According to Slee’s research, the United States economy experiences a recession (or other economic downturn) during the first three or so years of every decade.  The capital supply to the private markets becomes restricted, primarily because lending is restricted, which reduces the leverage a buyer can achieve and lowers valuations as well as limiting access to working and investment capital.

This begins to transition around the fourth year as companies improve profitability which leads into a period of free-flowing capital into the private market.  Humans are creatures of habit, so we quickly forget the recession we recently survived and continue to spend and invest until we are over leveraged and over invested.  At this point, parts of the economy begin to feel the strain and the economy as a whole is affected by the end of the ten year period.

Why will such a cycle be expected to continue?  Because the nature of people, namely, the private business owners, bankers, investors, and politicians in America, is to be overly optimistic in the good times and overly pessimistic in the bad times.  We also take a predictable amount of time to adjust to changing conditions and we can be counted on to react in certain ways.

Today, the catalyst for our recession was sub-prime mortgages followed by complete financial system meltdown, bankruptcies, and major fiscal policy changes.  Impending commercial mortgage uncertainty will help us to remain in a deal recession for the next several years.  Business values will remain flat or fall further as we struggle to adjust.  But adjust we will (or go bankrupt) and the survivors will profit again.

In my last post on business value, I mentioned that you can expect to achieve the highest return when selling your business at the right market timing.  If the transfer cycle holds, the best time to buy a business will be any time from now through 2013 or so.  The best time to sell a business will be toward the end of the prime selling time, or roughly 2016 – 2018.  Obviously, businesses will continue to be bought and sold every day, but a savvy business owner will look to exploit this cycle to his or her advantage.

• A couple of guys are writing a “Google killing” search engine.  Glad they hooked up with Shaun McNerney!
• A young man just graduated from CU with a degree in marketing was looking for opportunities.  His dad was in tow as a potential investor and owner of several businesses himself.
• A client needed some tax advice (to which I was fortunate enough to know the answer – given that I’m not the tax expert at our firm!)
• A couple of high powered managers were bored at their current positions and looking for new challenges.
• Davin owes me a lunch (not sure why, but I’ll never turn down a free lunch!)

All that was in just 30 minutes and as I peeled myself away, I’m sure there were more interesting discussions and connections that I missed.  Next social is probably in the Fall sometime, so stay tuned and I’ll keep you posted!

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Etienne Hardre is a CPA with BiggsKofford Capital specializing in helping entrepreneurs answer these questions: How do I sell my business, buy a business, or grow my business?

MIT ENTERPRISE FORUM

The Clean Energy Revolution
Monday, May 3rd
2:15 p.m. to 5 p.m.

Part of the MIT Global Broadcast Series held at the Colorado Springs Technology Incubator. Registration includes the broadcast and a light dinner.

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PVG BREAKFAST

Alumni Session
Friday, May 14th – networking begins at 6:30 a.m.

What happens to companies after their 5-Minute presentation? Where are they now? Where are they going? Imagine what you could learn from those who have been there, done that. Reserve your seat.

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M-ME BREAKFAST PANEL

Product Pricing in a Challenging Economy
Friday, May 21st
7:00 a.m. to 9:00 a.m.

Economic value is a key component in the entire marketing mix of price, product, promotion and place. Take an in depth look at the process for modeling economic value. Advance registration required.

CREATING VALUE THROUGH SUSTAINABILITY

MIT ENTERPRISE FORUM
Tuesday, April 20, 2010
4:45 p.m. to 7 p.m.

Broadcast begins at 5 p.m., held at:
Colorado Springs Technology Incubator
3595 East Fountain Blvd., Colorado Springs, CO 80910

Reservations:
$15 includes the program and a light dinner. Reserve online now….

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PVG VOLUNTEER RECRUITMENT BREAKFAST

Wednesday, April 21st
7:30 a.m. to 9:00 a.m.

PVG is run by volunteers and we want you to join our ranks. Join us for breakfast at Marigold Cafe & Bakery to learn about volunteer opportunities and PVG committees. Register now for this free event.

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PVG SOCIAL
April Fool’s Party at Hondo’s

Thursday, April 29th
5 p.m. to 7 p.m.

