Due Diligence Lip Service

“Culture isn’t just one aspect of the game. It is the game.”                          

 –   Lou Gerstner, former IBM chairman & CEO

Pritchett conducted a study of 135 executives from public and private companies and found that, on a 10 point scale, cultural due diligence rated a mean importance factor of  7.45. Privately held companies and private equity firms generally rated the importance higher than public companies. Yet, the same population rated their organizations’ success in blending cultures as only a 5.62. What does this mean? Have you ever heard the phrase “lip service?” It is one thing to acknowledge the importance, but something altogether difference to act in a way that supports that belief.

The study authors go on to note that, while culture is perceived as a key factor in merger success, there is not a consistent approach to measuring effectiveness, let alone the components that comprise it. Slightly less than half (49%) of organizations make an effort to measure. Privately held mid-cap companies and private equity companies set the pace in this arena. Non-profits and publicly-held large cap companies make far less effort to measure effectiveness post-merger or acquisition. 

Given, again, the relatively high value placed on the importance of culture to integrating two companies, it is dismaying that culture is not normally a part of the due diligence process. Of the executives surveyed, 4% say their teams ask specific questions about culture during vetting. Similarly, only 5% attempt to assess compatibility through some standardized means, with less than half of those administered by an objective outsider.  

It was observed that, when assessment is attempted, it tends towards subjective intuitions rather than a strategic metric. Furthermore, HR is excluded from the cultural discussion 94% of the time. On a high note, organizations that consider themselves savvy with regards to cultural due diligence perform assessments 70% of the time. 

While the results for pre-merger analysis and process are not good, those for post-merger are dismal by comparison. Only 21% of organizations surveyed have an established, repeatable process that is used consistently to facilitate seamless blending of organizations. 

The broad findings of the study were:

  1. Culture should be a more strategic consideration in the merger process. It deserves far more weight in the initial targeting of potential acquisitions or merger partners.
  2. Due diligence should scrutinize cultural aspects of the deal with the same discipline given to financial and legal issues. This simply cannot be done via a traditional culture gap analysis or compatibility survey. 
  3. Culture integration should be driven from the CEO/President level. This initiative cannot be delegated effectively. The architecture of culture strategy, plus the critical first steps of execution, belong to the leader.
  4. Organizations should be more astute in crafting their merger communications relating to cultural issues. Both the substance and timing of these messages are crucial. Management needs to be fine-tuned in managing people’s expectations, all the while shaping workforce behavior in the desired cultural direction.

 

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Successful Acquisitions Focus on Integration

Acquisitions are more prevalent when economies are tough. Companies hope that they will be able to achieve economies of scale by combining functions that require repetitive tasks. What is often underestimated is the work that must be done post-merger to actually experience the desired results. Yesterday, we examined the role of cultural due diligence in assessing the promise of combining efforts with another company. We assume that that assessment has been done and the decision was made to proceed. What is at issue is how to proceed!

Price Waterhouse Coopers conducted research that indicates that approximately 85% of acquisitions are seen as failures after the fact. In the UK, Cass Business School at City University of London studied 12,339 deals between 1984 and 2008. The findings were that price was not the best predictor of success, but that integration of the two companies was. The CEO Rountable recommends the following process and checklist for better integration:

Create a master to-do list broken down into themes including key items that arose in due diligence.

  • Allocate a manager, for each theme.
  • Be realistic with timetables.
  • Break items down into actions within 30, 60 and 90 days.

Checklist:

Finance/Costs

1. Get control of the bank accounts. Ensure all accounts are receiving the best group interest rate.
2. Establish operating budgets including capex with authorization guidelines.
3. Establish a new management information timetable. Metrics will be key.
4. Review balance sheets for adequacy of provisions.
5. Drive through planned cost savings quickly and effectively with clear communication.

People

1. Establish a reporting structure to ensure continuing trading is seamless.
2. Review reward structures to ensure continuity of management.
3. Anomalies between acquirer and target sales commissions will require urgent action as sales teams talk.
4. Quickly review of problem employment contracts and put resolutions in place to minimize exposure.
5. Organize immediate sales & customer service training.
6. Establish a key meetings schedule to allow free and timely flow of information.
7. Establish a clear understanding of the authority levels of the target’s leadership team.

Systems

1. Deal with exposures revealed by due diligence, prioritizing those related to keeping the trains running!
2. Plan for merging disparate systems or at least to allow them to “talk” to each other.
3. Lock down the security around customer databases.
Sales & Customers 

1. Ensure live deals under negotiation are not disrupted by the acquisition.
2. Cleanse all sales forecasts ASAP and integrate the revised version into the group cash forecasting system.
3. Review cross selling opportunities between key customers of buyer and seller.

