BERKONOMICS – Business insights from Dave Berkus

Create a ten percent profit model.

by on Jul.24, 2014, under General

Most entrepreneurs, when starting to model their business operations using a spreadsheet, start with expected revenue by month. Then they calculate cost of sales, and then project their expenses, to find the bottom line profit or loss each projected month.

There is a rarely-used twist that makes lots of sense. Add a new row at the bottom of the spreadsheet. Project your revenues and costs as in the original exercise. Then consider that an operating entity should be able to generate a ten percent operating profit based upon revenues, and add a row to your spreadsheet immediately below “operating profit” that calculates 10% profit from sales each month. Compare that with the operating profit as calculated, which surely will be

From Basic Berkonomics: Available Amazon, B&N,  berkus.com and booksellers everywhere.

From Basic Berkonomics: Available Amazon, B&N, berkus.com and booksellers everywhere.

lower, probably negative, for months or even years. The difference is something new – a target for reduction of expenses or addition to revenue for each month in which the calculated number is lower than 10% of revenues.

[Email readers, continue here...]  We are not taught to think this way, but rather to find the month in which we break even in our plan, then calculate the accumulated losses to that point, add all the cash needed for investment in fixed assets, and end up with the amount needed to finance the business to breakeven through equity or debt financing. This new tool gives you that number plus the amount needed to make the business a viable entity with a chance of long term survival.   The longer the time it takes to break even, the higher the number of dollars needed. Sometimes, the difference is a reminder to consider a reduction of expenses, if revenues cannot be raised from projected levels.

And sometimes, it is just a reminder that we are all in business to make money, not to break even. Just like assuring that your own at-market salary is included in a forecast even if not drawn in cash during the earliest periods, the 10% target reminds us all that the target must be higher than merely breaking even, even if that means reassessing all expenses until the target is met or exceeded.

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Don’t be defensive, but defend.

by on Jul.17, 2014, under General

When meeting with investors, during the period devoted to feedback after your presentation, you will hear comments and recommendations that don’t resonate with you. Some will be from a misunderstanding of your explanation. Some listeners will challenge your assumptions. Some will seem to ask just plain show-off questions, in which the questioner wants you and others in the room to know that s/he knows more than you do.

You are in a vulnerable position in that room, the salesperson looking for money before individuals who have nothing to lose but risky profits far in the future. You cannot appear to be standoffish, or above responding to some of these inappropriate questions.

Berkonomics books available at www.berkus.com

Berkonomics books available at www.berkus.com

Defend your position when appropriate. But listen carefully.   Although you may be completely right, the questioner’s comment may indicate that you are not getting your points across. That’s just as valuable for feedback as hearing a good, new idea.

[Email readers, continue here...] Sometimes, you will have an opportunity to present to several levels of an investor organization, from first prescreening, to a screening session with many present, to the final meeting of the members or partners. Plan to incorporate the appropriate responses to earlier questions in the presentation to avoid those being repeated. Show that you are both humble and adaptable.

Investment groups including venture capital fund managers will tell you that the very process of defending your plan will help you better think through the rough spots, better launch the business with fewer holes in reasoning, and better connect with resources that can be used to accelerate your growth to breakeven and beyond. The process is always time-consuming and grueling. But approached correctly, the time is well spent and the results almost always positive, even if money doesn’t come from the present effort.

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Don’t get hung up on valuation.

by on Jul.10, 2014, under Ignition! Starting up, Raising money

I can’t tell you how many times I’ve walked away from deals where the entrepreneur insists on a start-up premoney valuation that is so high, no angel could expect to make a return upon the investment, even with a reasonable sales price for the company down the road.

Raising_moneyThere is always another attractive deal at the ready, and most have reasonable expectations of valuation. Why fight about valuation, or disappoint the founder at the outset? The real focus should be on smart planning, finding ways to launch and build the business with smart but frugal use of money.

