Raise cash from trusted, close resources first.
by Dave Berkus on Feb.03, 2010, under Ignition! Starting up, Raising money
This insight follows closely the conclusions from the previous declaration, that professional investors negotiate tough terms, from provisions of control over asset acquisition, eventual sale of the company, future investments, forced co-sale when others attempt to sell their shares and more. And yet, in an earlier insight, we spoke of the problems that come when taking unstructured investments from friends and family. So how does the statement above fit into this sandwich of alternatives?
Trusted, close resources include sophisticated relatives, friends and business associates who know how to structure a deal as a win-win for you and for them, while allowing you to retain control over your vision and execution. Their investment should be structured with the help of a good attorney who understands the mutual goal of maximum leverage of funds with minimum interference in your business decisions.
Remember the admonition that investment from such close sources carries an additional burden for you – to protect your investors and their investment as if they were your alter egos, offering money as if from your own pocket. Such money should never be taken without clear understanding of the terms, whether a loan with a reasonable interest rate and strict repayment terms, or an investment valuing the company at an amount considered reasonable by a third party professional, even if as a sanity check as opposed to an appraisal. This money is personal, an investment in you as much or more than in your company. The degree of care you take increases with the reduced distance between you and your investor.
[Email readers continue here...] My very first investment as a professional angel was in a small startup where the entrepreneur’s vision fueled my imagination in the audio market niche where I had run a business in an earlier life. I was so enthusiastic that I coached the entrepreneur to approach his mother, who invested $50,000 under the same terms as my investment. A small venture firm and a few more angels rounded out the total investment. As the company grew and became profitable, it became more visible to others in the market niche. Two of us who invested served on the board of the company, advising the first-time entrepreneur with our business and industry experience. Several years later, with the approval of the board and entrepreneur, I was able to engage a very well-known potential acquirer of the business who offered an attractive price for the still-young but successful enterprise. After weeks of negotiation, the entrepreneur suddenly disengaged, claiming that he was no longer interested in a sale of his company. The rest of us were shocked and disappointed that after weeks of work and a fair price, we were left with nothing but to follow his lead and disengage. Shortly thereafter, in a board meeting, I brought up the issue of starting to pay board members for service in cash or in stock options, typical for outside board members but rarely for investors. The entrepreneur was angry, abusive, in his negative reaction to even bringing the issue to the board for a discussion. Five years had passed from my original investment in what I now clearly perceived as investment into a lifestyle business, one where the entrepreneur had no interest in selling or sharing. I resigned from the board on the spot and negotiated a sale of my stock to the entrepreneur at five times the earlier investment, a fair return for both, since the company was by then worth much more. It is now years later, and his mother along with other early investors are still in the passive game, not likely to see liquidity from this mistaken investment in an entrepreneur unwilling to take money in exchange for the eventual promise of liquidity.
Why tell this story at all? Mother is surely satisfied as a passive investor who probably would have given her son the money without structure. The other investors are probably in the unhappy never land of not being able to see liquidity after a decade and unable to write off the investment as a loss for tax purposes. This story would probably have ended in a lawsuit if a larger professional investor had been involved, since the entrepreneur did not follow the rules and seems to have no desire to do so.
Trust works both ways. Take money from close resources, but treat it as if the responsibility is even greater to protect the investors and their money than from a professional. These investors trust that you will do the right thing for them if at all able.
Outside investors want liquidity, not love.
by Dave Berkus on Jan.27, 2010, under Raising money
Taking in angel or venture money requires a setting of an entrepreneur’s expectations that may come as a shock at least at first. From the moment such an investor looks seriously at your company, the investor or VC partner is thinking of the end game, the ultimate sale of the company or even of an eventual initial public offering. There is no middle ground. Taking money from these sources involves resetting priorities over time. There is no such thing as a lifestyle business with outside investors. To protect against such an event, almost every professional investor includes a clause in the investment documents which allow the investor to “put” the stock back to the company after five years, requiring the company to pay back the investment plus dividends accrued during the term of the investment. This sword hanging over the company is not often used, but is a constant reminder that an outside investor is serious about getting out, hopefully in less than five years, at a profit, usually from the sale of the company. Many companies find themselves at the five year point completely unprepared for a sale and without the cash resources to carry out such a repurchase of investor stock, making the clause moot.
[Email readers continue here...] There are also clauses in many such investor documents that allow the investor to override the founder and force a sale of the company if a proposed sale is attractive to an investor for liquidity, even if the founder feels that there is much more potential if the business is not sold at the present time.
