Decoding and learning from a business failure

Have you experienced a business failure? Are you currently at risk due to events you cannot control?

Not all companies are successful. Your end game could be a failure of the business.  In fact, many angel investors or venture capitalists look for and respect the lessons learned by entrepreneurs that have survived a failed business.  The key question is: Why did an entrepreneur fail? And then: What lessons were learned from that failure?

You will have “seen the movie before”

One VC I know calls this entrepreneur someone who “has seen the movie before” and even if it was the investor’s money lost as well, he spends time questioning the entrepreneur on lessons learned, often praising the person for having figured out the issues leading to the failure.  Investors learn too, and often invest in a failed entrepreneur a second time if believing that those lessons have been well learned,

Success can teach lessons too

Yes, it works both ways.  A successful entrepreneur who has seen the movie before is even more valued.  But in these days of fast failures, of COVID-based markets drying up, and with the knowledge that 50% of all startups fail anyway within a few years of formation, there is a lot of learning to be had out there.

What questions should you ask?

[Email readers, continue here…]   Questions you should ask include: “What were the major factors contributing to the failure?” “How quickly did you and your team change the plan when faced with the first signs?” “Did you miss the chance to pivot based upon rapid market changes?” “Did you seek outside guidance?” “Was this a failed idea from the start?”

Blaming failure on undercapitalization or…

Most failed entrepreneurs blame undercapitalization for the cause of the failed business. Investors do not like to hear this excuse, even if true. Any business can use more money.  It is up to management to scale development, marketing and production based upon resources available.  Including cash.

The economic environment changing downward

Add the economic environment to the mix of reasons for failure, including jolts such as the Great Recession of 2007-8 or COVID’s devastation to travel, retail and other personal experience-based businesses.  Sometimes a failure is out of a business leader’s control, such as mandated stay-home orders from city, county or state authorities during the COVID crisis.

But sometimes, a failure comes from the investor side

Occasionally the investor does not fulfill those promises, even if in documents optimistically created at the start. This risk is especially dire when relying upon individual investors experiencing their own problems during a recession.  There are lessons to be learned about reliance upon outside investors, including your too-early use of investment funds, or your irregular communication with investors until needing money, all to be gleaned from such experiences.

Failure as an opportunity?

So, consider a failure as an opportunity. Some entrepreneurs will flee to safety and seek a stable job in the wake of a failure. Others, often serial entrepreneurs, will carefully think out the experience and vow not to repeat it, creating an intellectual advantage over others making their run in the establishment of a new venture.

How about you?

Have you experienced a business failure, or are feeling like your boat is being controlled by the tide no mater what you do or did?  If this is a current risk, can you pivot?  If in your past, can you analyze and learn to explain the reasons for the failure?

What about next time?  Now, that’s a question for anyone experiencing or having experienced a negative outcome.  We are mostly a bunch of optimists.  Let’s rely upon that to drive us all forward, no matter what the course to be navigated.

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Posted in Hedging against downturns, Protecting the business | Leave a comment

What’s your personal-business end game?

Remembering our original vision

When we start a business, we are optimistic that we will succeed and dream of riches to follow when the company is sold or even getting all the way to an IPO.   Some of us build our businesses to be lifestyle creations, destined to provide for our families but not necessarily as creators of great equity upon an eventual sale.  But most of us dream of selling the business someday for lots of money and building our wealth upon that event.

Envision your end game when you start

So, it is important to envision that end game even at the outset, especially when planning to take in money from others as investors, all of whom will seek a payoff someday in a sale or IPO.

An important exercise with your board and advisors

  An effective way to do this is to make a list of up to ten possible future buyers of the business, and to spend time defining what those buyers would want when purchasing your business.  Would it be your intellectual property?  Your skilled employees?  Your brand and market recognition? Your distribution channel relationships?  Whatever you envision that value to be, you should work to build that portion of your business by paying special attention to it as you work to build the operation.

