The biggest error in planning may not be spreadsheet calculation error. Or cost estimation. It is most often missed assumptions about the market, the competition, the speed of adoption, or other critical metrics you’ve researched, or selected, or even just guessed at to create your plan.
Where did you get the data to drive your assumptions of market size or market share? Most entrepreneurs quote a resource for market size, but fail to then take the next step to eliminate all parts of that market unreachable by the company or product. For example, if you supply software to the chip design industry, do you segment your market into digital and analog users, into high end or inexpensive buyers, and into which languages or platforms users demand or request?
It’s easy to find someone to quote a size of market estimate. I became something of my industry’s source for such a number when I carefully catalogued the 160 players both domestic and international, estimated revenues from knowing the number of employees or installations for each (which were often public knowledge or stated by those companies.) I then created a gross domestic and gross international annual market size estimate for my industry’s products. No-one challenged this number, and it became an unattributed source of the metric for market size for years. Perhaps there was no other way to project the size of that market. But many decisions were made within my company walls, and surely by competitors, based upon those numbers.
[Email readers, continue here...] Then there is the famous entrepreneur’s statement about market share: “All I need to sell is one percent of the total available market to make this a rampant success.” We call that the “gloves in China” syndrome when analyzing assumptions within business plans. Without a trace of how the business will get that one percent, the entrepreneur confidently shows that this is all it takes to make us all rich. Even if the total number of annual units in a market is known, the leap to a percent of that market without a specific plan is often a fatal one.
And these are just two of the many assumptions that underlie any business plan. At the very least, all assumptions should be driven by numbers separately listed in an “assumptions section” of the planning spreadsheet, allowing the reader to manipulate those assumptions to see the various outcomes, and challenge the numbers for the benefit of all who have to defend them.
By David Steakley
This week, David Steakley returns for another bite at the corporate apple, with just the right amount of tart comments that will keep this document legal for now. Read on! - DB
How do you judge a company’s prospects, if a corporate business-to-business sale has to be your game? If your company’s market is huge corporations, how do you convince investors you can crack the market, and how do you deliver?
To answer this, you have to understand the challenges of getting paperwork signed and checks issued, in a big company. You’ll notice I didn’t say “the challenges of selling,” because this is seldom the crucial challenge. I am assuming that you have an awesome product or service which cleverly solves some tough problem and promises to deliver solid ROI for the buyer.
Just to be up front, as an investor, I am allergic to companies which rely on making potentially huge sales to corporate clients. The corporate B2B sales cycle produces a harshly binary outcome: either the company dies while waiting for a corporate client to sign the paperwork and remit the funds, or else it delivers gigantic outsized sales with relatively little effort.
[Email readers, continue here...] I routinely see prospective investments which rely by their nature upon selling to corporate customers. I have learned through bitter experience that little can be predicted from analyzing the company’s product or service. Of course, you’d think the company has to have a useful, valuable, or somewhat unusual product in order to be successful. But, from a standpoint of efficient analysis of the company’s prospects, this is not the place to start.
Big corporations are just slow to act. The time needed for decision increases as a factor of the number of people involved in the decision process. The number of people involved in the decision process varies as a factor of the amount of money involved, the number of places in the company affected by the transaction, and the duration and contractual obligations of the commitment.
I have found that the predictor of success is really extremely simple: tell me the name, phone number, birthdate and favorite brand of scotch of the senior corporate executive who is going to be your first customer, and tell me how much he is going to pay you in the next twelve months. Now, I am not saying you have to sell only to scotch drinkers, but you get my point: the predictor is your intimate knowledge of people you already know who need your product, want your product, and who know and trust you to the point that they will work hard to overcome the obstacles of closing the deal.
In other words, you have to have inside agents. You have to know, find, create, recruit, whatever, senior corporate executives who will relentlessly and stubbornly perform the unnatural acts required to close the sale.
Occasionally, I have seen success with companies getting started by using channels, i.e., other companies which are already providing or selling some product or service to your customers, who will tuck your product or service into their bag of tricks in return for a slice of the revenue. But it is very, very difficult to get a new product started this way. Once you’ve established the product, and the channels can be persuaded that your product provides them with relatively easy incremental revenues; channels are a fantastic way to scale your sales effort without fixed costs.
