Your Business Plan; Are You Making a Living or a Killing?

“Go ahead. Make my day.” Harry Callahan (Dirty Harry) – from the movie Sudden Impact

I get the opportunity to see a good number of business plans / pitch decks each week and I focus on the section of the plan I believe is most critical. While some may believe it is the management team or barriers to entry; to me it is the financial projections. So at this point, you have to be saying, “Of course; he is a CPA. What is so surprising about that?” The truth is, there is no other place in a pitch where one can get a better picture of the “directional indicators” of a plan. Please allow me to explain.

Years ago, a colleague of mind was tired of working the long hours at our firm and wanted to become his own boss. He bought a Basking Robbins franchise. He accomplished his objective; he still worked long hours but now he was working for himself. However, at the end of the day, all he did was replace salary with small business income; from a financial perspective he was still just making a living.

If you are doing a pitch before investors, remember they are focused on high rates of return; getting their money back in multiples of what they invest. They are looking at what we euphemistically call “making a killing” and they are looking for you to “make their day” by showing them how. So where does the projection fit in to all of this?

First, what is the size of the opportunity in your eyes? If your projections show that in five years, your revenues will be $5 – 10 million, you cannot make enough money to attract most investors. Please do not get me wrong; growing a business to this size is a real accomplishment and can be financially rewarding. It is just not a killing.

Next, does the financial model follow the plan? If the plan is a SaaS model with monthly subscription payments, revenue is simple; multiply the expected users by the planned fee and that should be revenue. So now I can see how many users you expect to have (market share) as well as the monthly payment (market price). I can also look at how you plan to get to that level of users.

Finally, are the projections logical? If your margin or operating costs are substantially different from competitors, do you explain why or are you just plugging numbers to provide a financial result some online advice indicated was what investors want to see? It is a simple logic test that many fail on a daily basis.

Shakespeare said, “The eyes are the window to your soul,” and I think your financial projections serve the same purpose as it relates to your plan. So after you get done “crunching the numbers” please step back to see what they really say. There is nothing wrong with creating a nice profitable business model that might allow you to make a very good living for a long period of time. I have had hundreds of successful clients who have followed that path. Just keep in mind how this approach has to “step up” if you are looking for that investor who wants you to make their day.

Ownership Style Options for Key Employees

“I don’t like your cuffs, I don’t like your cuffs, I don’t like your cuffs . . . .” Line by Béarnaise from Mel Brook’s History of the World Part I.

When I begin a conversation on ownership type incentives with owners of early stage companies (and mature ones as well), my typical approach is to discuss the pros and cons of various instruments or techniques. I discuss stock options, restricted stock, phantom plans, profits interest (if an LLC), stock appreciation rights, ESOP’s and the list goes on and on. Inevitably, many instruments are met with disdain much like Béarnaise assessment of Count de Monet’s wardrobe in this famous scene. I must admit in most cases I “feel their pain.”

There always appear to be two challenging issues; the first is offering liquidity and the second is taxes. So let me add a little color to each. First, it appears few entrepreneurs are willing to write a check to buy out a partner / employee / shareholder when they need that cash to grow their business. For a sizable amount, bank financing is not a viable option and introducing a private equity player or sponsor is another kettle of fish. Second, spending an inordinate amount of time structuring the best tax position is not always worth it as it is usually the buyer of the company who will determine tax structure. Simple point; we advise that if you are dealing with a Company transaction, you buy assets and sell stock. Since you can’t have it both ways, if a good deal may not be a great tax deal, you will probably still take it. So what to do?

I have used a technique I call an Equity Bonus Plan for a number of years. It has a handful of simple components:

  • It only “kicks in” at the time of sale or IPO: in other words, a liquidity event;
  • You determine in advance a “pool” you will set aside upon achieving certain levels of net proceeds to the owners. Doing it early avoids emotional quagmires;
  • You allocate the pool to employees you choose. Some choose to select key people who will drive the business; others use the “chicken in every pot” method and set aside something for all;
  • Employees vest and have to be employed at the time the transaction is executed; there are also some protective provisions;
  • You can communicate what each person gets based upon certain proceeds without revealing financial results.

