Tuesday, May 31, 2011

Lesson #38: Things to Consider When Buying a Business

At times, it may makes sense to acquire a business.  Reasons could include acquiring technology or other assets, patents, or a revenue stream or client base.  Or even, for simply taking out a potentially competitive long term threat.  In today's post, we will assess how to go about: (i) identifying targets; (ii) approaching targets; (iii) things to look out for during due diligence; (iv) valuing target companies; and (v) structuring the deal.

As for identifying targets, my guess is you most likely have a target in mind if you are reading this post.  But, if not, there are many places to look for prospective targets.  Most industry associations have lists of key companies in their industry.  Many journalists or bloggers have specific industry or startup focus, and they may know about various players in the space.  As, do various investment bankers, many of whom typically have a specific industry focus.  So, use Google to track down who these key players are, that can point you in the right direction.  In addition, there are several websites that advertise companies for sale by industry, including BusinessesForSale.com,   BizQuest and BizBuySell.com, to name a few.

When you have found a target, how you approach them will go a long way towards increasing your odds of getting to the finish line.  Sometimes it makes sense to approach them directly, and other times it makes sense to approach them through a third party intermediary.  The latter is better with highly competitive businesses or with executives that may not present well on a first call.  And, when you do approach targets directly, I recommend not jumping right into merger discussions.  This is all about building up a relationship and comfort for the target company.  So, I like to start with "potential partner" discussions, that ultimately evolve into "potential merger" discussions down the road.  And, worth mentioning, the word "merger" sounds less harmful than "acquisition", for the target who is not quite ready to let go the reins.

During due diligence of the target company, make sure you have your lawyer send over a detailed information request list, which could include, review of: (i) all company financial statements, historical and projected; (ii) all company ownership history and shareholder records; (iii) list of all known assets of the business; (iv) a list of all known liabilities of the business, or its shareholders; (v) a list of all current and past employees by title, including resumes;(vi) a list of all contracts of the business; and (vii) a list of all intellectual property, to name a few.  These schedules will become the basis of any representations or warranties made by the seller in the closing documents.  But, more important than anything, make sure you trust the people you are "getting in bed" with.  So, make sure there is a good personality fit, a good skill fit and a good trust factor with the selling company and their shareholders.  Call their trade and personal references as a critical step during due diligence.

In terms of valuing a target business, the methodologies are no different than how you would value your own startup business with prospective investors, which we discussed back in
Lesson #32.  So, please re-read that post for the details.  But, with a merger, there is one additional technique which can be used, which is a "relative contribution analysis".  The relative contribution could relate to revenues or profits or website visitors or customers or whatever other metric the two companies can agree properly value their relative contributions.  So, let's say the acquiring business has $1MM of revenues and the target business has $500K of revenues.  In this example, Newco could be owned 66.7% by the acquiring company and 33.3% by the target company, using this methodology. 

But, if you do not like what the relative contribution method has to say, or if you don't want any outside shareholders in Newco, cash will be your primary currency using one of the techniques discussed in Lesson #32.  Beyond making the cash or equity acquisition decision, other structural considerations include the following.  The most important is deciding between an "equity purchase" or an "asset purchase".  The latter is preferred, as it leaves all the liabilities and other "skeletons in the closet" with the target company's shareholders, and do not transfer to Newco.  The timing of payments is another consideration.  If you don't have all the cash day one, you can structure payments over time if the seller is willing to take a seller's note from the buyer at closing.  Or, if you cannot agree on upfront valuation, you can put earn-out mechanisms in place, to get the target future upside payments if certain projection thresholds are met.  But, earn-outs are complicated to write for both the buyer and the seller, so get good legal advice here.  The other structural consideration is making sure the seller gives the buyer proper representations and warranties (from both the company and their underlying shareholders, individually and collectively), to make sure there are refunds to the buyer if anything was not delivered as promised after closing.  And, don't forget to make sure the target company is delivered to you with an adequate amount of working capital, in line with historical levels.

At the end of the day, there are a lot of things that go wrong with acquisitions, and very few go perfectly to plan.  So, be conservative in your forecasts, and consider haircuting target revenues by 50% as a cushion, especially if the "entrepreneurial fire" of the target's CEO are not going to be a part of Newco.  And, before going down this road in the first place, make sure you have done a complete "buy vs. build" analysis for this decision.  As, it may be cheaper to ultimately build the solution yourself, and not have to deal with any of the business combination or cultural integration issues of a merger or acquisition.  Proceed only with caution here, to not upset the apple cart.

This is too complicated a topic to detail in a simple post, so get a good lawyer to help you here.

For future posts, be sure to follow me at:  www.twitter.com/georgedeeb

Thursday, May 26, 2011

Lesson #37: The Plusses and Minuses of Franchising

In this post, we will discuss the plusses and minuses of both: (i) becoming a franchisee; and (2) becoming a franchisor, depending on your needs.

For a franchisee, franchises allow you the opportunity to start your own business, but in a way that reduces your startup risk by piggy-backing on the expertise of the franchisor.  As an example, let's say you wanted to open new fast food restaurant.  You could either design your own business from scratch (which have all kinds of startup risks), or license a franchise from an established chain like McDonald's.  With a franchise, you get the power of the McDonald's brand name and marketing expertise, plus decades of operational learnings.  All you need to do is be the investment capital behind the new store location, and manage that business going forward (with high level support from the franchisor).  McDonald's will find the site, tell you how big the store needs to be, provide the architectural/design specs, source the construction team, source equipment, source systems, design the menu, source food, etc.  And, you write the check and run that business.  Plus, you will need to pay McDonald's a percentage of the ongoing revenues from the business, in exchange for their ongoing marketing and operational support.

