Archive for September, 2011
Have you ever noticed how slow time passes when you are in a troubled environment? Conversely, sometimes you look up at the end of a great day and wonder where the time went. Over the years, I have discovered that the difference is not just applicable to the good times, but to the environment, created by the senior executives, that filters throughout the organization. Every time, a corporate work culture encouraging humor causes employees to enjoy their work, spend more time with associates, and laugh many more times through the day.
At one point in our mutual careers, my brother located his growing architectural practice just a mile from my record company in West Hollywood, California. I would visit his office and immediately notice an atmosphere of “joyous creativity” throughout the organization. Every cubicle was decorated with whimsical drawings, posters, kid’s creativity, and more. As I walked through the facility, I could hear laughter emanating from cubicles, almost constant as a background song of simple joy at work. Those visits were wonderful times to recharge my batteries, and I was not even a part of the company. Imagine how they affected the attitude and creativity of those working there. Think of how clients loved to associate with their counterparts in such an environment.
[Email readers, continue here...] Try as I could to reproduce such an environment, my company was too spread out, the background noises of manufacturing too loud to make the same environment possible. The best I could do was touch individuals and small groups with that same joy of the journey, adding humorous opportunities for lightening up as often as possible.
But after all these years, I will never forget the magic of that architectural office, and how much everyone there wanted not to let it ever slip away.
Take every opportunity to lighten up, to ease the often-self-imposed pressures of constant work, to unlock more of the creativity of your workforce through the use of appropriate humor. What a lift that brings.
I’ve been involved with well over a dozen successful exits and four initial public offerings over the years, some of them with monstrous gains, some more modest. Then in addition, there are the exits that returned some portion of capital, but nothing more. And finally, there are the sad exits that were complete write-offs for the investors, regaining some portion of note-holder or creditor money in the process.
I can tell you with great enthusiasm that the high gain exits are by far the most enjoyable in every way. There’s almost always a closing party where the board, prime investors, attorneys and investment banker all get together to celebrate the victory. It is an exhilarating ending to a great journey. The entrepreneur, whether remaining to the end as CEO or not, is celebrated for his or her prescient timing, great vision and excellent execution of the plan. One such celebration was even characterized as “We stuck the pig!” – the overly enthusiastic celebration of an outcome larger than expected.
But I cannot recall ever attending a closing dinner for a sale in which we returned only a portion of the investor group’s money. In fact, I don’t recall any formal post-sale meeting at all; even to digest the lessons learned from the entire experience, a missed opportunity for all.
[Email readers continue here...] And there is the sad truth of the large percentage of early stage investments that die an unceremonious death, often with the entrepreneur-founder left with a bitter feeling that “if only” there had been more cash invested, more co-operation from board members, more time to get to market, more of something, then the outcome would have been much better for all.
Of course the successful outcome is preferable for all. But more importantly, it marks a passing of a successful journey by a team first formed by a visionary entrepreneur, usually attracting smart money from good investors, who together effectively planned growth and finally a great exit.
Whenever those forces come together, celebrate them and the team that brought them all together.
I have saved this next story until now because it is one of my favorites, and certainly illustrates the point as well as anything I could devise from fiction.
First here is a bit of the background. The year was 1998. After presenting a “state of the company” report at a national meeting of resellers for a company where I sat on the board, I was approached by one of the audience members, complimenting my presentation and stating, “I have a problem. I’ve been offered $15 million for my company and my partner is suing me for all I am worth. What can I do?” I promised to come see him at his office the very next week. What I discovered was a contradiction that was too intriguing to ignore. The company of eight was engaged in web design, hot at the time. And yes, the partner had a valid suit, having been locked out of the business and denied access to decisions and accounting information.
