You Have to Be Fiscally Responsible

“Friends don’t do this to friends.” – quote from a new client CEO when told his CFO was “taking” money.

For those of you who follow this blog regularly, you know my background as a long-time audit partner with EY. That experience has allowed me to be a trusted advisor to many business owners of all types and to see first-hand the issues I use as content here. I use few, if any, “geeky technical topics” and I usually leave the ugly side of the business out. But there is a disturbing trend I see with too many of this generation’s entrepreneurs that I feel is worthy of exploring. First, let me provide some background.

There is a popular acronym called KPI (Key Performance Indicators) that many owners today rely on to gauge the health of their business. KPIs may include average sales per day or employee, days of sales in receivables, unique users to a site, etc. Many come into favor as early-stage companies may not have revenue but need some objective data to monitor progress. All understood. But this tool is not so new. As a young manager (yes, before the internet but not quite when people used quill pens), I was always interested in what data owners of established businesses used to manage their company. Interestingly, while some referred to monthly financial statements, most used daily information on shipments, cash collections and weekly payroll. As to the last item, even the most unsophisticated owners always knew their weekly “nut” or payroll. They would leave the full accounting and finance function to the CFO but they always had a handle on KPIs. So why the trip through accounting history?

I notice more and more a bifurcation of tasks and responsibilities by today’s entrepreneurs. Once a financial manager of any type is hired, it seems everything finance related is delegated to that hire. Someone in an owners’ blog somewhere must have said this is the right thing to do; that administrative tasks just bog you down and you should abdicate your fiscal responsibility and only spend time on activities that bring value (product development, team and customer building, etc.) to make your venture a success. Not true.

So, the genesis of this quote. We recently landed a new early-stage client and as part of our process did some simple diagnostics. The CFO was a close friend of the CEO founder with complete charge for finance and a few other functions. Without going into details, the CFO was paying himself unauthorized bonuses. No accounting tricks; they were right there on the payroll register; the CFO just felt he deserved more money. We were astonished to find the founder never reviewed payroll; did not know what his nut was. He was devastated. In addition, the bond company is giving them a hard time about covering the shortfall citing inadequate supervision.

So, a simple lesson for owners of all businesses. It is perfectly fine to leave the core of the finance function to others but always have some minimum KPI type of checks and balances in place as your predecessors did. Take the advice from Chris Anderson as relayed in David Kidder’s “Startup Playbook” – “engage in the whole process.” Because in the end, it is a real challenge to be a success if you are not fiscally responsible.

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.

How to Avoid Fundraising Woes (Hopefully!)

“The hurrier I go; the behinder I get” – quote by Lewis Carroll

I talk to so many startups that struggle with fundraising that at times it is really heartbreaking.  Well-intentioned and motivated entrepreneurs seem to get their dreams crushed by turn-downs and wasted meetings. While I have been advising startups for more years than I care to remember, I promise to find financing.  So, a quick story on that point.
It was a number of years ago and I was working with a company that had pioneered some really groundbreaking voice recognition technology.  They were making the rounds with investors and having a bad time of it. They approached me and I thought it fortunate that I knew an investor who understood this space.  We worked on refining their approach and they had their meeting.  They were told at the end of the meeting that both their team and technology were really top-notch, but the investor already had a voice recognition investment and wanted to diversify.  Once I heard this, I decided I did not have enough time in the day to get inside the mind of all the investors out there and thus, my no promises on funding pledge.
So what are the three things I find are major contributors to fundraising woes:

The first is clearly the lack of a sustainable business model.  Your solution must address a real problem (see my blog “Are You Selling Aspirin or Vitamins?) and be elegant in its simplicity.  Making it too complex to use is a no–no as is the model which will rely on advertising (eyeballs) to generate revenue.  If it takes three slides to describe your model or it requires too many revenue streams, it will not work with many investors who have come to appreciate the fine art of simplicity.  For you older folks, this in my opinion is why Excel endured and VisiCalc did not.

Next, approach the right investors.  For established companies seeking to expand, there are various sources of funds, from cash-flow lines of credit to asset-based loans to private equity and subordinated debt.  Financing 101 says match the financing need with the proper source.  It is the same for emerging growth companies.  Seed money is not venture money – getting a VC to get interested in your pre-revenue startup is an impossible mountain to climb.  Focus your efforts to match your stage of development with your financing source.

Finally, make sure your market is big enough.  I just reviewed a pitch deck for a “commission type” model.  All the market size data was based on gross sales which really exaggerated the market opportunity as certain sales in that space did not involve a commission.  If a CPA like me realizes that point, so will an investor.  Stay relevant and make sure there really is a big enough market.

So, if you want to avoid running around in circles as you undertake your rounds with investors, please keep these ideas in mind.  It may not result in success but at least it may keep you from spinning your wheels.  Good luck.

