How a Pre-Pandemic Shift Left Companies Vulnerable
At the Intersection of Financial Infrastructure and a Global Pandemic
How a Pre-Pandemic Shift Left Companies Vulnerable
Pre-pandemic (do we even remember that time?), the investment world had experienced a huge shift. Unfortunately, this shift did not help prepare companies or investors for what was to come. Priorities had shifted from a company’s sustainability and infrastructure to avenues of increasing revenue as quickly as possible. However, sustainability and infrastructure were exactly what was needed most during a global pandemic.
What Supply and Demand?
Everything we had learned in our earliest economics classes about supply and demand seemed to be irrelevant. I remember those classes –training my brain to think of opposites – supply goes up, demand goes down, and vice versa. However, that concept no longer applied to venture capital and private equity firms. The number of firms that were chasing deals with buckets of money created a huge supply of investor dollars. But the number of successful high–growth companies to invest those dollars did not increase at the same pace.
The result? Investment firms began expanding their reach. They started to invest not only in the usual entrepreneurial high-growth companies, but also in companies that would have typically received funds through stock sales in the public markets or through traditional bank financing. These companies needed to move into the investment firm world to fill the gap that had resulted in too much money and not enough companies. Additionally, investment firms began relaxing the guidelines associated with the due diligence process.
These changes forced a decline in the regulatory compliance surrounding the movement of investment dollars, financial audits, and other financial items. With the focus almost exclusively on top–line revenue growth, there just didn’t seem to be a need for them. Further, companies with contracts that brought in recurring revenue were trading in the investment world based on multiples of revenue (some as high as ten times what their revenue was currently).
A Lack of Infrastructure Meets a Global Pandemic
Enter COVID-19. With so much time and attention previously focused on quick revenue generation, many companies lost the infrastructure to produce the quality financial data and reports needed to make informed decisions for ensuring sustainability. However, infrastructure and sustainability were what was needed to survive the pandemic.
When the pandemic hit, every stakeholder (board members, investors, CEOs) immediately shifted their focus to cash flow analysis and sustainability. Chief Financial Officers have all noted that their interaction with other managers, officers, directors, and investors increased literally overnight. While no one could have predicted the full cash impact of the pandemic; in particular, the need for short-term cash flow, they could have been better equipped. The companies best prepared to analyze the situation were the ones that had the appropriate level of infrastructure prior to the pandemic. The stakeholders wanted to know if the entity would survive. While most had the ability to enter ‘survival mode,’ one has little to do with the other. Survival mode is simply not sustainable for any extended period … in any situation.
The pandemic taught us once again that knowledge is power. Infrastructure is crucial when analyzing different scenarios to make decisions quickly. Chief Financial Officers should take advantage of the temporary dynamic brought on by the pandemic. Using this time to get the right type of infrastructure in place will help prepare them to make critical decisions at any moment.
There are many companies that were forced to make difficult decisions to lay off employees, not renew leases, discontinue software development, or even close their doors for good. Unfortunately, most had to make these decisions without the confidence that they possessed all of the information. Full knowledge is mandatory for a sustainable future and for the success of any company overall.
By leading from a position of knowledge, which comes from having the right infrastructure, companies will have an edge over others whose directors or CFOs are blindly making decisions. What does that type of infrastructure mean? We’ve talked about it before – most recently in Oh No Not Again – but essentially it means having an Enterprise Resource Plan, CRM, General Ledger, Cash, HR System, and Payments. A clear vision and financial roadmap on how to achieve that vision, along with cash and a strong general ledger, are the foundation of an essential infrastructure.
Since March nearly everyone in the world has experienced change in their lives beyond our average experience. Some of the changes have been stressful and devastating; some have been positive. Most people with whom I have spoken have found times of joy in spending more time with their loved ones, having the time to cook, play games and just talk.
However, the negative impact on so many businesses seems almost unbelievable. Eight months ago no one would have predicted that restaurants, retail stores and gyms would have to completely shut down.
What has not changed are the core fundamentals of business. In order to survive, a business must have a product or service that solves a problem and can financially make a profit. From what I have seen, many businesses that will not survive until the end of 2020 were not sustainable prior to the pandemic because they did not understand which products or services were making money and which products were losers.
The core metrics and accountability required to run a profitable business were overshadowed by the exuberance of the economy and the unrealistic valuations private equity and venture capital firms were paying for investments. These valuations stemmed from the limited supply of investment-worthy companies and the requirement for investors to invest in order to stay in business.
The firms being capitalized had the Seven Essential Tools® – and knew how to use them to attract investors.
