Business

There's no business like show business, but there are several businesses like accounting.



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Other posts that may be of interest:

Entrepreneurial Law - Developing a Good Business Model
Culture of Private Equity
A World of Private Equity
Rules of Funding
Entrepreneurial Law - Proof of Concept & Proof of Scale
Fatal Flaws in Leadership
Keep the Good Ideas Coming but Stay Focused
Business Law - 10 Common Negotiation Mistakes
Funding Law - Presentations to Investors

I have heard this "problem" stated several times from private equity investors angel investment groups over this past year, "We are just not seeing any good deals lately."  The Halo Group, an Indianapolis-based angel investment group focusing on emerging technology companies, canceled its March meeting due to a stated lack of deal flow. 

Halo members, like most private equity investors, want to invest in businesses with proven markets and executives.  They, like most investment groups, also want to see a revenue stream before they will cut a check.

My firm works with a number of businesses seeking funding.  I believe we go miles further than most law firms in helping companies pursue funding because we get involved in improving business and capital models and leadership coaching - not just drafting investment documents.  We have helped six clients obtain funding so far in 2010.  

If the problem is in fact a lack of good deals - this should create an opportunity for better business models to pursue funding.  Now is the time to strike.  Now is the time to revise and revamp your business model to create a "good plan" that investors want to see.


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Other posts that may be of interest:

Fatal Flaws in Leadership
Talent is Overrated
Keep the Good Ideas Coming but Stay Focused
Business Law - 10 Common Negotiation Mistakes
Funding Law - Presentations to Investors

I wrote a post a few weeks back on B2B, B2C and C2C technology companies in Indianapolis.  Here are a couple of paragraph excerpts:


It makes sense to me that local investors are less interested in investments in C2C companies.  C2C Internet companies, usually social media sites, build scale rather than profit in the early years.  The company value is ultimately in the consumer database that is built over time rather than well thought through cash flow models.

Savvy venture capital and private equity investors who invest in C2C companies hedge their bets by investing in several C2C companies in a given period of time.  C2C companies are high risk - they usually will either be phenomenal and show a 150x return or more or they will crash and burn.  Let's say 1 of 10 C2C companies is successful - a wise investor will hedge his investments and put money in 10 to 20 companies over a period of time - knowing that most will crash and burn but a couple will work out.  The success stories realize a return large enough to make the entire portfolio of investments worth while. 

In a market like Indianapolis, which has not fully embraced C2C business models, I have seen investors invest in 1 or 2 C2C companies in their portfolio of investments made up mostly of B2B and B2C companies.  This seems like playing roulette with all money on one number. 

In my recent blog series, Entrepreneurial Law - Developing a Good Business Model, I addressed how an entrepreneur needs to work through three prongs in order to develop a sustainable business model developed for growth: Market Opportunity; Management Team; and Capital Structure.

Private equity investors asses the same prongs when determining whether to make an investment in an emerging company, but I find that investors tend to set the prongs in their own priority ranking.  I think all three must be in place, but investors always seem to have one prong that they really focus on. 

Some of this is cultural based on geographic region.  Take New York, Midwest and West Coast investors for example.  I do a lot of work with private equity groups in each region and consistently find investors in each region to rank the prongs in levels of their own importance.  Here is what I find:

New York (financial center of the world):
1.    Capital Structure
2.    Management Team
3.    Market Opportunity

West Coast (land of emerging technology businesses and venture capital):
1.    Market Opportunity
2.    Capital Structure
3.    Management Team

Indiana (my home; land of hard work and community)
1.    Management Team
2.    Market Opportunity
3.    Capital Structure

Consider this if you are looking for private investors in your business.  This affects how you may address certain investors and where you look for investments.

See also:

Entrepreneurial Law – Developing a Good Business Model – Part I
Entrepreneurial Law – Developing a Good Business Model – Part II
Entrepreneurial Law – Developing a Good Business Model – Part III
Entrepreneurial Law – Developing a Good Business Model – Part IV
Entrepreneurial Law – Developing a Good Business Model – Part V

This is the fifth and final post in a series on developing a good business model for an early stage company.

