial statements and repayment predictability  assessments can be produced daily or weekly.  The contracts between parties in a natural finance are much simpler from a legal perspective, because the elements of dilution risk is eliminated, as is the element of discretion in repayment, and so it is conceivable for very creative agreements to be agreed without legal representation from both sides.  The comptroller can act as a legal arbiter for both sides.

As shown in the next example, an even stronger benefit of natural finance is the preference for higher interest rate loans by the borrower, that is created by trust and flexibility.

Example wholesale venture
I want to buy 24000 drinks in 1000 cases for resale.  It will cost $24000 to get the drinks delivered.  I expect it will take 2 to 6 months to resell all of them, and total revenue will be $34000.  The financing options are I can borrow the $24k against my house from a bank (or from you) @ 6% (0.5%/month), with $3k/month minimum repayment.  Borrow a soft loan from you @9% (0.75%/month), or give you 20% of the shares in a corporation in exchange for the money.

Regarding the shares vs soft loan decision, if I plan on reinvesting the money, or sitting on it, instead of repaying you the money, then I prefer you take shares, and you should prefer the loan, because odds are you will never be repaid.  If I plan on repaying you quickly, then I much prefer the soft loan approach.  Since you want to be repaid, and I will say that I wish to repay you to sell you on the investment, then according to what we say, we both prefer the soft loan investment to shares.

The risks of the venture are:
  • Product may be lost, stolen or break:  The most serious risk.  If I borrow against my house, I lose $24k if product is lost.  If it is a soft loan, I still lose the profit opportunity.  This risk can be mitigated with insurance.  For the lender, a soft loan can be seen as equivalent to a loan + insurance product.  The extra interest may compensate for risk, but insurance for the investor's benefit is an option that may be both less risky and still more profitable.
  • There may be delays in shipment, personal or medical emergencies that delay my ability to sell the product:  Such delays could cause me to incur expensive credit card debt to meet fixed loan obligations.  Under a soft loan, if these are merely delays, then it is not a burden on the borrower, and results in higher returns for the lender.
  • I may lose interest in selling drinks, or it is not as profitable as hoped due to competition: Solution options include selling the drinks in larger lots at less profit, or hiring/delegating the sales efforts to others.  Although I feel much more pressured to enact one of these options quickly under a fixed loan than a soft loan, there is still moderate profit opportunity sufficient to repay the investor under the soft loan option.
For me, a soft loan is well worth the higher interest cost to save the risk of bankruptcy, credit score, and credit card fees.  Its likely also worth the insurance premiums on top of the higher interest cost.  For you, as the investor, if there is insurance to cover the main risk, then higher expected and likely returns are also worth any slight delays to repayment.  The most important point is higher interest return for you that happens to also be preferred by the borrower.

Virtual corporations and open source
Open source software is usually offered free of charge to users.  It frees users from oppressive reliance on a monopolist for future features, fixes, and systems compatibility.  Open source software still has a business model in paid consulting, features, fixes from the original artisans that likely have the best knowledge of the product.

One reason not to collect product sales revenue, is that it would be expensive/complicated for partners in the software to audit sales, and decide how to distribute rewards based on contributions.  A 3rd party natural finance comptrollership, or 3rd party mediator, or internal committee can assist with that function.

A virtual corporation is one where there are no physical offices.  All the employees work from their homes or at client offices.  Software and web companies are suited to this model, as is any startup with either no revenue, or no strict requirement for customers to come to their office.  Any corporation  could technically benefit from the cost savings of virtualization, but ornamental office space can enhance trust by giving the impression of financial stability.

A far more useful trust and confidence enhancement tool than office space is 3rd party natural finance comptrollership of the company's bank accounts.  If employees and investors cannot see the customers, they need accurate information to base whether and when they can be paid, and assurances without requiring nagging and repeated requests that they will be repaid when they are supposed to.  Natural finance comptrollership is likely much less expensive than office space, and may have some of its costs deferred.  NFCs provide especially significant trust enhancement to international stakeholders.

Solar cell industry
Commercial solar installations are already more affordable in terms of cost per MW capacity than moderately clean/efficient coal plants.  That is before considering operating and fuel costs.  Solar power delivery contracts are being signed well below new coal projects and even below existing coal delivery costs (5.8 vs 6.7).  Despite this, there has been many high profile solar cell manufacturer bankruptcies due to overproduction and rapid innovation.

Natural finance soft loans can help somewhat stop overproduction by not having fixed repayment obligations, and so enable the strategic option of not overproducing, but more importantly because natural finance companies have lower fixed costs, the option of overproducing to drive competitors out of business is also an option.

