Category Archives: Finance

How Do You Negotiate New Shares for the Founders? Five Suggestions

Situation: A company’s founders will be fully vested in their options by the end of the year. Also, the option pool for founders and employees has been exhausted. The CEO has spoken with the Board Chair and Compensation Committee about this in terms of fairness and incentives for future work to both founders and employees, while making it clear that the Founders are not unhappy. The Chair listened sympathetically and promised to get back to the CEO. Is there anything more that the CEO should do to negotiate new shares for founders and employees?

Advice from the CEOs:

  • Seek a letter of understanding from the Board that the founders and employees will have access to future stock incentives, and a timeline as to when this might occur – either in the near future or at the next financing round.
  • Wait a few weeks and have an informal follow-up conversation with the Chair about his current thinking. Ask whether he would like any further supporting information on the issue.
  • So far, your approach has been non-threatening. Keep it this way.
  • Maintain focus on fairness and your tone supportive of the best interests of the company.
  • Don’t press the issue if you sense resistance.

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How Do You Value the Stock of a Private Company? Three Factors

Situation: A private company has not issued stock options in over 6 months. The business press highlights concerns over appropriate valuation at the time of option grant. How do you value the stock of a private company to assure that option awards reflect proper company value?

Advice from the CEOs:

  • Decide on the objectives of your valuation exercise. These may include:
    • A credible valuation to protect the Board from challenges over option valuation.
    • A calculation that the company can use quarterly or semi-annually to assess company valuation; possibly something that can be done internally on a quarterly basis, with independent validation annually.
  • Given that your concern is option valuation and protection of your Board, they only clean way to do this is to have an outside party perform your valuation. Internal valuations are subject to challenge. Look for reputable CPAs that specialize in private company stock valuation and get quotes from several for initial valuations plus follow-up valuations in 12 months. You may anticipate paying a fee of $12,000 to $15,000+ for this service.
  • There are issues that you will want to address in your valuation process:
    • A valuation must have a supportable rationale and demonstrate consistency of methodology so that valuations will be performed on a comparable basis year after year.
    • You want to see consistency between valuations with your annual financial audits which will reflect company performance.
    • There are at least two models that you may follow – a hard model and a soft model.
      • The hard model is a one-time valuation based on your financials. This may include historic performance, as well as forward-looking ROI.
      • The soft model is based on operational and risk assessment.

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Arbitration or Suit to Settle a Dispute? Five Factors

Situation: A company has a long-term client that stopped a project suddenly 6 weeks ago with no explanation. Later, the client called saying that they do not intend to pay for work completed to date. Would you pursue either arbitration or injunctive relief to settle this dispute?

Advice from the CEOs:

  • If you have evidence of acceptance of a project contract or other documentation that the work proceeded under agreement with the client, this strengthens your position.
  • There may be other circumstances of which you are unaware such as financial or cash flow difficulties. Inquire through discrete channels to clarify this. Knowledge of the inside situation provides leverage as you negotiate a settlement.
  • Do you want to retain this client? If they have been valuable over the years this may just be the behavior of a single individual. If this is the case, work with your key contacts to bring this situation to light and try to solve the problem without legal action.
  • Because you have a long-term relationship with the client, focus your communications on the President rather than the VP who shut down the project.
    • Established your documentation, and complete your research on whether the client has cash flow problems; then call the President to work out an amiable resolution.
    • While you are justified in feeling miffed about the situation, business is business, and in this case it appears that your long-term relationship and the value of the ongoing business with the client outweigh the emotion of the present situation.
  • Focus on resolution of the dispute between the parties and do everything possible to resolve it between the companies rather than through legal avenues. This will help preserve the relationship with the client. Provided that you continue with this client, clean up the portion of the contract specifying notification and acceptance requirements and other areas of the contract that require attention.

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How Do You Maximize Shareholder Value and Liquidity? Four Factors

Situation: A private company creates a liquidity event every 3-5 years: selling pieces of the company, product-based spin-offs, or potentially the whole company. Most frequently, engineering efforts spin off opportunities for new product-based companies. How do you measure company or business valuation with the objective of maximizing shareholder value and liquidity?

