Beethoven's Ninth - A Lesson in Leadership for Entrepreneurs

Beethoven’s Ninth – A Lesson in Leadership and Control

Last Saturday evening my wife and I attended a wonderful concert by the Orlando Philharmonic Orchestra in which the featured work was Beethonven’s Symphony No. 9 in D minor Opus 125, conducted by Maestro Christopher Wilkins.  This symphony is considered by many to be among the most iconic works in western art, let alone music.  Beethoven’s Choral Symphony is a colossal masterpiece and one of the most difficult for an orchestra and choir to render well.  Many believe it to be the standard against which all subsequent symphonies have been measured.  It possesses unprecedented size, imposing grandeur of conception, and a revolutionary, for its time, choral finale.  This symphony has both inspired and intimidated later composers and can often measure the competence of the orchestra and choir bold enough to dare its performance.

Over 300 musicians and voices were assembled on stage for the performance, including many instrumental and vocal soloists for featured roles.  This is the largest assemblage of musicians in the history of the Orlando Philharmonic.  Although I have heard this symphony before, both live and in recorded versions, this performance could only be described as breathtaking in its scale and magnificence.

We watched Maestro Wilkins conduct over 300 performers through the entire symphony without a single page of sheet music in front of him.  The entire Philharmonic Orchestra, an assembled choir of over 230 voices formed from three separate chorus groups, and featured soloists assembled for the performance – all of these lead and controlled by Maestro Wilkins.  Each voice, every instrument, each section of the orchestra and choir had a separate part to play for the Symphony to be performed in its perfection.  All this led and controlled by a single conductor who already had each note, each measure, each phrase and theme assembled in his head.  As the conductor led the pace, cued each performer, and controlled the assemblage of musicians and voices everything came together in perfect precision to produce the Symphony and Choral.  The audience sat enthralled, worshipping the performance when it finished with a standing ovation.

Readers of this Blog may well be asking now, what does this have to do with entrepreneurism or business?  Ah, have patience good readers, please.

In reflection, Maestro Wilkins reminds me of a successful entrepreneur leading a new enterprise to growth and success.  The entrepreneur may not be working with “sheet music” in front of him, but he already knows the music by heart.  He or she knows exactly what and who will be required and when.  Key players have been identified and recruited for the endeavor.  Risks have already been examined and analyzed.  Contingency and risk mitigation plans made ahead of time to minimize the chances of a “wrong note” being played and plans made to deal with uncertainties and the hidden flaws.  A successful entrepreneur may be a good manager, but must be a great leader.  Just as 300 performers trusted Maestro Wilkins to lead them through the performance of such a difficult Choral Symphony, the enterprise team and stakeholders trust the successful entrepreneur to lead them through whatever challenges the business will face.  No one doubts that the end result will be success.  Everyone knows the part they are expected to play.  They have rehearsed.  They are prepared.  And, most importantly, the team knows someone they trust and respect leads them.

We cannot overemphasize the importance of leadership as a quality essential to the success of any enterprise.  This is even more so for an entrepreneurial business.  When investors, lenders, early customers, and other stakeholders evaluate a new business the quality of its leadership is among the most important criteria subjected to judgment.  If the team of founders surrounding the business lacks these critical leadership skills, the likelihood of failure is high.

© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved

Smart-sourcing - What to Outsource

What Should be Outsourced?

When considering Smart-sourcing alternatives, as with any strategic initiative, you must first assess your internal organization for overall strengths and weaknesses.  A few guides to assist you with this process are as follows:

·    What are your “Core” competencies?

According to “The McKinsey Quarterly 1995 Number 1” in “Make versus Buy” the authors state “Two new strategic approaches, when properly combined, allow managers to leverage their companies’ skills and resources will beyond levels available with other strategies: Concentrate the firm’s own resources on a set of ‘core competencies’ where it can achieve definable preeminence and provide unique value for customers.”

·    Transforming the “Good to Great”

In the book entitled “Good to Great: Why some companies make the leap … and others don’t” by Jim Collins, he conveys the fundamental message of core competencies around three basic things, identify:

1.        What you are good at

2.        What you are passionate about

3.        Where you make money

·    Knowing the Integrated Supply Chain

But it is not just that simple; you must first really know what the entire supply chain of your organization looks like, how it operates, and how functions interact with other functions.  For example what is the flow across your departmental functions from sales, to customer support, to development, to finance, etc?

