My dad said: “Never take on a business partner.”

My dad was a smart businessman, even if not formally trained. He occasionally gave me advice that turned out to be more than wise, looking back at subsequent experience and events.  His personal teaching event was a typical experience, as I reflect now upon the tens of partnerships I have counseled over the years.  Most often, one partner remained active as another partner drifted away from the business, no longer carrying the weight anticipated at start-up.

So, what could happen with a partnership over time?

It’s just one – the most prevalent – of the many things that can happen to well-meaning partners after time changes plans, and after the business passes through phases of growth or contraction.  The assumption at start-up is that all partners will carry their assigned weight for the foreseeable future, as percentages of ownership are divided accordingly.

Rarely is there any formal written agreement memorializing these initial expectations and stating the consequences of non-performance or inability to make capital calls when required.  In fact, rarely are issues discussed involving downside protections, even including key-person insurance benefiting the partnership in case of an unfortunate event.  And how about a buy-sell agreement if one partner wants to sell their interest to a third party unacceptable to the remaining partner(s)? How about non-compete agreements?  Non-disparagement clauses?

It is always wise to have an attorney help memorialize a partnership agreement, even if painful conversations must take place to do so.  Here’s an example of what not to do…

A personal story about a partnership gone bad

[Email readers, continue here…]   I recall one very personal situation when I was young, that reinforces Dad’s advice. Through my college years, I managed a phonograph record production and manufacturing business that I created as a senior in high school, using independent contractors in local venues to record tapes from musicals and performances from schools, colleges, churches and organizations throughout the USA and Canada – and then to sell the records to the appropriate audiences.

Partnerships are strained with growth and troubles

The business grew to significant size during my college years, and I informally associated myself with an equally young partner, of course without any written agreement or discussion of downside throughout those years, ceding to him all recording work throughout the large home territory and other helpful technical work. The agreement was that he would retain all the revenues generated from those activities and that I would finance the company and manage it.  We received lots of press, even nationally, as we managed our teenage business.

Changes of circumstance often ignite pressures

A year after graduation from college, I left for six months to serve my active duty obligation in the US Navy, while others – not the partner – took care of accounting and customer relations.

And shortly after I left for my military service, my partner left the company without notice and set up a competing company in my absence, never saying a word to any of us.  I was bitter, but unable to do anything about it, since there was no written partnership agreement.  Luckily, after my return from active duty, my company flourished, even went public later, and his remained a small, one-person operation for the rest of its existence.  But, as they say, everything he learned, he learned from me.

Dad was right, even if I learned the lesson years later.

Have you a partnership story to tell?  Lessons learned to be never repeated? Or do you have a harmonious relationship to recall, one that could even be ongoing?  My friend, Rich Sudek called partnerships “a marriage without sex” and reminded us that we often spend more time with our partner(s) than with our family.

Facebooktwitterlinkedinyoutubemail
Posted in Depending upon others, Ignition! Starting up, Protecting the business | Leave a comment

Should you include your sweat equity in a business plan?

Investors love it when entrepreneurs draw little or no money from their startups.  It extends the cash available for research and other necessary fixed costs and gives the fragile, young company more “runway” to get to breakeven.

What are you worth to the business?

But when forecasting the ultimate viability of a business, many times an entrepreneurial founder uses a low, unsustainable salary rate for him or herself in order to show early breakeven.  And that is the quandary for investors.  If you had to replace yourself with a professional hired to duplicate your skills, what would you have to pay in salary and incentive today?  That amount is almost always higher, much higher, than the amount budgeted for the entrepreneur.

A “messy” solution

[Email readers, continue here…]   You could start by charging more for your executive salary, then paying out less in cash, accruing the rest into a payable amount due to you in the balance sheet or plan.   But that is a messy way to demonstrate that you are taking less than market wages from your company.  Ultimately, the accrued difference will amount to a large enough liability that several things could happen, all of them negative.

What would the IRS think?

The IRS could see that you are not paying yourself interest on the accrued debt, and consider it invested capital, eliminating your ability to repay yourself in the future. Worse yet, the IRS would then consider the accrued amount to be taxable income upon which no tax was paid, since the accrued labor as an investment has value that was not accounted for from previously taxed earnings.

Another “trick you might use – wrongly

Or you could voluntarily convert the loan into stock with a single journal entry and a stock certificate. But the tax effect would be the same if audited – you would owe tax on the booked value even if not paid in cash.

What is the solution?

The solution is to explain to potential investors that you are projecting under-market wages for yourself or the founder(s) for a period of time, perhaps until breakeven, and then  to agree with them that you will move to market rate at that time.

Facebooktwitterlinkedinyoutubemail
Posted in Ignition! Starting up, Raising money | Leave a comment

What is your biggest error in company planning?

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.

Sources for your data

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?

TAM, SAM, SOM? What is your market size?

You could be fooling yourself with market data.  Are you trying to estimate TAM (total available market?)  That’s likely to be completely unreachable for you with almost any amount of resources. And yet, some plan their futures upon a percentage slice of this, rather than…

SAM (Serviceable available market) which is is closer – the market you might be able to reach in your future and service effectively.  And finally, there is the SOM – serviceable obtainable market, the one most likely to fit your planned resources and capabilities.

My story of creating a number for market size

[Email readers, continue here…]   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.

The “Gloves in China” syndrome

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.

Create an “assumption section” of your plan or spreadsheet

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.

