Special deals and product discounts: how to de-value your Company

April 30, 2010 2 Comments

During the past week, I have been covering many aspects of a due diligence. My latest post was about the Company’s portfolio of products and services. I wanted to go deeper on a very important point that some companies seem to be missing. While product discounts and special deals are great to lift up revenue in the short term, they have a major impact in the long term on fair price and sustainability – ultimately valuation.

Fair price
So how much is your product worth? If you keep discounting it and give special deals, it will be very hard to represent a fair price for your product. This means that any financial projections you might do will be heavily discounted on customer adoption and on price. It will make it very hard for your Company to prove that you can maintain your revenue line and growth numbers. What happens when you stop making these discounts? Does this mean that you need to continuously maintain discounts and promos? As you can see, it makes it almost impossible to convince someone that is can be sustainable.

Sustainability and valuation
I believe that sustainability is a core component of the valuation of a company. If you are looking for high valuations, you need to prove that what you have built can continue growing and sustain not only on the top line but also the bottom line. The stronger you are in proving this, the better the valuation ratios (2x or better). On the other side, if you can’t prove that you can sustain business without all these fire sales, then expect to get a much lower valuation ratio (around 0.5x revenue). As you can see, the difference in valuation can be quite huge.

When can you discount your pricing?
Discounts should be the exception. It needs to be part of an overall pricing strategy. For example, you can decide that you give a 10% discount on larger orders or deals. Notice here that I mentioned a small discount. Larger discounts (20% -30%) should be prohibited – unless you have a very strategic goal in mind (for example, to displace your competitor in its biggest customer site).  As you can see, this should not happen often and if done well, will not impact your company valuation. Another reason for special pricing is on product launches. This is acceptable as long as this is done with a strict time limit.  There is nothing worse for your business to continuously extend promos and discounts. If you do so, how can the customer know when they really stop? You just create conditions by which customer never buys list price, waiting for the next promo or discount to happen soon enough.

The end of quarter syndrome
It’s the end of the quarter or the year. How much does your sales team push to reach their quotas? If you keep on pushing at each financial milestones, you will implicitly create customer expectations that waiting until the last day of the quarter (or the year) will give them the best price possible.  This can be a huge chicken and the egg problem. Your sales team begs for more deal making at the end in order to make your number and by doing so, you achieve your quarter. But how much could you do if you did not have this time-based behavior? One simple trick to move your sales team away from this way of conducting business is to start tracking linearity of your sales pipeline. Indeed, you can rapidly modify this behavior by doing so. While it takes some time to achieve close to perfect linearity, just working at it will help you alleviate the end of quarter syndrome.

So if you are stuck in the world of discounts and promos and are thinking of selling the business, I have one simple suggestion: STOP DOING IT. The faster you can stick to your list price and push business on it own merit and demonstrate that you can sustain in the long run, the better you will be (and hopefully gain some points on valuation). If you don’t (or can’t afford to take that risk) then you just need to accept that getting a much lower valuation might just be the best offer you will get at this point of time – if you get any offer that is…

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Due Diligence: Products and Services

April 30, 2010 1 Comment

Next is the detail on products and services. It is important for the Company to list not only all current product offered and manufactured (including services), but also all products that have been manufactured and offered in the past. Don’t be surprised either if you are being asked to explain the reason for all product discontinued in the past. This also requires you to indicate all pricing for product and services offered.

Simplicity in pricing
Nothing better than a due diligence to scare off a buyer or investor if your pricing model is not simple enough. Some of you might smile but it is amazing how many companies have convoluted and complex pricing models. As a good test of diligence, you can ask the Company to supply sample sales quotes that are most often given to potential customers. Don’t be surprised to be requested to list all special deals and discounts offered in the past couple of years (more on this on my next post).

The inventory factor
If your Company has inventory, this can be a factor as part of diligence. Too much of it could reduce value. Not enough (and depending on your manufacturing process and delivery time) can also be a problem. Be careful if you also have inventory for legacy and obsolete products – can be  reason to discount past financials if you have too much of it.

The quality of your suppliers
How you are selecting for supplying you can be an important factor. While you might have chosen someone that cost you less but it could become a liability as part of a due diligence. Don’t forget that the objective in doing a due diligence is to properly adjust Company value in consideration of assets, intellectual properties but also all risks and potential liabilities.