·    Deciding the fundamental processes

Then within that integrated supply chain, you will need to decompose the functions down into the fundamental processes performed within each of the departments.  That is, you will need to understand what each function’s input requirements are, what process this function performs, and then what are the output requirements provided by this function.  By understanding this flow and process, you will be able to begin identifying those areas that are really your “core competencies.”

·    Seeking alternative solutions

The other strategic approach referenced in the McKinsey Quarterly article “Make versus Buy” allowing managers to best leverage their companies’ skills and resources is to “strategically outsource other activities – including many traditionally considered integral to any company – for which the firm has neither a critical strategic need nor special capabilities.”

This means, find other companies (this could be sister companies within the organization or external 3rd parties) where the function requiring outsourcing is their “core competency”.

Start with Lowering Costs

Once you’ve determined your core competencies and are ready to outsource the non-competency functions, you might want to first take an internal look at your existing operations and functions with a view of which areas might produce the most effective cost savings.  The strategic initiative of lowering costs can be obtained by one or more of the following:

·    Internal functions

You may be able to lower internal costs to acceptable levels without outsourcing considerations, by overall efficiencies with increased productivity, streamlined processes, more automation and less manual intervention, and such.  You should always seek efficiencies and cost reductions from within before looking outside the organization.

·    Shared functions

Next, you should look at those areas where you may be sharing functions across departments or business units to seek improved levels of service at lower costs.  Examples that might be shared include:  telecommunications functions, facilities, purchasing, HR administration, and the like.  Many times when functions are shared, both parties are focused on the output and now always the efficiencies.  Go to your partner and seek ways to lower costs without sacrificing service levels.

·    Outsourced functions

Then, there are the existing outsourced functions across your organization.  You should re-look at your existing contracts, agreements, and the overall relationship for areas of improvement.  Many times these functions are negotiated well in the up-front, but once the process and work begin to flow, we forget about the original objectives and get on with “business as usual”.  Go back and revisit the relationship and look for those unnecessary costs that may have crept into the process over time.

·    Increased productivity

Lastly, no matter which of the above (or combinations of several) you consider, it is all about increased productivity not just lowering costs.  Productivity increases are obtained in one of two ways, either you reduce the input and maintain the same level of output (cut staff to perform same level of revenue) or you increase output using the same level of input (increased revenues from same level of staffing).

Productivity gains come from innovation in the fundamental way a company delivers products or services.  Companies generate innovation by deploying new technology along with improved processes and capabilities.  By more effectively managing the Input/output control levers of your organization you can obtain dramatic results in your overall strategic objectives of lowering costs.

Move on to Raising Quality

The next key strategic objective for the organization is about raising quality, some might say it’s about “raising the bar”.  It is this initiative that can provide leverage across the organization in order to have significant impact on your results and not just minor improvements along the way.

·    Excelling in your core competencies

Once you’ve determined your “core competencies” you must now exploit them.  You must excel in these factors as if there is no stopping you from achieving market dominance (if you already have market share, this is what will keep you there).

The passion about doing what you do better than anyone else, being able to do that function at higher levels of quality than the competition, and demonstrating that value-add to your customer in the measured results that they gain by benefit of doing business with you; must permeate your entire organization.

·    Leveraging the competencies of your supplier and distribution partners

Then, by leveraging the core competencies of your suppler and distribution partners and allowing them to excel at what they do best, while you are doing what you do best; all creates the compelling proposition that extends beyond anything that your customer could do for themselves in-house or with any other competitor.

Next Add Improving Services

In today’s business pressures of finding 20+% gains in revenues or profit margins or market share, etc.; this last key strategic reason for Smart-sourcing your operations is about ways to get the jump on the competition and keep your organization out in front.

·    Faster time-to-market

By leveraging the combined core competencies of a Smart-sourced proposition, you should find new and innovative solutions coming to market availability in unprecedented time frames.  This faster time-to-market factor can propel your organization to be “top of mind” with your existing customers and also with your prospects.