3.  Sound Capital Structure.

I am not sure that enough could be said about this point, but I see so many business plans that only address market opportunity (with all the MBA highlights) and how smart the management team is but then ignore financial structure that I feel it must be addressed in some detail. 

A good financial model is one that starts with costs and then approaches revenue.  After all, for almost every early stage company, most costs can be fixed.  A good financial model should be able to nail expenses for 1st year operation within 5% of the budget.  This takes discipline – both on uncovering assumptions and implications when budgeting and in living to the budget after it is set.  Most variable costs should be tied directly into revenue (i.e., when revenue increases, these costs increase in proportion).  So, we don’t care as much about those.  In my first year of operating Alerding Castor Hewitt, I missed my expense projections by $27 – and it was not that hard to be that close. 

Revenue projections are harder.  Once you have good expense model, you develop your product price point and do your market research, you should be able to develop a reasonable break even analysis and first year revenue projections.  That is goal one.  You will need to talk to customers to develop the POCP (see my earlier post in this series about Proof of Commercialization at Profit under Market Opportunity) - ignore the hoopla but focus on what customers will actually write a check for.  Address every assumption and implication in your financial projections.  For every number you should be able to explain the story underlying that number.

Depending on the capital structure developed, you will need to address your strategy.  Most companies fall into one of three capital strategies: (1) Boot-strapping, (2) debt financing, or (3) raising private equity.  Don’t be too quick to jump to #3.  Raising capital from private equity firms, angel investors or venture capitalists is a hard process.  It will take over your life for a period of time and is a variable that is outside of your control.  I have seen many business die in this stage.  Only take on investors if you NEED investors. 


See also:

Entrepreneurial Law – Developing a Good Business Model – Part I

Entrepreneurial Law – Developing a Good Business Model – Part II

Entrepreneurial Law – Developing a Good Business Model – Part III

Entrepreneurial Law – Developing a Good Business Model – Part IV

I was told this past year that I am a "numbers guy".  Honestly, I think it was intended offensively, but I didn't take offense to it.  I was reminded of this recently when I read, and laughed at, this quote on Twitter:



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Other posts that may be of interest:

A World of Private Equity
Two Types of Violations in Private Equity Offerings
Rules of Funding
Entrepreneurial Law - Proof of Concept & Proof of Scale
Fatal Flaws in Leadership
Keep the Good Ideas Coming but Stay Focused
Business Law - 10 Common Negotiation Mistakes
Funding Law - Presentations to Investors

This is the forth post in a series on developing a good business model for an early stage company.

Here are some additional points to consider when structuring a management team:


See also:

Entrepreneurial Law – Developing a Good Business Model – Part I

Entrepreneurial Law – Developing a Good Business Model – Part II

Entrepreneurial Law – Developing a Good Business Model – Part III

Funding Law - Know Your Assumptions

Funding Law - Plan Your "To Market" Strategy

This is the third post in a series on developing a good business model for an early stage company.

2.    Solid Management Team

I have heard it said that more businesses fail due to cash flow than anything else.  I completely disagree.  I say that more businesses fail due to management team issues than any other reason.  If a company dies because of cash flow, it is usually because the wrong person was at the helm and poorly planning and/or making bad decisions – either market opportunity was not adequately addresses or expenses were not properly managed. 

Likewise, unmanageable disagreements and in-fighting amongst a leadership team kill a ton of companies.  Developing a solid business model MUST include an organization of the right players on the management team of the business.

Here are some points to consider when structuring a management team (list will continue in next post in series):


See also:

Entrepreneurial Law – Developing a Good Business Model – Part I

Entrepreneurial Law – Developing a Good Business Model – Part II

This is the second post in a series on developing a good business model for an early stage company.

Proof of Scale and Proof of Commercialization (at Profit)
 
Following POC, you want to prove that your concept can scale under a viable business model.  Proof of Scale and Proof of Commercialization (at profit) work hand in hand as each is often dependant on the other.  POS refers to the ability for a concept to scale in terms of sellable units in the marketplace and business growth requirements.  POCP refers to the ability for the scaling product to be accepted in the marketplace at a price point that leads to company profit.