The downside of being a franchisee, is your long term financial returns are typically not as high as they could have been, had your launched your own business yourself.  Whatever percentage fees are going to the franchisor, would have been long term monies into your own pocket.  But, it is the classic risk/reward conundrum:  although the rewards would be higher with your own business, the risks and work are certainly higher, as well (e.g., building business plan, store design, location strategy, menu design, marketing plans).  You just need to figure out what your personal appetite for risk is, and go from there.  Do you want to piggy-back on McDonald's coattails for a smaller potential return?  Or, do you want to launch the next great fast food chain, for a bigger potential return (from a lot more work).

For a franchisor, the advantages are pretty clear:  you have opened up a near limitless supply of investment capital from your franchisees footing the bill of your expansion.  That is how companies like Starbucks, Subway and Dunkin Donuts have seen rapid expansion on a global basis.  Yes, you now need to manage this network of franchisees, which can be distracting.  But, no more so than managing your own growth.  And, by franchising, you get your brand to market much faster, before somebody else comes in with a competing concept.  And, what many franchisors do, is use franchising to roll out the brand as quickly as possible, and then buy back their best-performing franchisees over time, as cash from operations start flowing through the business, and they have the resources to scale up revenues with company-owned locations.  Quite a clever model, as the franchisor, with the franchisees taking most of the financial startup risk.  The only downside is the franchisees may not be required to sell, so the franchisor may permanently lose key markets long term (so, plan ahead for which markets will be most critical for your long term strategy).

There are many websites where you can go to research or advertise franchise opportunities.  Here are a few to get you started:  Franchise.com, Franchise Direct, Franchise.org, Franchise Clique and Franchise Gator.  Entrepreneur Magazine also has a great annual list of the Top 500 Franchises, where you can do additional research.  There are franchise opportunities in literally most any business line (e.g., restaurants, retail, education, home services, business services), so it is worth exploring for both entrepreneurs looking for opportunities and established businesses looking for ways to fund their growth.

But before you make any franchise decision as a franchisee: (i) make sure you clearly read the obligations of the franchising agreements (e.g., the UFOC franchise disclosure document), as the devil is certainly in the details, for both the franchisee and the franchisor; and (ii) make sure you have done your due diligence on the franchisor (e.g., how long have they been in business, are they well funded, are locations growing, are other franchisees happy).  The last thing you want to do is start a new franchise without perfect information on your cash obligations or sale restrictions, your franchisor's committed contractual support or a franchisor that is in a weak financial position to back up their promises.  Here is a good article on Franchising.com about key things to look out for in the UFOC.  But, in all cases, call references and get a smart franchise lawyer to help you!!

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Wednesday, May 25, 2011

Lesson #36: Picking The Best Technology for Your Web Startup

I am a business person first, and a tech person second.  So, I solicited the input of my technology colleagues, Tyler Jennings and Todd Webb from Obtiva, a leading web development company in the Chicago area, who have done terrific work for Groupon and others.  So, be sure to follow up with them directly, for any detailed questions from here.

One of the biggest mistakes I made at iExplore in 1999 was building the website in entirely the wrong way.  The first problem, it was not a lean startup, by any means.  It was built using the most expensive technologies of its day, from providers like Oracle and Sun.  We just assumed the site would be a huge success, so we built a "mack daddy" back end to hand the meteoric growth.  But, the site never grew to 10MM visitors a month, it only grew to 1MM visitors a month.  And then, we were saddled with huge overhead costs of around $25K per month, just to run the website.  I equate it with building the foundation for a 10,000 foot mansion, but only constructing a 1,000 foot house on top of it, which was a very inefficient use of capital for a startup (with the 9,000 foot uncovered hole in the ground taking on water). 

The second problem was the site was not easy to maintain, requiring complicated builds to refresh the site for even the most simple of changes and a staff of expensive, hard-to-find developers that were proficient in the technologies we were using.  So, the key lessons: (i) never build a tech infrastructure in excess of reasonable growth targets (to keep your costs at an absolute minimum); and (ii) build your technologies in a scalable way where the site can easily be developed and maintained over time, by easy to find developers. 

Below is some high level guidance on current trends in the startup tech community.  But, the most important guidance of all:  finding the right CTO is 10x more important than picking the right technology itself.  Technology needs vary wildly based on the specifications of various projects.  And, only a strong CTO or technology consulting firm will ensure you are heading in the best direction, based on your specific needs and budgets.  And, in all cases, don't get romanced by "Rolls Royce" solutions, when a "Honda" will do just fine, for the needs of most lean startups.  And, keep in mind, preferred technology platforms for startups continue to change from year to year, as new advancements hit the market.  So, read the below from that perspective.  And, hopefully, this post will not become obsolete by the time I have finished writing it!

Most lean startups with basic website needs today are building their web-based businesses using the Ruby on Rails coding platform, which is entirely based on inexpensive and freely available open-source technologies.  So, if you can, avoid more expensive, licensed platforms based on Java, C#, PHP or VisualBasic.net.  Ruby has become the preferred language of choice since: (i) you can get your product to market faster with less code to write; (ii) it is a flexible language easily tied together with other systems; (iii) it is easy to scale and iterate; and (iv) Linux based hosting providers are numerous and inexpensive.  Many successful startups like Groupon, Living Social and Hulu, were all written with Ruby.  The only real negative of Ruby is that it is still a relatively new technology, and experienced talent are in high demand (although many new developers are learning the language in force).

As for the alternatives, Microsoft's VisualBasic.net technology is not advised unless there is a real business need to using it, like having to integrate with other Microsoft based technologies.  This is due to: (i) the ubiquity of open source solutions; and (ii) the higher expense of hosting sites on the Microsoft platform.  But, there are times when more complicated or expensive technologies could be the way to go.  For example, if you are processing tons of data, Java is a good choice.  If you are doing tons of number crunching, C# could be the way to go.  If you have a very small project that does not need to scale, PHP could be a good alternative, as it is inexpensive to host and requires fewer resources to operate. 