The great advantage of the B2B market is the potentially huge size of revenues from just one sale. Those revenues tend to be very durable, as quite often, you are getting your offerings wired into the DNA of the customer.
Before you tackle the corporate market, be sure you understand the challenges of this market, and think carefully about your product design and your sales approach, to reduce the barriers to closing sales as much as possible.
David Steakley, a past President of the Houston Angel Network, is a reformed management consultant. He is an active angel investor, and he manages several angel funds in Texas.
Cash is everything to a new business. How many times do we have to say this? The days of being able to trust that there will be an investor or lender on the other end of a call or email whenever needed ended with the 2000 and 2008 bursts of those respective bubbles. It’s entirely possible that Amazon could not be created and funded today with its planned seven years until profitability.
Early stage investors who take a chance on new businesses, often now plan their investments around the notion – or hope – that they can fund one or two rounds to lead the business to profitability. There is no longer a guarantee that VCs and later stage investors will be waiting at the run-out point of the angel money to pick up and grow the company.
Business plans that I see often show three to five years of projections, demonstrating profitability at the end of so many months of operation. Most every one of these uses an accrual basis for determining breakeven, never attempting to predict the cash impact of capital investment, slow collection times, large deposits upon leases, and other major items that consume cash.
[ Email readers, continue here...] Worse yet, most show rapid gains in revenues but do not account for the extra cash it takes for working capital to grow the business at the rate projected. If a business takes an average of sixty days to collect cash from the time it invests in the product with costs of inventory or labor, then shipping and billing, then the business will need increased working capital to pay its expenses including payroll while it waits for the cash to come in the door.
Recast your projections using cash, not accrual, as the measure for planning. An accrual statement is nice to produce. It confirms that the business is capable of ultimately throwing off positive cash flow. But only accurate projections of cash by the week or month as appropriate will assure the survival of a business in a rapid growth cycle, or even a startup raising just enough to make it to breakeven.
By David Steakley
Our guest insight this week comes from David Steakley, a past President of the Houston Angel Network, and a reformed management consultant. He is an active angel investor, and he manages several angel funds in Texas. Hang on, David tells it like he sees it! – DB
Business plans are interesting. But, as a famous field marshal (1) said, no battle plan survives contact with the enemy. I have found it more important to assess the capabilities of the founding team to react, revise and pivot (quickly change direction), than it is important to assess the business plan. How do you know whether your founder team and your added executives have the right stuff to survive contact with the enemy?
In addition to the ability to pivot, character matters, too. As my kids have commenced driving, I’ve harped incessantly, hopefully to the point of their nausea, on the notion that they should always have in mind that everyone driving on the road is in a massive conspiracy to collide with them, and make it appear that the collision was an accident. “Just assume everyone is trying to kill you,” I say.
I take this approach to angel investing. I begin by assuming that the founders of the company are incompetent, psychopathic, lying con-men and thieves; and I try to convict them of these charges. I ask them innocuous questions, and try to check as many seemingly inconsequential details of their story as I can. Where did you go to school? When did you graduate? In what field was your degree? What was your first job? Why did you leave that job? Where did you grow up? Did you play sports in high school? What are your hobbies?
[ Email readers, continue here...] Faithful in little; faithful in much. If someone will deceive about a small matter, he will deceive about anything and everything. I don’t do business with liars. If I am unsuccessful in proving these charges, then, perhaps the company is a candidate for investment.
I was a partner at a large global consulting firm. We hired literally hundreds of thousands of graduates every year. They had no meaningful experience. The only way to evaluate them was to look for a kind of raw, athletic talent. To help us in this, we adopted a technique which I believe is now universally used, but which was unusual at the time. We called it behavioral interviewing. This technique relies on identifying specific traits and characteristics which one wishes to find, either negatively or positively, and then asking the candidate to tell specific true stories about situations in which s/he would have had an opportunity to demonstrate the traits in question. A lot of the value of this technique relies on the interviewer being extremely aggressive with the candidate about the minutest of details within the story offered.