My business law practice is a lousy scalable business model.  All I have to sell is my time.  After my time capabilities are used up, I can only scale by hiring other expensive professionals who sell their time.  Of course, each of them is capped by how much time they can sell.  The only way to make more revenue is to hire more folks and make more sellable hours available.  As a result, this increases my overhead and directly impacts POCP.

An example of a good POS model is business-to-business SaaS.  In fact, this is one of the most scalable business models I have ever seen.  For most B2B SaaS models, once the first version of the SaaS application is launched in the marketplace, the variable costs are tied directly to revenue.  The ability to hit new customers is wide.  Geographic boundaries are nearly non-existent – excepting language barriers.  Additional subscriptions means additional revenue means more hosting and support costs – but these costs are directly tied into higher revenue. 

The final proof is commercialization at profit.  This is basic supply vs. demand meets cash flow analysis.  There is no point in the expending the blood, sweat and tears (and expense) of scaling a business if there is not a profitable goal.  At what point does the company break even?  Are there profit steps, peaks and valleys or a consistent profit curve in the cash flow projection graph?  How do you prepare for each?  Some business models require huge customer buy-in before they can be cash flow positive.  Others need very little.  Which is yours? 

See also:

Entrepreneurial Law – Developing a Good Business Model – Part I

Entrepreneurial Law - B2B, B2C and C2C

Good Metrics

SaaS Law - Market Growth

Any good business model includes: (1) a strong market opportunity; (2) a solid management team; and (3) a sound capital structure.

This is the first in a series of posts that will outline each point. 

1.    Strong Market Opportunity.

This is more than just finding a market opportunity that you want to address.  It involves development of a detailed model of what the opportunity is (“IS”), how you can address it better than anyone else (“HOW”), and how you can be profitable in doing so (“PROFIT”). 

I see a lot of business plans that address the IS and HOW but ignore PROFIT.  To satisfy the IS, HOW and PROFIT, I have organized three proofs for the business owner to satisfy:

At its heart every company has a concept to prove.  This step arises after you identify the problem in the market that you want to solve.  It is the first step to prove that you can solve the problem. 

In my business, for instance, the proof of concept is simply to prove that I can provide excellent legal council in areas of business law, entrepreneurial law, SaaS law, and funding law that helps clients through their business growth phases. 

For companies outside of professional services fields POC can be more difficult.  For a web analytics company, for instance, a basic software design and build will put out a POC product that can run and analyze data and provide basic results.  The design and build may also include user interface.  These steps can costs between $30,000 to $200,000 depending on the complexity of the design and build.  It is only after the design and build that you know, at the highest level, that you can solve the problem you identified in the marketplace. 

I just returned from the Masters.  What a thrill.  Augusta National is quite possibly the most beautiful place on earth, and the golf was stellar.  My dad and I spent much of the two days stationed around Par 3s.  We spent Saturday on the 16th green where we were 20 feet from the golfers as they putted.  You could see the green of hole 15 and the tee of for hole 17 from our spot.  On Sunday we spent the morning at hole 6 and the afternoon on amen corner – just beside the tee on hole 12 where you could see the green of hole 11, all of 12 and the tee of hole 13.  Amazing.

Last year I wrote a post on the similarities in mental dichotomies seen in golf and business.  On the one hand great golfers and business leaders painstakingly train and plan.  On the other hand, they have to maintain simplicity and execute.

In golf you train on details.  Keep your head down, swing through ball, pay attention to stance, keep your knees bent, have your elbows create a “V”, swing through waist, maintain balance…  But you also have to just relax, stop over thinking it and swing. 

In business good planning is a must.  Train yourself on cash flow management.  Learn from professionals.  Spend time on product development and marketing plans.  There should be no assumptions or implications in your business model.  Everything should be thought through.  But good planning without execution is wasted.  You must find a time to pull the trigger.  You must keep the business model simple.

This is what I stated in my blog post last year:

I had the privilege of speaking at the Rainmakers Incubator event this morning.  I thought the Rainmakers team did a nice job organizing the event - even with a last minute change in location due to factors outside of their control.  Thank you guys for the opportunity to join you this morning!