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Due Diligence: Intellectual Property

April 29, 2010 4 Comments

Ok, now on to the big whale of the due diligence process: intellectual property. This is where the buyers needs to weed out what is really valuable and for the seller to stuff as much as possible the value of the business. What are the trademarks that are truly valuable? What copyrights are worth something? That goes without saying about a well developed portfolio of patents.

  • Trademarks: list of the Company’s used & proposed trademarks, licences granted to third parties (including assignments). Is there is trademark claims for or against the Company?
  • Copyrights: what are the copyrights (registered or not) owned by the Company? What are the copyright licenses granted by the Company? Is there any copyright infringement for or against the Company?
  • Patents: what are the patents (registered or not) owned by the Company? Does the Company have any applications for registration? Did the Company license any patents. Even more importantly, has there been any discussion, claims or dispute regarding patent infringement (for or against the Company). This needs to be well documented – I’ve seen deals called off at the last minute just for on a risk of a patent infringement …
  • Industrial Designs: this is also a very important point. Your engineering team and product design team might have a lot of very interesting designs up their sleeves.  While these might not yet help the Company, they can still be quite valuable for the buyer.
  • Trade Secrets: this also applies to trade secrets. The seller needs to list all work done by the research team and other highly secret software development done.
  • Technological Processes: does the seller have any innovative processes? If so, this is key to identify here.
  • Confidentiality and Non-Disclosure: this is an area that I find too many companies are easy going when it comes to signing NDAs. A big portion of NDAs are often signed just because that’s how things are done. And I can’t disagree more. There is a lot of situation where non-disclosure are not needed (and will be a topic of an upcoming post). In any case, the seller needs to provide the complete list of all agreements signed. This is where having a paralegal and a good system to archive agreements makes the due diligence process easier to go thru.

The key takeaway point for me when it comes to intellectual property is all about the quality of the content that the seller can provide. If you don’t have any decent system to manage and retrieve all this information, you will spend a huge amount of time to assemble the data room – let alone forgetting to disclose important information. And this gets even more complicated as the Company gets older. And since many elements related to Intellectual Property lasts more than the usual five (5) years, you can actually drown yourself in a sea of content in trying to provide that the buyer is requesting. The worse of it all is that can be planned ahead – every deal requires for the same core of content (but not always formatted the same way).

So start-ups, start gathering and maintain your data in preparation for any due diligence you might encounter. Don’t wait until you get an offer …

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Due Diligence: Legal Information

April 28, 2010 3 Comments

This morning I am covering the legal portion of a due diligence. I look at this as the appetizer before we dig in Intellectual Property. Some of key elements you need to ask for include:

  • The name of all the law firms and professional services contracts signed with these law firms for the past five (5) years.
  • Did the Company make any claims in the past five (5) years? This includes injunctions, procedures, whether these were judicial or administrative. This also applies to any claims received against the Company or its directors and shareholders. From a sellers point of view, there is no reason to hide anything. With today’s day and age of the Web, there is a lot of info circulating out there and that last things you want is for the buyer to find something without you telling them first – even worse when this happens before the deal is closed.
  • If the Company has been in court, was there any Judgments or out of court settlements?
  • Ultimately, is there anything from a legal perspective that could raise the liability of the directors and shareholders that the buyer needs to know about. Again, if the seller has a well managed database, such things are easy to dig up. Otherwise you might just forget about something. And forgetting gives an immediate impression of hiding something…
  • In the context of IP (and we’ll get deeper on the matter in my next post), the seller needs to supply any form of Legal opinions prepared by any lawyer or law firm regarding the actual and potential liability of the Company.
  • This section also relates to compliance. The seller need to list all permits that they have in order to run de business as they do. This can also include components such as the Office of the Langue Française that we have here in Quebec. There is an obligation to comply to specific rules once a Quebec based Company is more than 50 employees. While the Company can still run their business without being 100% compliant, this is something you want to raise as you are looking to buy the business.