Let me tell you two stories that are linked. The first is of a 2004 startup that I cofounded and led the investment group for several early rounds, then VC rounds. The company has grown to forty employees and a healthy eight figure gross revenue run rate, but has absorbed over $36 million of angel and VC money to do so, and without yet reaching breakeven.

[Email readers, continue here...] The second story involves a founder who is using outsourced development, support, outsourced customer relations and more. The total capital raise will have been under $600,000 if all goes as planned, and the founder retains majority control of his baby through this and even one optional future round.

For the first, company, the founder’s remaining portion is under 4% after all the subsequent rounds, and not yet at breakeven. The second company finds the founder with majority control even if the original raise is not enough. For the founder to see any return at all in the first company, the ultimate selling price must be above $40 million. In the second company, better planned, the founder would be made pleasantly wealthy at a selling price of $10 million. The chances of the latter occurring are much greater than the former. This founder was not hung up on valuation for the second company, just upon efficient use of capital.

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Don’t over-estimate the knowledge of your audience.

by on Jul.03, 2014, under Finding your ideal niche, Positioning

When making a presentation to a new audience, the smart thing to do, if there is an opportunity, is to ask your audience by show of hands, if they have some knowledge of your industry or space. If you are making a one-to-one presentation, don’t start without a conversation about the other person’s knowledge of your space. With that conversation, you create an immediate connection with your audience even before beginning to present, and you know better how much explanation you will need to accompany your most elementary statements. And you will ventureforwardweb-237not insult the industry experts by appearing to talk down to them.

When I give a keynote address, I often start by asking my audience, by raise of hands, to tell me how many are angel or VC investors, and how many are entrepreneurs, how many are service providers such as attorneys. Immediately, I can tell how to orient the explanations behind my pre-cast slides, based upon the response. It always works, and the audience should appreciate that the speaker takes the time to orient the talk to the audience, not the other way around.

If your audience is composed of PhD’s in organic chemistry, would you want to explain the most elementary teachings in the field? On the other hand, it is most often true that only one or a few of your audience members is knowledgeable in your area of expertise. Address them directly with “I hope you will put up with me as I spend a few moments explaining some of our elementary knowledge to the others.” That makes these experts a part of your presentation, able to nod their heads when you do explain these things to the others, instead of looking a bit disdainful that you don’t recognize that there are experts in the room.

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Turn the tables: What’s an angel look like?

by on Jun.26, 2014, under Raising money

Angel investors, particularly those in organized angel groups, are typically former entrepreneurs who have had successful liquidity events in their pasts, or executives of companies who’ve retired with the funds from their stock options.  Occasionally, an angel is a member of a wealthy family, having little experience managing a business.  But most often these angels are skilled at growing companies, calling on their past experience to evaluate and then help entrepreneurs in their early stages of growth. Several times in our angel group, one of the largest in the United States, we have queried our group as to their motives in being active, risking their money, taking their time to research, perform due diligence and then coach entrepreneurs of young companies.  The result of these surveys over time is universally the same.  Although

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Order all 3 Berkonomics books for $49.95,a 33% discount. www.berkus.com

most every angel member joins a group to find great investments that will make money for the investor-member, all have other, sometimes more personally important goals.  These include giving back to the community in the form of time and investment, or learning about new industries, new advances, and a generation of new ideas.  Members want to socialize with those who have similar backgrounds and interests.  And members want to participate in the creation of the excitement they universally once felt in the growth and ultimate liquidity event they experienced with their previous company. [Email readers, continue here...] Angels come from technology, real estate, medical specialties, and many other industries, bringing a wealth of experience to the table to help evaluate and then coach entrepreneurs. So how an angel responds to your pitch depends upon his or her background.  You should try to find a way to get information about your audience before or even when standing in front of them.  What industry specialties do they like, or where did their experience come from?  Do you know any people in common?  Are they interested in your industry either to be educated or to share their skills and experiences? Connecting with these people often requires a bit of effort.  Networking events are great starting points.  Although many of these angels will appear standoffish at the start, if you can find some information from one or more of them before making your pitch, you will be in a far better place to succeed when pitching your idea to an individual or a group.