Because investing in solar power, even in residential installations, is one of the lowest risk possible investments, where power savings is a tax free return for residences, and so should be competitive at 3% ROI over 25-30 years.  Natural finance's power to form cooperative agreements with customers, and delay cash outflows to meet inflows, and even get company investors to finance customer purchases.  If the problems with the solar cell industry can be described as under purchasing instead of over supply, then facilitating customer purchases/financing would cure the industry.

A Grocery store cooperative
Customer cooperative grocery stores have been done before.  I haven't seen them done right, and basically what you can do with a grocery store, you can do with any business.  There are 3 key stakeholders in a traditional coop model, and they are rarely all addressed quickly.  Customers, management/employees, and financiers.

The principal appeal of being an owner of a grocery store coop is likely to be the customer benefits.  Providing every owner with a discount such that there sales target (very slightly above) 0 profit, is attractive to heavy customers and does not disadvantage any other owner.  If that discount is 10%, then it would be a benefit to grocery store customers of $200 to $600 per year (tax free), and so no matter how many owners join the coop,  a floor price for a share should be around $3000.  

Natural finance soft loans can also be used for a coop.  Small customer loans can be taken at very low interest rates if part of the repayment options includes using the same discount available to owners.  Loan balances are lowered by the actual value of the discount.  Loans are still repaid in queue with profits, but the repayment can be with store credits.  Interest should just need to be better than bank deposits, or equal to after tax mid-term government bond rates, to be attractive.

Employees and management can have part of their compensation be variable, and based on sales and profitability.  This "management performance bonus" should be included in the calculation for the owner price discount.  Employee and management performance for quality, service, selection and price is unaffected by whether sales are made to owners or non-owners, and so management/employees deserves compensation for making the store an attractive shopping option.

As mentioned earlier, the customer discount benefit of ownership alone may be worth $3000 per owner, and so $3M communal equity with 1000 owners with no profitability.  Every time an owner joins, all of the other owners are paid directly with the proceeds.  This means that there is significant incentive for a non-customer investor to get in early.  If initial capital and inventory costs are $500k, even if initial 50 partners are brought in at under 1M communal equity, and next 200 owners buy in at $2M, there is significant financial profit opportunity just from growing the network of partners.

The difference between what allows a 1000 owner (customer) coop and 10,000 member coop is not only price and quality performance that draws people from further away, but also store capacity.  A supermarket can serve more people than a smaller store.  Wider product selection means greater value in the customer-owner discount.  Expansion into a larger store or more locations increases customer-owner capacity (going from 1000 owners to 2000 owners at $3k/share, raises an additional $3M for ownership pool, and so 1000th partner would get most (about $2250) of his purchase price back).  Expansion into other retail categories (pharmacy, brewing supplies) increases selection and so the value of the discount.  Expansion into warehousing and wholesale services, or buying store location instead of renting would increase either profit or the discount percentage.  All of the above either increase the value per share or increase the capacity of owners and customers that can be served.

To expand from a 1000 member small store coop to a potential 10000 member supermarket coop, and raise the initial investment to do so, 1000 additional shares could be sold at $6000 each, with most of the proceeds set aside for development, or individual existing shareholders or outside investors can lend to the coop for any part of the development costs.  Growth from 1000 to 10000 owners still provides substantial profit opportunities for the 1000th and 2000th partners.  A 10000 member coop with $3000 owner discount benefit is worth $30M even if it makes 0 profit.

One issue with the grocery store owner discount benefit is that is worth much less to a single person, than to a family of 12.  Its not necessarily a major issue as it would simply make large families more eager to be shareholders, but there is an actual solution that is an overall improvement. If a 10% discount to owners results in 0 profit, then an 7% discount results in a 3% surplus that can be distributed to owner partners.  The small shopper that is an owner (or lenders) profits from the large and average shopper owners, while the average shopper owner is unaffected.  This is an overall improvement because it makes the value of a share more attractive to more people, while still providing a great deal for large and average shoppers.