Check out my Seven Essential Tools Road Map®, which shows the steps to preparing to pitch to investors. Along with the Seven Essential Tools® details, you can position your company for growth or simply gain a better understanding of where your company stands financially.
Investors are focused more than ever on the core attributes of a business when evaluating it for investment. The good news is that the information they want to know is the same information that is critical for you to run your business successfully.
If you are a founder or a C-suite executive of a fast-paced, growing entrepreneurial company, are you confident you have the Seven Essential Tools® you need to pitch to investors?
How would you respond if someone made a legitimate offer for your business? Would you know if the amount is what the market would pay? Even if the offer sounds like more, or less than you imagined, you want to respond from a position of knowledge, not sticker shock.
Valuation is the value an investor would place on your company if you were to seek investment funding. From a negotiating standpoint, it’s better for the prospective buyer to say a number first so you have an indicator of how serious they are. Prepare yourself – arm yourself with the knowledge of a realistic valuation so you can effectively negotiate.
One measure of the value of your business is what someone will pay for it. Enterprise Value is a real number that investors calculate using your historical financial statements to arrive at a multiple of revenue, or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Other factors influence the value that could actually be paid for the business.
For example, are you loading your books with personal expenses and other tactics to avoid paying taxes? When investors value your business, such expenses can lower your EBITDA and affect the sale of your company.
On the other hand, EBITDA can be higher when you keep personal and business expenses and bank accounts separate and run your business as a true entrepreneur. Large and small organizations alike are guilty of combining personal and business expenses. C Suite executives in large organizations without governance over their expense account can significantly impact the value of the business by deflating the run rate of profit. Smaller businesses sometimes pay their family members a salary without the family member ever doing any work for the organization. Neither of these examples are proper stewardship over the financial governance of the organization.
Then there is the value that the market will bear. Factors that can influence the actual value paid for your business include how scalable your infrastructure is – the people, processes, and technology. If a new owner wants to focus on growth, is the right infrastructure in place to support that or will the new owner have to invest in infrastructure first? How much debt are you carrying? Someone has to pay off debt when the business changes owners.
On the other hand, your approach to acquiring new capabilities – buy, versus build, versus lease – in some cases can raise the value that the market is willing to pay.
Your role as an entrepreneurial leader can also influence the market value of your business. Employing a strong team who lead and run your company with an eye to the future is much more attractive than a business operating with old, inefficient processes and no new product launches.
My goal with this post is to help you understand the importance of knowing the value of your business. You never know when someone is going to reach out to you with an offer you cannot refuse. Be ready by knowing the valuation of your company so you can speak intelligently – before you get on the emotional roller coaster of discussing a transaction.
We have learned many definitions
related to essential in 2020. The interpretation of essential has been heavily
debated, including discussions over golf courses, liquor stores, restaurants,
and bars. As communities open up, these debates are getting more interesting as
the discussions center around who is allowed to be open.
My favorite debate about “essential”
is the one where the attorneys representing Elizabeth Holmes, the Founder and
CEO of Theranos, appealed to the court that they should be considered essential
and allowed to meet at the office to work.
Pre-COVID, one meaning of “essential” described
having the right infrastructure in place if a company wanted to raise capital. The
right infrastructure is critical to generate the data about your business during
the due diligence process with potential investors.
Here are a few examples of why this is
Revenue projections will be a key
component of what the investor will look at when evaluating the business. The
revenue in the projected income statement for the prior year probably
represents an increase in the revenue over the current year. The investors will
ask questions like: “How long does it take you to close a deal from the time
you speak to a customer to close?” “How many deals do you have in the pipeline
now?” “What is your customer churn rate?” “How do you charge customers – as
SaaS, by transaction?” etc.
These questions will be asked during
the initial discussion as well as during the presentation. Whatever answer you
give, if the due diligence moves forward, must match the data in the general
ledger, CRM (Customer Relationship Manager data base) and other systems.
I have known a C Suite executive
falsely stating things like they have never lost a customer or they close a
deal in 30 days. But when we drilled down on the historical data his statements
are not supported by facts.
I have also experienced a C Suite
Executive who stated that the projections were high because “that is what we
need to close this deal.” False information may get the attention of a
potential investor but it will not keep their attention when they drill down to
the “essential” infrastructure and claims are not backed up by facts.
