Monday, May 15, 2017
As many of you know, Red Rocket has been looking for a businesses to buy. We have previously written about all the challenges that come...
As many of you know, Red Rocket has been looking for a businesses to buy. We have previously written about all the challenges that come with buy-side mergers and acquisitions work. But, there is a new wrinkle we have been running into, that is worth talking about. Most businesses we have looked at were managed to maximize net profit, which is typically a good thing. But, when trying to attract an acquirer, they really should have been managed to maximize net cash flow. As at the end of the day, that is really want matters most to investors--getting visibility into a near term return of their invested capital, that hopefully can pay back in 12-18 months, not 4-5 years. Let me explain further.
DEFINING THE DIFFERENCE BETWEEN NET PROFIT AND NET CASH FLOW
Net profit is a pretty straight forward calculation; it takes all the revenues of the business collected from customers in a time period and subtracts all the expenses of the business in that same period. Those expenses include things like the cost of goods sold and all the selling, general and administrative costs of the business (e.g., marketing, payroll, home office). Net profit is an income statement output.
Net cashflow is a cash flow statement output. It starts with the net profit calculated above and then adds back non-cash items like depreciation and amortization, and then subtracts other longer term investments made in the business, like build-up of inventory for future months' sales, research and development costs made for future product offerings and other capital expenditures (e.g., for new equipment or capitalized software investments).
WHY MANAGING TO CASH FLOW MATTERS
Let's say we had a business with $5MM in revenues generating $800K in profit before taxes and $1MM in EBITDA when you add back $200K of non-cash items, like depreciation. Since most businesses are valued on a multiple of EBITDA, this business may be worth 4x cash flow, or $3.2MM to a potential acquiror, depending on how fast it is growing.
But, then the potential buyer of that business starts to peel back the layers of the onion on the cash flow statement, and uncovers the business is making $1MM of off-income statement investments to support their growth, into things like building up inventory for future months and R&D investments into future products. That takes the net cash flow of the business down to zero.
So, with most acquirers looking for businesses with high net cash flow, with which to attract bank financing and to have funds from operations with which to pay down their loan and interest over time, this presents a major challenge for the buyer. Instead of getting a business that they thought was generation a lot of profits (which is valuable to them), they are getting a business which is cash flow neutral (which is not that valuable to them, given the nature of their business). What worked well for the entrepreneur in growing their revenues at the expense of short term distributions, does not work well for most private equity investors or acquirers of your business.
WHEN THIS IS NOT THE CASE
Obviously, if you are not trying to sell your business, making potential investors or acquirers happy doesn't matter. You can do what you like in those cases. And, the reason most businesses don't care about not driving huge positive cash flow, is because they are more focused on re-investing all cash flow into the company, to help propel the business to new heights in future years (not caring about the impact to profits or cash flow in the current year). Amazon is a great example of a company that has had major success with a strategy like this, although it ruffled the feather of many of their early investors as a public company, since it was counter to the norm of maximizing near term profits.
We were studying the potential acquisition of an ecommerce seller of branded shoes. They were showing very impressive revenue growth from $5MM to $10MM to $15MM over a three year period, and net profits were growing right along with it, from $1MM to $2MM to $3MM. That would attract the excitement of most any investor or buyer.
Until, we looked at the cash flow statement in more detail. And, we learned, they needed to invest the full $3MM of profit into their future inventory investment required to support the next year's expected revenues of $20MM. With a 50% cost of sales ($10MM) and a 3x inventory turnover ratio ($3.3MM of inventory needed for next four months), they needed every penny of the prior year profits, and more, to fund their growth.
So, yes, if the plan was to shut off the growth at $15MM, and milk the $3MM of profits out of the business in perpetuity, that would appeal to certain buyers. But, if the plan, was to grow a $15MM business into a $50MM business, all while distributing a portion of profits to the shareholders or the lenders along the way, this business wouldn't attract anyone.
WHAT THIS MEANS TO YOU
Yes, profits are important and should be maximized. Especially since they are the root driver of EBITDA which is relied on heavily in valuing companies. But, if at the same time, you are not being sensitive to maximizing cash flow during growth periods of your business, you are going to have a hard time attracting new investors, lenders or acquirers for your business. At the end of the day, there has to be enough cash left to distribute out to the investment partners in a business (e.g., banks, private equity firms), along the way, in order to get their upfront attention. So, plan accordingly.
