Lesson #234: Setting Mergers & Acquisitions Goals

Over time, merger or acquisition opportunities may present themselves as a growth opportunity for your business.  As discussed in the past, M&A can be very distracting to an early-stage business still trying to optimize their stand-alone business.  Especially when things can often go awry in merging businesses, management teams and employee cultures.  But, assuming you have done your homework on those fronts, and you are comfortable in taking the leap into world of M&A, here are some ways to set desired M&A goals for your business.

What Does the M&A Target Bring You?

There are many things an M&A transaction can bring you: customers, market segments, operating scale, revenues, cost savings, human talent, new products, capital, patents, you name it!  The key is prioritizing what is the most important thing your business needs to succeed, preferably something you cannot easily build on your own.  If you have the best product in the market, I tend to stay away from targets that only bring you customers or additional market share, as those relationships can be secured through strong sales and marketing efforts without having to dilute your equity owners.  So, focus on transactions that will materially move your business to new heights, for reasons beyond simply additional market share.

Is the Transaction Accretive to Your Shareholders?

You are either going to pay for the M&A transaction with cash (which may require raising capital) or with equity (issuing additional shares in your company).  In either scenario, it is most likely going to to dilute the ownership of your current investors.  You just want to make sure that the resulting business is going to be worth materially more together, than they are apart, so that your current investors will actually have a higher economic dollar value of stock, even if their stock ownership percentage is less.

Does 1 + 1 = 4?

In one scenario, where you merge two similar companies both selling into the same customers, your combined revenues will never be worth more than 1 + 1 = 2.   But, as a different scenario, let's say you have two companies selling technology into HR departments, but the first is selling application management solutions into 10 clients in the healthcare industry, and the second is selling onboarding solutions into 10 clients in the insurance industry.  When you merge these two businesses and start cross selling their respective products to unique customer bases, now 1 + 1 = 4, as you double the size of each stand-alone business by selling new products into the other business's client base.  Look for M&A partners that help you accomplish this latter scenario, where you can.

Does the Transaction Improve Your Competitive Position?

Maybe two competitors are in an aggressive pricing battle, lowering their margins farther than they need to.  By combining, they may be able to raise their prices and margins as one company.  Or, maybe a #2 and #3 player in the market combine, to create the new #1 player in the market.  Or, as another example, maybe alone you have 50% dependence on one customer or industry, and combined with another company you can lower that dependence to 25%, making the business perceived as less risky to investors.  Think through these advantages when picking optimal transactions.

Are the Two Businesses Compatible With Each Other?

Mergers in business are very much like marriages between two individuals.  Make sure you date a while, before you combine forces.  Make sure the two businesses share one combined vision for their future.  Make sure the management teams get along, personality fit wise.  Make sure the two employee cultures will mesh well with each other. Do everything you can to reduce unwanted employee turnover in the wake of the transaction.  If the businesses are not compatible, move on.

Assuming you have good answers to the above questions, you are probably in a good position to proceed with your transaction.  But, if you can't craft the right logic, or any warning bells are going off in your mind, it is best to walk away.  Too many things are naturally going to go wrong post an M&A transaction.  You don't want to go into it with known hurdles out of the gate, as it will most likely result in a big distraction and disappointment for you and your shareholders.

Be sure to re-read Lesson #225 on other potential M&A pitfalls to avoid.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #233: Key Red Flags for Startup Investors

In Red Rocket’s Definitive Checklist for Startup Success, we detailed the many things that startup investors are looking for before making an investment.  But, I didn’t really talk about the potential red flags investors are hoping NOT to see.  To that regard, I recently a read a good book called The Art of Startup Fundraising written by Alejandro Cremades, a serial entrepreneur and co-founder of Onevest, a venture investing community platform.  One of the chapters in Alejandro’s book specifically talks about these red flags for investors, and Alejandro was kind enough to let me share that list with you.

Too Many Members of the Founding Team

Giving equity is a great way to motivate and enroll the help of more individuals when your startup is lean on cash. This can be applied to cofounders, key team members, friends and family investors in the seed stage, and even advisors and professionals such as lawyers. However, too much equity in the hands of too many (especially inexperienced) early shareholders can be problematic. Even too many team members at the beginning can be problematic from an investor's point of view. So, keep your fundraising goals in mind when hiring and considering bringing on cofounders.