·    Enhanced offerings

Your value proposition is not just about getting base functional services to the market in an expeditious manner, but rather, when you leverage your core competencies it is about bringing better, more enhanced offerings to the market with you.  The two things you have that are part of your core competencies and are the most difficult to Smart-source are your business domain knowledge and business process expertise (pattern development).  You need to leverage this to enhance your offering beyond just the normal and routine product development cycles.

·    Expanded value proposition

When your value proposition includes the core competencies of partnered solutions, you should be looking for additional ways to expand that solution to your customers and your market.  By adding additional products or services from Smart-sourced providers, you can push more revenue through your brand and distribution channel without having to add the direct costs of the solution.  Not only does this provide you with more to sell, but it can also add to the reasons why you are “top of mind” with your customers.

·    “Doing more with less”

All of the above is about “doing more with less” and this is the magic formula that all firms aspire to achieve.  By blending the right components of your market solution that exploits your core competencies and those of your Smart-sourcing partners you can truly make an impact on this old adage.








© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved

Smart-sourcing - A Strategic Approach to Outsourcing

What is Smart-sourcing? 

Definition of Smart-sourcing Smart-sourcing is a set of strategies that focus on the conception and implementation of an optimal, enterprise business process model that integrates all essential business processes to produce maximum value at the lowest possible cost for all stakeholders

With the many buzz words floating around the industry like out-sourcing, in-sourcing, off-shore, near-shore, off-shore out-sourcing, off-sourcing, Greenfield out-sourcing, co-sourcing, and the like; you may be confused as to exactly what is ‘Smart-sourcing’ and how does it apply to you?  Therefore let us define ‘Smart-sourcing’  - Smart-sourcing is a set of strategies that focus on the conception and implementation of an optimal enterprise business process model that integrates all essential business processes to produce maximum value at the lowest possible cost for all stakeholders.   No ‘single sourcing strategy’, regardless of the size or breadth of the enterprise, will produce optimal value for all stakeholders.  A better approach is a Smart-sourcing strategy that recognizes those ‘Opportunity’ activities that produce competitive advantage and represent core competencies of the enterprise, as distinct from those ‘Risk’ activities that require sound execution to avoid competitive disadvantage but do not produce competitive distinction.  Smart-sourcing strategies can then be implemented to focus on tighter ownership and control of the ‘Opportunity’ activities, while looking to support sound execution at the lowest possible cost of ‘Risk’ activities.


Why Would You Consider Smart-sourcing?

Reasons for Smart-sourcing ·       Fluctuating capacity requirements ·       Cost pressures ·       Competitive pressures ·       Customer demands ·       Access to needed skills ·       Improve quality ·       Accelerate business growth ·       Extend and expand business

Before embarking on a new journey, every senior executive of the firm must ask some fundamental questions, and ‘Why’ is a logical first step.


Fluctuating Capacity Requirements

Virtually every business has ‘peaks & valleys’ in their workload, and many have looked offshore for lower cost labor.  For example, it seems in the IT industry there is always more demand from the user community than there is supply of IT resources to fulfill those requests.  By establishing strong relationships with offshore IT service providers, many firms have found gross savings in excess of 50% over in-house programming skills.  The attraction of offshore service partnerships for both staff augmentation and project work has seen a tremendous growth that is only projected to accelerate.

Cost Pressures

Cost pressures abound in business and very few firms are isolated from the increasing demand for business performance improvement.  Pressures from customers, , competitors, analysts and shareholders are forcing many companies to aggressively seek new ways of delivering similar products and services but at reduced costs.  For many businesses labor contributes a very significant portion of the cost of goods sold (CGS).  When you couple this with the additional costs for recruiting and training new staff on an annual basis, it is easy to understand why so many businesses are moving costs to lower cost economies.


Competitive Pressures


Not only does the pressure to lower cost come from within, competition is another reason many firms are looking at Smart-sourcing strategies.  To remain competitive, any internal  function must offer a stronger value proposition (higher value coupled with lower costs) than other potential outside providers.  And, just like the foreign automakers in the 1980s coming on-shore, providers from lower cost economies are looking to bring their quality solutions and lower-costs of manufacturing, execution, delivery, and support into higher cost North American and European markets.


Customer Demands

Ever increasing customer demands are another reason for Smart-sourcing, as businesses need to implement stronger retention strategies for their customers.  By leveraging external resources, many businesses are able to meet (and exceed) customer requests for specialized services, enhanced and new products, and customized offerings that may not be part of current standard offerings or competencies. 


