We all understand that T s should be crossed, I s must be dotted and rows & columns of numbers should reconcile exactly. But an obsession with absolute accuracy and complete perfection can destroy the ROI of an acquisition or roll up. A board member (Director) can help by asking questions about the optimum pacing for transactions and the key factors driving the success of acquisitions.
Situation # 1: Investors based in Europe were expanding their company to become a multi-service one stop shop. Since their first two acquisitions were specialized companies, it was time to strengthen their account and project management capabilities. Their due diligence process for the third acquisition dragged on for over a year. The target company’s 45% growth rate slowed to 25%. Valuation was adjusted three times. Some key employees who could have become key contributors to the success of the combined businesses lost confidence in the acquiring company and accepted positions elsewhere. The distraction of the onerous due diligence process definitely increased the cost of acquisition, cost them opportunities and slowed integration. Once the transaction was completed, everyone involved concluded that they should have just used their initial valuation “guesstimates.” They lost MILLIONS as the accounting departments parsed numbers that impacted hundreds. They would have made more money if their guesstimates had been off by as much as 30%!
It pays to gauge the PACE of the industry involved before committing to a specific due diligence process. It pays to know how quickly a transaction must be completed to achieve the desired competitive advantage before establishing the due diligence budget and timeline.
Situation # 2: Another investor had a similar vision. He would acquire complementary companies to provide a range of services for corporate accounts. They ran into difficulties when the next target company was being courted by multiple investors with varying approaches to due diligence, valuation and integration. Even though the prospective buyers were from Asia, Europe and South America, one might still assume that generally accepted accounting practices (GAAP) would yield comparable valuations. In this situation the variations in what constituted gross profit ranged from 32% – 38%; which is a huge difference. When it comes to B2B service businesses, stable scalable gross profit is central to success. This transaction got bogged down because each prospective buyer expected the target company to invest in additional accounting to match the prospective buyer’s definitions. The target company would need to have the equivalent of 4 sets of books to continue negotiating with the three prospective buyers. A fourth buyer, who could deal with accounting differences later, bought the target company while the other three were still focused on the definition of gross profit.
It often pays to accept different (even less sophisticated) financial reports from companies that are targeted for acquisition. Your estimate of the cost of upgrading the accounting later can be considered when the purchase price is established.
Situation #3: Same scenario – a roll up to become a one stop shop on a global scale.
The buyer’s due diligence process was very precise re. inventory, backlog, accounts receivable, repeat business, average order size, etc. But very little attention was focused on the people. Long story short: a handful of people in each of the acquired companies had large compensation packages, impressive C level job titles, and expectations that they would retain authority over their piece of the blended company. They also had varying levels of experience, skills and sophistication. The cost, risk and complexity of leadership integration and/or replacement absolutely dwarfed the precise numbers that were generated about “things”.
It pays to remember the Pareto Principal (80/20 rule). The best transactions follow due diligence that has emphasized the key factors behind success or failure. Acquisitions often involve “companies in search of a CEO”, so leadership-related due diligence matters.
Prominent proponents of diversity in the workplace acknowledge that the unique languages spoken within different professions (departments) can become more confusing and divisive than the differences between genders, generations, races and cultures. Maybe that is because gender, age, and race differences provide more visual cues for each of us to make the effort to understand what someone else is trying to tell us.
Some of the most volatile judgmental disagreements I have witnessed in my 40+ years as a business growth strategist have involved Chief Marketing Officers (CMOs) and Chief Financial Officers (CFOs). During one strategy clarification assignment, I witnessed pretty much the same heated discussion in English, Mandarin, German, Japanese and Yiddish. The energy and anger was similar to when people of different religions argue. Maybe that’s the way to think about it. Marketing and Accounting are different religions.
Being able to discern emotional triggers and then actually craft messages that not only sparks attention but prompts action is better than any drug for enthusiastic marketing professionals. That is the currency of marketing. When that magic happens, they KNOW they deserve their company’s sustained support. In this world of hundreds of thousands of daily marketing messages, getting attention and prompting action is fragile. Nothing is more frustrating to marketing people than achieving what feels like a miracle and then their own company doesn’t support them and doesn’t promptly offer to finance more or pick up the speed. When marketing people have experienced that intense surprise, disappointment, discouragement and rejection they can sound unreasonable, distrustful, resentful, entitled, ungrateful, unrealistic and even selfish.