Facebooktwitterlinkedinyoutubemail
Posted in General | Leave a comment

What’s the most important thing in a young business?

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.  (It actually took Amazon fourteen years to reach profitability.)

Cash from investors at the early stage?

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 often focus upon accrual not cash profit

[Email readers, continue here…]   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.

Profit gains without additional working cash?

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.

Change your projections to focus upon cash

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.

Facebooktwitterlinkedinyoutubemail
Posted in Growth!, Ignition! Starting up | 1 Comment

So, do you have that entrepreneurial DNA?

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.

My entrepreneurial start

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.

The first “real” business

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.

Our two important drivers of innovation

[Email readers, continue here…]   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.

Dad’s story of risk avoidance

We tell the story that dad was offered the general store franchise in the brand-new park in Anaheim soon to be built by – you guessed it – 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.

Now, how about you?

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.

Facebooktwitterlinkedinyoutubemail
Posted in Ignition! Starting up | 2 Comments

Entrepreneurs do not easily retire.

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.

And what’s next?

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.

A second act?

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.

Just saying…

Facebooktwitterlinkedinyoutubemail
Posted in General | Leave a comment

Shareholders and founders: The muted thrill of the deal closing.

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 lifestyle and give you that much needed pause in your life you have been looking forward to.

How it happens today

All the documents were signed in a rolling series of emailed scanned or DocuSign 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.

And if you are a major shareholder:

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.

Memories of how it used to be

[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.

And my favorite closing memory…

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 sometimes-smoke-filled rooms were real and the tension palatable, when a closing was a face to face event.

 

Facebooktwitterlinkedinyoutubemail
Posted in General, The liquidity event and beyond | 4 Comments

What use is an investment banker?

Many CEOs have asked me if I felt an investment banker adds value if the buyer has already been identified.

How investment bankers behave

Investment bankers sometimes slow the process by requiring a cloud-based “data room” and  “deal book” to be prepared containing considerable information about a company to help a buyer.  Deal books are expensive to create.  If you have a data room already, all the better.

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.

An unexplained conflict of interest

[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?

How about the corporate attorney guiding a deal?

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?

In my experience, the answer is…

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.

Insulating the CEO and team as negotiations get tough

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.

Your next steps

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.

Facebooktwitterlinkedinyoutubemail
Posted in The liquidity event and beyond | 4 Comments

What’s a “data room” and how do you use it?

First, what’s a “deal book?”

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 a cloud-based 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.

Your data room and its contents

Data 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. 

Who will use it and when?

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.

When to start a data room?

[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.

The payoff

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.

Facebooktwitterlinkedinyoutubemail
Posted in The liquidity event and beyond | 4 Comments

A million things can kill the deal.

So, you’ve found the buyer, received a letter of interest, signed it, and exclusively tied your company up for a period to complete the deal.  Everyone on the board is anxious to close this.  You’ve committed time to do whatever is needed.  You’ve informed your top management of the pending but still secret deal and they know they will be impacted and are a bit skittish.

Worrying over a public announcement?

You wonder if you should make a public announcement to your troops, worrying over loss of focus, people thinking of jumping ship, competitors finding morsels of weakness to exploit.

Welcome to the club.  If you’re seeing this movie for the first time from the top, you need to ask many questions and be led by your outside team, whether legal, financial, accounting, or networking – or all.  The months between the LOI and the closing are as stressful as any you will experience as a CEO, and there are few ways to reduce the stress.

Keep the deal a secret even as the buyer leans in?

[Email readers, continue here…]   First, should you inform your employees of the deal?  You know that the buyer will be crawling the offices with legal and accounting personnel, reviewing contracts, financials, governance documentation, intellectual property, leases, and much more.  How do you explain this if not by making a general announcement?

When to make an internal announcement

Let’s back up to the headline.  “A million things can kill the deal” is a statement from an experienced professional, and worth listening to.  During the due diligence period, before the signing of the definitive documents and establishing the closing date, it is not wise to make a general announcement, and certainly not wise to make a press release.  Public companies are forced to release this information in most cases after the LOI is signed, and this may impact you if being purchased by a public entity.

What can kill the deal after the LOI is signed?

What could happen to kill the deal that looks so good to all now?  For starters, as the due diligence and documentation period drags on, you’ll have to keep your company’s eyes on the ball to continue the increasing revenues and profit momentum.  A bad quarter in the middle of the process will certainly lead to the buyer either withdrawing the offer or more likely reducing the price, sometimes to a point that is unacceptable to you.

How can you derail a deal?

Few companies are squeaky clean.  And in this age of Dodge-Cox and Sarbanes-Oxley regulation, public companies are thrown by any hint of activities that might have seemed all right in the past world of private enterprise, but don’t fit with the regulations on public corporations today.  Paying commissions to undisclosed third parties in order to obtain deals, hiding or entering misleading financial data, associating with anyone with a past SEC suspension, and many more “gotcha” events, qualify as strong deterrents to a good closing.

What about events you can’t control?

Events that you cannot control such as changes in the buyer’s circumstance, a drop in the market price of the buyer’s stock, a bad quarter at the buyer’s shop, all can contribute to abandonment of a good deal.

Both sides have to work to get a deal closed.  Professional advice before and during the process is necessary.  No one can do this alone, especially a CEO who is involved and too close to see many of these issues.

Facebooktwitterlinkedinyoutubemail
Posted in The liquidity event and beyond | 2 Comments