Now, that we have picked our development language, we need to make our hosting decisions.  And, for lean startups, you can't beat the low-cost of cloud-based hosting.  So, instead of investing big monies in hardware, software and systems administrators, piggyback on the services of the cloud with a "pay as you use it" solution.  This is much preferred to building your own infrastructure, to run in your own server room or in a full co-location facility, which can get really expensive.  Leading cloud-based hosting providers with expertise with Ruby include Amazon's EC2 cloud, Engine Yard, Rails Machine and Blue Box, to name a few.  At some point (e.g., once you get to Groupon scale with tons of traffic), the cloud may become too expensive compared to internally built and managed solutions.  But, for most startups, the cloud works perfectly fine and is the preferred way to go.

As for other elements of your web architecture, assuming you move forward with Ruby as your coding language of choice, the following open-source LAMP stack is preferred: (i) Linux as the operating system; (ii) Nginx as the web page server; and (iii) MySQL as the database.  PHP written sites would be similar, except Apache would be the web page server of choice.  Other operating system options include RedHat, gen 2, and Debian.  Another database option includes Postgres.  But, in all cases, these are less used than the optimal set-up above.  All of these are free open-source technologies.  Each cloud-based hosting provider has their unique architectural set-ups and options, so research them accordingly, to make sure they are compatable with your needs.

The other thing to consider is making sure your product is readily available for use on multiple web or mobile platforms (e.g., web site, iPhone, iPad, Android).  The most inexpensive way is to build a browser-based "touch site", which automatically resizes and reskins your website based on the users' device.  This can cost $10-$30K to build this kind of functionality.  The other option is to actually build and maintain "native apps" for each of the various platforms, which can cost $50-$75K per platform, or $200K-$300K for the 3-4 key platforms.  So, much more expensive than the "touch site" option.  The primary reasons to build native apps are the full customizability of each app to each platform, and the marketing benefits you will get as consumers are browsing for new apps in the iPhone Store or Android Market.  So, consider this incremental investment as part of your marketing budget to attract new users, especially if you are a mobile based business which will be dependent on those stores for new business.

I hope this helps get your development efforts off to a good start in a "lean startup" kind of way: investing the minimum amount as possible to take a viable technology to market as quickly and cheaply as possible.  Thanks again to the Obtiva team, for their help here.

For future posts, be sure to follow me on Twitter at: www.twitter.com/georgedeeb

Tuesday, May 17, 2011

Lessons #1 thru #35: A Recapped Index of Startup Advice by Topic

Red Rocket created an index of all startup lessons from its blog to date, for your quick reference by topic.  Please forward to anybody that you think may be interested.

Lesson #1: Drivers of Success for Startups. Do I Have a Good Idea?

Lesson #2: Building The Right Team for Your Startup

Lesson #3: The Importance of Timing & Luck for Your Startup

Lesson #4: How to Raise Capital for Your Startup

Lesson #5: Finding Angel Investors for Your Startup

Lesson #6: Structuring Strategic Partnerships for Your Startup

Lesson #7: Key Components for Writing a Business Plan

Lesson #8: Startups Require Flexibility to Optimize Business Model

Lesson #9: Spreading Equity to Key Employees & Partners

Lesson #10: How Best to Approach VC's or Angel Investors

Lesson #11: Considering Incubators or Accelerators for Your Startup

Lesson #12: How to Structure Your Board of Directors or Advisory Board

Lesson #13: Creating the Right Culture for Your Startup

Lesson #14: The Role of a Startup CEO

Lesson #15: Hands-On vs. Hands-Off Management of Startups

Lesson #16: The Plusses & Minuses of Virtual Employees

Lesson #17: Pitfalls to Avoid When Joining Someone Else's Startup

Lesson #18: The Right Work-Life Balance for a Startup

Lesson #19: How to Identify Your Competition

Lesson #20: Setting Product & Pricing Strategy for Your Startup

Lesson #21: Setting a Sales & Marketing Plan for Your Startup

Lesson #22: How to Calculate ROI on Your Marketing Spend

Lesson #23: How to Design Effective Advertising Copy & Creatives

Lesson #24: How to Choose a Name for Your Startup

Lesson #25: How to Structure Your Sales Team & Procedures

Lesson #26: Designing Sales Incentives to Motivate Your Sales Team

Lesson #27: How VC's Define a Backable Management Team

Lesson #28: Expect the Unexpected -- Always Have a Cushion

Lesson #29: No Matter How Bad it Gets, Persistence Wins

Lesson #30: When to Hire Employees vs. Contractors vs. Crowdsources

Lesson #31: The Power of a Pivot -- Thinking Out of the Box

Lesson #32: How to Value Your Startup Business

Lesson #33: The Importance of Customer Service

Lesson #34: How Best to Recruit Employees For Your Startup

Lesson #35: How to Read Resumes & Screen Employee Candidates

Click Here for an Index of all Lessons #1 through #101

Hope you are finding these lessons helpful.  Check back soon for more lessons to come!

For future posts, please follow me at:  www.twitter.com/georgedeeb

Monday, May 16, 2011

Lesson #35: How to Read Resumes & Screen Employee Candidates

In my last post, we learned How Best to Recruit for Employees and get high quality resumes coming in.  We also talked about ways to automate the candidate screening process, so your time is more efficiently spent on interviewing your best candidates.  So, now you are down to "reading between the lines", in finding the best candidate for your open position, by properly reading a resume and asking the right questions during the interview.

For any candidate, I am trying to ensure: (i) they have the right skills for the job: (ii) they have a proven track record of career or educational success for the position; (iii) I can afford them; (iv) they have the right personality fit with the company; (v) they have references that will validate their claims; and (vi) they fit the company on other tangential topics.  I will tackle each of these points below.

Making sure a candidate has the right skills for the job sounds intuitive enough.  For example, a candidates with 20 years of marketing experience, should know something about marketing.  But, the devil is in the details.  Was that marketing person in your industry, as marketing tactics vary wildly by industry.  Was that marketing person a B2C marketer, when you need a B2B marketer?  Was that person spending huge budgets in mass media, when you have small budgets needing viral social media?  Did the person do the marketing themselves, or were they relying on a big team they managed?  You get the point:  drill down from the 30,000 foot view to ground level, where the boots hit the ground.