Finally, it is an unfortunate fact that when a company needs money and has not met its original planned targets, the newest investor prices the round at a level below the last or last several rounds of financing, angering and frustrating previous investors who took what they perceive as the greatest risks by investing before the business proved itself. The last money has the first say – in valuation and in sometimes forcing draconian terms that require prior investors to contribute a proportional new investment to retain a semblance of their original rights and avoid dilution or worse yet, involuntary conversion to a lower class of stock. As the years progress with typical VC firms seeing lower returns than expected by their limited partner investors, such terms are more common in secondary rounds of financing, causing a real riff between angel investors and their former close allies, the VCs, with whom they had once coexisted as suppliers of deals at expectedly higher valuations at each state of investment.
So be aware that professional investors are in your company for the eventual large profits at the liquidity event. They are your friends only as long as you meet or exceed planned growth and value. They tolerate you and your management when the numbers are a bit murky but with an explanation that is believable and correctable. They act in their own best interests when things go south. That’s just the facts.
Raising money for your business: What are the options?
by Dave Berkus on Jan.20, 2010, under Growth!, Raising money
This post will be perhaps a bit longer than usual, but certainly of great interest for those with interest in or have need for more capital…
This stage is critical to many businesses and a passing option to others, depending upon the capital efficiency of the enterprise. Some businesses require very little capital and the founder is able to self-finance the enterprise and retain 100% of its ownership and control from ignition through liquidity event (startup through sale). For you who fit that description, nice work. For the rest of us desiring to build large, valuable enterprises quickly, the need for outside capital is high on our list of requirements and even the source for some sleepless nights as we worry over the availability and cost of capital. It is for this group that we explore the implications implicit in raising money for growth.
Before we explore the next insight, it might be useful to list some of the ways in which you can raise money for growth with and without outside investors. [Email readers continue here...]
Bootstrapping: This term describes your ability to start a business with little investment and grow it using internally-generated funds. Certainly bootstrapping is a preferred method of funding growth if it does not hold back the speed of growth or hobble the quality of product or service to the extent that better-funded competitors can overtake the business. There is a lot to say about retaining control. You will realize much more from the ultimate sale of your business even if at a considerably lower price than if splitting the proceeds with investors. You will have more control over strategy and execution than with an outside board overseeing planning and performance. But few businesses grow into the sweet spot of $20 million to $30 million in worth to an ultimate buyer without the injection of outside capital.
Friends, family and fools: This term, although pejorative, describes the typical mix of early investors in a small, young growing business. Money from these sources is relatively easy to come by, and most often comes with no strings as to oversight by a formal board composed of these investors and management. However, most often, these funds are solicited by a well-meaning entrepreneur from investors who are not qualified as accredited investors under the law (currently requiring a proved income of $200,000 a year or $1 million in net worth for an individual investor). I’ve arrived at a significant number of companies that were looking for additional growth capital after a “friends and family” round, and had to “clean up” the cap table more than a few times over the years. Taking this kind of money has a number of pitfalls you should be aware of. It is most common to greatly overprice such a round of financing, valuing the enterprise well above what it may be worth at the moment for friend or related investors who do not have the sophistication or willingness to challenge the valuation. When professional investors look at such overvalued prior investments, they may refuse to become involved with a company, knowing that there will be, at the very least, universal disappointment and anger from prior investors when a new round is priced lower than the earlier friends and family round. Sometimes this money is just too available and the risks seem so far away; so an entrepreneur will take the money and put off the worry over the eventual consequences, all in the hope that no more investment will ever be needed and everyone will be richer for the effort.
Using your bank credit line and credit cards: Even with the credit crunch signaled by the recent recession, many banks will issue business credit cards with a $50,000 limit if the entrepreneur is willing to personally guarantee the balance, and has the net worth to do so. And even with the significant cost of credit card debt, many entrepreneurs aggressively use existing cards to finance a startup. It’s an option, even though an expensive one.
“Strategic partner” investors: If you can find a strategic partner willing to invest in your enterprise, consider it a blessing. Whether the partner is a supplier looking to gain a lock on your business as it grows or a customer looking to create a competitive barrier through use of your product, such an investment typically carries fewer restrictions than from a professional investor and less oversight. Better yet, the valuation of your enterprise is often higher than if the same investment were taken from a professional investor. Strategic investors validate a business, by their presence creating the very value they pay for with increased price per share purchased. It is most often a win-win for both you and the strategic partner.