Advice from the CEOs:

  • Look at a model to create productized service offerings that are replicable and predictable. This can create a stream of spin-offs to generate ongoing liquidity events. Jack Stack’s company, Springfield Remanufacturing has done this very effectively over the past two decades. He describes his methods in The Great Game of Business.
  • Regarding selling the whole company, the most important measure is strong company performance in recent quarters. Focus on internal metrics as well as revenue and profitability performance. Put together a solid 3 to 4 quarters of profitability with an upward trend to increase appeal to potential acquirers. The current market requires both a longer history of profitable performance and more data points of performance than was required in the previous decades.
  • To compliment internal measures develop a relationship with a business broker who can help you assess the value of either product or company spin-offs. A broker can determine the current value of the opportunity as well as a timeline and critical actions to enhance opportunity value.
  • Consider a roll-up of your company and one or more of your business partners.
    • Look for similar or compatible financial structures and complimentary capabilities.
    • A roll-up can broaden your range of products and services. As a bigger entity you have more options, and can enhance your ability either to generate spin-offs or become a more interesting acquisition candidate.
    • The downside is the time that it takes to complete the roll-up if you feel you have a short window of opportunity.

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How Do You Evaluate A New Business Opportunity? Six Questions

Situation: A company has been presented with a new business opportunity. The opportunity is compatible with the company’s current business, but also involves skills and markets with which the company is not familiar. How do you evaluate a new business opportunity?

Advice from the CEOs:

  • There are at least four critical questions to assess as you evaluate any new businesses opportunity:
    • What is the total available market, and what is the immediately convertible market for the product or service?
    • Can you acquire expertise in the new markets that this will open to you?
    • Do you have a track record starting and nurturing new business within your company?
    • Is there sufficient seed money available – through company funds or outside investment – to keep the effort going for at least a couple of years as you develop the core team that will operate this business and gain traction?
  • If there is an offer of outside investment, consider how many months this funding will support the salaries of the team that will build this business, plus operating and overhead costs. You want to be sure to give yourself an adequate runway.
  • New business development opportunities typically require huge energy, creativity and focus for the first few years. Key management will have to devote all of their effort during the start-up period. Can the company afford to lose the services of key personnel for the time that you estimate this effort will take?
  • Before deciding to pursue this opportunity, take the time to investigate the market for this opportunity.
    • In particular, look for other companies that have tried to enter this market, and learn from their experience.
    • Develop a network of advisors who understand this market and can help you understand both the workings of the market and why companies may have struggled trying to enter the market.

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How Can You Unwind a Redemption Clause? Six Options

Situation: A company exchanged a small percent of their stock for a Series A unsecured note 4.5 years ago. The company has not undergone an IPO because of the recession and if the note is not repaid in 5 years, the holder has the right to call the line. If the company can’t repay the line, the holder gains governance rights. Revenue declined during the recession and while it is on the upswing, the company doesn’t have the cash to repay the note. What are the best alternatives for the company to unwind this redemption clause?

Advice from the CEOs:

  • Raising money to repay the debt will be problematic because of the current liability. Investors want their investment to fund growth and returns, not to simply repay debt.
  • Assuming that your revenue rebound is sustainable can you prioritize resources to accumulate cash to repay the note? Jack Stack, in The Great Game of Business describes how he was able to rally his company’s employees to pay off a seemingly impossible debt load in one year to save his company,
  • If raising the cash to pay the note is impossible, you have 5 options:
    • Convert the note to long-term debt that you can service.
    • Convert the note to equity at a lower evaluation and take some dilution.
    • Renew and push out the note, with a sweetener.
    • A combination of the above.
    • File Chapter 11 if you can’t produce or raise the funds.
  • Have your options in place at least 2-3 months before the note is due. This gives you time to talk to and bargain with the note holder.
  • Start a PR campaign with the note holder.
    • Look for leading and lagging indicators that show your progress.
    • Build a story that lends credibility to your forecasts of future success.
    • Pitch that you are a good long-term investment, and now is the prime time to trade the note for equity.
    • Prep the holder, and build this story gradually over time.

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How Do You Structure Your Bookkeeping Function? Four Suggestions

Situation: A small company has a long term clerk employee. This individual is responsible for AR/AP, Payroll and also HR manuals and reports to the CEO. This individual has been a good employee, but doesn’t perform well in this role. How would you structure accounting and bookkeeping in a small company?