This plan has now been popularized (I might say plagiarized but imitation is the sincerest form of flattery) by Chobani who announced earlier this year they were adopting a similar plan. (I sound like Al Gore saying he invented the internet.) Though details are a bit sketchy, it appears it will follow a similar path. The liquidity issue becomes a moot point and while proceeds are taxed using ordinary rates, tax payments coincide with the receipt of cash.

It’s Time to be a Shareholder Not a CEO

Max Bialystock: “So you’re an accountant, eh?”

Leo Bloom: “Yes sir.”

Max Bialystock: “Then account for yourself! Do you believe in God? Do you believe in gold? Why are you looking up old lady’s dresses? Bit of a pervert, eh?”

Dialogue from the Mel Brooks classic “The Producers.”

A few years ago, I was working with a long-time client who followed a very democratic process when dealing with his senior management group who also had ownership through an ESOP. There were 5 key management members but the CEO would really not make a move unless he had unanimous agreement. The company had grown nicely in 20+ years but had started to plateau. The CEO approached me about getting an outside board member. He knew things had to change, but he was not sure what to do and felt some independent insight might be a solution.

A couple of years earlier, the CEO of one of my clients had sold (I can do a whole blog on that story), and he was looking for a board seat. While both CEO’s were highly technical (PhDs from top schools), the one who sold was more aggressive and I was reluctant to introduce him into this very democratic environment. After warning both sides, I arranged a dinner. The client who sold asked for some basic data and was very prepared. After exchanging some small talk, the potential board member began interrogating my current client. His basic line of questioning was simple; why was the democratic CEO not acting like a shareholder and avoiding decisions that could increase shareholder value? Did he not realize his fiduciary responsibility? The above noted dialogue came to mind and there wasn’t enough room under the table for me to hide; and after dinner, I felt I had to apologize to my current client for my experiment. To my surprise, he looked at me and said, “Your guy is right; we have to change our point of view.” Long story short; my former client ended up joining the company and becoming a change agent, including helping them with a successful IPO.

I tell that story because I recently met with a good friend of mine who is a middle market investment banker. In many ways, we see the same issue with the need to change the mindset of many of our owners so they can take the steps to maximize the value of their company, especially if they are thinking of an exit. The most successful solution is to build a strong management team who can take over. We both agreed that while our roles were different, getting CEOs to think like shareholders was a key part of what we had to do to help owners. This is especially true if the CEO is perceived as being one and the same as the company. Getting this point across is particularly hard when CEOs point to others who have tried it and failed. Steve Jobs and Apple come to mind.

So as in all things entrepreneurial, it is not easy. You have to stay involved sufficiently to help ensure your vision is executed but not so involved that you are seen as the only one who can run the show. As another good client of mine always said, “Says easy; does hard.” So all I ask is when you go into the office tomorrow, ask yourself if you are acting more like a CEO than a shareholder. Realizing there has to be a change is the first step on the road to your goal. This client (and others I had) did and had great success. With the right mindset, you can do the same.

Why and How Entrepreneurs Should Network – Part II

“Grandpa, walk like you have someplace to go.”

This admonishment from my 5 year old granddaughter (courtesy of my son I am sure) is my reminder that we have to do things with a purpose. And networking is not some random act that results in us meeting a valuable contact; it is a “process.” In Part I of this blog, I provided some background on networking and why I thought it was so important for entrepreneurs. In this second part, I will hopefully provide some helpful techniques.

First, find the right place to go. While it is great to bump into someone at a social event who may allow you to “advance your cause,” I prefer to increase my odds by frequenting events that increase my chances of meeting the right people. We do business with early stage tech companies, so MeetUps, hackathons, FinTech and similar events are popular places for us to be. For more established owners, we frequent business groups, bank and other service providers’ events and small networking groups. With some research and purpose, you can increase your odds by being in the right place.

Next, as the Boy Scouts say, be prepared. In advance of going to a session, see if you can secure an attendance list and set an objective of meeting one or two key people on that list. If there is nobody on the list you want to meet but you are new to the process, go anyway. If the group is right, you will come to appreciate the practice. You should also be prepared for your “pitch.” If someone asks (and they will) why you are there or better yet, what can they do for you, have your short elevator pitch ready.