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Find your champion.

by on Jun.19, 2014, under Depending upon others, Raising money, Surrounding yourself with talent

If you seek funds from an organized investment group such as an angel fund, venture capital entity, or even an investment club, the first thing you want to do is to find one person to buy into your vision, become excited by your enthusiasm and be willing to become the internal champion for your fund-raising effort.

In some groups, if you cannot find such a person, you cannot even find the way to apply for funding, as some groups make it imperative that any introductions come from the inside, from a member or partner.   In others, if you cannot find such a champion after initial presentations to a subset of the entire group, you will not be permitted to move from initial application to the next stages of due diligence and final funding.

And in all cases, simply sending in an executive summary of the business plan via email or filling in an application for funding on a website lowers the chance of success to near nil. If you cannot find someone on the inside, network with accountants, attorneys and bankers to find a name of an influential member or partner.

2014-0329_OxyTEDx-0276  [Email readers, continue here...]  You may have the most impressive plan in the world, but these organizations see tens of these each week, and often cannot be expected to understand the vision and potential of any at first glance at a document.   I receive three hundred unsolicited executive summaries a year, and my investment group, Tech Coast Angeles, sees over one thousand. Together we fund, maybe, twenty-five of these. Although much more than half are disqualified because of geographical location, industry, or amount of money needed, that still is a small percentage of funding to applications.

Banks and lenders often are the same way. Although anyone can walk into a bank and apply for a loan, those who are recommended by a trusted source are treated much more personally and have a greater chance of success.

Spend time finding your champion. Create time to network with members of these groups at their public events. Seek out names from your trusted sources.

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The Rule of Thirds

by on Jun.12, 2014, under Ignition! Starting up, Raising money, Surrounding yourself with talent

It is rare when one person starts a company, supplies all the funding, and shares no management tasks or equity with others, and still grows the company to any significant size, worthy of a multi-million dollar opportunity to cash out at exit.

We should think of the creation and growth of a high valued company as the sum of three parts, with three distinct classes of participants helping to make real value out of a raw start-up.

First, there is the entrepreneur, the visionary, and force behind the venture from start to finish. The reward for the entrepreneur, after years of effort, time and sacrifice, is measured by EA-9817what portion of the total pie s/he retains at exit, how much the person continues to participate through that time, and how many other resources are brought in to get to that point. Most importantly, the reward is measured by how much added value the total process creates over time. It is the old story of “100% of nothing is worth far less than 10% of a large number.”

[Email readers, continue here...] Few entrepreneurs can do it alone, with subordinate hired help and no expert management to share the burdens, skill sets and efforts involved in growing the enterprise. So co-management is the second group to share in the bounty upon a liquidity event. Often, if not co-founders, this group is rewarded through issuance of stock options from a pool of available options that usually totals 15-20% of the total company’s equity divided among all employees. Those who receive options but leave the company before a liquidity event may either purchase those shares represented by the options upon exit from the company, or lose the right to those shares, often 60 days after their exit.

The third group is made of the total number and types of investors, other than the founder(s). From friends and family early on, to angels that are not related to the founder(s), to venture capitalists for larger opportunities, these investors have risked their money in the venture for only one reason – to eventually profit from a liquidity event.

It is normal for the first round of organized angels to expect to purchase between twenty and thirty-five percent of the company with their investment. Second rounds, if needed, often drive the founder(s) into a minority position, unless the company has grown significantly by that time and can command a higher pre-money valuation, giving less stock for the same amount of investment. Investments in small companies involve a much greater degree of risk than investment in public companies, which provide immediate liquidity if needed and a ready measure of value at any time. That risk deserves reward if there is a profitable sale or even an initial public offering, rare as that event is.

So remember that there are three slices to the pie to consider when creating your company and again when considering a sale or liquidity event. All three deserve recognition for the risk, time and effort in driving the company to its ultimate value.

