Jan 12, 2023 | Governance, Innovation
Every start-up requires funding. A business plan, no matter how good, without cash for implementation will remain a dream.
Most start-ups get off the mark with investment of one sort or another by the ‘3 F’s’: Family, Friends and Fools, supplemented by savings from the aspiring entrepreneur.
At some point, after proof of concept when the aspiring entrepreneur needs more cash to fund the growth, or scaling of their now successful SME, they must seek alternative sources. The choices are simple: give equity in exchange for the funds, borrow them from some financial institution, or use a combination of both.
There are pros and cons to be considered for each path, the answer that best suits every instance will be different, and subject to all sorts of caveats and variables.
Pros for Loan funds.
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- The entrepreneur does not surrender any ownership and therefore control of the enterprise.
- The entrepreneur gets to keep all the profits, assuming success. This assumes that the business is housed in a limited liability company, rather than on a personal basis, or even worse, a partnership.
Cons for Loan funds.
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- A start-up may (probably will) have trouble getting a loan at a commercially viable interest rate, as there is no or very little trading history. Cash is the ultimate commodity, and institutions only lend money when they are comfortable, they will get their money back, and/or the interest rate is such that the risk is deemed acceptable.
- There is a debt that must be paid back with interest, irrespective of the success or failure of the enterprise. Interest however, is tax deductable, assuming there are profits that incur a tax liability.
- A lender will often place restriction on how capital is to be used, require reporting, and demand privileges that do not add value to the enterprise.
Pros for Equity.
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- The entrepreneur does not have to pay back the capital, it is invested at the risk of the investor. The investor is absorbing the risk of failure into their equity calculations. If the business fails, they lose their money.
- The absence of a schedule of repayments enables capital to be directed at the most productive uses
- Those who provide equity are often in a position to offer more than just money. It is in their interests to leverage their networks and experience to benefit the enterprise in which they have invested. This advice can be of immense value, particularly to the young entrepreneur lacking the wisdom that comes with experience.
Cons for equity.
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- Equity is just another word for ownership. If you give some level of ownership to another party, that entitles them to a share of the profits as a function of their equity, when and if they emerge.
- When the business is sold, acquired, or floated, the equity holders share in the proceeds, it is their opportunity to generate a return on their investment above the dividends received.
- Equity also entitles a say in management, strategy, and management of the entity. This can be agreed, but there are regulations and accepted practice around the power of an equity holder, and in the case of a listed company, the regulations are enforced by the Corporations Act.
- If an investors circumstances change, and they need their money out of the business, there is not usually a ready market that will value and buy that equity. This will cause considerable distraction to the management of the enterprise if it happens.
Raising funds is nothing more or less than a marketing project. The entrepreneur has a ‘product’ to sell, the future profitability and potential capital gain from the enterprise. The investor/lender has the funds necessary to crystallise the entrepreneurs dream.
Both lenders and investors require common information, which they use differently. For a lender, it is the reassurance that the loan including principal and interest will be repaid over the life of the loan. Whether that repayment comes from the cash flow of the business, or in the event of failure, sale of the assets against which the loan is secured is largely irrelevant.
In the case of equity, the driving consideration is the potential for capital gain at some point, after the payment of dividends. Both rely on cash flow forecasts from the enterprise.
Agreeing the level of equity that will be exchanged for the investment is a really challenging process. The financial interests of the entrepreneur and the potential investor are directly opposed. The question is how much a point of equity is worth in cash terms. In almost every case, the better prepared party to that negotiation will win. However, it should not be seen as a binary negotiation just about the cash, as there are other variables at work, such as the networks of the potential investor, which as noted above can have significant value.
This process also must place a value on the ideas, and time of the entrepreneur, without which there would be no potential investment.
In short, you need to find a mutually acceptable valuation of forecasts of future cash flow from the ideas and commitment of the entrepreneur, and the value of cash and other factors the potential equity holder brings to the table from which to agree an equity split.
Header cartoon credit: once again Scott Adams and his mate Dilbert understand the dilema
Nov 21, 2022 | Communication, Governance, Strategy
The purpose of a brief is not to be brief.
A brief, for whatever purpose it is written should be a catalyst for creative thinking, examination of options, and father of a robust solution. This applies equally to an engineering brief as it does to an advertising brief, research brief, or brief given to a head-hunter searching for a new CEO.
Failure to write a good brief will lead to a sub-optimal outcome, or at best, considerable delay and false starts that consumes resources unnecessarily.
A comprehensive, well thought out brief is not a guarantee of success, but it certainly shortens the odds.
Following is a framework for the next time you have to write a brief, for whatever purpose.
Let strategy drive the brief.