PR

1. Communicate often and clearly with staff and key stakeholders externally, especially key customers.
2. Visit key customers to share the strategy of the merged group and why it’s good news for them.
3. Use the joint press release on the deal to motivate staff and impress existing customers.
Marketing

1. Set a timetable for all web site changes and allocate a webmaster to drive the project.
2. Collateral may need to change to reflect the new products of the merged entity.
3. Emphasize the benefits of the merger for the customers.

Legal

1. Draw up a detailed checklist of contingent liabilities.
2. Note earn-out implications for company management. Factor into the integration plan.
3. Insurance and risk exposure reviews should be conducted as a high priority.
4. Tax and accounting matters related to regulatory compliance may require urgent action.

Obviously, this list is by no means exhaustive, but illustrative of how one would go about dissecting potential problem areas and making adequate preparation. If your team will make a commitment to be thorough and anticipate things that could go wrong, you will know what questions to ask and what systems to take apart and reassemble. Integration is hard, but the effort is critical to successfully meeting the goals of the transaction.

 

Watch Your Burn, Then Take Off!

When entrepreneurs start businesses, one of the last things they want to think about is running out of money. Whether the money is one’s own, that derived from friends and family, angel investors, or the bank, it has to be managed so that cash outflows are balanced by reserves and inflows. The term “Burn rate” is used commonly to describe  negative cash flow in a start-up. It indicates the speed of depletion of invested capital form shareholders. Once the cash reserves are used up, the company will either have to start making a profit, find additional funding, or close down. Venture Capitalists (VCs) are obviously very concerned about burn rates because they don’t want to see their investments wasted.

[Tom Tunguz, of Redpoint Ventures, in his blog, Ex Post Facto, writes the following:]

How does a VC think about your burn rate? First, it’s important to note that every company is different. Second, geography is an important factor. Third, pure consumer companies’ finances will differ dramatically from  e-commerce or SaaS companies. Given all those caveats, I’ve made a table of the rough figures that I expect to see in a company of various stages, immediately after financing.

When I make an investment, my aim is to fund the company to a milestone that enables the company to raise a subsequent round. Such a milestone tends to be achievable in 12 to 14 months. But a startup should raise 18 to 24 months’ capital to ensure some flexibility in case things don’t go according to plan.

A good rule of thumb in Silicon Valley is that every employee costs about $10k per month. By that estimate, a company of 20 people burns $200k for staff plus 25% for overhead, or $250k per month/$3M per year. This is on the richer side of burn rate calculations but given the rate of increase in engineering salaries recently, it may be closer to the norm.

For revenue generating companies, net burn (revenue – expenses) should be kept under $400k – $500k. A company burning more without the immediate prospect of revenue can be a concern because of how quickly these high burn rates reduce runway. Additionally, the company should aim to reach cash flow break even sometime after the Series B, before a Growth round. Again, every company is different, these guidelines are the mental model I’ve built of typical companies who have pitched us and worked with us.

Granted, Silicon Valley is more expensive than many other locales. Similarly, labor rates/salaries that drive the burn rate math are higher than in other regions. Even still, Tunguz makes a good point about the need to raise about 50% more than one expects will be required in terms of time to reach milestones. The “runway” referred to is the total amount of time before the venture crashes and burns due to lack of cash. As your company grows from solopreneur to employing 5+ people, these guidelines should come in handy to successfully manage the enterprise and its valuable cash.

Refuse to Lose (Investors’ Money)

Clarence Wooten, who sold his start-up Image Cafe to Verisign 7 months after founding for $23 million, told an audience at MIT/Sloan recently that there are keys to the entrepreneurial mindset. Barb Darrow with GigaOm summarized his comments into 12 lessons:

  1. Paycheck is an addiction. Not unlike crack cocaine. Entrepreneurs have to break that addiction to build an asset that will pay off long-term, not in a weekly paycheck.
  2. Beware of naysayers. Because 99 percent of this country works for the 1 percent, they  have risk-averse employee mentalities. Don’t listen to them.
  3. Just do it. Be like Nike. There is no roadmap. If you don’t do it, it won’t get done. Work lean. Corporate people are used to resources — HR departments, assistants but entrepreneurs do it on their own.
  4. Fail fast, fail cheap. You will fail a lot because you’ll need to try a lot things. So do that on the cheap. Instagram’s first product  – Brbn — failed but they distilled that app to its bare essence and it caught fire.
  5. Partner pitfalls. It’s scary to be out there alone. You want someone to share the ups and downs. Often one partner will work harder than the other but share the same upside. Share the downside as well and don’t necessarily split equity equally. Set up reverse vesting:  When you issue founder’s stock, make sure it vests in case someone leaves they don’t leave with all equity just with what has vested.
  6. Be naïve. Unlearn what you learned in corporate America about hierarchy. Being naive means being ballsy. Facebook turned down a $1 billion offer from Google and people thought Zuckerberg was crazy. He wasn’t but he may have been naive. That paid off pretty well.
  7. Business is a team sport. Would you rather own 100 percent of a $1 million-a-year business or 20 percent of a $100 million-a-year business? Everyone needs equity. You need as much brainpower as possible.
  8. Challenge your comfort zone. I knew I had to put myself out there speaking in public. I wasn’t comfortable with it but I did it.
  9. Image matters. People judge you when you talk about your company and you have one chance to make a first impression. If you’re not a design person, don’t do your own logo. Crowdsource if you need to.
  10. Shadow of a leader. You determine what your company culture looks like. Build it as a place you want to work every day. People watch you. At Image Cafe, I brought in a CEO who was religious. I wanted to act like a customer to get competitors’ pricing and she said “absolutely not.” She set the ethical tone.
  11. Investors want their money back. This is important. Investors back you. Your integrity is on the line. So know your exit strategy. I’ve never lost an investor’s money and I carry that chip with me every day.
  12. Cash and customers. Lessons 1 through 11 you can learn on your own but for #12 it helps if you have some education and understanding finance and marketing.

Wooten feels that entrepreneurship is a combination of talent, preparation and hard work. Following the 12 guidelines above will give you as an entrepreneur a chance to be more successful.

Fashion Entrepreneurship Lessons

Last night in Raleigh, North Carolina, there was a great convergence of people interested in fashion and design with others interested in fostering entrepreneurship. The Raleigh Emerging Designers Innovation Incubator (REDii) Launch Party was held at Solas restaurant and lounge on Glenwood South. Approximately 300 people turned out for the three hour event, which featured Kitty Kinin from local radio station 100.7, the River, as emcee. During the course of the gala, there was a fashion show with over 20 designers featuring their work, a silent auction for a live painting of the event, and much power networking to be enjoyed. The goal of the evening was to raise money for the support of the new REDii space at 131 S Wilmington St and its participants.

EntreDot, the not-for-profit who is responsible for the event and the incubator, seeks to supply retail display space for emerging designers locally in the apparel, jewelry, handbag, and related category niche(s) with a caveat: the designers will be more successful if enrolled in some educational courses on entrepreneurial best practices and paired with a mentor. Accordingly, as is mentioned on the website: www.rediiraleigh.org, those who are approved to exhibit their designs are required to sign up for assistance. The intent is to wed right brain and left brain competencies and mindsets to create something wonderful and, in the process, become a catalyst in the establishment of a Fashion District in Raleigh which, while it may not be as tight geographically as some of the fashion destinations across the country, will unite the community around great design elements and the opportunity to both buy local and support talent that may otherwise migrate elsewhere.

Brigid Sweeney, writing last month in Crain’s Chicago Business, featured the story of the Gilt Groupe and some lessons learned by its founders, Alexis Maybank and Alexandra Wilkis Wilson. Sweeney describes their story as follows:

The two young women, who met as Harvard University undergrads and reconnected at Harvard Business School in 2002, launched Gilt Groupe in 2007 as a way to bring designer sample sales online. In the process, they upended the way women shop and made 11 a.m. Central time (the moment new merchandise goes up daily) a witching hour for corporate women, who click over from Excel sheets and status reports to snag pieces from Carolina Herrera, Dolce & Gabbana, Zac Posen, et al. Ms. Maybank and Ms. Wilson also created a New York-based company that’s now valued at $1 billion, has more than 1,000 employees and runs sales in 36 cities in 14 countries.

In the course of her interview with Ms. Wilson, Sweeney was able to tease out some words of wisdom from her. Wilson feels the lessons below are important to any start-up business, but especially a fashion one:

  1. Relationships matter,
  2. Take calculated risks,
  3. Seek mentors who can help you recognize whether you have the right idea at the right time, and
  4. Seek out partners with complementary, not necessarily similar, personalities.

The folks at EntreDot are attempting to reinforce these principles with the REDii target crowd. During the event, it was noted that not enough well-heeled investor-types were present to maximize either the fundraising effort or the introductions to talented designers who, upon completion of their training, will need access to capital in most cases.  In our community, angel and venture capital has been raised successfully for life science and technology companies. it will be a wonderful day to witness when the same can be said of the local fashion and design entrepreneurship niche! Please support this effort through introductions, volunteering as a mentor or instructor, or sponsorship as you are able.