For future posts, please follow me on Twitter at: @georgedeeb.
Friday, May 5, 2017
There have been several articles written that talk about how venture capital investors prefer to bet on the jockey (the entrepreneur), o...
There have been several articles written that talk about how venture capital investors prefer to bet on the jockey (the entrepreneur), over the horse (the startup idea). As I have often said, I would much rather invest in an A+ team with a B+ idea, than a B+ team with an A+ idea. So I agree with this premise of the jockey being more important than the horse, usually. This post will tell you when one outweighs the other.
Read the rest of this post in Entrepreneur, which I guest authored this week.
For future posts, please follow me on Twitter at: @georgedeeb.
Spring cleaning time is the perfect time to fix broken businesses. Is your business broken? Revenues not scaling? Team not gelling? ...
Spring cleaning time is the perfect time to fix broken businesses. Is your business broken? Revenues not scaling? Team not gelling? Product keeps breaking? Getting bad customer reviews? Can't attract capital? At your wits end and contemplating throwing in the towel? Pretty much sounds like most early stage businesses!! But, there is a way out. Red Rocket is looking for broken businesses to fix.
We are looking for companies that:
- Are preferably a B2C company (although we would consider B2B)
- Have a solid product or service offering that is up and running (not a piece of paper startup)
- Have some base level of customer adoption (e.g., $1MM of revenues)
- Sales & marketing is the company's biggest weakness (revenues not growing)
- Has compelling unit economics--high average ticket/high margin vs. marketing costs
- The business must be cash flow neutral--not burning cash today
- Can be a newer company trying to scale, or a turnaround of former high flyer
We are looking for scenarios where we can:
- Invest our time as the new "proven CEO" of the business
- Invest our cash, as needed, for scaling sales/marketing needs
- Get a material (and preferably majority) stake in business we are excited about
Wednesday, May 3, 2017
I was recently introduced to Kevin Davis , the author of The Sales Manager’s Guide to Greatness , a new business book currently availab...
The single most common complaint from sales managers: “I don’t have time to coach.” In one company, 85 percent of the sales managers’ responsibilities were related to sales coaching. In interviews, this company’s regional sales managers said that in reality, none spent more than 10 percent of their time coaching. These managers, like most sales managers, spend 90 percent of their time involved in activities unrelated to their highest priorities. Being able to manage time (and thus your priorities) effectively is a prerequisite for being a great sales team leader. You simply cannot achieve your full potential as a sales team leader if you spend the bulk of your time in reactive mode—solving everyone else’s problems, holding ineffective meetings, shuffling through papers, or dealing with any other number of timewasters. You need to make sure you have plenty of time to plan, coach, measure, and manage. These are the priorities for sales management leadership.
3. Drive Rep Accountability for Breakthrough Sales Performance
It is impossible to hold reps fully accountable for their performance unless there is a clear description of what exactly excellence should look like. High expectations that are well communicated to your team are an essential component of a high-performance culture. You need a success profile that captures both the skills and wills needed for success in your company, plus a third element: the performance standards you want to establish for sales results and activity levels. When you are clear about what reps need to achieve, you can communicate more effectively with sales reps about what they need to do to improve.
4. Hire Smarter
Address the fundamental dilemma all sales managers face, namely that the best coaching in the world is not going to rescue someone who is ill-suited for the job. You have to evaluate not just the skills and wills of likely candidates but their cultural fit and their coachability. Why? While it’s true that some sales reps are naturals and likely will succeed in almost all situations, those self-driven top performers are more the exception than the rule. Most reps require sales coaching to attain top skills and performance levels.
5. Insert the Customer In Your Sales Process
Every company has a sales process whether or not it’s formalized. Ideally, a sales process provides salespeople with a consistent, repeatable path to follow that leads to a higher probability of sales success. But though many sales organizations think of themselves as customer-focused because they truly care about the customer, their sales process is seller-focused. Further, their systems—sales models, CRM, funnel structure, and pipeline—are set up to track sales rep activities, not customer actions. What too few companies realize is that selling activities are an inaccurate metric of progress because sales reps are so often out of sync with customers’ views. It’s not necessarily that salespeople are doing the wrong things. They could be doing the right things—identifying needs, delivering proposals, doing demonstrations—but at the wrong time in terms of the customer’s buying process. In short, any tracking or forecasts based on a selling-focused model are actually based on sales rep intuition, not on evidence that a prospect is making progress toward a decision. And it’s this disconnect between “sales rep actions” and “customer actions” that contributes to lost sales and missed forecasts.