Think of it as the rule of the thirds.

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Huge opportunities do NOT command amazing pre-money valuations.

by on Jun.05, 2014, under Ignition! Starting up, Raising money

Dave’s note: Popular Bill Payne returns this week with a thoughtful take on valuations.

By Bill Payne

One entrepreneur has a company which appears to be scalable to a $30 million exit value in five to eight years, and a second entrepreneur’s venture seems to be scalable to $200 million in exit value in the same time frame. Yet, at the pre-revenue stage of development, angel investors price both companies at a pre-money valuation of $1.5 million.

It doesn’t seem right, huh?

Bill PayneBut, it is… and here is why. It is possible to grow a company to a valuation of $30 million on one or two angel rounds of investment. But, the working capital and management team necessary to grow a company quickly to sufficient revenues to justify a $200 million valuation will require raising lots more capital. So, the angels who provided the most valuable and risky financing for the gazelle that can grow to a $200 million valuation quickly are going to get diluted by subsequent investors, probably by three to five-fold. They may own 30% after the first round of funding but will probably own less than 10% at exit. So, angels simply must value both ventures at about the same price.

[ Email readers, continue here...] Scalability is a critical factor for angel investment. Because of the risk inherent in funding pre-revenue companies, angels are unlikely to invest in any venture that cannot demonstrate the potential to scale to a $20-30 million in valuation in a reasonable time period (5-8 years).

So, angels won’t fund a deal that doesn’t scale sufficiently to justify investment, and they tend to value all pre-revenue stage companies at about the same valuation, which is currently about $1.5 million in most parts of the US. Although there may be some variation among business sectors, this is essentially true for software companies, medical device companies, life science ventures, electronics companies and alternate energy deals, regardless of the long term potential.

 

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Craft your roadmap. Plan your trip.

by on May.29, 2014, under Growth!, Ignition! Starting up, Positioning

By JJ Richa

J.J. Richa is a successful entrepreneur and technologist giving back to the entrepreneurial community in many ways, including his weekly Internet TV program on entrepreneurism, and participation in several mentoring programs.      

Business planning is a crucial part of a successful business. Business plans are dynamic instruments used on a regular basis to help owners and executives to plan for future growth, and

From Basic Berkonomics: Available Amazon, B&N,  berkus.com and booksellers everywhere.

From Basic Berkonomics: Available Amazon, B&N, berkus.com and booksellers everywhere.

assess past performances. Included in a business plan are financials, competitive landscape, marketing plans, and projected sales to name a few. Without a business plan, you probably are not sure where you are going, or how you are going to get there, or how you are going to know where you’ve been. If you don’t know these things, how are you going to course-correct if things go differently than forecast?

A business plan:

  1. Organizes your thoughts to better run your business
  2. Depicts your roadmap/blueprint, and must be revisited often
  3. Defines your business vision, objectives and goals
  4. Determines financial requirements
  5. Keeps you on track to achieve your goals
  6. Helps you to be more focused
  7. Forces you to be more objective
  8. Determines feasibility
  9. Serves as management tool
  10. Assists you in raising capital

I’m not seeking a bank loan or investment. So why make a plan?

[Email readers, continue here...]  A business plan is yours alone. Bankers, financial institutions, and investors hardly look at business plans. But it’s a valuable document for you. By creating a plan you are forced to think about your business and how it is structured, the objectives and other critical matters. The plan helps an owner realize how interrelated all aspects of the business are. In addition, it helps you focus your ideas and determine how to best manage your available resources including capital, cash, and people.

After completing your plan, you should be able to answer questions:

  • Is there really an opportunity here?
  • Can we pull it off?
  • Can we make money? Is there potential for profits?
  • Where are we?
  • How did we get here?
  • Where are we going and how will we get there?

Forecasting your finances as part of the plan will help you understand if, and how, you can improve revenue. It’s hard to make changes if you don’t know where you are, and where you’ve been.

