Early Stage Venture Capital Investment in Mobile App Developers

Early Stage Venture
Capital Investment in
Mobile App Developers
Claas Grimm
claas.grimm@gmail.com

I
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II
Table of Contents
Declaration in Lieu of Oath.................................................................................................
Table of Contents............................................................................................................. II
Table of Figures ...............................................................................................................V
Table of Tables................................................................................................................VI
List of Abbreviations..................................................................................................... VII
1 Introduction...............................................................................................................1
1.1 Foreword ............................................................................................................1
1.2 Scope of Work....................................................................................................2
2 How Early Stage Venture Capital Investment Works...............................................3
2.1 Introduction to Venture Capital..........................................................................3
2.2 Venture Capital Stages .......................................................................................4
2.3 Venture Capital Investors...................................................................................5
2.4 Risks ...................................................................................................................6
2.5 Expected Return on Investment .........................................................................7
2.6 Exit Scenarios.....................................................................................................9
3 Introduction to the Mobile App Economy ..............................................................10
3.1 Value Chain......................................................................................................10
3.2 Opportunities, Challenges and Risks................................................................13
3.3 Business Models...............................................................................................14
3.3.1 Ad-Funded ................................................................................................15
3.3.2 Freemium ..................................................................................................15
3.3.3 Premium....................................................................................................16
3.3.4 Subscription ..............................................................................................17
3.3.5 E-Commerce .............................................................................................17

III
3.4 App Marketing .................................................................................................18
3.4.1 App Store Placement.................................................................................18
3.4.2 Performance Marketing.............................................................................19
3.4.3 SEO and Branding ....................................................................................21
3.4.4 Viral Marketing.........................................................................................21
4 Key Performance Indicators for Mobile Apps........................................................22
4.1 User Acquisition: UAC, CAC and K-Factor....................................................24
4.2 Retention and Churn: Analyzing User Activity and Lifetime..........................25
4.3 Customer Conversion Rate...............................................................................28
4.4 Revenue: ARPU, ARPPU and LTV.................................................................29
4.5 KPI Based Projection of Proceeds Model ........................................................30
4.6 Example KPI Based Projection of Proceeds ....................................................31
5 Investing into a Mobile App Developer..................................................................34
5.1 Terminology and Common Legal Terms .........................................................34
5.1.1 Post-Money and Pre-Money Valuation.....................................................34
5.1.2 Shares Purchase Price ...............................................................................35
5.1.3 Option Pool ...............................................................................................36
5.1.4 Liquidation Preference / Preferred Stock..................................................36
5.1.5 Antidilution ...............................................................................................38
5.1.6 Pay-to-Play................................................................................................38
5.1.7 Vesting ......................................................................................................39
5.1.8 Drag-Along and Tag-Along Rights...........................................................39
5.1.9 Conversion ................................................................................................40
5.1.10 Dividends ..................................................................................................40
5.1.11 Redemption ...............................................................................................40
5.1.12 Summary: Suggestions for Deal Terms ....................................................41
5.2 Qualifying an Investment Target......................................................................42

IV
5.2.1 Company and Product Development Stage ..............................................42
5.2.2 Capital Requirement and Use of Funds ....................................................43
5.3 Quantifying an Investment: Valuation .............................................................43
5.3.1 Assets ........................................................................................................43
5.3.2 Goodwill....................................................................................................44
5.3.3 Discounted KPI Based Projection of Proceeds Approach ........................45
5.4 Exit and Follow Up Investment Considerations...............................................46
5.5 Investment Case Example: “FunApp” .............................................................47
5.5.1 Situation ....................................................................................................47
5.5.2 KPI Based Projection of Proceeds for “FunApp”.....................................48
5.5.3 Valuation and Shares Distribution ............................................................50
5.5.4 Exit Considerations and Result.................................................................51
6 Conclusions.............................................................................................................52
Bibliography.................................................................................................................VIII
Attachments..................................................................................................................XIV
Attachment 1: KPI Based Projection of Proceeds FunApp .....................................XIV
Attachment 2: Investment Case Example ................................................................. XV

V
Table of Figures
Figure 1: An Overview of the Venture Capital Process. Source: Gompers, P. A., Lerner,
J.: 2006, p. 9......................................................................................................................4
Figure 2: Scalability based on LTV and UAC................................................................23
Figure 3: Fixed and Variable Cost by Amount of Users and UAC ................................23
Figure 4: App Retention Rates 2011 – 2014...................................................................27
Figure 5: 1-Year KPI Based Projection of Proceeds for FunApp...................................33
Figure 6: Discounted Cash Flow Formula. .....................................................................46

VI
Table of Tables
Table 1: Sweet spot IRR of 25% - 75% based on ROI on invested capital. .....................8
Table 2: Global Smartphone OS Shipments (millions) and Market Share in Q2 2014..11
Table 3: Quarterly Smartphone Shipments.....................................................................12
Table 4: Median App Half Life (in Months)...................................................................28
Table 5: Example Valuation Table 1 ..............................................................................35
Table 6: Example Valuation Table 2 ..............................................................................36
Table 7: KPIs for “FunApp” ...........................................................................................49
Table 8: KPI Based Projection of Proceeds for “FunApp”.............................................49
Table 9: Shares Valuation Table “FunApp” ...................................................................50

VII
List of Abbreviations
ARPU Average Revenue per User
ARPPU Average Revenue per Paying User
CAC Customer Acquisition Cost
COGS Cost of Goods Sold
CPA Cost-Per-Action
CPC Cost-Per-Click
CPI Cost-Per-Install
DAU Daily Active Users
DCF Discounted Cash Flow
eCPM Effective Cost-Per-Mille
ERR Economic Rate of Return
F2P Free-To-Play
GP General Partner
IRR Internal Rate of Return
LP Limited Partner
LTV Lifetime Value
TC Total Cost
MAU Monthly Active Users
SEO Search Engine Optimization
UAC User Acquisition Cost

1
1 Introduction
1.1 Foreword
The introduction of mobile apps and app stores in 2007 has eradicated previously existing
barriers and made the mobile content market accessible to virtually everyone. This created
exceptional success stories around the world. The venture capital industry, traditionally
fueling innovation and disruptive business models in new markets, is adapting to this
democratization of entrepreneurship: Investors are placing more investments in smaller
volumes and shift their focus to the increasingly important early stage investments.1
At
the same time, 2014 saw a record high in venture capital investment since the dotcom
crisis,2
a large portion of which is directed towards the mobile content space. In 2014, 63%
of all venture capital investments in the United States went into the internet and mobile
sector.3
In 2010 I started my first government- and venture-backed online games company in
Hong Kong after spending the first 8 years of my career in mobile and interactive
entertainment startups. I made an exit after 2 years and after a short break I co-founded
my second venture, an app developer, which still exists today. Both companies were
started with the help of equity investors. The past 5 years have provided me with the
opportunity to learn hands-on how venture capital financing practically works, from pitch
to exit, while interacting with business angels, incubators, institutional investors, fellow
entrepreneurs, and government bodies.
This work is a representation of my own learning process, enriched by research and
formalized to meet academic standard with the goal to bridge the knowledge gap between
early stage investors and entrepreneurs in the mobile app development field.
1
Ernst & Young (2014), p. 11
2
Preqin (2015), p. 7
3
CB Insights (2015), p. 20

2
1.2 Scope of Work
The central research question for this work is: What are the conditions for a successful
early stage venture capital investment into a mobile app developer? In order to give an
academically sound answer to this question, this work investigates the investor and
entrepreneur perspective in the following 5 chapters.
 Chapter 2 provides a brief overview of the venture capital ecosystem, defines early
stage investment and outlines the financial risk and reward expectations.
 Chapter 3 defines the term ‘mobile app developer’ and explains how the mobile
app economy works including value chain and common business models.
 Chapter 4 expands on chapter 3 and establishes the universal key performance
indicators that allow measuring the financial and strategic potential of a mobile
app business.
 Chapter 5 links the content of chapter 2 with the findings of chapter 3 and 4 to
propose how these industry specific key performance indicators can be utilized to
qualify and quantify an investment into a mobile app business. The chapter also
explains the options how to structure and execute a deal under common
investment deal terms.
 Chapter 6 concludes this work with final thoughts and remarks.
This work may serve as a practical guide for both, the entrepreneur who entertains the
idea to raise investment capital for his mobile app development venture and the investor
who is interested in investing into this field.
While this work provides a general guideline for what kind of business or business plan
qualifies for how much investment, it does not explain how to access and successfully
pitch to investors. This work does not compare early stage investments into mobile app
developers with other forms of investment.