What Do You Know About Your Financing?

Barf: “I’m a mog: half man, half dog.  I’m my own best friend! “– quote from Mel Brooks Spaceballs :The Movie

I continue to experience some confusion by owners as to the nature of their financing agreements.  When I ask what form of financing they have, I get responses which remind me of this line by Barf.  I realize it can be complex and bankers, lawyers and even accountants seem to revel in throwing around terms like springing liens, clean up period and covenants and I am sure for most owners, this just serves to make their hair hurt. They wonder if their advisors and bankers are talking about some strange animal, their son’s bedroom (which never has a cleanup – period) or the Old Testament.  So, let’s spend a few minutes describing three basic types of financing. By design, I am leaving out equity and more complex instruments like commercial paper, subordinated notes and convertible debt in an attempt to keep the suicide rate down. Let’s stick to basic loans from financing (legitimate) sources.

The first is a cash flow loan sometimes called an unsecured loan. The banker or financing source looks to historical and projected cash flows and determines the amount they will lend, the period of the agreement and how and when they will get paid back. This is true borrowing off the cash flow of the business and usually has the most favorable rate. While personal guarantees are less prevalent now, they come and go based upon the overall economy.  These loans also usually have covenants – financial benchmarks you will need to meet to prove you are still worthy of this type of loan.  This loan is the most common instrument for providing working capital to a profitable business.

Next is a secured loan.  It is modeled similar to a cash flow loan but you may not be as credit worthy so the financial institution will take a security interest in (put a lien on) your assets – principally receivables, inventory and fixed assets. Many of the concepts under cash flow loans apply here and the rate is usually a bit higher.

Finally, there are asset based loans or ABL’s.  This type of loan is for those struggling a bit where the financing source wants to monitor the overall level of debt.  It is also a secured loan as the security interest is present but it is more formulaic – the company prepares a periodic borrowing base certificate containing eligible assets and negotiates a formula – usually a certain percent on receivables and inventory with exclusions for aging, concentration and foreign accounts.  The result is the amount of borrowings the financial institution will allow.  As you can tell, it is a bit more complex but it does force a discipline which keeps your borrowings within a range your assets can support.  This type of financing can be costly as it limits overall availability and there are a number of fees (in addition to a higher interest rate) to cover.  I would not suggest getting into this type of arrangement without some internal or external qualified financial personnel.  Dealing with an ABL can be a bit overwhelming.

While every loan does not fall directly into one of these categories the vast majority do, so as an owner, an awareness of the basics should make you more knowledgeable as to your alternatives and also provide you (based upon the type of loan you obtain) with a view as to how the outside financing world perceives your business.

Five Steps to Raising Funds

“Step 1: We find the worst play ever written.  Step 2: I raise a million bucks.  Lots of little old ladies out there.  Step 3: You go back to work on the books; one for the government and one for us.  Step 4: We open on Broadway and before you can say Step Five…  Step 5: We close on Broadway, take our million, and fly to Rio.”

Paraphrase of dialogue from The Producers by Mel Brooks

Okay, so you don’t exactly subscribe to Max Bialystock’s approach to raising funds.  Most of you do not start out counting on failure to succeed.  But, based upon some of the approaches I have seen, it may be helpful to compare and contrast what you are proposing versus what Max is doing; perhaps there is a hidden lesson there.

Everyone looking for financing wants the five steps to follow to achieve success.  I wish I had them, but this is one of the hardest things to do in business and, in 40 years, I have not found the secret formula.  However, I can offer five points to consider but they will all take some time and hard work.  (If it was easy, the success rate would be so much higher.)

  1. Prepare a pitch deck that is based on a true business model.  If you need help, you can refer to our website.  The good news is it will tell you exactly what should be in the deck; the bad news is you need to provide the content.
  2. Invest some of your money. Investors are not interested in helping someone with no “skin in the game.” They want to know that you are serious and have something to lose if you do not succeed. Fear is a great motivator.
  3. Get friends and family to invest. If the people who know you can’t be convinced, how are you supposed to win over strangers? They don’t need to mortgage their homes; they just need to demonstrate commitment.
  4. Communicate and refine your plan. Talk to advisors, friends and your network. See what they like and don’t like about your plan. And don’t force the issue; don’t let them feel bad if they are not thrilled and would like to tell you so. Make the feedback process easy and use what they say to consider modifications.
  5. Target your investors. Understand what they want and how you match up. If you are pre revenue and looking for seed money, friends and family and angels are the place to go, not venture capital funds. Use your network to get to the right people. A few good targeted meetings are much better than dozens of ones that end “don’t call us; we’ll call you.”

So, nothing magical here and no guarantees.  But, like everything else that is worth pursuing, it is a process.  Don’t let it control you.