Access to Needed Skills

With the advent of new technologies rapidly being embraced by businesses, many managers find themselves in need to access specialized skills to assist in their technology evolutionary path.  One reason to look at Smart-sourcing these specialized skills may be to protect current staff supporting legacy operations and infrastructure and rapidly respond to newer technologies without having to add the direct expense of the labor, as well as eliminate the delay in time required to either hire new staff or retrain existing staff.


Improve Quality

While many companies initially go offshore to gain cost reductions and efficiencies, they stay and expand their offshore operations and sourcing and service partnerships because of improved quality and productivity.  For example, in the IT industry Carnegie Mellon’s Software Engineering Institute’s Capability Maturity Model (SEI CMM) standards are now widely recognized as the benchmark for quality processes in software engineering and development.  Of the five recognized levels within the SEI CMM standards, level 5 is the highest and at present, only 116 locations in 73 companies have been audited and certified at this level.  Of these SEI CMM Level 5 organizations exhibiting the highest level of quality processes in software engineering and development, 71 of them, a remarkable 61%, are located in India.  Only 30 of the level 5 certified locations are within the US and virtually all of those are related to the defense industry with only a small handful in the commercial software space.


Accelerate Business Growth

Investors these days do not seem pleased with firms unless they can grow their business in the range of 20 percent annually.  During periods of ‘organic’ growth only, this is a very difficult task for management.  Therefore, to assist in acceleration of the business, firms are looking at out-sourcing alternatives to assist in this growth.  Examples include rapid sales cycles requiring additional resources for implementation and support and leveraging out-sourced staffing to assist in deployment and support.  This provides increases in top line numbers, without added direct costs into the business.


Extend and Expand Business

Additionally, to assist in furthering the organic growth, more businesses are looking at extensions & expansion of their services and competencies, by leveraging strategic partnered solutions to be able to provide more to their existing customers and attract new customers with enhanced and new products.  Again, smart-sourcing partnerships can provide a mechanism to add to additional products and services without taking on proportionate expenses.

No matter what your pressure(s) may be today, it is only a matter of time that many of the above and combinations of the above will be facing you in your decisions of how to improve new and improved deliverables to external and internal customers and while also lowering costs.


Competing Priorities

In every organization and across its many departments, units, and functions there are many competing priorities, activities, and processes.  An important responsibility of executive management of the firm is to balance all of these competing priorities in the battle for budget allocations and funding dollars.  To help create an analytical model to assist in understanding this, let us draw on the work conducted by the Boston Consulting Group and their famous BCG “box”.  In the diagram shown in Figure 1, you find a classic BCG Box representing the situation in which businesses find themselves with initiatives and activities in various stages of the product maturity life cycle.  These stages may be labeled: 1) High Potential, 2) Strategic, 3) Operational, and 4) Support.

As new products, services, or technology arrive on the scene, they typically represent ‘High Potential” opportunities.  High Potential opportunities generally find acceptance from early adopters in the markets.  Early adopters, while often eager and vocal supporters of a new line of business, still make up a relatively minor portion of the total potential market.  Therefore, we attach the characterization of High Potential to products and services at this stage in the product life cycle.  These early adopters often become market leaders and the new line of business begins to enjoy broader market adoption and growth.  At this point, the initiative and its associated processes become “Strategic” to the organization.  As the line of business achieves further market penetration and broad market acceptance, many organizations find the solution becoming fundamental to their business.  At this point the sales, support, and development functions of the company associated with this line of business are considered in the “Operational” quadrant in our model.  Lastly, as the product/service or technology becomes prolific throughout the industry, it becomes very much “business as usual” for the company and enters the “Support” quadrant of the model.  In this model we see organizations derive competitive advantage by being excellent in the high potential and strategic quadrants of our model.  An example of this movement of a new product / service and technology can be found in the banking industry in the ATMs of the 1970’s where it was very high potential as an innovative product for the banking community, then throughout the 1980’s ATMs became a strategic initiative for virtually every financial institution of size in North America, and then over the 1990’s this service transitioned into first operational and then support activities of the banking community.  One might also say that on-line banking and the Internet have gone through similar stages at this point, albeit in a much more rapid cycle of adoption and product maturity for the industry. 