3
2 How Early Stage Venture Capital Investment Works
2.1 Introduction to Venture Capital
Venture capital (VC) is a high risk and high return form of equity investment in which
the venture capital investor buys shares of a privately held company from its founders.
These shares can be cashed out at a high multiple of the original investment amount as
the company grows and is ultimately sold, but the investment can also be completely lost
if this venture fails.
While some investments are made by individuals, the vast majority of venture capital
funding is made by venture capital funds with a certain investment stage, industry sector,
deal size, and geographic focus.4
The typical organizational form of a venture capital fund
is a limited partnership (LP) in which venture capitalists are general partners (GP) who
control the fund's investment strategy and its existing investments - the portfolio
companies. Investors provide a fund with cash and act as limited partners who monitor
the fund's progress but are not involved in the everyday business. Venture capitalists are
compensated by a percentage of the committed capital or net asset value (1.5 - 3%) and a
part of the profit (around 20%).5
The incentive fee on profit is often referred to as carried
interest or just the “carry”.
Venture partnerships, or funds, have pre-determined life spans set out in the limited
partnership agreement. Usually around 10 years, while new investments are permitted
after year 5 to 6. A fund consists of 8 – 30 investments on average. Technology and
software focused funds tend towards 20 – 30 investments as these companies usually
require less funds than, for example, hardware-heavy biotechnology ventures.6
For entrepreneurs venture capital is an alternative route to secure the required capital to
bring an idea to live, to market or to expand. Selling equity to an investor provides the
4
Ramsinghani, M. (2014), p. 77 – 85
5
Gompers, P. A., Lerner, J. (2006), pp. 10
6
Ramsinghani, M. (2014), p. 77 – 85

4
entrepreneur with cash, for less risk than a loan, at the cost of a share of control and future
returns. Today - almost 70 years after the first venture capital firm American Research
and Development was formed - the venture capital industry has well established standards
how to propose for capital, how to present and measure a business case and how a funding
deal is legally governed. However, securing investment is a laborious task and once
achieved it does not guarantee financial success. Institutional investors invest in less than
1% of the companies that they review.7
According to an article about early stage financing
in Wall Street Journal, 95% of all early stage investments fail to return the investment as
projected.8
Figure 1: Overview of the Venture Capital Process.
2.2 Venture Capital Stages
The stages of venture capital financing correlate with the development stage of the
company that is to be invested in. There is a wide range of definitions available for each
stage. This work follows the definitions of the four venture capital stages suggested by
PricewaterhouseCoopers’ Moneytree service: Seed, early, expansion, and later stage.9
Seed stage is the beginning of any company. The product or service is still in concept
stage or in an early development stage. The company is less than 18 months old and is
maybe not even fully operational yet. The goals during seed stage are typically the
creation of a prototype or proof-of-concept and to ramp up business operations.10
7
Ramsinghani, M. (2014), p. 77 - 85
8
Gage, D. (2012)
9
PricewaterhouseCoopers (Y.U.)
10
Ibid.
Investors Firm
Venture
Capitalist
Fundraising
Return
Cash
Equity

5
Early stage starts when the company has its product or service in at least prototype or
pilot phase and may already be commercially available. The company can, but does not
have to be, revenue generating. The goals of the early stage are to show that the
company’s vision can translate into a high growth potential business. This work focuses
on this investment stage.11
Expansion stage follows the early stage. In this stage the company’s product or service
is fully commercially available and displays significant growth potential while not
necessarily cash flow profitable. Expansion stage investments aim to accelerate market
adoption and product development.12
Later stage Product or service mature while the company is generating stable, ideally
positive cash flow. The goal of later stage investments is typically to prepare the company
financially and strategically for an initial public offering (IPO).13
2.3 Venture Capital Investors
Business angels or angel investors are - at least moderately - wealthy individuals, in
many cases former entrepreneurs, who commit their own capital directly. Angel investors
typically invest in seed and early stage ventures under similar terms like an institutional
investor would. Especially former entrepreneurs focus on industries that they are familiar
with through their previous experience. Angel investors often group together in
organizations, platforms and networks to obtain better access to entrepreneurs that seek
investment.14
Angel investors can also be found in the form of family, friends and fools,
often referred to as FFF, represent the personal network of the company’s founders who
commit their savings based on trust. These investors usually do not invest past the seed
stage.15
11
PricewaterhouseCoopers (Y.U.)
12
Ibid.
13
Ibid.
14
Siegele, L. (2014), p. 7 -8
15
Feld, B., Mendelson, J. (2013), p. 8 – 9

6
Business incubators and accelerators emerged in 2005 and are essentially commercial
start-up schools funded by individuals, corporations or governments. Accelerators
support the seed and early stage development of selected companies with facilities,
networking events and mentorship in exchange for rent and a minority share of a
company’s equity. Notable incubators are Y Combinator, TechStars or Angelpad that
have spawned successful ventures like Airbnb or Dropbox.16
Venture capital firms have already been introduced in 2.1 – they are professional,
institutional venture capital investors who prefer to invest in companies with a proven
management team which have already achieved a certain level of development and
entrenchment. These firms receive hundreds of proposals and conduct extensive due
diligence for every proposal that they eventually commit capital to. Some also require
other investors to join an investment round with one of the investors taking the “lead” –
meaning the majority of the sold equity.17
These investors are the most important and
conservative type of early stage investors and they are able to provide the most capital
through their access to funds. Venture capital firms focus on early to later stage
investments. According to PricewaterhouseCoopers’ Moneytree report, in Q4 2014, 38%
of all VC money was apportioned on early stage investment.18
A collection of institutional
investors who often conduct joint investments is also referred to as “syndicate”.19
2.4 Risks
Different forms of investment are associated with a variable rate of risk and return. Early
stage investors expect a very high potential return on their investment. An expected return
of 10X within 3 to 5 years is absolutely normal. This is explained with the comparably
high risk that is associated with this specific form of investment. It is important to
understand and quantify the risks as they explain how the financial goal for an investment
is calculated (which is explained in detail in chapter 5). The major risk factors are
explained in the following section of this chapter.
16
Siegele, L. (2014), p. 9
17
Gompers, P. A., Lerner, J. (2006), p. 5 – 6
18
PricewaterhouseCoopers (2014)
19
Feld, B., Mendelson, J. (2013), p. 10

7
Long Term Illiquidity: Compared to other forms of investment, venture capital
investment is a long term commitment that offers no easy or quick way out. If things go
well, the investor typically has to wait at least 3 to 5 years until the company is ready for
a buy-out or an IPO that yields the opportunity to transform equity back into cash.
Uncertain Valuation: Especially early stage ventures lack of historical data and its
shares do not trade in an open market which makes a correct valuation of equity difficult.
An additional factor in highly innovative fields, such as software technology is a fast
changing and competitive landscape in which today’s trends can be outdated in a matter
of months.
Market Uncertainty: In the years between investment and exit the economic and market
climate can change significantly. The valuation upon exit depends on the market and
which firms are entering or leaving that market and when.
High Failure Rates: Approximately only 5% of all early stage investments meet or
exceed their projected return on investment. The performance of the remaining 95%
ranges from complete failure to providing only a small return on investment. 20
2.5 Expected Return on Investment
The exact expected return on investment (ROI) varies from investor to investor but falls
within certain boundaries for time and volume. These boundaries are dictated by statistics
of venture capital investments on one hand and the overall performance of the venture
capital industry on the other hand. Any business case that does not meet the minimum
potential ROI on invested capital is simply not suitable for venture capital.
The most common indicator to measure an institutional venture capital fund’s
performance is net IRR which refers to the net proceeds of a fund to its investors after
20
Gage, D. (2012)

8
carry and management fees. In 2013 the median net IRR of venture capital funds was
10%, the top quartile IRR was 20%, the bottom quartile IRR was 4%.21
It is safe to assume
that any investor or fund aims for “top quartile” performance. Taking a 20% carry into
account it means that a good portfolio would have to return an IRR in the realm of 25%.
Due to the high failure rate of venture capital companies, a minority of the investments
has to make up for all the underperformers of a portfolio. Of course, no investor commits
to a venture that is obvious to fail. Yet, failure is a likely fate for every investment. Due
to the limited number of investments in a portfolio, one or two investments need to have
the potential to boost the entire portfolio to a performance of IRR of 20%+. Villalobos
suggests a “sweet spot” ROI of 5 – 10X within 4 – 8 years for early stage investments in
work on the value of early stage venture capital investments.22
It is important to
understand that the investor and entrepreneur may have conflicting interests. For an
entrepreneur a 3X return would be considered a success in most cases, but for a
professional investor it is not and the investor will block such an exit if he believes a
better ROI is probable in future – even if it means taking the risk of total failure in the
end.
ROI 5X ROI 6X ROI 7X ROI 8X ROI 9X ROI 10X
YearstoExit
4 50% 57% 64% 68% 73% 78%
5 38% 43% 48% 52% 55% 58%
6 31% 35% 38% 41% 44% 47%
7 26% 29% 32% 35% 37% 39%
8 22% 25% 28% 30% 32% 33%
Table 1: Sweet spot IRR of 25% - 75% based on ROI on invested capital. Source: Payne,
W. H., Villalobos, L., (2007), p. 3
Example: Investor X receives an offer to acquire 20% of “Apps Limited” for USD
200,000. The projected exit scenario promises to sell the company 5 years later for USD
21
Preqin (2014), p. 52
22
Payne, W., H., Villalobos, L. (2007), p. 3

9
12,000,000. At that point in time the shareholding of Investor X will have diluted to 10%
as the company has taken on further rounds of investment. In this scenario, Investor X
will receive USD 1,200,000 (10% of USD 12,000,000) from the sale which equals 6X ROI
on his invested capital. The IRR for this investment would be 43%. Hence, judging by its
numbers only, this is an investment worth committing to.
2.6 Exit Scenarios
As investors seek to fully liquidate all equity owned by a fund within 10 years or less (see
2.1), the interest of investors in a company is always finite. Regardless of financial failure
or success, there are three types of so called liquidity events: incidences that allow an
investor to transform the equity back into cash.
Liquidation: Company is dissolved and all assets are sold. Since this sale brings in - at
best - the market value of all tangible and intangible assets, it is only done when the
company has failed in order to get a portion of the original investment back.
Merger, Acquisition or Buyout: A part or all of the company’s shares are sold - usually
if a company reaches strategic and financial value that is complementary to another
corporation. This is the most common scenario for a lucrative exit. In 2014, about 85%
of all exits in the United States were acquisitions according to research firm PitchBook.23
Initial Public Offering (IPO): A company may file for an IPO to begin trading its shares
on a public market. Technically an IPO is another funding round and not a liquidity event
but it allows all shareholders to sell their stock immediately at a high mark up once the
share are traded publicly. Filing for an IPO is a very lengthy process as the company
needs to undergo intense due diligence by the governing body of the market. Only a
minority of the exits happen via IPO. Early stage investment usually don’t provide
sufficient capital to support an IPO, the road to an IPO usually requires several additional
rounds of financing.
23
PitchBook (2014), p. 9