Professional angels: This is the arena where I work and play. This class of investor, once quite disorganized, has become much like the venture capital community, creating a process including due diligence (careful examination of a business before investment), terms of investment that match those of venture capitalists, and a process that often takes months from introduction to investment. Yet, professional angels are usually willing to take active board seats in a young enterprise and act as cost-free consultants to the CEO-entrepreneur, giving freely of their individual and collective years of experience, often in the same industry as the investment target. Do not expect grand valuations of your enterprise from these professional angels. They have been burned too badly during the last decade by overvaluing businesses and finding themselves like friends and family, “stuffed” into a down round of lower valuation when a company takes its next round of financing from the next step, venture capitalists. Professional angels, often organized into groups, usually invest from $100,000 to $1 million in a young enterprise.
Venture, private equity and more: Here we lump a large number investor classes into one. Venture capital comes with a cost, and there are no bargains for the company when taking such an investment. VC’s value an enterprise lower than others might at the same stage of investment, always aware of the need to create opportunities for “home run” profits at exit, since over fifty percent of their investments typically are lost when companies die before an opportunity to sell to others. Further, as a class, VC’s have not done well for their own investors over the past decade since the bubble burst, making it doubly important to fight for low valuations and high profits at exit. VC’s do not even engage in discussion with most of those entrepreneurs seeking capital. By some estimates, 95% of contacts are ignored unless they come as referrals from trusted sources such as known lawyers, accountants or fellow VC’s. And just for measure, VC’s fund less than 2% of all deals they do investigate. Typical VC investments begin at $2 million and quickly rise to $5 million and above, depending upon the size of the fund and stage of investment. Terms are much more restrictive than from strategic or angel investors, often requiring the entrepreneur to escrow his or her founder stock for a number of years to prevent the founder leaving, and restricting the sale of prior stock without the VC also being allowed to offer a share of its holdings in the same sale.
Private equity investments are available from firms created for this later stage opportunity, but typically are available only for businesses that have achieved revenues well above $50 million. Often private equity investors will want control of the business as well.
Bank lines of credit are often available to businesses that are profitable, most often personally guaranteed by the entrepreneur, but available at a cost in interest less than most any other source. Small Business Association (SBA) federally-guaranteed bank loans are becoming available again after years of limited activity. With some restrictive provisions, these loans are favored by many banks as carrying much less risk than loans without the guarantee.
But it is the outside investor that validates a business, often influencing growth with shared relationships, experienced guidance and providing a gateway to needed resources. There are a few insights that relate to this money resource, and you should know and respect these. We will cover these insights in the next several posts. So stay tuned…
Use metrics and a dashboard. ACT upon variances.
by Dave Berkus on Jan.13, 2010, under Growth!, Positioning
Have you ever driven a car that had no speedometer? I had that thrill when a student at the Richard Petty Stockcar School of Driving recently at a motor speedway in California. With a wide track, angled aggressively at the curves, and being told to hug the wall on the straightaways, there was little reference available to a novice driver as to speed. I followed my instructor’s car closely, but still could 
not tell anything about my speed, so that I could either compensate for lags behind the leader or a test my comfort zone at various points that matched the expectation of my instructor and my own increasing capabilities as a driver. Upon conclusion of eight laps of this, after pulling into the alley and climbing through the window on the driver side (there are no doors in these cars), I was handed a sheet with my timings for each of the eight laps. Only then, after when the information might have been useful, could I see how well I did.
That’s how you would feel if you ran your company without a dashboard containing relevant metrics that drive your company. If you cannot relate to this, then you probably have been driving without a speedometer from the start and need to pay particular attention.
[Email readers continue here...] Metrics should be created by you and your managers to measure near real time progress for your enterprise. A number of these deemed critical to you and your managers should be combined into a single page on your desktop screen or in printed form and available or circulated as often as daily. These measures of progress must be fresh and meaningful. Yesterday’s sales and returns compared to same day last week and last year for retail businesses; Units produced and units shipped compared to plan and same period last month for manufacturers; Yesterday’s overtime hours by department; Ratio of hours worked to units produced; Backorders unshipped; Customer service calls in cue or unresolved.
You can think of numerous critical measures for your business that must not be ignored, but often are neglected by senior management. It is not bad to manage by walking around, a term that became popular as a result of another of the many business advice books of the ‘90’s. But that method, although good for employee morale, is imprecise as a tool of measurement and should be relegated to a supporting role. Financial information for last month compared to plan and same month last year is certainly relevant, but not part of a dashboard, since there is nothing you can do to fix a problem when numbers are as old as a week, let alone the typical several weeks required to prepare financial statements for review.