Kick back and relax with Colorado Springs’ top entrepreneurs and business leaders. RSVP for this free event.

I love Colorado Springs because for a region of just over 600,000 people, we have a surprising amount of innovation and new business support.  For example, head over to the Colorado Springs Business Journal and read about the mentoring program Peak Venture Group has been offering for years.  Business advisors, successful entrepreneurs, educators, and seasoned investors all come together to support new business ventures and guide them toward growth, funding, and on to the next stage of their life cycle…nearly for free.

Check out the Middle Market Entrepreneurs, an exclusive program for executives of companies with either revenues of $5 million or more; or more than 50 employees.  These semi-monthly breakfasts are generally packed, which should give you an idea of the number of businesses based in the Pikes Peak Region that meet those criteria.

Shaun McNerny, a successful entrepreneur in several ventures including BitWeld, is running CXO Connect where executives of high tech companies can come together for a high caliber presentation and networking, again, typically for free.

I don’t even need to get into the Technology Incubator, Leadership Pikes Peak, Center for Creative Leadership, Tri-Lakes Business Incubator, High Altitude Investors, Manufacturing Task Force, the Bachelor of Innovation program at UCCS, Small Business Development Center, or a host of other groups, organizations, and programs all directed at fostering innovation, supporting small and mid-sized businesses, and developing the next market leaders in just about every industry.

If you’re an entrepreneur looking for the support of your community, come to Colorado Springs and we’ve got more support than you can handle.  If you’re already here, please get plugged in!  We have access to more knowledge, business acumen, and entrepreneurial power than most places in the world.  At the very least, give me a call and I’ll try to point you in the right direction.

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Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

This week was actually fairly average as far as the dollars invested, but it felt like a train wreck for most of the show.  Daymond was the only Shark really interested in any of the pitches and he convinced Kevin H to join him on one venture.  Together, they invested $290,000 in two companies for an average stake of just over 50%.

The night looked like it was starting off strong with Send A Ball.  These two ladies will ship an inflated ball with a message printed on it through the mail by slapping enough postage on the outside.  Cool idea and it seems to be popular enough to make them a living.  I do give them kudos for being among the few entrepreneurs pitching the Sharks who could actually explain why they needed $86,000.

Unfortunately, their killer phrase was: “We are slammed with orders!”  Seriously?!  Then why are you selling your equity?  Didn’t your CPA tell you there are factoring companies who will gladly finance those orders for you at a fraction of the cost of equity?  Heck, even a bank might do it!  Barbara said it best that Send A Ball just didn’t need the Sharks and Kevin H pointed out that there really weren’t any barriers to competition so the risk was too high.  Do they have a ball that reads “Research cheaper capital”?

Next up was Qubits who initially put the Sharks on their guard by voluntarily offering 51% of his company for $90,000.  Mark is from my old stomping grounds in Bend, OR, so I won’t be too hard on him.  Although he’s been marketing his construction toy product for over 2 years he’s only made $8,000 in sales, which in itself is a bad sign.  Kevin O asks if he’s approached the four major toy companies for licensing.  When the answer was no, the Sharks began dropping out one by one.  When Daymond was the only one left, he offered Mark the deal he was asking for but contingent on striking a licensing agreement with one of the big four.  Now why didn’t anyone else think of that?

Pillars of Slippers was dynamically presented by Nicole Jones with a pink Hummer and choreographed to hip hop music.  Definitely one of the most confident entrepreneurs, Nicole is hoping to franchise her home shoe party business and asked $150,000 for 15% of her equity.  That’s an initial valuation of $1,000,000.  So is this the next Mary Kay or Tupperware?  Unfortunately, while $64,000 in party-based shoe sales is nothing to laugh at, the $100,000 she was planning on charging her franchisees just doesn’t add up.  Why would someone shell out that kind of money just for the chance to work more than 150 parties a year for a normal salary?  And could a less outgoing person really expect to book almost half of every week with parties?  What makes any of that worth a million dollars?

Last but not least, what stops someone from doing shoe parties on their own for much less start up cost?  All Pillars of Slippers offered a potential franchisee was the car, the name, and their initial inventory.  Unfortunately, none of that is proprietary and all of the Sharks dropped out.