The challenge for any organization is which high potential and strategic activities and opportunities to invest in, and how to shift existing funding to them from the operational and support activities of the business as they mature.  The shift in funding priorities must be properly paced.  While excellence in operational and support activities will not produce competitive advantage for an organization, if these activities are not done well they can become a competitive disadvantage.  Thus in Figure 2, we see how the high potential and strategic quadrant represent the opportunity quadrants for a business in which competitive advantages are typically derived.  The operational and tactical quadrants represent the areas in which risks and threats are experienced and competitive disadvantage can result for poor execution. 

This model can help managers better identify and understand how a Smart-sourcing strategy can help the organization achieve maximum value at the lowest cost to all stakeholders.  Activities and processes in the high potential and strategic quadrants require the most attention, direct ownership and control as these activities are key to the success and growth of the enterprise and those from which competitive advantage is produced.  Activities and processes in the operational and support quadrants should be done well enough to avoid competitive disadvantage but lower costs are often more important in these quadrants than direct ownership and control.  A Smart-sourcing strategy would suggest that moving to outsource some functions in the operational and tactical quadrants to 3^rd party service providers for whom those activities and processes are core competencies can produce quality processes at significantly lower costs.  This frees the enterprise to concentrate more of its attention and resources on the high potential and strategic activities.  Figure 2 illustrates the concept of moving your internal initiatives from quadrant 1 through 4 and looking for ways to offset your resources with those of “smart-source” service providers.

Conclusion


Leveraging offshore economies of scale will be a requirement of your business.  You must recognize this fact.  It is not a matter of should you outsource, it is just a matter of when you will do it and how (what approach) you’ll take in doing so.

The competitive pressures within your industry will increase.  Just like the retail manufacturing of the 1970’s, managers will be required to look at their internal operations and find significant ways to reduce costs to remain viable and competitive.  The demand and pressure to reduce costs will only increase over time.

To survive, and be able to turn from “Good to Great” you must discover your core competencies and begin to leverage them to your fullest advantage.  And, in finding your core competencies you will also need to find sourcing partners where their core competencies fill in for your gaps and weaknesses in you’re bringing the total product, service, or solution to your user community.  Therefore, you will need to implement Partnership Relationship Management (the Partnership Model) disciplines into your organization, and seek those sourcing partners that embrace that model as well.

Smart-sourcing provides the means for you to source appropriate solutions for given business processes in your supply chain to your organization.  It is a means to successful survival.

© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved

Successful Turnarounds

Successful Turnarounds

Surprisingly often, it seems management of a troubled company is late to acknowledge a problem exists let alone recognize their role in both contributing to the challenges and the eventual decline of the company resulting from ignoring a pending crisis until it is too late.  The Association of Insolvency and Restructuring Advisors, recognized professionals in Turnaround Management, have identified the leading cause of business failure (52%) as “internally generated problems within management’s control.”  An additional 24% of the causes are a balance of internal and external factors that, although not under management’s control, are the responsibility of management to identify and address.  15% of the causes are internal problems triggered by external factors such as changing economic or market conditions and regulatory changes.

The message for managers of these statistics is that in a vast majority of business crisis management was either partially to blame for the troubles or, at best, remains at fault for a failure to detect and react to changes in the company’s situation.  Opportunity windows to turnaround a troubled company can quickly close when management ignores the early signs of trouble, misplaces blame, refuses to seek professional help, or procrastinates in taking necessary steps to address the problems. 

Picture of a Failing Company

Analyzing the four Stages of Corporate Failure shown in the accompanying diagram - Stagnation, Underperforming, Significant Performance Impairment, and Crisis - serve well to understand how to detect trouble early, deal effectively with causes of the problems, and the concept of closing windows of opportunity as a pending crisis approaches.

Picture of a Failed Company

The Stagnation Phase (Stage 1) is identified by the following characteristics:

● Operating margins and other key ratios falling behind industry averages

● Appearance of cash flow or liquidity challenges

● Period-over-period revenues flat or declining

● Increased inventory write-downs

● Lack of (or misguided) product investment

● Problems with integration of acquisitions

● Problems associated with business mission critical technology

Changes in the environment (e.g. economic, competitive, or regulatory) combined with internal shortcomings (e.g., poor, fraudulent, or inattentive management) can cause a company’s problems to grow during this stage.  Frequently, the Stagnation Phase is characterized by management being “in denial” on the severity of the problems and the need for immediate attention.  Simply persevering, waiting patiently for a change in circumstances, operating on momentum, more of the same, ignoring the problem, or hoping for an improvement are all ineffective strategies for dealing with challenges at this stage.  Yet all too often we find that these are the strategies employed by management of stagnating companies.