Burn rate – potential investors will
ask what your burn rate is, i.e. what is the amount of cash the company
requires each month. Burn rate is based on the cash leaving the checking
account – not the pretax income. These are two different calculations and often
commingled into one number for companies. If the C Suite executive states the
monthly burn rate is $10k because that is the best guess he has during an
investor presentation, but the historical cash spend is $15k per month, the
investor will lose trust and the company seeking investment will lose
credibility. Best guess does not get the job done.
buyers are looking for infrastructure that can help them identify, track,
measure and report on a broad range of externalities. Being able to demonstrate
actions taken to date, along with a path forward that helps buyers envision how
the company can help address or mitigate global challenges and serve societal
needs, can help them think more expansively about opportunities for creating
In their article, the E&Y authors
are directing their advice to Private Equity Firms to emphasize the importance of
creating value for portfolio companies the PE may want to sell. The quote above
supports my assertion that adequate infrastructure is essential for
companies seeking investment.
You may say to yourself, I will build
the infrastructure when I am ready to pitch to investors – we are not ready
right now. If you have the ability to influence decisions about company spend,
it is your fiduciary responsibility to insist the company has the right
infrastructure. Not only will it position the company to prepare for the future,
it will guide the entire management team in making the right decisions day to
Let’s dive into your essential infrastructure concerns – click here to set up a 30-minute free consultation to discuss your unique situation.
Most founders and CEOs are certain their business is a good investment and that others should see it that way. Unfortunately, that is not the case in a high number of instances when we dive deeper into the aspects of a company.
We each have a unique set of characteristics that drives us and puts us in situations where we are comfortable. Every time we make a choice to put ourselves in a situation and stay in it, something about that situation is working for us. Solid self-awareness and emotional intelligence help us make choices in life that work for all aspects of our lives and align with our relationship with money and our core values. A culture is developed around that. In business, the governance over this culture is ultimately driven by the purpose of the investors, shareholders, or founder(s). They determine the “Why” of the organization.
The culture and purpose of an organization can be several things.
It can be a hobby, and you are okay with not making any money. I know many business owners who have built a lifestyle company that provides enough cash to pay their bills; they may also run all personal expenses through the company. They are examples of “Lifers.” This practice is great if they happily accept the annual income they produce and do not have any desire to sell the company one day.
Entrepreneurs who are aware they need to build Enterprise Value will focus on establishing and monitoring metrics with the understanding they are building a business that can survive in the ecosystem of the investor world. They do not commingle their personal and business expenses. They listen to experts and focus on the important aspect of building a business. They may not take a salary from the business in the early years, opting instead to reinvest in the business and build a loyal customer base and revenue.
The problem arises when the Lifer wants to raise money from or sell the business to an investor – which really means they want the investor to fund their lifestyle.
Which Are You?
Before you get ready to pitch to investors, evaluate which type of business owner you are and if pitching to investors is the right thing for you. Do not waste your time and energy if it is not.
I am excited to announce the publication of my new book Pitching to Win: Strategies for Success! During my more 30 years of experience as a CFO and financial strategist, I have come across many businesses who do not understand the concept of financial readiness. This is particularly important if they are attempting to ready a company for investors. Pitching to Win is a practical how-to guide for entrepreneurs that details how to get a business infrastructure-ready and how to create pitch materials. I am passionate about creating financial clarity to enable businesses to focus on the big picture. This book allows me to share my passion and expertise with a wider audience.
I could not have written this book without my former colleagues and Barker & Associates clients over the years who have provided me with a wealth of experiences and examples which you see throughout the pages of Pitching to Win. I am also grateful for the Jacksonville Women’s Business Center (JWBC) and the Athena PowerLink program, which has given me invaluable experience working with fellow entrepreneurs. Pitching to Win is currently available for download as an e-book on Amazon.com, and it will also be available in hard copy soon through Amazon.
Money is everywhere! Banks, investment firms, and alternative lenders are getting incredibly creative with their marketing tactics to find companies to purchase and invest in. CEOs and Founders can become exuberant and confident they are the next best thing since Uber – Unicorn status is right around the corner in this market. They are a rock star!
These conversations often lead to discussions about high valuations, partnerships, and mentorship from the investment firm to help you grow exponentially. It seems that a glorious relationship is in the development stage.
Then what happens next …
Investment firms and banks are run by people with whom you develop a trusting relationship. Keep yourself centered, this friendly relationship that is developing is about business. Your business is held accountable by some sort of governance. Lenders and investors must follow certain processes and procedures prior to sending you the money. For this relationship to succeed, each partner must meet certain parameters in building the foundation, specifically those related to your financials.
Here is the harsh reality. A number of these deals go poof, up in smoke due, to the inability to provide the bank or investor with the right due diligence information. I met with a CPA firm today to discuss ways we can work together. One of the partners said he has seen more entrepreneurial growth company and private equity firm deals fall apart lately due to lack of infrastructure. The business may appear to be solid, with a great growth trajectory yielding nice margins. The list of substantiating documentation is long, and the money people require you back up your claims with evidence such as:
Accrual basis financials that are, at a minimum up to par for a quality of earnings report, if not an audit,
Analytics of any one-off revenue-producing events that may have caused a spike one month,
Employee records, with signed copies of employment agreements,
Organized stock ledgers with all warrants, stock options and stock equivalents available.
