Pay Back the Founders

One of the commonly misunderstood components of an investment in a growing business by people who have not been there before is the concept of paying back the founders. That is, the company has a value, and people sacrificed in some way to help the company get to where it is today. That might have been money, connections, time, or pretty much anything that can be valued.

When the potential investor comes around, the question arises as to how to place a value on that form of equity.

First, though, what has to be realized is that technically, the founders are not entitled to anything. Strictly speaking, the investment is a purchase of shares from the company, usually done by issuance of new shares, for a stated price. The founders are not the sellers, they are merely authorizing the corporation to create and distribute new shares according to the terms of whatever deal it is they made.

However, the founders may have to be convinced of the value of gaining the investment, and the company may owe some debt to the original founders (depending on how they structured the startup investment). As well, the investors may want to show some goodwill toward the founders by alleviating some of their contribution in the form of a payback.

As a buyer, though, the amount to be paid to the owners will be somewhat a function of the amount of real value that the initial brought into the company. If it’s merely time, that can be priced at a known rate (discounted by the amount of ownership the founders are retaining). Often, though, there’s also some form of IP (intellectual property) which, not relating to whether or not it is protected by the company, was provided by the founders.

At the end of the day, though, the amount to be paid to the founders is more a function of goodwill than of concrete value. The numbers may fluctuate wildly, and may have limited relationship to the value of the company as it stands in the accounting records. It is more of a bribe to the founders to convince them to part with a piece of their company than a part of the purchase.

It Pays to Give Away

A few years ago, when just starting out in the consulting business, I would have been reluctant to give up any business at all. If someone asked me to write them a tiny script, or a massive desktop application used by thousands of people simultaneously, I would have been eager and raring to go. The bigger the project, the more likely I was to take it on, and I would convince myself that I was actually the right person for the job.

Fortunately, that didn’t ruin my business, but in hindsight, I was running a huge risk. There were certainly projects that I should have turned down for a variety of reasons.

What I discovered during the growth of my business is that there are really only a subset of projects that I personally should be getting involved with. For the rest? I have a nice Rolodex with names of businesses that would love to have those projects, and would do a fantastic job at them.

It’s not that I couldn’t do those projects, but rather, that I shouldn’t be doing those projects. While the short-term gains for me I perceived to be significant, in truth, they probably weren’t nearly as important as I thought at the time. What gains I made through those projects I could have made elsewhere, or made irrelevant through other projects I did.

In any business, it can sometimes be difficult to look at the current situation, and the latest opportunity, and determine whether or not the gains from that option are worth pursuing. What can help with this determination, though, is the presence of a clear goal, and you can look at the opportunity from the perspective of how much closer it gets you in reaching those goals.

For example, a project recently arose in which a client required a fairly complex web application to be built. This isn’t my area of specialty, and it’s not where I would take my business. Reflection told me to pass it on to a friend, who’s business does exactly this type of work.

The return benefits are often late in coming (I rarely take a referral fee directly from handing over a project), but can be more significant that what I’ve given. In this particular case, I landed a dream client I would have never met without this friend.

In other words, giving away a project or client now can have bigger returns. I consider it to be an investment in the relationship I have with the client and the company to whom I pass on the client to.

The client is happier because I forwarded them to someone more qualified. They trust me to tell them about my own expertise, because I’ve already proven that I’m not afraid to say that this isn’t what I do best. Forwarding them to others within my network increases the likelihood that if this client ever has a project that does fit my vision of an ideal project, it will be sent my way.

Likewise, the company who is being referred appreciates the business, and when they come across a project that suits my business more than their own, it too will make its way to my desk.

Oddly enough, this exchange is actually measurable in terms of pure profitability. I try to determine with every project that comes my way how the client found me. Once I do that, I can actually balance the project I got against those I gave away.

To date, I’m still on the leading side of this overall. Sure, there are a few relationships weighted in one direction or the other, but the benefits have far out-weighed the costs overall, and that’s why I will continue to pass along on projects that don’t bring me any closer to my goals, because passing those along is bringing me closer to my goals.

How well do you know your own business

When Carl and Maria Griffin entered the Dragons’ Den to showcase their business and hopefully land an investment, they were awakened as to the true nature of their business. Their business, LiteLocker, makes it trivially easy to install and remove Christmas lights, by installing the system alongside the eaves of a building. The units can be painted to blend in with the rest of the building, and a handy contraption means that ladders are no longer needed either, once the system is in place.

The price, however, is what hit the business hard. A typical home would cost about $500 to get set up with the system, significantly more than what the average homeowner would pay. While cheaper that hiring someone to put up and take down the lights each season (which was estimated at about $750 for the same home), most homeowners are hanging the lights themselves to save the money.

However, one Dragon saw past that flaw, and focused on a market that would be only too happy to pay for such a product. Stores and offices, which typically do hire people to hang the lights, would see this product as saving them money. While in the first year the savings might be relatively minimal, by the second year, the savings can be quite significant.