The trend of high valuations continued with Llama Brew whose request for $125,000 for just 10% equity puts their company at $1.25 million.  Seriously now, call a valuation expert or even your accountant and just ask for a simple estimate of your company’s worth before you make any kind of pitch to investors.  This couple may have a potentially good idea, but $4,000 total sales is almost worthless no matter how you slice it.  Needless to say, all Sharks were out.

At BiggsKofford we can do full business valuations but generally that’s more than our clients need.  We often do simple income value calculations based on a multiple of weighted average historical net cash flow or EBITDA.  Comparing that to net asset value is usually enough to give our clients an idea of what an investor might be willing to pay for their business.

The final presentation came from Alan Kaufman of Nubrella, whose completely redesigned umbrella allows for hands-free use in high winds, even when riding a bicycle.  At first, the style looked awkward and I wasn’t optimistic but the design works, it’s patented, and hey, most new ideas look strange to someone entrenched in the old ideas.  That doesn’t make them bad ideas.  Alan started by asking for $200,000 for 25% of Nubrella and ultimately struck a deal with both Daymond & Kevin H for 51%.

One of the things that sent off the warning sirens in my head is that he has invested $900,000 in this company to date.  What in the blazes have you spent that much money on?!  And why do you only need $200,000 now?  I would have been much more rigorous with my due diligence of his operations to date and would have required a clear schedule of how he expected just $200,000 to do what $900,000 could not.  My guess is that he’s not good at managing his financials and will likely be a money sink for Daymond & Kevin.  Experience tells me that design work and patents don’t cost that much and if his product makes a gross profit, manufacturing doesn’t lose him money.  I’m glad the Sharks negotiated a controlling interest because they can replace him with a more competent manager.  Of course, that’s all speculation and Alan did land the deal.

Another lesson comes courtesy of Legal Grind, the curious merger of low cost legal services and coffee house.  Yet another attempt at franchising, these poor folks have been working for 14 years and still had to come crawling before the Sharks to drum up capital.  If that isn’t a bad sign in itself, Barbara asked what the money would be used for and there was initially no answer.  Finally Jeff Hughes says he would hire legal counsel, even though he is a licensed attorney!

The real lesson comes from Daymond, though.  He mentions that he’s skeptical the franchise will attract interest and Jeff responds that they already have over 200 franchise requests.  An incredulous Daymond responds with an easy solution: take $20,000 down payments from 10 of the requestors and they would have the $200,000 they’re trying to get from the Sharks.  Indeed, if you already have orders, there are far cheaper sources of capital than selling equity.  See my post on Innovative Funding Strategies for a few ideas, including asking customers to prepay or borrowing against purchase orders.

One final suggestion for Annie and Jeff Hughes: it’s the Shark’s money, treat them with respect.  Whether Annie was nervous or angry at the way things were turning out, neither is an excuse for arguing with your potential investors.  These people are buying something from you, taking a risk on you, and tying their financial future with yours.  They have their reasons for joining you or leaving you and you will have to accept them or change their minds.  Trying to beat them into submission is not a good negotiating tactic.

On the positive side, Caffeindicator was one of the most polished business plans I’ve ever seen.  He narrowly targeted an extremely structured industry and planned to pit the four most common sweetener brands against one another in a war to either increase their own market share or suppress their competitors from increasing theirs.  He didn’t even care if people used the actual sweeteners!  By using the caffeine indicator on the packet, the customers would waste a packet that would increase the amount purchased by the restaurant and in turn increase sales for the sweetener manufacturer.

His presentation clearly indicated how he planned to leverage his patent in this space and it left the Sharks free to calculate their risk of success and return on investment, which is precisely where you want them to be.  Kevin H. pulled an amazing negotiation trick by rushing an answer from Michael Schiavone before Kevin O. had a chance to make an offer and while Robert’s offer was still on the table.  Pushed for an answer, Michael accepted Kevin H.’s offer which was the best on the table.