Finally, what good is the information contained in a great dashboard if you ignore it? Show that you value the information by acting immediately upon variances, even if only to question the numbers. Everyone down the line will become aware of your attention to their work, your interest in the outcomes and care for their success. And you will drive revenue and better control costs and the customer experience with quick reaction to the variances within critical metrics the best describe your immediate situation.
Your budget and forecast light your goal.
by Dave Berkus on Jan.06, 2010, under Growth!, Ignition! Starting up
Let’s spend a few moments defining a sometimes confusing set of terms. A budget should be created each year as a result of a series of negotiations between departmental managers and their superiors through to the CEO, all in support of the next year’s tactics previously agreed upon (which in turn support the longer term strategies leading to the next goal beyond).
So a budget sets the limits upon spending for the next year that are negotiated between the players. An important part of the budget is the expected revenue for the coming year, a critical factor in setting hiring and resource expectations for the year. During the year, if the forecast revenues fall short or are greatly exceeded, it is fair to revise the budget and rethink hiring and resources. Otherwise, it is the expectation of the board of directors of a company that each year’s budget be approved in advance and adhered to as long as revenue goals are met.
[Email readers continue here...] Note that I used the term “forecast” for revenues for the next year. The term is also used when projecting revenues for succeeding years. The term “forecast” is a bit confusing, because it is also used by some as a measure of expected revenue and expenses to the end of the current year, found by taking actual performance year-to-date and adding best estimates of remaining revenues and expenses for the rest of the year to obtain an expected or “forecast” outcome at yearend. Both uses of the term are common. Just be sure all who participate understand which use of the word is the current one.
The real point here is to create a financial plan to support the strategic plan, marrying them in harmony one with another. Many entrepreneurs are impatient by nature, not the best of detailed planners. Yet, with the assistance of those in support such as the CFO, everyone in management must be aligned in a single direction, reviewed and updated annually as accomplishments, the marketplace, and even the competitive landscape change.
Strategic planning: Strategies and tactics
by Dave Berkus on Dec.30, 2009, under Finding your ideal niche, Positioning
In past insights, we explored the need for a tangible goal and strategies that are measurable as steps toward achievement of the goal. This insight calls to account tactics to accompany each strategy, and even suggests a number for each.
Tactics support strategies and allow your individual managers and departments to contribute to strategies in measurable ways that are more short term and procedural than are the strategies they support. Tactics change frequently as achieved and may be updated or replaced during a year when achieved, unlike strategies which often span a number of years.
Five tactics to support each strategy seem a fair, even if arbitrary number. Tactics direct each department in very specific ways. Here are several examples of tactics from my recent experience with companies where I serve as board member.
[Email readers continue here...]
Strategy Three: Expand into at least three new continents through new distribution channels.
- Sign one distributor by June of this year in each of three major geographic areas. EMEA, Asia, Latin America. Each distributor to be capable of generating $1 million in business by year two.
- Assign development manager to localize design and oversee needed enhancements to product and support materials for each new territory.
- Train and transfer technology to each new distributor within 90 days of signing.
- Assign one corporate employee to support sales and installation efforts by all distributors.
- Seed demand in each new territory with at least two corporate marketing events in partnership with each distributor.
Note that each of these tactics directly support the strategy, are measurable and assumed to be achievable, bought into by each department effected by the tactic. Note that the strategy calls for cooperation between business development, sales, marketing, product development, installation and support. This is a great way to unify departments that once may have competed for resources toward individual ends, now pointed toward a common goal supported by all levels of management up to the CEO.
In planning, the matrix, “5×5=1” is a good memory tool for management to keep from overreaching with too many strategies and too many tactics. But it is not written in stone. And development of these important elements of the plan should be made using all the resources available, from your board of directors to your senior management to departmental management. Getting all to buy into each step may not be easy, but when accomplished, is a powerful and invigorating opportunity to celebrate, then to get to work as a functional unit of the whole.
Strong strategies and tactics support your goal.
by Dave Berkus on Dec.23, 2009, under Growth!, Positioning
Now we’re getting organized. There are many ways to express the roadmap for your enterprise. One of the most popular was used by the U.S. Army late in World War II, and adopted by a number of high profile businesses such as Texas Instruments after the War. The structure combined the listing of the goal with a series of strategies and then tactics, each designed to support each other, each measurable and made public throughout the organization. The technique, “OST” (objective, strategies and tactics), is a very good way to organize your effort to find guideposts and then develop metrics to measure progress.