As for a proven track record in their educational history, I am looking for the following.  Does the candidate have the right college degrees for the position (e.g., majored in accounting or finance for a CFO), with post college degrees carrying more weight than undergraduate degrees (e.g., MBA in Finance worth more than a B.A. in Liberal Arts).  What school did they go to, as a Harvard or Stanford degree in business is worth more than a Southern Illinois or Ball State degree?  Did the candidate get good grades while in school, with A students typically smarter, more studious and more diligent than B students.  But, there are always exceptions to the rule (e.g., grades impacted by working two jobs to put themself through school), so read accordingly.

As for a proven track record in their career, you need look for these kind of things.  Was the candidate in big companies their entire careers, or do they have real startup experience, which is more important for startups.  Has there been nice upward promotions overtime, with titles increasing in importance from manager to director to Vice President to Executive Vice President?  Does the candidate have longevity from position to position?  I get really nervous about candidates with 10 jobs in 10 years being poor performers or simply bored easily, and am looking for a minimum of 2-3 years per company, unless there are logical reasons for quick job moves (like the company was sold).  Was the candidate cut during a layoff, as sometimes, but not always, companies typically cut their under performers when they tighten their belts.  Are their quantifiable successes they can point to that illustrates they have led and managed rapid startup growth and success in a similar environment to your own?  Ask for examples.

Affordability of a new hire is pretty straight forward, but sometimes a candidates says they are willing to work for $100K salary just to get in the door, but are really looking for $150K and don't tell you until you are "sold" on them as your key addition to the team.  In that scenario, think creatively out of the box.  Will they accept $100K salary plus $50K in performance based bonuses or other incentives?  If appropriate for the position, would they accept a four day a week schedule, allowing the the open day to make more money elsewhere?   Would they work for equity until we close our financing, and then will pay you $150K after funding closes?  But, if there are any long term discrepencies between what you can afford to pay, and what a candidate thinks they are worth, they will most likely be looking for another higher paying job down the road.

Personality fit perhaps is the most critical to the whole candidate review process.  You are going to be spending a lot of time working with this person.  Entrepreneurs tend to be A-type personalities and like to be surrounded by other A-type go-getters, which help to infuse that energy into the rest of the company.  Nobody wants to be around a perpetual pessimist, constant downer or pain in the ass, so make sure the candidate fits your desired company culture, regardless how good they are on paper.  It's just not worth it, if you can't get along with the person.

References are always good.  But, remember, a candidate is going to provide you their best references, that will most likely only say good things about them.  So, a couple things to consider.  Did the candidate give you references that are relevant to the position (e.g., their former bosses and former direct reports and former investors)?  If not, there may be a red flag that they are trying to hide something.  So, be sure to ask to speak to those people that can speak best to their skills, if possible.  And, frankly, do a little digging on your own?   Do you share any colleagues in LinkedIn, that may be able to speak about this person?  And, in all cases, remember, the person you are calling could be worried about violating employment laws with any negative reviews, so take references with a grain of salt.  And, if you don't get a response to your reference call, that sometimes means they didn't have anything nice to say and preferred to avoid an awkward phone call.  So, read between the lines.

To get a sense of how a person thinks on the fly in the topsy-turvy world of startups, I like to see how candidates handle random questions on random random topics.   First, on something they are familiar with, perhaps related to their favorite hobbies (e.g., ask a book reader how they would go about writing a book).  And, second, on something completely random (e.g., how would you determine the weight of a jumbo jet).  You are simply trying to determine how they think and see how logically their brain works in unknown situations, which often a startup can lead to.

And, there are other things to consider.  What is going on in their personal life, that may require a lot of time away from the office?  Can you deal with 10 smoking breaks a day?  How far does the candidate live from the office, as a long commute won't last long, before they start looking for a new job down the road?   As people get older, they typically have less energy, so make sure they have the stamina for a startup?  But, tread lightly on these areas, avoiding direct questions about gender, age, pregnancy, etc. which violate employment laws.

There is no one right way to recruit for candidates, given the wide variety of people, talents and personalities, but hopefully this will point you in the right direction.

For future posts, please follow me at:  www.twitter.com/georgedeeb

Saturday, May 14, 2011

Lesson #34: How Best to Recruit Employees For Your Startup

As a startup, odds are you will not be able to afford a dedicated HR person or 30% headhunter fees, and will most likely need to be doing the recruitment yourself.  In today's post, we will offer a few tips on how to find the right talent for your business, in a way that brings in the best candidates and reduces any distraction from your main business focus.

There are lots of different job posting sites out there, some are huge (e.g., Monster, Career Builder, Craig's List) and others are small (e.g., job boards for trade magazine sites).  Some offer national candidates, and others local candidates.  And, some are targeted to senior executives (e.g., The Ladders, Netshare, Execunet) and others for specific entry level jobs.  So, before randomly placing a job posting, figure out which audience is most relevant for your position. 

For example, I may go to Dice or CraigsList for technology developers, LinkedIn for mid-level managers and the Travel Industry Association website for national travel agents.  But, in most cases, I will first look for local job boards in your home city (e.g., Chicago Interactive Marketing Association for marketing people in Chicago), since I will not have budgets to relocate employees.  Unless national job boards are your only option, and then I will detail no relocation budget within the posting, so candidates know we cannot afford to relocate them or pay for their travel to interview with you.

And, let's not forget the power of working your network and word of mouth marketing via LinkedIn, Twitter, Facebook or otherwise.  It is a lot better to find a "colleague of a colleague", with first hand references in place, than to start blind with a random candidate, where you can.  Frankly, sites like LinkedIn are my favorite recruiting sites, simply because I can learn a lot about the candidate, above and beyond their simple resume data.  How many connections do they have?  Who are those connections, and can they help me?  Do I have any overlapping connections that I can call as a reference?  Also, it provides really good insights to how socially engaged the candidate is and the types of connections they can bring to your business.