Strategy should be the primary driver of every decision taken in an enterprise, down to the daily tactical decisions. It provides the framework for the choices that need to be made. Most briefs I have seen are disconnected from strategy. Sometimes this is just poor leadership, in others it reflects the lack of any strategy, which is evidence of poor management. In the absence of a clear strategy, the choices made as an outcome of a brief of any sort may as well have been taken in a vacuum.
Define the need.
A brief will be in response to some need to be addressed. It may be a competitive challenge, it may be seeking a solution for an internal problem, or it may be seeking information, or be focussed on an opportunity of some sort.
Ensuring the need the brief is seeking to address is clearly articulated is vital to the construction of an actionable brief to experts that will enable them to bring appropriate expertise to bear to deliver the planned outcome.
Define the objectives.
As noted above, the generation of a brief presupposes there is an investment of some sort being contemplated. No investment should be made in the absence of explicitly stated outcomes the investment is expected to deliver. These are usually stated as objectives.
The best objectives are always those against which performance can be measured, SMART objectives. In some circumstances, such as an advertising brief, such clarity is challenging to achieve. It requires deep thought to indentify the drivers of the outcome, the lead indicators, that can be reliably measured. However, the effort will deliver returns, whatever the arena for the brief.
Assemble all relevant facts and informed analysis.
It should go without saying, but no brief is complete unless there is a comprehensive collection and analysis of all facts, and information relevant to the choices that will be made. Objectivity is a blessing. Sometimes it is hard to know where to draw the line, particularly when constructing a creative brief. Average will rarely deliver results, and continuation of the status quo while often ‘safe’ in a corporate environment, is bound to deliver ordinary results at best. There is a warning here for marketers, who will take this to be a licence to change advertising execution. Marketers are often way too close to their advertising and get tired of it before the average participant in the market has seen the message sufficiently to absorb and act on it.
Execute with experts.
A great brief in the hands of the summer intern will not usually deliver a useful result. No matter how great the brief, expertise in coming to grips with the nuances and options presented, requires wisdom that only comes from experience.
Simplicity.
While this post opened with the observation that the purpose of a brief was not to be brief, it is also the case that the simpler, more concise, more focused on the drivers of success the brief is, the better. Simplicity will increase the ability of those responding to make the choices they need to in order to deliver the outcomes being sought. Steve Jobs said it best when he said: ‘Simplicity is the ultimate sophistication’ about 50 years after Einstein said: ‘everything should be made as simple as possible, but not simpler’
Note to the unwary. When what should be a ‘Brief’ is called a ‘Tender’ it is a sure sign that price is the dominating consideration, and you are not the only one being invited to the party.
Header cartoon credit: Tom Gauld in ‘New Scientist’
Nov 9, 2022 | Change, Governance
November 2022 is the 33rd birthday of what may be the most important month in recent history, November 1989.
A momentous month.
It saw the fall of the Berlin wall, the beginning of the end of communism and the soviet empire. We met that occasion with such hope, optimism, and a sense of relief that the immediate problems facing a Germany that needed a second reconstruction were pasted over. Slowly the optimism for the future of the now ‘free’ countries that broke away from the USSR has eroded, as the kleptocrats took power, and the spoils of previously state owned enterprises fell into a few select hands. It is the determination to extend the power and hegemony of that group that has led to the war in Ukraine.
The second momentous event that month was the completion by Tim Berners-Lee of the genetics of the web. Hypertext Markup Language (HTML), the formatting language of the web, and its siblings, URL, the unique web address and HTTP, the process of retrieving linked material from across the web.
These two events generated the drivers of the geopolitical face of the world, the way it communicates, does business, and governs itself. In short, they shaped the world we currently live in.
The commonality between these two momentous events is the simple words ‘democratic capitalism’
The economic battle between states, capitalism winning out over communism, and democracy winning over despotism. Suddenly we had freely available all the information and resulting transparency we could possibly need to live in some semblance of harmony.
Both have been proven to be false gods. The harmony and balance we sought has been comprehensively thrown out.
The power of the web has been weaponised and turned on us in ways inconceivable 33 years ago, and we have yet to develop an antidote. While this has been happening, the kleptocrates have exercised a level of influence and control the Stasi could only dream about, and led us into another war in Europe. As Einstein noted: The significant problems we have cannot be solved at the same level of thinking with which we created them.
Sadly, this is what we continue to do.
Photo credit. The header photo is of a nuclear explosion, one of which France set off on Mururoa Atoll in November 1989. Another event in a long list of what made that month a pivotal point in modern history.
Oct 10, 2022 | Governance, Marketing
Marketing programs should always be driven by the combination of your current position and the agreed strategy. Your marketing objectives should be directly and overtly tied to the achievement of the longer-term strategy.
