Value Adjustment Mechanism

See VAM Contract

# Investing on a ME: the VAMs A Valuation Adjustment Mechanism (VAM): investment contracts aimed at creating above-industry-average results. Incubated MEs normally receive investments from Industry Platforms during the Start-up Process.

The VAM-contract-mechanism normally defines: * ME's objectives in terms of Direct Market Performance (company Value - the value accrued inside the entity); * ME's Objectives in terms of Addressed Ecosystem Value and Performance (Network Value - the value enabled in the ecosystem].

> In this module we introduce the VAM contract, an essential element of RenDanHeyi and generally of entrepreneurial ecosystem enabling organizations (3EOs).

> VAMs which stand for Value Adjustment Mechanism are a mix between an Investor Term Sheet, a contract and a corporate Budgeting Statement.

>> VAMs normally cover the constitution phase of a micro enterprise and subsequent development periods and are used to set objectives for the Incubating Micro Enterprises. VAM contracts are signed between ME Owners, Employees, and a Subfield Owner. It used to be called an Industry Platform Owner. **VAMs are normally focused on the constitution phase of a micro enterprise**. > The most important thing that the VAM defines are the ME objectives in terms of both **Direct Market Performance** and Company Value (Profits) called Horizontal Goals and in terms of addressed Ecosystem Value, such as the value and size of the **Network of Entities** that the micro enterprise creates impact for and the **Overall Value enabled in the ecosystem** called Vertical Goals.

For the incubated ME, the VAM details; * Basic living expenses in the Constitution Phase. * Mechanisms for accessing the Option Pool to incentivise "skin in the game". * The mechanism for **Exit/dissolution** The Founding Partners in an incubated ME shall also: * Obtain external financing, within a certain period, before Haier would provide further investment. * Follow up with investments of their own founds, before receiving further investments.

> In more details. VAMa cover also > * one, how much is going to be paid to the entrepreneur in terms of living expenses, as long as the Emmy is seeking to become sustainable. > * Two. Mechanism for the Emmy owners to access an option pool that essentially grants them access to shares once and at the Emmy will become a separate incorporated entity with equity. > * Three. Mechanisms that cover Emmy dissolution in case it fails. At the stage of incubation, ME owners can also express the interest to invest their own funds in the startup. Depending on their investments, the VAM will offer different conditions. As we'll see in more details later, usually before further investment from Haier is received. > For example, at the separate Incorporation Phase, it will be required that the EMI owners and or other partners Co-Invest in the venture.

VAMs are not exclusive the Haier * A Valuation Adjustment Mechanism (VAM) agreement, aslos know as "Bet-on Agreement", is concluded between the Private Equity (PE) investor and teh invested company, agreeing upon some conditions (mostly the future financial performance indicatory of the invested companies), by which the investors may exercise the right to adjust the valuation, when the conditions are satisfied. * The VAM Agreement is widely employed in PE investment activities in China. * VAM agreements are focused on financial and non-financial performance (e.g. reach, technology achievements); when the conditions are met, the investors transfers some equity to the targeted company or its shareholder free or at low price, and in contrast, the investor is entitled to cash compensation or require the invested company or its shareholders to purchase back the equity when the invested fails to meet the conditions. They bode extremely well with Haire Goal Oriented Culture!

> It's important to clarify that VAM contracts are not an exclusive invention of Haier. Blank more specifically, they are frequent in Asia and essentially are to be seen as Qualitative Term Sheets that are based on the idea of having an Investment Contract based on qualitative outcomes that unlock certain opportunities for the investee to essentially **access more equity**.

Haier Artifacts: poor quality image of a VAM Contract 1: Basic information of the microenterprise: founders, investing industry planform... II: Strategic goal and ecosystem path of the microenterprise: Considerations on the goals and path to success III: Resource needs: Capital (partnerships, loans, etc...) IV: Leading target and inflection point of the value adjustment mechanism: Detailed targets for each period (horizongal and vertical) V: Microenterprise Valuation Adjustment Mechanism: basic living expenses, access to option pool, exit mechanism, other exit situations, dissolution