It helps other answer the following question:

  • Will they have a chance to succeed?
  • Can they pull it off?
  • Will the cash flow?
  • Did they make any headway?
  • What have they done so far?
  • Will they be able to execute and reach their objectives?

As your business grows, a business plan serves as a guide to help you track, monitor and evaluate your progress. Having your short-term and long-term goals written down and in front of you can help keep you on track to reach them. Business plans provide you with the ability to identify risks to your business and what alternatives exist to minimize them. By analyzing your business objectively in the plan, you can address problems before they escalate. Studies found that people who write plans are more likely to put their goals in action and increases your likelihood of success.

Business Plans are not static. As your business changes, your original plan may no longer be as relevant. Review your plan periodically – as often as once per month, but no less than once per quarter – and make updates as needed.

 

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Early stage money: The problem with PPMs

by on May.22, 2014, under Raising money

Bill PayneBy Bill Payne

Bill Payne has been actively involved in angel investing since 1980, funding over 50 companies and mentoring over 100 more. He is the recipient of the coveted “Hans Severiens Award form the Angel Capital Association, its highest honor.  

The sale of equity in private companies is regulated by the Securities Act of 1933, which requires that the company either register with the SEC or meet one of several exemptions (Regulation D). A Private Placement Memorandum (PPM) is a special business plan defined to meet an SEC exemption. In most cases, those entrepreneurs choosing to raise capital using PPMs retain specialists (many of whom are lawyers) to write their PPMs – a rather expensive undertaking. I don’t fund new companies that have prepared PPMs for investment. I am an angel investor, that is, an accredited investor who is assumed by the SEC and others to be sufficiently wealthy to afford to lose the investment and supposedly experienced enough to make good choices on fundable companies. Angels, as group of accredited investors funding startup companies, are assumed to meet a Regulation D exemption for purchasing equity in private companies.

Like most angel investors, I have preferences for the terms and conditions of investment and intend to negotiate with entrepreneurs on those terms, such as valuation, company structure, the makeup of the board of directors, liquidation preferences and others. I have yet to read a PPM written for a startup company that meets the parameters we angels generally establish for funding new ventures.

[Email readers, continue here...]  If I don’t like the terms offered in the PPM, why don’t I insist that the terms be changed to accommodate my partialities as an angel investor? Sounds simple, huh? Unfortunately, upon completion of the PPM, the first thing that entrepreneurs tend to do is sell shares to friends, family, friends of friends and other acquaintances. Then, only after convincing these “unsophisticated” investors to sign up and write their checks, the entrepreneur may approach an angel or group of angels.

The entrepreneur may have already raised half or more of the cash required in this round and is eager to top off the round. The PPM does not meet the investing terms and conditions of the angels. The valuation is too high, or the PPM is written to sell common stock when it really should have been a preferred stock deal, or other critical terms are not present in the PPM. Since many unsophisticated investors have already funded part of the round, it becomes too complicated to renegotiate the terms of the deal.

It is only fair that all capital sources in a given round should invest under the same terms and conditions. There should not be one version of terms for the early set of investors (the PPM terms) and a second version of terms for later investors in the same round. In the long term, different term sheets for investors in the same round leads to unhappy investors. We angels could insist that the entrepreneur go back and renegotiate the terms of the PPM with all the earlier investors, but the earlier investors may or may not agree to the changes. From a long history of angel investing, we have learned it is just easier to pass on PPM deals and move on to the next opportunity. We see many startup investment deals every year – too many for most of us to fund.

Regarding PPMs, my recommendations to entrepreneurs are:

  • Don’t prepare PPMs to fund startup rounds of investment. It is expensive and may preclude sophisticated investors from funding your deal.
  • Pursue smart money, that is, sophisticated investors who will negotiate a fair deal with you and help you grow your company.
  • Limit your offering: Only sell shares to accredited investors. In the long run, this usually works best for startup entrepreneurs.
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