[Email readers, continue here…] 

Focus your decisions and resources to build value

Step by step as you make decisions to allocate your scarce human and financial resources, you should remember where the ultimate value should be at the end game.  It will help you to explain the value of your business to potential investors and certainly help focus your efforts as you advance toward that goal of a liquidity event in your future.

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Posted in General, The liquidity event and beyond | 1 Comment

What would happen to the business if you die, leave or are disabled?

Yes, we’re invincible when young

When we are young and early in our business lives, we feel infallible to the degree that we do not think of what might happen if we die while in office or decide to leave the company for any reason.  Such thoughts just do not occur to most of us until the business is substantially far enough along in its growth to have multiple layers of management and enough employees and stakeholders that there is a board of directors and calls for key man insurance and succession planning.

Three stories where young CEO’s I knew died in office

I personally observed relatively young CEOs die while in their prime and while in office. Three times.

One had a heart attack while exercising at home.

Another died of an infection immediately upon returning from his honeymoon.

And a third died on the operating table during a heart operation.

Looking for the succession plan.

[Email readers, continue here…]  In each case, from five to hundreds of employees depended upon the continuation of the business and looked to the board of directors for immediate assurance that a plan was in place. And in these three cases, there was none.

The board of directors acts quickly and sometimes effectively

However, in each case there was a board of directors, and each board moved to protect the corporation quickly as people absorbed the shock of loss.  The outcomes were quite different with one board fending off immediate threats of lawsuit by creditors, another coaching a key employee into the CEO job, and the third electing a board member with experience to step in as CEO.

Not an easy conversation- succession planning

This is one sticky conversation for most young executives.  Have you thought of who might succeed you if you are incapacitated or worse?  Have you documented your position so a successor would know not only what you do but enough of how it is done to perform necessary functions early on?  It is rare when either is in place, yet experience has proved that none of us is infallible and planning for succession is a protection for those left behind.

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Posted in Depending upon others, Protecting the business | 1 Comment

Selling your company for less than expected?

How about outside investors?

Sometimes the end game or sale of the company is not a happy event.  Especially when outside investors, venture capitalists, or angels, have put in substantial money and the sales price is less than the value of their investment.  Most all experienced VC and angel investors have found themselves in such a situation, since it is the unfortunate truth that half of their investments fail, on average, within the first several years of the investment.

Dig into investment agreements for those expensive clauses

There are some questions a distressed sale brings to mind.  Does the board declare dividends upon the preferred stock invested in order to increase the amount paid out to the preferred – at the expense of the common – shareholders, which usually includes the founder(s)?  Is there a liquidation preference in place where the preferred investors can take a multiple of their investment, (twice or three times the amount) from a sale before the common shares receive anything?  Is there a participation clause in the investment agreement where, even after the preferred shareholders take their share, their stock also converts into common stock and participates (again) alongside the common shareholders?

Conflicts of interest with preferred investors

I have been on a number of boards where just these decisions are faced, often with the corporate attorney in the room as protection, with the specter of conflict of interest looming over the discussion, as board members who are preferred investors decide how to divide the proceeds of a marginal sale of the company or its assets.

[Email readers, continue here…]   A recent decision by the Delaware Court in favor of the common shareholders in marginal sales sheds light upon this dilemma for boards – at least for boards of Delaware corporations, no matter where they reside.

Can you protect the common shareholders?

The Trados Decision (Delaware Court of Chancery) protects the common and early stage investors even if the late stage investors can claim all from a sale with their liquidation preferences.  Directors can be held liable under certain circumstances for favoring the interests of preferred shareholders over common stockholders.   This raises the bar for venture capitalists in a marginal sale of a business.  It brings forward the question of conflicts of interest between VC investor board members and the shareholders they are legally bound to protect.