Third, learn how to break the ice. A simple “Hello, my name is…” works remarkably well. Weather, sports and family are also good topics but they should be of real interest to you. Today, most people are familiar with networking so they are prepared to respond. Ironically, while you might be there with a specific goal in mind, you should begin by asking why they are there and what you can do to help them. If you are genuine (this is the golden rule) the path to your goal may be longer but will be rewarding. I am fortunate to have relationships with a good number of contacts, so for most events, I leave with the task of connecting someone I just met with a contact. But that is fine; I do not mind that someone might remember me as the “person who helped them to connect.”

Finally, follow up. Make sure you under promise and over deliver. If you said you will try to get your new contact a meeting, call and arrange it and close the loop, even if you are not successful. My rule of thumb has always been to not attend a networking event if I don’t have some time set aside for follow up.

So in summary, networking is not just for sales people or professionals; it is a way of life today. Do it with purpose, stay genuine and use hints like the above and you will be surprised as to what can happen.

Why and How Entrepreneurs Should Network – Part I

“You can observe a lot by watching” – Yogi Berra

When I was gathering my thoughts for this blog, I happened to mention it to a good contact of mine at one of the accelerators who proceeded to hit me with a handful of very salient points that I had not even considered. So after reflecting, I decided to make this blog a “two parter” – this first part will provide some background on the process and make the simple case for why I think entrepreneurs should learn to network. Part two will provide some simple guidelines.

In my mind, there are two aspects to networking – the first (and more difficult) is assembling a list of meaningful relationship contacts. The second is to stay in contact and cultivate those relationships – aptly called “working the Rolodex.” My focus in these two blogs will be the first.

In the days of quill pens (and no social media) some of us thought that getting out and meeting people might be a good way to expand our businesses. When I first started to do what today is called networking, there was no process. So as Yogi said, I observed a lot by watching; I saw what worked and what did not. At first, I believed this was a skill you were born with like natural athletic ability because for some, striking up a meaningful conversation seemed so natural and for others it seemed awkward and painful. But observe I did, and I learned from others’ mistakes and successes. At one point, I thought I had found “the process” that I could use but soon realized that one size does not fit all. I came to the conclusion that while there were a few techniques (that sounds so clinical) that seemed to work, a few helpful reminders were the best I could do and I would have to play the rest by ear.

Today, I attend a good number of networking events from MeetUps, to accelerator events to general business venues where entrepreneurs of all types can be found. As you might imagine, since networking is a key part of earning my livelihood, this process has a real meaning for me. In fact, you might say I have become somewhat of a student of the process – and I am a student because I continue to learn. Each event has positives and negatives and some just end up being an enjoyable night out. All are learning experiences.

So let me just say why I think networking is so important. Simply stated, all the planning and positioning and methodologies we employ to either get a job, find financing or locate that key partner seem to get trumped by the old “I know a guy” phenomenon. Those seeking investment know this best – the universal advice for getting your deck before an investor group is to have a “warm introduction” to that group, also known as a network contact. So the second part of this blog will focus on how you light the fire. And make no doubt about it, your contacts are the fuel.

Congratulations; You Got Funded – Now What?

“The future ain’t what it used to be.”  famous quote by Yogi Berra

The closing of an early round of funding is certainly a milestone event in the evolution of any company, but after experiencing temporary euphoria, reality soon sets in. The extra capital, (while fending off the Ramen noodle diet) brings an added dynamic to your organization; you are now obligated to devote some of your time to communicating with and listening to investors. I don’t mean to simplify the paradigm, but here are three “musts” in that relationship:

Manage Investor Expectations

On your journey to getting funded, there was a great deal of information you shared with potential investors who are now your shareholders. Hopefully the financial projections, the milestones you planned to achieve and the “current state” of your company were honest and realistic, as they were a significant part of what set the expectations of your new partners.