For the founders of companies in which I am considering investing, I have concluded that flexibility, intellectual nimbleness, and a relentless focus on dispassionate examination of factual evidence of results, are some relatively rare traits with which I cannot ignore. “Tell me about a time when you changed your mind about something important,” I will ask. “Tell me about a time when what you were doing wasn’t working. How did you know it wasn’t working? What was the problem? What did you do?” “Tell me about a time when you screwed up big time. What happened? What did you do?” I will ask questions about the tiniest details of their stories. What were you wearing? What time of day was that?
I have actually had people respond along the lines of “I don’t recall a time when I screwed up.” Or “Sometimes I have been let down by my subordinates and my partners, though.” Check, please!
But, a more common problem is that you find out by detailed questioning that the story presented is not really a true specific story, but a theoretical composite story, which reflects theoretical behavior the interviewee assumes you want to hear about. I don’t want to work with these people. They are trying to tell me what I want to hear, and they do not want to admit the possibility of fault.
I want to work with people who are pleased to discover mistakes, errors, and opportunities for improvement. I will not work with people who hide mistakes, who ignore errors, and who pretend that everything is wonderful. I want to work with people who face the truth.
One of my very
favorite entrepreneurs is the shining example of taking himself to task over errors and missteps, and of a constant vigilant search for how things are going wrong in his businesses. Recently he launched a unit which developed a casual browser-based online game, monetized through micro-transactions for virtual in-game goods. One of the beautiful things about this kind of business is the depth and immediacy of information available about performance and results. So, when something is changed, you find out immediately how the change affects results. This company has been through so many iterations of its model that I have lost track. I love the willingness to experiment, and the perpetual dissatisfaction with how things are going, and the relentless quest for improvement. This guy is going to make me a lot of money, or die trying.
So, focus on the personal traits and characteristics of your team. Things will definitely go wrong. You want to have some idea of how your team will react when that inevitably happens.
(1) Helmuth Von Moltke the Elder, 1871
By David S. Rose
Described by BusinessWeek as a “world conquering
entrepreneur” and by Forbes as “New York’s Archangel”, David is a former Inc.
500 CEO, serial entrepreneur and the founder of New York Angels. He is the
founder and CEO of Gust, the angel financing platform used by over 50,000
accredited investors in 1,000 angel groups and venture capital funds to
collaborate with over 250,000 entrepreneurs in 95 countries.
Since Bill Hewlett joined with Dave Packard in 1939 to create what is today one of the world’s largest computer companies, there has been an evergreen debate as to who is more important in starting a tech company: the techie or the business guy? Steve Jobs or Steve Wozniak? Bill Gates or Steve Ballmer? Jim Clark or Marc Andreessen?
I propose that it is time to reject the notion of the business man or business woman entirely. The underlying problem is that there are really three different components here, and like the classic three-legged school, they are all essential for success, albeit with differing relative economic values. What confuses us is that the components can all reside in one person, or multiple people. And what upsets people is that there are different quantities of those components available in the economic marketplace; and the law of supply and demand is pretty good about consequently assigning a value to them.
Perhaps surprisingly, the components are NOT the traditional coding/business pieces; nor are they even coding /user interface / business / sales, or whatever. Rather, here is the way I see it, from the perspective of a serial entrepreneur turned serial investor, listed in order of decreasing availability:
[Email readers, continue here...] 1) THE CONCEPT: A business starts with an idea, and while the idea may (and likely will) change over time; it has to be good at some basic level for it to be able to succeed in the long run. How excited am I likely to be when I see a plan for a new generation of buggy whip, or another me-too social network? The basic concept has to make some kind of sense given the technical, market and competitive environment, otherwise nothing else matters. BUT good ideas are NOT hard to find. There are millions of them out there. The key to making one of them into a home-run success brings us to:
2) EXECUTION SKILLS: It is into this one bucket that ALL of the ‘traditional’ pieces fall. This is where you find the superb Rails coder, and the world-class information architect, and the consummate sales guy, and the persuasive business development person, and the brilliant CFO. Each of the functions is crucial, and each is required to bring the good idea to fruition. In our fluid, capitalistic, free-market society, the marketplace is generally very efficient about assigning relative economic value to each of these functional roles, based upon both the direct result of their contribution to the enterprise and their scarcity (or lack thereof) in the job market.
