March 26, 2024

The term “economic moat,” popularized by Warren Buffett, refers to a business’s ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders. What Is a Wide Economic Moat? A wide economic moat is a type of sustainable competitive advantage possessed by a business that makes it difficult for rivals to wear down its market share. The term economic moat was made popular by the investor Warren Buffett and is derived from the water-filled moats that surrounded medieval castles. The wider the moat, the more difficult it would be for an invader to reach the castle. A wide economic moat can be caused by several factors that might make it difficult for other businesses to steal market share. These factors may include high barriers to industry entry, or the business with the moat might own patents on several products that are essential to providing their particular product or service. Sources of Economic Moats A company that is able to maintain low operating expenses in relation to its sales compared to its peers has cost advantages, and it can undercut its competition by lowering prices and keeping rivals at bay. Consider Wal-Mart Stores Inc., which has an immense volume of sales and negotiates low prices with its suppliers, resulting in low-cost products in its stores that are hard to replicate by its competitors. Intangible assets refer to the patents, brands, and licenses that allow a company to protect its production process and charge premium prices. While brands are typically derived from superior product offerings and marketing, patents are obtained as a result of companies’ filings with governments to protect know-how for a specific period of time, typically 20 years. Pharmaceutical companies earn high profits due to patented drugs after spending billions on research and development.Efficient scale arises when a particular market is best served by a limited number of companies, giving them near-monopoly statuses. Utility firms are examples of companies with an efficient scale that is necessary to serve electricity and water to their customers in a single geographic area. Building a second utility company in the same area would be too costly and inefficient. Switching costs are another type of economic moat, which makes it very time-consuming and expensive for consumers to switch products or brands. Autodesk Inc. offers various software solutions for engineers and designers that are very difficult to learn. Once an Autodesk customer starts using its software, he is unlikely to switch, allowing Autodesk to charge premium prices for its products.The network effect can further fortify a company’s economic moat by making its products more valuable the more people use them. An example of a network effect is online marketplaces such as Amazon and eBay, which are widely popular among consumers because of the large number of people buying and selling various products through their platforms. Creating an Economic Moat Cost Advantage – As discussed in the lemonade stand example, a cost advantage that competitors cannot replicate can be a very effective economic moat. Companies with significant cost advantages can undercut the prices of any competitor that attempts to move into their industry, either forcing the competitor to leave the industry or at least impeding its growth. Companies with sustainable cost advantages can maintain a very large market share of their industry by squeezing out any new competitors who try to move in. Size Advantage- Being big can sometimes, in itself, create an economic moat for a company. At a certain size, a firm achieves economies of scale. This is when more units of a good or service can be produced on a larger scale with lower input costs. This reduces overhead costs in areas such as financing, advertising, production, etc. Large companies that compete in a given industry tend to dominate the core market share of that industry, while smaller players are forced to either leave the industry or occupy smaller “niche” roles. High Switching Costs – Being the big fish in the pond has other advantages. When a company is able to establish itself in an industry, suppliers and customers can be subject to high switching costs should they choose to do business with a new competitor. Competitors have a very difficult time taking market share away from the industry leader because of these cumbersome switching costs. Intangibles – Another type of economic moat can be created through a firm’s intangible assets, which include items such as patents, brand recognition, government licenses, and others. Strong brand name recognition allows these types of companies to charge a premium for their products over other competitors’ goods, which boosts profits. Soft Moats – Some of the reasons a company might have an economic moat are more difficult to identify. For example, soft moats may be created by exceptional management or a unique corporate culture. While difficult to describe, a unique leadership and corporate environment may partially contribute to a corporation’s prolonged economic success.  Economic moats are generally difficult to pinpoint at the time they are being created. Their effects are much more easily observed in hindsight once a company has risen to great heights.From an investor’s view, it is ideal to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat. In this case, the most important factor is the longevity of the moat. The longer a company can harvest profits, the greater the benefits for itself and its shareholders. FAQs How Companies Build an Economic Moat? Companies create an economic moat in the following ways- Decreased Production Cost: Companies need to follow the law of competitive advantage and produce cheaper products. They can do this by outsourcing the work that will be less costly. Increased Awareness of Customer Switching: The marketing team should work in an actionable way and check on the reasons if a customer switches to other brands. Companies should work on the insight provided by the marketing team to stay ahead