Investor notes vs. stock late in the game

And yet, VCs sometimes bravely put in more money near the end of the life of a company to bridge the company to a sale of assets in an attempt to recover some or all of the original investment.  This late money is at much higher risk to the VCs than even the early stage investments that were optimistically made by angels or friends and family.  Most of the time, this late money is advanced in the form of a loan, and all loans are paid out of funds before any investors receive their first dollar of return.  When this is the situation and the proceeds of a sale are too small to cover even the loan, there is no conflict between shareholders and note holders or VCs.

As the amounts recovered from the marginal sale increase, the conflict of interest problem becomes more acute.

A Delaware court decision may protect you

Guided by the Trados Decision, preferred investors should think twice before exercising the full amount of their documented preferences in a marginal sale, volunteering to leave some of the proceeds for common shareholders, perhaps in a negotiated agreement once the amounts are known and absolute.  This is rare today, but with the court decision in place, may become more of an issue in the future.

There is a time for all investors and founders to celebrate

Of course, once the amounts from a sale or IPO exceed all the preferences by a substantial amount, everyone is happier since the preferred shareholders must either take their multiple of investment or convert to common, losing their preferred preferences, and participate ratably (or equally) with all the common shareholders.  These are events to celebrate, since it certainly was the intent of all parties at the point of original investment to witness the day when just such a split of the proceeds would occur.

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Posted in The liquidity event and beyond | 1 Comment

An economics lesson for growing companies

Catching up from past insights

Growing companies usually require more working capital during their periods of rapid growth.  In past insights we have calculated the amount of additional capital needed for a business as it grows, and the additional capital required is often surprisingly large.  In this insight, we need to speak of the sources of working capital and the implications to the future financial health of the choices made when selecting one financial resource.

Surprise! It may not be equity

Venture or angel-financed companies with plenty of working capital sometimes are immune to this working capital need for some time into their growth, but at some point, it will become clear that the cheapest form of finance is not equity in a growing enterprise.  If the equity value of a company is growing at the same rate as the company, say 40% per year, almost any form of debt financing may be preferable as a way of preventing further dilution from issuing additional equity.

The banks need to be convinced

The problem is that few small, growing companies seem to be attractive to most banks for traditional unsecured or asset-backed loans.  The exception is for those venture-backed companies with a significant cash balance remaining in the bank, which ironically make the most attractive customers for banks to offer loans.

Ironically, the term is “compensating balances”

[Email readers, continue here…   ]   The banks want to maintain their venture relationships and of course, want to use the existing company cash in their bank as collateral for – you guessed it – their loans to the company.  The term of art is “compensating balances,” and certainly using existing cash to leverage new loans makes the company more liquid, but at a price, as the compensating balances cannot be touched and are essentially frozen for the duration of the bank loan.

How about asset-based lenders?

There are asset-based lenders of every size willing to take more risk and finance the growth of young companies without requiring compensating balances.  Using the company’s receivables and inventories as collateral, such lenders often also ask for a uniform commercial code (UCC) filing, perfecting their first interest in all of the remaining assets of the company – including intellectual property, the latter often being by far the most valuable asset the company has to protect.

Read the loan covenants carefully

Loan covenants are always required that clearly state how much net equity, the minimum current ratio, and other minimum financial requirements must be maintained to be compliant and state the penalties for non-compliance – which are always severe, often threatening to call or cancel the loan in its entirety.

Know how to calculate qualifying collateral

One of the important items in a calculation of amounts available to be borrowed is the amount of qualifying collateral, defined usually as the amount of net accounts receivable less than 60 days old, after deducting government billing – and all receivables from companies with some balances over 60 days.  To this net number, the lender will then apply a percentage, from 50% to 80% as the amount available for borrowing under the agreement.