Please reread the previous paragraph. Let the emotion of the words in.
Marketing professionals are not all angry, demanding or unrealistic. Cooperative interaction with a respectful CFO can prevent all of that from ever developing. The proactive CFOs with whom I have had the distinct pleasure of working, recognize that at the core, CMOs and CFOs want the same things. You both want more market share, increased net profit, a more nimble organization and more cash. (Who doesn’t need more cash?)
The perceived difference between CMOs and CFOs often lies within the areas of CONTROL (budgets) and METRICS (measurement). Too often, CEOs and CFOs inadvertently hold the CMO accountable for increased REVENUE when that is the purview of the CHIEF SALES OFFICER (CSO). As a reminder, the sales department is the primary client of the marketing department. By sparking interest and prompting action (eg. inquiries), marketing delivers warm leads and qualified prospects to SALES who then do their magic to turn qualified prospects into buyers.
Over the past 6-7 years, many corporations have made great progress because their CFOs and CMOs have been asked to have regularly scheduled focused working sessions to establish or update the values of each warm lead and each qualified prospect. That effort is worth its weight in gold. As you know, that effort also requires patience and a willingness to translate marketing-ese and accountant-ese so you understand and appreciate one another.
And now that work must go even further due to shorter attention spans and higher expectations that shrink the duration of warm leads and qualified prospects. There is a much shorter window of opportunity to step up marketing to produce more warm leads and qualified prospects &/or keep them warm…and less time for sales to turn those leads/prospects into buyers. A value must also be assigned to pacing.
It is exciting when a corporation’s CFO and CMO can agree upon metrics that will trigger immediate increased investment when/if the marketing department achieves magic … sparks attention and prompts action…delivers enough warm leads and qualified prospects. The benefits go beyond increased net profit. The effort also pays off in increased job satisfaction and appreciation for one another’s professional colleagues.
If your CFO spent the last several weeks pushing out year end financials and calculating so many numbers that they have all become “insignificant ratios”, pause for a moment to make sure that all of the executives in your company know one MAGIC number that will guide their decisions in 2015.
As many readers of this blog know, my tagline is Achieving Accelerated Growth with Sustained Profitability®. And you may also recall that the secret lies in reversing that phrase. It is essential for the leaders of any enterprise to know what truly drives their profitability. Like quality assurance versus quality control, it’s not just about examining the end result (net profit). It’s about using key indicators much earlier in the process that create and predict the end result.
Let’s use two companies within the same industry as an example. One time share enterprise has a magic number of “2.5″. That number results from a formula that involves the factors that drive their success and profitability. Debt/Equity divided by (Occupancy plus Customer Satisfaction). They closely monitor these indicators and pick up or slow down capital investment based on their magic number.
Say their Debt/Equity ratio has been running at 4.0. Whether that is considered aggressive or conservative depends on the economic season. In their case, if their capacity has been running .90 and their customer satisfaction rating has been holding strong at .95, they would be comfortable speeding up their investment in property acquisition and improvements. 4.0/1.85 = 2.16 which is well below their MAGIC NUMBER of 2.5.
A competitor with a more aggressive land approach utilizes the same components but has concluded that 4.0 is their MAGIC NUMBER. The addition of occupancy and customer satisfaction can’t exceed 2.0, so there is always a firm 8/1 cap on their debt/equity ratio. The CFO is happy about that, by the way. This company tends to focus much more on acquiring assets and less on customer service and occupancy, but when the sum of those two numbers slides below 1.5 they can only afford a 6/1 debt/equity ratio. You can probably imagine the fascinating discussions they have when that happens.
Use of a tailored MAGIC NUMBER captures strategy in a tangible way, involves multiple departments, applies short term results, guides decisions and helps to create a more resilient longer term result for the entire enterprise.
What drives your profitability? What components could comprise a MAGIC NUMBER for you in 2015?
Global competition. The rapid pace of technological advances. The uncertain economy. Cybercrime. Sarbanes Oxley & Dodd Frank. Activist investors. Terrorist groups. Shrinking windows of opportunity. The explosive influence of social media. As a business executive, you and your board have a lot on your plate.
Typical board members understand what is expected from the standard board committees (governance, audit and compensation). That’s good. But today’s effective board members must also understand the importance of subjects like risk and sustainability.