The topic given to me was "Three Things Every Entrepreneur Should Know."  My legal practice focuses on entrepreneurial law, funding law, SaaS business law and securities law.  In these fields I see a lot of business models for emerging companies and read a number of business plans - close to two a week.  When the topic was given to me I figured that the talk would be easy to organize as I review every business model under a 3-prong analysis. 

So, here is the cliffs notes version of my talk. 

There are 3 things that any successful company must have in order to be successful:

1.  The right market opportunity
2.  The right management team
3.  The right capital structure

If any of these are broken, move on - the business will fail.

The right market opportunity is more than just a great idea to hit a hole in a market.  The entrepreneur (or private equity investors) should satisfy 3 proofs:

1.  Proof of Concept
2.  Proof of Scale
3.  Proof of Commercialization (at profit)

For management team, beware of the scientist syndrome.  If the visionary is a scientist whose ultimate goal (in all honestly) is to advance his science, move on.  If the visionary does not understand corporate finances or cash flow models, move on.  Take on partners ONLY when you NEED them - not just when you like them, are buddies with them, or are related to them.

For capital structure, if you are raising private equity, set specific goals and milestones for equity raises.  Consult with a securities attorney who not only understands the law related to equity raises, but also understands how to get deals done. 

Side note - most attorneys don't understand the private equity landscape.  Don't hire your cousin the divorce attorney to help you with your equity raise.  Of those attorneys who understand securities law, all of them should be able to draft investment documents for you - but that is the easy part.  Find one that understands corporate finance and will help you model your capital strategy and help you meet investors.  That is the harder part - and I meet very few attorneys that are capable or willing to do this.  This is a point that I believe sets my firm aside from most.

If you are not raising capital, be specific on your cash flow projections.  Revenue projections should be an educated guess, but expenses can be largely known.  Most early stage companies have more fixed expenses than variable costs for their first year or two.  There is no reason that you should not be able to budget for this and keep costs under control.

I love Indianapolis, but I find it a difficult place for emerging companies to raise capital through private placement offerings.  More established companies have less trouble, but earlier stage companies often are caught in a chicken/egg situation – they need capital to move to the next business stage, but private equity investors don’t want to invest until they are through that next stage.

Part of what makes Indiana so great is that we are very fiscally conservative. In fact we were one of only three States with a budget surplus in 2009.   Private equity investors in Indiana seem to be willing to accept lower expected returns for lower risk investment opportunities.  That does not bode well for early stage companies as seed stage and early round equity raise companies are often seen as too high risk for investment. 

There are some exceptions.  Gravity Ventures, for example, is a private equity fund that invests in emerging stage companies.  Also, Indianapolis is home of some angel investors and angel investment groups that are true patrons for the entrepreneur and have a passion for helping early stage companies.  But, we don’t have enough of these funds and investors to take care of all of the great companies that are started in this city.

This is why I travel as often as I do to California and New York – to build relationships with investors and investment groups that make investments in companies in emerging stages.  Coastal investors appear more risk tolerant than Indiana investors.  They are not foolish (their due diligence processes often greatly outweigh what I have seen in Indiana), but they are willing to take more investment risk in hopes for higher returns.  One particular CA investor this past week was telling me about a 40x return on a 4 1/2 year exit off of a $200k investment.  That is $200k to $8M in less than 5 years.  Key to such a high return was the investment at the seed stage.  Of course, what he is not telling me is that he hits 1 for 10 of good returns. 


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Other posts that may be of interest:

A World of Private Equity
Two Types of Violations in Private Equity Offerings
Rules of Funding
Entrepreneurial Law - Proof of Concept & Proof of Scale

What happens if you do not follow securities law procedures to a "T" in private placement offerings?  The answer is messy.  In large part it depends on what type of securities law violation you are talking about. 

The first type of violation is procedural.  Examples may include a company relying on a 4(2) exemption but offering certain securities to non-sophisticated investors (which is a Section 4(2) requirement).  Another example may be simply failing to make, or untimely make, a securities filing.  