Other lender tricks adding to the true cost

It is important to calculate the true cost of such money.  It is typical to charge an interest rate that is higher than a normal bank loan for asset-based loans.  Also tacked on is a “float period,” typically two to five days, amounting to additional interest as if the money paid back is still outstanding for that time as compensation for the time to clear checks paid into the lender either by your customers directly (lock box method) or by you.  A five-day float increases the actual interest rate by up to an additional 2% over the stated rate. Then there is the loan audit fee, often more than $4,000 a year, to pay for the lender’s auditor to make sure the collateral and company are compliant with the covenants of the loan.

Even more add-on charges

Lenders sometime add a charge for loan oversight, called a consulting fee, and very often make warrants (a promise to later sell the lender stock at a fixed price) a part of the deal.  When calculating the true cost of a working capital loan, after adding all these elements and estimating the value of the warrants in dilution to the shareholders, you may be shocked at the number when expressed as an annual percentage rate.

Back to loans costing less than dilution of equity

And yet, such a loan does rise and fall with need.  And it is often cheaper than the cost in dilution of issuing additional stock to obtain working capital.  These decisions require knowledge by management, help from accountants and or attorneys, and an understanding at the start of such a relationship that borrowing from asset-based lenders is like entering a marriage where the other partner has all the power to ensure success in the event that anything goes wrong with the original plans.

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Posted in Depending upon others, Growth!, Protecting the business, Raising money | 1 Comment

How to make the most useful dashboard

The need for real time information

From sports car to aircraft to super tanker, successful operation depends upon the pilot’s understanding and urgent timely use of a dashboard.  Real time information is critical to real time decision-making, and increasingly in the modern business world, decisions are made by management without extended meetings or discussion with others.

Managers need real time information

And with the rise of modern technology-driven businesses, the same is true of management in the business world.  A good dashboard of relevant real time information is now available for most any business, often created by computer software from data derived from monitoring real time tasks within the business.

Consider these critical pieces of information

You should consider creating such a dashboard or reviewing the one you use if already driving with one at hand.  I’ve developed four criteria for use in creating and evaluating your dashboard.  When constructing yours, you should consider the following:

  1. Controllable outcomes: There is no use for information for which there is no ability to control changes as a result of analysis.  Ensure that you include only information for which you have a way to alter future outcomes in a positive direction.  An example would be a real time display of the value of the dollar against the yen.  If your business has no trade with Japan that could be affected by arbitrage, early shipments or other tactics that take advantage of the moving value of these currencies, that statistic is irrelevant to the dashboard – even if interesting to you.
  2. Earliest warning metrics:  [Email readers, continue here…]     What good is information if you can’t act upon it in a timely manner?  Find metrics that will be “leading indicators” of trouble to come.  Think of labor efficiency (future product or service delivery impairment) or warehouse inventory (sales slowdown, supply chain management problems) as examples.
  3. Items in the critical path (bottlenecks): This is one of my focus issues for my workshops, it is so important. One of your chief duties is to remove bottlenecks in the delivery process for your product or service, enabling all resources before and after the bottleneck to achieve maximum efficiency.  If a critical path machine or employee is slow or down, your own email box overflowing with questions from subordinates needing answers, or any other measure of critical path impairment in need of fixing, you should know about it at the earliest possible moment.  Add a measure of each that you identify with to your dashboard.
  4. Items impacting cash (now or later): Cash is the oil of your business.  Slowing of production, deliveries, raw materials, receivables collections, billing for work completed – all are going to influence cash flow soon and should be tracked when out of expected range.

Some simple indicators you can track

Simple indicators that affect multiple areas above include increasing backlog, call center delay time denigration, increases in finished goods inventory amounts, unbalanced work in process inventory buildups, and reduced efficiencies in billed time for consultants or experts.

And how about projecting cashflow?

How about projecting cash on your dashboard:  cash on hand plus expected accounts receivable collections subtracting necessary accounts payable payments and payroll.  You will find many more candidates for your personal dashboard.  Try to limit yours to five or fewer critical measures that can be updated no less often than daily if not in real time.

You will be steps ahead of most of your competitors and in a much better place to succeed if you create and maintain an effective dashboard.