The time for action is now!  Careful and objective examination of the business can identify internal and external causes for the challenges surfacing now.  Early focus on and correction of weak controls and reporting systems, increased emphasis on and attention to more profitable lines of business and products, improved understanding of customer needs and buying motivations, early attention to cash flow and liquidity challenges, more effective management of the supply chain and suppliers, objective evaluation of management actions and capabilities, attention to organizational culture, identification and retention of key employees, rightsizing the workforce to match demands, elimination of unnecessary expenses, closer attention to inventory management, examination of pricing strategies, and competitive analysis are all early steps which should be taken.  Most importantly, NOW is the time to ask for help from a team of professionals available to the business – legal, finance, accounting, and tax advisors, as well as specialized turnaround professionals are all sources of important assistance and advice.  Outside advisors often bring needed objectivity, professional and seasoned experience in your line of business, and in assisting in turnaround and workout situations.  Qualified advisors can save the company much more than their cost and preserve value for all stakeholders through early and effective action.

Inattention to turnaround activities early and effectively in the Stagnation Phase will result in further declines in the business as it moves into the Underperforming Stage (Stage 2).  This stage is characterized by:

● Significant declines in revenue and/or EBITDA

● Assets are not sufficiently liquid and cash flow challenges increase

● Underutilization of fixed assets

● Needed capital is tied up in receivables and inventories

● Management attention is diverted from traditional functions due to cash shortage

●Changes in banking relationship marked by frequent overdrafts, changes in borrowing patterns, missed financial reporting deadlines, and requests for waivers of loan provisions

This is the time to keep the brush fire from turning into a forest blaze.  However, management often continues to be unwilling to accept that problems exist, appreciate the severity of the situation, or acknowledge their role in creating or addressing the problems.  If effective action plans are not put in place quickly, needed outside assistance sought and advice heeded, it may soon be too late to save the company without the pain of a bankruptcy reorganization, or sale of the business.

The next stage of the Corporate Demise Curve is the Significant Performance Impairment Stage (Stage 3).  This stage is marked by many of the following characteristics:

● Credit and merchandise shortages occur

● Cash and credit difficulties become apparent to both insiders and the general business community

o   Creditors become unwilling to advance further credit

o   Suppliers may refuse to ship altogether or require payment in advance

● Increased risk of loan covenant defaults, if they have not already occurred

● Potential loss of key customers and/or suppliers

● Potential loss of key employees

● Lenders begin to move quickly into workout scenarios

o   Review credit documentation

o   Compliance with loan covenants is audited more closely

o   “Strict Compliance” letter sent by lender

o   Waiver of covenants accompanied by “Forbearance” letter to protect lender and lender’s position

● Tax lien and judgment searches performed by creditors

● Communication commences amongst creditors

● Management often develops “siege mentality” in this stage

Without proper controls and forecasting, and as a result of management denials, severe cash shortages occur at this stage and may be the first time management acknowledges a problem.  However, at this point it may be too late for independent management action to deal with the problems.  The sleeping giant in the form of the senior lender has now been awakened.  Indeed, an outside turnaround professional may now be imposed on the business by the senior lender or a creditors’ committee.

At this stage the chances of the business’ survival as a going concern under present management is increasingly unlikely and the least painful outcomes may be a bankruptcy reorganization or sale of the business.

The progression of stages to this point may have been relatively gradual with the cycle taking as much as twelve to eighteen months.  This timeframe may accelerate due to 2005 changes in the US Bankruptcy code.  Those changes may encourage creditors to take action more promptly forcing progression through the stages more quickly as cash demands accelerate on the business and creditors move more quickly to tighten controls.  However, early management attention to the building signs of trouble in the business can head off problems before they grow to crisis proportions.