Once, you have identified where you want to be recruiting, now you need to figure out what your job posting should say to: (i) stand out from the thousands of other job postings a candidate may be looking at; and (ii) limit the clutter of resumes coming into your office, to simplify the screening process.   I would not be vague in your copy, and disclose as much as you can to ensure the reader knows all the plusses and minuses, so only the most interested will apply.  That means, disclose your company name (so they can research your business on your website) and disclose the specific salary range (so people desiring a salary above that range do not apply).  The only time you need to be more confidential in your posting, is when you don't want an existing staff member to know you are recruiting a replacement for their position, or if you are worried about a competitor learning you are hiring for certain skills.  But, as a rule, more disclosure is better than less for all involved.

Also, if there is specific information that would be useful to you in screening candidates, make sure you ask for such information to be provided in your posting.  For example, if you need a technologist with strong C# coding experience, make sure that is detailed as a requirement for all candidates, and that they need to rate themselves on a scale of 1 to 10 for that skill in their cover letter.  If there are many skills that are required, and can easily be assessed by some simply Q&A, set up an online Q&A recruitment form on your website, so you don't have to waste time on the phone asking the same questions over and over again (since answers can easily be screened via the online responses).  I also think video can be a very effective tool to dig deeper than just a resume.  So, maybe set up your Q&A form with a video-based recruitment site, like Expressume, where you will get video responses to your questions, and can learn a lot more about the candidates' communication skills and personality fit in the process (again without wasting time on the phone).

The big picture point is:  waste as little time as possible in the minutia of recruitment, as that is time better spent on your business.  Put processes in place that allow for very efficient screening of candidates (e.g., detailed posting, Q&A forms, video responses), so only the most appropriate candidates apply, and they can easily be screened from there.  Then, once you find your favorite three candidates, now is where you dig in and spend quality time learning more about the candidate. 

Finding the right team members for your startup are critical for its success, so you have to invest the time here to get it right.  But, make sure that time is most efficiently spent (e.g., interviewing the best candidates, and not on preliminary screening of all that apply).  You never want to rush a hiring decision or take a marginal candidate just to fill a position, as long term, it will never work out for either party's long term interests.  And, it is a lot more expensive and time consuming to remove a poor performer down the road, than to get it right the first time.

In a following post, I will help you learn how best to screen a resume, so you are asking the right questions.

For future posts, please follow me at:  www.twitter.com/georgedeeb

Wednesday, May 11, 2011

Lesson #33: The Importance of Customer Service

This may sound pretty obvious, but don't take your customers for granted.  They are your lifeline, especially for a startup, and you need them to help serve as good references and to spread positive word of mouth.  Today, I will give you a couple examples from iExplore of how offering premium levels of customer service, helped to build long term customer loyalty and drive repeat sales and word of mouth for our business.

Go The Extra Mile:  iExplore had sold a horseback riding trip in South Africa to a mother and daughter.  On the day of departure from the U.S., we had a panicked call from the mother while at JFK airport that her crying daughter had forgot her horseback riding boots at home, and wondered if there was any way we could help.  We could have said, that is not our job, we just sell travel.  But, we took the extra effort, tracked down a horseback gear retailer in Cape Town, and had a pair of boots waiting for the client upon their arrival at their hotel.   The client was thrilled.

Add A Personal Touch:  You always want your customers to feel special, like they are getting something above and beyond the norm.  So, when we were selling tours, we would always include something in the client's trip, that they were not expecting from their purchased itinerary.  For example, maybe it was a bottle of champagne and fruit basket waiting for them upon their arrival.  Or, a special private dinner in a tented camp while on safari.  Or, a free tour book with their pre-departure materials.  Pleasant surprises go a long way to instilling long term loyalty.

Own Up To Your Mistakes:  When things go wrong with your customers, how you go about resolving these errors will dictate whether or not the customer will buy from you again.  If you show you sincerely care about them and making right by them, that is almost more powerful to long term loyalty, than had nothing gone wrong in the first place.  As you can imagine, when selling travel, there were a lots of places where the trip could go awry (e.g,. missed transfer, bad hotel, poor food, unpleasant guide, missed activity).  And, when they did, we would compensate the client with cash refunds and additional perks to make up for it.

Take Responsibility for Your Suppliers: In one extreme example of customer service, one of iExplore's sub-contractors in Alaska had gone out of business, and the client had already passed through their monies to the tour operator for their trip, scheduled to leave the next month.  It was a double problem of a client losing all their money and the client losing their valuable vacation time in Alaska.  Even though our contracts clearly stated issues like these were not iExplore's responsibility, we in fact found another tour supplier and paid for the trip out of iExplore's pocket.  That customer was very grateful, and we had numerous repeat bookings from that family.

Get Yourself Directly Involved with Customers:  There is no better way to learn about your product and interact with your customers, than to put yourself directly into the customer experience.  At iExplore, we had a "Travel With Our CEO" promotion, where I personally led trips with 8-10 customers at a time, in various destinations around the world.  It was a way for me to better learn about the business and our customers, and a way for our customers to get a special experience of traveling with the head of the company.  So, a win-win for all involved.

A good customer experience, will lead to 2-3 new customer referrals from positive word of mouth.  And bad customer experience, will lose you 8-10 referrals from negative word of mouth.  And, your litmus test to how well you are doing on customer service, is how quickly your repeat sales and word of mouth sales are growing.   So, make sure premium customer service is instilled into your company's DNA from day one.

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Tuesday, May 10, 2011

Lesson #32: How to Value Your Startup Business

One of the questions I get, more often than not, is what is the appropriate valuation of my business.  Typically related to an upcoming financing or pending takeover offer.  And, the answer is quite simple: like for anything, your business is worth what somebody is willing to pay for it.  And, the methodologies applied by one buyer in one industry, may be different from the methodologies applied by another buyer in another industry.  In today's post, I will give you some key drivers on how to value your business, in a way that will make sense to you, and will be in line with investor expectations.