10
3 Introduction to the Mobile App Economy
The previous chapter has briefly outlined the mechanisms of early stage venture capital
investment, profiled investors and defined their expectations. Before investigating if and
how these expectations can be fulfilled with mobile app developers, this chapter defines
mobile apps and mobile app developers, introduce the most important terminology and
describe the ecosystem in which apps and app developers function.
3.1 Value Chain
Apps are computer programs for mobile operating systems and run on mobile phones,
tablet computers and any other mobile computing devices. Apps are usually installed over
the air from centralized distribution platforms, known as app stores. Apps became
relevant in July 2008, when Apple opened its app store. It is accessible via the iPhone
which was released in 2007. When Google launched its own mobile operating system
Android in September 2008, it came with its own app store. In the following years the
app store model disrupted the mobile content business which was previously dominated
by mobile network providers and independent content providers such as Jamba. These
companies acted as resellers of the mobile content and were positioned between the
content creators and the consumers. The introduction of app stores enabled content
creators to reach a large amount of consumers directly, without the previous middlemen.
A new economy was created. From entertainment to business tools, from travelling
services to home automation – in 2015 there is an app for everything a connected mobile
user may want to do. App stores and apps have become an integral part of other media
devices like tablets, smart TVs or gaming consoles. Research firm Gartner predicts that
in 2015 180 billion apps will be downloaded.24
Original Equipment Manufacturers (OEMs) produce and market the mobile devices
that run apps – smartphones, smart watches and tablets. Samsung and Apple led the global
smartphone market in 2014 according to the International Data Corporation’s Worldwide
24
Blau, B., Shen, S. (2013), p. 2

11
Quarterly Mobile Phone Tracker.25
In 2014, over 150 companies were in the business of
producing mobile devices that run apps and there are thousands of different models of
mobile devices with different specifications and capabilities. While the global mobile
devices market is extremely fragmented, the top 5 OEMs hold a market share of over 50%
(see table 3).
Mobile Operating Systems are software that control mobile devices and determine how
distribution on a phone works. From all OEMs, only Apple has its own operating system
which is exclusive to its own mobile devices. The four largest operating systems are
Google’s Android, Apple’s iOS, Microsoft’s Windows Phone and RIM’s Blackberry
whereas only Apple and Google hold a dominant market share of over 95% combined.
This simplifies development of apps for a large audience. Prior to Android and Apple
being the quasi standard with a few centralized distribution platforms, mobile content was
extremely technically fragmented. Before the disruption of the mobile content market
through the introduction of app stores; a company that wanted to distribute mobile content
on a global scale had to manage hundreds of distribution partners with hundreds of
different versions of the content to cater towards the fragmented requirements.
OS Q2 2013 Q2 2014
Android 186.8 80.3% 249.6 84.9%
iOS 31.2 13.4% 35.2 11.9%
Windows Phone 8.9 3.8% 8.0 2.7%
Blackberry OS 5.7 2.5% 1.9 0.6%
Table 2: Global Smartphone OS Shipments (millions) and Market Share in Q2 2014.
Source: Strategy Analytics (2015)
25
IDC (2015)

12
Period Samsung Apple Lenovo Huawei Xiaomi Others
Q4 2014 20.01% 19.85% 6.59% 6.25% 4.42% 42.9%
Q4 2013 32.2% 17.43% 4.75% 5.66% 2.03 41.31%
Table 3: Quarterly Smartphone Shipments. Source: IDC (2015)
App Stores are the digital mobile app distribution platforms that allow users to purchase
and install apps on their devices. The owner of the app store manages the content: Apps
are being reviewed prior to release and might be removed from sale even after launch if
they are found to violate rules. At the same time app stores run “front page” promotions
to highlight products. This promotion can have major impact on sales and is highly sought
after.26
Price points are fixed. App stores take a share of the net revenue of every purchase
made through its system. Apple and Google both charge 30% net revenue share which
can be considered industry-standard though a few deviations exist.
Apple’s iOS app store is, like its operating system, fixed to Apple devices. While
Google’s Play store is not always the default distribution platform for Android devices.
Notable Android app stores are operated by retail firm Amazon or the OEM Samsung. In
China, one of the largest markets for apps, Google’s services are blocked and the market
is dominated by local android app stores such as 360 Market, Tencent and Xiaomi.
Mobile App developers are the companies or individuals that build apps and publish
them on the various distribution platforms. App developers have to register themselves
with the app store that they want to publish on. There are plenty of development tools that
simplify, enable and measure various aspects of app development. Marketing and
analytics tools on the other hand provide a plethora of solutions market apps and analyze
user behavior. The mobile app developer companies are the focus of this work.
End consumers or users use apps on their mobile devices. Revenue from users is divided
into two layers: Direct payments from the users or in-app purchases (IAP) and indirect
26
Koekoek, H. (2013), pp. 2

13
revenue such as income generated through the display of advertisement. In-app purchases
are managed by the app stores which typically pay out 70% of the net income to the
developer. Indirect revenue is realized through third parties, e.g. advertising networks.
3.2 Opportunities, Challenges and Risks
High capital efficiency: It is possible to build a very profitable mobile app with a
relatively small amount of capital. One such example is the newsreader app Summly that
was programmed by a 15 year old and his team in 2011. By 2013, only 18 months after
release, Summly had served 90 million news reads, secured numerous high profile
investors and was sold to Yahoo for an estimated USD 30 million as reported by the
startup and technology news website All Things Digital.27 28
Another case of an app achieving high return on investment was the game Flappy Bird
by Vietnamese game programmer Nguyễn Hà Đông. In an interview Đông revealed that
the simple game that he created alone in less than a week suddenly became one of the
most downloaded games in January 2014 and netted about USD 50,000 per day.29
Lots of copycats: In February the previously mentioned game ‘Flappy Bird’ was
discontinued and a tidal wave of copies was launched on the app stores. The mobile game
review website Pocket Gamer reported that in the first week of March 2014 - less than 2
months since the game became a hit - an average of 60 Flappy Bird clones were submitted
to Apple’s app store per day.30
Alongside of its success, Flappy Bird highlights a risk of
almost every mobile app business: it is very easy for copycat and me-too products to
launch and eventually become successful in a short period of time. This is not a
disadvantage for the original service in every case but it may very well water down the
success and limits the ability of a business to become firmly entrenched and defendable.
27
Swisher, K. (2013)
28
D’Aloisio, N. (2013)
29
Hamburger, E. (2013)
30
Brown, M. (2014)

14
Customer acquisition is difficult: Discoverability is a key challenge. Top grossing apps
make more than USD 1,000,000 revenue per day in 2014, as reported by Forbes magazine
in an article about the mobile game Clash of Clans by Supercell.31
On the other hand,
mobile market research firm Vision Mobile reported in 2015 that only 48% of all app
developers who seek to generate revenue, make over USD 5,000 per month.32
As of 2015
more than one million apps are live across the various app stores making every new
release a mere drop in an ocean while only few visible apps get all the attention. In 2012
mobile analytics firm Adjust noticed that out of a sample of 650,000 apps, about 400,000
were not even once installed.33
This overcrowded market situation makes customer
acquisition – the battle for the eyeballs of users – competitive. It raises a question that
every mobile app developer’s business plan needs to answer.
Perceived value of apps is low: Depending on the geographic region, apps that are free
to download are responsible for 79% - 96% of the revenue.34
While business models are
very individual it is clear that customer expectations are high for what is worth paying for
when there is so much free content on offer. Thanks to app store’s convenient over the
air delivery, it is also very easy for a user to trial or switch to a new alternative product
or service.
3.3 Business Models
Apart from offering a competitive product or service in the form of an app, it is important
to build value for the users and customers. For commercialization, the mobile app
economy offers six standard business models that can be combined.
31
Spence, E. (2014)
32
Voskoglou, C, Wilcox, M. (2015), p. 6
33
Zytnik, M. (2012)
34
Hezemans, A. (2014), p. 6

15
3.3.1 Ad-Funded
Ad-funded apps display advertisements in the form of banners, video or audio streams.
Essentially the app is selling parts of its own real estate to advertisers. While this business
model allows services to be offered entirely for free, balancing maximum revenue and a
good user experience is a challenge. In recent years, new advertisement services have
spawned that allow ads to be used flexibly, effectively and in a combination with other
monetization strategies.
Revenue is generated congruent with the amount of ad impressions or interactions with
the ad (e.g. click, download of an offered app, viewing a video ad in full length). Both
impressions and interactions are naturally driven by the amount of users and the average
time spent per user within the app. The ability to serve relevant and individually targeted
ads to quality users logically has a positive effect on the monetization of users. 35
Example: Pandora Radio is a free music streaming app and web service with a business
model very similar to analog radio stations: Every few songs an advertisement is played.
The company also offers an ad-free premium subscription but advertising comprises 80%
of the company’s revenue.36
3.3.2 Freemium
The word ‘Freemium’ is a compound of ‘free’ and ‘premium’. Freemium has currently
established itself as the most important business model for mobile apps. According to
mobile analytics firm App Annie, 98% of Google Play’s revenue comes from freemium
apps.37
A freemium app offers limited functionality for free. A user that wants to use
extended features needs to pay. Offering an app for free is a powerful marketing tool in
itself, no required upfront payment allows an app to gain a large user base that can turn
into customers later. To make a freemium app successful it is important to find the right
35
Applift (2014, p. 4 - 23
36
Pandora (2014)
37
App Annie (2014), p. 15

16
balance between an attractive free service and sufficient added-value in its premium
features to convert enough of users into paying customers.38
Freemium games are also labeled ‘free-to-play’ or ‘F2P’. Especially games tend to offer
usage based features or virtual goods (‘consumables’). This increases the maximum
possible spending per players to virtually infinite amounts. Apps that offer upgrades on
top of an initial purchase are also referred to as ‘paidmium’.
Example: The adventure game “The Walking Dead” by Telltale Games is released in
episodes. The first episode is offered for free on the app stores, additional episodes cost
about 5.00 USD. In an Interview with Wall Street Journal, Telltale CEO Dan Connors
explained that offering the first episode for free is done specifically to open the funnel
and get it out to more people who can then convert into the game39
. While the game is
also available on gaming consoles, 25% of its sales occur on mobile. The game series
sold 21 million episodes in the first 18 months after release40
.
3.3.3 Premium
In the context of mobile apps, a premium product is an app that is purchased for a fixed
price. This was the default business model for all apps until Apple enabled free apps with
in-app purchases in 2009. Since the introduction of the freemium model, pay-per-
download or ‘paid’ apps have been marginalized. App Annie reports that by mid-2014
only 1% of Google Play’s revenue comes from paid apps41
.
Example: The game developer Mojang released an Android and iOS version of its game
Minecraft (one of the best-selling video games of all time) years after being already
38
Kumar, V. (2014), p. 27 - 29
39
Lynley, M., (2013)
40
Telltale Games (2013)
41
App Annie (2014), p. 15