6. Be more strategic about your coaching time
When it comes to coaching, most sales managers have natural instincts to either rescue the worst players (because obviously they need the most help) or gravitate to the best players (because they will likely have the biggest, most exciting deal opportunities). If either of these sounds like you, the results of a study reported in the Harvard Business Review might come as a surprise. “In research involving thousands of reps, we found that coaching—even world-class coaching—has a marginal impact on either the weakest or the strongest performers in the sales organization.”That’s right. Your biggest payoff from coaching will come from working with the people you might think of as your “B” players. Your mindset needs to be focusing your one-on-one coaching time on the people with the biggest potential, not those with the biggest problems or biggest deals.
7. Commit to consistent coaching
Think about the best manager or coach you’ve had, whether in or out of sales. The answer that occurs to most people is someone who was truly committed to their success. People don’t remember a manager or coach so much for the step-by-step coaching process that person used (though they probably had one). They remember coaches more for how those managers interacted and communicated and the effort they put in to connecting with their team.
8. Motivate the Demotivated
The vast majority of sales managers that I deal with think as high as 75 percent of the performance issues on their team are due to bad attitudes or “willingness problems”. Deﬁciencies in will—a rep’s attitude and mental approach to the job—are much more difﬁcult to solve, and this is perhaps one reason why they get ignored so often. Yet taking action is imperative. Just one bad apple can bring a team’s performance down by more than 30 percent, no matter how good the rest of the group is. Poor behavior has a much stronger negative effect on a team than the positive effect of good behavior. Dealing with this wide range of willingness problems takes ﬁnesse. You can’t send someone to a class to improve an attitude. You can’t force someone to be more motivated simply by telling them what to do or cheerleading from the sidelines. Instead, you have to think about what will motivate—or what has demotivated—the person. Focus on the difference between motivators that raise the natural level of motivation (providing incentives for people to improve and get better), and demotivators that rob people of their enthusiasm for the job. As a manager, you have to be able to distinguish between these two so you know whether your job is increasing motivators or trying to diminish the impact of demotivators.
9. Increase Win Rates with Buy Cycle Coaching
When a company adopts a buying-process focus, part of a sales manager’s responsibility becomes reinforcing that perspective in their dealings with sales reps. See the process through the customer’s eyes. Learn to appreciate the steps a customer goes through when making a buying decision. And, resist the urge to “prematurely pitch.” Talking about features and benefits of a solution does no good if the customer has not even decided to buy yet. Pitching benefits too soon is one main way that reps get out of sync with customer buying. And, do so as a "helper", not a "critic", to not make your sales rep defensive and preserve your relationship with them. Usher the person to the intersection of choice. Be very clear about consequences: negative if the person does not change, and positive if they do. Focus on questions that get at the customer’s go-forward actions. Ask reps the questions those reps should be asking themselves, such as “Where is this prospect at in their decision-making process?” and “What does this customer need to learn in order to take their next buying step?” and “What action do I want the customer to take after this call (or meeting)?” You can’t improve closing ratios by going in at the end of the sales process. You have to fix what your salespeople are doing at the very beginning—what they are doing to understand the customer’s buying process. Those first few meetings are when a customer decides whether they have a problem that you can fix and whether it’s worth their time to fix it. It’s also where, from the customer’s perspective, the size of the sale is determined.
David Epstein, author of The Sports Gene, has devoted much of his career to studying the behavior of elite athletes and champions. He discussed a pattern he noticed in how champions set their goals. All of the champions he studied, said Epstein, have major goals they want to accomplish, such as winning a race or an Olympic medal. But on a daily basis they aren’t thinking about that end point. Rather, every day will be devoted to something very specific, such as “today in my workout, between mile three and four, I’m going to push hard.” In other words, these champions are really good at setting proximate (near-term) objectives that tell them what to do today. How can you do the same?
Thanks again, Kevin, for sharing your wisdom with our readers. Hopefully, you are all now better educated on how best to manage your sales teams. Be sure to read Kevin’s full book, for more details.