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Posted in General, Growth!, The fight for quality | Leave a comment

Crowdsourcing, collaboration, support groups. Oh my.

At the MIT Center of Collective Intelligence, professors and graduate students are wrestling with an important opportunity – and gaining ground.  With new collaborative tools available for use in the cloud, people are no longer isolated in their creative endeavors. Some label this “crowdsourcing,” a term used to describe one form of this new empowerment.

How to use the new tools for collective intelligence

How do you use the new tools for collaboration to enable people and computers to be connected so that collectively they act more intelligently than any individual?  MIT has come a long way in identifying tools and techniques.

Help from your peers

You can do the same.  First, realize that no individual in your organization, including yourself, is as effective alone as with collaborative help from peers.  Then find ways to build concepts, plans, documents, and actions through the collective collaboration of your key group.  Explore and implement one of the many collaborative environments available through cloud computing, products from Microsoft, Google, IBM, and others.

How to test the system

[Email readers, continue here…]  It is easy to test the system. Create a document with your basic plan or idea for action.  Post the document using one of these common tools and invite members of your group to add to or comment upon this beginning effort.  Respond and build upon the result.  You will note that within a short time, you will have created a plan or document usually far better than if you had worked alone.  And the added benefit is that the group will feel ownership in the result, a powerful step toward a successful outcome.

 

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Posted in General, Growth!, Positioning | Leave a comment

How to measure your power in the Internet marketplace.

There are several key performance indicators that help new generation company management see more clearly their progress and corporate health.  The old measures, including return on investment, percentage of profit against revenue or employee count, and more, obviously are still relevant.   But businesses that expose their story to tens of millions of potential customers through the Internet need additional tools.  Some of these are also applicable to non-Internet businesses.

Some of these measures, and how to calculate them.

You will recognize the value of these for any business, even if they have not been in common use in the past.

  • CHURN (% customer cancelling each month)
    • This is calculated by dividing the number of cancellations by the total number of customers before cancellations and multiplying by 100.
  • CMRR  (Contracted Monthly recurring Revenue)
    • A simple statistic which can be derived from a good general ledger using GAAP accounting procedures. Revenues are recorded as earned, not paid, especially when paid in advance.  This number is increasingly used by appraisers and buyers in valuing a business, with some multiple of this number being one measure of the value of the enterprise.
  • [Email readers, continue here…   ]   LPC (Lifetime Profit per Customer)
    • This is the total expected revenue for a customer (usually calculated with a five year life no matter what the type of business) less the cost of acquisition (see below) less the recurring direct costs of serving the customer or of product estimated to be sent to the customer over the lifetime relationship.
  • CACR (Customer Acquisition Cost Ratio)
    • This is a measure of capital efficiency, focusing upon the cost of acquisition of the customer (including direct sales, commission payable, direct marketing and other direct costs) divided by the expected gross revenues over the customer’s estimated lifetime of purchases. The lower the ratio, the more successful the customer acquisition campaign.
  • CPA (Cost per Acquisition)
    • This is simply the sum of the month’s direct costs for sales and marketing divided by the number of new customers acquired, yielding a dollar cost per average new customer. The lower, the better.
  • MBE (Months to breakeven)
    • A better measure of capital efficiency. Total new customers this month times the average expected revenue – divided by total direct sales and marketing cost together with the cost of product or service for those customers for the month. The result will yield the number of months the average account takes to be profitable for the company.  The lower the number, the more efficient the marketing and sales campaign, and the more efficient the use of financial capital in customer acquisition.

Shedding light on your efficiencies

Surely some of these measures would, if used by your organization, shed additional light on the efficiency of the operation and over time the trends related to efficiency.

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Posted in Finding your ideal niche, Positioning | 1 Comment

Traditional marketing vs. social engagement

Woe to those teaching yesterday’s methods

We all know that the world of marketing has turned upside down these past years through the power of the Internet.  College professors teaching marketing must be having a real challenge keeping up with the new channels of communication, the relative values of advertising buys in this new world and explaining how to make the most out of these cheaper and more powerful channels.