To start, let's not forget about the obvious: the natural economic principles of supply and demand apply to valuing your business, as well.  The more scarce a supply (e.g., your equity in a hot new patented technology business), the higher the demand (e.g., multiple interested investors competing for the deal, and taking up valuation in the process).  And, if you cannot create "real demand" from multiple investors, "perceived demand" can often work the same when dealing with one investor.  So, never have an investor think they are the only investor pursuing your business, as that will hurt your valuation.  And, before you start soliciting investment, make sure your business will be perceived as new and unique to maximize your valuation.  A competitive commodity business or "me too" story, will be less demanded, and hence require a lower valuation to close your financing.

Related to the above, is the industry in which you operate.  Each industry typically has its unique valuation methodologies.  A next generation biotech or clean energy business, would get priced at a higher valuation than yet another family diner or widget manufacturer.  As an example, a new restaurant may get valued at 3-4x EBITDA and a hot dot com business with meteoric traffic growth could get valued at 5-10x revenues.  So, before you approach investors with valuation expectations, make sure you have studied the valuations acheived in recent financing or M&A transactions in your industry.  If you feel you do not have access to relevant valuation statistics for your industry, engage a financial advisor that can assist you. 

In terms of techniques investors use to value your business, they will study things like: (i) revenue, cash flow or net income multiples from recent financings in your industry; (ii) revenue, cash flow or net income multiples from recent M&A transactions in your industry; and (iii) a discounted cash flow analysis of forecasted cash flows from your business.  As mentioned earlier, these multiple ranges can be very wide, and vary substantially, within and between industries.  As a rough ball park, assume EBITDA multiples can range from 3x to 10x, depending on your "story".  And, forecasted earnings growth is typically the #1 driver of your valuation (e.g., a 25% annual net income grower may see a 25x net income multiple, and a 10% annual net income grower may see a 10x multiple).

If there are no earnings yet, with your business plowing profits into long term growth, then revenue multiples or some other metric would be used.  Revenue multiples for established businesses are typically in the 0.5x-1x range, but in extreme scenarios, can get as high as 10x for high flying dot commers with explosive growth (e.g., Groupon).  But, that is, by far, the exception to the rule.  And, if there are no revenues for your business, unless you are a bio tech business waiting for FDA approval or some new mobile app grabbing immediate market share before others, as examples, raising funds for your business, at any valuation, will be very difficult.  Investors need some initial proof of concept to get their attention.

Worth mentioning, private company valuations typically get a 25%-35% discount to public company valuations.  While at the same time, M&A transacations can come at a 25%-35% premium to financing valuations, as the founders are taking all their upside off the table.

And, remember, at the end of the day, the investor will have a very good sense to what a business is worth, and what they are willing to pay for it.  As they see deals all the time and typically have their finger on the market pulse.  So, collect a few term sheets from multiple investors, and compare and contrast valuations and other terms, and play them off each other to get the best deal.  As a rule of thumb, expect to give up 25-50% of your equity, in your first financing round, depending on the size of the investment and the type of investor (e.g., angel vs. venture capitalist).

Most importantly, you need to put on the hat of your investor in setting valuation.  To get them excited about your startup vs. the hundreds of other startups they see each year, they are looking for that next 10x return opportunity.  So, make sure your 3-5 year forecasted earnings, will grow large enough in that time frame, to afford them a 10x return.  So, as an example, if you are worth $5MM today, post financing, and the new investor owns 25% of the company ($1.25MM stake), they are going to need a financial plan that will get their stake up to $12.5MM (and the company up to $50MM) within 3-5 years.  Which, as an example, could mean driving EBITDA up to $5-$10MM within that period.  So, do not show them a forecast that grows less than that, and make sure you have built a credible financial plan to acheive these levels before approaching investors.

There are too many nuances to valuing a startup business than I could do justice in this short post, but hopefully this post gives you a good sense to the high level issues in play.  If you have any questions for your specific situation, just ask.

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Monday, May 9, 2011

Lesson #31: The Power of a Pivot - Thinking Out of the Box

We are all familiar with the meteoric success of Groupon, the daily deals website.  But, as you can read in this Groupon case study at Business Insider, they were a struggling business in the group fundraising space called The Point.  Had, they not pivited their business model from a "tipping point" for fund raising needs, to a "tipping point" for consumer deals, they would most likely be out of business today, and not a company valued at $15BN.  Somebody inside of The Point had to be smart enough to realize their old business model wasn't working, and they needed to think drastically out of the box to create a winning long term business model.  And, as you remember, there were many other examples of successful business pivots that we discussed back in  Lesson #8 on startups requiring flexibility.  Today, we are going to tackle: (i) when pivots are required; (ii) how to identify what pivot opportunities may exist; and (iii) how these pivots can be minor or material in nature. 

I think it is pretty self explanatory, if limited revenues or traction is being made with the current business model, something needs to change, and fast.  But, is the business model flawed (requiring a pivot), or is the sales and marketing plan or the management team executing such plan the problem.  You need to do your best to assess the success of each of these elements in isolation, before resorting to a business pivot.  So, for example, if you have the exact same business model as several other successful businesses, your problem is most likely the wrong sales and marketing plan or management team.  But, in other examples, where the sales and marketing plan makes sense for your industry and you have a proven and competent team in place, if nobody is buying your product, that most likely means it is time for a business pivot.

In determining where the pivot opportunity is, you need to study the core assets of the business and how they may be applied in new ways.  In the Groupon example, it was the "tipping point" technologies used in a new industry (e.g., consumer deals, instead of fundraising).  There are other examples, where the exact same product wasn't working for B2B clients, but was demanded by B2C consumers.  Or, the product doesn't sell as a branded front end solution, but does as a white label back end solution.  Or, maybe your technology is too expensive on an installed license basis, but sells better under a more cost effective SaaS solution.  Maybe corporations don't need your solutions, but government or university clients do?