For many entrepreneurs, it is a rude awakening that now, for the first time, there are other individuals to whom they have to report. Since most investors are passive, the only real information they will get is what you decide to share with them. In the early going, there is a real need for increased communication between you and your investors. Without a steady flow of data, an ugly “expectation” gap can form between how a company is performing and how investors think it is performing.

So start by outlining a basic communication plan showing how you will work together. You should be proactive in making sure they clearly understand the company’s current state and the critical issues you are facing. Relevant information allows you to paint a realistic picture and helps to manage your investors’ expectations.

Generate Timely Reports

Whereas in the past you may have not generated detailed monthly financial statements, investors in the early stages of a relationship will likely expect timely financial data from you. Thus, a new initiative should be to establish a more rigorous reporting of monthly financial and operating results; say 10 to15 days after the end of the month.

Also, many early stage companies are at the beginning of the revenue cycle, meaning their level of revenue most likely does not cover operating costs. A company’s “burn rate” has to be closely monitored and reported so investors understand the status of their investment, which is often meant to take a company through its developmental stage. Keeping track of the burn rate versus the cash available allows you and your investors to understand if and when a follow-on round of financing will be required.

Track Progress Relative to Milestones

Often, the most important information is how your organization is operating relative to milestones. Many owners tend to focus on financial parameters, while investors typically look for some measure of organizational progress. While financial success is usually a part of every investor’s expectations, other measures may be equally important and should be included in your periodic reporting.

If the expectation when you received funding was that your company would build out a management team, it is critical to communicate progress in this area. The status of candidates, progress toward expanding the team, and even upcoming interviews should all be communicated to the investors. If another milestone is to improve and quicken the pace of product development, give a clear picture of the current state of your product, a path of steps you hope to accomplish in terms of functionality and usability and your progress toward completion.

So congratulations on getting funded; let us rejoice and be glad. But please follow these simple post funding guidelines and you will have even more success if you need another round. Good luck.

“Time Has Come Today” – Late 1960’s Hit by The Chambers Brothers

I saw a recent article in the NY Times where owners were lamenting their inability to buy out their partners.  As one who has dealt with entrepreneurs for many years, I really empathized with some of these cases.  It was particularly disappointing to hear of Partners who really could not work with each other but neither could afford to buy the other out. Perhaps the worst was the owner who gave substantial ownership to two Partners for some advice and connections in the early going.  Now years later, while their contribution was a distant memory, their ownership remained. To me, this was not really a buyout problem but an unfortunate use of equity.  I have probably blogged on this subject more than any other and it is painful to address it.

So, as your business grows, it is difficult to finance what I call the Big Three; namely increasing working capital needs, acquisitions and shareholder retirement. In fact of the three, financing sources despise the last item. In the first two, the money is hopefully acquiring something of value; not just going out the door to previous owners. In addition, the related accounting is usually just as bad; reducing the book value of the business. Talk about a double whammy.

Many (as this article did) suggest bringing in private equity and I have been involved in dozens of these transactions. It certainly is an alternative but it is naïve to think it does not come at an economic and times emotional cost. In many cases, dealing with your “new” partner is a lot different from dealing with the partner you are buying out. Please do not think of this in any way as an easy alternative. So what to do?

The best place to start is at the beginning with the old adage “don’t get into a deal unless you know how you are going to get out.”  Think of the exit before you sign the deal and along with it succession.  What happens under various scenarios?  Start with the worst first; what happens if a partner dies; do you want to be in business with that partner’s heirs?  Life insurance and non – voting stock are options that can be used to ameliorate this risk.

What about disability and who covers what that partner does?  Again insurances and appropriate provisions can protect the company going forward.  Pure liquidity for a partner who leaves remains as the issue.  I am not a fan of providing liquidity and you can finance the buyout with a long term note (I have seen 10 -15 years) but there always has to be the provision that note payments cannot kill” the goose that laid the golden egg.” Selling basically becomes the other option and we are seeing that option in more agreements if terms of a purchase cannot be worked out.  Price is also an issue and you can define it all you like; the only thing that works on basically all fronts is fair value.

So, this NY Times article would have had a much different tone had the owners considered their liquidity alternatives at formation. For the rest of you, the time has come today to address this before it is too late.