The final stage or late stage is the Crisis Stage.  The Crisis Stage generally includes almost all of the following:

● Company cannot pay obligations as they come due

o   Inability to service either short or long term debt

● Overall payables growth with delinquent payables becoming significant and unmanageable

● Actual loss of key customers and/or suppliers

● Actual loss of key employees

● Actual or appearance of insolvency

● Public acknowledgement of business failure

● Current management may no longer remain in control of the business

● Value of the business and its assets begins a rapid decline

● Bankruptcy may be unavoidable

At this stage the only remaining options may be a distressed sale of the business or liquidation.

The message here is that sound monitoring and controls, and management focus on key ratios and performance metrics of the business will result in early detection of problems.  Once problems are detected, management should be eager to seek objective outside analysis and advice.  The cost of inattention to building problems will far exceed the cost of professional advisory services and assistance.

© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved

Allocating Equity in Startup Companies

Allocating Equity in Startup Companies

When multiple founders build a startup, how big a stake should each one get?

Building a business is not unlike constructing a building, except that the required materials aren't tangibles like bricks and mortar, but intangibles such as a great idea, strategy, execution and most importantly capital. However, with multiple founders showing up with varying contributions at different times, it's hard to know how to divide the ownership of the company. This is particularly difficult when the company is in its early startup or development phases. However, before outside capital is sought, the division of equity ownership amongst the founders is a matter than must be settled. How much should be given to the entrepreneur bringing the idea versus the individuals required to execute? What about the investors contributing the initial development and launch capital?

Fair and equitable allocation of equity ownership is a question frequently asked of Harbour Bridge Ventures. While leaving this question ultimately to be settled by the entrepreneurial founding team, we have always suggested that a winning business partnership is built on compromise and fairness. But to split up equity fairly, all founders must agree on exactly what "fair" is. The option we most often suggest is for founders to think like investors when determining the value of their contributions, even if they have no plans to raise funds. As there is a significant volume of information and experience of valuations conducted by investors, this can be useful in providing a market-tested, third-party framework for equity allocations. By relying on such market-driven criteria, no party needs to prove the value of his or her particular contributions.

So let's take a closer look at how professional investors value founders' contributions in a Series A round, when a young company closes its first phase of financing. Typically, after such a deal, founders will be left with 30% to 50% of the total equity. That represents the product, the strategy, and other noncash contributions. The investors will get 30% to 50% of the equity in exchange for 12 months to 24 months of operating capital. Some 10% to 20% is reserved for future hires, including key managers.

Of the 30% to 50% set aside for the founders, the idea alone commands little payout. If contributing nothing more, the person who came up with the idea—no matter how brilliant—can expect to hold on to less than 5% of the company. After all, ideas are bound to evolve many times during the life of a startup. Even the principals of venture successes such as Google and Facebook only began to see a premium after the Series B and C rounds, once the businesses started to gain traction.

Instead, the bulk of founders' equity is granted for developing the product, building a viable business plan, and leveraging relevant experience and contacts. Founders responsible for the product or strategy should be compensated for their efforts, with a premium paid for a proprietary, working product. Founders who join the company full-time deserve more equity than those making early, one-time contributions. Opportunity costs are a factor, too. Equity should not only compensate founders who are giving up lucrative careers but also motivate them to propel the startup over the next four to five years.

Then there's the importance of cash. Even companies launched through bootstrap capital generally require some working capital to finance day-to-day operations until the company can support itself and its employees. This may be far less than a venture capitalist is likely to invest, but that's partially offset by the fact that the company, and any investment, is much riskier in the early stages. And these days, capital is frequently scarce and difficult to raise for early stage companies. In a tough fund-raising climate, cash commands a premium. In the current financial climate, Investors are valuing potential portfolio companies at 40% to 60% less than they did in 2007, when private equity flowed relatively more freely.

A final point is that, as time passes, the company will become less risky, and those who take on less risk deserve less equity. So later investors in a business that is cash flow-positive will receive far less for their contributed capital. Similarly, a founder or senior manager who joins a startup after it already has some traction should expect less equity — the foundation, after all, for later success and growth has already been laid — than an early founder who took potentially greater risk.

What is Corporate Renewal?

Corporate Renewal involves the formulation and implementation of a strategic plan and a set of actions for the turnaround and restructuring of a business, typically during times of severe corporate financial distress. Often this turnaround of the business requires the assistance of a turnaround professional with specific expertise and experience in the corporate renewal/turnaround profession.