Business owners who can produce this information are Rock Stars.
Failure to produce these documents means that a deal with a lot of potential may quickly go up in smoke. Poof.
After the “poof” it hits you – while preparing for the due diligence process, sales may have dropped, employees got wind of the potential sale and left the company. You are faced with building your company back up. The cost of not having the right reporting infrastructure and losing the deal will seem enormous at this point.
Selling your business may not even be on your radar but consider this. What if someone approached you with an incredible price you would have never imagined, contingent on the due diligence process yielding favorable results? If presented with this opportunity, would your company be ready?
The way you look at your company financials for strategic decision-making is the same way that a buyer would look at them. By operating your business like it is going to sell tomorrow, you are more likely to be making informed decisions using timely, accurate data. If you aren’t making informed decisions from your financial data, go ahead and get the kerosene and light the match, because it will all go up in smoke one way or the other.
Barker Associates can help you be a Rock Star and achieve financial clarity of your company’s position. By working with us, you will know what the numbers say to potential buyers. Call or contact us to make sure you are ready. firstname.lastname@example.org or 904.394.2913
Have you ever prepared for your workout but realized you had not done laundry, so you had no clean clothes or you could not find your tennis shoes? Were you still motivated to go for the run after you did your laundry and found your shoes? Many of us would have lost interest due to the time delay. The same concept applies to a deal. Time kills deals when too much of it passes.
Start with the end in mind. Every business owner should begin building their business with the idea of seeking investors or selling in the future, which means laying your due diligence foundation.
Have at hand the7 due diligence essentials. Investors will ask for them – do you know what they are? Do you have then available at all times, are you solidly prepared for due diligence, are you in a position to secure investment? Email me at email@example.com to get the list.
Then get your due diligence folder ready and keep it current.
What do making your bed and pitching to potential investors have in common? According to Admiral William McRaven, in his book, Make Your Bed (available at Amazon.com), it’s the simple steps, taken each day, that achieve great results.
To better link these two seemingly unrelated activities, consider this: Chief Executive and Financial Officers may feel overwhelmed by the need to focus on daily tasks and raising capital. But by executing a simple task, such as making your bed each day, the tone is set for the rest of the day’s attitude and accomplishments.
Combine the responsibilities of a C level position with the priorities of kicking off a new year, and CEOs and CFOs may lack the required focus to also prepare to meet with potential investors. I suggest you personally implement one to two simple habits successfully, then move on to other new habits. The success of achieving even simple changes will reinforce your mindset for success.
As with any business relationship, finding the right fit with your investor is the first step in a long and successful association. This may sound like dating advice, as there are many similarities. For example, identifying potential investors through word-of-mouth or introductions from mutual friends has a better chance of success than selecting the first name your search engine delivers.
But don’t stop there, ask your acquaintance why they recommend this or that one. Understanding your goals is critical with whomever you choose to ask for money.
With potential candidates on your list, think of a few “speed dating” questions to narrow it down. You should know yourself well enough to already know which questions/answers are deal-breakers. What do I mean by that? Let’s say you want a silent investor who is hands-off. Ask how they work with their current clients – hands-on, hands-off or somewhere in the middle.
Other filtering questions might include: who are some of their other clients (besides your referring friend); are they local; in which industries do they specialize? Are they a solo investor or in a group? What type of client do they prefer – are you that client?
By doing your due diligence you have reduced the risk of having to break up with your new investor sooner than planned.
One of your goals in securing an investor should be that once they have reached their goal with your business, they stick around as your #trustedadvisor. You just may need them again when your successful business is ready to rise to the next level of success!
Building trust takes time and an investment from both parties. At the end of a successful pitch to gain an investor, the trust clock with that investor starts ticking. You both must deliver now on the promises made during the courtship; nothing builds trust quicker than doing what you said you would do. And when you follow through, the role of trusted advisor just naturally evolves.
At Mindy Barker & Associates we help entrepreneurial businesses prepare for meeting with investors to pitch their business and obtain funding. If you think you need an investor, but don’t know where to start, contact me at firstname.lastname@example.org to set up a no-obligation 30 minute discovery call to discuss how we can help.
My final word of advice: this process should begin the minute you start a business – not when you need the money. If you are trying to raise money at a time you are getting ready to lose money – you lose leverage.