> As a recap, the VAM contract of which you see a VAM Contract Template in this slide contains five key elements. > * One, basic information of the micro enterprise, such as who are the employee founders. You normally need three that's the industry platform or a subfield that invests, et cetera. > * Two, the Strategic Goals and the so-called Ecosystem Path of the micro enterprise, essentially, including detailed considerations. I'm reaching the goals, the envisioned path to success. Normally two major types of goals are set. Initial Inflection Points and so-called Ignition points. Second stage. > * Three, the Needed Financial Resources, including capital. > * Four, the so-called inflection points and reaching the leading targets expressed in terms of horizontal or direct market and vertical ecosystem reach value. These leading goals are set according to several Leading Goal Timeframes. > * Five, the real micro enterprise valuation adjustment mechanism. Including how Basic Living Expenses are covered, what Option Pool Access will be made available. > * Number six. Exit Mechanisms and Dissolution Mechanisms.

# The Incubation Process evolutionary flow (best outcome) Stage 1 Right after signing the VAM The VAM is key to define the initial conditions, set ME owners(s) entrepreneurial risk, exit conditions... * Members receive basic compensation (covering living expenses) * Can fund the ME with their own capital (optional) Stage 2 The ME hits it first inflection goal * Receives the basic compensation * Starts to receive profit sharing

Stage 3 The ME hits it second inflection goal ("ignition poing") *Recieves basic compensation * Receives profit sharing * Recieves dividends * Can buy "virtual" shared of the ME (optional) Stage 4 The ME achieves a leading position and gets incorporated as an independent subsidiary * Members receive stock shares based on the contributions/VAM agreement * Members/Ecosystem partners are required to co-invest * The ownership structure contains at least 2 parties

> This final slide provides a classic version of the Incubation Process. > * At Stage One, the VAM signature members receive basic compensation and enabling capital and can fund the incubating Emmy with her own capital optional. > * And stage two, when the Emmy reaches a first goal, the owners started to receive profit sharing. > * When the ignition point is reached stage three, the employee can buy Virtual Shares according to the option pool clause and start receiving Virtual Dividends. > * And stage four when the Emmy achieves market leading position and is incorporated in a separate entity, the owners receive stock based on their preexisting agreements. Further investments from Haier in this case, we'll need other stakeholders to invest.

# The VAM on the employer-employee relationship Valuation Adjustment Mechanisms have a large impact not only on creating new Micro-Enterprises but also on the relationship between Haier and its employees. As a discontinuity from the traditional tayloristic bundle, individuals working in Haier benefit from a much larger level of **autonomy** but also **responsibility**: All of them receive a basic income, as stated by the law, and only sufficient to cater to the **foundational needs of security and survival**. The basic income is the only source of earning. At the same time, employees sit in the Talent Pool, a temporary aggregation of colleagues available to be involved in Micro-Enterprises and Enterprise Micro-Communities. Joining opportunities happens through a Bidding Process. That means an order/request for support/services by a Micro-Enterprise or Enterprise Micro-Community, and individuals making themselves available to contribute. The ability, proactivity, and Reputation accumulated in previous initiatives will determine the number and nature of opportunities for work each employee will have access to. Once joining a ME or EMC, the salary gets augmented by a “bidding-order” related component or, in other terms, the **earnings associated with the work** for the nodes and activities they contribute to. Theoretically, an employee could join more than one ME. Normally the order they are committed to is so demanding to make it hard to contribute to two MEs. When a ME creates an “order” and doesn’t find anyone to fulfill it inside the organization, the owner can go out and **“hire” an outsider**. This process is called “Social Recruitment” in China.

The scheme just described suggests a two-pronged approach to allocating and incentivizing work. * On one side, the same existence of a Talent Pool decouples available competencies and time from the organizational hierarchy. Employees are no longer "owned" or controlled, as properties or resources, by their bosses. They instead become their own CEOs and entrepreneurs. With technological support and transparency, such liquidity increases the probability of effectively matching demand and supply of work most firms lack. * At the same time, the space of freedom offered through structural mechanisms is also reinforced by incentivization: the size of the basic income makes it absolutely compelling for individuals to go and scout for bidding orders actively. **Bureaucracy and complacency are suddenly dismantled.** Only this way, they will obtain a large enough salary, a good reputation, and a proper role in the company, at the **sole benefit of customer outcomes and the overall level of adaptivity of the entire firm**.