What is important to capture here is not only any information that indicates issues from a legal and compliance perspective but also the level of precision on how legal was managed. Too many times, legal is managed by an outside firm and the management of records is not really being kept in order. Due diligence is as much about how you get the info as the info itself. This is why I always suggest that start-ups invest just a bit more on legal (for example, by hiring a junior paralegal) and make sure that everything is tidy and clean. Again the whole point of doing a due diligence and purchase agreement is to make sure that you are fully aware of all potential risk and liabilities – getting no surprises once the deal is done. And this applies also to the seller; you need to minimize risk and liability for the shareholders as they will mostly have a portion of the deal under escrow.

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Due Diligence: Financial Information

April 27, 2010 2 Comments

Now lets move on to financial information. Not only you want to get the latest data but as many things in a due diligence, you want to get historical information for the past 5 years:

  • All the financial institutions that the Company has dealt with
  • For each of the Company’s bank account, obtain the monthly bank statements
  • Does the Company have any loans or line of credits with any financial institution, institutional lender or private lender
  • Is there any real restate mortgage agreements (Immovable hypothec agreements) ?
  • Same questions goes for any personal property mortgage agreements that a founder might have contracted (you want to eliminate any links to share ownership to debt, etc)
  • You also need to receive any documents such as acknowledgement of debt, promissory note, letter of credit, etc.
  • Did any of the executives or Director receive personal loans?
  • You also need to get copy of all form of government grants, subsidies, etc. that the Company has received or have on-going …

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Due Diligence: Corporate Information

April 27, 2010 2 Comments

Let’s now look at a big component, the Corporate information. This includes all aspects such as structure of share capital, governmental notices, minutes and resolutions, list of directors, securities, agreements relating to Shares of the Company and operations. Here are some specific point of interests:

Directors
This can be quite important if you are doing some form of Merger or Leveraged buy-out (LBO). Understanding who these Directors are can actually help you during the deal making process. Everybody is involved for a reason (and it can’t just all be about philanthropy) and knowing this early on can be valuable – even more if you are considering keeping some of these Board members going forward. Of course, you will want to get rid of the VC related Directors but you don’t want to exclude 3rd parties without a proper reflection.

Senior Executives or Officers
Who is the executive team? What is their individual roles and actual contribution? You want to find out who is really running the business and how they are doing it. Sometimes you might have many VPs in the Company but only to realise that they are basically a bunch of “yes men” to the CEO. It is crucial to understand beyond their title who are the movers and influencers (right or wrong) within the Company you are acquiring.

Shareholders’ agreement
Does the Company have a shareholders’ agreement, what type is it? Who are the shareholders that have special voting rights? You also need to understand any special components such as vetoes, multiple dips, carve outs, etc. This can actually help formulate a valuation/offer that will make the deal happen. You also want to make sure who is benefiting from the employee stock option plan (ESOP). Often, start-ups are very aggressive on valuation and therefore put the exercise price under water (ESOP’s worth nothing). Planning to new ESOP or special consideration for key employees are not required to make the deal but are key in making the integration and acquisition ultimately successful.

Subsidiaries and Other Entities
How is the overall Corporation structured? How many subsidiaries does the Company have. This is crucial in understanding how you will operate this going forward but also for things such as Tax considerations. Never underestimate how this can impact the business once acquired. Not all finance deal coming out are as good as when created…

Business Plan
You need to get an up to date version of the Company’s business plan but also all business and products plans from the past five (5) years. This is key in determining how accurate and realistic the product and executive teams have been for the past years. As the Company will make representations on the sustainability of the business going forward, knowing how good they’ve done in the past will help you put in place the right level of reps and warranties on the deal (and also including escrow).

Relationships Between Individuals
Another very important aspect of a transaction is to understand the relationship (family, corporate, financial) between every director, senior executive, shareholder or employee of the Company. Who is dating the CEO’s daughter? Who is working in Support but is also married to the VP of Products? Is the main supplier of consulting services actually the cousin of the Dir. Of Operations? Never forget that blood is ticker than ink and enterprises that have deep roots in family ties require a greater deal of attention (and finesse) if you want the acquisition to be successful.