The new power model of marketing

Although there is still a place for display advertising in this new world, increasingly small businesses are discovering that creating buzz and engaging their audiences through social media are more powerful and cost effective.

The old “seven impression” model

Marketing texts and college professors say that it takes at least seven impressions – exposures – before a person recognizes and acts upon the message.  That’s an expensive proposition for small companies.  On the other hand, your target audience is already talking to their friends and associates about products and services they like and use.  Plugging into those conversations gives you the power to multiply your message many times over, often at no cost at all.

Using influencers to tap their massive group of followers

[Email readers, continue here…]    How do you engage your customers in a conversation instead of merely broadcasting your message again and again in hope that some one remembers it?  The answer comes in several forms, but centers around your finding the thought leaders within circles of influence, attracting the “influencers” that people follow.  Now companies engage and pay influencers to get your attention and want their products. To do this, your message must resonate in a way that it appears unique.

The way to do this for most of us

If you cannot incorporate social content into your product, surround your product with social content.  Create groups in Facebook, followers on Twitter, a comments section on your blog or website, and more.  Identify a number of influencers, and then offer to let them use your product or service at low or no cost if they will join your informal advisory group on the ‘net.  Ask for endorsements when appropriate.  Just be aware that most influencers today make their living by charging for their “blasts” about your product to their usually gargantuan base.

The golden rule of today’s marketing

Above all, make every outreach an attempt to engage your customers, listening to their responses and responding one-to-one wherever possible.  Make each customer feel important and valued.  In this new world of engagement marketing, the customer has a voice much earlier and much louder than ever before.

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Posted in Finding your ideal niche, Positioning | 2 Comments

Economics 101: If water flows downhill, then why fight it?

You’ll get the importance of this in a moment. Hang in there.

Substitute the word “money” for “water” and we have an explanation for most all the reasons why successful products move from concept through early adopters through mass market.

How money flows through the system

Money flows to the cheapest effective solution to a problem.  Fighting this fact will just extend the misery of accepting a result with as product or marketing failure in the marketplace.  Want examples in the “real world?”

Examples of the proposition

Take for example, adoption of solar panels or electric vehicles in the mass market.   Most of us want to do well for the environment. But most of the time we are willing to do so only if we do well for ourselves when measuring alternative costs.  Solar panel installations break even only after over years of use, even with subsidies offered by the electric companies or by the Federal government. And adoption of solar technology for home and business was relatively slow until solar companies began offering systems as rentals with guaranteed returns.

Solar panels are getting closer to economic savings

[Email readers, continue here…]    As solar panel efficiency increases from the present average of 22% to 30% and more, and as electricity prices rise, the net break even for solar panels should decrease dramatically.  It’s already happening in some sunny areas of the country. When subsidies stop, the economic break even will decrease to a few years as mass acceptance becomes real.  And the reason for the delays, as well as the later successes, will surely be in the money saved, not just in “doing well by doing good.”

Note the exception of states where rooftop solar panels are now required for new construction, a clever way to increase acceptance.

Electric cars as an example

Electric cars become attractive investments when the extra cost can be amortized over a year or two of savings in fuel.  And we are a long way from that. Making this more difficult, the cost of fuel for gas-driven cars is volatile, making the calculation more difficult.

Yes, many people salivate over the latest Tesla; and the sales of the Chevy Volt are surprisingly strong, priced low enough for commuters to calculate that break even is close enough to satisfy the desire to help the environment while enjoying daily savings.

Back to the water flowing downhill example.

Whenever someone asks why a product or service has taken so long to succeed in the marketplace – when so obviously a success with early adopters – why not try using the water flowing downhill analogy?  It provides a proper insight almost every time.

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Posted in General | 4 Comments