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The next episode of Shark Tank airs Friday, February 5 at 9/8c on ABC

This morning’s panelists:

• Matt Barrett, Colorado Springs Small Business Development Center
• Karl Dakin, DaVinci Quest, LLC
• Jeff Schneider, Entrepreneurial Finance and Accounting Services (This guy is everywhere!)

The moderator for today’s featured presentation was Jeff Chapman of Pivotal Path, LLC.  Each of the panelists was asked about creative ways for entrepreneurs to fund their companies.  Below is a brief list of their suggestions.

Investor-backed Bank Lines of Credit: Although this is a traditional line of credit from a bank, the difference is that a business that might not otherwise qualify on its own can achieve the same result by getting an investor (or investors) to sign a guarantee for the bank.  Provided the investors qualify for the line of credit, the business owner can generally get approved.  In exchange for the guarantee, the investor usually receives stock warrants.

Strategic Investments: These are investments made by other companies, generally strategic partners such as a key supplier or customer.  If your business is critical to another business or vice versa, consider exploring a strategic investment to support one another.  Another way to structure a strategic investment is for a manufacturer to build your first shipment in exchange for equity.  After that, cash flow can keep them paid.

Letters of Commitment: So, Wal-Mart is excited about putting your product in 500 stores as soon as you can produce 10,000 units.  Unfortunately, you’ll need a large amount of cash to ramp up manufacturing operations.  If your key customer will sign a commitment letter promising to purchase a certain amount of product, investors and others will generally loan you the money to get started.

Factoring Accounts Receivable: There are investor groups and factoring companies that will purchase your accounts receivable at a discount in exchange for giving you cash up front.  For example, if customers owe you $500,000 over the next six months, a factoring company may give you $400,000 in cash now in exchange for the cash flow from the customers as they pay off the receivables.  Factoring has a bad reputation with most business owners because it is extremely expensive.  However, it is ultimately less expensive than giving up equity and you may have few other options if you need cash.  Be careful with factoring: one of the panelists related a story of a client factoring their receivables and then offering a discount if customers paid early.  Unfortunately, the client ended up receiving no additional benefit from early payment but was forced to reimburse the factoring company for the cost of the discount for a double whammy.

Patriot Express Loans: This is a guarantee program through the Small Business Administration (SBA) for veterans and their spouses.  One interesting note about these government guaranteed loans is that banks still have the ultimate authority over whether they will lend you the money.  In most cases, banks are most interested before the business is actually formed and after the business has at least 2 years of history.  If the business is less than 2 years old it is considered much higher risk.

What about Grants? In general, the SBA offers no grants.  There are other government organizations that have grants available, but they are usually for very specific uses and have strict qualifications, such as the business being located in a rural area.

Enterprise/HUB Zones: These only apply if your business is located within an area defined by the U.S. Census.  Most of the time businesses are incentivized to relocate to otherwise underserved parts of the country in the form of tax credits or other reduced fees.

Alternatives to Cash: All of the above options are creative ways of producing cash for your business.  Below are several ways to achieve the same effect without actually using cash at all.

1. Joint Advertising: Perhaps you own a fresh new technology or product but lack the cash to advertise properly.  Joining with a larger company that has a well established marketing budget that may benefit from being associated with your “freshness” and “newness” can get publicity for you while the larger company still spends the same marketing dollars.  For example, if a startup condiment manufacturer teams up with Wells  Fargo Bank, the bank’s new ad could read “We’ve got the special sauce” and a free bottle of sauce for all new accounts.  The startup benefits from a national ad campaign while no additional cash is actually spent or transferred.
2. Equity in Lieu of Salary: Often, a startup is selling stock to raise the capital to hire top talent.  Why not give that equity directly to the new hire instead of salary for the first year?  The effect is the same but the business avoids the hassle and expense of preparing presentations for investors and managing diverse groups of stakeholders.

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Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

Jeff Schneider

Laura Benjamin interviewed Jeff Schneider, president of Entrepreneurial Finance & Accounting Services to get his top tips for entrepreneurs and small business owners.  Although you might recognize these tips as the very basics it is definitely worth a reminder.  Take a look at Benjamin’s Business Blog for the full article.  There is also an audio interview.

With the recent economic downturn, more of my clients have been asking themselves the hard question of “will I survive this?”  That is leading to a lot more of what Schneider recommends: Plan, plan, plan.