That is why it is not uncommon to see big enterprise sales people making high six figure – or even seven figure – salaries or commissions, while a neophyte coder might be in the low five figure range. Similarly, a crackerjack CTO might be in the mid six figures, but a kid performing inside sales may start at the opposite end of the spectrum. Coding, design, production, sales, finance, operations, marketing, and the like are all execution skills; and without great execution, success will be very hard to come by.
But, as noted, each of these skills is available at a price, and given enough money it is clearly possible to assemble an all-star team in each of the above areas to execute any good idea. That, however, will not be enough. Why? Because it is missing the last, vital leg of the stool, and the one that ultimately–when success does come–will reap the lion’s share of the benefits:
3) THE ENTREPRENEUR: Entrepreneurship is at the core of starting a company, whether tech-based or otherwise. It is not any one of the functional skills above, but rather the combination of vision, passion, leadership, commitment, communication skills, hypomania, fundability, and, above all, willingness to take risks, that brings together all of the forgoing pieces – and creates from them an enterprise that fills a value-producing role in our economy. And because it is this function which is the scarcest of all, it is this function that (adjusting for the cost of capital) ends up with the lion’s share of the money from a successful venture.
It is crucial to note that the entrepreneurial function can be combined into the same package as a techie (Bill Gates), a sales guy (Mark Cuban), a user interface maven (Steve Jobs), or a financial guy (Michael Bloomberg). And that it is the critical piece which ultimately (if things work out) gets the big bucks.
The moral of the story is that, for a successful company, we need to bring together all of the above pieces, realize that whatever functional skill set the entrepreneur starts out with can be augmented with the others, and understand that the lion’s share of the rewards will (after adjusting for the cost of capital), go to the entrepreneurial role, as has happened for hundreds of years.
My immediate family members were entrepreneurs from as far back as I can trace. Dad was a jeweler, then a furniture store owner. Mom wrote books and articles from her college days until she could no longer see the keyboard. One grandfather owned and maintained his apartment houses. The other was a grocer, then a jeweler.
So it seemed perfectly natural that my brother and I find our separate callings as entrepreneurs from the very start. I took pictures of neighbor children, developing them in my bedroom closet, selling the prints to those neighborhood families. I was twelve. The prints were not very good. At fifteen, I started a recording business that would pay my way through college, a business that I’d take public in a limited IPO years after, before getting into the computer software business in its infancy. My brother, who had an artist streak where no-one could identify its roots, drew pictures that were extraordinary, and became one of the world’s one hundred most noted architects.
What drove my brother and me to perform, to risk so much, to skirt bankruptcy, to press on again and again? For us, I believe it was two important things. First, our family DNA made us comfortable talking about risk and self-discovery in running a business, even without formal training. Second, and more importantly, my brother and I watched our dad run his business in the most conservative manner possible, refusing to expand or take risks, comfortable with a steady income and no prospects of building wealth through building business equity. Both of us reacted in different ways, but in common was the urge to take much more risk, to push the boundaries, to succeed spectacularly or fail and start again. We reacted to our view of dad’s conservatism.
[Email readers, continue here...] We tell the story that dad was offered the general store franchise in the brand new park in Anaheim soon to be built by Walt Disney. The price for the franchise in 1953 was $50,000. Dad turned it down, stating that there was no chance of success for a park so far from downtown Los Angeles. His two sons observed, and perhaps reacted in later years by pushing to take the chance for themselves equal to that declined by dad.
Are you a DNA-based entrepreneur? Or are you starting out to build the next Cisco Systems because you know how your employer has failed to do so? Or do you want freedom from the senseless bureaucracy you face daily in your present job? Have you found the cure for cancer and need to bring it to the world? Or is your reason for risk more basic – that you found an easy opportunity to fill a need and you have the skill and desire to take that chance.