Overhead Is Too High

If overhead is already too high, or the profit margins are going to be too small, investors should rightly be concerned. One of Sam Walton's core principles when building the Walmart empire was to always control costs better than the competition. That's where he found his advantage, and sustainability. Not everyone wants to run a discount business, but there is no lack of scale or revenue at Walmart.

Buzzwords

Peter Thiel at Clarium Capital says that the use of buzzwords is one of his pet peeves and biggest turnoffs. Forget the jargon when speaking with investors. Deliver substance.

Founders Have Other Jobs

Is this just a hobby for the founder? A part-time gig? Or are founders really serious and dedicated to making this work? Are founders available enough, and at the right times, to make the venture work?

Founders Have No Other Source of Income

Don't expect investors to be throwing millions on the table for you to go off and buy a bigger house, get a new car, party half the week away, and generally upgrade your lifestyle. This is money to use to carefully and prudently grow the business. Investors may be split on whether it is better for startup founders to have another job or not, but those without another source of income or some financial reserves could be prone to making rash mistakes. Whatever your situation is, make sure that you can eloquently convey the pros and cons.

Poor Credit Ratings

You may have been beat into foreclosure and default on almost everything back around 2008, but what does your track record look like before and after that blip? If there are small charge-offs you can pay off, does it make sense to clear that up? Are you up to date on your taxes? Failing to pay taxes as a business and business owner can be catastrophic for everyone involved. If you are at risk of being hit with a federal tax lien, consider at least working out a payment agreement with the IRS.

Weak Marketing Plans

Scaling and generating real revenues is going to require a realistic and aggressive plan. If this isn't your area of expertise, look for guidance.

Relying Only on Paid Advertising

Building on the previous point; startups can't rely only on paid advertising. Especially if they have only identified one or two channels to use. There may be times when funds are tight, and you need to be able to generate sales regardless of fundraising success, and profits and profit margins will be a lot better if there are other sales channels working.

Blind Optimism

You have to be an optimist to launch a startup, but unrealistic, blind optimism isn't going to sell investors, and it isn't going to make for a sustainable startup. Be positive, but acknowledge the real challenges that exist too.

Claims of Having No Competition

Claiming you have no competition is a sign of being overly optimistic. There will be the potential for some form of competition. Recognize it, and admit it, and you'll gain credibility and investors will be confident that you are on top of it.

No Technical Founders

If you aren't technical, and you have no technical founders, that means there will likely be significant cost in paying for technical development and maintenance. That is a hard cost that the venture may not survive without. Contrast that setup with having at least two or three cofounders who cover all of the main functions and skill sets.

Asking for Too Much or Too Little Capital

This can be a red flag that founders may not really know that they are up against. Don't be too shy. Don't forget that you can raise additional capital in further rounds.

Poor Use of Previous Funds

Startups that have burned through previous rounds of funding without generating results can be a scary proposition. Note that this doesn't necessarily have to mean break even or, in some cases, revenues. Some of the biggest stories of recent years appear to have changed these rules. However, you've got to have something to show for it.

Early Investors Not Participating in Additional Funding Rounds

If previous investors are not getting in on a round, that can definitely be a bad sign. If there is a good reason for that, make sure to address it proactively, rather than allowing it to work against you.

Entrepreneurs Have No Financial Skin in the Game

When launching a startup, entrepreneurs know they are going to be putting in a lot of time and energy. But many have no financial skin in the game. It's not really about the amount, it is about equal risk sharing. You are probably looking for investors who will not just bring money, but will also put in some work. You want them to bring some effort, their contacts, their expertise, and a lot of money to the deal. From the other side of the table, it makes investors feel a lot better if founders are putting some money in, too.

Lack of Momentum

Even if you haven't raised any funds before, it is critical to track and show progress. It doesn't have to be huge. It can be revenue, users, market share, or another metric you are focusing on. But make sure you are tracking and reporting traction and momentum.

Moving the Ball Forward . . .