Nearly all business owners can project revenue or even just sales for the next 12 to 24 months.  Some financially savvy entrepreneurs can take this a step further and project all revenues & expenses to produce net income for the next two years.  Very few have the time or the skill to produce an up-datable financial model that not only projects Profit & Loss, but also projects the Balance Sheet and the expected Cash Flows for 24 months.

It is important for business owners to understand their cash flow needs, but in lean times it becomes critical.  If you want more information on financial modeling and the services we can provide at BiggsKofford, please give Etienne Hardre a call at 719.579.9090 or use our handy contact form.

What Happened

After several successful tech companies, Al Davis started a company that developed a software product aimed at assisting engineers with calculating the optimal mix of features in a product. After four years and several investment rounds, the company liquidated, paid its remaining debts, and returned pennies on the dollar to its shareholders. So what went wrong?

What Went Wrong

According to Davis, the company’s most visible failure was the late addition of a qualified marketing & sales executive. His company went through three marketing/sales directors, each with a dramatically different focus and with varying levels of understanding of both the company’s product and its customers. The first involvement from marketing wasn’t until 6 months after the company was formed and by the time they found a marketer with a deep understanding of their customers and technical knowledge of the product, it was too late. Davis’s hindsight advice is to involve a professional marketer at the very beginning, along with the rest of the skill sets generally considered critical to your success such as financial, management, and legal professionals. Make sure this person understands your customer and your product and knows the appropriate sales methods to utilize.

Another failing was the attempt to create a complete “Cadillac” solution right out of the gate. The software product they developed contained all the bells and whistles they could think of and was priced accordingly. They had trouble selling the product because their customer didn’t even realize their need for all that software. Davis calls it a “solution looking for a pain”. Instead, they ended up stripping many of the features and selling an entry level tool at an entry level price.

Starting with a simple product has several advantages:

1. It is less expensive to develop
2. It is faster to develop, allowing you to reach your market sooner
3. It is easier to explain lowering the average time to close a sale
4. You can add the more complex features your customers really want by soliciting their feedback
5. It brings cash in the door today

Finally, spend according to your means. Davis developed a detailed business plan for his company that included targeted levels of investment at each round and expected uses of that capital to meet growth targets. When one of the investment rounds brought in less than projected, Davis chose to continue hiring personnel according to the plan to drive growth. Looking back, he recommends scaling growth investment to the level of available capital, especially if sales are less than expected. In addition, the company was renting Class A office space, and he had personally guaranteed the lease, when their customers rarely visited headquarters. A much less expensive location would have met their needs and freed up cash for reinvestment.

What Went Right

Al Davis has actually been quite successful over his career and the reason he attracted investment in the first place was because there are many things he did right. In fact, a major contributor to this particular failure was the market downturn in 2001.

My favorite positive feature is his employee and investor friendly equity structure. Davis reserved 1/3 of the equity for the founders, 1/3 for future investors, and 1/3 for his employees. Nearly everyone to whom he presented his plan applauded his balance of employee motivation and investor reward.

Davis went even further for his employees and removed nearly all symbols of hierarchy in his company, down to maintaining the same size offices for all employees (including himself). He also went out of his way to keep them informed, even as the company was on its way down. This style of management kept panic to a minimum and employee involvement high which turned what could have been a precipitous plunge into a quiet exit.

Another powerful decision was for the principals to personally invest in every round. Other investors will ask you two questions and personally investing allows you to truthfully answer both questions correctly:

Question: Am I the first investor?
Answer: No, you are not.

Question: Do you have skin in the game?
Answer: Yes, I do.

Finally, and probably most importantly, Davis organized powerful external boards to oversee his company. Not only did he find a qualified board of directors with a variety of useful experience (except marketing, of course), but he also developed an external advisory board in addition. The combined experience and knowledge of these individuals might have prevailed even as the company learned the lessons above had the market not also contributed by reducing the capital expenditures of their customers.

Thanks to Al Davis for his frank and humble commentary. If we are wise, we will let his experience teach us how to become more successful entrepreneurs.

Resources:

• Colorado Springs Gazette Article