Startup Funding Myths

Dr. Thorndike: “Do you really think that is nece…”

Professor Lilloman: “Don’t tell me what’s nece…. I’ll tell you what’s nece..”

Script from High Anxiety by Mel Brooks

So why the arcane quote? In this scene from one of my favorite Brook’s films, Dr. Richard Thorndike is being told by his mentor, an old psychology professor that he (Richard) needs psychoanalysis. Richard does not even get the chance to complete his question about if it is necessary; he is stopped in mid-word. His mentor tells Richard (again with a partial word) that he will tell him what is necessary.

The parallel for me is the guidance I constantly hear at MeetUps and other gatherings that those “in the know” give to startups regarding achieving success with funding sources. The common theme to me is these so called “advisors” never listen to the startup. Many just dive right in with their advice and while some of it is good, some just seems to perpetuate what I think are myths. It is the same phenomena we hear as tax advisors when clients call about some great tax saving gimmick they learned about on a golf course. Raising capital is an intense process requiring serious dialogue, so let me try to debunk or perhaps clarify five of the more egregious myths I hear:

  • You don’t need revenue – while this is true for very early start up funding, you do need a revenue model and a “path” to revenue. At some point, you have to show that investor money will eventually lead to a “salable product or service” and revenue will commence. Without that, you are going down a very long road.
  • You need an introduction from a trusted advisor – this is false. While an introduction from someone known to the funding source is helpful, it is more important to make sure when approaching a funding source that the stage of development they seek and the space they like match with you. A venture capitalist interested in emerging growth medical device plays is not the right source for an “ed tech” company seeking seed financing regardless of who introduces you.
  • You can build the team later – while true as to a full team, investors want to see more than one person dedicated to the Company vision – – how do you operate together, how do your skillsets match your business model. If it is just you and an organization chart with boxes that contain TBD, you are not going to make it.

You do not need a business model; just a product or concept – false. As the late Jeff Timmons would say “an entrepreneur knows the difference between an idea and an opportunity.” Business models validate opportunities.

You can use funding meetings to practice your pitch – false. I think the idea of getting before as many investors as possible for a true “funding pitch” is not the way to go. There are friends, professional advisors, pitch competitions and a dozen other venues to practice your pitch. A funding meeting is the real game – – not a warmup and you should treat it accordingly.

We have watched our entrepreneurial friends waste endless hours in the pursuit of funding. Some blindly follow all of this “advice” and have minimal success. Hopefully, by delving behind these myths, I can help shorten your journey.

Your Dream Deal Team

“We have the tools, and we have the talent.” Winston Zeddemore – (quote from Ghostbusters)

You have decided it is time to sell your business and you hear that you should have a deal team.  So, “who you gonna’ call?” Do you think you can do it on your own or should you get help?  Here is some practical advice.

I am going to suggest a solid deal team.  However, please understand that the size of the transaction is going to determine what the team will look like. At this point, do not look at the individual players but the roles that have to be played.  I have seen smaller deals done with just a good transaction lawyer and an accountant.  But, before you go there, think of these roles:

  • Investment banker – they are the “broker” in the deal and simply put, if you wouldn’t sell your house without a broker, why wouldn’t you have this role in the sale of your business?  There may be “ugly” points that both sides have to make – having a pro as an intermediary really helps.  One who knows your industry can be critical in lining up the right buyer.
  • Lawyer – here there are two roles.  The “transaction” lawyer who understands how deals are structured and the “estate” lawyer who will help make sure you get maximum capital preservation / tax efficiency for the next generation.
  • Accountant – tax and deal structure as well as a trusted advisor who can help you quarterback the process.  And keep in mind, it is a process. You also need someone to guide you on the due diligence the purchaser will want to perform. Trust me; the bigger the check, the more questions they will ask (see my blog on the Spanish Inquisition)
  • Decision maker(s) – you need some governance around who is going to make the call when critical milestones come up.  Concluding on the Letter of Intent (LOI), due diligence requests, negotiating offers.  Put some governance in place before you start the process as decisions in this process are often time sensitive and usually emotional.  Better to set this process when the cooler heads prevail.
  • Financial advisor – someone to guide you on how to invest what you get from the deal.  Keep in mind, if you are an entrepreneur, you are probably used to being in control of your economic freedom. You can raise prices, trim staff or do what you have to do to run your business. You are nothing but a minority player in the investment world and you need an advisor who can help you understand what this means.

You will need to spend some money and good deal professionals can also help you manage this spend.  There are so many data points to consider; valuations, audits, stay bonuses, reward programs for key employees, etc. that it can be a bit overwhelming.  So make sure you get the tools and the talent and your chances for a successful deal will be greatly enhanced.  And keep in mind as Yogi says; “it will be over when it is over.” Good luck.