Being alert to these red flags, and tackling them in advance is smart when it comes to clearing the path to getting funded fast. To save precious time, be prepared, streamline the process, clear any potential hurdles, and find the most efficient method of raising capital. Ultimately none of the red flags above are a show stopper by themselves. As a founder, what you need to do is keep the red flags to a minimum and have plans in place to correct them.

Thanks again Alejandro for sharing these excellent points with the Red Rocket readers.  You can learn more about Alejandro on his LinkedIn profile, and you can follow him on Twitter at: @acremades.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #232: Do You Own the Copyright to Your Own Technology?

Back in Lesson #70, we talked about the importance of protecting your intellectual property.  But, that was focused mostly on your brands and your trademarks.  It is equally important to make sure you have the appropriate contractual paper trail to prove you in fact own all of the technologies you are building through third party contractors.  To help me with this post, I thank Steven Buchwald, a startup attorney in New York at Buchwald & Associates, for his wisdom on this topic.

DO YOU OWN THE COPYRIGHT TO YOUR OWN TECHNOLOGY?

That’s not as unusual a question as you’d think - many startup founders don’t. Creations such as graphics, web design templates, and software are all governed by copyright law, according to which the copyright owner is the creator/author of a given work. The company commissioning the work, meanwhile, has no ownership unless a written contract exists that speaks to the contrary.
What this means is that every time a developer or designer works on a site without a sufficient contract, they’re the ones that own the content they create - not their client.

THE IMPORTANCE OF A GOOD CONTRACT

In situations like this, copyright law seems more counter-intuitive than protective. After all, when you a hire a designer, they’re creating something for your company that they wouldn’t have otherwise thought to make. Why should they own the rights, rather than you? Unfortunately, this is simply how the law is structured, and even a written contract on its own isn’t necessarily enough.

Although a copyright transfer must be in writing in order to be effective, intellectual property law often requires time-tested “magical language” - legalese and formulaic wording - in order to be valid. A contract which lacks this language offers little to no protection. It’s therefore imperative that you have your lawyer draft contracts that include a binding, accurate intellectual property clause.

This isn’t simply a matter of content ownership, either. Imagine the ramifications of not owning your own logo - the primary image of your brand. Imagine how it might impact your core business if the source code of your site belonged to someone else.

In some cases, lack of contracts may even impact your startup’s ability to receive funding. VCs and angel investors alike diligently examine whether a company has ownership of its intellectual property before putting forth capital. If you don’t own your own content, many will abandon your startup and seek out one that does.

THE CAUTIONARY CASE STUDY OF MIKKI MORE

These are not simply empty warnings, either - there is legal precedent for our discussion here.
In Smith v.  Mikki More LLC, a startup hired one graphic designer and one website developer. The designer was responsible for designing labels, packaging, and advertisements for the startup products; the developer was responsible for the creation of the company website.  Neither agent signed a written contract with the company.

When Mikki More failed to pay the service providers their agreed-upon compensation, the case eventually went to court. There, it was found that Mikki More was, at best, the holder of a non-exclusive license. As explained by the court, “ownership of a copyright or an exclusive license can only be transferred by an “instrument of conveyance, or a note or memorandum of the transfer” signed by the owner of the right.”

Because there existed no IP contract between Mikki More and its service providers, they were able to cancel the company’s implied permission to use their work. Without such implied permissions, the startup was placed in the awkward position of infringing upon the copyright of the very content it had hired the contractors to create.

Mikki More attempted to argue that it was a co-author of the commissioned work. It had, it maintained, contributed the product name, the outline of the marketing story, and the font.  This argument ultimately fell flat - none of these were independently copyrightable contributions.
Indeed, according to the proceedings of Gaylord v. United States, “a person who merely describes to an author what the commissioned work should do or look like is not a joint author.” Only the person actually doing the work is deemed to be the copyright owner of such a work.

Accordingly, the court found the startup guilty of copyright infringement for using its own website and package designs.

THE KEY TAKEAWAY

Service providers must sign a contract transferring the legal right to their work over to you - if they do not, they remain the copyright owners. Further, never fail to pay your service providers in full - not only is nonpayment bad business, it also gives them the right to revoke permission to use their work, placing you in the same situation as Mikki More. That is, you could be committing copyright infringement simply by using your own website, app or other technology.