But the real asset became obvious at almost exactly 5 PM that day, when all eight stopped what they were doing and began using a tool they had licensed from a Florida company to find other Internet gamers to join them in playing intense first party shooter games over the ‘net. The tool it turns out had been posted on the company’s website and downloaded by over a million gamers. Over a million of these came to the company’s game web site each month for new information and to form an early Internet game community. The company made little effort to charge for the software or community. Microsoft had just bought Hotmail for $9 per registered user; AOL had just bought ICQ for $40 per registered user. And here were over a million users, with no apparent value to the web designers, except as a community of friends with similar interests.
[email readers continue here...] Did I forget to tell you that on that day, looking into the company’s books, I discovered that neither the company nor its founder had filed Federal income tax returns during the three years in business? And there were other quite obvious problems, unattended to, along with the partner’s suit hanging over their heads.
I immediately agreed to come aboard at no cost to clean up the corporation, deferring my investment until that was done. I negotiated a settlement with the partner for $100 thousand which I paid, then filed all of the overdue tax returns of various types, and cleaned up the books. Offering to reincorporate the game company as a new entity to avoid any more surprises, we negotiated 10% for my $100 thousand, with the remaining 90% for the founder. In addition, I loaned the new company $150 thousand for working capital. By this time there were not one but four million registered users.
Within three months, we easily obtained $3 million of investment at a pre-money valuation of $30 million. Can you begin to tell that this is a story of timing, and of the Internet bubble? Three months later, another investor company in the business offered to invest $3 million at a valuation of $60 million. Two months after that, a French game company offered $1.5 million at a valuation of $80 million. Of course we took all of these.
We now jump forward to February, 2000, 14 months after formation of the company. Another major competitor in the industry, directly competing with one of our investors, offered $140 million for 49% of the company in a combination of equal cash and stock in its public entity.
Fast forward a month to a meeting between a senior executive of the buyer, our hero the entrepreneur, our corporate attorney and myself. In planning for the transition about to take place, the executive stated to the entrepreneur, “You know, we are buying only 49% so that we do not have to roll your losses into our income statement; but we do expect to make the decisions as if a majority owner.” Our entrepreneur, engorged with the year’s effortless value increases, turned to the executive without a pause, and said something to the effect of “Hell no! We can make this company worth a billion without you!” And so, a mere month before the crash of the Internet bubble, the buyer withdrew the offer. And, even if some of us were more than unhappy, we went back to the work of building the company value. And a month later the bubble burst.
It took almost four years to sell the company for over $60 million, not at all a bad outcome for us founders and the early shareholders. And I do need to note that the entrepreneur in the meantime became a model executive of a growing company, much more mature and understanding of market forces than that fateful day in February, 2000.
Could I have found a better example of “Timing is everything”? The lesson: Look for cycles in your business and in the marketplace. There are natural high points in one or both that may not be obvious until looking back. But they occur often enough to watch for and take advantage of if ready to make the run for a liquidity event.
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This is an exercise I perform with my boards no less than once every several years in planning exercises attended by the board and senior management, sometimes augmented with an industry consultant or expert from the outside.
Use a white board visible to the entire group. Draw and label four columns and ten rows. The columns: “Name of candidate acquirer”, “what they want”, “what we want” and “likelihood”. Then in a brainstorming session, fill in the ten rows with the names of ten potential purchasers of the business, looking deeply for strategic and emotional candidates (see insight 91). Next, return to the list on the board and have the group do its best to divine what it is about your company that would most attract the buyer if it had perfect knowledge of your business and its resources. This could be your intellectual property, your geographic reach, your superior product, your management team, or perhaps your dominant position. Next, have the group focus upon column three, ignoring the obvious gain our company would make in liquidity to shareholders. List what the company would most gain in new resources from this acquirer. Would it be more cash for expansion, new intellectual property, better distribution, completion of drug trials, or more? And finally, have the group put a number in column four, estimating the likelihood of such a sale ever being consummated, with “10” the absolute highest and “1” unlikely to occur.