In the absence of an overall strategy, writing a marketing plan becomes an exercise with little meaning. The marketing plan is how you allocate external communication investment and align internal resource allocation priorities to the achievement of the strategic objective.
The marketing objectives should be designed to contribute to the achievement of the strategic objectives, along with other corporate plans such as the financial plan (budget) manufacturing plan, personnel plan. They work together to achieve the overall strategic objective. They represent the desired end points, the strategies and tactics employed are how you get there.
It is a simple formula: Objectives = Current situation X strategic choices.
A plan without an objective is not a plan.
Objectives have three functions:
- They provide the target that every stakeholder understands is, or should be, the focus of their daily, weekly, monthly activity.
- They provide the framework and means for the alignment of cascading contributing objectives, performance measures, milestones, accountabilities, and responsibilities, through the organisation, up, down, and across.
- They provide a framework for measurement of progress.
The compounding of the effectiveness of effort when these three functions are present, and working together, is enormous.
These three functions of objectives are the same at the strategic level as they are at the coalface. The only difference is the time frame, the nature of the immediate objectives, and the activities to be undertaken by individuals.
At the coalface you are looking at the objectives for today, tomorrow, and next week.
At the strategic level you are looking at next quarter, year, and 3 years.
The means by which the gap between the levels is addressed is reflected in the 2-way flow of information, priority and feedback that occurs, which is a function of the culture and resulting ‘flow’ through the processes in the business.
It is easy for me to say, but very hard to get right, and it is not a task, it is a continuing journey.
Everyone, at every level should be aware of the strategic objectives, the strategy, and how their piece of the world fits into and contributes to the larger picture.
Think about the many wheels inside a mechanical clock, all are driven by the central objective of telling the time, then hours, minutes, date, day of the week. All are run off the central powered flywheel.
The strategy is the flywheel, delivering accurate information is the objective.
The strategic objectives should evolve out of the interrogation and questions that are asked in the assessment of the current situation, and the vision/mission, whatever you choose to call it, of the organisation.
A daily ‘toolbox’ or ‘stand-up’ is the coalface equivalent of a quarterly strategy review, just held at a different level. They are the catalyst for the difficult questions that need to be answered.
Sep 30, 2022 | Governance, Leadership, Strategy
At a time when the market value of a business bears no relationship to the financial balance sheet, when PE ratios of market darlings are counted in geometric multiples, something is wrong.
Currently the PE ratio of stock market darlings: Apple at 33, Microsoft at 39, Alphabet (Google) at 34, Facebook at 30, and Amazon an eyewatering 68, are completely disconnected to the tangible assets of the businesses. By contrast, the PE ratio of some of the industrial stocks which built the economies we currently enjoy, GM 9, Ford 9, GE zero, (25 years ago the biggest company in the world is trading at a loss) still reflect tangible asset values.
The governance and operational reporting of business is often left in the hands of the CFO. They produce all the numbers and do most of the analysis of those numbers, as well as determining the investment choices other functional heads make by way of budgets, and the accounting for the spending of those budgets.
Several things have changed recently, on top of the rapid change that was proceeding up to 2020. The drivers of our economies took a dose of steroids from Covid, which not only accelerated the rate of change, but drove it in unpredicted directions.
- The accounting function deals with patterns and reporting that relies on history. This is a very poor guide to what happening around us now. The landscape has changed fundamentally, and that rate of change is not slowing down.
- Legacy systems now includes much of the stuff that was installed last year. Digital transformation has happened, redundancy is now counted in months, not years and decades.
- Business models have changed dramatically. Online ordering, and ‘no touch’ delivery of various types, previously struggling to get a foothold in many categories have taken off, while those that were already strong, have had their pedal to the metal. Legacy business models are dead. For accountants, trying to make sense of all of this while knee deep in the financial and governance accounting required, have run out of the gas necessary to accommodate it.
- Suddenly there are new power bases within an enterprise. All sorts of ‘Chiefs’ have emerged from hiding, and a few new ones have popped up. CDO (chief digital officer) CMO, CIO, and others that now have as much grunt at board level as the CFO, changing the nature of boardroom debates. ‘Traditional’ accounting is struggling, and largely failing, to keep up with the reporting and forecasting of increasingly fast cycle times and changing market and regulatory demands.
- How should the CFO deal with the accounting for innovation and change? The key for them is to learn much more quickly than they are used to doing, so they can recognise the demands, risks and costs of innovation, and think their way around the legacy accounting systems to deliver some sort of innovation and qualitative scorecard that fills the need for quantification.
- Sorting out Capex priorities, used to be done by business plans and discounted cash flow models driven by the often optimistic forecasts of marketing people. They usually relied on history to deliver an extrapolation, with allowances for the vagaries of new stuff. The time frames are now much shorter, the 10-year depreciation schedules allowed in financial accounting have become irrelevant when you are dealing with radically shorter equipment life and competitive needs.