# The VAM Canvas The VAM Canvas helps Micro-Enterprises go through a Constitution Phase to secure the resources necessary to achieve above-average results. It’s an agreement that drafts Actors, Roles, and Investments to meet financial and non-financial Objectives at specific Inflection Points, together with how the Micro-Enterprise owner and the team will benefit from it. The key questions and context of application this canvas addresses are: What direct Market Performance Goals does the ME want to achieve (e.g., “Profits or product completion”)? What will the returns for the other parties in the ecosystem be (e.g., “Developing knowledge assets or a larger user base”)? What Capital Expenditure CAPEX and Operating Expense OPEX investments are required? How are the Owner-Equity Holders and Employees-Value Producers benefitting?

The following video proposes an overview:

Key Questions for the exercise:

The Valuation Adjustment Mechanism Canvas is made by: * The Value Proposition area synthesizes the unique promise of value the Micro-Enterprise will deliver. * The “Micro-Enterprise Owners” area lists the 1-3 members that will also take on a leadership role by representing the ME and guiding its action. * The “Inflection Points' Definition” area includes as many rows as the goals the ME commits to, distributes them chronologically, and specifies the value for the ME and for the ecosystem the team will have to achieve. * The “Inflection Points' Effect” area articulates how the value generated by the Micro-Enterprise is distributed, at each inflection point, among the owners and the team through variable pay, profit sharing, and equity. * The "Capital Expenditures”, "Operating Expenditures" and "Cashflow Allowance" areas detail the upfront capital, operational investment, and monetary allowance the Micro-Enterprise needs during the VAM duration.

# The VAM Canvas: Exercise The Valuation Adjustment Canvas helps incubating new Micro-Enterprises through contracts and investments performed by Industry Platforms. Through this lesson, we would like to invite you to experiment with it. You can download the Canvas here:

# Start by copying the ME Canvas value proposition to follow the steps below: * Decide who the Micro-enterprise owner or owners will be (up to 3 are usually expected). These individuals will bear both the responsibility and the credit for the development and success of the ME. * Use benchmarking or other available data to set challenging but credible inflection points, including timing (each step usually happens in a matter of months), direct value (for the Micro-Enterprise), and ecosystemic targets (for other Micro-Enterprises, the Industry Platform, or the company overall). * For each one of them, explain how the owner and team members will receive part of the value created in variable pay, profit sharing, and equity. * Articulate upfront capital investments (e.g., "To develop software assets"), operational investments (e.g., "To cover salaries") for owners, employees, or other costs, and any cash advance to anticipate expenses (e.g., "For extrun-l services before customer revenues are obtained."

The ME and VAM Canvases usually serve as inputs for negotiating with internal sponsors and stakeholders to access both the conditions and the funds required to incubate new Micro-Enterprises.

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# Additional Content Before let you go, we have prepared this "goodbye module" to provide additional content allowing you to further deep-dive into aspects connected to the 3EO, its underpinnings, and its connection to market dynamics. It includes two lessons: * Radical Innovation: introducing a framework to reflect on radical innovation dynamics from markets to organizations, to look at the 3EO as an opportunity to embed similar mechanisms with the enterprise. * Roots of the Reform: providing an overview of the philosophical backbone of Haier's RenDanHeYi and how its principles are related both to Chinese and West culture. A stimulus to reflect on how this could work in different contexts.

# From Radical Innovation to Organization Design Companies and organizations go through phases when dealing with innovation. Exploration and evolution come in cycles. Simon Wardley describes the process of innovating inside organizations by making use of three macro moments:

A succinct recap of each one of them is provided below: * The pioneering space is appropriate in poorly understood contexts, where it is mandatory to remain agile, even to fail because every action may guarantee a first-time mover advantage. Companies like Amazon created web services (APIs) as a commoditized good that everybody could use. The entire Amazon ecosystem subsequently started to build all sorts of pioneering value propositions on top of this computing facility, including startups, products, and services. * The settler space is where the organization starts to nurture its market and get closer to the value proposition it is trying to fulfill. In this phase, customer feedback is the fuel to make the product fits with distinctive buyers' expectations. The necessity to grow and stabilize at the same time let the company settle into a new space. * The town planning represents a stage of convergence, where margins usually decrease, and the focus goes to efficiency and competitiveness on essential costs of business. It is the maturity stage.

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It is clear that ReLocalize RenDanHeYi be come a EMC that will provide a few support microenterprises to include: Legal Services ME, RenDanHeYi Facilitation Services ME

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