[Email readers continue here...] The magic of this exercise is not only in the organization of group focus upon the liquidity event and possible buyers. It is in revisiting column two of the chart. You will quickly note that at least four of the ten candidates, if each had perfect knowledge of your company and its resources, would want the very same thing from an acquisition. Whatever that is, it shines as the true core competency of your corporation, whether previously expressed or even recognized by management. It is in this area where I would redirect resources such as manpower and money, to build value more effectively and quickly than in any other area of the enterprise.
Occasionally, the insight gained from this exercise comes as a complete surprise to the board and management. And that is most rewarding to see.
This is one of my favorite insights, since I lived this one in a positive exit from my computer business. Most people will tell you that there are two kinds of eventual buyers for your business: financial and strategic. A financial buyer will analyze your numbers, past and forecast, to the n’th degree, and calculate the price based upon the result, after carefully comparing your numbers with those of others in the same and similar industries. The object of a financial purchase is to negotiate a bargain, capable of payoff through operating profits or growth over time, or even of immediate profit from arbitrage – knowing of a purchaser that is willing to pay more for your company if repackaged, or even with no changes at all.
A strategic purchaser is one that understands what your company has to offer in its marketplace, and how your company will add extra value to the purchaser’s company. Strategic buyers look for managerial talent, intellectual property, geographic expansion, an extension into adjacent markets and more that will be achieved with the acquisition of your company. Such a purchaser usually is willing to pay more to secure this new leverage, understanding that the value of the acquisition is more than the mere financial value of your enterprise. Most investment bankers will coach you into helping them find you a strategic buyer, knowing that such sales are quicker, often less focused upon the small warts of a business, and yield higher prices than financial sales.
[Email readers, continue here...] There is a third class of buyer I discovered first hand when selling my company – the emotional buyer. This rare buyer needs your company. He must have you or one of your competitors, and now. The buyer may be a public company attempting to defend decreasing market share and being overly punished by Wall Street. You may represent the only obvious way to protect against obsolescence from a buyer’s declining marketplace, or failure to compete against others with better, newer technologies. You may be a most successful direct competitor, one that the buyer’s sales people have observed jealously and nervously, sometimes even jumping over to your company as a result. No matter what the emotional focus, the buyer cannot continue to stand by and watch its business challenged so effectively. The price negotiated is not at all the critical factor in the emotional sale. It is the elimination of pain that drives the buyer to action.
I experienced just this phenomenon and profited by the added value in the transaction provided by an emotional public company buyer for my business. The potential buyer was a hardware company, well aware that margins were decreasing and that software companies, once considered mere vehicles to help sell hardware, were now becoming the central component in a sale, mostly because hardware was fast becoming a commodity as prices dropped. My buyer-candidate had previously licensed our firm as a distributor, a value-added reseller for its hardware. As we grew to capture 16% of the world market in our niche, we successfully migrated from the single platform of the buyer-candidate onto hardware from any of its competitors from IBM to NCR to HP and others. At the same time, the buyer-candidate realized that we had become its largest reseller. In one of many meetings with the buyer’s CEO, I “accidentally” dropped the truthful fact that his hardware now accounted for only about a third of our hardware revenues, down from 100% several years earlier. It did not take but moments for him to realize that his largest reseller was giving his company only a third of its business, that his revenues were declining and ours increasing dramatically. Simple in-the-head math shocked him into the realization that, if he could increase our use of his equipment in more sales, that he could slow or stop the decline in his revenues and he could migrate into a more software-centric company, much more highly valued by Wall Street, which was punishing his company for its decline and coming obsolescence.
The resulting negotiation was rather quick and very lucrative for our side. It was the first time I had witnessed an emotional buyer, and appreciated the difference between “strategic” and “emotional” immediately. Ever since, I have been urging my subsequent company CEO’s and boards to perform an exercise at regular intervals to seek out and identify future strategic and emotional buyers. We’ll describe that exercise in the next insight.