Jim Treliving, with 350 branches of Boston Pizza to outfit with lights, calculated the savings in his first year at about $80,000. The following year, this number would triple with no more outlays needed. The money for the investment ($200,000) could come directly from the savings in the first two years of using the product.

The problem, however, was valuation. While the product was clearly good, sales were still non-existent. The million dollar valuation had to go, but the question remained how to balance out the $200,000 with the company. On air, the counter offer of 35%, which converts to a valuation of about $570,000 was accepted. The premise, of course, is that the business can do quite well.

It’s unclear from the site whether or not the deal has gone through. While they are clearly celebrating their airing on CBC, there is no indication that they have actually adapted their business model to approach businesses rather than homes. Why they would choose not to target stores is, to me, a mystery, since those are the customers who can afford their solution, and are likely willing to spend it to save in the long run.

However, more interesting is the fact that Carl and Maria learned on the Den that the focus of their business, or the market they should be aiming for, was not the same as what they came on the show airing. The question, though, is how well they learned that lesson, and whether or not it will translate into a stronger business, with or without dollars from the dragons.

Are You Magnetized?

Over the last few years, I’ve begun to suspect that in some sense, I’m a magnet, and I’m not sure why. Not that I’m complaining – on the contrary, this magnetism has brought me large amounts of business, but I’ve tried to understand how this can be replicated.

First, though, I should explain what I mean by being a magnet. If I attend a networking event, I’ll meet people with businesses larger and smaller than my own. Chances are, at least a few of these encounters will result in second meetings over a cup of coffee. Or, I’ll hire someone on contract to do a bit of work for me, and the next thing I know, we’re sitting down to discuss opportunities for development.

It’s not just that I attend these events, though that does lend itself to making it easier to meet people. I think it’s more about the attitude toward meeting people at an event.

At this stage of my business development, I will often have more to gain from a networking associate, who may be more established in their business, and therefore able to offer more. However, one of the things I’ve learned is to never ask for the help, but rather, educate your network on what you do and the types of people you would like to meet, and the introductions will follow.

The second part of this is how conversations flow at these events. I try to express a genuine interest in what other people are doing with their businesses, and what they might need. This knowledge helps me in that for most of my business needs, I can find an answer with a couple emails or phone calls. I know who’s out there, I know what they can and can’t do, and much of the time, I also know who they know, or are connected to.

This ability to link people together makes people want to be in your network – they want to know you, and are happy to share their network, because they are aware that I do the same in return. The benefits are rarely aligned, but it is a large cycle, and most people intuitively know this.

Apparently, they’re also good at spotting such people. I can think of several people who would likewise describe themselves as a magnet, and I’ve discovered that they are taking the same approach as myself toward meeting people.

That, I believe, is one of the cornerstones of building a solid network.

When You Work for Yourself

Perhaps one of the factors of life as the self-employed freelancer is in regard to what happens when you get sick. Or, if it isn’t you who gets sick, a family member who you have to care for. Even for those under the impression that they rarely get sick, it tends to happen, as Murphy’s law dictates, at the least opportune time.

There are a few factors to consider here, and unfortunately, few solutions offered. However, bearing this in mind, it can help in alleviating client concerns when planning is done for this dreaded eventuality.

First, many clients will be reasonable if you get sick – it’s a risk they take working with a freelancer, and therefore they have already accepted that this may happen. As such, for non-urgent requirements, a quick email letting them know that you’re ill will usually suffice to remove the mundane tasks from your schedule as you recuperate.

Second, since you may get sick, it is prudent to avoid working to deadlines. With being ill occupying up to 2-3 days, a wise approach would be to target all deadlines to 3 days prior to the client-designated deadline. If you finish early, you can fine-tune for the last few days, or give the client the work ahead of schedule. If it requires an extra few days of work, you’ve built that into the schedule. And if you get sick, that’s okay because you still have some time for that.

Third, when emergencies come up, be prepared to work despite being sick. You might not be able to get out of bed, but your laptop may join you there as you log in remotely to the system and do what needs to be done.

Alternatively, have a network that you can fall back on in case you are unable to work. This network may not be able to help you for major projects, but if you are in a support role with fairly standard emergencies arising from time to time, then if you can find one or two people you can call on in a pinch to backstop you, it would help you in reassuring your clients as to what will happen if you should suddenly be unavailable.

In short, don’t wait for the inevitable to happen to start your planning – as the expression goes, an hour of planning can save you weeks of work.

The Difference Between Marketing and Sales

I have a client with an interesting employee – he can take a product, and figure out who the best customers of this product are. He knows how to reach those people, as well as the people who would ultimately pay for the product. He can get these people to seriously consider using his product over the competion. Many times, this results in sales, and until recently, the line between sales and marketing was blurred.

With recent developments, the nature of the products was changing, and it was realized that this person is actually a fantastic marketer, but not a salesman, much to many people’s surprise.

The difference between the two, however, is quite important, and in growing businesses, these two roles will eventually diverge from one another.