Or, maybe there are dramatic changes that could lead to much better financial returns on your investment.  In one example, at MediaRecall, a digital video services and technology company serving the film studios and television networks, we learned that instead of taking an upfront cash fee for services provided, we could do the work for free and keep a 50%/50% revenue share on the resulting professional entertainment content.  These content royalties would ultimately result in 10x the overall revenues than what we would have received from the upfront for-fee services model, as the resulting content gets distributed and monetizing on sites like YouTube and Hulu.  So, if we could fund the upfront work, definitely worth the wait for revenues over time, instead of upfront.

So, when looking for your strongest assets, look enterprise wide.  Your asset can be a technology.  Or, in distribution and logistics.  Or, in search engine marketing.  Or, offshore product sourcing.  Or, in call center operations?  Or, whatever.  Just figure out what it is, and leverage the hell out of it in new industries, sales channels or applications.

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Friday, May 6, 2011

Lesson #30: When to Hire Employees vs. Contractors vs. Crowdsources

Employees are on-staff individuals working for your company, accruing benefits and where the company controls their working hours and how they are paid.  Independent contractors are individuals engaged as a third-party entity, not accruing benefits, setting their own hours and invoicing the company as they complete their work.  There is a good article on the  differences between employees and contractors on the IRS website.  A new category of workers, called crowdsources, are the same as contractors, but you have them in mass, with hundreds of potential workers competiting for work at typically much reduced prices. 

Crowdsources have been built in nearly every type of human work category, including graphic design (Crowdspring, DesignCrowd, Kluster, Fellow Force, 99 Designs, Genius Rocket), search bid management (Trada), banner ad creation (Data Pop), professional writing (Contently) and market research (Crowdtap), just to name a few.  These crowdsources are typically offering companies much more selection to choose from, at a fraction of a price.  As an example, let's say you need a new logo.  You post your need on one of the graphic design crowdsource websites, and you will get 100-200 logos to choose from (designed by 100-200 different designers trying to win your business), and only pay for the one you decide to buy (typically at a fraction of the price a logo design agency would charge for only a couple options to choose from).  Crowdsources are very clever businesses!

Now, when is it best to use employees vs. contractors vs. crowdsources?  The answer typically comes down to: (i) is the position long term in nature, or temporary; and (ii) does the complexity of the work require onsite management or not.  In all cases, you want to avoid adding employees, unless absolutely necessary.  Employees come with expensive payroll taxes and employee benefits, which are typically 20% more monies on top of their base salary.  And, when you terminate them, any unemployment benefit claims, will ultimately get paid by the company in the form of higher unemployment insurance premiums.  And, management level employees may also have big severance packages (which should be avoided, if you can).  Not to mention, the mindset of an employee is that they are a long term team member, and any layoffs will dramatically impact company morale for the remaining staff, if they see their friends cut. 

That said, employees are the way to go for permanent jobs, as employees salaries are typically a lot lower than the hourly rates that can be charged by an independent contractor.  As an example, if the company needs C-level management or an office manager, these are most likely long term jobs that will never go away.  These would be employee hires.

Independent contractors, on the other hand, are better for projects that are more interim in nature.  As an example, if you need a new website design, that is typically a three month project and then the designer is done with their work.  You don't want to take a person on your employee payroll for an interim project like this.  Unless your company has full time design needs (e.g., web site changes throughout the year, marketing materials throughout the year), it is preferred to hire an independent contractor in this example.  It makes your overhead that much more variable in nature, allowing your cost stucture to move up and down as your work needs ebb and flow.  This is much preferred to carrying fixed overhead.

Now, in terms of hiring an independent contractor or using a crowdsource, it comes down to the complexity of the work.  If it is something simple, like designing a logo or website header, that can easily be done by anybody worldwide, and it would be beneficial to get a bunch of different examples to choose from.  Not to mention the dramatic costs savings of the crowdsources, compared to independent contractors.  But, for complex work, like architecting your website backend and making all the database, network, hardware and software decisions, that is most likely best served by an in-house independent contractor working hand-in-hand with your CTO.

So, long story short, keep your long term overhead (e.g., employee base) as low as possible, and structure your human resources in as variable a way as you can.  While at the same time, maximize your selection of options and keep your costs low with crowdsources, when complex work is not involved.  Start researching crowdsources on the web, there is most likely one for most any of your needs.

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Tuesday, May 3, 2011

Lesson #29: No Matter How Bad It Gets, Persistence Wins

In my last post, we talked about iExplore's scary experience in the wake of 9/11/01, and the need for startups to expect the unexpected with enough cash cushion on hand.  I mentioned iExplore ultimately survived that negative impact on the travel industry, but did not give you the details of how we actually avoided bankruptcy and kept the business afloat.  I will highlight a few key points below, summarized as "no matter how bad it gets, persistence wins!"

To set the stage, here were the key datapoints for iExplore's business at 9/11/01.  The company had about $5MM in debt ($3.5MM from venture capitalists and $1.5MM from creditors), a cash burn rate of around $250K per month, no revenues coming in (due to low demand post 9/11/01), a low margin business and no cash in the bank (with our $4MM committed venture deal falling apart post 9/11/01).   To say the situation was bleak was an understatement, and any normal business would have called it a day and closed the business.  But, I was passionate about the business and our progress to date, and knew the markets would ultimately recover.  All I needed to do was to restructure our business to give it a chance to succeed long term.

It terms of the $250K burn rate, that was net of any discretionary spending like marketing that we had immediately cut.  It was largely the expenses related to our 45 person staff.  With no cash in the bank, and no cash in sight, I had no choice but to layoff 100% of our staff, including myself.  That got the burn down close to $50K per month, a much more reasonable level to find a "white knight".  I basically told nine of our employees, that if you are willing to volunteer your time over the next couple months, they would be rehired (and paid any unpaid back pay) if a new financing closes.  But, no promises, proceed at your own caution.  Believe it or not, those nine employees were as empassioned about iExplore as I was, and agreed to stay on for no pay, on the hopes of having a job on the back end.  Those were some really terrific people!