Thanks again, Steven, for helping me research these very valuable insights.  Feel free to reach out to Steven at 212-729-8505 or via his Buchwald & Associates website, in case you need any help with your contracts or other questions here.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #231: The War Between Driving Growth and Profitability

I have previously written about WHEN it is better to drive growth vs. profitability.  But, what wasn’t clear in that post, which I want to better explain here, is it is mathematically impossible to try to maximize growth and profitability at exactly the same time.  The math just doesn’t work.  And, for the many companies I meet that are trying to do both, I figured you could benefit from the below reality check.

The Math

What specifically drives growth?  More salespeople for B2B companies and more marketing budgets for B2C companies.  And, both of these typically have a ramp up period before they are driving revenues.  For example, if you are selling enterprise software, you most likely will be incurring salaries for your sales team today, well ahead of the sale actually closing a year from now (given the long sales cycle).

Or, as another example, many B2C companies rely on a high lifetime value of their consumers to get a payback on their upfront marketing investment to acquire that consumer.  Said another way, they may need to spend $100 in marketing today, which may drive $500 in cumulative gross margin over five years, at $100 per year (with a break even in year one, and profits starting in the second year).  What did you see in both examples above?  Growth comes with near term costs which eat into the company’s near term profitability.

You Need to Choose Between the Two Roads

I won’t reiterate WHEN you should focus on driving growth vs. profitability, as I already did that in the linked article I referenced above.   But, understand, you need to pick one route or the other.  You are either in a rapid growth phase with near term losses before the revenues show up.  Or, you are in maximizing profit phase, which means lifting off the accelerator, and cutting back on your sales and marketing expenses. 

As an example, a 40% growth company may be operating at a break even, and a 10% growth company may be operating at a 20% profit margin.  If you are committed to driving both, you really only have one option: a medium growth scenario that drives medium profits.  Continuing the example above, this could be a 25% growth company driving a 10% profit margin (the midpoints of the above examples).  But, to make it clear: using the above examples, it is mathematically impossible to get a 40% growth rate and a 20% profit margin at the same time, so don’t even waste your time trying.

Which Road Do Investors Prefer

Since many of you desire to attract investment capital for your business, it is a fair question to ask which route investors prefer.  The answer is:  it depends what type of investor you are trying to attract.  Most venture capital firms are perfectly fine sacrificing near term profitability in exchange for maximizing growth.  Frankly, many venture investors who see a race to lock up market share as a first mover in your space, may want you incurring big losses in the near term to sign up as many customers as possible today, before a competitor does. 

On the flip side, most private equity firms need some base level of profitability before they will invest, as they will most likely want to lever up the business with debt, to reduce their equity investment.  And, debt service will require cash profitability to pay the interest expense on that debt.  So, if you are trying to tee your company up for a sale to a private equity firm, that would be a good time to lift off of the growth accelerator and start driving some profits.

Closing Thoughts

As a marketer, it baffles me when a business leader doesn’t truly understand what drives growth.  Growth doesn’t just happen on its own.  You need to invest in growth by increasing expenses around your sales and marketing investment.  And, the minute you say expenses need to increase, that means profits only have one way to go: down!  So, be smart, understand the basic math and pick which route is best for your business.  But, to be clear, it is a fork in the road where you will need to decide between the two options.  As trying to maximize both at the same time is a fool’s errand.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #230: Evolve From Selling 'Widgets' to 'Wisdom'

When I previously wrote about the 1,024 different types of salespeople, one of the variables I talked about was the difference between selling simple products vs. selling ones that are much more complex and consultative in nature.  I like to think of that as the difference between selling “widgets” vs. selling “wisdom”.   This post will help you understand the difference between the two, the advantages of selling wisdom, and how to effectively transition your selling efforts towards selling wisdom.

The Difference Between Widgets & Wisdom

In one sentence, selling widgets is basically selling things, and selling wisdom, is selling actionable insights with the data coming out of those things.  So, as example, let’s say you are an advertising platform (a thing).  There are plenty of other advertising platforms in the market where advertisers can be matched to publishers.  And, with high levels of competition, often comes a lot of pricing and margin pressure on the players in that space.