The National Association of Corporate Directors (NACD) provides numerous well-crafted educational conferences, webinars and publications. And they have a structured multi-year program to ensure that members who have earned FELLOW status are ready to serve. Anne Sheehan, Director of Corporate Governance, CalSTRS says it best: “NACD’s director credentials are the new gold standard.”
Although Alan Thicke is handsome and talented and perhaps a bit troubled (thus interesting fodder for blogs), he is not the only person confused by “blurred lines.” Folks who are trying to navigate publicly traded businesses have more reason to be confused than ever.
Look at what is happening with the DARDEN Corporation. They own/operate The Olive Garden, Red Lobster and other restaurants. You don’t have to be an investor to know that Red Lobster parking lots seem less crowded and TV advertising seems more crowded with Olive Garden menu changes. Among other options, DARDEN’s executives have been considering the possible sale of Red Lobster. If you have been reading publications, like the WALL STREET JOURNAL, you know that a group of “activist investors” who own a fairly small percentage of DARDEN stock were recently able to get the entire DARDEN Board of Directors replaced. What are parameters of investor rights? It wasn’t that long ago when only major shareholders, like Carl Icahn or Donald Trump could wield that kind of power and influence. It some ways, this feels like the 1960s.
I would want to see the details of the market analysis, the company’s financials, the logic behind the executives’ recommendations, etc. before expressing my opinion about whether selling Red Lobster is/isn’t a good idea. Isn’t that the point!? The confusion in this situation isn’t as much about whether a line of business should be sold. The confusion seems to be about who has the authority and responsibility to make the decision. This situation would make many leaders of $Bil privately held companies think twice (perhaps three times) before going public!
At the annual board leadership conference of the National Association of Corporate Directors (NACD) I heard several illuminating presentations about best practices. Several case studies included details about boards being involved in strategy formulation instead of the old “review and concur” model. More than one speaker expressed the belief that boards “own” strategy. Most of the CEOs I know would say ”the CEO owns strategic direction. The boards hire, compensate, and evaluate the CEOs. Board members shouldn‘t meddle in the executive’s primary areas of responsibility and expertise!”
I have served on several nonprofit and a few for profit privately held company boards. I recently earned my FELLOW status from my investment in excellent NACD education. When I talk with other directors and CEOs, it seems to me that it is time for most companies (publicly traded or not) to revisit the responsibilities and deliverables of executive teams, boards, and investors.
Are you sure that an activist investor group couldn’t disrupt everything for you?
Warning: This blog entry reveals a bit of cynicism.
I would like to believe that the boards of major corporations actually understand the value of a diverse workforce, including at the executive level. Varied experience and viewpoints can provide perspective and insights to generate exciting strategies or solve complex challenges.
If the leadership of General Motors and IBM truly valued diversity, would Mary Barra and Ginni Rometty be their first female CEOs? Really?
These women are bright, accomplished, highly skilled, and deserve to be CEOs.
But, look at the timing.
Barra became CEO as General Motors while dealing with the largest vehicle recall ever (29 million so far, according to FORTUNE magazine). They declared bankruptcy and needed a government bailout not that long ago. And the intractable “GM culture” poses a significant challenge for any CEO.
Rometty is CEO of IBM as revenue has been declining (-5% to $99.8 Billion in 2013) and the media keeps asking “Can IBM Ever be COOL Again?”
What is the logic? When a fairly homogenous group of corporate leaders find themselves in a terrible situation, do they think Well, maybe it’s time to give a minority or a female executive a “chance.” Why not? If the executive fails to pull the corporation out of the mess, some bigoted people would have their biases confirmed. After all, they weren’t expecting success anyway. And if/when the female (or minority) executive succeeds despite the huge odds against her, she probably won’t be compensated higher for that incredible accomplishment. She could also become so tired after pulling a huge corporation into the future, she may just retire.
And then, who will the rescued corporation bring in as her successor? Usually, the corporations revert back to homogeneity. Look at the composition of corporate boards!
This reminds me of observations my late husband had about governmental entities with which he worked. Leaders of states, counties or municipalities would repeatedly find themselves in “messes.’ Then they would scratch their heads and say, “You know what?! We need to bring in a community planner.” If they had actually understood and valued planning, wouldn’t the professional planner have been brought in long ago? And the “big mess” would have been prevented.