17
incredibly popular on gaming consoles and PC. Leveraging its popularity among gamers,
the game sold 10 million units in the first 2 years for a price of around 7.00 USD each.42
.
3.3.4 Subscription
The subscription to a service offered by an app is essentially an in-app purchase that
grants a license to use the app, or certain features of it, for a limited time. This business
model is popular with the software as a service (SaaS) model. SaaS is cloud hosted
software that is accessible on demand via a minimal client or web browser. Many SaaS
products only grant a temporary free trial period or even no free service at all.
Example: Music streaming service Spotify offers its service for free but supported with
advertisements. For USD 10.00 per month, the user can get rid of all ads. Spotify claimed
about 60 million active users at the end of 2014, of which 15 million are paying
subscribers.43
3.3.5 E-Commerce
With the increased availability of mobile internet, many large e-commerce retailers have
extended their web based online shop and services to apps for numerous reasons: To
increase accessibility to their shops or to make use of features that are unique to mobile
devices such as camera, geo-location services or integration with other popular camera or
social apps. E-commerce apps, sometimes also referred to as m-commerce do not
commercialize through the app stores but sell products and services through their own
shopping system.
Example: Kuaidi Dache is an ‘e-hailing’ app for the Chinese market. It allows users to
book taxis or drivers. The app is free of charge for taxi drivers and their customers.
42
Kaplan, D. (2013)
43
Spotify (2014)

18
Kuaidi Dache takes a commission on the mobile data services provided by mobile network
operators to the taxi drivers.44
3.4 App Marketing
Mobile apps can be marketed via traditional or new media just like any other product.
Successful apps appear in TV, print or online advertising. There are however marketing
mechanisms and strategies that are specific to the mobile app economy. These
mechanisms imply how success of a business can be measured which is discussed in
chapter 4. Mobile app marketing as a whole is a very exhausting topic and it would go far
beyond the scope of this work to discuss it in detail. This chapter focuses on the aspects
that are relevant to derive meaningful performance indicators for an app business.
Since all business models scale with the amount of users, the main goal of marketing an
app is to generate users for an app. These incoming new users are often referred to as
‘traffic’. There are two methods for marketing: organic and paid. Organic methods are
the various methods that create more users for an app by itself without paying for traffic
(app store placement, SEO, branding and viral marketing). Paid methods, as the name
suggests, include all methods that generate a measurable amount of ‘traffic’ and are paid
for (classic media ads, performance marketing). The sum of these activities constitutes
the user acquisition.
3.4.1 App Store Placement
Placement on the starting page of any app store has an extremely powerful effect on
downloads due to the sheer number of potential users. Placement on high level pages in
any app store can occur through performance of the app itself and to get listing in
rankings. These are typically driven by number of downloads within a certain time frame
or generated revenue within a certain time frame. App stores usually also reserve some
44
Davison, N. (2014)

19
real estate on their high level pages for selected content. Being featured in a highly visible
position can increase revenue from that particular app store by up to 900%.45
Getting a highly visible placement within any app store, such as the front page
recommendations in Apple’s App store, cannot be planned and should hence not show up
in any business plan. Alternatively, it is possible to buy a spot in performance rankings
(e.g. top 100 by download) through performance marketing, so called ‘burst campaigns’.
A burst campaign is a short, concentrated marketing effort, usually heavily relying on
performance marketing, with the goal to break into the top rankings of an app store. The
idea is that once the app has reached a top placement, the increased visibility leads to a
big amount of extra users that pays off the marketing. Ideally the app keeps performing
well and is able to maintain good placement. Burst marketing campaigns are relatively
expensive, depending on timing and location the required amount of installs varies. A top
10 placement in Apple’s USA app store requires about 70,000 installs. If achieved by
performance marketing only, that equals about USD 100,000 for a 24 hour campaign.46
3.4.2 Performance Marketing
Cost-Per-Mille (CPM) refers to cost per thousand impressions. The advertiser pays a
fixed price for every thousand times an ad is displayed to a user and is most useful if the
goal of a campaign is to be seen. Pricing varies by advertising (a small, static banner
image is less costly than full screen, 30 second video ad). Compared to other performance
marketing models, CPM is an efficient way of achieving awareness but relatively
inefficient to gather active users. However, users acquired though this method are
typically more valuable as they have installed the app through their own interest triggered
by the ad.47
Cost-Per-Click (CPC) campaigns are paid by the amounts of desired interactions with
an advertisement – typically click or tap. CPC campaigns are more expensive than CPM
45
Agten, T. v. (2014), p. 9
46
Koekkoek, H. (2013), pp. 3
47
Applift (2014), p. 6 - 7

20
campaigns since the advertising agent covers the risk of a low quality advertisement that
does not generate enough clicks per impression.48
Cost-Per-Install (CPI) is currently a very popular mobile advertising model among app
developers. CPI campaigns are paid by the amount of unique app installs on mobile
devices. This also makes CPI the most expensive advertising model. These installs
however, do not convert 100% into users, especially when employing advertising
solutions that reward installs. This leads to users who install an app for the reward but
not for the app itself (so called incentivized traffic). The motivation to actually use the
installed app by these people is low. Installs for no reward (so called non-incent traffic)
are even more expensive but typically yield a higher conversion rate from install to active
users because the installs were generated out of genuine interest. Another downside of
CPI stems from its recent popularity that led to a decline in quality of the installs delivered
by the advertising networks which is reflected in slight decline of the average CPI cost.
In March 2015, depending on geography and OS, the average CPI in all countries ranged
between USD 0.47 – 3.00.49
Practically the price for every advertising model fluctuates depending on demand and
supply. Advertising service providers offer their deliverables as an auction model: The
advertiser bids for a maximum amount of installs, clicks or impressions in a fixed
timeframe at a maximum purchase price. Once the campaign is launched the contingents
are distributed to the highest bidder first. App developers with less pressure to acquire
users will usually have lower performance marketing cost due to the ability to pick and
choose cost efficient markets. App developers that have a higher marketing goal are
increasingly vulnerable to supply and demand price fluctuations and will have higher
performance marketing cost.
48
Applift (2014), p. 7 - 8
49
Chartboost (2015)

21
3.4.3 SEO and Branding
Search engine optimization (SEO) includes optimizing an app’s name, description and
meta-information to achieve maximum visibility in search queries from users in the app
store. For example a user that searches for “cheap hotel in Bali”, might be a potential user
of a hotel booking app, even if he has not specifically inquired for it. In similar fashion -
leveraging famous brands can be an efficient source of users, especially for games if the
licensed brand are a good match, for example attaching a sports fashion brand to a sports
game. For app developers it is a guarantee to receive a certain amount of installs from
users searching the app stores for key search terms. App stores and numerous third party
services support extensive tracking of keywords and search results which to measure the
success of this marketing method.
3.4.4 Viral Marketing
Viral marketing is the ability off an app to create additional users from the existing user
base, just like a virus that spreads from host to host and infect others. This is an important
feature to reduce marketing cost and increase profitability. Many apps reward users for
spreading it among their family, friends or co-workers. Every app developer can record,
track, analyze, and optimize such features. Viral marketing also includes traffic that is
generated by ‘hype’ – popular online videos or coverage in social media such as blogs,
Facebook, Twitter and the likes.

22
4 Key Performance Indicators for Mobile Apps
This chapter suggests a model that allows to examine an app developer’s business case
based on universal key performance indicator (KPI) metrics so it can be put into the
perspective of an early-stage venture capital investment deal. Additionally this chapter
touches on upper and lower limits of each KPI based on currently available market data.
All data required to establish these KPI can be collected by every app developer as app
stores provide a large number of basic analytics. These basic analytics are supplemented
by many services that measure a virtually infinite amount of freely customizable metrics.
At the end of this chapter, the defined KPI are embedded in a universal model to calculate
financial performance of a mobile app developer business case. The model to analyze and
measure an app business suggested by this work is based on the total cost (TC) principle.
Total cost is a management accounting principle that separates all cost into fixed cost and
variable cost. The result shows a company’s or business line’s performance potential
based on cost units. As previously discussed in chapter 3, all app business models scale
with the amount of users, multiplied by the proceeds that can be generated by those users.
Marketing methods also evolve around quantifiable user acquisition. This makes the user
the ideal generic cost unit for an app business analysis. Consistently - applying the total
cost principle implies that the income is measured based on amount of users. The
following sections define a detailed breakdown of user as a cost unit: the user acquisition
cost (UAC) representing the cost side and the on the income side the proceeds from the
average user over the lifetime: lifetime value (LTV).
The differential between UAC and LTV effectively illustrates the scalability of a mobile
app developer business case. It is a key indicator for investors, it answers the question
how much value can be created per dollar invested (see figure 2).