Past acquisitions
What acquisitions were done in the past. What are the key elements still ongoing on those deals (escrow, retainer programs, IP ownership, etc)? What assets were acquired in recent years? You want to make sure that all IP and rights were properly transferred to the Company you are acquiring. Make sure to include all past obligations as part of your assumptions – including implicit rights given to certain employees or shareholders. Just remember that while it is good for a seller to go thru multiple acquisitions (greatly reduces their own liability), it is the opposite for the acquirer ..

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Due Diligence: History of the Company

April 26, 2010 Leave a comment

While this section is far from being highly critical in the due diligence process, I find this to be quite important when it comes to preserving historical information and valuable archives. It is always interesting to see companies scrambling to get historical data from founders and key executive ONCE they left the company once acquired. This is actually a lot easier to get early on so don’t be shy to ask for more information – to be stored at a jointly approved area if needed (picture and video archived, memorabilia)

Early days
Get the seller to explain the early days of the company. Is there any skeletons in the closet? Is there is series of events or specific opportunities that have led the company to become what they are now today. This is also good to identify how far along they have been working on structured processes when planning.

Past product roadmap
Make sure you get all previously released product roadmap and plans. For one, it is important to look at the quality of what has been done in the past. Also, this is a good indicator on how accurate engineering is when it comes to deliver product plans. It is also very important to capture all past product packaging and historical pricing, including any important product bundling or OEM.

Current Situation
What kind of picture can the seller’s management team can paint on the current situation – from employee morale, product positioning, where the company plans to be successful and what are the known challenge.

Nature of the services or products offered
How is management describing their product line and services. Try to get here a different version than what Marketing has put on the web site and company brochure.

While most of the initial founders might still be in the management team, it can be interesting to interview a few of the initial employees – they usually have to most to complain about what even when trying to be polite about it, they can give you some valuable information. From the other side, I am always reluctant to give access to staff that are not properly trained to go thru a diligence process – never really sure about what will come out …

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The A to Z of Due Diligence: high level view

April 26, 2010 1 Comment

In the coming blog posts, I will be covering some key aspects of the due diligence when acquiring a company. But to begin, here is the high level view from A to Z of the typical due diligence list. I will review specific points (and more based on your feedback) in the coming days and weeks.

A- Identification of the Company
B- Identification of the Authorized Representative
C- History of the Company
D- Corporate Information

  • Certificate or Articles
  • Governmental Notices
  • Minutes and Resolutions
  • Incorporators
  • Directors
  • Senior Executives or Officers
  • Shareholders
  • Securities
  • Share Transfers
  • Share Certificates
  • Agreements Relating to Shares of the Company
  • Subsidiaries and Other Entities
  • Business Plan
  • Relationships Between Individuals
  • Suretyships and Guarantees Granted in Favour of the Company
  • Corporate Operations
  • Numbers Attributed to the Company by Various Governmental Organizations

E- Accounting Information
F- Tax Information
G- Financial Information
H- Legal Information
I- Compliance With Laws
J- Intellectual Property

  • Trademarks
  • Copyrights
  • Patents
  • Industrial Designs
  • Trade Secrets
  • Technological Processes
  • Confidentiality and Non-Disclosure

K- Machinery, Tools and Equipment
L- Products and Services
M- Computer
N- Immovables
O- Insurance
P- Internet / Web sites
Q- Environment
R- Operations
S- Franchise
T- Marketing
V- Suppliers, Subcontractors and Consultants
W- Employees
X- Competition
Y- Research and Development
Z- Miscellaneous

As you can see, there is a lot of topics to cover in a due diligence … let me know what you really want to know more about …
Note: original check list courtesy of: http://www.scribd.com/doc/258570/Due-Diligence-Checklist

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Business Plan: Knowing who is your real customer

April 20, 2010 Leave a comment

So your Company has identified a real market problem and you have the technology to solve it. You have drafted a business plan and are looking for funding in order to execute your plan. The revenue forecast sounds pretty exciting as you are looking to commercialize a solution for the general mass (B2C). But have you answered this question: who is your REAL customer?

End user vs. customer
There is a big difference between the end user (the person that will ultimately consume your product) and your real customer (the person that will give you money – that will help you monetize your technology). The answer is far from easy in this day and age with electronic distribution, apps stores and social media platforms that allow you to integrate and sell plug-ins.