Be honest with yourself. Look at the composition of your executive team and your board. And look at the timing of when you “give a woman or a minority a chance.” Are you really setting people up to fail or serve as scapegoats for problems that resulted from homogeneity? (Similar people with similar thinking using similar approaches)
Each week, my email inbox includes several inquiries from entrepreneurs who are looking for startup or growth financing for their businesses.
Typically, the first email is polite and conveys a sense of excitement about his/her product innovation. Most of the emails include a request for a referral to appropriate funding sources.
Some information to provide CONTEXT: The Service Industry Fund that I founded in the mid ‘90s has invested over $1 Bil in scalable service firms. When a business plan comes in that doesn’t fit that FUND, our intermediaries can “shop” for funding from other sources. Plus, since one of the primary challenges to sustained growth is funding, my 35 year old growth strategy firm has helped hundreds of our midsized privately-held consulting clients to obtain appropriate growth financing.
So when I receive a financing inquiry, I provide tailored responses based on the information provided in the initial email ….and then frankly, we brace ourselves for the replies. Last week, I forwarded an email inquiry directly to a past client who is poised to invest several million dollars in the right deal. In the same email I asked the entrepreneur if he had contacted the Technology Council in his state because several have well financed startup funds or angel networks. His product concept would go over very well at NJTC’s JUMP START. You would have thought I called his mother a whore.
It is amazing how many times entrepreneurs will:
- Immediately dismiss a suggestion (no matter what it is, by the way). That behavior is insulting to the resource person who has generously taken the time to read, think and offer advice (for free)… and is a disincentive for any future interaction…let alone funding!
- Provide a detailed history of their past accomplishments that has an arrogant or defensive tone. Many entrepreneurs are quick to feel insulted, misunderstood or unappreciated. Hello! It’s an email inquiry and response between people who do not know one another. Plus, funding is about the enterprise, the potential to make money, market need or demand, etc. Investors don’t fund the entrepreneur’s ego.
- Not express gratitude for the prompt response or informed suggestion. Most intermediaries and funding sources do not respond quickly or provide tangible suggestions…partly because so many entrepreneurs aren’t polite, act entitled, or think they can demand attention.
- Make grandiose claims that their concept is “the next Google”… “bigger than APPLE”… Huge claims like that backfire on entrepreneurs. Real funding sources involve industry experts during their due diligence and will make their own decisions about the significance of the innovation.
- Declare that their unproven concept deserves millions of dollars of outside financing. These entrepreneurs are often the same people who think they can refuse the addition of investors to their board(s) and haven’t invested huge sums of their own money in the concept.
I wonder how many innovative products are not adequately funded because the arrogance of the entrepreneur gets in the way. You can tell a great deal from the second email how a funding search is probably going to turn out.
Alright…I admit…I am probably too close to this topic.
Those of you who have known me for a long time know that (although it sounds corny to some people) my personal mission has long been to be “a positive force for economic development.” Think about all of the time and money you and other parents have (and continue to) invest in your children! Once it was clear that I was never going to become a MOM, I decided to invest an equivalent amount of time, money, and effort in economic development to help generate jobs, improve policies, encourage continued growth of existing businesses, support innovation, etc.
Over the summer, I found myself wondering if all of the effort that I and so many other people have put into economic development is working. The economy still has dramatic swings and is incredibly vulnerable. Disincentives to growth of existing businesses stubbornly persist. Jobs seem to bleed through borders like water. Yes…strengthening the economy is difficult but what’s the alternative?
Personally, I am grateful for what I have learned through my 35 years as an economic development advocate. When I hosted a weekly talk show to shine a light on what it takes to keep growing midsized companies, I got to interview and meet 300 of THE most amazing, bright, ambitious people. Serving on chamber of commerce boards, I have been fascinated by the complex blend of diplomacy and influence executed by many corporate CEOs. There are more steps in that dance than in a number choreographed by Napoleon and Tabatha. Most of us must resist the urge to solve problems in our own companies. We provide vision and lead strategy but must depend on our great employees to prevent and solve problems. Sometimes, executives find participating in broader problem solving initiatives is a refreshing change of pace. Plus, Governors seem to appreciate when business leaders find ways to solve problems.
When you have presented alternative approaches to legislators as often as I have, you can’t help but notice that their time is thinly distributed across hundreds (if not thousands) of issues and is often dominated by fundraising and campaigning. Important people are often grateful for the provision of constructive suggestions instead of being subject to yet another diatribe of complaints. Providing expert testimony at a public hearing is very scary the first few times you do it, but having survived that experience, you are better prepared to face media scrutiny as the CEO of a significant business.