Since the early 1990’s corporate renewal has gone from being an unknown and little used skill to being a full-fledged business discipline widely practiced and trusted by managers. Much of that growth and development resulted from the professionalization of the field by the Turnaround Management Association (TMA). TMA is the largest global professional organization dedicated exclusively to the corporate renewal profession. Established in 1988, TMA has nearly 9,000 members in 45 chapters, including 32 in North America, and one each in Australia, Brazil, the Czech Republic, Finland, France, Germany, Italy, Japan, the Netherlands, Southern Africa, Spain, Taiwan and the UK, with a chapter in formation in China. All TMA members must sign a Code of Ethics each year specifying high standards of professionalism, integrity, and competence.

Why Use a Turnaround Professional?

Periods of economic and financial distress pose special challenges to the capabilities and decision-making processes of most management teams. Not only do such occurrences increase demands on existing managerial abilities, but they also create a whole new spectrum of legal, accounting, and financial considerations that impact the renewal process. Today’s increased competition, cyclical and volatile financial markets, and economic trends have created a climate in which no business can take stability for granted.

As once-stable, profitable, and competitive companies struggle to improve operational and financial performance, the expertise of corporate renewal professionals is critical to this revitalization process. The chances of successfully navigating the corporate renewal process increases through the use of qualified turnaround professionals, who have the experience and expertise to apply sound practices of turnaround management to failing businesses.

Harbour Bridge Ventures (HBV) Principals are long standing members of TMA and have access to the required resources and the experience to manage the turnaround of a business in a time of crisis.

HBV professionals can enter a company with a fresh eye and complete objectivity. This allows us to spot problems that may not be visible to company insiders. HBV has no political agenda or other obligations to bias the decision-making process. This enables us to take sometimes unpopular, yet necessary, steps required for a company’s survival. In corporate renewal engagements, experience within a particular industry is less important than experience in crisis situations when a company is facing bankruptcy or the loss of millions of dollars in revenue. Like an emergency room doctor, HBV professionals must make critical decisions quickly to staunch the financial bleeding and give a patient the best chance for recovery. Operating in the eye of the storm, HBV will deal equitably with angry creditors, frightened employees, wary customers, and a nervous board of directors. Clearly this is no assignment for the faint-hearted. That is why HBV’s professional corporate renewal experience and professional disciplines are so important in such crisis situations. HBV professionals can preserve and often restore value when the only other alternative may be failure or bankruptcy.

What Causes Businesses to Fail?

There are generally a limited number of “root causes” for the failure of a business:

• “Acts of God” – Certain risks may occur and cause irreparable damage to a business (despite proper anticipation and thorough preparation)
• Poor vision or understanding of the market and the competitive landscape
• Inability to anticipate and properly prepare for change
• Poor strategy
• Poor business model
• Poor execution

Underlying many of the above root causes one often finds one or more of the following symptoms that likely contributed to the distress:

• Lack of expertise or experience within the management team
• Market circumstances or changes
• Challenging economy
• Threat of bankruptcy of a holding company, major supplier, or major customer
• Board level controversy
• Fraud or at least insufficient financial controls
• Overly optimistic sales/revenue projections
• Financing problems, liquidity crisis, excessive debt burden, undercapitalization
• Operating cost levels are too high
• Very strong, successful competitor(s)
• Excess capacity (over-investment)
• Insufficient resources (under-investment)

What are the Steps in a Turnaround?

HBV employs a five-step process in our renewal engagements analogous to that employed in the medical profession:

1. Diagnosis – Determine the chances of the business’ survival, reasons for failure, appropriate strategies for survival, and initial action plan
2. Triage – Take immediate action to treat the wounds endangering the company’s survival. This is necessary to provide the time and opportunity to effect necessary changes.
3. Treatment - Develop and Implement the action plan to treat identified problems and effect necessary changes to turnaround the company’s fortunes.
4. Stabilize the Patient – Once the emergency rescue plan has been implemented, it is necessary to turn attention to getting the company back on track to sustainability, increasing profitability, and generating acceptable cash flow and returns on assets and equity.
5. Restore Long-Term Health – Effect long-term structural changes necessary to sustain improvements and ensure the long-term health of the business.