Think for a minute about your real reasons for taking this ride. It will help you to make better decisions about future risk, about your tolerance for it, and about your inner-self.
HARD COVER book directly from Berkus.com, signed by Dave (with gift inscription if requested): http://www.berkus.com/_e/Books/product/Advanced_Berkonomics-hardcover/Advanced_BERKONOMICS_Hardcover.htm
SOFT COVER book directly from Berkus.com, signed by Dave (with gift inscription if requested): http://www.berkus.com/_e/Books/product/Advanced_Berkonomics_soft_cover/Advanced_BERKONOMICS_Soft_cover.htm
Next week, we begin again with new insights from startup through liquidity event, including guest postings by some of the nation’s best known angel investors and entrepreneurs. Stay tuned! – Dave
So you’ve successfully sold your business and have received enough money from the sale to become financially independent, no longer having to work for a living. That is a comfortable place to be, and it is one experienced by more and more people, especially in technology-based businesses.
Most successful sales of businesses, again especially in the technology arena, enrich younger entrepreneurs and stock-option holders who are under fifty years of age. Having interviewed many of these newly-rich alumni, I have found that most want to take time off for an indefinite time to think out their next move, which is not a bad idea. Some immediately start to plan their next venture. And some tell me that they will just retire, finding travel, coaching, teaching and a life of leisure their most attractive alternative.
I followed many of these stated retirees, and very few if any retiring entrepreneurs stay that way for long. Their lifestyles may change, sometimes dramatically, but for a driven entrepreneur, a full stop is difficult over time.
Now you have worked for months to get this deal to the closing, anticipating the wire transfers to the shareholders that will come any minute. This could change your life style and give you that much needed pause in your life you have been looking forward to.
All the documents were signed in a rolling series of emailed scanned signature pages during the past week or more, with each party signing their own set, never having to be in the same room to sign the single signature page for each agreement. And in the end, the deal that means so much to you closes with a whisper. You check your bank account every half hour to see if the wire has been posted.
Finally it arrives and you see the balance in your account jump to a number you’ve never seen there before. You pause for a minute to savor the victory. And you go back to what you were doing right before that moment. Or not. But the closing was such a non-event that you wonder why people even call it a “closing.”
Congratulations. You have joined an exclusive club, and have earned your membership.
[Email readers, continue here...] It used to be thrilling to participate in a real “live” closing. The date and time of the closing would be published for all interested parties. The lawyers for both buyer and seller would meet the day before to go over a “trial closing” to be sure all documents were ready to sign. And on the appointed morning, often at 10 AM, all attorneys, the investment bankers, you and your buyer’s CEO would all gather in a large conference room with documents already spread around the conference table. After pleasantries, you and your opposite CEO would pick up your (fountain) pens and start moving around the table, signing agreements in the appointed spots until your fingers were weak from the effort. The lawyers would follow and check, then finally all nod that the work was done. A handshake, applause, a promise to meet the next day, and a celebration closing meal either immediately following or at a future time sealed the deal for all.
Those were the days. The smell of the newly-copied papers, the smudges from the fountain pen ink, the tension followed by smiles all around, all contributed to the feeling that something grand was happening.
My favorite closing followed this pattern with a twist. There must have been 25 of us that arrived for a 4:00 PM closing after the day-before trial closing by the attorneys. We all expected to be finished and out of there for a late dinner. At five the next morning, after an all-night session with revisions, midnight calls to the buyer’s parent CEO in New York and more, we finally signed the papers, all completely worn out from the many anxious moments and long, long night. All the parties vowed to go home and get some sleep. I went home, took a shower, and went to work as if a typical day, working now as CEO of a subsidiary of a parent company. And yes, I checked the bank account every half hour for the wire transfer. Some things do not change.
For those of you who ever experience the muted thrill of today’s electronic closing, you can give a nod to those days when the smoke-filled rooms were real and the tension palatable, when a closing was a face to face event.
Many CEOs have asked me if I felt an investment banker adds value if the buyer has already been identified.
Investment bankers sometimes slow the process by requiring a “deal book” to be prepared containing considerable information about a company to help a buyer. Deal books are expensive to create.