The second violation type is related to securities fraud.  Examples of this may include failure to disclose material information (e.g., financial data, relevant risk factors) or making misleading statements in a private placement offering documents.

Obviously the damages for the second type of violation are much more steep than the first.  For the second, civil and criminal damages are in the minefield.  Think Martha Stewart for worst case scenario.  Civil damages are similar to other fraud claims and can include punitive damages. 

The hard thing about securities fraud, as opposed to other areas of fraud, is that it does not require reliance on the part of the investor in order for the investor to have a solid cause of action.  In standard fraud claims a person has to show that there was a misrepresentation of a material fact which was relied upon by the person that resulted in damage to that person.  In securities fraud, you remove the reliance element.  It makes it borderline strict liability.  This is why full disclosure of terms and risk factors at the time of the offering is so important.

For procedural violations, damages are all over the place, ranging from “no harm, no foul” slaps on the wrists to rescission of the investment, plus interest  Note that certain procedural violations can give rise to fraud and open damages to those Martha Stewart levels.  One of the more common procedural violations is when companies ignore securities procedures and either make public solicitations of private securities or make offerings to investors who are not classified under the appropriate guidelines of the exemption rule which the company is filing under. 

For instance, certain securities exemptions allow for unlimited accredited investors and up to 35 non-accredited investors.  If a company sells securities to 36 non-accredited investors, a procedural violation has occurred and may give rise to a right to rescission from investors. 

Of course this is the fire hose version.  I am amazed at how much uncertainty there is from the SEC and courts in what damages to apply in certain common violations, but that is the simple truth of the legal landscape we live in.  Best thing is to walk the line and do the offerings and subscriptions in full compliance with the exemption rules.  Consult with securities attorneys, like those at Alerding Castor Hewitt, as you navigate through your private equity offering.

Last week I wrote a post entitled What Your Company Needs for Execution which addressed a business' ability to seize opportunities when they arise.  In this months Harvard Business Review, Donald Sull addresses seven points to consider on whether your company has good business execution practices.  Last weeks post addressed the first three.  Here are the next two:

This last week has been a whirlwind including trips to Scottsdale, AZ and Newport Beach, CA.  I first attended an ABA private equity conference in Scottsdale.  The focus was on securities regulations for exempt offerings.  Sounds boring, I know, and parts of it definitely were.  But this area of law is the foundation underlying my partnership with clients in their strategic growth and capital phases. 

Raising capital is both an art and science.  The art is in the structuring of capital strategies, tuning business models and presenting to investors.  The science is in the law. 

Regulation D and other exempt filing areas are very unforgiving and a constantly shifting area of business law.  Not following the strict procedures of offering processes and filing procedures can result in damages ranging from investors’ right to recession on investment to criminal actions for securities fraud.  The risks are too great to rely on assumptions, and the process itself really is not that difficult to follow - if you know what you are doing. 

This is an area of business law that most business owners don’t fully understand.  Thus, they rely on their attorneys for direction.  Unfortunately, I think a lot of attorneys take advantage of business owners in exempt securities transactions.  I have seen clients pay $20k or more in legal fees for attorneys to merely draft private placement memorandums and operating agreements.  Drafting is the easy part (and should seldom be so expensive).  A good business law/securities law attorney should get dirty in the more difficult aspects of private equity, helping in the capital structuring, business modeling and investor offering processes. 

After Scottsdale I flew to Newport Beach.  The CA leg of the trip served two purposes.  First, I visited with a client on Monday who is about three months into a merger.  The business doubled in size following the merger closing and is going through the cultural growth pains that companies often face after a merger or acquisition.  M&A deals have three components: Financial, Legal and Cultural.  The first two are squared away in deal documents.  The final is handled through good, old-fashion business leadership. 

I then met a SaaS business client on Tuesday for two strategic investor meetings.  The meetings went well.  The client recently issued a PPM, and I am very hopeful that we will have this client’s business funded soon. 

The week was crazy, but it proved beneficial.  That said, I am looking forward to being back in Indy.

Does your business take advantage of opportunities when they arise?  Or, like most businesses, do you watch competition seize opportunities before you consider or execute on them? 