23
Figure 2: Scalability based on LTV and UAC
Individual variable and fixed cost occur for every app developer (e.g. staff payroll plus
fringe cost, facilities, customer service, hardware cost, royalty proceeds …). Placeholder
fixed cost and individual variable cost is included in further calculation without a detailed
breakdown because the result of this work is meant to be universal for every app
developer.
Example: An analysis of the financial performance of a mobile app developer reveals that
the UAC for this business case is USD 0.50. Fixed cost per month is USD 50,000, and
LTV per user is USD 0.75. These figures imply that the app developer can scale and
returns USD 50,000 if USD 100,000 are invested into marketing (see figure 3).
Figure 3: Fixed and Variable Cost by Amount of Users and UAC
$-
$25,000.00
$50,000.00
$75,000.00
$100,000.00
$125,000.00
$150,000.00
0 Users 50,000 Users 100,000 Users
UAC
Fixed Cost
Sales Revenue
COGS
LTV
Scalability
UAC
$

24
4.1 User Acquisition: UAC, CAC and K-Factor
User Acquisition Cost (UAC) is the average cost of a mobile app developer to create
one additional user to its service or product. It is the total sum of the cost of all marketing
efforts divided by the amount of users created within the specific time frame. This figure
can vary widely. If an app has to rely entirely on paid CPI, CPM or CPC campaigns, the
UAC might reach up to USD 10.00. If an app can pull enough users from leveraging a
licensed brand, making performance marketing unnecessary, the UAC could be zero.
Example: If an app developer has spent USD 100,000 on marketing in one month and
registered 200,000 new users in the same time frame – the UAC for that month is USD
0.50.
Customer Acquisition Cost (CAC) is the same calculation as for UAC but it only takes
users into account that have converted from non-paying users to paying users or
customers. The definition of a paying user depends on the business model of the app. For
paid apps every user is a paying user. Apps that rely on advertising revenue also do not
have customers per se. Freemium apps and e-commerce apps on the other hand live and
die by the ability to convert users to paying users or customers. The success of mobile
app developers that chose these business models is determined by a positive balance
between CAC and LTV. There is no standard how to determine CAC, users might convert
to customers after several months of activity. This is particularly true for games – the
highly successful The Walking Dead mobile game (previously mentioned in chapter
3.3.2) requires the users to finish the first, free of charge, episode before they are
prompted to purchase the additional content for the first time.50
K-Factor, is a marketing term that is originally used in epidemiology to describe how
efficient a virus spreads among the population. It is sometimes also referred to as viral
growth, virality, viral coefficient or organic growth - due to its uncontrolled nature - and
describes the percentage of users or installs that an app generates outside of its regular
50
iTunes (2015)

25
marketing efforts for user acquisition. Every app has a certain amount of organic growth
as it could be found by accident by users that are randomly browsing an app store for
specific keywords, features in magazines or review websites, or simple word of mouth.
Some of this organic growth is very hard to influence but organic growth can be fostered
by adding so called “viral features” into an app. For example rewarding users for inviting
friends or sharing on social networks. Another way to increase the organic growth is
through search engine optimization: To increase the visibility of an app in app stores or
web by digitally “tagging” popular keywords to the content.
A very good example for a viral growth feature is the mobile game Candy Crush Saga
from King.com. It is a puzzle game in which players begin with five lives, losing one
when a level is failed. When they are exhausted, users can request their Facebook
connections for an extra live (a simple button click after receiving a message) or wait for
them to restore after 30 minutes. This simple feature has largely contributed to the game
being the top grossing mobile game in 2013, generating over USD 1,000,000 daily
revenue.51
Example: An app has received 500,000 new installs within one month. 400,000 of these
installs were generated by performance marketing service providers. 100,000 installs
were generated organically through invites that users sent out to their friends. The k-
factor for that month was 25%.
4.2 Retention and Churn: Analyzing User Activity and Lifetime
Install base is the total amount of unique installs that an app has generated over its
lifetime. As the install base does not give any insight into how many of these installs are
actually users it is necessary to look at the active users when defining key performance
metrics. Although it should be noted here that a large install base has a value of its own
as a portion of the inactive users can be reactivated if they are addressed with win-back
marketing campaigns.
51
Stokel-Walker, C. (2014)

26
Daily Active Users (DAU) and Monthly Active Users (MAU) indicate how many users
are currently using the app. An app that has been in the market for a long time might have
a large install base but only a small percentage of this install base will be part of the MAU
or DAU group. The most common definition of an active user is a user who has started
the app at least once within the time frame in question. This metric is often loosely used
and it is important to understand how exactly activity is defined in every case. Different
app developers might also use a different base to calculate MAU. Some use calendar
months but it is also possible to use 31 or 30 days by default. In this work MAU refers to
calendar months. In the context of evaluating a business this is a key figure as it
demonstrates the ability of an app to generate an active user and customer base. This leads
to the next interesting question when investigating user activity: How many of the active
app users from today will still be using the service tomorrow or next month? While DAU
and MAU give an insight into the amount of active users, it is not possible to derive how
long these users will stay active.
Retention describes the how many users are staying active over time. It is a good
indicator to measure how attractive or useful an app is to the average user and how well
traffic converts to a long term user base and ultimately revenue generating users. The
ability to convert installs into users and to retain active users is crucial, making all user
acquisition efforts more efficient. Retention can be visualized well in a ‘retention curve’,
starting at day 0 with 100% of the users and then fading out over X amount of days or X
amount of times the app was used. When comparing apps by fixed days by using the
retention rate on day 1, day 3, day 7, etc. industry jargon sometimes refers to these rates
as D1 retention, D3 retention, etc…
What are realistic retention rates for apps as of today? Mobile analytics firm Localytics
releases extensive data of app user behavior and retention. The firm has published average
retention rates from 2011 – 2014 and while investigating these numbers it is clear that a
large portion of the installed apps are abandoned relatively quick. In 2014, depending on
the type of the app, 9% - 23% of all installed apps have only been opened once while only
39% of all apps have been opened more 11 times or more. These numbers demonstrate

27
clearly that it is not easy to retain a user and ultimately turn him into a source of revenue
(see Figure 4 below).52
Figure 4: App Retention Rates 2011 – 2014. Source: Hoch, D. (2014)
Lifetime or, more precisely, Average User Lifetime indicates the amount of days that
the average user stays active before he or she becomes inactive. There is no standard
calculation for this metric and the result varies depending on the definition of the point in
time when a user is deemed inactive. It could be 20, 50 days, or 100 days of inactivity.
Similar to retention it is a good indicator of the quality of the service offered by the app.
In 2014 Mobile analytics firm Flurry has published an overview of the average user
lifetime in mobile apps, using the data of 26,176 apps that were published between 2011
and 2014. The analysis finds that user lifetime has been fairly stable between 2011 and
2014 and that user lifetime varies significantly depending on the type of app. See the
following table for the results of this analysis.53
52
Hoch, D. (2014)
53
Gordon, M. E. (2014)
26.0%
26.0%
22.0%
31.0%22.0%
34.0%
20.0%
39.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
1 2 3 4 5 6 7 8 9 10 11+
Total Number of Times Apps Were Used
2011
2012
2013
2014

28
Category Median App Half Life (in months)
News 7
Health, Fitness, Medical 6
Business and Communication 6
Tools 5.5
Travel 4
Lifestyle 4
Media 4
Shopping 4
Social 3
Games 2
Table 4: Median App Half Life (in Months). Source: Gordon, M. E. (2014)
4.3 Customer Conversion Rate
Customer Conversion Rate is a metric that only applies for apps that are free to use and
offer purchases as part of a freemium or ecommerce business model. It describes how
many of the active users opt to pay either directly (for example by credit card) or indirectly
(for example by consuming advertisements). It does not make sense to apply it to the
generation of advertising revenue.
Example: An app has 100,000 monthly active users (MAU). In the same month 1,500 of
these have successfully completed a purchase within the app. The customer conversion
rate for this month was 1.5%.
After investigating numerous sources it appears that a normal conversion rate would be
in the range of 0.5% to 3.0%. Forbes magazine suggested in an article that freemium
games typically convert 1% – 2% of their users to paying users. 54
According to
Monetate’s Ecommerce Quarterly, the conversion rate for m-commerce between Q4 2013
to Q4 2014 ranged from 0.70% to 1.06% for smartphones and from 2.13% to 2.86% for
tablets.55
54
Spence, E., (2014)
55
Monetate (2015), p. 12

29
Obviously a higher customer conversion rate is better but it is important to consider that
this number is highly influenced by the quality of traffic. 100,000 additional users that
convert only at 0.3% are still 300 customers more and it would be unwise to reject them
just because they make the customer conversion rate look bad.
4.4 Revenue: ARPU, ARPPU and LTV
Average Revenue per User (ARPU) describes how much the average active user is
spending in a certain timeframe. For paid apps this number is naturally flat but on apps
that feature in-app purchases this metric is an important indicator as it changes with the
introduction of new features, a different user experience or events such as seasonal
discounts.
Example: An app has 100,000 monthly active users (MAU). In the same month the total
revenue generated was USD 50,000 after tax and transportation cost. The ARPU for this
month was USD 0.50.
Average Revenue per Paying User (ARPPU) is the same as ARPU but takes customer
conversion into account. For apps with a paid or upgrade-once business model this metric
is not useful. For other apps this figure provides a lot of inside into customer’s purchase
behavior. While one app may have many customers that spend little another app might
have very few customers that spend a lot.
Example: An app has 100,000 active users within one month. In the same month the total
revenue generated was USD 50,000 after tax and transportation cost. The user to
customer conversion rate was 2%. The ARPPU for that month was USD 25.00 while the
app had 2,000 customers.
Lifetime Value (LTV), as detailed in the beginning of this chapter, measures the
monetary value of every generated user by multiplying ARPU with User Lifetime. LTV
is the most important high level metric together with UAC as the difference between LTV
and UAC ultimately determines how successful and how scalable a business can be.