The second thing I needed to do was come up with an alternative revenue stream, to make the business more attractive to investors.  So, I evolved the business from a 15% travel agency (selling third party trips) to a 35% margin tour operator (selling iExplore branded trips).  And, at the same time, entered the 75% margin online advertising sales business, selling banner ads on the iExplore website.  Those two changes allowed us to present a profitable business plan, even in the low travel demand environment post 9/11/01.

The third thing I needed to do was to settle our debts at much reduced levels, as new investors would not touch our business with a $5MM noose around our neck.  For the $3.5MM of venture debt, those investors agreed to convert their stake into equity in the going forward business, if I could find new cash investors.  This debt was intended to convert to equity anyway, albeit not at the much reduced valuation that was required post 9/11/01, so the investors ultimately agreed given the company's dire straits. 

Settling the $1.5MM of creditor debt was a lot trickier, as they were not board members and did not have a vested equity stake.  The good news was, these creditors were not iExplore customers or going forward vendors.  They were 100 old vendors that we did not plan on using going forward (e.g., old advertising agency, unneeded software/hosting vendors post our reorganization).  So, we hired bankruptcy counsel who filled in a 75 page draft bankruptcy filing and sent it to the 100 creditors with a cover letter that basically said, "we all know what happened at 9/11/01, iExplore is illiquid and needs to raise cash, new cash has been identified but only if you settle your debts at $0.10 on the dollar, and if you don't agree, you are sitting behind $3.5MM of senior venture debt and will get zero when this draft document gets filed".  It was basically a huge game of "chicken" with what would become 100 hostile and pissed off creditors.  But, after lots of calls by myself and our CFO, we got 100% of the creditors to agree to the settlement, since $0.10 on the dollar was better than zero.  And, we turned $1.5MM of liabilities to $150K of liabilities, a lot easier for a new investor to digest.

The final thing we had to do was raise the new capital, which was torture in the wake of 9/11/01 when the whole financial market basically went on pause.  I had made 400 phone calls to my venture capital colleagues looking for anyone to listen, and they were just too worried about the long term impact on the travel industry in a world of increased terrorism.  So, I had no choice but to call my uncle, who was one of my advisors, that was willing to fund me $50K per month, assuming he could see material progress in our business.  That was our lifeline, that gave me the time to ultimately find $1MM of new venture capital that was willing to fund the business in January 2002.  These investors got more comfortable the longer we got away from 9/11/01 and they could actually see revenues starting to recover.  Not to mention, buying into established iExplore (with over 1MM visitors a month) at much reduced valuations, could lead to juicy financial returns when the market fully rebounded.

So, that was how iExplore survived 9/11/01 and lived to fight another day.  And, as we all know, it ultimately became the largest website in the adventure travel space, and was sold in 2007 to TUI Travel PLC, a $25BN company and largest seller of leisure travel in the world.  The investors who saved the business after 9/11/01 made a good return on their investment.  And, I now have a success story on my resume and not a failure.

This clearly demonstrates that no matter how bleak a position you think you are in, persistence will ultimately win the day.  And, with a lot of hard work and creative thinking, a phoenix can indeed rise from the ashes!

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Monday, May 2, 2011

Lesson #28: Expect the Unexpected -- Always Have a Cushion

On the morning of September 11, 2001, I was sitting at my desk working on the final draft of a $4MM venture capital financing, that was due to close on September 15, 2011.  It was the last round of capital that iExplore would need to bridge it to profitability.  It was a very exciting time for the business and continued the validation of our business model.  Then I heard a commotion in the office, as our staff was gathering in the conference room, huddled around the television.  As I walked into the room, 45 people were glued to the news broadcast of two planes having crashed into the World Trade Center, in an obvious act of terrorism on the U.S. soil.

My head of sales and operations at the time was a seasoned travel industry veteran, formerly with Abercrombie & Kent, a leading tour operator in the industry.  He had remembered the first Gulf War and the negative impact that had on the travel industry.  By the look on his face, he was clearly troubled, and pulled me into the other room.  He basically said iExplore should prepare for the worse, that travel sales were most likely going to come to a halt in the wake of 9/11.  I was still wrapped up in the moment, trying to digest the falling towers in NYC, and wasn't really sure what was going to happen in term of future travel sales.

But, those words of caution surely proved true in the days that followed 9/11.  The investors that were supposed to fund our last round, got nervous and pulled their committed funding.  And, sure enough, travel sales fell off a cliff, at exactly the same time the company was nearly out of cash (optimistic the venture funding deal was only a couple days away).  But, in the words of show business, "it ain't over until the fat lady sings".  And, iExplore found itself with 45 employees, no cash, no prospects of cash, a ton of debt and no revenues, staring over the edge of the abyss and at the precipice of bankruptcy.  In one fell swoop, a really exciting time in iExplore's history, became its worst nightmare and darkest moment.

In the months that followed, we ultimately got through this difficult period (I will save the details for my next post).  But, the point here is to always have a cash cushion and plan far enough ahead.  I should have never let the cash position get near zero, on the 95% odds a venture round was closing in a couple days.  Regardless of the opposite advice I got from my board, I should have had at least a few months worth of cash on hand, by the time a venture capital round was supposed to close, leaving a cushion in case anything delayed the deal.  A valuable lesson for next time.

So, when doing your budgeting and fund raising, always assume you will need 2x the money you think you will need, 2x the timeframe to acheive profitability and 2x the length of time required to close any financing, and that should leave you with enough cushion to get through the bad times or any delays.  Building cash reserves like this is not always easy for a startup, but it is critical if you want to survive any and all scenarios.  So, where you can, keep your expenses razor thin until revenues or funding allow you to do otherwise.  And, do your best to "turn pennies into manhole covers".  You'll never know when you'll need them!

I hope you enjoyed today's post, coming out of today's news about the death of Osama Bin Laden.  Bringing back some very bad memories, not only for the country, but for iExplore, as well.

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