Other investment bankers insist that the company create competition for a deal, even if the buyer has already submitted a letter of interest to the seller. Competition opens the deal to more public access, slows the deal and could give competitors wind of an otherwise confidential process. And yet, it is almost universally acknowledged that without competition for a deal, the price will be lower, sometimes much lower.
Then there is the question of fees. For small deals, an investment banker will ask as much as ten percent, although the average is slightly above half that. For larger deals, expect the fee to start at five percent and scale downward with size. And expect the investment banker to ask for an advance against expenses of at least $20,000 or much more with larger deals, with any unexpended funds not to be refunded. If a buyer is already in hand, many will work for far less in percentage fees, and even in advances, because much of their work is done at that point.
[Email readers, continue here...] And there is the question of whether an investment banker has a personal agenda to get a deal done in minimum time, even if the proceeds to the seller are less than could have been expected. Is there any conflict of interest? Is this not a parallel to the question of a real estate agent who cares little about that last five or ten percent of the purchase price, if it would kill a deal or slow its close, since the agent’s commission amount is only a fraction of that difference?
And finally, could not the corporate attorney do just as good a job of negotiating a great deal for the seller, and do it for hourly rates instead of a percent of the transaction?
My experience is that good investment bankers do add significant value to a deal in most cases, easily earning multiples of their fee by increasing competition, upping the price, and finding areas for extra value that the seller did not think of. Good investment bankers work with your attorney to structure the deal, help the seller to see more of the value hidden in the candidate seller, and increase the sense of urgency to close the deal among all parties.
Perhaps most of all, a good investment banker will insulate the seller CEO against the anger and ire of the buyer during the process that always accompanies stressful negotiations or issues revolving around the seller CEO’s continuing employment contract. Imagine you’re fighting with the buyer CEO about your expected salary and benefits during a transition period to follow, expecting to work harmoniously with that CEO after all the tension and conflicts during the negotiation of the deal. And imagine having that buffer in the form of the investment banker arguing on your behalf while you sit silently, giving up little or no good will during the maelstrom around you. Presented with these mental pictures and the recommendations from so many of us that have done deals with and without investment bankers, you may lean toward interviewing a group of your industry’s best for the size of your deal, and being convinced that creating such a team is a good investment.
Maybe you have not heard the term, “deal book.” That’s a comprehensive piece on a company for use by a buyer in determining fit. A “deal room” is an electronic or physical space dedicated to storing the massive amounts of data to be used in due diligence by a buyer, lender or by an investor.
Deal rooms contain access to or copies of all significant contracts with suppliers, customers, consultants, and others. All corporate governance documents, from incorporation articles to minutes of all meetings of the board are maintained in the deal room. Up-to-date insurance policies, leases, financial documents and schedules such as fixed assets are copied here. Copies of intellectual property filings such as patents, copyrights and trademarks, all owned URL addresses, and even copies of source code, may be resident in the deal room, dependent upon the type of buyer. Current documents relating to any lawsuits by or against the company are maintained there as well.
In this day of electronic record-keeping, access to the deal room is available remotely by a buyer with appropriate access, saving the long and expensive personal visits by lawyers, accountants and others to the seller’s facility. Well-maintained deal rooms enhance a company’s image with a buyer, quicken the pace of the deal, help maintain secrecy from employees while due diligence is in process, and lower the stress levels of all parties during the process.
[Email readers, continue here...] But maintaining such an electronic or physical facility is time-consuming and costly. The question is whether to start this exhausting process early in the life of a corporation, or rush to complete it when a deal is identified or the run to a sale is imminent.
Because deal rooms have multiple applications, the best advice is to begin the process right after incorporation and make keeping it current a continuing job of your financial senior management. Whether it means copying physical printouts and creating volumes in three-ring binders or scanning documents and creating electronic folders, incremental additions are much easier to make than an all-out run at the finish.
Bankers, investors, strategic partners, and ultimately your buyer or even attorneys providing opinions for an IPO, will all be most impressed by your thoughtful early management decision to make their lives easier and their job more productive.