- The significant move has been from a balance sheet that had little influence exerted by qualitative stuff, to a balance sheet structure that absolutely fails to reflect the real value of an enterprise, i.e.: what is in people’s heads. Those assets walk out the door every night and make choices about what to do tomorrow. This was previously a challenge, now it is a huge problem. The stock market calculations of start-ups with small if any revenues, but a few employees with a great idea can run to billions in the extreme case. They are backed by no hard, resalable assets at all, making valuation a nightmare for accountants.
What is a Strategic balance sheet?
Just as businesses undergo a regular financial audit, to ensure the appropriate governance and consumption of the enterprises resources, and account for the gains and losses of owners’ equity, so should it undergo a process of a Strategy Audit.
The financial balance sheet has a key role in articulating the ‘balance’ of assets and liabilities built up by the business, the difference between those totals is the owners’ equity, or what is left over to repay owners for the risks they have undertaken in lending the enterprise their money.
A standard balance sheet is a document assembled with historical data. It is subject to considerable ‘management’ by the valuation and classification methods employed in determining how an item will be treated.That is no longer even a fraction of what is requred to reflect the real competitive and strategic health of an enterprise.
Strategy drives the way resources will be deployed today in an effort to harness and maximise the potential for future returns.
This process of identifying the drivers of performance, and forecasting the optimised outcomes, is considerably harder than simply extrapolating the past. The only thing we know for sure about the future is that it will not be the same as the past, and even present.
Therefore, the strategy audit process is more qualitative. This does not mean that data and critical thinking should be thrown out the window as often happens, it makes it even more critically important.
Building a Strategic Balance Sheet is an iterative process. As you cycle through the expected costs and outcomes of strategy implementation, you will learn more and more about the relative weight, timing, cause and effect chains, and the trade-offs that exist between them. Being difficult to do means very few are doing it.
What an opportunity for those few who can get their heads around the drivers of strategic success and start to quantify them.
What do you think?
Send me your suggestions.
Sep 16, 2022 | Change, Governance, Strategy
In an economy desperate for productivity, how often does stupid, mindless bureaucracy get in the way?
This is not an argument against bureaucracy, rather it is an argument for strategic common sense. It is a nonsense to apply one standard across a myriad of differing circumstances, allowing no margin for reasonable error, then penalising tiny acts of reasonable noncompliance that do no harm.
A tale of woe.
One of my mates runs a small freight company based in a town in the central west of NSW with his two sons. He carries a range of agricultural goods, from grain to fertilisers to live animals, and has built a successful business by skilfully providing specialised services requiring investment in customised trailers designed to meet these specialised needs.
I spoke to him on the phone yesterday as he fumed at yet another example of bureaucratic stupidity making his life a misery.
One of his sons had been pulled up earlier in the day and fined $600 for being 40kg overweight in a 68,000 kg load of grain, loaded from a farm silo without a weighbridge. This is an error margin of .059%, hardly earth-shattering, presenting no danger to anyone, and absolutely understandable given the lack of expensive public infrastructure at the loading dock. The monitors on his axles, properly calibrated and checked, showed no overweight at the time of loading. His assumption is that one axle was in a very slight depression not visible to the naked eye in the loading area.
This is the second time in a few weeks this has happened.
His solution: get out. He can retire, remove the stress of running a small capital intensive business, and his sons will make more money doing something else. Meanwhile, the grain, and live animals he transports either stay where they are, or the costs of moving them go up dramatically as the haulage contractors either charge more to cover the risk of such tiny errors, or simply take less on board.
These standards are set and enforced by the ‘National Heavy Vehicle Regulator’ which has operations in each state. In NSW, there are 310 admin staff and 250+ compliance inspectors, according to their website. I wonder if any will jump in a truck to move the freight when my mate closes his business?
Who knows how the standards are set.
My assumption is that the big operators, Linfox, Toll, and perhaps a few others sit around with a few bureaucrats, agree some stuff, and go to lunch. The big operators go from weighbridge to weighbridge, they are unlikely to ever go up a muddy track to a paddock to take on a load of cattle or sheep to go to the abattoir, or a load of grain in an isolated silo going to a processor.
Is it any wonder it is getting harder to keep the supply chains moving, when the experienced owner-drivers are being driven from the chain by bureaucratic short sighted stupidity imposed for no good reason. The undertrained and inexperienced drivers being pushed in to fill in the gaps are a greater danger to themselves and everyone else on the road than a truck 0.059% overloaded, driven by an experienced driver with skin in the game.
Update: September 23, 2022. This ABC article dramatically underscores the point made in the post.