On the flipside, there is a lot a data running through that advertising platform.  If you can create algorithms that help the client make better advertising buying decisions, comparing which campaigns did better or worse, or clearly calculating product sales sold from each advertising campaign, now you are selling wisdom.  And, once clients are making decisions on the wisdom coming out of your system, it is like an addiction that makes it very difficult for them to switch to a competitor.

The Advantages of Selling Wisdom

So, as seen in the example above, what are the key advantages of selling wisdom?  Firstly, it is very sticky.  Once you are in the company, and proving you are helping your clients make everyday decisions, they are very unlikely to kick you out, especially if all their internal reports are built off the intelligence coming out of your systems (where they are going to want to maintain consistency).

Secondly, wisdom is harder to compare from vendor to vendor, and hence, makes it less subject to intense price competition.  Once the customer trusts you are helping make their business “smarter” and more efficient in the ways it deploys capital, they will really compare your prices to the value of revenues or costs savings you are powering for them (not to the prices of your competitors, whom they have not yet tested, and will be afraid to swap out).  Compare that to selling a widget, which can look very similar from one vendor to the next, leading your prices and margins into a race to the bottom.

Thirdly, customers pay up for wisdom, far more than they are willing to pay up for widgets.  So, most wisdom sellers see a material increase in their average ticket, the farther up the “wisdom curve” they evolve their product or service.  So, you don’t need to sell as many wisdom customers, to drive the same amount of revenues you are driving from widget sales.

How to Transition Your Sales Efforts Towards Selling Wisdom

Shifting from selling widgets to selling wisdom typically requires these three evolutions:  your product, your marketing messaging and your targeted sales clients.  As for your product, it is a pretty intuitive change:  instead of simply building a product, figure out what data can come out of that product, how that data can be synthesized down into actionable insights, and be clearly communicated to your clients.  Worth mentioning, the more beneficial the dollar impact from your wisdom, the better.  As an example, if the wisdom can lead them to a 20% lift in revenues or cost savings, that is a lot better than simply helping them drive a 5% benefit.

Once, the wisdom is flowing, you need to educate your widget clients that your new wisdom solutions exist, with a clear overhaul of your product marketing materials.  For example, you should no longer lead with the “what” of your product; you should lead with the “why” coming out of the data from your product and the “how” to make such insights actionable.  

And, this last point is perhaps the most important:  the individual person you are selling the wisdom to, is most likely a materially higher level inside your client’s organization than the person you are selling the widget.  Mid-level managers have the decision making authority on widgets, and they most likely don’t really care about the wisdom, or the accountability that comes with that wisdom. But, their bosses, and the bosses of their bosses at the executive level are assuredly interested in any wisdom that can help them better improve their business economics and ROI.  So, that means you need introductions into higher levels of your client’s organization, or new salespeople all together that are pros in consultative selling, with the right rolodex of senior level relationships interested in buying wisdom (it is very unlikely your widget seller can effectively evolve into a wisdom seller, as the skills are quite different).

Case Study

I had one client that was selling widgets, and giving away insights reporting pretty much for free.  But, as I studied their business, it became clear to me that the widgets were really becoming a commodity in their industry, and prices were on a free fall in light of increasing competition.  But, what really made this company unique, was the actionable insights that could be gleaned by the data coming out of the widgets, which no other competitors were offering.  So, we flipped the model:  we stopped leading with widgets, and instead, lead with wisdom sales, giving the widgets away as free enablers of the wisdom.  Sure enough, the average ticket on a new sale increased from $20,000 for a widget to $200,000 for the wisdom, and the company is off to the races.

Conclusion

Obviously, not all companies are in a position to sell wisdom (it is hard to drive wisdom from a hammer, as an example).  But, if your widgets can be technology enabled, like many of the new innovations we are seeing in the Internet of Things boom, the sooner you can start harnessing the data coming out of those widgets, the sooner you can start selling intelligence, and the sooner you can be having a material and beneficial impact on your clients over the long run.

For future posts, please follow me on Twitter at: @georgedeeb.