The marketer is concerned with getting people to look at the product, to consider its merits, sometimes in light of competing products. He listens to what potential customers are saying about the product, and requests changes to be made to the product. He does not, however, work with real products, but rather with demo versions, wish lists, and spec sheets.

The salesman deals with a completed product, getting people to actually pay for it. He will follow up on leads created by the marketers to get people to pull out their credit cards and pay. He will work on pricing models, support contracts, and return policies. He will focus, in short, on getting the working product into the end user’s hands.

The skills needed for both these roles are similar, but not the same. If you see your product struggling to be adopted by your target market, think about whether the problem is one of knowledge in the market at large, or in closing deals. Do your potential customers know about your product, and how it fits into their view of the world? If not, the problem is likely one of marketing. If, on the other hand, people know about the product but are not buying, then your problem may be in sales.

Knowing your problem is one of sales at least gives you a place to start your research into why people are not buying. It might be because you don’t have appropriate staff to follow up on leads, or it might be because your product fails to fulfill the needs you think it does.

However, at least you have been able to narrow down the problem into a set of solvable questions.

Competition is Healthy

When a new product was launched by a company with a large amount of clout and marketing power, a project I was working on had its management team move into crisis mode fairly quickly. The competing product, at first glance, seemed to compete directly with the product we were building, which raised the question as to whether or not we should cut losses immediately, or persevere with the development.

Upon consideration, however, it was decided that development would continue, though the focus of the project, and how it would be marketed to potential consumers, would need to change. After all, the features of the product were sufficiently different from what the competition was offering, to the point that there was little concern as to whether those features would appear in future versions of the competing product.

That being said, the few hours of crisis during which there was uncertainty about the future of the product was extremely beneficial to the product. Everyone involved had to reflect on what exactly the project we were working on was trying to achieve. Everyone had to get more focused on what set us apart.

Competition does that – when competing with many other products, the differences may be price, features, availability, marketing spin. When competing on new products, the differences may go deeper than that, dealing with different needs, different consumer bases, or even different approaches to the same problem. The more prevalent the competition is in your market, the more carefully you will be forced to examine your customers, and why they buy from you rather than from anyone else.

Likewise, you will have to pay better attention to what gives you an edge in a certain market – what are the true barriers to someone else entering your market? Is it actually surmountable, or have you created, by way of completely filling a need, made the concept of competition irrelevant?

While making competition irrelevant may lead to lawsuits under anti-trust laws, it is the place where many businesses would like to be. Offer something so unique, and available to everyone who needs it no matter their location, at a price they can all afford, and the competition will have no reason to exist. After all, any consumer will already be shopping from you, and are happy to stay with the established status quo rather than risk jumping to a new-comer.

In your business, are you looking for ways in which you can consolidate your customer base and build loyalty so that there is little reason for them to move to an alternative? Or are you focused on the growth of your business today, with little thought to the longevity of your business, especially in light of the fact that there eventually will be competition to any business which does not properly care for its consumers.

Your Biggest Asset and Liability

In last week’s episode of Dragons’ Den, one pitch went sour for the simple reason that the biggest asset in the business was also its biggest liability. This is a fairly common problem in family-run businesses, often a function of one member of the family remaining in control of a business even when it has grown far beyond their ability to manage it.

In this particular case, Kim and Paul Nolet were unlikely prepared for the reception their business would receive on the show. Their product, an electric scooter with some pizazz, was driven out of the den for the simple reason that the creator of the scooter was not a savvy businessman, yet would not relinquish control of his company to make it profitable.

Paul Nolet manufactured the scooters in his garage, and would sell them for a price competitive with wheelchairs. With his margins so small, Kevin O’Leary suggested he raise his prices to about $6,000 a unit, which would provide a healthy margin to make the business viable. Paul’s response was admirable, but businesses are not built that way:

I prefer to make my living the honest way.

It’s very noble to not fleece your customers when you have a product they clearly want, and would pay any price for. However, there is still the issue of charging fair rates for the products, and Paul’s price fell far short.

Kim Nolet, who appeared to be more business savvy, was asked what the biggest problem her business had. She seemed amused when the Dragons informed her that Paul was the biggest liability, but they weren’t joking. With every decision needing to be cleared through Paul, there was a limitation on the ability for the business to grow. Paul was set in his ways, and had his opinions as to how the business should operate, and appeared reluctant to move from his position.

This is not a surprising issue. Perhaps one of the more difficult tasks investors face when working with a new business is in determining which portions of the existing management can bring the business to the next level, and which portions need to be trimmed and removed. The biggest obstacle is often the egos involved – people who have put incredible amounts of effort into growing the business don’t like to be told that they are no longer needed.

In various articles I’ve written about succession planning, this is one scenario I didn’t discuss, though it is relevant and perhaps one way succession happens that people partially plan for. How will the business transition under the new owners, and how will the current management team evolve to a new team?

If your business is prepared, this transition can be smooth, making such opportunities a dream to execute. Unprepared, though, and even the best of businesses can fail for the sole reason of lack of foresight.