Monday, April 18, 2011

Entrepreneurial Excess

My recent article 4 Indulgences Your Business Can't Afford must have really struck a chord with the readers of American Express OPEN Forum®. It ranked in the top five of all articles for the week in total visits, unique visitors, and more. The point of the article was that too much focus on 4 specific parts of your business, without being balanced by other important things, will hurt or even kill your company. Here is a quick analysis of what you need in place to properly discipline an attitude of "excess" in the areas of product, marketing, overhead, and competitors.

Product Infatuation, or focusing only on how great your product is, must be balanced with an even greater focus on the needs of your customers.

Marketing Worship, or becoming consumed with a lot of spending on "branding" activites that do little or nothing to actually help your business grow, needs to be disciplined with rigorous ROI calculations to determine which marketing activities bring the most customers per dollar spent, not which activities stroke your entrepreneurial ego with unnecessary exposure. I refer to "Branding" in quotes because the entire concept of branding is something big companies with big marketing budgets do. Entrepreneurs don't have time to wait for branding pay off, they need to spend all their marketing resources on getting customers now.

Overhead Abundance, or spending lavishly on unnecessary, non-revenue-generating activities, must be countered with displined, exacting controls on the growth in overhead spending. For example, if your company grew 20% last year while your overhead spending grew by 50%, you probably have some abundance in your overhead. I'm not suggesting you don't invest in the systems, infrastrucutre, people, and processes of your business, but I am suggesting that some entrepreneurs have a tendency to allow their overhead growth to get a little ahead of what it should be.

Competitor Obsession, or spending too much time thinking about and stewing over your competitors, needs to be put in check with a focus on improving your own company. Strengthening your points of differentiation, your unique selling proposition, and the breadth and depth of the needs and buying motivations of your customers will always bring more value to your company than spending too much time wondering what the competition is up to.

The most interesting observation I have from this brief analysis is that all of these tendencies have to be kept in balance, avoiding extremes one way or the other. For example, trying to keep overhead too low can hurt the company's ability to grow just like not putting any thought into the competitive landscape of your industry will hurt you as well.

Monday, April 11, 2011

The Capitalization Table

Jeff Hall and I have almost finished teaching another semester of Entrepreneurial Finance at UVU. We've come a long way since the first time I taught the class, which was the first time any such class was ever taught at this University. The students have been diligently building business models and plans all semester, building up to the climax at the end--the capitalization table, or cap table.

When forming, planning, building, and growing a successful entrepreneurial venture, entrepreneurs need to be very familiar with their cap table. It is not enough to assign that to your legal counsel. The cap table will make all the difference in whether or not you maximize your chances for success, both personally and for the business as a whole.

Before I talk about why it is so important, here is the cap table we built during class while going through a series of ficticious rounds of funding:

The rounds of funding included seed, angel, series A, series B, series C, and then an Initial Public Offering (IPO). We assumed it was a C-Corporation with only common shares and no stock options to keep the example simple. With each round we valued the shares, determined the pre and post-money valuations, allocated the appropriate shares for the new round, and re-calculated the percentage ownership for each shareholder.

To make it interesting, I purposely made it so that we did not have enough shares authorized to complete the Series C round so we could discuss the corporate governance issues surrounding authorizing more shares. Up rounds, down rounds, cash-on-cash returns, and more were hot topics of conversation.

Not including all of the legal, accounting, and regulatory reasons for properly tracking and knowing your cap table, the most important reason for it is so that the entrepreneurs can understand if raising equity is really their best option for growth.

I often hear business people say things like this: owning 20% of a really big company is better than owning 100% or a really small one. Conceptually this makes sense, but the cap table proves it. A financial model without a cap table is incomplete. Why? Because the whole purpose of modeling is to figure out which choices will prove the most beneficial for the stakeholders. Without the cap table, the benefits to the stakeholders is usually not apparent, meaning the analysis and decision-making is not as good as it could be.

The key take-aways: have a cap table, keep track of it, and use it to analyze the potential returns for all of the funding strategies you consider.

Saturday, April 2, 2011

Knowledge Manifest in Numbers

Business owners should continually improve the way they are using, analyzing, and presenting numbers that represent past, present, and future business performance. I have consistently found that the right information in the right hands at the right time in the right format empowers entrepreneurs to make the very best business decisions possible, maximizing chances for success.

I was recently re-reading How to Measure Anything: Finding the Value of 'Intangibles' in Business and was reminded of how numbers can play a critical role into gaining knowledge about a problem, situation, or task at hand. The author, Douglas W. Hubbard, quotes Lord Kelvin in the very first chapter of the book:

“When you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind" (emphasis added).

Interesting how he feels that being able to express information in numbers constitutes knowledge where the lack of numbers in expression weakens or maybe even invalidates knowledge. Not only do I agree with this concept, but I also have seen how a knowledge based in numbers improves decision-making and vision.

Next time you want to express your knowledge on something, challenge yourself to express that knowledge in numbers and see if you are more persuasive and can have more impact.