30
Example: An app has a user lifetime of 3.5 months and a monthly ARPU of USD 0.50.
LTV equals USD 1.75.
4.5 KPI Based Projection of Proceeds Model
Any of the standard business models detailed in chapter 3 can be disassembled into the
KPIs that are defined in this chapter. This section explains how to bring all of them into
context to show how each of them affect financial performance of an app developer.
Chapter 5 examines how model can be applied in the process of preparing an early stage
investment into a mobile app developer.
This model makes a necessary simplification of the timing of the projected income. Using
the LTV to project income means that all the associated cash flows from a user base are
accounted for the month in which this user base is generated. This is acceptable because
of the, in any case, loose nature of early stage business case projections.
This model can be used based on historical data that an app developer can provide from
an existing pilot launch or entirely made up figures. The previous descriptions of this
chapter should allow for a reality check if the projected estimates are within reason.
As described in the beginning of this chapter the following basic calculation determines
scalability from the cash flow perspective. Using the KPIs LTV and UAC it can be
expanded per business model.
𝑈𝑠𝑒𝑟𝑠 ∗ (𝐿𝑇𝑉 − 𝑈𝐴𝐶) − 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡

31
For the freemium and subscription business model alike ARPPU and conversion rate
need to be on display as they are vital components.
For the ad-funded business model the ad revenue (eCPM or whichever business model is
chosen) can be used to calculate the ARPU and it is not necessary to divide between
customers and active users so the conversion rate can be replaced with 1:
For the premium business model there are only paying users, lifetime is irrelevant and is
replaced with 1:
4.6 Example KPI Based Projection of Proceeds
This section will illustrate by a simple example how KPIs can be employed in a KPI based
projection of proceeds using realistic figures. The hypothetical mobile app developer
FunApp offers a game for free that displays ads in the game. Further, the users can
upgrade to an advertising free premium version of the game for USD 9.99 and an add-on
for another USD 9.99. The KPI of the app are projected as follows.
(𝐴𝑅𝑃𝑃𝑈 ∗ 𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 ∗ 𝐿𝑖𝑓𝑒𝑡𝑖𝑚𝑒) − (
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐶𝑜𝑠𝑡
𝐴𝑐𝑞𝑢𝑖𝑟𝑒𝑑 𝑈𝑠𝑒𝑟𝑠 + 𝐾 − 𝐹𝑎𝑐𝑡𝑜𝑟
)
(𝐴𝑅𝑃𝑃𝑈 ∗ 1 ∗ 𝐿𝑖𝑓𝑒𝑡𝑖𝑚𝑒) − (
)
(𝐴𝑅𝑃𝑃𝑈 ∗ 1 ∗ 1) − (
)

32
 Customer conversion rate: 2.0% of all users buy the ad-free version of the game
for USD 9.99 and the add-on for another USD 9.99. 100% of the user that upgrade
also purchase the add-on.
 ARPPU: App stores deduct 30% of the sales revenue, taxes and transportation
cost deduct another 20% from this purchase. This being said, net income for the
app developer is USD 9.99 per paying user (50% of USD 18.98). The premium
purchase is made by users on average after 1 month. Users that buy the premium
version of the game do not generate further advertising revenue.
 ARPU per month from in-app advertising is USD 0.02.
 Average user lifetime is 3 months.
 K-factor: Active players will generate additional users through a viral feature
within the game adding a 30% k-factor to all user acquisition efforts.
 10,000 organic users are generated per month from the app store, review sites and
other unidentified sources without any further cost.
 500,000 users per month are acquired through various performance marketing
methods for an average cost of USD 0.20 per active user (USD 200,000 per
month).
 Based on these user acquisition efforts, additional 153,000 users are generated per
month from the game’s 30% k-factor.
 Fixed cost: FunApp is a small team, it projects that USD 50,000 are required to
operate the business.
The first step is to use the KPI to calculate the LTV and UAC. Calculating the LTV shows
that if the projections are met, the app generates value of USD 0.259, the UAC is USD
0.1508 and the differential between LTV and UAC is USD 0.1082.
LTV =
0.02 ∗ (𝑈𝑆𝐷 9.99 + 𝑈𝑆𝐷 0.02) | Paying users
+ 0.98 ∗ 𝑈𝑆𝐷 0.02 ∗ 3 𝑚𝑜𝑛𝑡ℎ𝑠 | Other users
= 𝑈𝑆𝐷 0.259

33
Now that UAC and LTV have been established, it is possible to make projection of
proceeds that includes fixed cost and variable cost. The company FunApp employs a
small team to operate the app. Monthly operations are projected to cost USD 50,000.
UAC adds another USD 100,000 to the cost per month. If the app performs as predicted,
the value generated from 663,000 users per month will be USD 171,717 (Users multiplied
by LTV). Profit based on projected proceeds of the app developer FunApp per moth
would be USD 21,717 which equals an operating profit margin of about 14.5%. While
this looks good as a business case, the following chapter will investigate if this case is
suitable for an early stage investment.
Figure 5: 1-Year KPI Based Projection of Proceeds for FunApp.
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
1 2 3 4 5 6 7 8 9 10 11 12
Fixed Cost UAC LTV from Users generated in that month
UAC =
𝑈𝑆𝐷 100,000
10,000 + 500,000 + 153,00
= 𝑈𝑆𝐷 0.1508
UAC - LTV =
𝑈𝑆𝐷 0.259 − 𝑈𝑆𝐷 0.1508 = 𝑈𝑆𝐷 0.1082

34
5 Investing into a Mobile App Developer
The previous chapters have described what the requirements and expectations for a ‘good’
equity investment are and how app developer’s performance can be measured. This
chapter attempts to bring both sides together and investigates how to qualify and quantify
an investment into an app developer. Additionally, this chapter gives an overview how an
early stage investment is executed practically.
5.1 Terminology and Common Legal Terms
This section gives an overview of the common terms that make up an early stage
investment agreement or term sheet. Different types of stock of the same company may
have different rights associated with them. These legal terms can affect follow up
investment rounds and how much each entity gets out of an exit or liquidity event.
5.1.1 Post-Money and Pre-Money Valuation
The sentence “Investor X invested USD 1 million into company A at a valuation of USD
4 million” often refers to post-money valuation – the company valuation after the
investment. This means that in this case Investor X purchased 25% of company A.
Nonetheless an entrepreneur could very well understand it differently when offered “an
investment of USD 1 million at a valuation of USD 4 million”. It is not entirely
unreasonable for the entrepreneur to think that the investor assumes that the company is
already worth USD 4 million and therefore offers to buy 20% of its shares. What the
entrepreneur in this example is thinking about is the pre-money valuation. In professional
correspondence, term sheets or legal agreements the two interpretations of the word
valuation are clearly defined.
𝑃𝑟𝑒 − 𝑀𝑜𝑛𝑒𝑦 𝐸𝑣𝑎𝑙𝑢𝑎𝑡𝑖𝑜𝑛 + 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 𝑃𝑜𝑠𝑡 − 𝑀𝑜𝑛𝑒𝑦 𝐸𝑣𝑎𝑙𝑢𝑎𝑡𝑖𝑜𝑛.

35
5.1.2 Shares Purchase Price
This is naturally the term on which investors and entrepreneurs focus on most. It sets the
amount an investor pays per share of the company. In a term sheet or investment
agreement it is represented in a valuation table that contains, or clearly implicates, a post-
money and pre-money valuation and an overview of the distribution of shares.56
Example: Investor X plans to invest USD 100,000.00 into company A. Prior to the
investment, the company is entirely owned by the two founders A and B who both own
4,500 shares each. All parties have settled upon a post-money evaluation of USD
1,000,000. Consequently Investor X will buy 1,000 newly created shares (10% of the total
share). In a term sheet this would be shown in a valuation table similar as below:
Initial Shares
Position
Shares
Issued Past
Investment
Fully Diluted
Ownership
Past
Investment
Founder A 4,500 4,500 45.00%
Founder B 4,500 4,500 45.00%
Investor X - 1,000 10.00%
Total 9,000 10,000 100%
Table 5: Example Valuation Table 1
56
Feld, B., Mendelson, J., (2013), p. 35 - 40
Post-money Evaluation “Company A” USD 1,000,000
Price Per Share USD 100
Investment Investor X USD 100,000
Percentage of Shares Purchased by Investor X 10%

36
5.1.3 Option Pool
The option pool is a shares reserve that is not issued to founders or investors. The purpose
of this pool is usually to reward key employees with a stake in the company or to create
a reserve for a follow up investment. It is not uncommon for investors to demand a bigger
option pool which has direct impact of the shareholding percentage of a company.57
Example: Just like in the previous example, investor X plans to invest USD 100,000.00
into the company “Company A”. This time the two founders A and B have already created
an unvested option pool consisting of 2,000 shares. The valuation table now takes the
shareholding into account how the option pool affects the shareholding percentage
(unvested versus completely issued):
Initial Shares
Position
Shares Issued
Past
Investment
Fully Diluted
Ownership
Past
Investment
Issued Shares
Position
Founder A 3,500 3,500 35.00% 43.75%
Founder B 3,500 3,500 35.00% 43.75%
Investor X - 1,000 10.00% 12.50%
Unvested Option Pool 2,000 2,000 20.00% -
Total 9,000 10,000 100% 100%
Table 6: Example Valuation Table 2
5.1.4 Liquidation Preference / Preferred Stock
Professional investors will almost always ask for a separate class of shares that has
different rights associated with them. This stock type is called preferred stock as opposed
to common stock. There can be multiple different classes of preferred and common stock.
57
Wilmerding, A., (2006), pp. 22

37
Liquidation preference comes into effect in the case of a company being liquidated or
wound up (for example, due to bankruptcy). A liquidation preference is an optional term
that can be used to give an investor additional security or to distribute the returns of an
exit disproportional to the shareholding positions. Liquidation preference has two
elements: preference and participation.
Preference: In case of a liquidity event, a shareholder of preferred stock will receive an
amount equal to X times the original purchase price per share before shareholders of
common stock receive anything. The most common form is a 1X preference which means
that the liquidation preference equals the original purchase price. Liquidation preferences
that are given in multiple rounds of financing can stack on top of each other.
Participation: Liquidation preference can be nonparticipating, participating or capped
participating. In a liquidity event, a nonparticipating liquidation preference gives the
holder of preferred stock the option to either receive the liquidation preference or to
convert the preferred stock to common stock and participate in the gains pro-rata. A
participating liquidation preference will grant the holder of preferred stock the amount of
the liquidation preference before the common shareholders receive anything. Afterwards,
the stock is converted and the remaining gains are distributed accordingly. A capped
participation guarantees the preferred stock holder only a maximum multiple on his shares
purchase price.58
Example: Company A sells for USD 10 million. Investor X has invested USD 100,000 into
company A and now holds 10% of the company’s stock in the form of preferred shares
that have a non-participating 1X liquidation preference. Investor X can now opt to
convert the preferred shares to common stock to fully partake in the gains from the sale
(10% of USD 10 million) or execute the liquidation preference (USD 100,000). Certainly
an easy choice for the investor in the case of a profitable sale. If in the same situation,
investor X would hold a participating 1X liquidation preference, the preferred stock
would get converted after the liquidation preference was paid out. In this case the investor
58