Partners can be your competitors
If you are trying to acquire the wrong customer base, you might end up competing with someone you thought would be your partner. For example, if you are looking to release a great solution that will help Facebook increase its revenues, you need to make sure that they do not plan to do the same as well. If you follow closely the customer ownership trail, it will help you create an answer.

Monetizing vs. customer ownership
Great technology will allow your Company to get to bigger revenue if you pick to right way to monetize it. Don’t focus on customer ownership – this is even more important when you are making low prices one-time consumer products sold for a few dollars. OEM or Affiliate partners can be most of the time the better customers, giving you indirectly access to their large customer base and share revenue.

Listing all potential customer types
You should take the time to list all potential customer types you might have: consumer, hardware manufacturer, distributor, etc. Thinking out of the box can actually help you identify a better customer that you might have thought about initially. For each type, you need to recognize the benefits and revenue potential but also (and that is very important) the cost to acquire the end-user base.

Having clarity about your real customer will not only give you a better path to success but also minimize any burn rate you will have in trying to monetize with the wrong audience…

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The cost of Marketing and getting media coverage

April 12, 2010 Leave a comment

I always love to see Apple launch new products (iPad) or new updates (iPhone 4.0 SDK) and the quality of their presentation, message and media coverage they are getting. I don’t know a single company that would not love to have such a marketing machine. Many Entrepreneurs will just assume that this is only possible once you have a gazillion of dollars to spend on Marketing. But then again, if it were the case, every other Fortune 500 company would be just as good, right? While money is key in doing things at a greater scale, there are some basic fundamentals that every company can apply to get an excellent Marketing foundation – that will get just more impressive once you have more money to spend on product launches and marketing campaigns.

Marketing takes time

That is perhaps the most important point. No matter how some people think that marketing can be done in a quickie, it is far from the truth. First, you need to build a team and that does not end once you have hired the staff. As a rule of thumb, I assume that building a team and getting all the contributors to be working as a unified group takes at LEAST 6 months. It does not mean that nothing can be done in the meantime, but you can’t expect a team to function and work cohesively in less time than this (no matter how much you pout, scream, put your foot down and lose patience). I have a similar rule for tracking the impact of Marketing. Getting market traction and media coverage takes time, you won’t get it from a single event or even worse – expecting that one press release or a snazzy re-designed web site will do the trick. Consumers are bombarded with news and information; it takes time to imprint brand value and media awareness into the cerebral cortex…

Spikes vs. marketing buildup

Entrepreneurs (and their CFO) do not often see the hidden cost of doing sporadic Marketing activities. The amount of energy and time that you need to put in order to get a single event to move the needle on media coverage is borderline insane. But I still see companies every day still hoping that this will work for them. What startups don’t seem to understand is that marketing is all about buildup. This is just like collecting wine. Every time someone asks me how I got to build my wine collection (I have about 600 bottles), I simply answer that I just buy a little more than what I drink. After time, this builds up to bigger numbers. Now if I was trying to build the same wine collection over a small amount of time – the effort, pain and cost would be much higher than what it took doing it the right way (if you just won the lottery disregard this comment…). Think of marketing as a long term buildup that after a while (and this is at least beyond a yearly cycle), you will be doing more and more Marketing activities that combined will have a real impact over your business.

Planning and process
In order to get marketing buildup, you need to plan ahead and have simple, yet effective processes. Activities such as blogging, tweeting, writing customer stories & eBooks, and doing press releases all need to fit in a marketing timeline that allows you to successfully spread your message. Each element needs to have it’s own process where things are done on a regular basis and ultimately effortlessly. If each time you write something on your blog, it eats too much of your time, it will be very hard to continue contributing on a regular basis. Without a due process and regularity, you cannot yield more output from your Marketing team. As an example, I rarely take more than 30 min to write each of my blogs. Writing a few times a week then only takes me an hour (two at the most) to support my blogging effort. If it was more than this, I would not be able to sustain such a frequency…

Bottom line is that marketing is more of a process and takes longer than most entrepreneurs are willing to accept. Never underestimate the cost of building a team, and getting this Marketing buildup. Without patience, you will just simply keep changing your team every 6 months to a year, continuously re-working the foundation (and web site) and never achieve any kind of Marketing momentum and media coverage you desire.

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