A bigger issue, is that for simple customers the thought of investing over $10k or even just $3k is not a typical conscionable occurrence regardless of the potential benefits.  The natural finance solution is deposit call options.  One solution might be to offer customers a (version 1) call option with strike price of $3.5M where premiums are based on 7% of purchases.  This would mean that any customer that spends $50k in the store would automatically become an owner after 1000 other owners exist.  They automatically gain ownership after spending $25k if 2000 other owners exist.  From the existing partnership perspective, they prefer the first scenario to the second, and they don't like the lack of a fixed commitment to the option.  Because the owner discount provides a unique value to a share that is independent of the number of owners, the partnership may feel cheated if it receives less than $3k for one share.  A solution that keeps the customer simplicity of the first option is that if a customer either spends $50k, or pays the difference between 7% of what he spent and $3500, then he will receive the 7% discount in the future, and when there are at least 1000 partners, he will become a full partner.  Another alternative is to allow the customer the option of purchasing a share at $500 more than whatever the partnership wants to sell it for but allowing the customer to deduct 7% of all past store spending.  All of the above alternatives have no cost to the customer, and no benefit until a share is acquired.  Its like a long term rewards program, but may be too long to seem attractive.

A more balanced deposit call option terms is to offer a $4M communal equity strike price for premiums of $400/year ($34/month).  This is using the version 2 deposit call option formula.  Assuming an initial (arbitrary) 360000 non-voting shares, the call buyer gets in return for his $400/year in premiums in addition to the call right, 36 shares per year, and an 8% discount (1% higher than owners) while he maintains the option.  Because, in this scenario, the owners and company are paid each month/year for the benefit of the discount, they benefit if the customer doesn't spend very much, and they benefit if they spend a lot.  Whether there becomes 1000 or 2000 partners before the option is exercised, there is no loss to the owners from granting the option.  Note that although the option is for a $4M total equity value, the option buyer is accumulating non voting shares at the cost of $400/36 ($11.33).  With 1000 owners, once he owns 360 non-voting shares he gains full owner status, and so after 8 years of the option he has accumulated 288 shares, if the communal equity market for a full share is at $3M, he can abandon his option and pay $600 for 72 remaining shares that he needs instead of $800 over 2 years for those shares.  There are significant advantages to the partnership of granting such options.  For one, if a happy target value of the company is $3M in the future, then selling shares today at a $4M value is good for the partnership.  Also, non-voting shareholders do not receive any proceeds from communal equity transactions when new buyers join the partnership, and so early partners are not diluted by option holders when it comes to sharing new share buy ins or option income.

Yet another option for financing share purchases that is useful both when there are very few partners and very many is to create a natural finance soft loan queue to finance the share purchase.  Since buying a share involves paying cash directly to the partnership group, the partnership giving a loan to the purchaser instead is always an alternative.  The partnership would be advised to take at least a small deposit, but it can then finance the rest of the share purchase at say 12%/year.  Under natural finance principles, anyone and any individual partner can underbid the collective partnership by offering part of the loan at a lower interest rate and thereby receive higher payment priority.  The terms of the loan are likely to include a payment schedule, and the new buyer/borrower may abandon his share at any time by stopping the payments.  Let's say the founder who spent $500k on creating the business will sell you the next day half the business for a total equity value of $1M, and so your required payment would be $500k.   If the founder allows you to leverage that investment by only putting down $1k, and having a $499k loan at 12% with $50k/year in payment obligations.  One way to meet the payment obligations is by having new partners buy in.  If a 3rd partner paid cash ($200k) for a $600k equity value, although you appear to be losing money because the company value is going down, $100k of that $200k would go towards paying down your loan, and you have no payment obligation for 2 years as a result.  If instead the 3rd partner bought in at $1.2M equity but used a $400k loan instead of cash, you may be ahead on paper, but you have not received any liquidity help in making your required annual payment.  Incidentally, you becoming the 2nd 50% partner at say $600k equity value with very little of your own money would be a sensible proposal if you were going to manage the operations.  It can be great for you because you have so much leverage, and can walk away without losing much.  It can be good for the financial partner because of the high interest returns or getting back their share while keeping any payments if it doesn't work out.

For a smaller partnership buy-in fee of $3000 (1000+ partners), some people might still prefer a loan.  A $300 annual payment and 5% interest.  Doing so purely for the benefit of the owner discount may make sense, and if you don't want to shop at the store often after some years, you wouldn't really lose anything if you abandoned your share, and neither would the partnership or company.

Cooperatives Advocacy
Communes and cooperatives are always worth more than the same company under traditional corporate structure because first, communal equity values shares at the median owner value rather than the most pessimistic owner's opinion, and second and more importantly, equality of ownership prevents the systemic bias towards a majority owner.  That systemic bias necessarily pushes actions towards corruption and oppression even if those actions don't cross a thin binary moral/legal line that defines corruption and oppression.

IMO, it is a mistake to advocate for cooperatives on the basis that they are a near charity to the employees.  This places employees above and in opposition to investors and customers.  Instead, the proper way to reward the contribution of labour in a broader more open commune is through a performance bonus "tax".