Situation: A family-owned company has built a sustainable and modestly profitable business. They have built high quality, referenceable collaborations. The CEO is ambitious and wants to become a world-class company. They now seek limited partners as investors to grow the company. Which is more important – cash flow or value creation?
from the CEOs:
Both cash flow and value creation are important. There are several sub-questions to the question:
First, what is the fundamental business model?
Second, the CEO is the company’s charismatic leader. How best to follow his energy?
Finally, and most fundamentally, does the current business model make sense? Can it be simplified it to improve its scalability?
Currently there are three divisions, each with a different objective.
Operations – to be sustainable.
Services – low profit and low percentage of company revenue but also low overhead.
Investment – to achieve an acceptable rate of return.
How does the company get the best valuation?
Currently, the company is organized as a conglomerate.
Conglomerates are too diffuse and difficult to optimize to attract investors. Pure plays do better. Consider refocusing the company around its key strengths.
The family business model is fine. The question for the family – how does the CEO keep and attract the key staff like that makes this business work? Salary alone doesn’t do it. What are the future rewards for key personnel? Consider deal participation to incentivize key employees.
The investment and operations divisions are different companies – this is fine. Optimize both.
To attract the best LPs, the business model should evolve from a family to corporate model. This will make more sense to investors and improve their ability to participate in future growth and profits.
Situation: A CEO is contemplating retiring in the next two years. The company is profitable but is primarily dependent upon a single large client for whom the CEO is the primary contact. Compared to national averages the company’s profitability is very favorable. The CEO questions whether his valuation of the company is reasonable. What is a favorable exit strategy?
Advice from the CEOs:
The principal question from the group is whether the anticipated valuation on exit will yield the financial rewards that the CEO requires.
The buyer will discount the value of the current business because the CEO is too important to the business, and because they will not assume that there is ongoing value to the current business beyond 2-3 years.
The best option is to sell to a buyer who wants entry into the key client. They will have reasons beyond the value of the company to pay a premium for this access.
For planning purposes put the value at 2-3 years of the cash that the CEO takes out of the company, discounted to present value plus some premium for the entry that the buyer seeks. Look at the dollars that this will yield and decide whether this sum is a satisfactory payment.
Concerning the company’s relationship with the key client:
The company’s reliance on the key client is two-fold – they are the key customer, and they drive the market which yields a premium price for the company’s products.
Purchasers do not like to be dependent on a single supplier. Their purchasing department will always be looking for alternative sources.
During the exit window it is critical to develop new customer relationships to sustain the company’s growth and reduce reliance on the single key customer.
If the key client is #1, who is developing technologies that will compete with the key client?
What are their markets?
Where are they going?
How are they trying to exploit the chinks in key client’s armor?
What can the company do to secure a vendor relationship with the companies who may replace the key client?
Situation: A company’s goal is to replace an old, established market with new technology and, by owning the technology, to reinvent the industry. Given this aggressive goal, there is a temptation to go into volume production before establishing the cost advantages to make the technology profitable. The challenge is to establish disciplined, stable, qualified, scalable and profitable manufacturing. To accomplish this, the company must decide between alternatives as they cultivate new customers. How do you optimize your pipeline?
Advice from the CEOs:
There are two sides of the market:
Mega-markets dominated by large corporations which have long lead-times and potentially huge payoffs; however, these markets present long payoff delays for the company.
Smaller, quicker markets with limited volume but which will offer rapid PO acquisition and proof of concept.
The question is how much effort to devote to which market.
Look for early customers who are cast in your own light – disruptors who can help to catapult you into the marketplace
The trade-offs are strategic vs. tactical opportunities.
The immediate tactical need is to generate cash to show that you can. This is the steak.
The strategic need is to seed a foothold in a mega opportunity – to show the potential to revolutionize the market. This is the sizzle.
Identify a killer app that will gain tactical advantage and cash and help prompt maturation of a strategic opportunity.
Another CEO shared experience landing a large client.
They used a short, low cost pilot project to prove the concept to skeptical client staff. The client was surprised and delighted by the success of the pilot project. The pilot project was then articulated into larger projects.
Over time the company used incremental steps to gain a broad presence within the large company.
Focus business development on selling killer apps.
Find low hanging fruit for quick proof of salability and to show a revenue ramp.
Small design wins exercise the machine.
Is it possible to conserve cash to raise the impact of early wins to the bottom line?
Are all current staff during the next 12 months?
Early on, the game is business development – gaining key contracts and agreements with lead customers. Sales follows, with focus on the larger market. This may be 6 months to 2 years out. How many people are needed to focus on business development?