Term sheets are often less complicated than some other legally enforceable agreements and is not a binding Shareholder contract. Without including all of the small details mentioned in a contract, a term sheet concentrates on the most important components of a business.  The longer, legally-binding agreements contain the more complex elements. The agreed-upon terms and conditions may alter in several ways. The majority of startups make mistakes here. They consider the words on the term sheet to be final and legally binding. What is meant by a Term Sheet? Any business partnership can employ a term sheet as a pre-contractual agreement. During finance rounds for businesses, term sheets are frequently used to lay down some basic terms amongst co-founders and possible investors. To reduce the possibility of a future misconception and lay the groundwork for signing a legally binding document, this Term Sheet would outline the key elements of the deal between founders and investors. The term sheet doesn’t have to be a sophisticated agreement, and if it’s not meant to be enforceable by law, it gives both the shareholders and the founders a way out if a common decision of no cooperation commences between the team members. What is a Shareholder Agreement (SHA)? An agreement between stockholders and a company’s directors that controls commercial transactions and their relationship is known as a shareholders agreement. It should specify each shareholder’s special rights, duties, and commitments while safeguarding their interests in light of their unique situation. It is the main document that establishes the relationship between the firm and each shareholder make money and the connection among the shareholders. The basic difference between a term sheet and SHA is that the former need not be necessarily legally binding. In the case of the latter, generally, it is legally binding. An SHA is an agreement that helps in holding the interaction between the company and the shareholders. SHA is a widespread and prominent type of tool which manages the connection between the shareholders entering into such an SHA. It lays out the shareholders’ rights, responsibilities, and liabilities. When Are They Required? SHAs may be employed in various situations, like when establishing a joint venture business to define the connection between the parties and outline their rights and duties, when entering into another strategic alliance agreement, or when raising venture capital or private funding.  When prospective investors are given shares in your company, a shareholder agreement is beneficial. After both parties have finished their due diligence, a draft of the contract should be made. Given that it contains the important terms of the agreement, a term sheet aids in this process. Before a formal Stakeholders Agreement is drafted, this enables the founders and venture capitalists to write due diligence and make sure all pertinent details have been contained in the term sheet. The investors conduct a thorough background check of the company before investing in it. If they take the decision of putting their money into a company, both parties come to an agreement and sign a deal. They both sign the Shareholder Agreement. How Do You Get an Shareholder Contract? The legality of the founders’ and investors’ connection and the fact that investors would get interests in your firm make the switch from a Disclosure Statement to a Stakeholders Agreement crucial. A shareholders agreement may be seen as a phase in the procedure leading from having a term sheet prepared to the final stage of formalising the connection. A Shareholder’s Agreement is often longer and more detailed than a Term Sheet. To add to the many keywords lined out in the Settlement Agreement, it will also outline additional information. The provisions would be: 1) The business activities of your startup 2) Duties of directors What happens if a shareholder contract decides to leave? The shareholder agreement often ratifies the terms in the term sheet. There may be instances, though, where the disparities are substantial. There are principally two causes for this: Due diligence- The investors begin their due diligence procedure following the term sheet’s signature. The procedure can be said to mimic the assertions you made throughout the investor negotiations. Be prepared to expect significant modifications in your final agreement if a considerable disparity between the realities of your case and your bargaining claims is discovered throughout this process. Negotiation Leverage- It takes negotiation to secure funds from outside parties, particularly from venture capitalists. Startups are frequently unable to exert influence over experienced VCs. The fact that most investors view the term sheet as a movie preview is another good part. For them, it is ‘simply another’ paper. The shareholder agreement is a crucial document, and it is what they are most worried about. Even by the time, the shareholder agreement shows up, companies have already spent a lot of money and time. They may be persuaded to agree to terms they otherwise would not have. Even though this kind of event is uncommon, it does happen occasionally. Conducting a comprehensive background check on investors may be a solution, enabling the business to select the ideal investor. Choosing the right time to make your investment is much more crucial than that. There is always the perfect moment to receive funding. These issues typically develop when a firm seeks funding too soon, giving the investor the upper hand. For instance, a start-up with a transparent prototype and an actionable operational blueprint is expected to have a strategic advantage over one with only a concept. The same venture capitalist for the same industry sector may invest significantly more for a smaller share in the former than the latter. Judging time becomes crucial as a result. FAQs How do they differ in purpose? Term Sheet serves as a preliminary document to outline the main points of a deal before a formal agreement is drafted. An SHA, on the other hand, governs the ongoing relationship between shareholders in a company. What elements are included in a Term Sheet? Term Sheet typically covers essential terms such as valuation, investment amount, ownership stakes, and key milestones. What