38
would receive USD 1,090,000 (USD 100,000 plus 10% of the remaining USD 9.9
million). If the same investor would hold a participating liquidation preference with a 5X
cap on the original shares purchase price, the gain from the sale for the investor would
be only USD 500,000.
5.1.5 Antidilution
Antidilution prevents the investors’ shares from being reduced to a decreased value in the
case of new shares being issued at a lower price. There are two types of antidilution
provisions: weighted average antidilution and full or direct ratchet antidilution. Full
ratchet antidilution is a full protection of the investor’s shareholding position in the case
of additional shares being issues – usually for a follow up investment. Practically the
investors will get additional shares issued, if the valuation of the company drops, to retain
his original shares value. Weighted average antidilution is less severe as it only protects
a middle ground value between the original and the new share price. There are several
different models for the calculation of the weighted average antidilution.59
Antidilution
in an early stage investment deal might hurt the venture. Follow up investors are likely to
have issues with one of the shareholding parties having a heavily entrenched position.
5.1.6 Pay-to-Play
Pay-to-Play is a term designed to encourage investors to co-invest further in follow up
investment rounds, especially in a round at a lower shares price than the initial investment
(so called “down rounds”). A pay-to-play clause automatically converts all or some of the
investor’s preferred stock into common stock so that liquidation preference and
antidilution is lost, if an investor does not participate at least partly according to his shares
position.60
59
Wilmerding, A., (2006), p. 42 - 44
60
Feld, B., Mendelson, J. (2013), p. 47 - 49

39
This clause makes sense if company and an institutional venture capital investor agree on
a plan to raise future investment rounds. For business angels, family, friends or incubators
this term does not apply because these investors typically do not plan to invest above the
initial investment. It is also likely to waive the pay-to-play clause, especially in a situation
when all parties welcome additional funding.
5.1.7 Vesting
A vesting schedule could be demanded by an institutional investor or angel investor and
serves the purpose of protecting the company’s interests against those of the individual
founding partners in case of departure. A typical vesting schedule applies to founding
partners allowing them to keep only a part of their stock if they depart from the company
or have the employment terminated. Feld and Mendelson suggest that a vesting period of
4 years is standard for early stage ventures while founders usually get credit up to a year
accredited for the time already spent with the company. The shares that become free if a
vesting schedule triggers are staying in the unvested option pool, the vested shares might
be bought back by the company at fair value.61
5.1.8 Drag-Along and Tag-Along Rights
In the context of equity investment, a drag-along clause forces the minority shareholder
to join a sale. Tag-along, conversely, allows the minority shareholder to join any deal that
the majority shareholder concludes. This is a standard protective provision that
institutional investors typically demand.62
It is also in the interest of the entrepreneur who
will usually still hold the majority after an early stage financing, this clause helps to avoid
that shareholders with a small number of shares hold up a sale.
61
62

40
5.1.9 Conversion
Conversion rights grant an investor the option to convert preferred stock to common stock
at any point in time and it is not possible to reverse that process. 63
This clause has
implications on antidilution and liquidation preference protections. An investor might
exercise this right if the gains from a liquidity event are more in the favor of common
stock holders. An additional conversion clause is automatic conversion in the case of an
IPO. Consequences of conversion clauses are not significant, they are a tool to protect the
investor against falling short in comparison to the other shareholders in a liquidity event.
5.1.10 Dividends
Dividends usually provide an investor around 5 – 15% annually on the investment. While
a common and decisive factor for publicly traded or private equity stock, such terms have
no place in early stage venture capital other than providing additional security to the
investor as the impact on a successful or failure investment is insignificant.64
5.1.11 Redemption
This right grants the holder of the stock associated with this right an option to pull out the
original investment without a liquidity event. This helps an investor to get a return from
an investment that does not yield any return otherwise. After a fixed amount of years
without a liquidity event the company is required to pay back the investment amount
immediately, over time in full, partly or with a premium (multiple or interest rate). It
serves a similar purpose like dividends but is a lot harsher.65
This term is highly unfavorable for the entrepreneur and it can prevent follow up investors
who may dislike such a strong position of the early investor. Asking for such a high degree
of security also contradicts with the risky and volatile nature of early stage investments.
63
Wilmerding, A., (2006), p. 47
64
65
Wilmerding, A., (2006), p. 44 - 46

41
5.1.12 Summary: Suggestions for Deal Terms
Below is a list of suggestions, which terms should be included in an early stage venture
capital investment into a mobile app developer. For an early stage investment it appears
advisable to keep the deal terms clean and simple to not overcomplicate the situation for
a follow-up investment.
Option Pool 10% to 20% option pool for key hires and follow up
investors is advisable.
Liquidation Preference Preferred stock is usually vested to any investor.
Preference should not exceed 1X.
Participating or nonparticipating is possible, an investor
would be ill-advised to cap the participation unless
conversion right at any time is granted.
Antidilution Protection No antidilution protection should be granted to neither
party to not complicate follow up investment rounds.
Pay-to-Play Can be included if there is a clear strategy for a follow up
investment round in which the investor plans to partake.
Otherwise do not include.
Vesting (founder shares) Should be included with a vesting schedule of around 4
years. Up to one year of the time spent for prototyping or
test launching an app should be accredited to the founders.
Drag-Along / Tag-Along Both standard for institutional investors but can be omitted
when the investment is done by an angel investor.
Conversion Automatic conversion could be included but is ideally not
mentioned at all.
Dividends Dividends have little impact on the financial performance
of the investment and should not be included.
Redemption Redemption clause should not be included, an early stage
investor should not ask for this amount of security.

42
5.2 Qualifying an Investment Target
Investors typically have a clear set of hard and soft requirements for their investments.
The hard requirements have already been discussed in chapter 2. Soft requirements may
include the composition of the leadership team or personal preferences about how the
business may impact the environment. This, certainly important, aspect of an investment
shall not be discussed in this work since the focus here is on the specific characteristics
of early stage investments into mobile app developers only.
5.2.1 Company and Product Development Stage
Early stage investments have the purpose to bring a company and its product or service
from pilot stage to proof-of-concept (see chapter 2.2). For a mobile app business this
implies the following criteria should be met by the product or service itself and by the
business plan:
 Existing pilot: A functional app has to exist that is able to demonstrate the core
features of the app in a real life environment. It is even better if the app has been
launched into at least one test market, however defined, and live user data is
available. If none of the aforementioned criteria has been met, the app developer
would be considered to be at seed stage.
 Defined proof-of-concept: It has to be clearly specified which goals are to be
reached with the funds of the investment round. Every applicable KPI should have
a target value. What kind of exit strategy will be achievable and would be the
buyer.
 A well-defined user acquisition strategy: Ideally an existing test launch or test
product already allows to make early assumptions on how feasible or realistic the
core elements of the business plan are.
 Revenue: There has to be no existing revenue stream yet but business model and
revenue streams have to be clearly defined.
 Everything may be subject to change, if executed with reason, many successful
startups have pivoted away significantly from their original plans.

43
5.2.2 Capital Requirement and Use of Funds
Early stage investments have the goal to verify an existing business case (see chapter 2).
Funds from an investment deal should therefore not be directed towards the development
of core features, these should already be existent in an early stage. It is of course
acceptable to use the funds provided by an investment to remove ‘roadblocks’ such as
licenses. Ideally the investment provides a mobile app developer with the capital that is
required to bring KPIs to a target standard that is previously agreed upon. A large portion
of the capital should therefore be directed towards user acquisition or developing a proof
that the desired user acquisition can be achieved. It does not matter if that is performance
marketing or the development of a feature, as long as it fits with the strategy of the app
in question. A bottom line value for KPIs does not exist since the app developer could be
in a pre-release, alpha or closed beta stage.
5.3 Quantifying an Investment: Valuation
The value of a company always exists of the sum of its assets, future cash flows and
goodwill. There are many different asset valuation models using either an income, market,
risk or asset approach or a middle-ground combination of all of them.66
Most of these
approaches do not apply to an app developer in the early stage because the valuation can
only be based on future projections. The same reasons that make an early stage venture
capital investment risky (see chapter 2.4), make it challenging to determine a value of
mobile app developer in its early stage. All this being said - determining the value of a
young firm based on future growth will always yield noisy results that ultimately have to
be accepted all parties.
5.3.1 Assets
Assets are the book value of a company. An app developer in early stage will typically
not possess any significant tangible assets.
66
Damodaran. A., (2002), p. 16 - 36

44
5.3.2 Goodwill
In the context of company valuation, goodwill is the item on the balance sheet that
represents the value if the intangible assets such as brand value, intellectual property,
customer relations, patents, and the likes.67
When the photo sharing app Instagram was
acquired in 2012 by Facebook for approximately USD 1 billion it was not making any
significant sales. Instagram had a huge install base, a large amount of active users and,
most importantly, it was service that was complementary with Facebook – the
combination of all this was the justification for the extremely high acquisition price.68
This example illustrates that a highly lucrative exit through acquisition does not have to
be motivated by a strong cash flow but a competitive technology, service or product. The
success of an acquisition for intangible assets is often hard to determine for outsiders. It
depends how well the acquirer can leverage the intangible asset. A famous example for
failure is the 2005 acquisition of the social networking site Myspace by News Corp.
Intermix Media, the owner of Myspace was acquired for USD 580 million to leverage it
as a platform for advertising69
. In June 2011, after several years of a shrinking user base
and annual losses of over USD 100 million, the company was sold again by News Corps
to Specific Media for a speculated USD 35 million70
.
By the time of an early stage investment, the app developer will not have built any
significant goodwill but building intangible value is a valid strategy towards and exit.
Making a general statement how to create a potentially high strategic value is not subject
of this work and these cases follow very individual market, technology and cultural
trends. If a company chooses this path, the goodwill that is to be created needs to be
clearly defined: Who would pay for this intangible asset and why? A high k-factor, high
retention rates coupled with a long average user lifetime also help as it can compensate
for pricey user acquisition.
67
Carver, L. (2012), p. 19 - 26
68
Facebook (2012)
69
BBC News (2005)
70
Segall, L. (2011)