[Email readers continue here...] What is a strategy? It is a medium range process involving senior management and departmental management as well, directing resources in ways that, as accomplished, lead the company toward the goal. A typical small to medium, business finds five sweeping strategies for the current year, many cross-departmental, and some carried over from the previous year’s plan and even from years before that. Here are some example strategies from some of my companies over the recent years.
- Expand into at least three new continents through new distribution channels.
- Penetrate the Fortune 500 with at least five active accounts within two years.
- Create a hosted “software as a service” or “on demand” addition to our product line by end of (next) year.
Note that these are expansive “junior” goals that, if achieved, would certainly move the company forward toward a larger financial goal. Yet each is measurable if achieved. In fact, the degree of progress toward achievement can also be achieved, such as “We did establish and do business with two of the five Fortune 50 accounts this year.”
Measurement is the key to success. Even at the strategic level. Next we’ll look at the last major step in creating an OST plan for an entire organization.
Map your goal and use your map.
by Dave Berkus on Dec.16, 2009, under Growth!, Positioning
It’s time to speak of some sort of business plan. As a professional investor in early stage companies, I have long discounted long, detailed business plans in favor of a concise “executive summary” followed by a believable spreadsheet-based financial forecast projecting three to five years into the future.
Yes, everything does change between drafting that plan and its successful execution. But flying without a map of some kind seems just plain too risky.
[Email readers continue here...] I recently joined the board of a company that was growing slowly, running beyond breakeven, but had not approved a plan for the current year, let alone attempted to develop one for the next. So the CEO had one of his own that he did not share, while the CFO had one for internal use that was never shown to the CEO or to the Board. No wonder the Board members wanted to dig in and find who was communicating with whom, and who was in charge of the map to the goal. By the way, there was no goal understood by all or agreed to by anyone. How do you compensate executives and all levels for successful accomplishments if there are no established steps toward the goal? And how do you measure a person’s contribution to an unnamed goal?
So if you have not, create a concise map for your enterprise. Start with a reasonable goal, usually expressed as a revenue number some number of years in the near future. Assess your current resources and attempt to calculate the resources needed to accomplish the goal. Do you need to raise money, focus spending upon only core projects that advance the company toward the goal, or bring in new management talent to make it happen? Write these steps down in any form for now. We’ll explore a more organized approach in the next insights.
Set a realistic goal. When reached, set another.
by Dave Berkus on Dec.09, 2009, under Growth!, Positioning
There’s a big difference between your vision for your company, your mission and your goal. Your vision tells the world what you want to be as you contemplate in advance how you will change the world for the better. Your mission merely states who you are and what you do. It is used to limit and sift your opportunities to keep you from using resources for projects outside of your core, your mission.
But your goal is a tangible aiming point, one that should be achievable within several years if you accomplish your progressive steps planned between now and then. You can express it in terms of money, market share, influence or other measure that reflects success. An example: “To be at a $25 million run rate by the end of our fifth year in business.” That is measurable and from this you’ll be able to look backward to develop a set of steps (strategies) to achieve that goal.
[Email readers, continue here...] Once achieved, a goal is meant to be overwritten with a newer one, set to even higher standards. If achieved early, celebrate and set another goal earlier than planned.
The good thing about a goal is that it is measurable, and progress toward it can be measured as well. Unlike a mission or even a vision, neither of which may be measured, there is a satisfaction in each step toward achievement. Better yet, your employees and investors will appreciate constant attention to the goal and reports of progress toward it. A goal serves as a rallying point for all associated with your vision.
Make the goal realistic, achievable and public. You’ll find others buying into the objective and even creating better ways to achieve it because they are invested in the dream and the measure of that dream – the mutual goal.
Fewer words, greater effect.
by Dave Berkus on Dec.02, 2009, under Ignition! Starting up, Positioning
I have a business friend, an experienced manager and teacher with a Harvard MBA, whose creativity and intelligence are admired by many. But he dilutes his effectiveness with wordy PowerPoint presentations. It has become a long running joke between us, as I often remind him that most of us have a very limited attention span and ability to recall important points from a presentation.
Note the title and tone of these insights. Short, to the point.
Mark Twain said, “I didn’t have time to write a short letter so I wrote a long one instead.” He cogently encapsulated the problem.
It is more difficult to reduce your thoughts to a few core sentences, but that is what you should do for maximum effect.
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