Trying to PUSH THE ECONOMIC ROCK UPHILL is not a one person task. I value being part of the collective village of the business community that keeps trying. And frankly, the effort has consistently influenced our employees to also think about issues that are larger than just themselves.
A recent pre acquisition due diligence process raised a fascinating question for the leaders of both entities.
Like most due diligence processes, the leaders of each business began with valuation formulas and a series of questions. If the industry multiplier for acquisitions is currently averaging between 5 and 6, would 5.5 X net profit be an affordable purchase price? If so, will the seller accept payment over time to reduce strain on the buyer’s cash? Could a lower purchase price be acceptable to the seller if more cash is involved up front? What percentage of the seller’s existing customers should the buyer realistically expect to retain and at what revenue/customer? What’s the value of the seller’s equipment, inventory and vehicles? How should the seller’s sales pipeline be valued? Which prospective customers might hesitate if a new owner is involved? Would there be additional costs associated with any differences in geographic areas or target markets/customers? Which employees are most important? Should anyone be paid a bonus to stay and give the buyer a chance? What additional costs should be anticipated due to employee turnover? Could the possibility of an acquisition simply invite employees to leave and start their own competing business?
We slowed them both down and asked that they consider if and how the goal of profitable business growth would be served by an acquisition? The answers and values related to the questions listed above are impacted by whether the purchase being considered will eliminate a competitor, increase the buyer’s production/capacity or add complementary products/services to the buyer’s offering.
In this situation, the services provided by the seller’s business require more experience and training. The acquisition would add a desired complementary service to the buyer’s offering. The people-related questions became the major variable in these pre-acquisition valuations. The fact that the seller’s business has a collaborative culture and the buyer’s corporate culture is more autocratic became the most important variable. The employee and customer retention and the projected growth and profitability of the combined entities could be higher IF the buyer is invested in learning how to be a more collaborative leader. They might have to leave the businesses completely separate (even when/if the ownership changes) if the buyer has no intention of changing. And if the collaborative leader (the seller) values keeping a team of people together, a sale may not be possible at any price.
It’s been our experience that the purchase price and long term ROI is adversely impacted when an autocratic buyer is involved. Would acquiring a collaborative business raise, lower or have no impact on the purchase price for you? What could you do to be more collaborative and be more ready to acquire businesses at more affordable prices and increased ROI?
If your business grew by 5% last year, should this year’s goal be 6%? If your segment of an industry has been shrinking by 8% each of the last 3 years, should you scrap your growth goals and only focus on cost cutting? Or are a series of sub goals related to increased productivity, product improvements, and targeted marketing campaigns behind your growth goal?
Our best results have been achieved when clients have embraced transformative goals.
It is much more rewarding to intentionally create a company that is designed to be profitable than arbitrarily incrementally reactively grow into an awkward less profitable size.
When you truly know what drives the profitability of your business, you know to look for more of that. For example, operational excellence can drive profitability. One service oriented business may have operational excellence when it has a 1/2/6 ratio of account executives/project managers/ associates. That company’s growth goals could be based on maintaining that ratio. The question becomes how do we create a company that attracts gross revenue that fuels 6 account executives, 12 project managers and 36 associates? Operational excellence for a distributor might be realized through a 1/6 ratio of hubs to branches or always hitting a specific return on total assets (ROTA).
One of the many responsibilities of an accounting department is to track key ratios. The best CFOs know how to identify and recommend a few critical key ratios that are closely related to what drives profitability for the specific company. And their choice go much deeper than simple gross profit.
The attributes of the sales people can simultaneously be the optimizing and limiting factor when profitability is driven by consultative selling. The sales department may track average order size, closing rate, gross profit, orders per month, orders per sales professional, etc. They may even track the time from lead to close (buying cycle). I’ve seen powerful transformative growth goals result when the VP Sales and CFO confer and create combined ratios (magic number) like Average Order Size X Closing Rate/Length of Buying Cycle. Maybe the optimum Order X Rate/Cycle value is achieved through a specific combination of experienced and new sales people. Maybe the value of their “magic number” goes up when each sales professional has a book of 50 targets instead of 200.
Do you really know the most critical numbers behind what drives your profitability? Could you generate a transformative goal based on a “magic number” created only for your business?