There is a good article in this months Harvard Business Review by Donald Sull on a business’s ability to execute on opportunties.  It is a worth while read, but I will summarize the key points in the next three posts.

What your company needs for execution:

1.    The ability to spot new opportunities.  This requires the ability to access real-time data and share the data across the organization.  In my experience many companies have access to real time data, but they either do not know what data to focus on or have poor communication lines between different divisions of the company. 

2.    Strong operational hydraulics.  This is the ability of executives to convert organizational opportunities into operational objectives and priorities for employees (including measuring them on their goals).

3.    Rewards for performance, not mediocrity.  The business must create incentives that encourage individuals and teams to focus on the long term as well as short term. 

I particularly like the interaction of these three points.  They cover the ability to see opportunities, communicate opportunities, convert the strategy to operational objectives and creative incentives for the opportunities to be carried out. 

My business law practice focuses on helping companies and owners work through the complicated cycles of business growth.  My firm often takes a key role in the execution dynamics of our clients.  Our focuses in funding law, entrepreneurial law, strategic business and financial consulting, and our abilities to create more efficiency in the sales-process and contract negotiating ties us into this execution process. 

Consider how well your business addresses each factor and whether you need help in working through these dynamics.


Source: Are You Ready to Rebound?  Donald Sull, Harvard Business Review, March 2010.

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Other posts that may be of interest:

Fatal Flaws in Leadership
Talent is Overrated
Keep the Good Ideas Coming but Stay Focused
Business Law - 10 Common Negotiation Mistakes
Funding Law - Presentations to Investors

There is a good article on the Mercury News Blog today on How dot-com start-ups have changed 10 years later.  The article addresses the maturity of both technology companies and US private equity investors over the last decade.  It is an interesting read.

There has been a lot of activity in angel investor groups and venture capital investments in Indiana technology companies over the last few months.  2010 has definitely started with a bang at Alerding Castor Hewitt where we have helped five companies secure funding this calendar year.  I am traveling with two technology clients in a couple of weeks to meet with investors in Southern California. 

Still, the same rules apply when seeking funding.  An early stage company looking for funding must prove:



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Alerding Castor Hewitt, LLP is an Indianapolis law firm focusing on business law, information technology law (including SaaS law and legal technology consulting), private equity consulting, and business and Internet litigation.

A few years back, sometime in the mid 1990’s, while an undergraduate business student at Purdue University, a fellow classmate and I entered the Burton Morgan Entrepreneurship Competition.  We were the only undergraduate students chosen as top 10 finalists in the event – an accomplishment for which I am still quite proud. 

I remember the program as being challenging, informative and humbling.  Following rounds of having our business plan reviewed and commented on by professors, we presented to a panel of judges which was made by business owners, private equity investors, and professors.  The judges did not hold back on us.  They told us exactly where our business model issues were.  Most of the issues related to assumptions and implications underlying our financial projections and other business model variables that we had not taken into account.

I remember as a 21 year old being embarrassed by some of the points that we had not addressed in our plan, but the judges’ comments were not degrading – they were taken as a challenge and learning experience.  We did not make the top 5, but the experience was invaluable.

It is amazing that I use these same comments today as a business law / funding law attorney with my business law clients.  I review somewhere in the range of 75 to 100 business plans a year - either for clients seeking private equity or venture capital funding, for due diligence for clients looking to make investments, or for clients creating operational plans to launch out in their own venture.  It is interesting how many of these plans fail to address financial assumptions and implications and business model variables.

Today I am closely connected to two of my three alma maters – Krannert School at Purdue and Butler College of Business where I did my MBA.  Both schools have great entrepreneurship programs.  Last month I guest lectured at Purdue’s entrepreneurship capstone course.  Next month I am serving as a judge in their elevator pitch competition.  I also stay tightly tied in with Butler and have worked on business or private equity deals with certain professors at the MBA program.

This week Purdue announced their top 10 finalists for the Burton Morgan Business Plan Competition.  Our friends at Inside Indiana Business wrote a nice summary of the finalists.  Check out the article.