to Maximize Your Company's Valuation
always been amazed by the number of deals that go to bed without having realized
their full valuation. A maximized valuation allows you to realize
the biggest price for the smallest slice.
At the Harvard Capital Group, we’ve
read, written and advised on zillions of business plans. Here are some of
the most often overlooked secrets that your mother never told you. Your
company might score high marks on some of these items, but circle the ones where
you’re weak and fix them.
Dream Team. The ideal
management is a well-rounded team of people who have been profiled in Business
Week for successful mega-deals, have depth in your industry, and have worked
together before as a team. In all my years as an investment banker or
investor, I have never seen such a management group.
But some get close. If you
study the high-valued IPOs, you will notice that the hotshot management fill-ins
all came six months before the IPO. In one deal, we even suggested that
the founder move “up” to Chairman of the Board to open the seat for a new
CEO. Similar shuffling is sometimes recommended for the heads of
engineering, marketing, and finance. The challenge is how to integrate the
new talent with the old.
The purpose of this exercise is to
maximize valuation. It helps if you can attract the talent light on cash
and heavy on stock grants or options. It offers the promise of becoming a
millionaire to key employees, and incoming investors love it because it
leverages their dollar investment, and ensures that the recruits are true
If you are short on cash, another
option is to list high-octane “employees” waiting in the wings, pending
funding. That way you get their benefit for valuation purposes, but
don’t spend any pre-money nickels.
Board Seats. In forming
your management team, many companies take the lazy-man approach to their Board
of Directors. Don’t. For best valuation, you want a majority of
board members to be outside members to keep the company honest. If you are
a good negotiator with stock options, you might be able to attract some
well-known luminaries without cash, and build on their reputations to benefit
your own valuation.
Sometimes talent is not willing to
risk the liability of board membership, or the potential talent pool is too
large a group to allow a Board to function properly. Creating a Board of
Advisors packed with well-respected names can solve this. Such boards
come in handy in high-tech environments, where the board is there as a resource
to advise on cutting-edge issues. Investors love it.
Part of the concept in both the Dream Team and the Board Seats, is to build
value by affiliation. The theory is that if you keep good company, you
will get access to well-formed ideas. The same concept can be extended to
contract, outsourcing, and joint venture, even test site, deals. When
possible, affiliate with companies known for quality and reputation. A
little of their value will rub off on you… and so will the valuation.
Solve a Problem. Of
course, the best employees and affiliations in the world are worthless without a
great product or service to concentrate everyone’s mind. Whatever the
product or service, it must solve some human problem that is not solved better
elsewhere. Too often, I’ve seen well-meaning engineers sporting a
“product” with glitzy technology, but worthless for solving any real-world
problems. You need to start with a pressing human problem, show why your
product is the best way on earth to solve it, and that your price is in
proportion to the value-added to the customer. The better job you do, the
better your valuation.
In order to show that your solution is the best, you also have to expose the
failings of competitive solutions. Who are the competitors? Why is
our product better? How big is the market? Even better, is there
anything about the competitors that structurally will give them a handicap?
(For example, in online retailing, how can the “brick and mortar” culture of
Barnes and Noble compete with the “Nintendo” culture of Amazon.com?).
you have customers, showcase them. It helps to put a face on real-world
problems solved for real people who write checks. If you can’t disclose
the identities of the customers for confidentiality reasons, describe them
generically. Is there a backlog? Is there expressed interest for the
future product line under development?
During the Industrial Revolution, if you owned the factory, you generally owned
the company. In today’s world, wealth comes not from the physical plant,
but from ideas and knowledge, and how they are deployed. The problem is
that knowledge, unlike the building, is mobile and easy to copy. To
maximize valuation, you need to anchor down the intellectual property.
This is done with patents, trade secrets, and non-compete clauses with
employees, perhaps even key suppliers. You have to nail these down.
Interestingly, in some high-tech
valuations (read “Internet) it is not intellectual property, but first-mover
status that anchors the valuation. The theory is that by being first, the
company becomes the largest, attracts more customers, becomes the most robust,
and remains the largest. Investors like that.
Wide and Deep. In
general, investors do not want to see a one-product company, especially in an
age where technology makes products go obsolete like yesterday’s bananas.
They want to see a whole family of products for today and beyond. But
investors also want each product to be robust. Catch 22: how can you be
both wide and deep on a shoestring?
I’ve seen too many companies with
four products going on five, each just 60% complete – worthless if they expect
to sell anything. Better to focus on your best product, and forget the
rest. Get customers, get backorders, and get testimonials. The other
products have a place, but only after first products get out the door. (Of
course, some situations require the whole family of products or nothing.
In that case, the first product is the family.)
Be Honest. Unlike
selling a second-hand car, a company’s valuation is best maximized with honest
disclosures. Big-dollar deals always have due diligence that will unmask
any secrets. Anything discovered that was not disclosed in advance will
shake investor confidence. “What else are they not telling me?”
Expect a huge valuation discount if you fail to disclose… and that assumes the
investor even stays in the room.
It’s better to be upfront. No
deal is perfect. I like to even turn disadvantages into advantages.
For example, “we know we have Defect X, but the incoming capital will allow us
to hire this person, or pursue that acquisition to plug the void.” Your
candor will attract more money than you asked for.
the boring part, but it drives valuations… and kills deals. For
big-ticket deals with established companies, the best valuations go to companies
having everything audited going back three or more years. It removes the
risk. For high-tech startups, nobody cares about history as the valuation
is based on the future.
When you do your projections, go out
five years, and then cut it back to three and compare them. If the
three-year projection is almost as good, just show the three years, otherwise
five. Unless you are building a hydroelectric dam, you generally should
not go beyond five years. It is beyond the natural planning cycle of most
projects, and you lose credibility.
Smart investors do not take
projections seriously. I use them to see if management has its thinking
cap on. Did they take everything into account? Are the assumptions
reasonable? Does it dovetail with the other aspects of the plan, the
products, personnel and financial resources?
One red flag is when projections
contain too many numbers with trailing zeros. It shows the numbers are
simple-minded and not resulting from the confluence of multiple assumptions.
In my office, too many zeros add up to a zero deal valuation. Such
projections are appropriate only on a restaurant napkin.
Depending on your personal goals, sometimes deal structure can be traded off
against a higher valuation. For example, issuing well-crafted Convertible
Preferred Stock may allow you to give up a smaller percentage of the company for
the same amount of money. In exchange for that, the Preferred stockholders
have certain privileges, such as, say, appointing a few board members or taking
control of the company if the grapes sour. In a way, it is trading off
power for valuation. Properly done, both sides can end up with a better
deal, and the valuation zooms.
There is no one standard outline for a business plan. Each has to be
tailored to the extraordinary qualities of each company. However, for
maximum valuation, any plan should be up-to-date (otherwise the deal looks
shopped), focused on the deal at hand (to exploit each nuance of the company
relevant to the deal), and targeted to a specific, narrow audience (CEOs think
differently from, say, VCs). For most private transactions, I rather
prefer a format based on the SEC’s Form S-1 (or Form SB-2), so that sophisticated investors
know where to find what intuitively. But for private transactions, this
format needs to be considerably beefed up, especially in the areas of product
advantages, competition, customers, operations and future prospects. For
the best valuation, all the key decision information has to be there.
People will not buy what they cannot understand. And people will value
highest that which is precious.