Advice from the CEOs:

  • This is a key role, but there are a number of options. One is for the individual to continue reporting to the CEO, but train someone else to back them up. This will enable you to either shift the individual to another, more appropriate role within the company, or to continue with minimal disruption if the individual leaves.
  • Because of history and loyalty, this is a difficult emotional issue for you as CEO. It is important to consider what you would do if you could remove your emotions from the issue. If the answer is that you would eliminate the clerk position and hire a qualified, experienced bookkeeper at the appropriate salary, then this is your answer.
  • Packard’s Law – from one of HP’s founders – is that no company can grow beyond the capabilities of their employees. Hire the right person. This individual must be process-oriented – someone who routinely checks their own work to make sure that it is right. There is an adage in accounting that good accounting is 20% knowledge and 80% double checking the work. Hire a person who loves to do this.
  • Take care of this position in the best interests of the company, and look for another, more appropriate within the company job for the clerk.

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How Can You Best Use Excess Profits? Five Suggestions

Situation: A company, an S Corporation, produced substantial profits during the first 6 months of their fiscal year. This becomes taxable personal income to the owners if it remains profits. How would you advise the CEO and owners to make best use of these excess profits?

Advice from the CEOs:

  • Use some of the funds to invest in new opportunities for the future growth of the company.
  • Prepay significant costs like software licenses multiple years in advance. Make sure that you attend to your accounting so that you properly reflect the ongoing profitability of the business. Otherwise, what you may believe is profitable in future years will not reflect true profitability because you will not be accounting for all of your true expenses.
  • Is anyone in the company deserving of a one-time special bonus for performance or a salary increase?
  • It may make sense to take dollars out of the company and to diversify owners’ investments by investing in real estate, stocks, etc.
    • Check out the current rules around 401K programs that may allow you to invest increased amounts per year per person. Talk to your financial advisor about the details and regulations surrounding these programs.
  • List your alternatives and compare the anticipated ROI, on an after-tax basis, of the various options. This will help you to evaluation options including:
    • Reinvesting in the business – various options.
    • Investing outside of the business – various options.
    • Talk to your financial planner about the choices.

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Should You Offer Employees Stock Ownership? Four Thoughts

Situation: When an early stage company was founded, the CEO made vague promises of stock ownership to new employees. Some original employees have asked whether and when they will receive ownership. Should the CEO offer stock ownership, and what is the message to employees?

Advice from the CEOs:

  • The first question concerns company policy on ownership. For example, what do the founding owners think about expanding the ownership pool? It is important for the founders to have this discussion and agree on official company policy on ownership. This can then be communicated consistently to employees.
  • Investigate practices for similar companies in your industry. If you find that there is a size at which companies typically start to diversify ownership, then have a conversation among the owners as to what your company will do. You don’t have to follow the pack, but you may risk turnover if your policy is significantly different from the industry norm.
  • Employee stock ownership is a double edged sword. Employee shares only receive a true value in a liquidity event – sale of the company or an IPO. Absent a liquidity event, employee stock ownership can complicate corporate decisions, and there’s also the question of the value of an employee’s stock if the employee leaves.
  • If you decide not to expand ownership, what’s the best way to update earlier promises of ownership?
    • Tell the story: stock ownership was one option that we considered. We looked at industry practice, and here’s what we found. We determined that at our size there are few advantages to broad employee ownership, and several potential disadvantages to additional owners including tax consequences. Therefore, we decided that we could achieve our objective more effectively through our profit sharing plan.

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How Do You Bridge a Short-Term Cash Crunch? Three Options

Situation: A technology company has grown rapidly over the last year. Two customers representing a significant share of business have temporarily reduced orders for one quarter, resulting in a cash crunch until these orders resume. How do you bridge a short-term cash crunch?

Advice from the CEOs:

  • Do you feel relatively secure that once the quarter is over these orders will resume and your cash crunch will be resolved? If so, ask your bank to increase your cash line. Explain the situation, the companies involved, their order history and the expected timing until you get your next payments. A letter from each company saying that they plan to resume orders will help your case. Be aware that the bank may request a personal guarantee to substantially increase your credit line.
    • If you have to personally guarantee a line of credit extension, make sure that you see this as an acceptable risk, and that you can trust the customers to come through with their orders as promised.
  • If you produce products or subcomponents critical to these customers, ask whether they will extend a bridge loan or make a payment against future orders to assure their place in your production queue once their orders resume. You may have to escalate this request within the customer companies if you are currently dealing with purchasing personnel or lower level management.
  • Can you redeploy excess labor to other projects during the cash crunch? You will have to do this carefully so that you can rapidly redeploy these resources to priority projects once a large order comes in from one of these customers.

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