45
5.3.3 Discounted KPI Based Projection of Proceeds Approach
The model suggested by this work will employ the KPI based projection of proceeds for
mobile app developers and combine it with a standard valuation model, the discounted
cash flow (DCF) approach. The result is the universally applicable “discounted KPI based
projection of proceeds approach” to valuate any mobile app developer’s business case.
DCF calculates the present value of an asset based on a free cash flow projection.
Projected cash flows are discounted based on how far away they are from today and then
added up. It is the model most commonly used for the valuation of assets that have to rely
on projection instead of historical data. There are many different variations of the DCF
valuation approach which are essentially expansions of one basic model to cover specific
or special circumstances.71
This work will only cover the basic, most common, DCF
calculation. DCF calculation can also be used in reverse to determine what cash flow
would be required to justify a certain valuation. The calculation is explained below, the
factors taken into account deviate slightly, case by case.
Cash Flow (CF) usually means projected earnings before interest, tax, depreciation and
amortization (EBITDA) but it can very well include goodwill, cost of capital,
amortization and depreciation.
Projection Length (n) is the amount of future years’ free cash flow taken into account
for the calculation. In the case of early stage investment typically between 3 – 7 years.72
Discount Rate (r) represents the ability to generate risk-free return on capital, typically
the average performance of government bonds that are usually around 4 - 5%. For early
stage ventures a much higher discount rate between 40 – 70% applies to represent the
risky natures of such investment.73
71
Damodaran. A., (2002), p. 9 - 17
72
Carver, L. (2012), p. 85 - 89
73
Ibid.

46
Figure 6: Discounted Cash Flow Formula. Source: Damodaran, A. (2002), p. 10
It is possible to connect the KPI based projection of proceeds model (see chapter 4.5)
with the DCF valuation approach to determine the net present value of a mobile app
developer business case. Albeit that a KPI based projection of proceeds is not exactly the
same as cash flow by definition, the difference in timing of when income is realized is
marginal compared to the uncertainty of early stage business cases. Section 5.5 provides
a detailed example how DCF the KPI based projection of proceeds for mobile app
developer can be married practically.
5.4 Exit and Follow Up Investment Considerations
When a valuation has been established and agreed upon, every shareholder will ask the
question how much his stock could be worth in the future. Usually an investor would keep
his stock in a follow up investment round. It is not common but every financing round
could also provide the opportunity for an existing investor to exit by selling all stock to a
new investor. Albeit very hypothetical in the field of high risk and high return, there is
an approach to answer that question: Valuating the company in the future, considering
the projected performance becomes reality. At that time the company will be in a different
development stage and different valuation approaches with adjusted parameters will be
employed:
 DCF approach will be done at a lower discount rate, it could be as low as 5% if
the company has matured significantly at that point.
 Tangible assets might have been created or added to the company’s inventory.
 Alternative valuation approaches could be used such as the P/E or earnings
multiple approach: Multiplying the company’s earnings by the P/E ratio of
∑
𝐶𝐹𝑡
(1 + 𝑟) 𝑡
𝑡=𝑛
𝑡=1

47
comparable, publicly traded companies. This can well be in range of 5 – 15X.
Publicly traded mobile and social game company King Digital Entertainment
reports a P/E ratio of 9.66 in March 2015.74
5.5 Investment Case Example: “FunApp”
5.5.1 Situation
The app developer FunApp is looking for USD 200,000 early stage investment to close
the financing gap to bring its prototype mobile game product line to market. Currently a
lean version of the product is commercially released but to achieve the desired
performance and quality further development is necessary. The app developer also
looking to fund user acquisition to collect user behavior data that allows to test the
company’s ability to serve customers on larger scale and make informed decisions on
future product design and development.
The game is offered for free and displays ads in the game. Further, the users can upgrade
to an advertising free premium version of the game for USD 9.99. Starting in year 2 the
app developer will release additional content for the game for another USD 9.99 every
year with the goal to increase the ARPPU constantly. The developer expects the KPI to
improve slowly over time as the quality if their product increases. The projected KPI of
the app for the coming 5 years are as follows:
 Customer conversion rate: 1.0% for the first year. 2.0% for the second year and
beyond. To keep it simple, it is assumed that 100% of the user that upgrade also
purchase all available add-ons.
 ARPPU: App stores deduct 30% of the sales revenue, taxes and transportation
cost deduct another 20% from this purchase. This being said, net income for the
app developer is USD 4.995 per paying user in the first year and increases by an
additional USD 4.995 per year when additional content is released. The premium
74
NASDAQ (2015)

48
purchase is made by users on average after 1 month. Users that buy the premium
version of the game do not generate further advertising revenue.
 ARPU per month from in-app advertising is USD 0.02.
 Average user lifetime is 2 months in the first year and 3 months in the following
years.
 K-factor: Active players will generate additional users through a viral feature
within the game adding a 30% k-factor to all user acquisition efforts.
 Every month in every year 10,000 organic users are generated per month from the
app store, review sites and other unidentified sources without any further cost.
 Performance Marketing: FunApp will step its user acquisition through
performance marketing every year as the ARPPU is expected to grow. Users to
be acquired per month: year 1: 100,000, year 2: 500,000, year 3: 1,000,000, year
4: 2,000,000, year 5: 3,000,000.
 The average cost to acquire one active user will increase as performance
marketing is conducted more aggressively: year 1: USD 0.10, year 2: USD 0.20,
year 3: USD 0.30, year 4: USD 0.40, and year 5: USD 0.50.
 Fixed cost: FunApp starts as a small team, it projects that USD 35,000 are required
to operate the business in the first year but will grow with the size of the
operations. Year 2: USD 50,000, year 3: USD 100,000, year 4: USD 200,000, year
5: USD 500,000.
5.5.2 KPI Based Projection of Proceeds for “FunApp”
Just like in the previous example (see chapter 4.5 and 4.6), the performance data from the
app developer is used to establish the KPIs and to create calculate a 5-year the KPI based
projection of proceeds. The result shows that FunApp is able to create very profitable
business if it is able to perform as projected.

49
KPIs FY1 FY2 FY3 FY4 FY5
Customer
Conversion
Rate
1.0% 2.0% 2.0% 2.0% 2.0%
Average User
Lifetime
(months)
2.00 3.00 3.00 3.00 3.00
ARPPU (From
IAP)
$4.955 $9.990 $14.985 $19.980 $24.975
ARPU per
Month from
Ads
$0.02 $0.02 $0.02 $0.02 $0.02
Organic Users 10,000 10,000 10,000 10,000 10,000
Acquired Users 100,000 500,000 1,000,000 2,000,000 3,000,000
Performance
Marketing UAC
$0.10 $0.20 $0.30 $0.40 $0.50
K-Factor 30% 30% 30% 30% 30%
Users from
Virality
33,000 153,000 303,000 603,000 903,000
Total New
Active Users
(Month)
143,000 663,000 1,313,000 2,613,000 3,913,000
Combined UAC
Effort (Month)
$10,000 $100,000 $300,000 $800,000 $1,500,000
UAC $0.0699 $0.1508 $0.2285 $0.3062 $0.3833
LTV $0.1397 $0.2590 $0.3589 $0.4588 $0.5587
Monthly
Operations Cost
$35,000 $50,000 $100,000 $200,000 $300,000
Cost Total
(month)
$45,000 $150,000 $400,000 $1,000,000 $1,800,000
Table 7: KPIs for “FunApp”
FY1 FY2 FY3 FY4 FY5
Net
Proceeds $239,725 $2,060,604 $5,654,828 $14,386,133 $26,234,317
Fix Cost $420,000 $600,000 $1,200,000 $2,400,000 $3,600,000
UAC $120,000 $1,200,000 $3,600,000 $9,600,000 $18,000,000
COGS $540,000 $1,800,000 $4,800,000 $12,000,000 $21,600,000
EBITDA $(300,275) $260,604 $854,828 $2,386,133 $4,634,317
Table 8: KPI Based Projection of Proceeds for “FunApp”

50
5.5.3 Valuation and Shares Distribution
As discussed in 5.3, the example case will be valuated employing the DCF approach. A
discount rate of 50% is used due to the very early company development stage of FunApp.
The projected proceeds based on KPIs over 5 years is used. This leads to a pre-money
valuation of USD $1,250,538.62 (see details in attachment 2: Investment Case Example).
Adding the USD 200,000 investment leads to a post-money evaluation of USD
1,450,538.62. For his investment the investor would get 13.79% of the total shares. Since
the company has so far created 10,000 shares, the investor would receive 1,599 shares.
Investment Investor X $ 200,000.00
Pre-Money Evaluation $ 1,250,538.62
Post-Money Evaluation $ 1,450,538.62
Percentage of Shares Purchased by Investor X 13.79%
Initial
Shares
Position
Shares
Issued Past
Investment
Fully
Diluted
Ownership
Past
Investment
Issued
Shares
Position
Founder Shares 9,000 9,000 77.59% 84.91%
Unvested Option Pool 1,000 1,000 8.62% -
Investor X - 1,599 13.79% 15.09%
Total 10,000 11,599 100% 100%
Table 9: Shares Valuation Table “FunApp”

Early Stage Venture Capital Investment in Mobile App Developers

Early Stage Venture Capital Investment in Mobile App Developers

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